Jack Tar, CFO of Sheetbend & Halyard, Inc. opened the company confidential envelope. It contained the draft of a competitive bid for a contract to supply duffel canvas to the U.S. Navy. The cover memo from Sheetbend’s CEO asked Mr. Tar to review the bid before it was submitted.
The bid and its supporting documents had been prepared by Sheetbend’s sales staff. It called for Sheetbend to supply 100,000 yards of duffel canvas per year for 5 years. The proposed selling price was fixed at $30 per yard.
Mr. Tar was not usually involved in sales, but this bid was unusual in at least two respects. First, if accepted by the navy, it would commit Sheetbend to a fixed price, long-term contract. Second, producing the duffel canvas would require an investment of $1.5 million to purchase machinery and to refurbish Sheetbend’s plant in Pleasantboro, Maine. Mr. Tar set to work and by the end of the week had collected the following facts and assumptions:
The plant in Pleasantboro had been built in the early 1900s and is now idle. The plant was fully depreciated on Sheetbend’s books, except for the purchase cost of the land (in 1947) of $10,000.
Now that the land was valuable shorefront property, Mr. Tar thought the land and the idle plant could be sold, immediately or in the future, for $600,000.
Refurbishing the plant would cost $500,000. This investment would be depreciated for tax purposes on the 10-year MACRS schedule.
The new machinery would cost $1 million. This investment could be depreciated on the 5-year MACRS schedule.
The refurbished plant and new machinery would last for many years. However, the remaining market for duffel canvas was small, and it was not clear that additional orders could be obtained once the navy contract was finished. The machinery was custom built and could be used only for duffel canvas. Its second-hand value at the end of 5 years was probably zero.
Table below shows the sales staff ’s forecasts of income from the navy contract. Mr. Tar reviewed this forecast and decided that its assumptions were reasonable, except that the forecast used book, not tax, depreciation.
But the forecast income statement contained no mention of working capital. Mr. Tar thought that working capital would average about 10 percent of sales.
Armed with this information, Mr. Tar constructed a spreadsheet to calculate the NPV of the duffel canvas project, assuming that Sheetbend’s bid would be accepted by the navy.
He had just finished debugging the spreadsheet when another confidential envelope arrived from Sheetbend’s CEO. It contained a firm offer from a Maine real estate developer to purchase Sheetbend’s Pleasantboro land and plant for $1.5 million in cash.
Should Mr. Tar recommend submitting the bid to the navy at the proposed price of $30 per yard? The discount rate for this project is 12 percent.
See table attached for foracsted income statement for 5 years
Critically appraise how companies set their financing – both short-term and long-term policies, and explain the factors that a company should consider in setting its policies to raise capital for investment and in determining the level of debt equity balance to be maintained. The debt and equity financing strategy should be highlighted in detail.
Support your arguments by reference to TWO FTSE100 firms in the SAME INDUSTRY. Your comments should incorporate both theoretical and academic arguments and real world practices. You should research the subject beyond the basic facts, and must provide calculations, references and critical commentary to support the points. You should also provide a brief introduction on the key issues and a conclusion consistent to your discussion.
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