Case Study: Lehman Container

Corporation
Prepared by
Erdenechimeg.A
Battuul.B
Narantuya.N
Ganzorig.G
Enerel.T

Corporate Finance

Sep 10, 2016

Contents

Case background
Cost of capital

SLIDES 3-4
SLIDES 5-16

Investment opportunity
schedule

SLIDES 17-22

Optimal capital budget

SLIDES 23-35

Summary

SLIDE 36

LEHMAN CONTAINER CORPORATION

Lehman is leading manufacturer of various plastic containers and has been
operation since 1978. Its sales growth never become negative although there
was reduction in sales during recessions.
CEO had rather heated meeting with his marketing manager, operations
manager and VP discussing new investment opportunities.
Thus Howard, the accountant was given a task to analyse 5 different
investment project under consideration for next year.
Project 1- Regular, stand alone, do it or leave it project
Project 2 and 3 are Competing, mutually exclusive project for Computing
facility
Project 4 and 5 are also mutually exclusive project for Factory location
Howard has no idea who supports which project.
Based on the some gathered information such as market and financial
information, he is required to:
1. Calculate component cost of capital, and create graphs of marginal cost of
capital for DCF, CAPM, and BY+RP
2. Create investment opportunity schedule
3. Determine the optimal capital budget
3

IRR %

Net
initial
cost

Positive comment

Negative comment

1. Moulding
machinery
updates

16,8 % 3,02 mill

All prefers new

equipment

Current one is old and

caused backlog, it is recipe
for disaster. Possible
economy downturn

2. IBM Computing
facility

18,0 % 1,78 mill

More efficient, better

technical support, can
support office network in
future

Seen as an Inferior product

3. Sun Microsystems 17,4 % 1,83 mill

facility

Retraining cost can be

avoided, as current
system is Sun

Seen as an Inferior product

4. York Factory

20,6 % 2,1 mill

Offers more
transportation option

In distant from home and

office. Not cost effective
becos of lack waste product
storage

5. Curry business
park location

21,2 % 2,4 mill

Waste product storage,

utilities service.
40 year lease term

40 year lease term

COST OF CAPITAL

1.1.1 Cost of Capital (DCF)

DEBT

RETAINED EARNINGS

PREFERRED STOCK

NEW COMMON STOCK

1.1.1 Cost of Capital (DCF)

BANK LOAN
Maximum

1,500,000.00

Interest rate

9%

Tax

34%

Capitalization

38%

COST OF CAPITAL

5.94%

Break-even point

3,947,368.42
7

1.1.1 Cost of Capital (DCF)

BOND
Bond yield

11%

Tax

34%

Capitalization

38%

COST OF CAPITAL

7.26%
8

1.1.1 Cost of Capital (DCF)

RETAINED EARNINGS
Retained earnings

706,000.00

Dividend

$1.01

Average price

$11.08

Capitalization

56%

Earning growth

4.5%

COST OF CAPITAL

14.03%

Break-even point

1,260,714.29
9

1.1.1 Cost of Capital (DCF)

PREFERRED STOCK
Dividend

$1.00

Average price

$9.12

Flotation cost

$0.72

Capitalization

6%

COST OF CAPITAL

11.90%
10

1.1.1 Cost of Capital (DCF)

COMMON STOCK
Dividend

$1.01

Average price

$11.08

Flotation cost

$0.72

Capitalization

6%

Earning growth

4.5%

COST OF CAPITAL

14.69%
11

1.1.2 Cost of Capital (CAPM)

CAPM approach
Average return on treasury bond (Rf)

4.20%

Average return on a broad stock market index (Rm)

13.10%

Beta

1.1

Equity cost

13.99%
12

1.1.3 Cost of Capital (BY+RP)

BY+RP=Long term bond yield+ risk premium

BY+RP=11% + 7%= 18%

13

1.2.1 DCF approach (MCC)

Bank loan
Preferred stock
Retained earnings
WACC2

Bank loan
Preferred stock
New equity

Bond
Preferred stock
New equity

WACC3

WACC1

14

1.2.2 CAPM approach (MCC)

Bank loan
Preferred stock
Common stock
WACC1

Bond
Preferred stock
Common stock
WACC2

15

1.2.3 BY+RP approach (MCC)

Bank loan
Preferred stock
Common stock
WACC1

Bond
Preferred stock
Common stock
WACC2

16

INVESTMENT
OPPORTUNITY SCHEDULE

17

York
IBM
Molding

Curry
IBM
Molding

York
Sun
Molding

Curry
Sun
Molding

18

2.1 York, IBM, Molding

19

2.2 Curry, IBM, Molding

20

2.3 York, Sun, Molding

21

2.4 Curry, Sun, Molding

22

OPTIMAL CAPITAL
BUDGET

23

3.1.1 DCF: York, IBM, Molding

Excess return ($ million)
1.26 x (20.6% - 10.83%)
(2.1 - 1.26) x (20.6% - 11.2%)
(3.88 - 2.1) x (18% - 11.2%)
(3.95 - 3.88) x (16.8% - 11.2%)
(6.9 - 3.95) x (16.8% - 11.7%)
Total

0.1232
0.0789
0.1211
0.0038
0.1506
0.4777

24

3.1.2 DCF: Curry, IBM, Molding

Excess return ($ million)
1.26 x (21.2% - 10.83%)
(2.4 - 1.26) x (21.2% - 11.2%)
(3.95 - 2.4) x (18% - 11.2%)
(4.18 - 3.95) x (18% - 11.7%)
(7.2 - 4.18) x (16.8% - 11.7%)
Total

0.1308
0.1140
0.1053
0.0147
0.1541
0.5188

25

3.1.3 DCF: York, Sun, Molding

Excess return ($ million)
1.26 x (20.6% - 10.83%)
(2.1 - 1.26) x (20.6% - 11.2%)
(3.93 - 2.1) x (17.4% - 11.2%)
(3.95 - 3.93) x (16.8% - 11.7%)
(6.95 - 3.95) x (16.8% - 11.7%)
Total

0.1232
0.0789
0.1135
0.0009
0.1532
0.4697

26

3.1.4 DCF: Curry, Sun, Molding

Excess return ($ million)
1.26 x (21.2% - 10.83%)
(2.4 - 1.26) x (21.2% - 11.2%)
(3.95 - 2.4) x (17.4% - 11.2%)
(4.23 - 3.95) x (17.4% - 11.7%)
(7.25 - 4.23) x (16.8% - 11.7%)
Total

0.1308
0.1140
0.0960
0.0161
0.1541
0.5109

27

3.2.1 CAPM: York, IBM, Molding

Excess return ($ million)
2.1 x (20.6% - 10.81%)
(3.88 - 2.1) x (18% - 10.81%)
(3.95 - 3.88) x (16.8% - 10.81%)
(6.9 - 3.95) x (16.8% - 11.31%)
Total

0.2057
0.1281
0.0040
0.1622
0.4999

28

3.2.2 CAPM: Curry, IBM, Molding

Excess return ($ million)
2.4 x (21.2% - 10.81%)
(3.95 - 2.4) x (18% - 10.81%)
(4.18 - 3.95) x (18% - 11.31%)
(7.2 - 4.18) x (16.8% - 11.31%)
Total

0.2495
0.1113
0.0156
0.1659
0.5422

29

3.2.3 CAPM: York, Sun, Molding

Excess return ($ million)
2.1 x (20.6% - 10.81%)
(3.93 - 2.1) x (17.4% - 10.81%)
(3.95 - 3.93) x (16.8% - 10.81%)
(6.95 - 3.95) x (16.8% - 11.31%)
Total

0.2057
0.1207
0.0010
0.1649
0.4923

30

3.2.4 CAPM: Curry, Sun, Molding

Excess return ($ million)
2.4 x (21.2% - 10.81%)
(3.95 - 2.4) x (17.4% - 10.81%)
(4.23 - 3.95) x (17.4% - 11.31%)
(7.25 - 4.23) x (16.8% - 11.31%)
Total

0.2495
0.1020
0.0172
0.1659
0.5346

31

3.3.1 BY+RP: York, IBM, Molding

Excess return ($ million)
2.1 x (20.6% - 13.05%)
(3.88 - 2.1) x (18% - 13.05%)
(3.95 - 3.88) x (16.8% - 13.55%)
(6.9 - 3.95) x (16.8% - 13.55%)
Total

0.1585
0.0881
0.0022
0.0959
0.3447

32

3.3.2 BY+RP: Curry, IBM, Molding

Excess return ($ million)
2.4 x (21.2% - 13.05%)
(3.95 - 2.4) x (18% - 13.05%)
(4.18 - 3.95) x (18% - 13.55%)
(7.2 - 4.18) x (16.8% - 13.55%)
Total

0.1956
0.0766
0.0103
0.0981
0.3805

33

3.3.3 BY+RP: York, Sun, Molding

Excess return ($ million)
2.1 x (20.6% - 13.05%)
(3.88 - 2.1) x (18% - 13.05%)
(3.95 - 3.88) x (17.4% - 13.55%)
(6.9 - 3.95) x (17.4% - 13.55%)
Total

0.1585
0.0796
0.0006
0.0975
0.3362

34

3.3.4 BY+RP: Curry, Sun, Molding

Excess return ($ million)
2.4 x (21.2% - 13.05%)
(3.95 - 2.4) x (17.4% - 13.05%)
(4.18 - 3.95) x (17.4% - 13.55%)
(7.2 - 4.18) x (16.8% - 13.55%)
Total

0.1956
0.0673
0.0109
0.0981
0.3718

35

Summary

IBM, Molding,
Curry

Sun, Molding,
Curry

IBM, Molding,
York

Sun, Molding,
York

DCF

$518,761.96

$510,932.84

$477,656.62

$469,740.39

CAPM

$542,221.03

$534,587.29

$499,943.49

$492,309.74

BY+RP

$380,537.83

$371,781.29

$344,659.17

$336,153.42

36

THANKS FOR YOUR

ATTENTION