Order Description

Case Study.
Lamar corporation manufactures products for the construction market. The company is considering purchasing one of the following computerized laser cutter for cutting steel. Lamar’s cost of capital
is 12%. Its tax rate is 35%.

Required 1.
With using the NPV and IRR criteria, the company has asked you to analyze the two options and make some recommendations.

Model – A Model – B
Cost of machine AED 300,000 AED 400,000
Life of machine 5 years 5 years
Salvage (resale) value – Year 5 AED 20,000 AED 40,000
Annual revenues AED 130,000 AED 150,000
Annual operating expenses (including Depreciation) AED 75,000 AED 85,000
Major repairs – year 3 AED 18,000 AED 22,000

Mr. Lamar has recently been approached by his first cousin, Mr. Adkins, with a proposal to buy a 15 percent interest in Lamar corporation.

Mr. Lamar is quick to point out the increase in sales that has taken place over the last three years as indicated in the income statement, Exhibit 1. The annual growth rate is 25 percent. A balance
sheet for a similar time period is shown in Exhibit 2, and selected industry ratios are presented in Exhibit 3. Note the industry growth rate in sales is only 10 to 12 percent per year.

There was a steady real growth of 3 to 4 percent in gross domestic product during the period under study.

Exhibit 1
LAMAR Corporation
Income Statement (AED)
201X 201Y 201Z
Sales (all on credit) 1,200,000 1,500,000 1,875,000
Cost of goods sold 800,000 1,040,000 1,310,000
Gross profit 400,000 460,000 565,000
Selling and administrative expense* 239,900 274,000 304,700
Operating profit (EBIT) 160,100 186,000 260,300
Interest expense 35,000 45,000 85,000
Net income before taxes 125,100 141,000 175,300
Taxes 36,900 49,200 55,600
Net income 88,200 91,800 119,700
Shares 30,000 30,000 38,000
Earnings per share AED 2.94 AED 3.06 AED 3.15
*Includes AED 15,000 in lease payments for each year.
Exhibit 2
LAMAR Corporation
Balance Sheet (AED)
Assets 201X 201Y 201Z
Cash 30,000 40,000 30,000
Marketable securities 20,000 25,000 30,000
Accounts receivable 170,000 259,000 360,000
Inventory 230,000 261,000 290,000
Total current assets 450,000 585,000 710,000
Net plant and equipment 650,000 765,000 1,390,000
Total assets 1,100,000 1,350,000 2,100,000
Liabilities and Stockholders’ Equity
Accounts payable 200,000 310,000 505,000
Accrued expenses 20,400 30,000 35,000
Total current liabilities 220,400 340,000 540,000
Long-term liabilities 325,000 363,600 703,900
Total liabilities 545,400 703,600 1,243,900
Common stock (AED2 par) 60,000 60,000 76,000
Capital paid in excess of par 190,000 190,000 264,000
Retained earnings 304,600 396,400 516,100
Total stockholders’ equity 554,600 646,400 856,100
Total liabilities and stockholders’ equity 1,100,000 1,350,000 2, 100,000
Exhibit 3

Selected Industry Ratios
201X 201Y 201Z
Growth in sales — 10.00% 12.00%
Profit margin 7.71% 7.82% 7.96%
Return on assets (investment) 7.94% 8.86% 8.95%
Return on equity 14.31% 15.26% 16.01%
Receivable turnover 9.02x 8.86x 9.31x
Average collection period 39.9 days 40.6 days 38.7 days
Inventory turnover 4.24x 5.10x 5.11x
Fixed asset turnover 1.60x 1.64x 1.75x
Total asset turnover 1.05x 1.10x 1.12x
Current ratio 1.96x 2.25x 2.40x
Quick ratio 1.37x 1.41x 1.38x
Debt to total assets 43.47% 43.11% 44.10%
Times interest earned 6.50x 5.99x 6.61x
Fixed charge coverage 4.70x 4.69x 4.73x
Growth in EPS — 10.10% 13.30%

The stock in the corporation has become available due to the ill health of a current stockholder, who is in need of cash. The issue here is not to determine the exact price for the stock, but
rather whether Lamar corporation represents an attractive investment situation. Although Mr. Adkins has a primary interest in the profitability ratios, he will take a close look at all the ratios.
He has no fast and firm rules about required return on investment, but rather wishes to analyze the overall condition of the firm. The firm does not currently pay a cash dividend, and return to the
investor must come from selling the stock in the future.
Required 2.
After doing a thorough analysis (including ratios for each year and comparisons to the industry), what comments and recommendations do you offer to Mr. Adkins?
Now, Mr. Adkins is studying a new investment and trying to determine if the expected revenues justify a substantial investment of AED 70 million. According to its calculations, operating cost would
rise by AED 23.8 million in the first year, which would include hiring and training of new personnel, maintenance of equipment etc., and likely increase by about 5 percent per year thereafter. With
an aggressive marketing strategy, he believes that a revenue enhancement of AED 20.8 million in the first year is realistic and that a subsequent annual increase of about 15 percent for eight to
nine years, with revenues leveling off thereafter, can be achieved. Ideally, Mr. Adkins would like to retire in ten years. Seeking advice, he shares his detailed cost and revenue projections:

Year Cash (AED) Revenue (AED)
0 -70 000 000
1 – 23 800 000 20 825 000
2 -24 990 000 23 949 000
3 -26 239 000 27 541 000
4 -27 551 000 31 672 000
5 28 929 000 36 423 000
6 -30 375 000 41 887 000
7 -31 894 000 48 169 000
8 -33 489 000 55 395 000
9 -35 163 000 63 704 000
10 -36 922 000 73 259 000

Required 3.

Determine the resulting net cash flow for each year.

Base on a cost of capital of 9 percent for the long-term projects, compute the NPV, the IRR, the Payback period and the profitability index.

Interpret each result in terms of the project’s expected profitability and Mr. Adkins’s ten-year investment horizon.

Lamar Swimwear
201X 201Y 201Z
Growth in sales (Company) 25% 25%
(Industry) 10% 12%
Profit margin (Company) 7.35% 6.12% 6.38%
(Industry) 7.71% 7.82% 7.96%
Return on assets (Company) 8.02% 6.80% 5.70%
(Industry) 7.94% 8.68% 8.95%
Return on equity (Company) 15.90% 14.20% 13.98%
(Industry) 14.31% 15.26% 16.01%
Receivable turnover (Company) 7.06x 5.79x 5.21x
(Industry) 9.02x 8.86x 9.31x
Average collection period (Company) 51.0 days 62.2 days 69.1 days
(Industry) 39.9 days 40.6 days 38.7 days
Inventory turnover (Company) 5.22x 5.75x 6.47x
(Industry) 4.24x 5.10x 5.11x
Fixed asset turnover (Company) 1.85x 1.96x 1.35x
(Industry) 1.60x 1.64 1.75x
Total asset turnover (Company) 1.09x 1.11x 0.89x
(Industry) 1.05x 1.10x 1.12x
Current ratio (Company) 2.04x 1.72x 1.31x
(Industry) 1.96x 2.25x 2.40x
Quick ratio (Company) 1.00x .95x 0.78x
(Industry) 1.37x 1.41x 1.38x
Debt to total assets (Company) 49.58% 52.12% 59.23%
(Industry) 43.47% 43.11% 44.10%
Times interest earned (Company) 4.57x 4.13x 3.06x
(Industry) 6.50x 5.99x 6.61x
Fixed charge coverage (Company) 3.50x 3.35x 2.75x
(Industry) 4.70x 4.69x 4.73x
Growth in E.P.S. (Company) —- 4.1% 2.9%
(Industry) —- 10.1% 13.3%