Stellar Division financial resuits for FY2018 The 2018 financial results of the

Question

Stellar Division financial resuits for FY2018 The 2018 financial results of the Stellar Division are given to the right. The balance sheet data represents beginning of the period values. Below you are asked to calculate the ROI's under various alternative scenarios. Treat each scenario separately and do not carry forward assumptions unless instructed to do so. The scenarios are: $43,000,000 $24,400,000 $9,600,000 $1,100,000 $35,100,000 $7,900,000 $3,160,000 $4,740,000 $89,000,000 $3,200,000 $700,000 S 19,500,000 6.50% Sales Revenue Cost of Goods Sold Operating Expenses Interest Expense Total Ex Income before taxes ncome Iaxes Net Income Total Assets Total Current labilities Non Interest-bearing Current Liabilities Long-term debt (5% interest rate) 1. As reported. 2. As reported but with the tax rate reduced to 21%. 3. Incorporate changes resulting from the retirement of $10 million in long-term debt using cash on hand. Assume the debt is retired at the beginning of 2018. 4. Stellar invests $8 million in a new project. The project is financed with new long-term debt with a 5% interest rate. During 2018, the project returned $1,300,000 in revenues, incurred cash expenses of $200,000, and had depreciation charges of $500,000. 5. Same facts as in 4, above, but a change in the tax laws allows $1,000,000 of depreciation in the new investment to be deducted on the tax return. This does not change the project's before tax income on the financial reports. It may, however, impact the amount of taxes owed on the project's 2018 income. Cost of capital Show all ROI calculations to 3 significant digits. Answers Calculate the ROI for the Stellar Division using the formula ROI- NOPAT divided by Invested Capital. Use the beginning of the period value for Invested Capital - this number may vary from one scenario to another Recalculate the ROI assuming the tax rate falls to 21% (Scenario 2) Recalculate the ROI assuming retirement of debt (Scenario 3) Calculate the ROI for the new project only (Scenario 4). Treat any interest expense as a non-operating charge and base your calculation on the beginning value of the asset. Recalculate the ROl for the new project (Scenario 5) as described in 4, above, with the further assumption that accelerated depreciation is allowed on the tax return for the purposes of calculating the taxes owed in 2018

Explanation / Answer

1. Calculation of Invested capital:

Total Assets = $89,000,000

Less:Current Liability= 3200000

Less:Long term debt= 19,500,000

Balance =66,300,000

Less:Income for Current year $4740000

Balance is Opening Invested Capital=61,560,000

ROI = NOPAT/invested capital where NOPAT is 5,840,000[$43,000,000-24,400,000-9,600,000-3,160,000]

= 5,840,000/61,560,000*100= 9.487%

Scenario 2:NOPAT: $43,000,000-24,400,000-9,600,000-1,659,000=7,341,000

ROI= 73410000/61560000*100=11.924%

Scenario 3: assuming that tax rate is same as in scenario 1.

Debt retirement reduced int exp by $10,000,000*5%=500,000and tax expenses incresed by 500000*40%= 200000.

NOPAT shall be $5840000+200000=6040000

and ROI shallbe $6040000/61560000*100=9.812%

4th scenario Debt incresed by $8000000 and interest exp by 400000 however extra income from new project is $600000 therefore overall profit shall be increased by $200000($600000-$400000).

Where as opearting profit shall be increased by $600000-tax on $200000*40%=80000 i.e. $520000

Ne NOPAT is $5840000+$520000=$6360000

ROI = $6360000/61560000*100=10.333%

Scenario 5 Extra tax benefit on extra depreciation is $500000*40%=200000 which will increase our NOPAT by $200000 hence it will be $6360000+200000=$6560000

ROI = $6560000/61560000=10.66%

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