Homework 1 Assignment: Due via email by end of day November 6th.

This is an individual assignment and should NOT to be completed in groups

If you have questions regarding the homework, please email my Teaching Assistant Sohit Dave
([email protected]). He will be able to answer most questions regarding the case.
Case Overview
Consider Ideko Corporation, a privately held firm. The owner has decided to sell the business. Your job,
as a partner in KKP Investments, is to evaluate purchasing the company, implementing operational and
financial improvements, and selling the business at the end of five years. A price of $150 million for
Idekos equity has been suggested. To assess whether this investment is attractive, the operational aspects
of the firm and of the ultimate cash flows the deal is expected to generate need to be analyzed.
Operational Improvements:
By cutting administrative costs immediately and redirecting resources to new product development,
sales, and marketing, you believe Ideko can increase its market share from 10% to 15% over the next
five years.
The increased sales demand can be met in the short run using the existing production lines. Once the
growth in volume exceeds 50%, however, Ideko will need to undertake a major expansion to increase
its manufacturing capacity. Idekos average selling price is forecast to increase 2.50% each year.
Raw materials costs per unit sales are forecast to increase at a 1.6% rate.
Labor costs per unit sales are forecast to increase at a 3.85% rate.
Capital Expenditures:
In 2008, a major expansion will be necessary for Ideko, leading to a large increase in capital
expenditures in 2008 and 2009.
Working Capital Management:
Idekos Accounts Receivable Days is 90 days, while the industry average is 70 days. You believe that
Ideko can tighten its credit policy to achieve the industry average without sacrificing sales.
Ideko currently holds 45 days worth of raw material inventory. You believe that, with tighter controls
of the production process, 42 days worth of inventory will be adequate.
Ideko currently experiences Other Accounts Payable Days of 45 but they are expecting Other
Accounts Payable Days to increase to 52 days as a result of being able to delay payments.
Other working capital items are forecasted to remain unchanged (Finished Goods, Minimum Cash
Balance, and Wages Payable).
Capital Structure Changes:
You believe Ideko is significantly underleveraged so you plan to increase the firms debt. The debt
will have an interest rate of 6.5% and Ideko will only pay interest during the next five years.
The firm will seek additional financing in 2008 and 2009 associated with the expansion.
In addition to the $150 million purchase price for Idekos equity, $4.5 million will be used to repay
Idekos existing debt.
With $5 million in transaction fees, the acquisition will require $159.5 million in total funds.
KKPs sources of funds include the new loan of $100 million as well as Idekos own excess cash
(which KKP will have access to). Thus KKPs required equity contribution to the transaction is $53
million.

Directions
NOTE: many line items in 2005 (the year of the transaction) have already been computed for you on the
template (they are in BLUE). Do not compute these line items; they should be left as they are in the
template.
1) Start with Operating Assumptions, and complete the Sales Data for 2005-2010.
Unit Sales=Market Size x Market Share
Revenue=Unit Sales x Average Sales Price
All Growth assumptions are included in the model
Market Share is expected to grow 1% each year (e.g., from 10% in 2005 to 11% in 2006)
2) Forecast COGS for 2005-2010.
Cash COGS is the total cost per unit (raw and direct) x Unit Sales
3) SG&A expense is modeled as a % of sales. Forecast 2005-2010.
4) Forecast Capital Expenditures and Fixed Assets for 2005-2010.
CAPEX and Depreciation are given
Opening Book Value is last years Closing Book Value
5) Working Capital Requirements. Forecast 2005-2010.
All current assets and current liabilities are modeled using working capital days. Use 365 days for
these calculations.
Inventory-Raw Materials is based on COGS-Raw Materials
Inventory-Finished Goods is based on Total COGS (Raw Materials and Direct Labor)
The working capital forecast should include the plans to tighten Idekos credit policy and reduce
Idekos inventory of raw materials.
The minimum cash balance is the minimum level of cash needed to keep the business running; it is
determined using Sales.
Firms typically earn little or no interest on these balances. As a consequence, the opportunity cost of
holding cash is accounted for by including the minimal cash balance as part of the firms working
capital. We assume this cash balance does not earn interest.
Wages Payable is based on the sum of COGS-Direct Labor and Administrative Expenses.
Other Accounts Payable is based on the sum of COGS- Raw Materials and Sales and Marketing.
6) Sources and Uses of Funds and Goodwill have been calculated for you.
7) Debt and Interest Table
Outstanding Debt has been calculated for you. You need to calculate Interest on Debt. Note: for this
project, calculate interest expense using current debt rather than average debt.
8) Calculate the Income Statement for 2005-2010. Most of 2005 is already done; be sure to calculate GP,
EBITDA, EBIT, Pretax Income, and Net Income for 2005.
9) Calculate the Balance Sheet (except Cash and Stockholders Equity). Many line items in 2005 have
been done for you; be sure to calculate the rest.
Assume Goodwill will not become impaired (hold constant)
Accounts Payable is the sum of Wages Payable and Other Accounts Payable
10) Calculate the Cash Flow Statement for 2006-2010

11) Cash on the Balance Sheet is last years Cash plus Change in Cash from the Cash Flow Statement
12) Forecast Free Cash Flows for 2006-2010 by starting with Net Income. Once the model is complete,
show that starting with EBIT yields the same amount.
13) Assume that if Free Cash Flow to Equity is positive a dividend will be paid, negative stock will
be issued. We are assuming Ideko pays out all of its cash flows going forward
Dividends=MIN(0,-FCFE)
Capital Contributions=MAX(0,-FCFE)
14) Complete the entire model in worksheet 1.
15) Complete the income statement metrics in row 25. To the right of the model, describe the patterns you
observe in these metrics. What is driving these patterns? Complete the balance sheet metrics in row 58.
To the right of the model, describe the patterns you observe in these metrics. How did the deal impact the
firms capital structure? How does capital structure change in the forecast period? Be sure to be concise,
specific, and clear in your answers. Provide an answer no longer than 4 sentences.
16) Next, copy the model to worksheet two and consider what happens if the firm does not meet the
expected working capital requirements. Assume AR Days increases to 115 in 2006-2010 and Raw
Material Days increases to 48, and Other Accounts Payable decreases to 40. Show the model with these
changes. At the bottom of the model, write a 2-5 sentence explanation of the key changes to the financial
statements and free cash flows.
17) Next, copy the original model from Step 14 to worksheet three and consider what happens if the
firms CAPEX in 2008 is $35,000 rather than $20,000. What other changes must we make given the
increase in CAPEX? Also assume the firm must raise additional debt for the increased capital
expenditure: assume debt is $125,000 in 2008-2010. Show the model with these changes. At the bottom
of the model, write an explanation of the key changes to the financial statements and free cash flows.
18) Finally, on worksheet four, answer the following question. Provide specific examples of why a firm
like Ideko might have negative FCFs. Are negative FCFs always an indication of poor operational
performance? Are there situations where negative FCF is not a bad thing? Finally, are negative FCFs
sustainable going forward? Explain why or why not. Be sure to be concise, specific, and clear in your
answers. Provide an answer no longer than 6 sentences. Note: there is no model required for Problem 18,
simply a written answer clearly addressing all parts of the question.
Grading/Due Date
The Excel document must be submitted via email by end of day November 6th.
The original model completed in Step 1-14 is worth 52% of the grade.
Problem 15, 16, 17, and 18 are worth 12% each.
If you have questions regarding the homework, please email my Teaching Assistant Sohit Dave
([email protected]). He will be able to answer most questions regarding the case.