operations focus on commercial agents

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Case Study 2 (1,5 mark)

Electronics Communications Technology Investment Development Corporation (ELC), Part II

Electronics Communications Technology Investment Development Ltd., Co., Elcom’s forerunner, was set up in 1995. In 2003, the Company operated in the form of JSC with an initial charter capital of VND10 billion. The Company’s current charter capital is VND211.25 billion. Elcom now is provider of software and system products for network providers. The Company’s operations focus on commercial agents; producing software and integrating software. In addition, the Company has some real estate and mineral exploiting projects. The Company is now the first unit in Vietnam as well as in the world which successfully studies the application of E-meeting system solution with MPEG and 3G technologies. Its competitors are Huawei, ZTE ( China), NEO, FPT, Siseo (US).

The chairman of Board of Directors is Phan Chien Thang and Đang Thi Thanh Minh has been hired by the company as a chief accountant. One of the major revenue-producing items manufactured by ELC is Call Accounting System (CAS) for prepayment subscribers IN/Convergent billing of Vietnam mobile and Gtel, and 90% share market of Vinaphone. ELC has one CAS model on the market, and sales has been excellent. Products of the sector must be continuously updated to avoid being backward; however, telecommunication infrastructure in Vietnam is not synchronous, causing difficulties for the development of the Company. Furthermore, as with any electronic item, technology changes rapidly, together with the number of mobile phone subscribers saturated is an obstacle for the growth of telecommunication sector in the future. Therefore, the current CAS has limited features in comparison with newer models.

ELC spent $750,000 to develop a prototype for a new CAS that has all features of the existing CAS but adds more new features. The company has spent a further $200,000 for a marketing study to determine the expected sales figures for the new CAS.

ELC can manufacture the new CAS for $150 each in variable costs. Fixed costs for the operation are estimated to run $4.5 million per year. The estimated sales volume is 70,000, 80,000, 100,000, 85,000, and 75,000 per each year for the next 5 years, respectively. The unit price of the new CAS will be $340. The nexceesary equipment can be purchased for $16.5 million and will be depreciated on a seven-year MACRS schedule. It is believed the value of equipment in 5 years will be $3.5 million.

As previously stated, ELC currently manufactures a CAS. Production of the existing model is expected to be terminated in two years. If ELC does not introduce the new CAS, sales will be 80,000 units and 60,000 units for the next two years, respectively. The price of the existing CAS is $280 per unit, with variable costs of $120 each and fixed costs of $1,800,000 per year. If ELC does introduce the new CAS, sales of the existing CAS will fall by 15,000 units per year, and the price of the existing units will have to be lowered to $240 each. Net working capital for the CASs will be 20% of sales and will ocurr with the timing of cash flows for the year; for example, there is no initial layout for NWC, but changes in NWC will first occur in year 1 with the first year’s sales. ELC has a 35% corporate tax rate and a 12% required return.

Mrs. Thang asked Ms. Minh to prepare a report that answers the following questions:

1. What is the profitability index of the project?

2. What is the IRR of the project?

3. What is the NPV of the project?

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Case Study 3 (1,5 mark)

Electronics Communications Technology Investment Development Corporation (ELC), Part II

Mrs. Thang, the president of ELC, had received the capital budgeting analysis from Ms. Minh for the new CAS the company is considering. Mrs. Minh was pleased with the results, but he still had concerns about the new CAS. ELC had used a small market research firm for the past 20 years. Because of rapid changes in technology, he was concerned that a competitor could enter the market. This would likely force ELC to lower the sales price of its new CAS. For this reason, he has asked Minh to analyze how changes in the price of the new CAS and changes in the quantity sold will affect the NPV of the project.

Thang has asked Minh to prepare a memo answering the following questions:

1. How sensitive is the NPV to changes in the price of the new CAS?

2. How sensitive is the NPV to changes in the quantity sold of the new CAS?

Question 5: Arbitrage Pricing Theory (1,5 marks)

Assume that the returns of individual securities are generated by the following two-factor model:

Rit = E(Rit) + βi1F1t + βi2F2t

Here:

Rit is the return for security i at time t

F1t and F2t are market factors with zero expectation and zero covariance

In addition, assume that there is a capital market for 4 securities, and the capital market for these four assets is perfect in the sense that there are no transaction costs and short sales (i.e., negative positions) are permitted. The characteristics of the four securities follow:

Security β1 β2 E(R)
1 1.0 1.5 20%
2 0.5 2.0 20
3 1.0 0.5 10
4 1.5 0.75 10

a) Construct a portfolio containing (long or short) securities 1 and 2, with a return that does not depend on the market factor, F1t, in any way. (Hint: such a portfolio will have β1=0). Compute the expected return and β2 coefficient for this portfolio.

b) Following the procedure in (a), construct a portfolio containing securities 3 and 4 with a return that does not depend on the market factor the F1t. Compute the expected return and β2 coefficient for this portfolio.

c) There is a risk-free asset with expected retrun equal to 4.9%, β1 = 0, and β2 = 0. Describe a possible arbitrage opportunity in such detail that an investor could implement it.

d) What effect would the existence of these kinds of arbitrage opportunities have on the capital markets for these securities in the short and long run? Graph your analysis.