Corporate Finance Project

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University of California, Berkeley *

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101

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Finance

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Jan 9, 2024

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© 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 Corporate Finance Project Project Description 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 propose that Orange build a new facility, while Pennsylvania is offering grants to help Orange renovate a recently closed factory. Build a workbook to calculate the weighted average cost of capital (WACC), net present value (NPV) and internal rate of return (IRR) 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 WACC, NPV, and IRR: 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 Year 1 1 . Orange forecasts that they can gradually raise the price of their phones by 2% per year over the next 10 years. 1 Assume upfront investments in land, factory, and equipment are made in Year 0.

Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 2 3. A new factory would be 5 million square feet at a cost of $160/ft to build in North Carolina or Texas. After grants, Orange would only need to pay $125/ft 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 with the local property tax of 0.5%, property tax in North Carolina is 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 for 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. Pennsylvania is offering to help pay for the equipment which lowers the cost to $300 million, but it has added a caveat that forces Orange to sell the equipment to the state when Orange disposes of the equipment after 10 years. The estimated proceeds on the sale of the equipment is presented in the template for each location. Note, do not use “proceeds on equipment sale” as “salvage value” when calculating depr eciation. Use the “proceeds on equipment sale” in calculating the gain or loss on the equipment sale. 6. Orange can depreciate 100% of the cost of equipment when it’s put into service for tax purposes 2 or it can depreciate the equipment on a straight-line basis with a useful life of 10 years. Factory cost must be depreciated over 15 years on a straight-line basis. There is no salvage value to consider for either the equipment or the factory. Also recall 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 deductible when calculating federal taxes. 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. 9. For operational expenses, assume that fixed overhead will be 10% of annual sales and cost of goods sold will be 60% of annual sales at each factory. Labor costs will be calculated separately using the inputs applicable for each location, (note number 8 information above). Orange will also need to maintain a total of 10% of next 2 According to the US tax law passed a few years ago, companies can choose to depreciate 100% of the equipment cost in the year it is put into service.

Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 3 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. 3 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%. Your calculation for WACC must be presented in cell B32. Note that interest expense is not included in operating income as the interest rate will impact the WACC. Including interest expense in calculating operating income will double-count the effect of interest on the project. Also, note that interest expense is considered a non-operating expense and hence would not be included in calculating operating income. Learning Outcomes When completed successfully, this project will enable you to: ● Use your knowledge of costs of capital and capital budgeting to project financial outcomes and choose how to allocate resources between competing projects. Assignment Requirements ● The main component of this case study is the workbook you prepare with the provided information to calculate WACC, NPV, and IRR. Begin by downloading this template . (Note: after opening the link, click “make a copy” to begin working on your own copy of the template. When you save this copy, please title it with “Member Name 1, Member Name 2, etc - Finance Project”. Populate the workbook including the first tab, entitl ed “Cover Page”.) ● Once you’ve completed your workbook, complete the sentence in the “Conclusion” box (on the “PA” sheet) with the correct response, as well as a brief rationale for why you chose your answer. ● Be sure the grader can see the underlying formulas when they click on cells that contain calculations. Do not save these as values! In other words, use the worksheet formula function to perform the calculation within the cells. We want you to use the workbook effectively, therefore do not hardcode amounts, but link to applicable cells. It is important to perform the calculations in the applicable cells, see grading rubric. ● To submit your project, please click on the "Submit Project" button on your dashboard and follow the steps provided in the Google Form. If you are submitting your Finance project as a group, please ensure only ONE member submits on 3 The case template has been pre-populated with the required formulas to capture working capital movements from one year to another, do not override them. Note that working capital is released at the end of the project life (in year 10). Cash is being reserved in years 0 to 9 and in year 10, it is released for the company to be able to use it for a different purpose or project.

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Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 4 behalf of the group. You will also be prompted to upload the final page of your Group Project Agreement , which must be completed and signed by all group members. Please reach out to projects@quantic.edu if you have any questions. ● It typically takes about 3-4 weeks for projects to be graded. There is no score penalty for projects submitted after the due date, however grading and feedback may be delayed. Tips & Resources ● Make sure to go through our Cost of Capital: Capital Structure , Capital Budgeting , and Excel for Finance courses before starting this project — these will help you prepare your workbook. ● Don’t forget— Quantic students have access to Microsoft Office Online, including an online version of Excel. Follow these instructions to access it. ● If you have any questions, be sure to reach out to projects@quantic.edu for help! Plagiarism Policy Quantic takes academic integrity very seriously —we define plagiarism as: “Knowingly representing the work of others as one’s own, engaging in any acts of plagiarism, or referencing the works of others without appropriate citation.” This includes both misus ing or not using proper citations for the works referenced and submitting someone else’s work as your own. Quantic monitors all submissions for instances of plagiarism and all plagiarism, even unintentional, is considered a conduct violation . If you’re still not sure about what constitutes plagiarism, check out this two-minute presentation by our librarian, Kristina. It is important to be conscientious when citing your sources. When in doubt, cite ! Kristina outlines the basics of best citation practices in this one- minute video . You can also find more about our plagiarism policy here . Frequently Asked Questions Below are answers to some of the common questions asked about the Finance project. Is there a prerequisite course for this project? We strongly recommend reviewing the Excel for Finance course before starting this project — this will help you complete most of the required calculations in the template provided with this case.

Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 5 How do I calculate the weighted average cost of capital (WACC)? All the data required to calculate WACC is provided in the template. Refer to the Capital Structure and WACC lesson to help you complete the calculation. 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 =CF 0 +NPV(rate,CF 1 :CF n ,...) Alternatively, you can just calculate present values for all cash flows and sum them up. Be sure to point to the cell containing the discount rate instead of typing in a rounded value in the NPV formula, to ensure all decimals are appropriately captured in your calculation. How is the working capital (reserved) returned formula set up in the template? 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. These amounts are reflected as negative numbers to denote that cash is being reserved. At th e end of the project’s life, (year 10), the funds reserved during the life of the project are then available for general use by the company, hence they are summed up and reflected as a cash inflow, (a positive number), in year 10, “working capital returned”. The worksheet template contains the formulas necessary for these calculations, do not override them. Are we to assume that Orange builds out the infrastructure in Year 0 and begins selling in Year 1? Consider the construction, acquisition, upfront investment in the factory and equipment occur in year 0. The factory and equipment are then used, (“put in service”), starting with year 1. Depreciation and property taxes should only be applied when operations (production and sales) begin. Should I use bonus depreciation or straight-line depreciation for the equipment cost? You must use the method that will maximize the value to the company. Note that bonus depreciation only applies to the equipment and not the factory.

Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 6 How do I apply straight-line depreciation method? You must apply the applicable useful life to the factory and equipment cost as depreciation expense for each of the years during the project life. Keep in mind that there is no salvage value for the factory or the equipment when calculating depreciation. Similar to the sale of the equipment, should we consider a sale of the factory in year 10? No, you are only provided information about the sale of the equipment. Corporate Finance Project Rubric Scores 2 and above are considered passing. A project grade of a 1 or 0 will not receive credit for the assignment. Students must revise and resubmit to receive a passing grade. Score Description 5 ● Clearly addresses the case study prompts. ● Workbook is complete, accurate, and intelligible. ● Workbook has no more than 1 minor error*. ● Workbook has no major* errors. 4 ● Clearly addresses the case study prompts. ● Workbook is complete and intelligible. ● Workbook has no more than 1 major* error or 3 minor errors*. 3 ● Clearly addresses the case study prompts. ● Workbook is complete and intelligible. ● Workbook has no more than 2 major* errors or 6 minor errors* or combination as shown in the chart below. 2 ● Clearly addresses the case study prompts. ● Workbook is complete and intelligible. ● Workbook has no more than 3 major* errors or 9 minor errors* or combination as shown in the chart below. 1 ● Barely addresses the case study prompts. ● Workbook is missing many pieces of information and riddled with errors.

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Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 7 ● Calculations do not show underlying formulas, making it impossible to troubleshoot errors. ● Rationale is missing. 0 ● The assignment is plagiarized, not turned in, or completely off topic. *The following list provides examples of minor and major errors. ● Minor errors include, but are not limited to: o Assuming book value for factory/land when no information is provided in the case prompts. o Incorrect equipment depreciation method selected to maximize value, (i.e. straight-line versus bonus depreciation). o Incorrect signs for positive and negative cash flows. o Missing or incorrect equipment sale value. o Missing or incorrect Federal and State tax calculations. o Incorrect depreciation calculations. o Incorrect tax rate applied for property tax calculations. o Incorrect time bucketing of revenue and relevant costs (upfront vs. operating). ● Major errors include, but are not limited to: o Calculated cells are not displaying formulas to help with troubleshooting. o Incorrect decision criterion applied for location selection. o Incorrect WACC calculation. o Incorrect discount rate applied for present value calculations. o Incorrect cash flow range selected for IRR calculations. o Incorrect NPV calculation. o Complete omission of required calculations.

Corporate Finance Project © 2024 Quantic Holdings, Inc. All rights reserved. 2/2/23 - 3 8 Highest grade with # of errors Minor ↓ Major → 0 1 2 3 4+ 0 5 4 3 2 1 1 5 4 3 2 1 2 4 3 2 1 1 3 4 3 2 1 1 4 3 2 1 1 1 5 3 2 1 1 1 6 3 2 1 1 1 7 2 1 1 1 1 8 2 1 1 1 1 9 2 1 1 1 1 10+ 1 1 1 1 1