FLASH MEMORY INC

Case Write-Up

 AHSAN IQBAL (16824)

 ABDUL HALEEM ABBASI (16823)
 SYED ALI ROSHAAN RAZA (16716)
 SAAD NAZIR (16693)
 OMER KHAN (16704)
Flash Memory Inc. is a privately held company where the 6 individual hold entire equity of
the firm. Flash competed in a low profit, fast growth, short product lifecycle business which
needs constant investment in Research & Development.

For Calculating Current WACC of the Firm (as of May 2010), we have Considered Following a
Debt to Capital Ratio of 34% i.e. 34% Debt 66% Equity.

We are given that, the current Cost of Debt is 7.25%, which prime rate of 3.25% + 4% Risk
Premium applicable for 70% funding of accounts receivable. For calculating cost of equity we
need a Beta of comparable listed entity. we have considered Beta of Micron technology
which has a Capital Structure very similar with Flash Memory and competes same category.
First we need to unleveraged the beta to isolate beta of equity which we can further use to
estimate cost of equity.

First, Levered Beta of Micron Technology is 1.25, this represents the sensitivity of the
company at current capital structure towards the industry. we have isolated the beta of
equity which we can use in CAPM model to calculate cost of capital for Flash Memory.
Below is Formula for Leveraging are releveraging this Beat to arrive at Cost of Capital for
Flash Memory:

Using the Above, formula we could determine that Unlevered Beta is 0.965.

Further, we used this Beta to arrive at Cost of Equity using below Formula. Thus, we could
determine that Current Cost of Equity for Flash Memory was 8.75%.
Now we had D/E Ratio and Cost of Debt & Cost of Equity, we could easily calculated out
current WACC. Formula for Weighted Average Cost of Capital is as following:
As Mentioned in the case study, the Flash Memory in an industry which needs constant
investment in Research & Development. With an investment of $2.2mn company would be
able to access an innovative product line and possibly have a first mover advantage. It is also
mentioned that the new product line has higher margins over sales (COGS is 79% vs 81.10%
of Sales).

Further, we understand that the Company has already reached its Notes Payable limit and
any further borrowing will attract stringent terms and higher, the management is of the view
that company must dilute the equity if need be but must bring the Ratio of Debt in its overall
capital structure to 18%. Thus for evaluating the Project the IRR must be greater than the
WACC. we have used a WACC of 10.03% with Capital Structure as 18:82 Debt to Equity.
Please See Exhibit 2. Based on my Calculations we are of the view that company must accept
project. The Project has an IRR of 21.9% and has a Positive Net Present Value.
Please not and expenditure of $400,000 is treated as sunk cost and is not included as a part
of calculation.
Assuming That Flash Memory does not accept the new Product line we can clearly see that
the Company maintain healthy growth forecast. Our Sales Figures are based on estimates
provided by marketing team. For further clarity we have mentioned the source of each
calculation in the comments column.
we have assumed that company continues to fund its Funding Requirements using Debt
Financing as long as it maintains the 70% of Accounts Receivable threshold.

2010 2011 2012

Notes payable (Additional Funding $13,310 $15,423 $11,435
)
Notes Payable/Accounts 67% 64% 48%
Receivable

While calculating there are 2 assumption that we have mare,

1. Company Continuous to Debt Finance it Business as long as the ration of Notes
Payable to Account Receivable remains under 70%.
2. Number of Days is 360 in a year. This is done for Calculation continence and does not
change the outcome.

Assuming Flash Memory accepts the new Investment we see that in very first year i.e. in
2010. The company needs to invest more than 7 million in the new project which results in
increase in Debt to Capital. The board is of the view that an ideal Debt Equity ratio is around
22%. While we consistently see that this ratio is breached.
Howere based on the projections of the company we can see that the company forecasts
higher sales and better margins in the future.

According to us, company must continue using debt financing for its Working Capital
Requirements, further, the company has a substantial amount of Retained Earnings which it
can Use for Funding this Project. Flash Memory should avoid issuing additional Capital, as
dilution of equity would result in loss of management discretion.