Introduction To Modern Technology Media Essay

Introduction To Modern Technology Media Essay Modern technology has made the requirement for information flow to be quick and effective. We have been able to achieve this through the internet; the medium i.e the internet has facilitated each of us, by making the communication cheap and fast. News for U.K is available in the Australia as soon as its on the media, accessible by millions at one time. The growth of the internet is a necessity nowadays. Now internet, where people choose to spend a major part of their day has brought social communities where people can chat, message, share beliefs, extract information, share information about things they are interested in. The internet being the centre of usage for millions of users every day, thus it also appears to be a medium for brands and products to advertise, but this advertisement is different from the advertisement we see otherwise. This advertisement takes into account that the information flow is fast and inspired by people more than the advertising agencies. So let us see how social networking became the part of our lives. The last ten years of the century brought the innovative technology Internet. As predicted by Newman (1991) Internet: Altered the meaning of geographic distance. Allowed the huge increase in the volume of communication. Provided the possibility of increasing the speed of communication. Provided opportunities for interactive communication. Allowed forms of communication that was previously separate to overlap and interconnect. Whereas Grieco and Holmes (1999) (citied in Combe et al, 2003) identifies three powerful features of Internet: Disintermediation or the removal of brokers by allowing direct communication across spatial and sociometric distance; Asynchronicyty of the removal of temporality as a barrier to communications; Oculacy or the ability to communicate messages through images. According to Hermeking (2006) the spread of modern technology, including information and communication technology (ICT), is commonly regarded both as an indicator of the postmodern era of globalization and as the very precondition for that era of intensive worldwide interactions of people and exchanges of goods, services, information, and capital. On the contrary Hoffman (Hoffman et al., 1995) believes that the popularity of the WWW as a commercial medium (in contrast to other networks on the Internet) is due to its ability to facilitate global sharing of information and resources, and its potential to provide an efficient channel for advertising, marketing, and even direct distribution of certain goods and information services. world internet users Sixty five per cent of all UK households had a broadband connection in 2008. Adults under 70 years of age who had a degree or equivalent qualification were most likely to have access to the Internet in their home, at 93 per cent (Office for National Statistics,2009). According to Linda Peters (1998) the Web presents a fundamentally different environment- both as a medium and as a market from traditional communication channels perspective. It creates the Marketspace a virtual realm where products and services exist as digital information and can be delivered through information-based channels (Rayport and Svikola, 1994). Social Networking is a phenomena that has seen a rapid growth over the last few years. If you are not involved in one (or more) of these sites you are probably wondering, so what is this Social Networking thing all about?. Let us go through a general overview of a description of a Social Network A website where people are able to develop networks of friends and associates (whether only ever on line, in real life, or both) and create, share or give information on similar interests, tastes, lifestyles and other information. Also keep in mind that social networking websites are like communities. The Social Networking sites have gained popularity and are on the increase for one simple reason, the ability to share, with others, information about yourself, your interests, your hobbies, your thoughts and your feelings or anything you choose. These can quickly be seen by others in your network and by you through messages, comments, instant messaging applications, photos, games, and group interaction. Facebook one of the most popular social networking sites started as a site for previous College Associates to remain in contact with one another during and after they had finished College. Youtube is another social networking site not just a repository for uploading various types of videos. Some people have found new friendship and romance. People get to know events like fires, storms, and even floods in other countries that have occurred locally in that vicinity, usually even hours before these events are made public by the media. People become involved in many discussions which have given them an opportunity to get to know differing cultures and beliefs One other belief some people have is that it is only Generation Y that use these sites. You will be surprised that many people from many different walks of life in many countries in many age groups use these sites. Some sites are broad category sites like Myspace and Facebook (now). Some are specific to a narrow category, like Small business, the Arts, connecting Families, Blogging, Making Money on the Internet and Dating Services (using a broad and polite term there). Some are popular by type of category they use, where others are popular by region (like UK and Europe, Africa, etc). Social media According to Liu Shrum (2002) new media (Internet), brought new models of interactivity: user-to-user and user-to-message. The interactivity develops a new meaning when it is applied through Web 2.0 platforms and Social media channels as dialogue between consumer and company becomes much more active and interactive. Contemplating about user-to-user interactivity Ha and James (1998) suggested that the more communication in a computer-mediated environment resembles interpersonal communication, the more interactive the communication isà ¢Ã¢â€š ¬-. Defined by Steuer (1992) users-to-message interaction as follows: à ¢Ã¢â€š ¬Ã¢â‚¬ ¢the extent to which users can participate in modifying the form and content of a mediated environment in real timeà ¢Ã¢â€š ¬-. The above figure outlines the E marketing strategy suggested Constantinides (2008) Nielsen Company analyzed and found that the global average time spent for a person on social networking sites is over five each month (February 2010 data), Facebook being the major part of the usage. Social networking is a great option to advertise your business. Social networking does not require large amounts to be invested in, rather its free most of the time, moreover its very simple, easy and quick. There are dozens of websites on the internet where you can sign up within a few minutes and network with millions of people quickly and easily. Social media encourages feedback from everyone who is interested. Social media provokes the user controlled media, empowering the users to drive the communities they are in. Make their comments on products and brands, as they come to them. They can exploit these communities to promote a product and also ruin the reputation of one. Weston (2008) says that, social networking, if approached in the right manner, can build brand awareness, find new customers, help find talent, and help creating a database for market research and analysis. Some businesses find it unnecessary to market themselves on social networking sites, although it is a good way to advertise products/services with knowing what consumers think and want. Social network marketing can be very fruitful for businesses. Social networking media has been thought to be an advertisement source though should be used cleverly to reap of the benefits from it. Thus it is important that the brands committed to using it should use it in the correct way. Zirinsky, 2009 believes online social advertising is all about two way conversations with consumers, not one way broadcastmaking this mistake is far too common and simply makes brands appear out of touch with their audience and reality, and is detrimental to their overall image. Social media keeps an edge over other forms of online communication for its use of enabling content sharing on a network. Content sharing and interaction is defines social media making it different from other means of communication. This means that if brands are going to the get value from social media, they should use it for what it is good in; allowing and helping the sharing of interesting material to create relevant positive hype for the brand or product. Powell, 2009 on the other hand states that Brands need to add value into an online community through enabling the sharing of content, if it cannot do this it has little value, and will be perceived as having little value. For information sharing social media has accelerated the entire process. James in 2009 has said Across networks, a good or bad experience will be shared, potentially on a huge scale. Between 700,000 and 1.3 million blog posts are made daily and, according to Google, a new blog post is being created every second of every day. Most social media services are open to feedback and participation. They encourage voting, comments and the sharing of information. There are rarely any barriers to accessing and making use of content password-protected content is frowned on. Thus a free portal for information sharing, which is effective and fast engages millions of users, now for brands they should be aware how to engage masses they are interested in, because as discussed earlier social networking is probably the fastest way of communication and words positive or negative spread very quickly. Powell, 09 debates Normal social etiquette has crossed over into social media. Social media are communities and there are standards and protocols as to what kind of behavior is acceptable and unacceptable. This statement suggests that the brands should communicate and behave in the social media as to not offend the users of social networking. It is important that whatever information the brands or products are interested in sharing has been uploaded after careful screening and thought process. The strategy for online advertising has to be defined precisely. Thorbjornsen et al. in 2002 affirms that empowering consumers is crucial to online relationships. Rowley in 2007 argues that the concept of customer community leadership has been proposed with the customer being viewed as a partner. Virtual space was a key aspect in amplifying community member experience. Kozinets solicited that retribalized virtual communities of consumption require a newer framework for traditional relationship marketing theory. It is therefore vital at this point to provide a brief overview of tribalism. Cova, 1997 proposes that the potential of tribalism and the linking value has been developed. A tribe is defined as a network of heterogeneous persons in terms of age, sex, income, etc. who are linked by a shared passion or emotion; a tribe is capable of collective action, its members are not simple consumers, they are also advocates; (Cova and Cova 2002: 602). The Internet has only helped to increase the potential of tribalism. E-tribes allow people to gather together in groups based on a huge range of cultural and subcultural interests and social affiliations (Kozinets, 1999: 253). Muniz and OGuinn, 2001 argue that it is crucial to notice that tribal communities are argued to be less explicitly commercial than brand communities. Social Media Web 2.0 Social media and Web 2.0 are two words which are many times used interchangeably in the marketing literature, even though they are not entirely the same. As per the marketing perspective, the Web 2.0 should be apprehended as the recent tool for the marketing communication mix and facilitator and enabler of social media. The Web 2.0 term was introduced by Tim Oà ¢Ã¢â€š ¬Ã… ¸Reilly in 2004, it has originated from talks about social software and the communities surrounding these applications. Tim Oà ¢Ã¢â€š ¬Ã… ¸Reilly said the companies that survived the dotcom boom had something in common; these companies realized that the Web is much more useful for delivering service than being used just as a platform for packaged products (i.e. software). Constantinides and Fountain (2008) on the other hand defined Web 2.0 as follows: à ¢Ã¢â€š ¬Ã¢â‚¬ ¢Web 2.0 is a collection of open-source, interactive and user-controlled online applications expanding the experiences, knowledge and market power o f the users as participants in business and social processes. Web 2.0 applications support the creation of informal users networks facilitating the flow of ideas and knowledge by allowing the efficient generation, dissemination, sharing and editing / refining of informational content . Hoegg believes that Web 2.0 is the philosophy of mutually maximizing collective intelligence and added value for each participant by formalized and dynamic information sharing and creationà ¢Ã¢â€š ¬-. Both of these definitions are exhibits of similar concepts for amplifying the collated intelligence, a community regulated by itself, effects of the network, openness in showing the information creation and sharing process, but the vital aspect here is the consumer. There are not many changes in the Web 2.0 compared to Web 1.0 applications from the technological aspect; value over here is created by the people as they do not just use this software but also play a major role in the creation of these soft wares. Thus as apprehended in modern IT solutions and models, user input is the most vital aspect, can be viewed on a global level with each social networking website. Web 2.0 applications are still considered to be in the development stage, they are categorized according to the purpose and field of the research. Constantinides and Fountain (2008) classify them into 5 broad types according their nature: Blogs: Short for Web logs: online journals, the most known and fastest-growing category of Web 2.0 applications. Blogs are often combined with Podcasts, that is, digital audio or video that can be streamed or downloaded to portable devices. Examples: www.blogtopsites.com , www.blogger.com and several others. Social networks: applications allowing users to build personal websites accessible to other users for exchange of personal content and communication Examples: www.facebook.com , www.myspace.com and others. (Content) Communities: Websites organising and sharing particular types of content. Examples are applications of Video sharing: http://video.google.com, www.youtube.com, http://etsylove.ning.com, Photos sharing: http://www.flickr.com, Social Bookmarking: www.digg.com , http://del.icio.us and Publicly Edited Encyclopedias (Wikis): www. wikipedia.org , http://en.citizendium.org/wiki/Main_Page. Forums/bulletin boards: sites for exchanging ideas and information usually around special interests Examples: www.epinions.com, www.personaldemocracy.com, http://www.python.org. Content aggregators: applications allowing users to fully customise the web content they wish to access. These sites make use of a technique known as Real Simple Syndication or Rich Site Summary (RSS). Examples http://uk.my.yahoo.com/, http://www. google.com/ig, http://www.netvibes.com/. Blogs and blogging Web Logs (knows as Blogs), according to Tredinnick (2006), are arguably the oldest Web 2.0 applications and have been in the web space since mid 1990à ¢Ã¢â€š ¬Ã… ¸s. Constantinides and Fountain (2008) states that it is the most known and fastest-growing category of Web 2.0 applications. Published in Daily Blog Tips, 2008 A Blog is a Web site, usually run by any individual with regular entries of discussions, happening of events, or other content such as graphics or videos where entries are commonly displayed in reverse-chronological order and has permalinks. Antony Mayfield argues (2008), the most important features of the blogs are Linking, Trackbacks, Comments and Subscription (RSS) which allow companies to engage with their stakeholders and facilitates conversations between them. Good blogs are used by people to easily access information and share the viewpoint of things. People from various geographical locations, can log in and write blogs at one place, being able to share knowledge and express them. Blogs help people discover a lot a things that a layman would not be aware of but yet, through a search engine would reach a blogspot where he or she can gain the information they require. The internet guru Seth Godin (2004) remarked that good blogs work when they are based on: candor, urgency, timeliness, pithiness, controversy and utility. Armano (2008) groups these features to 4 Cà ¢Ã¢â€š ¬Ã… ¸s of blogging. Furthermore, Huang in 2007 identified the main techniques for how to manage brand communications according to various blogging motivations. Table 2.2. Bloggersà ¢Ã¢â€š ¬Ã… ¸ motivations. Source: Huang (Huang al., 2007) Social networks Social networking is the fastest growing Web 2.0 application, and this is the main reason for the social media to prosper as quickly as it is powered by effective, fast communication, this media is driven by the users demand. A user prefers to believe in their counterpart rather than any organization. McKinsey defines social networking as systems that allow members of a specific site to learn about other members skills, talents, knowledge or preferences. Pew/Internet believes- A social networking site is an online location where a user can create a profile and build a personal network that connects him or her to other users. Wikipedia states that a social network service focuses on the building and verification of online social networks for communities of people who share interests and activities, or who are interested in exploring the interests and activities of others. It provides various ways for users to interact chat, messaging, email, video, file sharing, blogging and discussion groups The features of social networks present an opportunity to create brand communities and interact with them online. It allows people from all over the world to sign up within a few minutes and access the information available, this has allowed the organizations to be acting in a multinational mode, as they can reach anywhere in the world with the least amount of time taken. Tim Oà ¢Ã¢â€š ¬Ã… ¸Reilly (2005) thinks otherwise and said that Web 2.0 doesnt have a hard boundary, but rather, a gravitational core which could be visualized as a set of principles and practices that tie together a veritable solar system of sites that demonstrate some or all of those principles, at a varying distance from that core (Appendix 2.4). Therefore it is difficult to classify the Web 2.0 into the precise groupings, because the applications are interrelated and most of the time a few Web 2.0 features works on one platform. The mixture of Web 2.0 applications working under one site are known as Mash-ups. On the contrary according to Mayfield (2008) this combination of two or more pieces of content (or software, or websites) is one of the phenomena in social media that make it at once so exciting, fast-moving and sometimes bewilderingà ¢Ã¢â€š ¬-. But even more vital aspect of Web 2.0 applications is the coherence with the different platforms. Social applications are getting more and more popular on mobile devices (Phones, iPods (via podcasts)). In fact, according to BBC News (2008) one of the reasons the Internet usage on the mobile devices is increasing Web 2.0 applications. According to Drury (2008) social media applications has an ability to bring Head (Professional) and Tail (UGC) content together in all the formats (audio, video , text). As more and more professionally edited websites incorporate social media content some companies (i.e. Joost) are trying to apply Web 2.0 principals (live participation) for even bigger media platforms as TV. These applications are being tested in the Internet TV and in the near future have a good chance to redefine TV experience completely. All these changes open new opportunities for integrated marketing campaigns, where marketers are enabled to reach bigger number of audiences of consumers at all their touch points with mediated world at one-stop shop. Facebook is the most used social networking site that has involved the masses all over the world. Facebook is a social networking site, which provides users with a platform to create a personal profile page, add friends, and send messages, post on their profiles, comment on their status. Kazeniac, 2009 said that since the company was founded in 2004, it has become the top ranked social networking site. According to Facebook Statistics (2009), there are over 300 million current active users (i.e. users that have logged-on in the past 30 days). Facebook users have claimed the site a necessity, along the lines of oxygen, water, and food (Verna, 2009). For many people, visiting Facebook has become an integral part of their daily lives, and has even caused some to have an unhealthy obsession with the site. According to Elizabeth Cohen (2009), a CNN medical correspondent, therapists are seeing more and more Facebook addicts, who become compulsive Facebook users to the point where the site interferes with relationships, jobs, and normal daily life. The site has transformed social communication in the 21st century, with Facebook and other Social networking sites reaching hundreds of millions of people across the globe. Facebook achieves the comptetive edge by adding new features and developments on a continuous basis. Since it is free to create an account, Facebook has to generate its revenue elsewhere, through a venue such as advertising. Companies can utilize Facebooks features to reach their audiences in different ways. Gangadharbatla (2009) states that Social networking sites are changing the way advertisers reach consumers, and that these changes are transforming online advertising all together. There are a variety of ways to use Facebook, and the different features allow creativity and experimentation in advertising. For instance, when users log-on, they are taken to a homepage called a News Feed which highlights recent activities from other users. Each Facebook account also includes a personal profile page, a Wall to write public messages to other users, Facebook-generated applications (photos, events, groups, video, notes, and links), and an inbox to write private messages to other users. T he site also allows users to add optional features called Platform applications to connect in new ways. According to Facebooks statistics (2009), more than 70% of Facebook users utilize Platform applications on a monthly basis. Since these Platforms are optional, it is significant that users are seeking out additional Facebook features and uses for the site. The purpose of Facebook has shifted, as the continued popularity of added features proves that its users are looking for more than just casual networking with friends. A few of the currently popular platform applications include games, fan pages, and gifts. Social-network gaming company Zynga has dominated the site with applications such as FarmVille, Cafà © World, and Mafia Wars. Zynga has over 126 million monthly active users, making it the leading Facebook development platform. The company reported that they currently spend approximately $50 million on Facebook advertising annually, and this figure is expected to increase as the company continues to develop over the years. The games allow Facebook users to purchase virtual products with a credit card, as a means to advance further in the game. Techniques such as these provide Zynga with Facebook-user generated revenues and encourage more advertising and developing on the site. Advertisers can also utilize the option to create a free fan page, where companies and individuals can invite users to become a fan of a product, service, person, company, brand, etc. The page is set up similarly to a profile page, with the option to add status updates, photos, announcements, etc. According to Facebooks statistics (2009), over 10 million users become fans of pages on a daily basis, which provides growing possibilities to reach consumers without any financial risk. The updates on the fan pages are also displayed on the home page news feed of the fans who have joined as fans. There is also a chance to buy birthday gifts, as Facebook has expanded its gift shop to include real gifts alongside virtual ones. This type of online shopping connects cyber space with the real world, so that what happens online does not necessarily stay online. Impact of Social media advertising Castells, 2000 states that it has long been suggested that the western world in particular operates in a network society. The leitmotif of societing the link is more important than the thing is central to tribalism. Crucially, tribalism encourages dialogue in many directions and combinations; Business to Consumer (B2C), Customer to Business (C2B) and Consumer to Consumer (C2C). Drury (2008) suggests that when analyzing social media marketers too often concentrates on the media factor, when social element is the key, because marketing within social media is about building a relationship and conversation with the audience, where the simple message delivery is changed by ongoing exchange of perceptions and ideas between company and the consumer. Haven (2008) argues that social media key elements are not entirely new as features of sharing, connecting, opining, broadcasting and creating has been long in our lives, but there are several characteristics of new technologies and behaviors that set them apart from the past: Reach Historically, audiences for the common person have been limited: a tribe, family, friends, neighbors, or the local community. Todays technologies provide scale and enable anyone to reach a global audience. Accessibility The means of production for most media used to lie in the hands of enterprises with unlimited resources (financial or human). Todays technologies for media creation are available to anyone at little or no cost. Usability The means of production typically required specialized skills and training, both technically and creatively. Todays technologies simplify those processes, or in some cases reinvent them, so anyone can create and operate the means of production. Transparency People, especially Americans, historically kept personal information to themselves and had a general distrust of authority (enterprises, government, etc.). Today, people are willing to share anything about themselves (interests, location, family situations, health condition, etc.) in a public venue, and todays technologies make that both possible and purposeful. Recency When people did have the means of production and distribution in the past (albeit limited), the time lag between communications was typically long (days, weeks, or even months). It was a limitation of the technology or system in which it operated. Todays technologies enable instantaneous responses and dialog where only the participant determines the delay in response. From the results of a research, Ofcom (2008) identified the following fundamental principle of social networking; By extending their social networks, users have the opportunity to communicate with people who share their interests and with people from different countries, cultures and backgrounds (Ofcom,2008). And, Communication with family and friends was found to be the main reason adults used social networking sites (Ofcom, 2008). Next Thing Now (McCann, 2008) said that 74% of social media users use the social media to be able to get in touch with their friends. This fact emphasizes on the fact the social network advertising has to be dealt with care and for the reason of not getting into the line of bad publicity. Glen Urban argued that the customer has much more power then ever before because of the three main reasons: More information. More alternatives. Easy transaction. A study from Delloite Touche USA narrated that 62% of the U.S consumers read consumer generated online reviews and 98% of them find these reviews reliable enough. 80% of these consumers say that these reviews have affected their buying intentions. According to Lockhorn (2007) word of mouth campaigns can take off very quietly through niche communities and can be powerfully persuasive, or conversely result in an astonishing backlash. This perhaps is not good for products, the habitat in which they are pushing to gain an entry is not notably considerate, and even if they do get a break, there is still a lot of competitor brand presence. James, in 2009 states that In a UK study by Jam/MySpace in early 2009, 26% of social media users said they already felt bombarded by too much clutter/advertising. The social media networking is uncommon and challenging and the brands that do not comply to the requirements will have to combat as their competitors reap on the market share. But the ones that can exploit the environment stay to make deeper relationships with the audience, and increase their brand awareness. The information over a social network spreads like a fire. Thus a bad word or a wrong mode of communication will also travel to millions of people at the same time, accessible by millions. The User Generated Content (UGC) can become an influential message of the consumer to the consumer (C2C) about the company and therefore should be carefully monitored. In fact, the content is the new message in social media channels. According to Eikelmann (Eikelmann et al, 2008) the best marketers can do in this environment is to try to engage with the consumers through social media in order influence these messages. Drury (2008) proposes that instead of sending simple messages, marketers should provide the audience with content that would intrigue them and would also be a means to kick off conversations at. Therefore, influence will become a standard measurement in Marketing 2.0 (Dowdell, 2008). As blogger and social media strategist Douma (2008) put it: The age of persuasion is over. Welcome to the age of influence. Give us the people control and we will use it, if you do not give us control you will lose us (Jarvis, 2009). Control now lies with the users, their perceptions, opinions, demands, satisfaction is what matters more. Previously, the powerful; companies, institutions and governments believed they were in control, and they were. Now the internet allows us to speak to the world, to organise ourselves, to find and spread information, to challenge old ways, to retake control (Jarvis, 2009). Companies realize this shift in control when they can stop holding on to what is lost, and start indulging in what is going to attract consumers. Engagement means giving the users content that is interesting and would appeal the masses, also providing them space where they can discuss the content. The control can be handed to the consumer. If the consumer spreads out a positive word for brand, this will create a positive image for it. Social media communities are used by humans, for a brand to prevail, it must use emotions, or undergo the subsequent results. Jarvis 2009 quotes Today, when you lose a customer, you dont lose just that customer, you risk losing that customers friends. And thanks to the internet and blogs and consumer rate and review services, your customers have lots and lots of friends all around the world. According to Powell (2009) The brand is no longer

The Internet as a Learning Tool Essay -- Technology Web Essays

The Internet as a Learning Tool The Internet has a universal appeal for most people. We (in the United States) have become dependant on it for our daily routines. We shop, send mail, read the news, look up movie reviews, etc., using the Internet. We depend on this service, because we have told ourselves that "It" has made our lives easier. We advocate the use of similar technologies within the classroom, because we are convinced that the use of computers and having access to the Internet is the best way to educate our children so they can have an equal chance to reach their potential and accomplish their goals. It is true that the Internet is a great source of information. Its value as a resource is immeasurable. Unfortunately, to get this benefit we have to pay a price. In some cases this comes as loss of privacy. The Internet and the digital world are a part of the public sphere; therefore, our speech has to be measured and revised to be appropriate for this realm causing our free speech to be limited. Access to the Internet is also restricted to a certain group of people. One has to own a computer, or have access to one to be able to make use of its benefits. Internet access is uneven, therefore unfair. The other potential problem with the Internet is the access that people with shady intents or with low morality have to it. Anyone with the means to a computer can be online with our innocent children. Are their intents innocent also? In the realm of education, I think that the Internet can be a great resource for information. Research can be easily planned and implemented for the benefit of both students and educators. Unfortunately, this brings us back to the issue of limited access. Some students are more readily... ...ose to a multimedia / interactive classroom as we think we are. The school district (LAUSD) has spent several millions on purchasing computers and hooking them up to the Internet. The emphasis is on acquiring technology instead of implementing it. I still think that the novelty of computers and its tremendous appeal to students of all ages should be utilized to teach. Works Cited "Fast, Easy and FREE Webpages." http://www.webspawner.com/ (1 Nov. 2001). "How to Publish Web Pages." http://itsweb.hartford.edu (1 Nov. 2001). "How to Publish Web Pages to an Internet Server." http://www.surfwise.com/support/publish.htm (1 Nov. 2001). "Personal Publishing." http://www.utexas.edu/ (1 Nov. 2001). "Publishing Your Page for Free." http://home.san.rr.com/artbytes/publish.htm (1 Nov. 2001). "Yahoo! GeoCities." http://geocities.yahoo.com (1 Nov. 2001).

Case Solutions for Corporate Finance Ross, Westerfield, and Jaffe 9th Edition

Case Solutions Corporate Finance Ross, Westerfield, and Jaffe 9th edition CHAPTER 2 CASH FLOWS AT WARF COMPUTERS The operating cash flow for the company is: (NOTE: All numbers are in thousands of dollars) OCF = EBIT + Depreciation – Current taxes OCF = $1,332 + 159 – 386 OCF = $1,105 To calculate the cash flow from assets, we need to find the capital spending and change in net working capital. The capital spending for the year was: | |Capital spending | | |   |Ending net fixed assets |$2,280 | |   |– Beginning net fixed assets |1,792 | |   |+ Depreciation | 159 | |   | Net capital spending |$ 647 | And the change in net working capital was: |   |Change in net working capital | |   |Ending NWC |$728 | |   |– Beginning NWC | 586 | |   | Change in NWC |$142 | So, the cash flow from assets was:    |Cash flow from assets | | |   |Operating cash flow |$1,105 | |   |– Net capital spending |647 | |   |– Change in NWC | 142 | |   | Cash flow from assets |$316 | The cash flow to creditors was: |   |Cash flow to creditors |   | |   |Interest paid | $95 | |   |– Net New Borrowing | 20 | |   | Cash flow to Creditors | $75 | The cash flow to stockholders was:    |Cash flow to stockholders |   | |   |Dividends paid | $212 | |   |– Net new equity raised | –29 | |   | Cash flow to Stockholders | $241 | The accounting cash flow statement of cash flows for the year was:    |Statement of Cash Flows | |   |Operations | | |   |Net income |$742 | |   |Depreciation |159 | |   |Deferred taxes |109 | |   |Changes in assets and liabilities | | |   | Accounts receivable |(31) | |   | Inventories |14 |   | Accounts payable |17 | |   | Accrued expenses |(99) | |   | Other |(9) | |   |Total cash flow from operations |$902 | |   |   | | |   |Investing activities | | |   | Acquisition of fixed assets |$(786) | |   | Sale of fixed assets |139 | |   |Total cash flow from investing acti vities |$(547) | |   |   | | |   |Financing activities | | |   | Retirement of debt |$(98) | |   | Proceeds of long-term debt |118 | |   | Notes payable |5 | |   | Dividends |(212) | |   | Repurchase of stock |(40) | |   | Proceeds from new stock issues |11 | |   |Total cash flow from financing activities |$(216) | |   |   | | |   |Change in cash (on balance sheet) |$39 | Answers to questions 1. The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from operations and a positive cash flow from assets. The firm invested $142 in new net working capital and $647 in new fixed assets. The firm was able to return $241 to its stockholders and $75 to creditors. 2. The financial cash flows present a more accurate picture of the company since it accurately reflects interest cash flows as a financing decision rather than an operating decision. 3. The expansion plans look like they are probably a good idea. The company was able to return a significant amount of cash to its shareholders during the year, but a better use of these cash flows may have been to retain them for the expansion. This decision will be discussed in more detail later in the book. CHAPTER 3 RATIOS AND FINANCIAL PLANNING AT EAST COAST YACHTS 1. The calculations for the ratios listed are: Current ratio = $14,651,000 / $19,539,000 Current ratio = 0. 75 times Quick ratio = ($14,651,000 – 6,136,000) / $19,539,000 Quick ratio = 0. 44 times Total asset turnover = $167,310,000 / $108,615,000 Total asset turnover = 1. 54 times Inventory turnover = $117,910,000 / $6,136,000 Inventory turnover = 19. 22 times Receivables turnover = $167,310,000 / $5,473,000 Receivables turnover = 30. 57 times Total debt ratio = ($108,615,000 – 55,341,000) / $108,615,000 Total debt ratio = 0. 49 times Debt-equity ratio = ($19,539,000 + 33,735,000) / $55,341,000 Debt-equity ratio = 0. 96 times Equity multiplier = $108,615,000 / $55,341,000 Equity multiplier = 1. 96 times Interest coverage = $23,946,000 / $3,009,000 Interest coverage = 7. 96 times Profit margin = $12,562,200 / $167,310,000 Profit margin = 7. 51% Return on assets = $12,562,200 / $108,615,000 Return on assets = 11. 57% Return on equity = $12,562,000 / $55,341,000 Return on equity = 22. 70% 2. Regarding the liquidity ratios, East Coast Yachts current ratio is below the median industry ratio. This implies the company has less liquidity than the industry in general. However, the current ratio is above the lower quartile, so there are companies in the industry with lower liquidity than East Coast Yachts. The company may have more predictable cash flows, or more access to short-term borrowing. The turnover ratios are all higher than the industry median; in fact, all three turnover ratios are above the upper quartile. This may mean that East Coast Yachts is more efficient than the industry in using its assets to generate sales. The financial leverage ratios are all below the industry median, but above the lower quartile. East Coast Yachts generally has less debt than comparable companies, but is still within the normal range. The profit margin for the company is about the same as the industry median, the ROA is slightly higher than the industry median, and the ROE is well above the industry median. East Coast Yachts seems to be performing well in the profitability area. Overall, East Coast Yachts’ performance seems good, although the liquidity ratios indicate that a closer look may be needed in this area. Below is a list of possible reasons it may be good or bad that each ratio is higher or lower than the industry. Note that the list is not exhaustive, but merely one possible explanation for each ratio. | |Ratio |Good |Bad | | |Current ratio |Better at managing current accounts. |May be having liquidity problems. | | |Quick ratio |Better at managing current accounts. May be having liquidity problems. | | |Total asset turnover |Better at utilizing assets. |Assets may be older and depreciated, requiring | | | | |extensive investment soon. | | |Inventory turnover |Better at inventory management, possibly due to |Could be experiencing inventory shortages. | | | |better procedures. | | | |Receivables turnover |Better at collecting receivables. |May have credit terms that are too strict. | | | |Decreasing receivables turnover may increase | | | | | sales. | | |Total debt ratio |Less debt than industry median means the company|Increasing the amount of debt can increase | | | |is less likely to experience credit problems. |shareholder returns. Especially notice that it | | | | |will increase ROE. | | |Debt-equity ratio |Less debt than industry median means the company|Increasing the amount of debt can increase | | | |is less likely to experience credit problems. |shareholder returns. Especially notice that it | | | | |will increase ROE. | | |Equity multiplier |Less debt than industry median means the company|Increasing the amount of debt can increase | | | |is less likely to experience credit problems. |shareholder returns. Especially notice that it | | | | |will increase ROE. | | |Interest coverage |Less debt than industry median means the company|Increasing the amount of debt can increase | | | |is less likely to experience credit problems. |shareholder returns. Especially notice that it | | | | |will increase ROE. | | |Profit margin |The PM is slightly above the industry median, so|May be able to better control costs. | | | |it is performing better than many peers. | | | |ROA |Company is performing above many of its peers. |Assets may be old and depreciated relative to | | | | |industry. | | |ROE |Company is performing above many of its peers. Profit margin and EM could still be increased, | | | | |which would further increase ROE. | If you created an Inventory to Current liabilities ratio, East Coast Yachts would have a ratio that is lower than the industry median. The current ratio is below the industry median, while the quick ratio is above the industry median. This implies that East Coast Yachts has less inventory to current liabilities than the industry median. Because the cash ratio is lower than the industry median, East Coast Yachts has less inventory than the industry median, but more accounts receivable. 3. To calculate the internal growth rate, we first need to find the ROE and the retention ratio, so: ROE = NI / TE ROE = $12,562,200 / $55,341,000 ROE = . 2270 or 22. 70% b = Addition to RE / NI b = $5,024,800 / $12,562,200 b = 0. 40 or 40% So, the sustainable growth rate is: Sustainable growth rate = (ROE ? b) / [1 – (ROE ? b)] Sustainable growth rate = [0. 2270(. 40)] / [1 – 0. 2270(. 40)] Sustainable growth rate = . 0999 or 9. 99% The sustainable growth rate is the growth rate the company can achieve with no external financing while maintaining a constant debt-equity ratio. At the sustainable growth rate, the pro forma statements next year will be:    |Income statement |   |   |   | |   |Sales |$184,018,615 |   |   |   | |   |COGS |129,685,224 |   |   |   | |   |Other expenses |21,990,725 |   |   |   | |   |Depreciation |5,460,000 |   |   |   | |   |EBIT |$26,882,666 |   |   |   | |   |Interest 3,009,000 |   |   |   | |   |Taxable income |$23,873,666 |   |   |   | |   |Taxes (40%) |9,549,466 |   |   |   | |   |Net income |$14,324,199 |   |   |   | |   |   | |   |   |   | |   |Dividends |$8,594,520 |   |   |   | |   |Add to RE |5,729,680 |   |   |   | |   |Balance sheet | |   |Assets |   |Liabilities & Equity | |   |Current Assets | |   |Current Liabilities | | |   | Cash |$3,345,793 |   | Accounts Payable |$7,106,236 | |   | Accounts rec. 6,019,568 |   | Notes Payable |14,384,050 | |   | Inventory |6,748,779 |   | Total CL |$21,490,286 | |   | Total CA |$16,114,140 |   |   | | |   |   | |   |Long-term debt |$33,735,000 | |   | | |   |   | | |   | | |   |Shareholder Equity | | |   | |   | Common stock |$5,200,000 | |   |Fixed assets | |   | Retained earnings |55,870,680 | |   | Net PP&E |$103,347,828 |   | Total Equity |$61,070,680 | |   |   | |   |   | | |   |Total Assets |$ 119,461,968 |   |Total L&E |$116,295,966 | So, the EFN is: EFN = Total assets – Total liabilities and equity EFN = $119,461,968 – 116,295,966 EFN = $3,166,002 The ratios with these pro forma statements are: Current ratio = $16,114,140 / $21,490,286 Current ratio = 0. 75 times Quick ratio = ($16,114,140 – 6,748,779) / $21,490,286 Quick ratio = 0. 44 times Total asset turnover = $184,018,615 / $119,461,968 Total asset turnover = 1. 54 times Inventory turnover = $129,685,224 / $6,748,779 Inventory turnover = 19. 22 times Receivables turnover = $184,018,615 / $6,019,568 Receivables turnover = 30. 57 times Total debt ratio = ($116,295,966 – 61,070,680) / $116,295,966 Total debt ratio = 0. 49 times Debt-equity ratio = ($21,490,286 + 33,735,000) / $61,070,680 Debt-equity ratio = 0. 90 times Equity multiplier = $119,460,968 / $61,070,680 Equity multiplier = 1. 96 times Interest coverage = $26,882,666 / $3,009,000 Interest coverage = 8. 93 times Profit margin = $14,324,199 / $184,018,615 Profit margin = 7. 78% Return on assets = $14,324,199 / $119,461,968 Return on assets = 11. 99% Return on equity = $14,324,199 / $61,070,680 Return on equity = 23. 45% The only ratios that changed are the debt ratio, the interest coverage ratio, profit margin, return on assets, and return on equity. The debt ratio changes because long-term debt is assumed to remain fixed in the pro forma statements. The other ratios change slightly because interest and depreciation are also assumed to remain constant as well. 4. Pro forma financial statements for next year at a 20 percent growth rate are: |   |Income statement |   |   |   | |   |Sales |$200,772,000 |   |   |   | |   |COGS |141,492,000 |   |   |   | |   |Other xpenses |23,992,800 |   |   |   | |   |Depreciation |5,460,000 |   |   |   | |   |EBIT |$29,827,200 |   |   |   | |   |Interest |3,009,000 |   |   |   | |   |Taxable income |$26,818,200 |   |   |   | |   |Taxes (40%) |10,727,280 |   |   |   | |   |Net income |$16,090,920 |   |   |   | |   |   | |   |   |   | |   |Dividends |$9,654,552 |   |   |   | |   |Add to RE |6,436,368 |   |   |   |    |Balance sheet | |   |Assets |   |Liabilities & Equity | |   |Curren t Assets | |   |Current Liabilities | | |   | Cash |$3,650,400 |   | Accounts Payable |$7,753,200 | |   | Accounts rec. |6,567,600 |   | Notes Payable |15,693,600 | |   | Inventory |7,363,200 |   | Total CL |$23,446,800 | |   | Total CA |$17,581,200 |   |   | | |   | |   |Long-term debt |$33,735,000 | |   | | |   |   | | |   | | |   |Shareholder Equity | | |   |   | |   | Common stock |$5,200,000 | |   |Fixed assets | |   | Retained earnings |56,577,368 | |   | Net PP&E |$112,756,800 |   | Total Equity |$61,777,368 | |   |   | |   |   | | |   |Total Assets |$130,338,000 |   |Total L&E |$118,959,168 | So, the EFN is: EFN = Total assets – Total liabilities and equity EFN = $130,338,000 – 118,959,168 EFN = $8,753,040 5. Now we are assuming the company can only build in amounts of $30 million. We will assume that the company will go ahead with the fixed asset acquisition. In this case, the pro forma financial stat ement calculation will change slightly. Before, we made the assumption that depreciation increased proportionally with sales, which makes sense if fixed assets increase proportionally with sales. This is not the case now. To estimate the new depreciation charge, we will find the current depreciation as a percentage of fixed assets, then, apply this percentage to the new fixed assets. The depreciation as a percentage of assets this year was: Depreciation percentage = $5,460,000 / $93,964,000 Depreciation percentage = . 0581 or 5. 81% The new level of fixed assets with the $30 million purchase will be: New fixed assets = $93,964,000 + 30,000,000 = $123,964,000 So, the pro forma depreciation as a percentage of sales will be: Pro forma depreciation = . 0581($123,964,000) Pro forma depreciation = $7,203,221 We will use this amount in the pro form income statement. So, the pro forma income statement will be:    |Income statement |   |   |   | |   |Sales |$200,772,000 |   |   |   | |   |COGS |141,492,000 |   |   |   | |   |Other expenses |23,992,800 |   |   |   | |   |Depreciation |7,203,221 |   |   |   | |   |EBIT |$28,083,979 |   |   |   | |   |Interest |3 ,009,000 |   |   |   | |   |Taxable income |$25,074,979 |   |   |   | |   |Taxes (40%) |10,029,992 |   |   |   | |   |Net income |$15,044,988 |   |   |   | |   |   | |   |   |   | |   |Dividends |$9,026,993 |   |   |   | |   |Add to RE |6,017,995 |   |   |   | The pro forma balance sheet will remain the same except for the fixed asset and equity accounts. The fixed asset account will increase by $30 million, rather than the growth rate of sales. |   |Balance sheet | |   |Assets |   |Liabilities & Equity | |   |Current Assets | |   |Current Liabilities | | |   | Cash |$3,650,400 |   | Accounts Payable |$7,753,200 | |   | Accounts rec. 6,567,600 |   | Notes Payable |15,693,600 | |   | Inventory |7,363,200 |   | Total CL |$23,446,800 | |   | Total CA |$17,581,200 |   |   | | |   |   | |   |Long-term debt |$33,735,000 | |   | | |   |   | | |   | | |   |Shareholder Equity | | |   |   | |   | Common stock |$5,200,000 | |   |Fixed assets | |   | Retained earnings |56,158,995 | |   | Net PP&E |$123,964,000 |   | Total Equity |$61,358,995 | |   | |   |   | | |   |Total Assets |$141,545,200 |   |Total L&E |$118,540,795 | So, the EFN is: EFN = Total assets – Total liabilities and equity EFN = $141,545,200 – 118,540,795 EFN = $23,004,405 Since the fixed assets ha ve increased at a faster percentage than sales, the capacity utilization for next year will decrease. CHAPTER 4 THE MBA DECISION 1. Age is obviously an important factor. The younger an individual is, the more time there is for the (hopefully) increased salary to offset the cost of the decision to return to school for an MBA. The cost includes both the explicit costs such as tuition, as well as the opportunity cost of the lost salary. 2. Perhaps the most important nonquantifiable factors would be whether or not he is married and if he has any children. With a spouse and/or children, he may be less inclined to return for an MBA since his family may be less amenable to the time and money constraints imposed by classes. Other factors would include his willingness and desire to pursue an MBA, job satisfaction, and how important the prestige of a job is to him, regardless of the salary. 3. He has three choices: remain at his current job, pursue a Wilton MBA, or pursue a Mt. Perry MBA. In this analysis, room and board costs are irrelevant since presumably they will be the same whether he attends college or keeps his current job. We need to find the aftertax value of each, so: Remain at current job: Aftertax salary = $60,000(1 – . 26) = $44,400 His salary will grow at 3 percent per year, so the present value of his aftertax salary is: PV = C {[1/(r – g)] – [1/(r – g)] ? [(1 + g)/(1 + r)]t} PV = $44,400{[1/(. 065 – . 03)] – [1/(. 065 – . 03)] ? [(1 + . 03)/(1 + . 065)]40} PV = $935,283. 49 Wilton MBA: Costs: The direct costs will occur today and in one year and include tuition, books and supplies, health insurance, and the room and board increase. So the total direct costs are: PV of direct expenses = ($65,000 + 3,000 + 3,000 + 2,000) + ($65,000 + 3,000 + 3,000 + 2,500) / 1. 065 PV of direct expenses = $141,544. 60 The indirect costs are the lost salary, so the value of the indirect costs are: PV of indirect costs (lost salary) = $44,400 / (1. 065) + $44,400(1 + . 03) / (1 + . 065)2 PV of indirect costs (lost salary) = $82,010. 18 The financial benefits are the bonus to be paid in 2 years and the future salary. PV of aftertax bonus paid in 2 years = $20,000(1 – . 31) / 1. 0652 = $12,166. 90 Aftertax salary = $10,000(1 – . 31) = $75,900 His salary will grow at 4 percent per year. We must also remember that he will now only work for 38 years, so the present value of his aftertax salary is: PV = C {[1/(r – g)] – [1/(r – g)] ? [(1 + g)/(1 + r)]t} PV = $75,900{[1/(. 065 – . 04)] – [1/(. 065 – . 04)] ? [(1 + . 04)/(1 + . 065)]38} PV = $1,804,927. 68 Since the first salary payment will be received three years from today, so we need to discount this for two years to find the value today, which will be: PV = $1,804,927. 68 / 1. 0652 PV = $1,591,331. 25 So, the total value of a Wilton MBA is: Value = –$141,544. 60 – 82,010. 18 + 12,166. 90 + 1,591,331. 25 = $1,379,943. 36 Mount Perry MBA: The direct costs will occur today and include tuition, books and supplies, health insurance, and the room and board increase. So the total direct costs are: Total direct costs = $80,000 + 4,500 + 3,000 + 2,000 = $89,500. Note, this is also the PV of the direct costs since they are all paid today. The indirect costs are the lost salary, so the value of the indirect costs are: PV of indirect costs (lost salary) = $44,400 / (1. 065) = $41,690. 14 The financial benefits are the bonus to be paid in 1 year and the future salary. PV of aftertax bonus paid in 1 year = $18,000(1 – . 29) / 1. 065 = $12,000 His aftertax salary at his new job will be: Aftertax salary = $80,000(1 – . 29) = $65,320 His salary will grow at 3. 5 percent per year. We must also remember that he will now only work for 39 years, so the present value of his aftertax salary is: PV = C {[1/(r – g)] – [1/(r – g)] ? [(1 + g)/(1 + r)]t} PV = $65,320{[1/(. 065 – . 035)] – [1/(. 065 – . 035)] ? [(1 + . 035)/(1 + . 065)]35} PV = $1,462,896. 46 Since the first salary payment will be received two years from today, so we need to discount this for one year to find the value today, which will be: PV = $1,462,896. 46 / 1. 065 PV = $1,373,611. 70 So, the total value of a Mount Perry MBA is: Value = –$89,500 – 41,690. 14 + 12,000 + 1,373,611. 70 = $1,254,421. 56 4. He is somewhat correct. Calculating the future value of each decision will result in the option with the highest present value having the highest future value. Thus, a future value analysis will result in the same decision. However, his statement that a future value analysis is the correct method is wrong since a present value analysis will give the correct answer as well. 5. To find the salary offer he would need to make the Wilton MBA as financially attractive as the as the current job, we need to take the PV of his current job, add the costs of attending Wilton, and the PV of the bonus on an aftertax basis. Note, this assumes that the singing bonus is constant. So, the necessary PV to make the Wilton MBA the same as his current job will be: PV = $935,283. 49 + 1414,544. 60 + 82,010. 18 – 12,166. 90 = $1,146,671. 37 This PV will make his current job exactly equal to the Wilton MBA on a financial basis. Since the salary will not start for 3 years, we need to find the value in 2 years so that it is the present value of growing annuity. So: Value in 2 years = $1,146,671. 37(1. 0652) = $1,300,583. 34 Since his salary will still be a growing annuity, the aftertax salary needed is: PV = C {[1/(r – g)] – [1/(r – g)] ? [(1 + g)/(1 + r)]t} $1,300,583. 34 = C {[1/(. 065 – . 04)] – [1/(. 065 – . 04)] ? [(1 + . 04)/(1 + . 065)]38} C = $54,691. 54 This is the aftertax salary. So, the pretax salary must be: Pretax salary = $54,691. 54 / (1 – . 31) = $76,263. 10 6. The cost (interest rate) of the decision depends on the riskiness of the use of funds, not the source of the funds. Therefore, whether he can pay cash or must borrow is irrelevant. This is an important concept which will be discussed further in capital budgeting and the cost of capital in later chapters. CHAPTER 5 BULLOCK GOLD MINING 1. An example spreadsheet is: [pic] 2. Since the NPV of the mine is positive, the company should open the mine. We should note, it may be advantageous to delay the mine opening because of real options, a topic covered in more detail in a later chapter. 3. There are many possible variations on the VBA code to calculate the payback period. Below is a VBA program from http://www. vbaexpress. com/kb/getarticle. php? kb_id=252. Function PAYBACK(invest, finflow) Dim x As Double, v As Double Dim c As Integer, i As Integer x = Abs(invest) i = 1 c = finflow. Count Do x = x – v v = finflow. Cells(i). Value If x = v Then PAYBACK = i Exit Function ElseIf x < v Then P = i – 1 Z = x / v PAYBACK = P + Z Exit Function End If i = i + 1 Loop Until i > c PAYBACK = â€Å"no payback† End Function CHAPTER 6, Case #1 BETHESDA MINING To analyze this project, we must calculate the incremental cash flows generated by the project. Since net working capital is built up ahead of sales, the initial cash flow depends in part on this cash outflow. So, we will begin by calculating sales. Each year, the company will sell 500,000 tons under contract, and the rest on the spot market. The total sales revenue is the price per ton under contract times 500,000 tons, plus the spot market sales times the spot market price. The sales per year will be:    | |Year 1 |Year 2 |Year 3 |Year 4 | |   |Contract |$47,500,000 |$47,500,000 |$47,500,000 |$47,500,000 | |   |Spot |10,800,000 |16,200,000 |20,700,000 |8,100,000 | |   |Total |$58,300,000 |$63,700,000 |$68,200,000 |$55,600,000 | The current aftertax value of the land is an opportunity cost. The initial outlay for net wor king capital is the percentage required net working capital times Year 1 sales, or: Initial net working capital = . 05($58,300,000) = $2,915,000 So, the cash flow today is:    |Equipment |–$85,000,000 | |   |Land |–7,000,000 | |   |NWC |–2,915,000 | |   |Total |–$94,915,000 | Now we can calculate the OCF each year. The OCF is: | | |Year 1 |Year 2 |Year 3 |Year 4 |Year 5 |Year 6 | |   |Sales |$58,300,000 |$63,700,000 |$68,200,000 |$55,600,000 | | | |   |VC |19,220,000 |21,080,000 |22,630,000 |18,290,000 | | | |   |FC |4,300,000 |4,300,000 |4,300,000 |4,300,000 |$2,800,000 |$7,500,000 | |   |Dep. 12,155,000 |20,825,000 |14,875,000 |10,625,000 | | | |   |EBT |$22,625,000 |$17,495,000 |$26,395,000 |$22,385,000 |–$2,800,000 |–$7,500,000 | |   |Tax |8,597,500 |6,648,100 |10,030,100 |8,506,300 |1,064,000 |2,850,000 | |   |NI |$14,027,500 |$10,846,900 |$16,364,900 |$13,878,700 |–$1,736,000 |–$4,650,000 | |   |+ Dep. |12,155,000 |20,825,000 |14,875,000 |10,625,000 |0 |0 | |   |OCF |$26,182,500 |$31,671,900 |$31,239,900 |$24,503,700 |–$1,736,000 |–$4,650,000 | Years 5 and 6 are of particular interest. Year 5 has an expense of $2. 8 million to reclaim the land, and it is the only expense for the year. Taxes that year are a credit, an assumption given in the case. In Year 6, the charitable donation of the land is an expense, again resulting in a tax credit. The land does have an opportunity cost, but no information on the aftertax salvage value of the land is provided. The implicit assumption in this calculation is that the aftertax salvage value of the land in Year 6 is equal to the $7. 5 million charitable expense. Next, we need to calculate the net working capital cash flow each year. NWC is 5 percent of next year’s sales, so the NWC requirement each year is: |   | |Year 1 |Year 2 |Year 3 |Year 4 | |   |Beg. NWC |$2,915,000 |$3,185,000 |$3,410,000 |$2,780,000 | |   |End NWC |3,185,000 |3,410,000 |2,780,000 | | |   |NWC CF |–$270,000 |–$225,000 |$630,000 |$2,780,000 | The last cash flow we need to account for is the salvage value. The fact that the company is keeping the equipment for another project is irrelevant. The aftertax salvage value of the equipment should be used as the cost of equipment for the new project. In other words, the equipment could be sold after this project. Keeping the equipment is an opportunity cost associated with that project. The book value of the equipment is the original cost, minus the accumulated depreciation, or: Book value of equipment = $85,000,000 – 12,155,000 – 20,825,000 – 14,875,000 – 10,625,000 Book value of equipment = $26,520,000 Since the market value of the equipment is $51 million, the equipment is sold at a gain to book value, so the sale will incur the taxes of: Taxes on sale of equipment = ($26,520,000 – 51,000,000)(. 38) = –$9,302,400 And the aftertax salvage value of the equipment is: Aftertax salvage value = $51,000,000 – 9,302,400 Aftertax salvage value = $41,697,600 So, the net cash flows each year, including the operating cash flow, net working capital, and aftertax salvage value, are: |   |Time |Cash flow | |   |0 |–$94,915,000 | |   |1 |25,912,500 | |   |2 |31,446,900 |    |3 |31,869,900 | |   |4 |68,981,300 | |   |5 |–1,736,000 | |   |6 |–4,650,000 | So, the capital budgeting analysis for the project is: Payback period = 3 + $5,685,700/$68,981,300 Payback period = 3. 08 years Profitability index = ($25,912,500/1. 12 + $31,446,900/1. 122 + $31,869,900/1. 123 + $68,981,300/1. 124 – $1,736,000/1. 125 – $4,650,000/1. 126) / $94 ,915,000 Profitability index = 1. 174 To calculate the AAR, we divide the average net income by the average book value. Since the cash flows from the project extend for two years past the end of mining operation, we will include an average book value of zero for the last two years. So, the AAR is: AAR = [($14,027,500 + 10,846,900 + 16,364,900 + 13,878,000 – 1,736,000 – 4,650,000) / 6] / [(85,000,000 + 72,845,000 + 52,020,000 + 37,145,000 + 26,520,000 + 0) / 7] AAR = . 1485 or 14. 85% The equation for IRR is: 0 = –$94,915,000 + $25,912,500/(1 + IRR) + $31,446,900/(1 + IRR)2 + $31,869,900/(1 + IRR)3 + $68,981,300/(1 + IRR)4 – $1,736,000/(1 + IRR)5 – $4,650,000/(1 + IRR)6 Using a spreadsheet or financial calculator, the IRRs for the project are: IRR = 19. 1%, –74. 64% MIRR = 12. 94% NPV = –$94,915,000 + $25,912,500/1. 12 + $31,446,900/1. 122 + $31,869,900/1. 123 + $68,981,300/1. 124 – $1,736,000/1. 125 – $4,650,000/1. 126 NPV = $16,472,777. 67 In the final analysis, the company should accept the project since the NPV is positive. CHAPTER 6, C ase #2 GOODWEEK TIRES, INC. The cash flow to start the project is the $120 million equipment cost and the $11 million required for net working capital, yielding a total cash outflow today of $131 million. The research and development costs and the marketing test are sunk costs. We can calculate the future cash flows on a nominal basis or a real basis. Since the depreciation is given in nominal values, we will calculate the cash flows in nominal terms. The same solution can be found using real cash flows. Since the price and variable costs increase by 1 percent, and the inflation rate is 3. 5 percent, the nominal growth in both variables is: (1 + R) = (1 + r)(1 + h) R = [(1. 01)(1. 0325)] – 1 R = . 0428 or 4. 28% To analyze this project, we must calculate the incremental cash flows generated by the project. We will calculate the real cash flows, although using nominal cash flows will result in the same NPV. The sales of new automobiles will grow by 2. 5 percent per year, and there are four tires per car. Since the company expects to capture 11 percent of the market, the number of tires sold in the OEM market will be: |   | |Year 1 |Year 2 |Year 3 |Year 4 | | |Automobiles sold |5,600,000 |5,740,000 |5,883,500 |6,030,588 | |   |Tires for automobiles sold |22,400,000 |22,960,000 |23,534,000 |24,122,350 | |   |SuperTread tires sold |2,464,000 |2,525,600 |2,588,740 |2,653,459 | The number of tires sold in the replacement market will grow at 2 percent per year, and Goodweek will capture 8 percent of the market. So, the number of tires sold in the replacement market will be: |   | |Year 1 |Year 2 |Year 3 |Year 4 | |   |Total tires sold in market |14,000,000 |14,280,000 |14,565,600 |14,856,912 | |   |SuperTread tires sold |1,120,000 |1,142,400 |1,165,248 |1,188,553 | The tires will be sold in each market at a different price. The price will increase each year at the inflation rate, so the price each year will be:    | |Year 1 |Year 2 |Year 3 |Year 4 | |   |OEM |$38. 00 |$39. 24 |$40. 51 |$41. 83 | |   |Replacement |$59. 00 |$60. 92 |$62. 90 |$64. 94 | Multiplying the number of tires sold in each market by the respective price in that market, the revenue each year will be: |   | |Year 1 |Year 2 |Year 3 |Year 4 | |   |OEM market |$93,632,000 |$99,091,916 $104,870,213 |$110,985,458 | |   |Replacement market |66,080,000 |69,592,152 |73,290,975 |7 7,186,390 | |   |Total |$159,712,000 |$168,684,068 |$178,161,188 |$188,171,848 | Now we can calculate the incremental cash flows each year. We will calculate the nominal cash flows. Doing so, we find: |   | |Year 1 |Year 2 |Year 3 |Year 4 | |   |Revenue |$159,712,000 |$168,684,068 |$178,161,188 |$188,171,848 | |   |Variable costs |78,848,000 |84,151,806 |85,026,717 |87,024,208 | |   |Mkt. nd general costs |26,000,000 |26,845,000 |27,717,463 |28,618,280 | |   |Depreciation |20,020,000 |34,300,000 |24,500,000 |17,500,000 | |   |EBT |$34,844,000 |$23,387,262 |$40,917,008 |$55,029,360 | |   |Tax |13,937,600 |9,354,905 |16,366,803 |22,011,744 | |   |Net income |$20,906,400 |$14,032,357 |$24,550,205 |$33,017,616 | |   |OCF |$40,926,400 |$48,332,357 |$49,050,205 |$50,517,616 | Net working capital is a percentage of sales, so the net working capital requirements will change every year. The net working capital cash flows will be:    | |Year 1 |Year 2 |Year 3 |Year 4 | |    |Beginning |$9,000,000 |$23,956,800 |$25,302,610 |$26,724,178 | |   |Ending |23,956,800 |25,302,610 |26,724,178 |0 | |   |NWC cash flow |–$14,956,800 |–$1,345,810 |–$1,421,568 |$26,724,178 | The book value of the equipment is the original cost minus the accumulated depreciation. The book value of equipment each year will be:    |   |Year 1 |Year 2 |Year 3 |Year 4 | |   |Book value of equipment |$119,980,000 |$85,680,000 |$61,180,000 |$43,680,000 | Since the market value of the equipment is $54 million, the equipment is sold at a gain to book value, so the sale will incur the taxes of: Taxes on sale of equipment = ($46,680,000 – 54,000,000)(. 40) = $4,128,000 And the aftertax salvage value of the equipment is: Aftertax salvage value = $54,000,000 – 4,128,000 Aftertax salvage value = $89,872,000 So, the net cash flows each year, including the operating cash flow, net working capital, and aftertax salvage value, are:    |Time |Cash fl ow | | |   |0 |–$149,000,000 | | |   |1 |25,969,600 | | |   |2 |49,986,547 | | |   |3 |47,628,637 | | |   |4 |127,113,794 | | So, the capital budgeting analysis for the project is: Payback period = 3 + $28,415,213 / $127,113,794 Payback period = 3. 22 years The discounted cash flows are:    |Time |Discounted cash flow | |   |0 |–$149,000,000 | |   |1 |22,406,903 | |   |2 |34,978,941 | |   |3 |30,592,703 | |   |4 |70,446,422 | Discounted payback period = 3 + $61,021,454 / $70,446,422 Discounted payback period = 3. 27 years The required return for the project is in nominal terms, so the profitability index is: Profitability index = ($25,969,600/1. 15 + $49,986,547/1. 152 + $47,628,637/1. 153 + $96,714,733/1. 154) / $149,000,000 Profitability index = 1. 63 The equation for IRR is: 0 = –$149,000,000 + $25,969,600/(1 + IRR) + $49,986,547/(1 + IRR)2 + $47,628,637/(1 + IRR)3 + $96,714,733/(1 + IRR)4 Using a spreadsheet or financial calculator, the IRR for the project is: IRR = 18. 35% AAR = [(20,926,400 + 14,032,357 + 24,550,205 + 33,017,606)/4] / [($140,000,000 + 119,980,000 + 85,860,000 + 61,1180,000 + 43,680,000)/5} AAR = 25. 67% NPV = –$149,000,000 + $25,696,600/(1. 15) + $46,986,547/(1. 15)2 + $47,628,637/(1. 15)3 + $127,113,794/(1. 15)4 NPV = $9,424,967. 81 In the final analysis, the company should accept the project since the NPV is positive. CHAPTER 7 BUNYAN LUMBER, LLC The company is faced with the option of when to harvest the lumber. Whatever harvest cycle the company chooses, it will follow that cycle in perpetuity. Since the forest was planted 20 years ago, the options available in the case are 40-, 45-, 50, and 55-year harvest cycles. No matter what harvest cycle the company chooses, it will always thin the timber 20 years after harvests and replants. The cash flows will grow at the inflation rate, so we can use the real or nominal cash flows. In this case, it is simpler to use real cash flows, although nominal cash flows would yield the same result. So, the real required return on the project is: (1 + R) = (1 + r)(1 + h) 1. 10 = (1 + r)(1. 37) r = . 0608 or 6. 08% The conservation funds are expected to grow at a slower rate than inflation, so the real return for the conservation fund will be: (1 + R) = (1 + r)(1 + h) 1. 10 = (1 + r)(1. 032) r = . 0659 or 6. 59% The company will thin the forest today regardless of the harvest schedule, so this first thinning is not an incremental cash flow, but future thinning is part of the analysis since the thinning schedule is determined by the harvest schedule. The cash flow from the thinning process is: Cash flow from thinning = Acres thinned ? Cash flow per acre Cash flow from thinning = 5,000($1,000) Cash flow from thinning = $5,000,000 The real cost of the conservation fund is constant, but the expense will be tax deductible, so the aftertax cost of the conservation fund will be: Aftertax conservation fund cost = (1 – . 35)($250,000) Aftertax conservation fund cost = $162,500 For each analysis, the revenue and costs are: Revenue = [? (% of grade)(harvest per acre)(value of board grade)](acres harvested)(1 – defect rate) Tractor cost = (Cost MBF)(MBF per acre)(acres) Road cost = (Cost MBF)(MBF per acre)(acres) Sale preparation and administration = (Cost MBF)(MBF acre)(acres) Excavator piling, broadcast burning, site preparation, and planting costs are the cost of each per acre times the number of acres. These costs are the same no matter what the harvest schedule since they are based on acres, not MBF. Now we can calculate the cash flow for each harvest schedule. One important note is that no depreciation is given in the case. Since the harvest time is likely to be short, the assumption is that no depreciation is attributable to the harvest. This implies that operating cash flow is equal to net income. Now we can calculate the NPV of each harvest schedule. The NPV of each harvest schedule is the NPV of the first harvest, the NPV of the thinning, the NPV of all future harvests, minus the present value of the conservation fund costs. 40-year harvest schedule:    |Revenue |$42,194,250 | |   |Tractor cost |9,870,000 | |   |Road |3,525,000 | |   |Sale preparation & admin |1,269,000 | |   |Excavator piling |750,000 | |   |Broadcast burning |1,500,000 | |   |Site preparation |725,000 | |   |Planting costs |1,125,000 | |   |EBIT |$23,430,250 | |   |Taxes |8,200,588 | |   |Net income (OCF) |$15,229,663 | The PV of the first harvest in 20 years is: PVFirst = $15,229,663/(1 + . 0608)20 PVFirst = $4,681,788 Thinning will also occur on a 40-year schedule, with the next thinning 40 years from today. The effective 40-year interest rate for the project is: 40-year project interest rate = [(1 + . 0608)40] – 1 40-year project interest rate = 958. 17% We also need the 40-year interest rate for the conservation fund, which will be: 40-year conservation interest rate = [(1 + . 0659)40] – 1 40-year conservation interest rate = 1,183. 87% Since we have the cash flows from each thinning, and the next thinning will occur in 40 years, we can find the present value of future thinning on this schedule, which will be: PVThinning = $5,000,000/9. 5817 PVThinning = $521,825. 80 The operating cash flow from each harvest on the 40-year schedule is $15,229,663, so the present value of the cash flows from the harvest are: PVHarvest = [($15,229,663/9. 5817)] / (1 + . 0608)20 PVHarvest = $488,615. 51 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 20 is: PVConservation = –$162,500 – $162,500/11. 8387 PVConservation = –$176,226. 22 And the value today is: PVConservation = –$175,226. 22/(1 + . 0659)20 PVConservation = –$49,182. 52 So, the NPV of a 40-year harvest schedule is: NPV = $4,681,788 + 521,825. 80 + 488,615. 51 – 49,182. 52 NPV = $5,643,046. 36 45-year harvest schedule:    |Revenue |$49,232,800 | |   |Tractor cost |11,480,000 | |   |Road |4,100,000 | |   |Sale preparation & admin |1,476,000 | |   |Excavator piling |750,000 | |   |Broadcast burning |1,500,000 | |   |Site preparation |725,000 | |   |Planting costs |1,125,000 | |   | EBIT |$28,076,800 | |   |Taxes |9,826,880 | | |Net income (OCF) |$18,249,920 | The PV of the first harvest in 25 years is: PVFirst = $18,249,920/(1 + . 0608)25 PVFirst = $4,177,464 Thinning will also occur on a 45-year schedule, with the next thinning 45 years from today. The effective 45-year interest rate for the project is: 45-year project interest rate = [(1 + . 0608)45] – 1 45-year project interest rate = 1,321. 11% We also need the 45-year interest rate for the conservation fund, which will be: 45-year conservation interest rate = [(1 + . 0659)45] – 1 45-year conservation interest rate = 1,666. 38% Since we have the cash flows from each thinning, and the next thinning will occur in 45 years, we can find the present value of future thinning on this schedule, which will be: PVThinning = $5,000,000/13. 2111 PVThinning = $378,470. 46 The operating cash flow from each harvest on the 45-year schedule is $18,249,920, so the present value of the cash flows from the harvest are: PVHarvest = [($18,249,920/13. 21111)] / (1 + . 0608)25 PVHarvest = $316,209. 37 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 25 is: PVConservation = –$162,500 – $162,500/16. 6638 PVConservation = –$174,800. 29 And the value today is: PVConservation = –$174,800. 29/(1 + . 0659)25 PVConservation = –$35,458. 26 So, the NPV of a 45-year harvest schedule is: NPV = $4,177,464 + 378,470. 46 + 316,209. 37 – 35,458. 26 NPV = $4,836,685. 86 50-year harvest schedule:    |Revenue |$52,024,993 | |   |Tractor cost |12,110,000 | |   |Road |4,325,000 | |   |Sale preparation & admin |1,557,000 | |   |Excavator piling |750,000 | |   |Broadcast burning |1,500,000 | |   |Site preparation |725,000 | |   |Planting costs |1,125,000 | |   |EBIT |$29,932,993 | |   |Taxes |10,476,547 | |   |Net income (OCF) |$19,456,445 | The PV of the first harvest in 30 years is: PVFirst = $19,456,445/(1 + . 0608)30 PVFirst = $3,316,238 Thinning will also occur on a 50-year schedule, with the next thinning 50 years from today. The effective 50-year interest rate for the project is: 50-year project interest rate = [(1 + . 0608)50] – 1 50-year project interest rate = 1,808. 52% We also need the 50-year interest rate for the conservation fund, which will be: 50-year conservation interest rate = [(1 + . 0659)50] – 1 50-year conservation interest rate = 2,330. 24% Since we have the cash flows from each thinning, and the next thinning will occur in 50 years, we can find the present value of future thinning on this schedule, which will be: PVThinning = $5,000,000/18. 0852 PVThinning = $276,468. 34 The operating cash flow from each harvest on the 50-year schedule is $19,456,445, so the present value of the cash flows from the harvest are: PVHarvest = [($19,456,445/18. 0852] / (1 + . 0608)30 PVHarvest = $183,367. 60 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 30 is: PVConservation = –$162,500 – $162,500/23. 3024 PVConservation = –$171,485. 25 And the value today is: PVConservation = –$171,485. 25/(1 + . 0659)30 PVConservation = –$25,283. 50 So, the NPV of a 50-year harvest schedule is: NPV = $3,316,238 + 276,469. 34 + 183,367. 60 – 25,283. 50 NPV = $3,750,790. 98 55-year harvest schedule:    |Revenue |$54,516,748 | |   |Tractor cost |12,670,000 | |   |Road |4,525,000 | |   |Sale preparation & admin |1,629,000 | |   |Excavator piling |750,000 | |   |Broadcast burning |1,500,000 | |   |Site preparation |725,000 | |   |Planting costs |1,125,000 | |   | EBIT |$31,592,748 | |   |Taxes |11,057,462 | |   |Net income (OCF) |$20,535,286 | The PV of the first harvest in 35 years is: PVFirst = $20,535,286/(1 + . 0608)35 PVFirst = $2,606,233 Thinning will also occur on a 55-year schedule, with the next thinning 55 years from today. The effective 55-year interest rate for the project is: 55-year project interest rate = [(1 + . 0608)55] – 1 55-year project interest rate = 2,463. 10 We also need the 55-year interest rate for the conservation fund, which will be: 55-year conservation interest rate = [(1 + . 0659)55] – 1 55-year conservation interest rate = 3,243. 60% Since we have the cash flows from each thinning, and the next thinning will occur in 55 years, we can find the present value of future thinning on this schedule, which will be: PVThinning = $5,000,000/24. 6310 PVThinning = $202,995. 97 The operating cash flow from each harvest on the 55-year schedule is $20,535,286, so the present value of the cash flows from the harvest are: PVHarvest = [($20,535,286/24. 6310] / (1 + . 0608)35 PVHarvest = $105,810. 96 Now we can find the present value of the conservation fund deposits. The present value of these deposits is at Year 35 is: PVConservation = –$162,500 – $162,500/32. 4360 PVConservation = –$169,097. 37 And the value today is: PVConservation = –$169,097. 37/(1 + . 0659)35 PVConservation = –$18,121. 00 So, the NPV of a 55-year harvest schedule is: NPV = $2,606,233 + 202,995. 97 + 105,810. 96 – 18,121. 00 NPV = $2,896,918. 96 The company should use a 40-year harvest schedule since it has the highest NPV. Notice that when the NPV began to decline, it continued declining. This is expected since the growth in the trees increases at a decreasing rate. So, once we reach a point where the increased growth cannot overcome the increased effects of compounding, harvesting should take place. There is no point further in the future which will provide a higher NPV. CHAPTER 8 FINANCING EAST COAST YACHT’S EXPANSION PLANS WITH A BOND ISSUE 1. A rule of thumb with bond provisions is to determine who the provisions benefit. If the company benefits, the bond will have a higher coupon rate. If the bondholders benefit, the bond will have a lower coupon rate. a. A bond with collateral will have a lower coupon rate. Bondholders have the claim on the collateral, even in bankruptcy. Collateral provides an asset that bondholders can claim, which lowers their risk in default. The downside of collateral is that the company generally cannot sell the asset used as collateral, and they will generally have to keep the asset in good working order. b. The more senior the bond is, the lower the coupon rate. Senior bonds get full payment in bankruptcy proceedings before subordinated bonds receive any payment. A potential problem may arise in that the bond covenant may restrict the company from issuing any future bonds senior to the current bonds. c. A sinking fund will reduce the coupon rate because it is a partial guarantee to bondholders. The problem with a sinking fund is that the company must make the interim payments into a sinking fund or face default. This means the company must be able to generate these cash flows. d. A provision with a specific call date and prices would increase the coupon rate. The call provision would only be used when it is to the company’s advantage, thus the bondholder’s disadvantage. The downside is the higher coupon rate. The company b

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