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[answered] MBA 655 Quiz 4 General Energy Storage Systems General Energ


? I need the answers for this case study please...I know for a fact that my 2nd answer is wrong...so if you can redo it with the right answers. Thank you. It is for MBA finance class.


MBA 655

 

Quiz 4

 

General Energy Storage Systems

 

General Energy Storage Systems (GESS) was founded in 2002 by Ian Redoks,

 

a Ph.D. candidate in physics who was interested in ?outside-the-box?

 

solutions to the problem of storing electrical energy. Redoks had obtained

 

several patents with potential applications for plug-in hybrid cars, off-grid

 

home electrical systems, and large-scale storage of commercial electricity,

 

produced by conventional means from excess capacity at off-peak hours or

 

from non-fossil-fuel sources such as solar power and wind power.

 

The timeliness of Redoks?s research has quickly attracted investors. For

 

example, GESS has won contracts from an automobile company to

 

manufacture batteries for a limited-production plug-in hybrid. It is also ready

 

to begin commercial production of storage components for off-grid home

 

electrical systems. More product means more storage space, however. To

 

acquire the necessary manufacturing facilities, GESS needs to obtain

 

additional financing.

 

Up to this point, GESS?s primary source of funds had been form the sale of

 

stock. The company is entirely equity-financed except for current liabilities

 

incurred in the course of day-to-day operations. There are 200,000 shares

 

outstanding, which are mostly owned by large, diverse technology

 

companies that may wish to partner with or even acquire GESS at some

 

point in the future. The shares trade occasionally in the NASDAQ over-thecounter market at an average price of $20.00.

 

The investment bankers who placed the stock have suggested that an alldebt plan would minimize taxes, but it would be risky and leave little room

 

for future borrowing. Instead, they recommend staying close to the industry

 

averages for debt-to-assets and debt-to-equity ratios. They have proposed

 

two alternative plans:

 

a. Plan A calls for $2,000,000 of new equity (100,000 new shares at the

 

firm?s current stock price of approximately $20.00) and $4,000,000 of

 

privately placed debt at 9%.

 

b. Plan B calls for $4,000,000 of new equity (200,000 new shares at the

 

current stock price of $20.00) and $2,000,000 of privately placed debt

 

at 8%

 

Under either plan, GESS?s combined state and federal marginal tax rate will

 

be 40%.

 

Required: 1. Why should GESS expect to pay a higher rate of interest if it borrows

 

$4,000,000 rather than $2,000,000?

 

2. Estimate earnings per share for Plan A and Plan B at EBIT levels of

 

$800,000, $1,000,000 and $1,200,000.

 

3. At what level of EBIT would EPS be the same under either plan?

 

4. Suppose GESS?s management is fairly confident the EBIT will be at

 

least $1,000,000. Which plan would the firm be most likely to choose? 1) Interest on debt would be higher for higher amounts as risks are more with

 

higher

 

Financial leverage; i.e.: higher debt ratio. Hence, the firm has to pay higher interest for a

 

higher loan.

 

2)

 

EBIT of

 

$800000 EBIT of $1000000 EBIT of $1200000 Plan A Plan B Plan A Plan B Plan A Plan B EBIT 80000

 

0 80000

 

0 100000

 

0 100000

 

0 120000

 

0 120000

 

0 Interest 36000

 

0 16000

 

0 360000 160000 360000 160000 EBT 44000

 

0 64000

 

0 640000 840000 840000 104000

 

0 Tax at 40% 17600

 

0 25600

 

0 256000 336000 336000 416000 Net Income 26400

 

0 38400

 

0 384000 504000 504000 624000 # shares 10000

 

0 20000

 

0 100000 200000 100000 200000 EPS 2.64 1.92 3.84 2.52 5.04 3.12 3) EPS would be same

 

if

 

(E-360000)*0.6/100000 = (E-160000)*0.6/200000, where E is the EBIT level to

 

be found out.

 

(E-360000)*0.6 = (E160000)*0.3

 

2E - 720000 = E 160000

 

E = $560000

 

Check:

 

EBIT of

 

$560000

 

Plan A Plan B EBIT 56000

 

0 56000

 

0 Interest 36000

 

0 16000

 

0 EBT 20000

 

0 40000

 

0 Tax at 40% 80000 16000

 

0 Net Income 12000

 

0 24000

 

0 # shares 10000

 

0 20000

 

0 EPS 1.2 1.2 4) The firm will choose Plan A, as the EPS will be more. The EBIT level for equal

 

EPS is $560000.

 

If the expected EBIT is beyond this level, the plan with more debt will yield

 

higher EPS.

 


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