Finace case help for brain girl only

FIN 319 - Winter 2015

Case #1: Capital Budgeting – Product Decision

Google Glass2

Google has long been a leader in internet search, online advertising and developing new technologies.

One new technology Google developed and launched in 2013 was Google Glass. Google Glass displays

information in a smartphone-like hands-free format. Wearers communicate with the Internet via natural

language voice commands. While this is an interesting new technology, sales have been below

expectations. Google is considering launching a revised product, Google Glass2, which would

incorporate new features, look more like traditional eye glasses and be significantly lower in cost. It is

believed that the combination of these factors may significantly increase demand in an emerging market

that currently does not have any competition. Google has already invested $50 million in research,

$10M in test marketing and believes their revised product will be able to significantly increase demand

and create a new category of products. You have been approached by the president of the company to

analyze the proposed project and make a recommendation on whether Google should launch the

revised line of wearable smartphones – Google Glass2.

In thinking about the potential size of the market, Google believes that the potential sales volume of

Google Glass2 will be related to the size of smartphone market, specifically early adopting technology

enthusiasts. In the current year 1.2 billion smartphones are expected to be sold worldwide and the

market is estimated to grow at 11% per year. Given the product concept is new, Google expects to

initially get 0.5% of the total smartphone market to purchase Google Glass2 once it is ready for sale.

After the first year of sales the share of the smartphone market that purchases Google Glass2 is

expected to increase by 0.25% per year (i.e. in the 3rd year of sales Google Glass2 volume is estimated to be 1% of total

smart phone sales volume). Once Google Glass2 is ready for sale, the product is expected have a sales life of

4.5 years. After that the technology will become obsolete and Google will need to decide if it launches a

new and improved replacement product (aka Google Glass3) or exit the market. At the time of initial

sales it is expected that Google Glass2 will have an average selling price of $500 per unit and the price is

forecast to decrease by 5% per year. The company is fairly confident in most of its projections, but

market share and price are the two items with the most variability.

The variable cost of goods sold is forecast to be $395 / unit at time of product launch and is forecast to

decrease by 6% / year as the company gains experience with the manufacturing process. Sales and

Marketing expenses are forecast to be 12% of sales each year and General and Administrative expenses

are forecast to be 8% of sales each year.

Google will need two years from now to ready the product for market. Prior to launching the new

product line, Google will need to spend an additional $125 million on R&D over the next two years to

complete the design ($50M in the current year and $75M next year), $20 million on test marketing and

$500M on capital equipment to support the manufacturing process. The equipment purchase and test

marketing will be done one year prior to the start of sales. The equipment will be depreciated using the

five year MACRS schedule. The equipment will have a $35 million salvage value after all sales of Google

Glass2 have been completed and might be able to be used in a future company project. Also, the

company will need to invest $50 million in inventory prior to the first year of sales. Once sales begin the

company will plan to maintain 15 days of accounts receivable, 45 days of inventory and 60 days of

accounts payable.

The corporate tax rate is 20%. In your recommendation please include the payback period, NPV, IRR,

MIRR and profitability index.

In estimating the WACC for Google, be sure to describe the sources of capital the firm uses to finance

operations. Include specific assumptions that support the calculations for: cost of debt, cost of equity,

market values of debt and equity. To be consistent, please refer to Google’s 2014 Third quarter 10Q

filing for its financial statements and current capital structure. Please include a definition of WACC and

why it is relevant to the firm.

To estimate the weighted average cost of capital you will need to:

• Utilize the Capital Asset Pricing Model to estimate the cost of equity: o Risk Free Rate: The proxy for the Risk Free Rate should be a US Treasury note bond o Beta: To estimate beta you can utilize published betas which can be found at a variety of finance sites to

include: Morningstar, Yahoo! Finance, Google Finance and databases available at the PSU Library and / or

calculate your own estimate of beta.

o Market Risk Premium: Decide on an appropriate approach to estimate the Market Risk Premium and incorporate the necessary assumptions.

• Utilize the after tax yield to maturity of debt for the company to estimate the cost of debt: o A company will often have multiple bonds outstanding at any one time. If so, calculate a weighted average

YTM for the bonds outstanding.

o A list of bonds outstanding can be found in the company’s 10Q or 10K o The current pricing and YTM on publically traded bonds can be found at:

http://finra-markets.morningstar.com/BondCenter/Default.jsp

• Financing weights. Calculate the market value of debt and equity. The value of debt plus equity is equal to the overall value of the firm. Based on the values of debt and equity you can calculate the weights of each type financing.

For this case, please use the market value weights to estimate the weighted average cost of capital.

o The market value of equity is also known as market capitalization and can be determined by finding the current stock price per share and multiplying it by the number of shares outstanding.

o The market value of debt can be calculated from the bond site listed above. o Market prices of bonds are often quoted as a percentage of par value. For example, if a bonds current price

is 110, it is currently trading at 110% of par.

o The book values of debt and equity can be obtained from the company’s balance sheet.

I am interested in the structured frameworks you use to solve the problem/s, assumptions made,

analysis, recommendation and ability to clear communicate. Grading will consider:

• Critical Thinking: Have you formulated meaningful questions (what are the critical issues or problem), synthesized information and financial data, considered alternatives or improvements,

proposed position / solutions.

• Analysis: Have you chosen the appropriate analytical framework/s to utilize and appropriately applied them. Assess quality of supporting evidence, key assumptions are identified and a clear

recommendation supported by the analysis.

• Communication: The paper must be written clearly with a central message and logical organization. Ideas and recommendations are well supported. The case should contain an

executive summary, framing of the problem, analysis, consideration of alternative solutions and

recommendation. Please ensure correct spelling, grammar and clear formatting of financial

exhibits. Use of tables and charts are often an efficient means to communicate financial

information.

Papers should be between 5-6 pages in length (single spaced) plus any exhibits in an appendix.

Absent Satisfactory Excellent

WACC 0 1 2 3 4 Comment

Overall framework

Market value of Debt

Market value of Equity

Cost of Debt

Cost of Equity

FCF Forecast

Overall framework

Proforma Income Statement

Proforma Balance Sheet

FCF Forecast

Decision Criteria

Decision Frmework

NPV, IRR, MIRR, PI

Communication

Overall Presentation

Executive Summary

Supporting evidence

Synthesis & Recommendation

Grammar, spelling

Use of Exhibits, Charts