TN(t) cORPORATION

REPORT TO THE BOARD

Overall Strategy:

Seeing that we are in a competitive market where the market controls the price, we focus more on

advertising to attract more customers because more customers means more sales and higher net income.

We also plan to buy enough machine and plant capacity in order to produce enough units and avoid stock

out.

Cash Management:

Due to its liquidity, cash is a very practical asset to have on hand. Marketable securities are similar in the

sense that they can be sold and converted into cash. For this reason, it was good to maintain a sizeable

balance of cash on hand. See table 1 and graph 1 (Appendix pg.1) for the quarterly reserves of cash for

our corporation.

While there are certainly benefits to having cash and marketable securities on hand, there are

disadvantages to having excess quantities of them. While having liquid assets is good, cash and

marketable securities in particular are not the types of assets that provide any kinds of positive returns. By

investing excess cash into areas such as improved forecasting, capital budgeting, and equipment purchase,

we were able to see positive returns in the form of increased sales.

Capital Budgeting Analysis:

In order to do capital budgeting evaluation in each quarter, we followed the following procedure to

calculate NPV of each project:

● Deducted depreciation from the sum of labor savings and overhead savings in order to calculate

EBIT.

● Subtracted income tax from EBIT to get the net income after tax and added depreciation back to

get the period’s free cash flow.

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● Discounted all the future cash flows that the project would bring using 2.85%, the cost of capital

as the discount rate.

● Summed up the present values of all the future cash flows and deducted the cost of the project at

the beginning to get the project’s NPV. (See table 2a for the NPV of project A and B in each

quarter.)

When making investment decisions, we followed the NPV Decision Rule, which states that we should

accept positive NPV projects and reject negative NPV ones. In the case when both projects had positive

NPVs, we normally accepted both of them. However, there were some quarters that we only chose one

project even though both had positive NPVs. Those quarters were:

● Quarter 3 and quarter 6: Both NPVs were positive. However, because we only wanted to invest

in one project to save money to buy PP&E, we chose the one that had a higher positive NPV.

● Quarter 2: Although project B’s NPV was higher, we invested in project A because A had a

higher and more constant future labor savings than project B (See Table 2b). When making this

decision, we overlooked fact that project B would last four more quarters than project A and thus

benefit us over a longer period of time.

Except for those quarters, we normally accepted both projects when their NPVs were positive. Table 2c

summarizes our investment decisions throughout the quarters.

Capital structure:

a. Strategy in determining debt/equity mix: We tried to increase leverage of our company. We

chose this strategy because we needed to raise a lot of money to finance our investment activities

and at the same time we did not want to issue more shares to prevent our share price from falling.

b. Strategy in determining the maturity structure of debt:

(See table 3a for the amount of each type of debt and equity issues in each quarter.)

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● From quarter 2 to quarter 6, we borrowed more short term and intermediate loans than bonds

because these loans had lower interest rates than bonds.

● However, in quarter 7 and 8, we decided to finance mainly through bonds because although

interest of bonds was higher than that of the other loans, their required repayment in each quarter

was lower.

● In quarter 9, we borrowed a lot of short and intermediate loans and repurchased shares because

we wanted to increase our firm’s leverage. We were also able to use our large cash reserves to

retire $100,000 worth of bonds.

c. Mistake: We did not take into account the effect of increased debt on our firm’s value and our

WACC. We should have increased our debt only up to the point where we saw our WACC start

to increase.

If we had adopted this strategy instead of trying to borrow to balance between debt and equity

financing, we would have stopped increasing our leverage once we reached our lowest WACC of 2.204%

in quarter 6. Had we maintained the optimal level of debt that would bring us the lowest WACC, we

would have been able to prevent our equity cost of capital from increasing in the last four quarters of the

game. We would also have kept our WACC from rising and lowering our firm’s value if we had adopted

the alternative strategy. Table 3c shows our WACC and firm’s value through market value of equity.

Performance Evaluation:

a. Mistakes:

● 1st quarter: We borrowed too much for our expense. We purchased 40,000 plants but borrowed 6

million, while around 3 million should be enough. This only increased our payments required in

future rounds.

● 2nd and 3rd quarters: In quarter two, we did not produce as many units as were needed to keep up

with market demand. This led to a stock-out and eventually forced us to increase production in

quarter three. Additionally, we increased our dividend too rapidly (from $0.10 in quarter 1 to

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$0.35 in quarter 2, and $0.35 in quarter 2 to $0.42 in quarter 3). This increase had a severe effect

on our net income transferred to retained earnings.

● 4th quarter: We borrowed too little, which led to liquidation of marketable securities and around

$300,000 penalty loan.

● 5th quarter: Once again, we were unprepared for the amount of units that needed to be produced

to satisfy market demand. When we saw that demand was projected to be at 123,000 for quarter

five, we did not have the facilities to meet that level of production. Thus, once again, we had a

stock-out.

● In quarters of 7, 8, 9 and 10, we had very high machine and plant capacity, but we did not use this

capacity to our full advantage, and produce as many units as possible. We did not make use of

economies of scale, and as a result we saw production costs skyrocket. The production costs for

quarters 7-10 ranged from $74.90 to $80.80, while production costs for quarters 1-6 ranged from

$69.36 to $72.21. Despite undertaking capital budgeting projects, we were not able to reduce

production costs.

● Reduced dividend in the later rounds in an attempt to save money. These sudden decreases in

dividend caused a major drop in investor confidence and we saw our share price plummet.

b. Success:

● Maintain high machine and plant capacity which has allowed us to produce large quantities of

units, and rarely face stock-outs.

Have enough marketable securities and/or cash to prevent incurrence of penalty loans

Production Strategy:

Production of goods required the continued use and purchase of machine and plant capacity. Inadequate

amounts of either machinery or plant, would adversely affect the ability to produce goods, and

subsequently it would have a negative effect on sales. With regards to the purchase of machine and plant

capacity, it was very important to know the number of units that would be demanded in the next quarter.

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In order to produce one unit of good, one unit of machinery was required. With respect to the plant, there

was no established ratio that compared the required plant capacity to the quantity of units produced.

Units of plant and machinery could not be built immediately, and this delay presented a challenge. An

order of machinery took one quarter to build whereas an order of plant required two quarters to build. The

forecasts provided accurate estimates for the amount of units that would be demanded in future quarters

in addition to providing vital information regarding the depreciation of plant and machinery.

Every quarter, we decided to produce more units than the forecasted demand. While forecasts were

generally accurate, in the event of actual demand being higher than the forecasted count, we did not want

sales to be constrained by our lack of production. Any unsold units were left in inventory and could be

sold in future rounds at a potentially higher price. Table 5a shows the beginning and ending balances of

inventory for each quarter.

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