Internal Rate of Return and Terminal Value free essay sample

For both financing alternative, develop a model that shows forecasted revenues, expenses, profits, and free cash flows generated by Harmonic in years one through seven. -Model shown in chart below. †¢What is the terminal value of the company under each scenario? As you can see in the graph below, the terminal value for the company if it takes the equity route is about $106M, where if it takes the debt route its terminal value will be about $45M. †¢What cash payments will be made by the company at the end of year seven? As you can see in the graph below, the only cash outflows from the company in year 7 will come from debt financing, with about an $11M outflow from buying back the building from Frank Thomas, as well as about a $6M outflow from paying back the 9% interest loan. 2)At what price must Harmonic repurchase the building from Frank Thomas to produce his required 15% after-tax return? In order for Frank Thomas to earn his 15% after tax return, Harmonic must buyback the building for just over M. We will write a custom essay sample on Internal Rate of Return and Terminal Value or any similar topic specifically for you Do Not WasteYour Time HIRE WRITER Only 13.90 / page The calculations can be seen in the chart below. 3)What proportion of the terminal value must be distributed to Comet Capital to produce its required 25% before-tax rate of return? In order for Comet Capital to produce its 25% before tax return, they must receive about $73. 5M terminal value. This amount is about 69% of the total terminal value at the end of year 7. 4)What are the forecasted cash flows, rates of return on investment, and value created for Burns and Irvine under the debt and equity financing alternatives? As you can see in the chart below, in respect to equity financing, the forecasted cash flows begin negative, and then gradually increase until a highly increase terminal sell price. The IRR of the investment will be 559%. And the value created from their very small investment will be around $50M in only a 7 year period. As for debt financing, the forecasted cash flows will also begin negative, and then increase until year 5. In year 5, they have one major cash outflow from repurchasing the equipment, but their cash flow will still remain positive. After year 5, they cash flow will pick up where it left off and increase even higher until they sell the company. The IRR will be around 429%. And the value created from the small investment will be just under $45 million in only a 7 year period. 5)What are the positives and negatives of each proposal? Which financing alternative would you recommend and why? Equity Proposal †¢Advantages i. Higher IRR ii. Can immediately complete launch of new hearing aid ?Will stay ahead of competition iii. Will reduce the risk of the transaction iv. Will reduce cost of goods sold on new goods from purchasing new equipment v. Will increase depreciation expense, lowering tax expenses vi. Will have no rent, interest, or lease expenses vii. If company goes down, will not have to pay any additional money back †¢Disadvantages i. Less ownership in company ii. Will have to invest more capital in the company than the debt proposal Debt Proposal †¢Advantages i. Maintain 100% ownership of company ?Will not have to follow anyone else’s plans for the business and can completely control the direction the company moves in ii. More tax deductions †¢Disadvantages i. Lower IRR ii. Will have a delay in bringing new hearing aid to the market ? Will allow competition to catch up to them faster iii. Will have to worry about having enough cash flow to pay for several different interest payments and buy back the land/building iv. Much more likely to have to worry about financial distress in the future since they will have to pay some money back v. Will increase the cost of goods sold on future developed products vi. Much lower receivables As you can see above from the advantages/disadvantages of both financing alternatives, it seems like a very easy decision to take the route of the equity financing. They will not be in complete control of the company, and will have to find a way to get an additional $50K to invest into the company, but their expected return after paying off the additional investor is still much higher than the debt alternative. Also, by taking the equity route, they will be able to immediately release the new hearing aid, and will have enough funds to stay ahead of the competition. It will increase their market share, which in turn will help them in the future years if they decide to release a new, not already planned for product. Their risk of falling into financial distress will also be much lower, their free cash flows every year will be larger, and their company will have a larger terminal value than the debt financing route. Also, since they will have another investor, they should have easier access to future financing if needed, as well as some additional expertise to help them out. I would without a doubt recommend them taking the equity financing route.