TO: FROM: DATE: SUBJECT:
Mr. Hathaway Browne, CFO of Flash Memory Inc. MP.JAW Consultants October 11, 2010 Analysis of the Investment Opportunity and Financing Options
! As your financial consultants, we have conducted a comprehensive analysis of Flash Memory Inc. (FMI)’s current business situation, its new potential investment opportunity, and financing options. Our recommendations are as follows: 1. Pursue the suggested new product line. 2. Seek additional funding through equity financing and reinvestment of earnings. We proceed to present our findings, analyses, and rationales behind these recommendations.
Current Business Environment
FMI is a small private firm specializing in manufacturing “solid state drives” (SSDs), a growing segment of the technology industry. Its product lines include “flash memory technology” devices and “other high performance” devices. These segments compose 80% and 20% of the company’s revenues respectively. The SSDs market is characterized by fast growth, high competitive pressure, continuous technological transformations and changing consumer preferences. These factors contribute to short product life cycles, high Research and Development (R&D) costs, continuous need for working capital and low profit margins. FMI’s business model is heavily impacted by these issues.
FMI attains its competitive advantage by focusing on aggressive R&D investments in order to counteract the short life cycle of its products. In the previous three years, the firm invested on average 78% of its gross margins on R&D and related activities. FMI has funded these expenses through Notes Payable which are secured by its Accounts Receivable. It is projected that by the end of the current year, the company will have difficulty generating enough new cash flows to meet its growing sales. The company is facing the additional problem of having reached its current Notes Payables limit, set at 70% of Accounts Receivable. Management have resorted to negotiating for a more expensive loan agreement, with interest rate of prime plus 6%. Furthermore, the company’s 2009 debt-to-capital ratio, 44%, far surpassed the management’s targeted ratio of 18%. Currently, FMI remains a private company with its equity shared between top managers and Board of Directors.
Forecasted Financial Statements under Current Conditions
We begin our analysis by presenting a set of forecasted financial statements for the period of 2010 to 2012 without investing in the new product line. (Refer to Exhibit 2 for Forecasted Income Statements and Exhibit 3 for Forecasted Balance Sheets). Our forecasts are based on management approved ratios and parameters, as listed in Exhibit 1. We advise management to take note of the following points: 1. The profitability of our current products will decline as per the cyclic nature of the industry. Our projected net income will reach a peak of $3,963K# in 2011 before declining in future years. 2. In 2012, the amount of current assets and total assets are projected at $45,637K and $52,145K respectively. 3. Notes Payable will grow by $44,544K in the next three years. This will result in $3,825K of related interest expense.
Qualitative and Quantitative Analyses of New Investment Opportunity The new product’s features (speed, size, density, reliability, and power consumption) are a great fit with FMI’s strategy to provide high quality products. The new product line also offers a better chance for FMI to stay abreast with its competitors. This helps the company retain its position in this high-growth segment of the industry. We therefore believe the project is a desired investment when considering its qualitative benefits. In addition, the project shows positive quantitative results. We would recommend FMI to accept the project based on Net Present Value (NPV) calculations and its Internal Rate of Return (IRR). We assume that the new product line does not represent a major change in FMI’s operations...
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