Corporate Finance Case Study Assignment

Assignment Task

Corporate Finance Case Study

Orange Computers has transformed into one of the largest smartphone companies in the world. Based on recent changes to the federal tax code, building phones in the US has become more attractive. Orange wants to build a single factory in either Pennsylvania, Texas, or North Carolina. Each state is offering incentives to woo Orange. North Carolina and Texas have proposed building a new facility, while Pennsylvania is offering grants to help renovate a recently closed factory.

Project Description

Build a workbook to calculate the net present value and internal rate of return (rounded to two decimal places) for each location over ten years using the information provided. Determine where Orange should locate their factory and give a brief explanation of why.

Below are the pieces of information necessary to calculate the net present value and internal rate of return:

1. The factories in North Carolina and Texas could produce and sell 20 million phones annually, while the Pennsylvania factory could produce and sell 12 million.

2. Orange can sell all the phones produced at an average of $400 per phone in 2019 . Orange forecasts that they can gradually raise the price of their phones by 1 2% per year over the next 10 years.

3. A new factory would be 5 million square feet at a cost of $160/ft 2 to build in North Carolina or Texas. After grants, Orange would only need to pay $125/ft 2 to renovate the existing 3 million square foot factory in Pennsylvania.

4. Texas will lease publicly owned land for the factory to Orange tax free, but the local government won’t waive the 1% annual property tax which is calculated on the initial cost of the factory. The land in North Carolina will cost $20 million, and the local property tax is 0.5%, calculated based on the initial cost of the factory plus the cost of the land. Since there is an existing factory in Pennsylvania, there will be no cost in purchasing the land, and the state has agreed to pay the local property tax for 10 years.

5. Orange plans to spend $500 million on equipment for the new factories in Texas or North Carolina. Salvage value for the equipment after 10 years is expected to be 10% of the equipment’s purchase price. Pennsylvania is offering to help pay for the equipment which lowers the cost to $300 million, but it has added a caveat 1 Assume upfront investments in land, factory, and equipment are made in 2018. that forces Orange to sell the equipment to the state for $1 when Orange disposes of the equipment after 10 years.

6. Orange can depreciate 100% of the cost of equipment when it’s put into service for tax purposes. (Since salvage value will be taxed as a gain at the end of 10 2 years, do not subtract it from the equipment’s value for depreciation.) All other depreciation will be on a straight-line basis over 15 years. (Don’t forget that there is no depreciation on land.)

7. The federal income tax rate for Orange is 21%. In their pursuit of new manufacturing jobs, all three states have offered different incentive packages that result in a state income tax equivalent to 3% for the first 10 years. State income tax is not deductible on federal taxes, so the effective tax rate is 24%.

8. Orange plans on hiring 8,000 workers in North Carolina or Texas with a total annual expense of $80,000 per worker. The factory in Pennsylvania would require 5,000 workers at $90,000 per year. Wage inflation is forecasted to be 5% per year in Texas, 4% in North Carolina, and 3% in Pennsylvania over the life of the project.

9. For operational expenses, assume that fixed overhead will be 10% of annual sales and cost of goods sold (excluding labor) will be 60% of annual sales at each factory. Orange will also need to maintain a total of 10% of next year’s sales in working capital. In other words, this is the cash that Orange will have to reserve for this project. It cannot be used elsewhere in the company. 

10. Orange keeps a stable debt-to-equity ratio of 0.8 and will use the same mix of debt and equity to finance this project. The average interest rate on its debt is only 3%, but its required rate of return on equity is 35%. Note that interest expense is not included in operating income as the interest rate has already impacted the weighted average cost of capital (WACC). Including interest expense in the operating income will double-count the effect of interest on the project.

Learning Outcomes

When completed successfully, this project will enable you to:

• Use your knowledge of capital budgeting to project financial outcomes and choose how to allocate resources between competing projects.

Frequently Asked Questions

Below are answers to some of the common questions students ask about the Finance project.

Is there a prerequisite course for this project?

We would recommend completing the Excel for Finance course before starting this project—this will help you complete the required calculations in the template provided with this case.

What tax rate should be used to calculate taxes on salvage value?

Use the effective tax rate.

Is the Equipment value used for PP&E in the year 2018? Factory, Land and Equipment are all listed under PP&E in the Inputs and then Land, and Factory are listed separately on the cash flow statement, but so is PP&E. Can you please clarify why?

Typically, PP&E is a catch-all term representing property, plant & equipment. Note that plant and factory are interchangeable terms. That’s why the inputs section lists factory and equipment under PP&E. However, in the cash flow section, they are separated out since the depreciation amount and treatment varies across these categories.

Is the interest expense relevant to NPV & IRR calculations?

Yes, it is. However, the after-tax cost of debt (reflected in WACC for the case) already factors in interest expense so should not be included again.

How is the working capital reserved formula set up in the template? Can you describe what it is doing?

As you may recall from your accounting coursework, any project will require a certain amount of working capital (current assets - current liabilities) to get an operation off the ground and then sustain it through time. For year 0, it’s estimated that 10% of the year 1 sales will be required. However, from year 1 onwards, the working capital requirement is only 10% of the incremental sales from one year to the next. At the end of the project (10 years) the remaining funds are assumed to be available as a cash inflow. This is shown as “working capital returned” line. The worksheet template contains the formulas necessary for these calculations.

Do we apply depreciation for the factory and equipment in the first year (2018)?

Depreciation should only be applied when the equipment is put into service. That is, when units are produced and sold (2019).

Should we use the excel NPV formula or calculate NPV by summing all the present values?

Either method will work. If you're using Excel NPV formula, remember you should only apply it to the cash flows occurring from 1st period, then add the period 0 cash flow to your NPV value. So, the Excel formula would be

=CF0+NPV(rate,CF1 :CFn ,...)

Are we to assume that Orange builds out the infrastructure in 2018 and begins selling in 2019?

Yes, upfront investments in land, PP&E, and plant are made in 2018. Operations (production & selling) will begin in 2019.

How do I use the information provided in the case footnote about bonus depreciation?

You will find that taking 100?preciation in the first year of service increases after-tax cash flow and therefore net present value. Note that bonus depreciation only applies to equipment and not to plant(factory).

Should we consider book value of the plant (factory) for salvage value calculations?

No, you are only provided information about equipment salvage value so don’t make any assumptions about other cash flows.

This Accounting and Finance has been solved by our PhD Experts at My Uni Paper. Our Assignment Writing Experts are efficient in providing a fresh solution to this question. We are serving more than 10000+ Students in Australia, the UK, and the US by helping them to score HD in their academics. Our Experts are well-trained to follow all marking rubrics and referencing styles.

Be it a used or new solution, the quality of the work submitted by our assignment experts remains unhampered. You may continue to expect the same or even better quality with the used and new assignment solution files respectively. There’s one thing to be noticed you could choose one between the two and acquire an HD either way. You could choose a new assignment solution file to get yourself an exclusive, plagiarism (with free Turnitin file), expert quality assignment or order an old solution file that was considered worthy of the highest distinction.