1.

Assuming the company does not invest in the new product line, prepare forecasted income
statements and balance sheets at year-end 2010, 2011, and 2012. Based on these forecasts,
estimate Flash’s required external financing: in this case all required external financing takes
the form of additional notes payable from its commercial bank, for the same period.
First, we see that forecasted income statement based on the assumption we have been given:

Next, we see the forecasted balance sheet:

Below looking at the picture above we can see there is a large amount of external capital there will
be need to fund the daily operations of the company.

2. What course of action do you recommend regarding the proposed investment in the new
product line? Should the company accept or reject this investment opportunity?
First, the assumption needed. We have been informed that the corporate tax rate is equal to 40% and
that the working capital will be equal to 26.15% of sales for the project. Until now the company
have spent $400,000 on devex for the project which we should not include in the valuation due to
cost has already taken place. On page 5 we have been informed about the risk-free rate of 3.70%
which is the long-term treasury yield. Additionality there has also been mentioned that the market
premium is equal to 6% and that the beta on debt is equal to 0.2 and the return on debt is equal to
D
9.25% - interest rate of 3.25% + 6% in premium. The =18 % for the project which means that
V
E
=82 % and we can find that the peer group has an asset beta of 1.08,
V

Which makes it possible to find the beta on equity:

D E
β a= ∗β d + ∗β e
V V
Which we can rewrite to the following:
 V
E ( D
β e = ∗ β a− β d
V )
Insert values:

β e=
1
0.82 (
1. 08−
0.18
1 )
∗0.2 =1. 27

New we can find the cost of equity with the CAPM formula:
CAPM : Re =R f + β e ( r m −r f )
Insert values:
Re =3.70 % +1. 27∗6 %=11 . 3 2%
Next, we can find the WACC:
E D
WACC = ∗R e + ∗Rd∗( 1−t )
V V
Insert values:
WACC =0.82∗1 1 .3 2 %+ 0.18∗7 .25 %∗( 1−0.4 )=1 0 . 07 %
Now, we can find the different cash-flows when we are taking on debt to due the project.

Next, we can look at the case, when we use equity to finance the project, but issuing shares. Some
of the assumptions are the same - the corporate tax rate is equal to 40% and that the working capital
will be equal to 26.15% of sales for the project. Until now the company have spent $400,000 on
devex for the project which we should not include in the valuation due to cost has already taken
place. On page 5 we have been informed about the risk-free rate of 3.70% which is the long-term
treasury yield. We can find that the peer group has an asset beta of 1.08, and with no debt then asset
beta will be equal to the equity beta.
New we can find the cost of equity with the CAPM formula:
CAPM : Re =R f + β e ( r m −r f )
Insert values:
Re =3.70 % +1. 08∗6 %=10.18 %

We can see that the NPV is a bit small when using equity to finance the project due to the higher
discount factor.
3. How does your recommendation from question 2 above impact your estimate of the
company’s forecasted income statements and balance sheets, and required external financing
in 2010, 2011, and 2012? How do these forecasted income statements and balance sheets
differ if the company relies solely on additional notes payable from its commercial bank,
compared to a sale of new equity?
Debt:
Share issuing:
Income statement:
The difference will only be in the interest expenses as when they are issuing shares the interest
expenses will not increase, but when they utilise a capital structure of 0.18 debt/capital will the debt
for the firm overall increase and therefore all the interest expenses. Therefore, will the income
before tax be different resulting in different tax payments. Additionally, there has been added some
extra cost in the form promotion of the new product, but this cost is the same for both.
Balance statement:
Additional capex expenditure has been added, which will be paid for with cash and in the case of
using debt also debt. When issuing shares will the cash also increase compared to the other where it
only will decrease - number of outstanding shares also increases when there are being issued shares.

4. As CFO Hathaway Browne, what financing alternative would you recommend to the board
of directors to meet the financing needs you estimated in questions 1 through 3 above? What
are the costs and benefits of each alternative?
For a financial view will the best method of financing the investment be a sale of new equity to
increase cash flow. Flash Memory can issue 300,000 new share at a price of $25 per share and after
cost will company raise $6,900,000. These funds can also help the company payback some of the
bank debt to achieve their goal of keeping the debt-to capital ratio equal to 18%. The downside is
dilution of ownership, but with issuing of the new share will the original owners of the company
still have the maturity ownership of the company and can control discussion and future strategy for
the firm.
However, if they choose not to dilute their ownership or it is not possible to sell their shares. Their
only option will be requesting more loans from the bank. From the NPVs we found earlier it really
does not make the biggest difference which wat the company raises the fund for the investment if
they do it. The company can either sell common stock or get a loan from the bank. Borrowing
money from the bank to invest increases the risk and tightens the company’s cash flow. It also
increases the cost of investing in the project since the company already has reached the 70% notes
payable limit. The interest expenses will be high at 9.25% of bank debt. This is against the
company’s target of decreasing debt-to-capital ratio of 18%, so their first option should be issuing
common stock.