FLASH MEMORY INC.

Name of Student

Name of Institute

Date
Flash Memory Incorporation

The Chief Executive Officer of Flash Memory was considering the financing opportunities

regarding the company’s current product line as well as all other new investments that are being

approved by the board. CFO, Browne, was worried about whether to take the project or not. He

was also worried about the ways to finance the new project. Uncertainties resulted in clear

foresight.

Question 1

In order to evaluate the future project, it is important to calculate the weighted average cost of

capital. This would need to the calculation of other variables as well such as the cost of equity

and debt. However, for the purpose of calculation of cost of equity, we needed to have the risk-

free rate and the market premium.

The risk-free rate is estimated by looking at the current yields to maturity on debt securities.

Here, the risk-free rate 10-year Treasury bonds are considered and the market premium is 6%.

That represent the expected return of the overall stock market versus the Treasury bonds. The tax

rate of 40% is used to calculate the beta equity. Beta equity is assumed to be 1 as the company

with 100% equity finance shows the beta coefficient of 1 (STEC INC.).

Beta equity represents the risk that it attached to the particular industry. As Flash Memory

Incorporation was the small private company. Beta equity was of no use to them but when it

comes to investment, the risk factor was necessary to take into consideration. Therefore, the beta
equity is calculated that represents that risk of the company or industry after incorporating the

beta assets and beta debt into it.

After this, the weighted average cost of capital is calculated. The weighted average cost of

capital for Flash Memory Inc. is 9.48%. This WACC would be used to evaluate the future

investments. This weighted average cost of capital represents the risk as well as the discount rate

from calculating the present value of future cash flows. On the other hand, it is the average rate

of return for the company’s investor to compensate them. It incorporate the capital structure of

company within it.

Question 2

The free cash flow forecast is calculated to estimate the future cash flow stream that would

derive from the project. However, the figures calculated such as sales, cost of goods sold, sales,

admin and general expense might not be exactly as accurate as the forecast but it did generate the

ideas for the management of Flash Memory Incorporation to the critical variables for the success

of the project.

The forecasted free cash flow is based upon several assumptions due to uncertainties in the

future. Sales are estimated by the management as the sales and marketing team is quite excited

about this investment and believes that this would be one of the healthy investments. Cost of

goods sold is assumed to be the 79% of the sales. This might be based upon the previous year’s

COGS margin against the sales.

However, the management is just concerned about the margin whereas other costs may also arise

in the future and Flash Memory Incorporation is going through advancement in the global
environment. Technology is changing day by day and so does the demands of the customers,

therefore, Flash Memory Incorporation might have to introduce innovative techniques in the

future that would affect its cost of sales.

Same case goes with the sales, general and administrative expenses as they are expresses in same

percentage of sales as in 2009. However, the management cannot rely that these expenses would

be the same during the planning horizon as well as in the actual future time. The management

need to consider alternatives that could lead to the increment of such costs. Flash Memory

Incorporation is considering to expand its operations in the future and therefore would need to be

more conscious about administration expenses.

In 2011, the management estimated that due to the new project there would be direct

advertisement and campaign but still the management cannot be sure that this type of expense

will only rise in 2011. The number of competitors might increase as this industry has been

developing very fast. This market of solid state drives (SSD) is continuously boosting as it

reached to $1.1 billion in 2009 from $400 million in 2007. As so increased to $2.8 billion in

2011 to $5.3 billion in 2013.

This reflects that the market for SSD is at its best and the expectations can be made that the

number of competitors would increase and therefore Flash Memory Incorporation must have

large budget for the its advertisement and administrative department. Increased number of

competitors would result in increased number of substitute thus the only different would be

between them is possibly the marketing strategies.

There are other uncertainties such as the need for the working capital might not remain the same

throughout the period of the project. Although, the management has provided the best estimate of
the working capital but the situation in the future might differ. Induction of new technology and

innovation is circulating very fast and if Flash Memory Incorporation does not cope-up with the

fast paced environment, it would left behind.

Moving on, the free cash flow reveals that the net income after tax would increase till 2013 and

then decrease at a significant rate. The possible reason for this could be that the management has

estimated that the project in which they are considering to invest and the technology they will

use would be out dated till the year 2013. And therefore, the Flash Memory Incorporation would

charge low prices to compensate with the industry.

It furthers reflect the effect of taxation on the free cash flows of each particular year. The tax

takes up to 40% of the income and the management cannot evade this. However, the

management can make sure that they earn sufficient sales revenue and left with significant after

tax income. Similar to the sales pattern that is forecasted, the tax would increase significantly in

line with the sales till 2013 and then it would decrease.

Question 3

Net present value shows the net amount that the company would be left over with after

incorporating in it all the risk and inflation factors. Net present value is the value that help the

management to decide on the major projects and also allow the management to have choices

between several opportunities. However, projects with zero or positive NPVs are selected and

projects with negative NPVs are rejected. The Net present value of this project is $3.126 million.

The net present value of project that Flash Memory Incorporation is considering to take is

positive and therefore, the project is financially viable. The weighted average cost of capital for
the evaluating this project is 9.48%. This WACC is specifically for the purpose of evaluating the

projects of Flash Memory Incorporation as it incorporates all the market risk that the company is

exposed to. Despite taking account of all the risk, the project showed that positive net present

value. The management should go ahead with this project and yield the financial benefit out of it.

Question 4

The finance through a sale of common stock would give raised to $7.5 million after selling

300000 shares at share price of $25. However, the investment bank who has provided this

estimation cannot guarantee Flash Memory Incorporation that the in actual the situation would

be same. Plus, the share price that the company has selected is also ambiguous as no information

is given regarding from where this share price is estimated.

The companies from which the comparable is possible have comparatively low share prices as

shown in Exhibit 4. Mircon Technology who have comparatively large size than Flash Memory

Incorporation have a closing share price of $10.56 in 2009. However, the dividends are not paid

because the reason might the arising opportunities for the companies and the company is more

emphasizing on its growth rather than paying more dividends from the funds.

Similarly, SanDisk Corporation whose size is smaller than Micron Technology has a closing

stock share price of $28.99. Therefore, this can be concluded that the share prices are effected by

the risk incorporated in each of the particular company. The estimation of the Investment bank of

the share price might not be appropriate and if Flash Memory Corporation go with the plan of

raising finance through common stock, they might face difficulties.

the cash that would be needed for the project. It would be the duty of investment bank to look out

all the share transactions and collect the cash. In this way, Flash Memory Corporation can look

into their other critical issues with more concentration.

Flash Memory Incorporation can also raise finance through factoring. Factoring is linked to the

value of the accounts receivable. Currently, the value of account receivable that is shown in the

balance sheet of 2009 in about $14.67 million. This shows the company have lenient policy and

gives longer credit. However, to raise finance through factoring the company would need to seek

help from the debt factoring company. On the positive side, if company go for this source of

raising finance, it does not have to reply on external sources of funds and therefore, it can remain

its debt reduced so as to reduce the weighted average cost of capital.

Another option remain open for the company is the financing through reinvesting the earnings

back into the project. However, due to the low profit margins of the company, it is unsuitable to

reply on this type of source to finance. If the company go with this option, it would have to face

many challenges regarding the initial investment as well as the capital required in each of the

subsequent years.

Question 5

If Flash Memory Incorporation have ten similar projects, we can assume that those ten project

would have almost the same Net present value, for the purpose of our analysis. Roughly, the total

net present value would be around $31 million. Taking into account the success and failure rate,
we have calculated the total net present value of success and failed projects as $25 million and

$6.2 million respectively.

The total net present value of such a portfolio of ten projects would be $ 18.757 million. When

compared with the research and development budget that Flash Memory Incorporation have, it is

evaluated that research and development contributed for 15% for the successful projects but 60%

for the failed project. That means the spending as research and development contributes to 60%

for the failed projects. The more Flash Memory Incorporation is spending on the research and

development, the more it contributes to the failed projects. It represents the company needs to be

strong to avoid those project failures.

Question 6

A real option is related to the project appraisal. It may be possible the return by the project may

be improved by making some amendments into the project during its life. This is known as the

‘real option’. There are different types of real options that are available but according the

situation, ‘option to delay’ is considered as to whether the project would be more viable after 6

months or now. The calculations are shown in the Excel Exhibits.

The option to delay the project for six month is not suitable since the solution to options to delay

shows the negative value of -0.851. It means that if the company choose to delay the project,

return that would flow from the project would decline. Thus, the impact of this on the

management of the Flash Memory Incorporation would be significant.