FIN 450 Guna Fibers ltd case

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FIN 450

Eastern Michigan University

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Format for Individual Cases (2 Page MAX – Single Spaced)

Individual case analyses are equivalent to preparing an executive summary of the problem. The following format is REQUIRED:

I.Title Page

II. Recommendation - Short Version

A solution must be recommended and supported by rational arguments.It is important to be able to articulate why a certain solution is recommended and to be able to defend it.There is usually not one correct solution to these case problems. But, there are incorrect solutions. For example, solutions that violate economic principles, or are inconsistent with financial theory, or are based on inconsistent assumptions, or violate ethical or legal standards are not acceptable solutions.Solutions not supported by data are not acceptable solutions.

III.Statement Problem – Do not repeat case – just state the problem to be solved.

[3 Sentences at most]- For this case, lack of cash flow b/c excise taxes

This statement should briefly outline the problem presented in the case. Case details do not need to be repeated.The student should assume that the instructor has read the case. It is analogous to writing a report for a supervisor.

IV.Analysis of Problem - Whats the problem? --> Sales forecast reasonable, running out of cash, problem with A/R & A/P, Etc. for Exhibit 3 (TM), Exhibit 4 (OM), and Exhibit (Custom)

This statement should briefly outline the problem presented in the case. Case details do not need to be repeated.The student should assume that the instructor has read the case. It is analogous to writing a report for a supervisor. DO NOT OUTLINE PROCEDURES.

5. Alternative Solutions- (Exhibit 3 (TM), Exhibit 4 (OM), and Exhibit (Custom)).

This section of the case analysis is where alternative solutions are explored. Pros and cons of different solutions should be presented. Application of theoretical models will be done in this section. Quantitative analysis should be done in exhibits and tables and referenced in this section.

Exhibits/Tables/Charts – Attached. Must be labeled and organized with the paper. For example, Exhibit 1 has to be the first exhibit discussed in the paper. You would never start with Exhibit 4 for example.

Unformatted Attachment Preview

This spreadsheet supports STUDENT analysis of the case “Guna Fibres, Ltd.” (Case 12). This spreadsheet was prepared by Michael J. Schill, Associate Professor of Business Administration. Copyright © 2013 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. For customer service inquiries, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, posted to the Internet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Feb. 4, 2013 Exhibit 5 GUNA FIBRES, LTD. Monthly Financial Statement Forecast (in thousands of Indian rupees) Assumptions Excise Tax Rate Cost of Goods Sold / Gr Sales Annual Operating Expenses / Annual Gr Sales Depreciation / Gross PP&E Interest Rate on Borrowings (and Deposits) Income Tax Rate Dividends Paid (000s in March, June, Sep, Dec) 15% 73.7% 6.0% 10% 14.5% 30% 500 Minimum Cash Balance (000s) Accounts Receivable Collection In One Month In Two Months Purchases / Gr Sales in Two Months Direct Labour / Purchases Last Month Capital Expenditures (every third month) Accounts payable / Purchases 750 40% 60% 55% 34% 350 50% Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 2,717 2,214 2,616 2,892 4,447 8,804 13,885 17,588 16,315 8,576 5,031 4,447 3,531 2,767 392 434 667 1,321 2,083 2,638 2,447 1,286 755 667 530 415 2,224 2,458 3,780 7,483 11,802 14,950 13,868 7,290 4,276 3,780 3,001 2,352 1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039 296 327 503 995 1,569 1,987 1,844 969 569 503 399 313 454 454 454 454 454 454 454 454 454 454 454 454 84 84 87 87 87 90 90 90 93 93 93 96 10 6 3 48 123 216 294 266 149 62 27 10 -253 -218 -42 406 905 1,227 1,005 158 -128 -107 -175 -248 -76 -65 -13 122 271 368 302 47 -38 -32 -53 -74 -177 -152 -29 284 633 859 704 111 -89 -75 -123 -173 500 500 500 500 Full year 2012 90,899 13,635 77,264 66,993 10,272 5,454 1,074 1,213 2,531 759 1,771 2,000 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Cash 762 750 750 750 750 750 750 750 750 750 750 750 750 Accounts Receivable (6) 2,673 2,773 3,291 5,011 10,301 17,996 24,748 25,697 17,194 9,006 6,295 5,028 3,715 Inventory 3,450 2,063 2,377 4,774 7,568 9,605 8,905 4,648 2,698 2,377 1,873 1,453 1,802 Total Current Assets 6,885 5,586 6,418 10,535 18,619 28,351 34,403 31,095 20,642 12,133 8,918 7,231 6,267 Gross Plant, Property, and Equip (7) 10,096 10,096 10,096 10,446 10,446 10,446 10,796 10,796 10,796 11,146 11,146 11,146 11,496 Accumulated Depreciation 1,484 1,568 1,652 1,739 1,826 1,913 2,003 2,093 2,183 2,276 2,369 2,462 2,558 Net Plant, Property, and Equipment 8,612 8,527 8,443 8,706 8,619 8,532 8,792 8,702 8,612 8,869 8,777 8,684 8,938 Total Assets 15,497 14,113 14,861 19,241 27,239 36,883 43,195 39,797 29,255 21,002 17,695 15,915 15,204 2012 9,762 133,727 53,594 197,083 138,943 26,129 112,814 309,898 Accounts Payable (8) Note Payable (9) Accrued Taxes (10) Total Current Liabilities Shareholders' Equity (11) Total Liabilities & Equity 1,384 1,223 971 761 935 12,323 5,170 2,221 827 690 349 0 -32 -85 -159 14,056 6,393 3,160 1,503 1,466 15,199 14,610 14,534 14,412 13,738 29,255 21,002 17,695 15,915 15,204 25,240 101,101 -330 126,011 183,887 309,898 Inventory Detail Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Purchases (12) 1,439 1,591 0 2,446 4,842 7,637 9,673 8,973 4,717 2,767 2,446 1,942 1,522 1,871 Direct Labour & Other Mftg Costs (13) 489 541 0 832 1,646 2,596 3,289 3,051 1,604 941 832 660 517 Cost of Goods Sold 1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039 2012 48,836 16,509 66,993 Gross Sales (1) Excise Taxes (2) Net Sales Cost of Goods Sold Gross Profit Operating Expenses (3) Depreciation (4) Interest Expense (5) Profit Before Taxes Income Taxes Net Profit Dividend 822 0 1,223 2,421 3,818 798 489 232 3,955 10,150 -90 -166 -231 -244 -122 1,530 323 1,223 6,133 13,846 13,967 13,790 13,638 13,108 13,392 15,497 14,113 14,861 19,241 27,239 4,837 17,872 149 22,858 14,026 36,883 4,487 24,324 0 28,810 14,385 43,195 2,358 22,049 302 24,709 15,088 39,797 Jan-13 Feb-13 3,401 3,616 -4% 34% 74% Inventory (14) 3,450 2,063 2,377 4,774 7,568 9,605 Notes: (1) Follows forecast in Exhibit 2 (2) Gross Sales * Exercise Tax Rate (3) Annual Operating Expenses / 12 (4) Gross PPE * Depreciation Rate / 12 (5) Notes Payable (t - 1) * Interest Rate / 12 (6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2) (7) GPPE(t -1) + Capex(t) (8) 50% * Purchases(t) (9) Total Assets - AP - AccTax - ShrEquity (10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment (11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t) (12) 55% * GSales(t + 2) (13) 35% * Purchases(t-1) (14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t) 8,905 4,648 2,698 2,377 1,873 1,453 1,802 53,594 Exhibit 5 GUNA FIBRES, LTD. Monthly Financial Statement Forecast (in thousands of Indian rupees) Assumptions Excise Tax Rate Cost of Goods Sold / Gr Sales Annual Operating Expenses / Annual Gr Sales Depreciation / Gross PP&E Interest Rate on Borrowings (and Deposits) Income Tax Rate Dividends Paid (000s in March, June, Sep, Dec) 15% 71.0% 6.0% 10% 14.5% 30% 500 Minimum Cash Balance (000s) Accounts Receivable Collection In One Month In Two Months Purchases / Gr Sales in Two Months Direct Labour / Purchases Last Month Capital Expenditures (every third month) Accounts payable / Purchases 750 40% 60% 55% 29% changed from 34% 350 50% Nov-11 Dec-11 Jan-12 2,717 2,214 2,616 392 2,224 1,856 368 454 84 10 -181 -54 -127 Feb-12 2,892 434 2,458 2,052 406 454 84 35 -167 -50 -117 Mar-12 4,447 667 3,780 3,155 625 454 87 96 -12 -4 -9 500 Apr-12 May-12 8,804 13,885 1,321 2,083 7,483 11,802 6,246 9,851 1,237 1,951 454 454 87 87 166 224 530 1,185 159 355 371 829 Jun-12 17,588 2,638 14,950 12,479 2,471 454 90 261 1,666 500 1,166 500 Jul-12 16,315 2,447 13,868 11,575 2,292 454 90 269 1,479 444 1,035 Aug-12 8,576 1,286 7,290 6,085 1,205 454 90 199 461 138 323 Sep-12 5,031 755 4,276 3,569 707 454 93 94 65 20 46 500 Oct-12 4,447 667 3,780 3,155 625 454 93 46 32 10 22 Nov-12 3,531 530 3,001 2,505 496 454 93 51 -103 -31 -72 Dec-12 2,767 415 2,352 1,963 389 454 96 84 -245 -74 -172 500 Full year 2012 90,899 13,635 77,264 64,493 12,771 5,454 1,074 1,534 4,710 1,413 3,297 2,000 Dec-11 Jan-12 Cash 762 750 Accounts Receivable (6) 2,673 2,773 Inventory 3,450 7,055 Total Current Assets 6,885 10,578 Gross Plant, Property, and Equip (7) 10,096 10,096 Accumulated Depreciation 1,484 1,568 Net Plant, Property, and Equipment 8,612 8,527 Total Assets 15,497 19,106 Feb-12 750 3,291 11,453 15,494 10,096 1,652 8,443 23,937 Mar-12 750 5,011 14,748 20,509 10,446 1,739 8,706 29,216 Apr-12 May-12 750 750 10,301 17,996 14,952 11,550 26,003 30,297 10,446 10,446 1,826 1,913 8,619 8,532 34,622 38,829 Jun-12 750 24,748 5,522 31,020 10,796 2,003 8,792 39,812 Jul-12 750 25,697 396 26,843 10,796 2,093 8,702 35,545 Aug-12 750 17,194 762 18,706 10,796 2,183 8,612 27,318 Sep-12 750 9,006 3,642 13,398 11,146 2,276 8,869 22,267 Oct-12 750 6,295 6,937 13,981 11,146 2,369 8,777 22,758 Nov-12 750 5,028 10,882 16,660 11,146 2,462 8,684 25,343 Dec-12 750 3,715 15,368 19,833 11,496 2,558 8,938 28,771 2012 9,762 133,727 106,717 250,207 138,943 26,129 112,814 363,021 Accounts Payable (8) Note Payable (9) Accrued Taxes (10) Total Current Liabilities Shareholders' Equity (11) Total Liabilities & Equity 822 2,500 798 2,910 -90 -144 1,530 5,265 13,967 13,840 15,497 19,106 2,500 7,909 -195 10,214 13,723 23,937 2,500 13,699 -198 16,001 13,215 29,216 2,500 18,576 -39 21,037 13,586 34,622 2,500 21,598 316 24,414 14,415 38,829 2,500 22,231 0 24,731 15,081 39,812 2,500 16,485 444 19,429 16,116 35,545 2,500 7,796 582 10,879 16,439 27,318 2,500 3,782 0 6,282 15,985 22,267 2,500 4,241 10 6,751 16,007 22,758 2,500 6,929 -21 9,408 15,935 25,343 2,500 11,102 -95 13,507 15,264 28,771 30,822 138,057 568 169,447 193,574 363,021 Inventory Detail Nov-11 Dec-11 Jan-12 Purchases (12) 1,439 1,591 5,000 Direct Labour & Other Mftg Costs (13) 417 461 Cost of Goods Sold 1,856 Feb-12 5,000 1,450 2,052 Mar-12 5,000 1,450 3,155 Apr-12 May-12 5,000 5,000 1,450 1,450 6,246 9,851 Jun-12 5,000 1,450 12,479 Jul-12 5,000 1,450 11,575 Aug-12 5,000 1,450 6,085 Sep-12 5,000 1,450 3,569 Oct-12 5,000 1,450 3,155 Nov-12 5,000 1,450 2,505 Dec-12 5,000 1,450 1,963 2012 60,000 16,411 64,493 Gross Sales (1) Excise Taxes (2) Net Sales Cost of Goods Sold Gross Profit Operating Expenses (3) Depreciation (4) Interest Expense (5) Profit Before Taxes Income Taxes Net Profit Dividend Jan-13 Feb-13 3,401 3,616 18% 27% 71% Inventory (14) 3,450 7,055 11,453 14,748 14,952 Notes: (1) Follows forecast in Exhibit 2 (2) Gross Sales * Exercise Tax Rate (3) Annual Operating Expenses / 12 (4) Gross PPE * Depreciation Rate / 12 (5) Notes Payable (t - 1) * Interest Rate / 12 (6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2) (7) GPPE(t -1) + Capex(t) (8) 50% * Purchases(t) (9) Total Assets - AP - AccTax - ShrEquity (10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment (11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t) (12) 55% * GSales(t + 2) (13) 35% * Purchases(t-1) (14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t) 11,550 5,522 396 762 3,642 6,937 10,882 15,368 106,717 Exhibit 5 GUNA FIBRES, LTD. Monthly Financial Statement Forecast (in thousands of Indian rupees) Assumptions Excise Tax Rate Cost of Goods Sold / Gr Sales Annual Operating Expenses / Annual Gr Sales Depreciation / Gross PP&E Interest Rate on Borrowings (and Deposits) Income Tax Rate Dividends Paid (000s in March, June, Sep, Dec) 15% 73.7% 6.0% 10% 14.5% 30% 500 Minimum Cash Balance (000s) Accounts Receivable Collection In One Month In Two Months Purchases / Gr Sales in Two Months Direct Labour / Purchases Last Month Capital Expenditures (every third month) Accounts payable / Purchases 750 40% 60% 55% 34% 350 50% Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 2,717 2,214 2,616 2,892 4,447 8,804 13,885 17,588 16,315 8,576 5,031 4,447 3,531 2,767 392 434 667 1,321 2,083 2,638 2,447 1,286 755 667 530 415 2,224 2,458 3,780 7,483 11,802 14,950 13,868 7,290 4,276 3,780 3,001 2,352 1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039 296 327 503 995 1,569 1,987 1,844 969 569 503 399 313 454 454 454 454 454 454 454 454 454 454 454 454 84 84 87 87 87 90 90 90 93 93 93 96 10 6 3 47 121 212 288 259 141 54 19 2 -253 -218 -42 406 906 1,231 1,011 165 -120 -99 -167 -239 -76 -65 -13 122 272 369 303 50 -36 -30 -50 -72 -177 -152 -29 284 635 861 708 116 -84 -70 -117 -168 500 500 500 500 Full year 2012 90,899 13,635 77,264 66,993 10,272 5,454 1,074 1,162 2,582 774 1,807 2,000 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Cash 762 750 750 750 750 750 750 750 750 750 750 750 750 Accounts Receivable (6) 2,673 2,773 3,291 5,011 10,301 17,996 24,748 25,697 17,194 9,006 6,295 5,028 3,715 Inventory 3,450 2,063 2,377 4,708 7,378 9,249 8,384 4,023 2,052 1,730 1,227 806 1,155 Total Current Assets 6,885 5,586 6,418 10,470 18,429 27,996 33,882 30,470 19,996 11,486 8,271 6,585 5,620 Gross Plant, Property, and Equip (7) 10,096 10,096 10,096 10,446 10,446 10,446 10,796 10,796 10,796 11,146 11,146 11,146 11,496 Accumulated Depreciation 1,484 1,568 1,652 1,739 1,826 1,913 2,003 2,093 2,183 2,276 2,369 2,462 2,558 Net Plant, Property, and Equipment 8,612 8,527 8,443 8,706 8,619 8,532 8,792 8,702 8,612 8,869 8,777 8,684 8,938 Total Assets 15,497 14,113 14,861 19,176 27,048 36,528 42,674 39,172 28,608 20,356 17,048 15,268 14,558 2012 9,762 133,727 48,603 192,093 138,943 26,129 112,814 304,907 Accounts Payable (8) Note Payable (9) Accrued Taxes (10) Total Current Liabilities Shareholders' Equity (11) Total Liabilities & Equity 1,384 1,223 971 761 935 11,660 4,504 1,548 146 0 353 0 -30 -80 -152 13,396 5,727 2,489 827 784 15,212 14,628 14,559 14,442 13,774 28,608 20,356 17,048 15,268 14,558 24,998 96,196 -309 120,885 184,022 304,907 Inventory Detail Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Purchases (12) 1,439 1,591 0 2,446 4,777 7,534 9,543 8,852 4,653 2,767 2,446 1,942 1,522 1,871 Direct Labour & Other Mftg Costs (13) 489 541 0 832 1,624 2,562 3,245 3,010 1,582 941 832 660 517 Cost of Goods Sold 1,928 2,131 3,277 6,489 10,233 12,962 12,024 6,321 3,708 3,277 2,602 2,039 2012 48,353 16,345 66,993 Gross Sales (1) Excise Taxes (2) Net Sales Cost of Goods Sold Gross Profit Operating Expenses (3) Depreciation (4) Interest Expense (5) Profit Before Taxes Income Taxes Net Profit Dividend 822 0 1,223 2,388 3,767 798 489 232 3,923 10,011 -90 -166 -231 -244 -122 1,530 323 1,223 6,067 13,656 13,967 13,790 13,638 13,108 13,393 15,497 14,113 14,861 19,176 27,048 4,772 17,579 150 22,501 14,027 36,528 4,426 23,860 0 28,286 14,389 42,674 2,327 21,446 303 24,076 15,096 39,172 Jan-13 Feb-13 3,401 3,616 -5% 34% 74% Inventory (14) 3,450 2,063 2,377 4,708 7,378 9,249 Notes: (1) Follows forecast in Exhibit 2 (2) Gross Sales * Exercise Tax Rate (3) Annual Operating Expenses / 12 (4) Gross PPE * Depreciation Rate / 12 (5) Notes Payable (t - 1) * Interest Rate / 12 (6) AR(t - 1) + GSales(t) - 40% * GSales(t - 2) - 60% x GSales(t - 2) (7) GPPE(t -1) + Capex(t) (8) 50% * Purchases(t) (9) Total Assets - AP - AccTax - ShrEquity (10) AccTax(t - 1) + IncTax(t) or 0 if positive balance and month of quarterly payment (11) ShrEquity(t - 1) + NetProfit(t) - Dividend(t) (12) 55% * GSales(t + 2) (13) 35% * Purchases(t-1) (14) Inventory(t - 1) + Purchases(t) + Direct Labour(t) - COGS(t) 8,384 4,023 2,052 1,730 1,227 806 1,155 45,153 -62% Exhibit 4 GUNA FIBRES, LTD. Guna Fibres Annual Income Statements (in thousands of Indian rupees) Gross Sales Excise Tax Net Sales Cost of Goods Gross Profits Operating Expenses Depreciation Interest Expense Profit Before Tax Income Tax Net Profit 2010 64,487 9,673 54,814 44,496 10,318 3,497 769 910 5,142 1,545 3,597 2011 75,867 11,380 64,487 53,866 10,621 4,829 909 1,240 3,644 1,093 2,551 Cash Accounts Receivable Inventory Total Current Assets Gross Plant, Property, and Equipment Accumulated Depreciation Net Plant, Property, and Equipment Total Assets 895 2,390 2,974 6,259 8,868 1,170 7,698 13,957 762 2,673 3,450 6,885 10,096 1,484 8,612 15,497 Accounts Payable Notes to Bank Accrued Taxes Total Current Liabilities Owners' Equity Total Liabilities and Equity 603 0 -62 541 13,416 13,957 822 798 -90 1,530 13,967 15,497 Exhibit 5 GUNA FIBRES, LTD. Guna Fibres Monthly Sales, 2011 Actual and 2012 Forecast (in thousands of rupees) January February March April May June July August September October November December Year 2011 2012 (Actual) (Forecast) 2,012 2,616 2,314 2,892 3,421 4,447 7,043 8,804 12,074 13,885 15,294 17,588 14,187 16,315 7,144 8,576 4,025 5,031 3,421 4,447 2,717 3,531 2,214 2,767 75,867 90,899 Too optimistic, about 20% sales growth Exhibit 6 GUNA FIBRES, LTD. Forecast of Accounts by Month 30 25 Millions of Rupees 20 15 10 5 0 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 -5 Net Sales Net Sales Accounts Receivable Inventory Accounts Payable Notes Payable Jan-12 2 3 2 0 0 Accounts Receivable Feb-12 Mar-12 2 4 3 5 2 5 1 2 0 4 Inventory Apr-12 May-12 7 12 10 18 7 9 4 5 10 18 Jun-12 15 25 8 4 24 Accounts Payable Jul-12 Aug-12 14 7 26 17 4 2 2 1 21 12 Sep-12 Oct-12 Accounts Payable Sep-12 4 9 2 1 5 Nov-12 Dec-12 Notes Payable Oct-12 Nov-12 Dec-12 4 3 2 6 5 4 1 1 1 1 1 1 2 0 0 Teletech Corp. Case FIN 450W January 31st, 2018 Recommendation Teletech should adopt the practice of using divisional hurdle rates for its two business lines. For Telecommunications Services, the hurdle rate (WACC) should be 8.53%. For Products and Services (P&S), the riskier segment, it should be 11.63%. This will allow each segment to more accurately identify positive net present value (NPV) activities. Although P&S was unprofitable in 2004, this division should not be sold because it creates opportunities for corporate growth and substantial future return. Problem Statement Teletech is under considerable scrutiny from both internal management and external analysts on how to optimize business performance. The issues Teletech faces are to ensure that the corporate hurdle rate has been correctly calculated; whether to use one corporate hurdle rate or adopt separate, risk-adjusted rates for each business segment; what the proper rates for Teletech’s two segments should be; whether or not to sell the P&S segment; and how to respond to the corporate raider. Analysis of Problem Corporate Hurdle Rate After careful analysis, the current corporate hurdle rate of 9.30% was determined to be an accurate representation of Teletech’s cost of capital. The rate’s inputs (i.e. costs of debt and equity) were calculated based on current market values and sound reasoning (Exhibit 1). Based on Teletech’s A-/BBB+ bond rating, a pretax cost of debt of 5.88% corresponds to industry averages. The risk-free rate of 4.62% is based on 30-year U.S. Treasury Securities, which is an appropriate measure. The weights used for debt and equity were based on market values. In addition, the hurdle rate is essentially equivalent to the weighted average of the divisional hurdle rates, which are discussed below. Calculation of Divisional Hurdle Rates Exhibit 1 summarizes the calculations of hurdle rates for Teletech’s two divisions. The pretax costs of debt for the divisions were obtained from current corporate bond yields in the industrials industry. To calculate the divisional equity betas, each division was first matched to companies with similar operations. These companies function exclusively in the same line of business as the divisions and have similar performance measures, such as revenue and bond ratings. Telecommunications Services was matched with Alltel Corp. and BellSouth Corp. due to their similarities in revenues, bond ratings, and capital structures. Products and Services was matched to Avaya Inc., Corning Inc., EMC Corp, Gateway Inc., and Seagate Technology for similar reasons. The betas for these companies were unlevered using their capital structures, relevered with the divisions’ respective capital structures, and then averaged. Telecommunications Services’ equity beta was determined to be 1.06 while P&S’s was 1.41. The yield on 30-year Treasury Securities was chosen as the risk-free rate, and the risk premium was assumed to be the same as Teletech’s corporate rate (5.50%). The cost of equity was calculated using the capital asset pricing model (CAPM). The capital structures for each division were assumed to be their respective industry’s debt-to-equity weights. Using these inputs, the hurdle rates for Telecommunications Services and P&S were estimated to be 8.53% and 11.63%, respectively. Advantages and Disadvantages of Divisional Hurdle Rates A primary center of debate is whether to maintain the use of one corporate-wide hurdle rate or to adopt individual rates for Teletech’s divisions. To generate maximum shareholder wealth, Teletech should implement the use of divisional hurdle rates. With a single corporate-wide rate, the Products and Services segment, which offers higher returns than Telecommunications Services, will be awarded ample capital due to its lofty returns. Conversely, Telecommunications Services will be starved for resources because its projects generally have a rate of return less than the corporate hurdle rate. What must be taken into consideration, however, is that P&S operations are far riskier than Telecommunications Services’. Projects that bear more risk must offer greater returns due to risk aversion. Lower risk projects should not be penalized for marginally lower returns. Risk-adjusted hurdle rates must be used to accurately judge the profitability of these segments. As shown in Exhibit 1, the risk-adjusted hurdle rates are 8.53% for the Telecommunications Services and 11.63% for P&S. Divisional projects should be judged on these rates. This would make it easier to identify sound investment decisions, and either accept or reject them accordingly. The largest disadvantage of using divisional hurdles rates is that they’re difficult to accurately calculate and require a sizable degree of qualitative judgement. In addition, risk-adjusted rates might cause the company to reject investments that offer long-term, strategic advantages, because they might cause losses in the short-term. Nevertheless, the benefits of using divisional rates far outweigh these costs. Products and Systems Segment and Response to the Corporate Raider A significant point of dispute is whether the Products and Systems segment is destroying value and should be divested. An analysis of economic profit using risk-adjusted hurdle rates is shown in Exhibit 2. In 2004, the P&S segment had an economic loss of almost $27.48 million, while Telecommunications Services had an economic profit of $73.31 million. Since P&S’s return of 11% did not surpass its hurdle rate of 11.64%, the division was operating at a negative net present value. As Exhibit 3 displays, P&S’s return is less than both its divisional WACC and the corporate rate of return line (CAPM line), while Telecommunications Services is above both its WACC and the corporate required rate of return. Although these findings present strong arguments for selling Products and Services, other factors must be considered. If this segment were sold, the company’s corporate hurdle rate would decline to that of Telecommunications Services, as this would be the sole business segment. Although corporate risk would decline, so would returns. Even though P&S has not been profitable in recent history, it has had tremendous revenue growth (40% the past year). The market that P&S operates in has grown enormously as well, while Telecommunications Services’ market has been fairly stagnant and is being invaded by new competitors. Hence, selling P&S would eliminate a highly valuable corporate growth opportunity. Due to this, Teletech should not sell this segment. Without accepting a degree of risk to gain strategic advantages, Teletech faces the threat of being surmounted by its competitors. In response to Victor Yossarian’s statements that Teletech is misusing its resources and Products and Systems should be sold, Teletech should emphasize the importance of continual expansion into computer/telecommunications technology. With the growing interdependence between computer systems and telecommunications services, this division will position Teletech for significant growth opportunities. Even though P&S suffered economic losses in the previous year, this division should offer premium returns in future business activities. With the implementation of divisional hurdle rates, decisions about which capital projects to pursue—those that generate acceptable return—will be simplified. Exhibit 1 TELETECH CORPORATION, 2005 Summary of WACC Calculation for Teletech Corporation and Segment Worksheet MV asset weights Bond rating Pretax cost of debt1 Tax rate After-tax cost of debt Corporate 100% A-/BBB+ Telecommunications Services 75% A 5.88% 40% 3.53% 5.74% 40% 3.44% Rf RM RM-Rf Cost of equity 1.15 4.62% 10.12% 5.50% 10.95% 1.06 4.62% 10.12% 5.50% 10.43% Weight of debt 22.2% 27.10% Weight of equity WACC 77.8% 9.30% 72.90% 8.53% Equity beta2 Products and Systems 25% BB 7.47% See note 1 40% 4.48% D 1.41 BL=BU(1+ /E) (see note 2) 4.62% 30-Year Treasury Yield 10.12% 5.50% 12.35% Ke=Rf+Beta(RM-RF) 9.19% See notes 3 and 4 90.81% we=1-wd 11.63% Notes: 1 Based on bond yields for corporate bonds in the Industrials market 2 Divisional betas were calculated by unlevering betas of companies that closely matched the division, relevering them the division's capital structure, and then averaging them. Telecomm. Services was matched with Attel Corp (beta of 1.00 and D/E of 30.1%) and BellSouth Corp. (beta of 1.00 and D/E of 29.7%). Products and Services was matched with Avaya Inc. (beta of 1.35 and D/E of 4.6%), Corning Inc. (beta of 1.45 and D/E of 13.4%), EMC Corp. (beta of 1.55 and D/E of 0.4%, Gateway Inc. (beta of 1.35 and D/E of 13.4%), and Seagate Technology (beta of 1.20 and D/E of 11.1%). 3 Telecommunications Services' capital structure is assumed to be the industry average for telecommunication services (27.1% debt to total capital). 4 Assumptions Products and Systems' capital structure is assumed to be the average of the telecommunications equipment (13.1% debt to total capital) and computer and network equipment industries (5.3% debt to total capital). Exhibit 2 Teletech Corp. Economic Profit for 2004 Telecommunications Services Corporate Products and Systems $1,660 $1,180 $480 9.58% 9.10% 11.00% 9.30% 8.53% 11.63% NOPAT (millions) Return on Capital (ROC) Hurdle Rate 1 Capital Employed Economic Profit (millions) 2 $17,328 $12,967 $4,364 $48.52 $73.31 -$27.48 Notes: NOPAT /Return on Capital 1 Capital = 2 Economic Profit = (ROC - Hurdle rate) * Capital Exhibit 3 Assessment of Constant vs. Risk-Adjusted Hurdle Rates 18.00% 16.00% 14.00% WACC and Return % P & S WACC 12.00% P & S Return 10.00% Rate of Return (CAPM) 8.00% Teletech Corp. WACC 6.00% 4.00% Telecomm. Services Return 2.00% Telecomm. Services WACC 0.00% 0 0.5 1 Risk (Beta) 1.5 2 Products & Systems WACC Products & Systems Return Telecomm. Services WACC Telecomm. Services Return CASE 9 Guna Fibres, Ltd. Surabhi Kumar, managing director and principal owner of Guna Fibres, Ltd. (Guna), discovered the problem when she arrived at the parking lot of the company's plant one morning in early January 2012. Customers for whom rolls of fiber yarn were intended had been badgering Kumar to fill their orders in a timely manner, yet trucks that had been loaded just the night before were being unloaded because the government tax inspector, stationed at the company's warehouse, would not clear the trucks for departure. The excise tax had not been paid; the inspector required a cash payment, but in seeking to draw funds that morning, Vikram Malik, the book- keeper, discovered that the company had overdrawn its bank account—the third time in as many weeks. The truck drivers, independent contractors,cursed loudly as they unloaded the trucks, refusing to wait while the company and government set- tled their accounts. This shipment would not leave for at least another two days, and angry customers would no doubt require an explanation. Before granting a loan with which to pay the excise tax, the branch manager of the All-India Bank & Trust Company had requested a meeting with Kumar for the next day to discuss Guna's financial condition and its plans for restoring the firm's liquidity. Kumar told Malik, “This cash problem is most vexing. I don't understand it. We're a very profitable enterprise, yet we seem to have to depend increasingly on the bank. Why do we need more loans just as our heavy selling season begins? We can't repeat this blunder.” Company Background Guna was founded in 1972 to produce nylon fiber at its only plant in Guna, India, about 500 km south of New Delhi. By using new technology and domestic raw mate- rials, the firm had developed a steady franchise among dozens of small, local textile weavers. It supplied synthetic fiber yarns used to weave colorful cloths for making This case was written by Thien T. Pham (MBA '90), Robert F. Bruner, and Michael J. Schill as a basis for class discussion. The names and institutions in this case are fictitious. The financial support of the Batten Institute is gratefully acknowledged. Copyright © 2013 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying, recording, or otherwise-without the permission of the Darden School Foundation. 133 134 Part Two Financial Analysis and Forecasting saris, the traditional women's dress of India. On average, each sari required eigen female population at around 600 million, the demand for saris accounted for more yards of cloth. An Indian woman typically would buy three saris a year. With India's than 14 billion yards of fabric. This demand was currently being supplied entirely from domestic textile mills that, in turn, filled their yarn requirements from suppliers Case 9 Guna Fibres, Ltd. 135 Company Performance Guna had experienced consistent growth and profitability (see Exhibit 9.1 for firm's recent financial statements). In 2011, sales had grown at an impressive rate of 18%. Recent profits were INR25 million, down from INR36 million in 2010.' Kumar ex- pected Guna's growth to continue with gross sales reaching more than INR900 million in 2012 (Exhibit 9.2).? Synthetic Textile Market able seasonal fluctuations. Unit demand increased with both population and na- The demand for synthetic textiles was stable, with year-to-year growth and predict- tional income. In addition, India's population celebrated hundreds of festivals each most important festival, the Diwali celebration in midautumn, caused a seasonal year, in deference to a host of deities, at which saris were traditionally worn. The peak in the demand for new saris, which in turn caused a seasonal peak in demand for nylon textiles in late summer and early fall. Thus the seasonal demand for nylon yarn would peak in midsummer. Unit growth in the industry was expected to be Consumers purchased saris and textiles from cloth merchants located in villages 15% per year. throughout the country. A cloth merchant usually was an important local figure who was well known to area residents and who generally granted credit to support consumer purchases. Merchants maintained relatively low levels of inventory and built stocks of goods only shortly before and during the peak selling season. Competition was keen among those merchants' suppliers (the many small textile- weaving mills) and was affected by price, service, and the credit they could grant to the merchants. The mills essentially produced to order, building their inventories of woven cloth shortly in advance of the peak selling season and keeping only maintenance stocks at other times of the year. The yarn manufacturers competed for the business of the mills through responsive service and credit. The suppliers to the yarn manufacturers provided little or no trade credit. Being near the origin of the textile chain in India, the yarn manufacturers essen- tially banked the downstream activities of the industry. Reassessment After the episode in the parking lot, Kumar and her bookkeeper went to her office to analyze the situation. She pushed aside two items on her desk to which she had intended to devote her morning: a message from the transportation manager regarding a possible change in the inventory policy (Exhibit 9.3) and a proposal from the operations man- ager for a scheme of level annual production (Exhibit 9.4). To prepare a forecast on a business-as-usual basis, Kumar and Malik agreed on vari- ous parameters. Cost of goods sold would run at 73.7% of gross sales—a figure that was up from recent years because of increasing price competition. Annual operating ex- penses would be about 6% of gross annual sales. Operating expenses were up from recent years to include the addition of a quality-control department, two new sales agents, and four young nephews in whom Kumar hoped to build allegiance to the family business. Kumar had long felt pressure to hire family members to company management. The four new fellows would join 10 other family members on her team. Although the company's income tax rate of 30% accrued monthly, positive balances were paid quarterly in March, June, September, and December. The excise tax (at 15% of sales) was different from the income tax and was collected at the factory gate as trucks left to make deliveries to customers and the regional warehouses. Kumar expected to pay dividends of INR5.0 million per quarter to the 11 members of her extended family who owned the entirety of the firm's equity. For years, Guna had paid substantial dividends. The Kumar family believed that excess funds left in the firm were at greater risk than if the funds were returned to shareholders. Accounts receivable collections in any given month had been running steadily at the rate of 48 days, comprised of 40% of the previous month's gross sales plus 60% of the gross sales from the month before that. The cost of the raw materials for Guna's yarn production ran about 55% of the gross sale price. To ensure sufficient raw material on hand, it was Guna's practice each month to purchase the amount of raw materials ex- pected to be sold in two months. The suppliers Guna used had little ability to provide credit such that accounts payable were generally paid within two weeks. Monthly direct labor and other direct costs associated with yarn manufacturing were equivalent to about 34% of purchases in the previous month." Accounts payable ran at about half of the month's purchases. As a matter of policy, Kumar wanted to see a cash balance of at Dividendo AIR Production and Distribution System Thin profit margins had prompted Kumar to adopt policies against overproduction and overstocking, which required Guna to carry inventories through the slack selling sea- son. She had adopted a plan of seasonal production, which meant that the yarn plant would operate at peak capacity for two months of the year and at modest levels the rest of the year. That policy imposed an annual ritual of hirings and layoffs. To help ensure prompt service, Guna maintained two distribution warehouses, but getting the finished yarn quickly from the factory in Guna to the customers was a chal- lenge. The roads were narrow and mostly in poor repair. A truck was often delayed negotiating the trip between Kolkata and Guna, a distance of about 730 km. Journeys were slow and dangerous, and accidents were frequent. Challenge INR - Indian rupees. -At the time, the rupee exchange rate for U.S. dollars was roughly at the rate of INR50 per The 73.7% COGS rate assumption was determined based on these purchases and direct cost figures: 73.7% = 55% + 55% X 34%. dollar. 25 Part Two Financial Analysis and Forecasting 26 cash Case 9 Guna Fibres, Ltd. EXHIBIT 9.1 1 Guna's Annual Income Statements (in millions of Indian rupees) 137 least INR7.5 million. To sustain company expansion, capital expenditures were antici- pated to run at INR3.5 million per quarter. Guna had a line of credit at the All-India Bank & Trust Company, where it also maintained its cash balances. All-India's short-term interest rate was currently 14.5%, but Kumar was worried that inflation and interest rates might rise in the coming year. By terms of the bank, the seasonal line of credit had to be reduced to a zero balance for at least 30 days each year. The usual cleanup month had been October, but last year Guna had failed to make a full repayment at that time. Only after strong assurances by Kumar that she would clean up the loan in November or December had the lending officer re- luctantly agreed to waive the cleanup requirement in October. Unfortunately, the credit needs of Guna did not abate as rapidly as expected in November and December, and although his protests increased each month, the lending officer had agreed to meet credit until Kumar presented a reasonable financial plan for the company that demon- strated its ability to clean up the loan by the end of 2012. Guna's cash requirements with loans. Now he was refusing to extend any more seasonal 2010 2011 Gross Sales 644.8 758.7 Excise Tax 96.7 113.8 Net Sales 548.1 644.9 Cost of Goods 445.0 538.6 Gross Profits 103.1 106.3 Operating Expenses 35.0 48.3 Depreciation 7.7 9.1 Interest Expense 9.1 12.4 Profit Before Tax 51.4 36.5 Income Tax 15.5 10.9 Net Profit 35.9 25.6 Cash 9.0 7.6 Accounts Receivable 23.9 26.7 Inventory 29.7 34.5 Total Current Assets 62.6 68.8 Gross Plant, Property, and Equipment (PPE) 88.7 100.9 Accumulated Depreciation 11.7 14.8 Net PPE 77.0 86.1 Total Assets 139.6 154.9 Financial Forecast With some experience in financial modeling, Malik used the agreed-upon assumptions to build out a monthly forecast of Guna’s financial statements (Exhibit 9.5). To sum- marize the seasonal pattern of the model, Malik handed Kumar a graph showing the projected monthly sales and key balance sheet accounts (Exhibit 9.6). After studying the forecasts for a few moments, Kumar expostulated: The loan officer will never accept this forecast as a basis for more credit. We need a new plan, and fast. Maintaining this loan is critical for us to scale up for the most important part of our business season. Please go over these assumptions in detail and look for any opportunities to improve our debt position. 6.0 Accounts Payable Notes to Bank Accrued Taxes Total Current Liabilities Owners' Equity Total Liabilities and Equity 0.0 8.2 8.0 -0.6 Then looking toward the two proposals she had pushed aside earlier, she muttered, “Perhaps these proposals will help.” 5.4 134.2. 139.6 -0.9 15.3 139.6 154.9 Source: All exhibits created by case writer.
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