# ﻿USEC Capital Budgeting Case Questions

Last Updated: 14 Sep 2020
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In one paragraph (max 5 sentences), describe the general situation faced by USEC: USEC is the lead supplier of enriched uranium, which is used to fuel nuclear reactors. Due to an expiring contract with a power supplier, the production of Uranium fuel became very expensive at the current Paducah plant. USEC created a new plant called APC in an attempt to advance technology and become the low cost producers in the Uranium industry. Mackovjak is a financial analyst tasked with the evaluation of USEC. In order to properly value USEC, Mackovjak needs to evaluate APC and its contributions to USEC.

2) What is the Weighted Average Cost of Capital for USEC in July 2006? (Assume the expected return on the market is around 11%)

WACC= 10703

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We calculated a = 134 which we calculated using the expected return equation:  Our equation looked similar to this: For the equity, we assumed the number of shares outstanding for 2006 which was 86.1 million *10.8 (price per share) 930 million The debt was given in the capital market conditions at 475 million (making D+E equal 1405 million) For we used the yield to maturity, which was given at 0.0904 The tax rate was estimated based on the 2005 data to be roughly 40 percent.

3) After determining the relevant Cash Flows for the project, what is the NPV? *FCF were calculated in the excel spreadsheet

We were using a \$20 fixed price due to an agreement for the Uranium however this changed as the agreement expired and we were required to buy Uranium at market price. Sales= (Production *SWU price)

Cash Costs= (Production of APC* Market price )+ (Production of APC* Enrichment costs) *When APC became functional, enrichment costs were reduced by half Non Cash Costs= Depreciation

Current assets= production* inventory (this was only used in 2012) Market price* production (was used for 2013 and after) Current liabilities= 1 % of
DOE for initial research of centrifuge technology Networking capital= current assets - current liabilities (we found the change in Networking capital) Operating cash flow= S-C(1-T)+TD

Changed in fixed asset= capital expenditure

We used these values to calculate a future cash flow using the equation: FCF= operating cash flow
-increase in networking capital
-increase in fixed assets.

In order to find the NPV of the project, we took the FCF from ACP alone. We had to recognize that the lease on Paducah was not associated with ACP, however, a one percent royalty was added to current liabilities on the ACP projecting. In order to check our initial estimation, we compared the networking capital of the APC project to 5% of sales that was recommended by another analyst Craig Weise. Every year the value was positive and above 5% reinforcing our decision that USEC will take on the project. Based on our calculated NPV of the project we determined that APC would return 2,020,167,627 dollars.

The cost of the project is 1.7 billion so the difference in return and cost is a positive 320,167,627 dollars. Thus USEC will take on the project and therefore the company is undervalued. Mackovjak, the financial analyst, seeing that the company is undervalued should pitch to upper management they should take a long position in USEC.

From the syllabus: “Write-ups should be self-contained Word documents, running 2-3 pages or less, including exhibits. Separate spreadsheets containing original calculations should be attached to the email, but exhibits should be placed within the Word document, not left to be found somewhere in the spreadsheet.” Please conform to these exhibition expectations in future write-ups. As to your spreadsheet:

For Paducah, the CFs shown would be irrelevant, as “with ACP, Paducah operates in 2006-2010, and without ACP, Paducah operates in 2006-2010”, so Paducah CFs irrelevant to ACP valuation in 2006-2010. But necessary to estimate from 2006-2010, so that when lost 2011-2025, Paducah CFs are already escalated and easily estimable. In that regard, all CFs to the NPV calc is too high as you have included irrelevant 2006-2010 CFs for Paducah, but more importantly, have ignored all Paducah CFs lost from 2011-2025 as suggested by the case comments given in class the prior day to case discussion.

Further, your Paducah OCF format of (S-C)(1-T)+TD should only contain cash costs in “C” and your spreadsheet shows that “C” contains Capital Expenditures. Capital Expenditures is ALWAYS outside of OCF, with (S-C)(1-T)+TD – ChgNWC – Yearly CapEx., which you do, thus effectively double deducting for CapEx. You did not return NWC at the end of the project.

For ACP, Uranium Costs are basically ZERO in your valuation after 2012. This error SEVERELY underestimates costs, and overestimates FCF and thus NPV. Further, in your “double 2011” method, a Uranium cost of \$21? Where is this from? For Depreciation in ACP, you are using Depreciation for Paducah (Old), not the Capitalized Plant Bldg costs. Further, your analysis does not seem to include the \$1.7b cost anywhere, other than in the text of this document where you apparently take a t=0 PVCF and subtract amounts that sum to \$1.7b, but occur across 5 years (thus ignoring discounting of the capital costs and including 100m of a sunk cost in your NPV). Finally, your methodology of PV’g does not use the spreadsheet effectively. As with any hard number entry, if you wanted to change this, you would have a significant task ahead of you.

Please think about using functions, or at the very least using equations that refer to a single cell containing WACC, and sequential cells containing 1,2,3, etc. for “T”. Overall, a submission with many errors; some to be expected, and some that appear to be unexplained or work potentially done too quickly without review. I would very much suggest that you use FAR fewer hard numbers in the spreadsheet calculations, and layout more of the assumed values as separate cell entries (the tax rate, the UrRawMatls quantity, the SunkCost, the WACC). If you ever had to go back and change some of these things, it is far easier to change one cell than try to remember ALL cells that contained the hard number entry.