Question 1: Weighted Average Cost of Capital and understanding risk
(Total of 80 Marks)
Consider the firm that you have selected to analyze for this course. Calculate the firm’s
Weighted Average Cost of Capital (WACC), using the methodology set out in Lecture 4
and in Chapter 13.5 of the textbook. For this question, assume that you are at the
end of the Calendar Year 2019 (Pre-COVID) i.e., you should not use 2020 and
onwards data. You may use information from financial and management disclosures,
FactSet, Capital IQ or any other publicly available sources.
a) [10 Marks] Provide a company overview for your selected firm. In not more than
200 words, include: business overview, primary industry of operation, business
segments, geographical overview, founder(s) and executive team, public listing
date, capital structure overview, and key financial metrics (profitability margins, 3Year Historical ROA, 3-Year Historical ROE, and 3-Year Historical revenue
growth). [no lecture required]
b) [20 Marks] Calculate your company’s WACC and provide the results of your
analysis in an Excel spreadsheet. Your spreadsheet should contain enough
detail such that another analyst could replicate your work. [covered in Lecture 4]
c) [10 Marks] Write a short report (maximum 300 words) that describes your
process to calculate WACC: where you found the information and how you
applied the calculations to get your result. [covered in Lecture 4]
d) [5 Marks] Name two firms that could be considered comparable to your selected
company. See note below for suggestions on picking similar firms. Justify your
selection in not more than 100 words.
Note: Although two firms are never directly comparable, comparable firms should
operate within the same industry, have similar business models, similar size, and
similar geography. For example, compare a tech firm with another tech firm, an
airline with another airline etc. For firms in the same industry, it would be typically
better to compare a US based firm with another US based firm operating in the
same industry. For this specific question, students can consider any firm that
may/may not be included in the list of firms provided to them.
e) [10 Marks] Without any formal calculations, provide the following information
about the comparable firm: leverage ratio, cost of debt, and cost of equity. You
may use information from FactSet, Capital IQ, Yahoo Finance, or other publicly
available sources.
In your opinion, is your firm’s WACC higher or lower compared to both
comparable firms? Which element(s) is(are) driving these results? Explain your
reasoning in no more than 300 words.
[covered in Lectures 4, 5 and 6]
f) [15 Marks] In not more than 300 words, discuss three risk factors that
management outlines in their financial statements or official reports (e.g.,10-K,
10-Q, MD&A). Pick any one report you find useful from the year 2019 for this
question. Without doing a formal calculation, explain to what extent each factor is
affecting your firm’s Cost of Equity. Discuss whether firm operations, earnings,
and/or cash flow will be affected if the risks materialize and in what way will
equity investors be affected? [covered in Lectures 4, 5 and 6]
g) [10 marks] Find your chosen company in WRDS going to the “ISS: Institutional
Shareholder Services” database > section “Voting Analytics” > subsection
“Company vote results US” and download the csv file for the last five years.
What’s the share of proposals sponsored by management and by shareholders?
What’s the most frequent topic for manager sponsored proposals? Similarly,
what’s the most frequent topic for shareholder sponsored proposals? What share
of management sponsored proposals get passed? Similarly, what share of
shareholder sponsored proposals get passed? Can you find any risk factors you
identified in (f) being discussed in shareholder/management sponsored
proposals? Summarize all your findings in 150 words.
Note: Please consult the word document uploaded on Quercus to see how to
access WRDS.
[no Lecture required]
Question 2: Project Analysis (Total of 95 Marks)
You were recently hired by the Boston Consulting Group (BCG) in their Corporate
Finance and Social Responsibility Team in Toronto. Your Managing Director (MD) has
staffed you on a project for CorpFinCo (later referred to as “the company”). The
company is currently evaluating two potential projects (Project Phoenix and Project
Valhalla) with hopes of pursuing one of the two. Your MD has asked you to conduct an
analysis of each project with following details provided to you:
CorpFinCo Overview:
Founded in 1976, CorpFinCo is an energy company operating in Western Canada. The
company has historically operated in Oil & Gas Exploration, Drilling, Refinement, and
Distribution. With recent trends in Environmental, Social, and Governance (ESG)
investing and green energy, executive management announced plans to expand into
renewable energy.
Project Phoenix Overview and Details:
Projected Phoenix is part of CorpFinCo’s renewable energy plan to expand into Solar
energy for the next five years. Sunshine hours in Western Canada are ~3,000 per year
starting at t=1 and expected to increase by a 100 hours each year for the next five
years (till t=6). Each sunshine hour can produce a hypothetical maximum of 45 KW of
electricity. However, current technology has an 80% efficiency rate (at t = 1). Over the
next five years (from t = 1 to t = 6), as technology improves, the efficiency rate grows by
2% percentage points. The company will incur variable costs on hypothetical kWsh
while it will earn revenue on (kWsh) produced.
The company estimates that it can establish a monopoly as the sole solar energy
provider and sell each kWsh of energy at $85 with price per unit (starting at t = 1) while
variable costs on hypothetical kWsh are expected to be $32, both increasing at the rate
of inflation of 2% per year. The Government of Canada (GoC) currently has incentive
programs for companies within renewable energy and provides a 3% rebate on total
variable costs.
Fixed costs each year (starting t = 1) will be $1.5 million for maintanance, salaries, and
R&D. The company will need to invest in PP&E curtailing a one-time cost of ~$9 million
at t=0. The required PP&E qualifies for depreciation at a CCA rate of 25%. The
company estimates its cost of capital to be 14% and corporate tax rate to be 23%.
Assets will remain in the CCA class after the end of the project with a salvage value of
$3.8 million.
Project Valhalla Overview and Details:
Five years ago the company established a drilling site and refinery next to Greenlake,
Alberta. The site has been one of the company’s most profitable divisions and the
company is looking to further expand the site. The expansion plan is projected to result
in the following cash flows: (CF0, CF1, CF2, CF3, CF4, CF5) = (-$25 million, $9 million. $9
million, $10 million, $10 million, $11 million) with a cost of capital of 14%. Environmental
activists in the region have raised concern regarding this expansion as the current
drilling site has already led to water contamination, increased frequency of acid rain,
and killed all the fish in Greenlake.
Your manager has asked for multiple components:
a) (30 Marks) Calculate the NPV of projects Phoenix and Valhalla. Provide a
recommendation for senior management: which project (of the two) should the
company proceed with? The company can only choose one. Explain your
reasoning in no more than 100 words. Submit an Excel spreadsheet showing
detailed calculations of each component of the cash flow for each year of the
project horizon. In the final column of your table, provide a very brief explanation
in words for each row of calculations in your table. [covered in Lectures 1&2]
b)
(i) (15 marks) Create an NPV profile for both projects. Identify the IRR for each
project from the graph. What is the cross-over rate and what does this tell us
about the value of the two projects? Explain your reasoning in no more than 100
words and show the graph. [covered in Lecture 1]
(ii) (30 marks) Now also calculate the Profitability Index (PI), payback period and
the discounted payback period for each project. Does your decision from part (a)
change if you use IRR, NPV, PI, payback period or discounted payback period?
Discuss any differences if they arise, and finally decide which of the two projects
you would recommend to undertake. For clarity present all these numbers in a
table. Explain your reasoning in no more than 200 words.
[covered in Lecture 1]
c) (15 marks) Where applicable, calculate the sensitivity of the project NPV to a 1%
point change in the discount rate, 1% point change in tax rate, 1% change in
required plant and equipment, and 1% change in salvage value for Project
Phoenix and Valhalla. Provide a table summarizing your calculations. What is
your conclusion from the analysis regarding the importance of each factor you
analyzed? Explain your reasoning in no more than 300 words. [covered in
Lecture 3]
d) (5 marks) Discuss what the quantitative calculations above are missing? As a
member of the Corporate Finance and Social Responsibility team would you
consider these important and would you still recommend CorpFinCo proceed
with your answers in (a) and (b)? Hint: Think about how NPV and other
calculations in parts (a) (b) and (c) do not consider social welfare. [covered in
Lecture 1 and 2]