Download Managing the Future for Sun River`s Long

Managing the Future for Sun River’s Long-Term Shareholders
Currently, Sun River has a debt to equity ratio of 0.187, which is lower than the
optimal corporate debt level. The lower debt ratio shows that Sun River can increase
their profitability by raising their leverage level. Thus, long-term shareholders of Sun
River would see increased return of equity. However, raising the leverage level also
increases the company’s risk. Since Sun River wants to focus on creating benefits for
their long-term shareholders, they should increase their leverage level. All of the
proposed projects are riskier than Sun River’s current projects. Therefore, caution
needs to be used when raising the leverage ratio and capital should be carefully
allocated to each project. By taking on a higher leverage level, risk needs to be managed
effectively.
All of the proposed long-term projects have a positive NPV. The risk associated
with launching the projects is increased because the debt level will be raised to finance
them. The process we used in evaluating the Synergy2 project did not considered the
levered project β. Since the new project is evaluated similarly, we ignore the leverage
effect by using the unlevered β. However, the higher leverage ratio will increase the
risk Sun River is taking in launching each project. Therefore, Sun River needs to
consider the levered β in addition to the unlevered β. In order to evaluate the leverage
effect on each project, Sun River needs to build a specific plan about how they will be
financed.
The elevated level of volatility for each project is the result of higher market wide
and firm focused risk. The projects are more sensitive to overall economic movements,
so they have a higher market wide risk. A high market wide risk drives volatility
higher, but firm focused risk affects the volatility as well. Taking more firm focused
risk will not generate long-term returns for the firm. The firm-focused risk will not be
considered in the calculation of β, so the firm-focused risk is not measured into the
required rate of return of each project. Even though the projects have a positive NPV,
high firm-focused risk may shrink the value of the projects to a point where it no
longer creates value for the company. Therefore, Sun River should avoid taking
firm-focused risks. To minimize firm-focused risk, Sun River should diversify their
corporate portfolio by launching different projects. Thus, the implementation of all
five potential projects will decrease the firm-focused risk.
When estimating the OCFs, Sun River needs to consider the side effects of each
project on one another. Vertical integration into the distribution industry for small
beverage companies might have some negative side effect on our current beverage
business. While, moving into the consulting business may create value for Sun River.
Therefore, the company should carefully evaluate all side effects of their future
projects. However, the evaluation of side effect before launching the project can be
difficult and misleading. This may create ambiguity to the project NPV’s calculation.
Since firm-focused risk is decreased by diversifying Sun River’s portfolio,
market-wide risk is the major component on the return of the project. Even though the
market fluctuates in the short term, it will always have an upper trend in the long run.
By investing in the market an investor can expect positive returns in the long run.
Therefore, with the carefully evaluated positive NPVs for all of the projects and
diversified corporate portfolio, our consulting group is confident that the projects will
create value for Sun River in the future. By launching value creating projects, Sun
River’s stock will increase, benefiting the long-term stockholders.