ATLAS METAL COMPANY CASE
The purpose of this report is to help a financial special assistant, Linda, to analyze the financial position of Atlas Metals Company and deciding its capital budgeting and capital structure. Firstly, I explain why firm should use Net Present Value (NPV) methods for capital budgeting rather than Return on Investment (ROI) method and Payback Period method. Secondly, I calculate the Weighted Average Cost of Capital (WACC) which will be used as discount rate while calculating NPV. Then, I decide which rapid prototyping system company should invest as well as I compare the each expansion projects’ IRR with WACC to decide which projects should be invested and which should not. After deciding projects which should be accepted, I draw Investment Opportunity Schedule (IOS) and Marginal Cost of Capital (MCC) graphs to decide where the company should finance accepted projects. Why Should Atlas Metal Company Use NPV?
Atlas Metal Company use payback period and ROI for evaluating projects. Both of these methods have some drawbacks which lead to manager to give wrong decision. Firstly, the firm use payback period by simply calculating the average time when project’s cash flow exceeds the initial investment cost. This method ignores the cash flow after the payback period. In other words, there may be some negative cash flow after payback period which may incur extra costs to company. Moreover, it also ignores the time value of money which causes a miscalculation of expected future cash flows. Secondly, increasing the ROI and deciding projects according to only ROI might harm company in the long-run. If a company always accepts higher ROI projects, company’s average return will also increase which also lead higher risk. Furthermore, there is a time difference between incurring the initial cost for project and later future cash flow. Therefore, this is difficult to evaluate the project with its cost and return in the same time. Also, ROI does not consider opportunity costs of projects. When a firm deciding invests in a project by ROI, it might miss the opportunity of allocation of the same amount to another project. If Atlas Metal Company uses NPV method rather than payback period or ROI, they will decide more accurate decision thanks to many advantages of NPV. Firstly, NPV method adjusts all expected future cash flow to time value of money. Therefore, no matter whether it is positive or negative future cash flow, NPV calculate present value of all expected future cash flow which helps the company for comparison. Also, the size difference between projects will not cause any problem if the firm uses NPV because NPV presented in net dollars amount. Thus, company can easily understand how much money is expected to earn rather than percentage. This also led to evaluate both mutually exclusive and independent projects. Calculating Weighted Average Cost of Capital
In order to calculate the WACC, I find the total amount of company’s value (Long-term debt + Short-term debt + Preferred Stock + Common Stock). Here, I also add short-term debt in total value of the firm, while generally it is not added. The reason is that Atlas Metal Company use short-term debt as a source of permanent financing. After deciding value of firm, I find weight of each component in value of company and multiply it by their cost of funding as well as by (1- Tax Rate) for long-term and short-term debts. The calculation is below; Cost of Long-Term Debt : Since the value in balance is based on book value of long-term debts, I firstly find the market value by disclosure information about bonds; Par Value: $1000, Coupon Payment : $80, Remaining Life: 10 years, YTM= %9, number of bonds: 121,326,000/1000 (Bond price= C*[1-1/(1+r)t]/r + par value/(1+r)10
Market Value of Bonds: $113,539,297
Cost of Short-Term Debt: Since short-term debts have a life of 1 year at most, the amount in balance sheet is true amount of short-term debt for...
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