# Alfin Fragrances Inc. Harvard Case Solution & Analysis

ASSUMPTIONS OF WACC:

For the calculation of cost of capital the following assumptions are used, these are shown in Table 2.The market return is assumed to be 12.5%, which is above from the risk free rate around 3.6%. This assumption is taken because of the reason that market return is always higher than the risk free rate incorporating the risk in it. The Risk Free Rate is around 8.9% taken from the Exhibit 10 of annual rates Treasury Bills. Beta is calculated using the competitors Beta’s average and that is around 1.01.The debt is 12% and the cost of equity is around 13%. Debt is around 12% and the cost of debt is 13%.These assumptions used in calculating the cost of capital and resulted in 12.5% as Cost of Capital.

Table 2:

 Rm 12.5% Rf 8.9% Beta 1.01 Re 13% WACC= 88% 13% 12% 10% 52% WACC= 12.5%

DISCOUNTED CASH FLOWS:

With regard to the Free Cash Flows of the Alfin the Net Profit of the firm is assumed to grow 10% over the five year period where depreciation on fixed assets is assumed to be incurred on a straight line basis. The net working capital would grow by 10% annually as the new product Glycel would be produced at a higher level to meet the future demand. The capital expenditure would be around \$5,376,000 and this would be made when the new product Glycel would be introduced in the market. The Free Cash flows then resulted and on the basis of the free cash flows the net present value would be around \$106,170,000. The per share value of Alfin after introducing the Glycel would be around \$32.  Table 3 shows that Net present value and Per share Entreprise value of Alfin with Glycel product.

Table3:

 1985 1986 1987 1988 1989 1990 0 1 2 3 4 5 Net Profit \$4,278 \$4,706 \$5,176 \$5,694 \$6,263 \$6,890 Depreciation and Amortization 205 205 205 205 205 205 Net Working Capital (\$1,930) (\$2,123) (\$2,335) (\$2,569) (\$2,826) (\$3,108) Capex (\$5,376) \$0 \$0 \$0 \$0 \$0 FCF (\$2,823) \$2,788 \$3,046 \$3,330 \$3,643 \$3,986 Terminal Value \$0 \$0 \$0 \$0 \$0 \$175,318 Discount Factor 1 0.89 0.79 0.70 0.62 0.55 PV of FCF (\$2,823) \$2,478 \$2,407 \$2,339 \$2,274 \$99,496 Net Present Value \$106,170 Total Numbers of Shares 3,309,684 Per Share Entreprise Value \$32

Table 4 shows the Cash Flows from 1986 to the year 1990.

Table 4:

 Year Cash Flow with the Glycel 1986 2,788 1987 3,046 1988 3,330 1989 3,643 1990 3,986 Terminal Value 175,318

FINANCING NEEDS:

After analyzing the Free Cash Flows of Alfin Fragrance Inc., it can be observed that Debt financing is a feasible option for Alfin. This is feasible because of the reason that Alfin is in the highest tax bracket which is around 48% that would enable the Alfin to acquire debt at lower rates and it would giveAlfin the tax benefit. The new product of Alfin namely Glycel would be risky for the firm and it is because of the intense competition in the industry. In the product development,the debt financing would helpAlfin to diversify its risk between the external parties.

WORKING CAPITAL MANANGEMENT:

For the short term investment as well as for shorter term financing, working capital is the most significant component and it also ensures the payoff possibilities for the short term debts. Fore the Alfin the working capital management is crucial as its solvency depends upon it. Alfin’s solvency ratios show that the Current ratios, Quick ratios and Cash ratios are weak. This is due to the reason that, Alfin’s current liabilities are increasing in terms of its assets. Alfinhas more il-liquid assets and due to higher levels of il-liquid assets, its Quick ratios are weak.

On the other hand, the cash position of the Alfin is also weak due to the reason that, Alfin invested its cash into capital expenditure that is for the Trademark and Licensing of its Glycel product. It is also reduced because of the reason that, Alfin’s account receivables and inventoryare increasing that reduces the cash flows generated from operations.Furthermore, its cash increasing receivable shows that Alfin is flexible in its credit policy which creates problems in terms of paying its account payables.

Another reason of the weakness in solvency of the firm is that, Alfin’shas been engaged in more mortgage and notes payables which are affecting the firm with respect to its solvency ratios...................................

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