Reference no: EM131516208
Galaxy International is a small privately held company in the Northeast U.S. which manufactures high- tech carbon composite skis for the U.S. market. The company has been in business for 20 years, has 125 employees, and has $50 million in annual sales. Its owner, Jeremy Riven, is an ex-Olympic skier who developed the proprietary technology and bonding polymers that give Galaxy skis their unique flexibility, durability, and propensity to need low maintenance-all of which serious skiers in the U.S. have come to prize. Major costs involved in the manufacturing of skis are oil polymers, carbon fiber, and labor. Ski technicians are highly skilled machinists, and manufacturing the finished product is as much an art form as it is a science.
Jeremy has recently considered an initial public offering (IPO) to allow the firm to raise the funds it needs to go international. The underwriting group from Morgan Stanley believes they could easily raise sixty million in the equity markets, and fifty million in the bond market. Jeremy is trying to determine the cost of debt, the cost of equity (four million shares at $15/share), and the firm's weighted average cost of capital if he goes public and issues corporate bonds with a coupon rate of 4%. Last year, the firm resided in a 28% tax bracket. The risk-free rate in the U.S. is 2%, and the expected return on the market is 8%. Morgan Stanley estimates Galaxy's beta, if traded publicly, would be approximately 1.8. Galaxy has been growing at 12% a year since its inception.
Jeremy would like to expand his current U.S. facility from 40,000 square feet to 100,000 square feet, automate certain processes which heretofore have been done manually, and outsource work to China, where he plans to either build or lease a plant to extend his ski line worldwide. He could build a 50,000- square-foot facility in Canton for fifty million dollars, or lease a similar facility for ten million a year. Annual operating costs would be twenty million dollars, and projected free cash flow, based on past experience, would be twelve million a year (whether he leases or buys). The life of the plant would be fifteen years, and inflation in China is currently running at 2.5% annually. Galaxy would repatriate profits from the Chinese operation and consolidate them with those of the U.S. operations. All expenses of operating the plant in China would be in Yuan.
When determining whether Jeremy should lease or buy the plant in China, use the Internet to locate information about current events in China related to its economic state, foreign investment climate, and leasing versus buying restrictions. Complete a NPV analysis on both the lease and the buy options using the data provided.
Write a six to eight page paper in which you:
1. Examine the pros and cons of an IPO for Galaxy International. Recommend whether the company should or should not proceed with an IPO.
2. Evaluate the appropriateness of the financing alternatives and strategies that are available to Jeremy, and select the one you believe best suits the company. Provide support for your rationale.
3. Determine the advantages of debt over equity, and what each would cost after taxes. Determine Galaxy's weighted average cost of capital (WACC) if it uses both alternatives to raise capital (i.e., debt and equity).
4. Recommend one specific financial derivative contract that Jeremy could use to ensure a stable supply of oil for his operations and to protect his firm from currency translation losses. Provide support for your suggestion.
5. Suggest one specific type of financial derivative contract that Jeremy can use to hedge his currency translation and transaction exposure to the Yuan. Provide support for your suggestion. Note: You should discuss a different approach than the one recommended for the previous rubric.
6. Determine whether Jeremy should lease or buy the plant in China. Justify your position using information regarding the current economic state in China, foreign investment climate, and leasing versus buying restrictions. Complete a NPV analysis on both the lease and the buy options using the data provided to further support your recommendation.
7. Determine if a portfolio manager would want to participate in the IPO if Galaxy International goes public. Provide a rationale for your decision. Determine the expected return on the stock using Capital Asset Pricing Model (CAPM) and discuss how this affects your recommendation.
8. Determine if the Galaxy International's expected return on stock would exceed its WACC. Discuss how this affects your analysis.
9. Use at least five quality academic resources in this assignment. Note:Investopedia, Wikipedia and general commercial financial websites do not qualify as academic resources. Instead, you are expected to use acceptable academic journal references, government data sources and current statistics.
Your assignment must follow these formatting requirements:
• Be typed, double spaced, using Times New Roman font (size 12), with one-inch margins on all sides; citations and references must follow APA or school-specific format. Check with your professor for any additional instructions.
• Include a cover page containing the title of the assignment, the student's name, the professor's name, the course title, and the date. The cover page and the reference page are not included in the required assignment page length.
The specific course learning outcomes associated with this assignment are:
• Examine the concepts related to financial management and the financial environment.
• Evaluate different types of financing available in the marketplace and the related impact on firm value.
• Examine the various alternatives to managing and mitigating business and financial risk with the use of forwards, futures, swaps, and options.
• Evaluate how simulation and scenario analysis can be used to improve an organization's forecasting ability, and reach an optimal financing mix through the use of these methods.
• Develop strategies to protect a firm from financial distress.
• Examine the tools and methods used for portfolio analysis.
• Use technology and information resources to research issues in corporate finance.
• Write clearly and concisely about corporate finance using proper writing mechanics.