Flash Memory

The forecast income statement (Exhibit 1) shows the profit projections for Flash Memory assuming they do not invest in the new product line. In summary, they maintain their 2009 Operating Margin of 5.5%. Net Income increases from $2,509 in 2009 to $4,096 by 2012 (a 17.8% CAGR over the three year period).
All assumptions were provided in the case, but we did assume a reduction in the interest rate back to the 7.25% for the current loan in 2012, when the Notes Payable to Accounts Receivable ratio falls back below the 70% threshold.
One concern not discussed in the case is the relative growth of Flash Memory vs. the SSD category. Based on the information provided, we estimate Flash’s share of the market at 15% in 2007 which rapidly declines to an estimated 2% by 2013. This underscores Flash Memory’s need to accelerate top line growth to remain a significant player in the market.
The forecast balance sheet (Exhibit 2) shows the account balances for Flash Memory assuming they do not invest in the new product line. The financing requirements in 2010, 2011 and 2012 are $14,433, $17,120 and $13,228 respectively. This increase in debt levels has changed the capital structure of the firm over time, increasing debt as a percentage of capital from 28% in 2007 to as high as 39% by 2011 (vs. a target of 18%).

We calculated WACC for both scenarios - funding by increasing notes payable or by the issuance of stock. For the notes funding, we assumed a 9.25% cost of debt (loan rate of 3.25% prime + 6%) and a forward looking 2010-2012 average forecast debt/value ratio of 41%, resulting in a WACC of 10.11% (Exhibit 3). For the equity funding, we assumed a 7.25% cost of debt (loan rate of 3.25% prime + 4%) and the target debt-to-capital ratio of 18%, resulting in a WACC of 11.67% (Exhibit 4).

The proposed investment would require a substantial cash