Group Project By:

Sherry Sebastian, Kipley Pereles, Joshua Roller,

Michelle Torres, Erin Morris, Joseph Molina, Luis Lindemann

MBA 606 Finance

Professor Janet Muller

Spring Semester 2010

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Financial Project Overview

This financial analysis business project is based on the type of work financial annalists’

encounter in the corporate world. Financial analysis is looking at all the different factors

involved in making strategic business decisions in order to recommend the course that would

maximize the market value of the firm. For this project we picked Broadcom Corporation. We

will perform ratio analysis to determine the company’s strengths and weaknesses. Next, we will

pick an investment model that would generate a positive cash flow. Strategic long range planning

including three year financial projections will be prepared in order to develop an appropriate

capital structure and financing strategy for the proposed investment. Lastly, a pricing model will

be assembled in order to understand the financial impacts of customer contracts and pricing for

the anticipated project on the company.

Company Profile

Broadcom Corporation is a leading provider of semiconductors for wired and wireless

communications technology. Net revenue for Broadcom for the past year ended December 31,

2009 was $4.490 billion1. This is a decrease in net revenue of 3.6% from the $4.658 billion from

the year ended December 31, 20081. Net income for the year ended December 31, 2009 was

$65.3 million, or $.13 per share (diluted), compared with $214.8 million, or $.41 per share

(diluted), for the year ended December 31, 20081. Broadcom has a market capitalization of $15.5

billion. During this economic downturn, Broadcom gained market share, and attained record

quarterly revenue. Currently Broadcom has total assets of $5.127 billion with a market

capitalization of $15.5 billion. Through this current economic crisis Broadcom’s stock price

ranged from a low $7.90 and a high of $166.24.

Broadcom’s corporate headquarters is located in Irvine, at UCI’s University Research

Park. Henry T. Nicholas III, Ph.D., and Henry Samueli, Ph.D. founded Broadcom in 1991 as a

private company whose initial focus was on the emerging markets in communications that

utilized cable or wire2. Over the years, the company has specialized in creating high-speed

Integrated Circuits (ICs) used in parts for cable TV set-top boxes, cable modems, and local area

network (LAN) cards2. Broadcom also develops key technology and products in emerging

broadband markets such as digital subscriber loop (DSL), fixed wireless, direct broadcast

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satellite, and terrestrial digital broadcast2. Broadcom is dependent on five independent foundry

subcontractors located in Asia to manufacture substantially all of their products. The past

nineteen years, Broadcom has diversified its product portfolio contending against competitors

such as Qualcomm and Texas Instruments to deliver solutions to meet the needs of industry

leaders in broadband communications, enterprise networking, mobile, and wireless3. Apple,

Cisco, Dell, Echostar, HP, Huawei, LG, Motorola, Nintendo, Nokia, Pace, Samsung, and

Thomson are a few customers currently incorporating Broadcom devices in their communication

products1.

Company Analysis

A company analysis was conducted to determine Broadcom’s financial health. We began

by reviewing the company’s published financial statements, downloaded from the investor

relations department found on Broadcom’s website. This included obtaining the annual report,

10K and 10Q. We computed common ratios for the year ending 2008, and 2009. Common ratios

provide the most accurate depiction of a company’s financial health, encompassing the true

measure of a company’s liquidity, leverage, activity and profitability. Each ratio was therefore

computed, analyzed, and measured against the industry average. In order to calculate the industry

average, we obtained the financial statement of each of Broadcom’s top competitors, including

Qualcomm and Texas Instruments. We manually computed each ratio for the most accurate

comparison year over year. All data used reflects the ending balance. The only exception to this

is that since the Balance Sheet had very similar data from the beginning of the period to the end

of the period (year), we used the ending balance instead of the average. Included below is a

detailed description of each ratio analysis.

Liquidity ratios measure short-term liquidity of a company’s financials. The current ratio

measures the ability of a company to pay its bills over the short run and the margin of safety to

meet everyday cash needs. A current ratio in the 2 to 1 range is a strong sign of health and

Broadcom’s current ratio of 2.54 times for 2009 is reflective of its strength. Its 2006, 2007 and

2008 numbers are relatively flat, although they have dropped over time from 4.94 to 2.54.

Liquidity continues to be strong, although deteriorated somewhat from the prior year and is not

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as liquid as industry competitors. This could become a weakness if not corrected. Cash balances

and strong liquidity have been a hallmark of financial strength and have allowed the company to

take advantage of opportunities such as buybacks, acquisitions and dividends. Current Liabilities,

which include accrued liabilities, have doubled resulting in reduced current ratio figures.

A quick ratio is the measure of a current ratio that excludes the value of inventory. It

demonstrates the danger of using cash, or the carrying over of large inventories. Any ratio of 1

to 1 or greater is a strong ratio. Its 2006, 2007, 2008 and 2009 ratios have decreased over time

and fallen to a low in 2009 of 2.22 times; low when compared to the industry average of 3.27

times. This is similar to the reasoning above for the current ratio.

Leverage ratios measure the long-term ability of a company to meet its obligations. For

instance, the debt ratio measures how much debt a firm has for every $1 of assets and the debt-

to-equity ratio measures a company’s total debt to its total equity. Year over year, Broadcom’s

debt ratio has increased from 14% in 2006 to 24% in 2009, resulting from a dramatic increase in

current liabilities which doubled from $0.6B in 2006 to $1.2B in 2009 while the firm’s total

assets stayed relatively flat. However, Broadcom’s debt ratio of 24% is only slightly higher than

the industry average of 23%. Broadcom’s leverage ratios continue to be very low as they have no

interest bearing debt and would only become a concern if the ratios reach a 50% level or more.

The company’s debt-to-equity ratio is a result of increased liabilities (payable and

accruals,) but not interest bearing debt. With a debt-to-equity ratio of 32% for 2009 it is still a

very low ratio, relative to their competition, within the industry as it continues to show a very

strong financial position for Broadcom. Year over year, Broadcom’s debt ratio has increased

from 16% in 2006 to 32% in 2009. The industry average for 2009 is 31%.

Activity ratios measure how efficiently a firm uses its assets to generate sales. These

include Inventory Turnover, Asset Turnover and Average Collection Period calculations.

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Inventory Turnover is the measure of cost of goods sold divided by its inventory. In other

words, it’s a ratio measuring the number of times a year that inventory is turned over or in effect,

how well Broadcom is managing its inventories. In this case, Broadcom is inefficiently

managing its inventory turnover compared to the industry average. This means it has taken

longer for them to clear their inventory compared to other companies in the industry. Year over

year Broadcom’s inventory turnover ratio has fallen from 18 times in 2006 to 12 times in 2009.

Broadcom uses the sell-through method for distributor sales which means sales aren’t

booked until the distributor has sold to the end-user. The company can afford to be high in

inventory because they have a strong financial position and low leverage (debt relative to

equity). Lower turnover may be result of a rapidly expanding product line and should be watched

carefully. In this case, Texas Instruments and Qualcomm are doing a better job of managing their

inventory.

In contrast, the company has a good total Asset Turnover, measured by dividing sales by

total assets, which is better than industry average, which reported in at 0.70 times for 2009. . In

Broadcom’s case, 2006 and 2007 data was flat representing approximately 0.75 and 0.78 times.

Broadcom has had a good revenue stream in relation to its assets, giving a result of 1.06 times in

2008 and 0.88 times in 2009, respectively. Asset Turnover is a measure of the strength of a

company’s sales in relation to its total assets, calculated by dividing sales by total assets. It is

better in this case to have a high asset turnover; however, large cash balances may distort the

usefulness of this ratio.

The average collection period in this case is measured in days and is calculated by

dividing sales per day by accounts receivable. Broadcom’s average collection period of 41.34

days in 2009 has deteriorated from prior years, which reported in at approximately 31 days, and

is quite a bit worse than its industry competitors. These measures reflect how fast the company

collects on their sales. Sales have been flat year over year and receivable balances have increased

resulting in an increased average collection period. In other words, Broadcom is more liberal on

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their collection policy and allows their customers to take longer to pay on their accounts. Most

companies sell on a 30-day term, a generally accepted industry standard.

In measuring profitability, a key metric used by shareholders and investors alike, we have

found that except for gross margin, all of Broadcom’s profitability measures are weak and have

deteriorated from the prior year in 2008. This is an indication of the weak economy and strong

competitive pressures. Included within the profitability ratios are Gross Margin, Profit Margin,

Return on Assets, Return on Equity, Earnings per Share, and Price to Earnings ratios, which are

noted as follows.

Broadcom’s gross margin percentage, defined as gross margin divided by sales, year over

year has been very consistent in the range of 51-52%, meeting its long-term stated target of 50-

52%. The industry average reported a gross margin of 56%, better than the performance of

Broadcom. Broadcom’s margins have been enhanced by licensing revenue resulting from

Qualcomm’s litigation settlement, which added approximately a 4% improvement in its gross

margin performance.

The company’s 2006 profit margin of 10%, measured as net income divided by sales,

declined sharply in 2007 to a level of 5% due to an increase in research and development

expenses from $1.1B to $1.3B with flat revenue of approximately $3.8B year over year. In spite

of continuing increases in research and development expenditures from $1.3B to $1.5B in 2008,

profit margins stayed the same at 4.61% because revenues increased during the period from

$3.8B to $4.7B. In 2009, the profit margin fell to a record low of 1.45% , which is due in part to

Broadcom’s slightly reduced revenue coupled with continuing increased heavy research and

development expenditures and settlement costs of $118M in addition to a new $50M charitable

contribution figure. Comparable industry profit margin numbers in 2009 were 11.78%.

Broadcom’s Return on Assets ratio measures the company’s total profit per dollar of

assets and is defined as net income divided by total assets. Broadcom’s ratio was 7.77% for

2006 before declining year over year to 4% in 2007 and 2008. In 2009 return on assets further

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declined to 1.27%. These were all the result of expenses below the gross margin line and similar

to the profit margin discussion above, including reduced revenue, heavy R&D expenditures, and

litigation costs. Total assets remained relatively constant over the time period. Comparably, the

industry reported a 6.88% for 2009.

Broadcom’s return on equity ratio, net income divided by total equity, is the amount of

net income returned as a percentage of shareholder’s equity or how much profit a company

generates with the money shareholder’s have invested. For 2006, the return on equity was 9%

and in 2007 it dropped down to 5% because of the increased R&D expenditures of $200M. In

2008, the ROE remained flat and in 2009 it dropped significantly to 1.68% due to revenue

decreasing by $200M, which impacted gross margin and net income. The industry average for

2009 was 8.86%.

Furthermore, the company’s earnings per share estimates served to be worse relative to

its competition and are purely the result of Broadcom’s earnings being weak. This ratio is solely

based on the company’s earnings and the number of shares outstanding and is calculated by

dividing net income by shares outstanding. Earnings per share decreased from $0.64 in 2006 to

$0.37 in 2007, largely due to increased research and development expenditures of $200M. The

earnings per share ranged from $0.41 to $0.13 in 2008 and 2009, largely due to a slippage of

total revenue by $200M falling to the bottom line. The company helped themselves by doing

share repurchases starting in 2007. The industry reported $0.84 for 2009, closer to the level that

Broadcom reported in 2006.

Finally, in assessing the company’s price to earnings ratio, the measure of a company’s

price per share divided by its earnings per share, Broadcom’s ratio is higher in part because of its

weaker earnings and the investor’s belief of how the company will perform relative to its

competition; profits are probably expected to grow at a far faster rate than its competitors. The

P/E ratio is based on stock price and earnings and expectations of future growth of earnings.

From 2006 to 2007, the price of the stock went from $32.31 to $26.14 and from 2008 to 2009,

the share price doubled to $16.97 in 2008 to $31.47 in 2009. Essentially, investors are paying

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247 years of current earnings (the P/E ratio for 2009 is 247 times). For example, if Broadcom’s

earnings were to double next year, which analysts expect they will, and if the number of shares

remains the same, the P/E ratio will drop to half of what it is at the end of 2009 to 123.

Additionally, the change in the P/E ratio from 2006, of 50 times, to 2007 of 71 times, is due to

the earnings dropping by half from an increase in R&D expenditures of $200M with flat revenue.

The change from 2007 to 2008 of 41 times is due to the change in share price dropping by $9.17.

For 2009, the price to earnings ratio of 247 times is high, relative to its earnings, because the

market and the investors of Broadcom believe in their efforts and know that Broadcom will make

major headway in 2010 in the wireless sector. Also, now with the new litigation resolved with

Qualcomm, their earnings will more than likely improve significantly. The industry price to

earnings ratio for 2009 was 111.08.

Research and development expenses were $1.5 Billion for Broadcom in 2009, or 34% of

revenues, substantially greater than their industry peers which averaged 18%. The company’s

new product and development initiatives are a reason that investors are willing to pay a high P/E

ratio with the belief that new product and high profitably are soon to follow. Although these

expenses have been high and a strain on the company’s earnings performance, it has turned out

to be one of the company’s strengths. For example, they will soon be competing head on with

one of their most rivaled competitors, Qualcomm, to produce chips for small laptops.

Broadcom’s weaknesses have resulted from their decreasing inventory turnover of 12

times per year due to rapidly expanding product lines, and an average collection period of 41

days, which has deteriorated from prior years due to the company’s accounts receivables

increasing and their revenues decreasing. All profitability measures are weak and have

deteriorated over the last four years due to increased R&D expenditures, litigation related

expenses and most recently a decline in revenue. Profitability has been impacted by the recession

and increased R&D expenses which have positioned the company for future growth and

increased profitability.

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In order to forecast the company’s growth and return on investment, all with the goal of

increasing shareholder value, we will analyze the long range strategic plan and estimate the

company’s projected financials for 2010, 2011 and 2012. Once this is completed, it will be

necessary to rerun all of the common ratios mentioned above to see just what will happen over

the life of the plan and find out just how successful Broadcom can become based on its

initiatives. This is discussed in Section 3 below.

Capital Budgeting

A state of the art Bluetooth earpiece was selected as a project to generate revenue for

Broadcom. The company already holds patents for Bluetooth technology as well as software

utilized in devices with Bluetooth capabilities. Due to the difficulty in generating numbers for

one piece of hardware or software we bundled the two and chose to create a more advanced

Bluetooth earpiece.

To distinguish the Broadcom earpiece from comparable products in the Bluetooth

earpiece market, we will manufacture an earpiece that has voice to text capabilities. The main

inspiration for this product derives from the recent passing of laws making it illegal to operate a

vehicle and talk on the phone or write text messages. In addition to the voice to text capabilities

Broadcom has engineered an earpiece with advanced Bluetooth capability eliminating the

majority of static and connectivity issues.

Investment Overview

To engage in the project of the new Bluetooth earpiece with voice to text capabilities

there will be a required investment of $30,000,000. After six years there will be a salvage value

of 20% or $6,000,000. Initial net working capital will be $500,000 and it will then be 2% of

revenue the following 5 years. Superior performance and technology allows for the Broadcom

Bluetooth earpiece to be placed on the market at $85 per unit, which is higher than competing

brands, but priced accordingly with quality. With annual inflation at 2.7% the price of the

earpiece will increase 3% per year. Costs associated with the manufacturing of the earpiece are

estimated to be $25 the first year and increase 3% each successive year to accommodate for

inflation and other price increases that may occur from vendors. The growth of the product is

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projected to be 5% annually and first year sales volume to be 1,000,000 units. It would be

prudent to calculate the decline of the product life after year 3; however, due to more states

passing laws forbidding the usage of mobile devices while operating a vehicle, it is projected that

as one regional market becomes saturated with our product and that of competitors other

immerging markets will compensate for the loss in sales. This will allow Broadcom to maintain a

5% yearly growth rate for the Bluetooth earpiece.

The cost of capital is projected to be 15% resulting with a net present value totaling

$152,539,536 for the six-year life of the project. The internal rate of return is 130% and payback

is 1.67 years. Based on established requirements this is an acceptable project to undertake. To

compensate for potentials risks involved with releasing a new product we have created scenarios,

best case and worst case, in order to create a range of numbers from which informed decisions

may be made.

Best case scenario – The Bluetooth earpiece with voice to text capabilities is met with great

demand during the first year of operation. Instead of a yearly unit sales increase of 5%

demand after year 1 has created a 15% increase in unit sales for the following five years. In

addition, due to the increased demand the unit price is increased from $85 to $110. Net

present value will be $244,245,199, which is a 60% increase in NPV from the base case

model. The internal rate of return will be 156% and payback is 1.38 years.

Worst case scenario - In worst case scenario it is found that there is no demand for the

product and sales decrease by 10% yearly. In addition, sales price is decreased to $70 per unit

in order to be more competitive with other Bluetooth devices on the market and costs

increase to $30 per unit. This decreases net present value 42% to $87,957,375. The internal

rate of return will decrease to 97.3% and payback will be 4.24 years.

Other elements have been evaluated to further prepare for other potential risks in capital

budgeting. This includes a change in tax rate from 34% to 39% and also a change in cost of

capital to 10% rather than the projected 15%.

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Change in tax rate – By changing the tax rate from 34% to 38% there is a decrease in net

income per year, NPV, and IRR. NPV decreases 6.61% or $142,464,195. IRR decreases to

122.8% and payback is 3.63 years. By forecasting a change in tax rate action can be taken

with further research to lessen tax burden on the project. While this is highly unlikely

situation to occur any drastic changes in the United States politics could see a shift at higher

taxation of American companies. Also, if Boradcom decides to place the Bluetooth earpiece

in the internal market it will be exposed to VAT, which will significantly affect Broadcom’s

financials.

Cost of capital – When discounting cash flows the expected risk is 15%, but there is a

potential for the risk to be greater or less than expectations. If the discounted rate were to be

more than 15% than there is more risk associated with the Bluetooth earpiece project. With

greater risk there is more potential for a larger return, but equally an opportunity for a greater

loss. In looking at various elements there is a chance that our discount rate for cost of capital

will be 10%. This creates a net present value of $183,763,020, which is a 20.5% increase.

IRR is 130% and payback is 3.67 years. Using numbers from the calculation of WACC cost

of capital for the project is actually 35.55% when this is plugged into the equation there is a

significant effect on NPV. NPV decreases to $75,916,331 or a decrease of 50%. IRR and

payback remain unaffected.

Capital Budgeting Outcome

After constructing a capital budgeting model for the Bluetooth earpiece Broadcom can go

forward with the project. All indicators show that this would be a sound project in which it can

invest. Models have been made to anticipate changes in scenario that could bear positive or

negative consequences for the project as well as changes to tax rate and change in the present

value over the course of the project. These models help management an informed decision as to

which direction the project may need to go. All models show that regardless of projected

conditions that Broadcom would not lose money by investing in the Bluetooth earpiece project.

While under certain unfavorable conditions the return will be less, but the capital generated will

exceed the initial investment of $30,000,000.

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Planning Process

Once the advanced Bluetooth earpiece was selected, strategic planning was conducted

with a three year plan with projected income statements and balance sheets. Three important

questions were answered: 1. where is Broadcom’s current position relative to the competitive

marketplace, 2. where would Broadcom like to be in the long-run, and; 3. how does Broadcom

plan to get to where it wants to be?

Where is Broadcom’s current position relative to the competitive marketplace?

A SWOT analysis was conducted to determine the company’s strongest qualities and its position

in the semiconductor industry. The main internal and external strengths, weaknesses,

opportunities and threats of the company were examined.

Strengths:

Internal

Broadcom competes strongly in product quality, product capabilities, level of product integration, and engineering execution

The company excels in reliability to the customers, price, time to market, market presence, standards compliance, and systems costs

Broadcom prides itself in intellectual property holding over 3,1000 U.S. and 1,400 foreign patents and more than 7,600 additional domestic and foreign pending patents

Strong Research & Development Division that obtains sufficient funds and packaging materials

R&D expenses have set up the company’s future for growth and increased profitability.

External

Strong market presence Customer base are leaders in their industry

Weaknesses:

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Inability to retain, recruit and hire key executives, technical personnel, and other employees inaccurate positions and at precise numbers

Difficulties in timely and accurately predicting market requirements and industry standards Lengthy sales cycle makes it difficult to accurately forecast customer demand Lengthy sales cycle increase the risk that a customer will decide to cancel or curtail,

reduce or delay their product plans The company typically sells products pursuant to purchase order, rather than long-term purchase commitments.

They have an inventory turnover of 12 times per year during an average collection period of 41 days.

All profitability measures are weak and have deteriorated over the past years.

External

The communications and semiconductor industries are characterized by rapid technological change, evolving regulations and standards, short product life, and price erosion

Sales of Broadcom’s products largely depend on the commercial success of their customer’s products

Opportunities

Internal

Greater incorporation of Broadcom ICs in consumer products such as desktops, laptops, cellular phones, and satellite and digital cable boxes for example

The development of new product lines and technologies Currently 74% of employees are in R&D Acquisitions of key businesses in target markets to effectively develop and integrate

External

The effects of competition The effects of competitive pricing programs and rebates

Threats

Internal

Substantial litigation costs and diversion of our resources to enforce intellectual property rights

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Legal issues related to stock backdating and any adverse rulings in these cases or possible future cases could impact the company’s brand reputation and their ability to do business.

External

Many of their competitors operate their own fabrication facilities and therefore have greater advantage with longer operating histories, presence in key markets, greater name recognition, larger customer base

Increased competition could result in pricing pressures, decreased gross margins, loss of market share

Potential inability to protect intellectual property in the forms of patents, copyrights, trademarks, trade secret laws, confidentiality agreements with employees and strategic partners, and nondisclosure agreements

Worldwide political and economic uncertainties Changes in governments, coups, wars, changes in trade policies Economic downturns, like the one we are experiencing decreases product demand, since

there is excess customer inventories, which accelerate the wearing down of prices

Where would Broadcom like to be in the long-run?

Broadcom’s core mission is to “Connect Everything”, which has allowed the company to become a leader in broadband connections. A main goal for the company is to continue to innovate existing products while further developing research and development initiatives. Annual plans for the next three years were forecasted for the advanced Bluetooth earpiece investment project.

Target Objective: To grow the company by five percent year over year Strategy: To utilize bonds to increase funding capital for the Bluetooth earpiece

How does Broadcom plan to get to where it wants to be? Strategy: In order to implement targeted business and product plans, Broadcom will need

to expand, train, manage, and motivate the current workforce in order to convince leading communication equipment manufacturers to select Broadcom products for design into their own new products.

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Capital Structure

Broadcom has decided to undertake a $30,000,000 investment project using their

Bluetooth earpiece in order to generate additional revenue. Our goal is to determine the

appropriate way to fund the project, either using equity or through the issuing of bonds. Analysis

of the current capital structure is necessary to see how the company is currently operating. First,

we will examine the company’s current use of debt and equity from our ratio analysis. Next, we

will perform a WACC (Weighted Average Cost of Capital) calculation using its base financials

to determine the firms overall cost of capital. In order to calculate the cost of equity we will

apply the CAPM model. Since Broadcom does not have any interest bearing debt (outstanding

bonds) we assumed the cost of debt to be zero. Furthermore we will use the WACC results to

determine the ideal mixture of debt and equity to support the investment project.

WACC

The WACC is the discount rate we use in the firm’s overall cash flows. It is the overall

return a firm must earn on it’s existing assets to maintain the VALUE OF THE STOCK. The

WACC is the average of the cost of equity and the after-tax cost of debt. The formula is as

follows, WACC= R(E)*E/V +R(D) * D/V * (1-Tc), where R(E) is cost of equity, R(D) is the

cost of debt, 1-Tc is the after tax cost of debt and V is the market value of the firm’s equity plus

market value of the firm’s debt.

Using the CAPM formula, Er=Rf + (Rm-Rf) x β we are able to calculate the cost of equity R(E)

portion of the WACC. R(f) is the risk-free rate which we used the current treasury yield at 3.6%.

R(m) is the average market return where we chose the average return for the S&P 500 in 2009 at

23.5%. The Market Risk Premium (Rm-Rf) calculates to 19.90%. The Beta Coefficient, the

measure of the amount of systemic risk of an asset relative to that of an average risky asset, is

1.31 (per Yahoo Finance). As a result the total cost of equity (E) for Broadcom is 29.67%.

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The market value of equity for Broadcom is calculated by dividing the total number of

outstanding shares, 512,645,000, by the stock price of $32.31 giving us a value of (V)

$16,563,559,950.

It is important to re-emphasis that Broadcom does not have any interest bearing debt

(outstanding bonds). Therefore we are able to assume the cost of debt (D) to be zero and the

WACC to be equal to the cost of equity. However, if debt was involved we would continue the

calculation as follows. This gives us the value for debt in the WACC formula.

The percentage weights of equity and debt can now be calculated. We find equity by

dividing the cost of equity by the market value of the firm, E/V, resulting in 1.00. Also, we can

calculate the weight of debt by dividing the cost of debt by the market value of the firm, D/V,

resulting in 0.

Having compiled all the factors in the WACC formula, the cost of equity, the cost of

debt, the weighted averages of debt and equity, the market value of the firm and the tax rate

allowed us to derive at a WACC of 29.67%. This means that Broadcom must earn 29.67% or

greater on an investment to create value of the stock.

Ideal Capital Structure

Knowing the WACC value and the respective percentage weights of equity and debt we are

now able to determine the best capital structure for Broadcom. After careful review of their

current capital structure and the outcome of their latest financials we have suggested the

company continue the use of equity or cash to fund the Bluetooth investment project. Since

there is a high availability of cash, a $30M investment will not make a significant impact on

revenue and will not have any adverse effects to the company financials. In our analysis we

show the current capital structure and 6 other scenarios that fluctuate percentage weights for debt

and equity. Scenario 1, we use 75% equity and 25% debt, scenario 2, we use 50% equity and

50% debt, scenario 3, we use 33% equity and 66% debt, scenario 4, we use 25% equity and 75%

debt, scenario 5, we use 10% equity and 90% debt and scenario 6, we use 0% equity and 100%.

If additional funding is needed, this analysis shows that adding debt to the capital structure will

reduce the WACC.

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Instead of funding this project with cash, Broadcom can also chose to float a bond offering of

$30M. In this option we will assume they will take their investment in this project entirely from

the sale of bonds. We calculated the impact on WACC and wrote an indenture for the bond

offering. Since Broadcom has an excellent credit rating it can have a debt usage of 100% which

we illustrated in option 2 scenario 6. This results in a WACC of 3.68%.

Raising Capital Funds

In order to illustrate the agreement between Broadcom and its bondholders of the $30M bond

offering we wrote the following terms in the indenture.

Broadcom has issued 30,000 bonds worth the value of $30M. The Bonds will

be sold on June 1, 2010 and will mature on June 1, 2030. Interest will be paid

annually on June 1 of each year to the person in whose name is registered at

the close of business on May 15. Each bondholder will receive $55.70 per

bond per year. Bonds will not be secured by any assets. There is no security

to the bond. No sinking fund available. A call provision is allowed at any

time and do not have a “deferred call”. The bonds have a “make-whole” call

feature. The call price is listed as the Treasury Rate plus 0.15%. The bonds

are in the top grade investment, S&P giving a “AA” rating and Moody’s an

“A” rating. The following covenants are included. The firm may not pledge

any assets to other lenders. The firm cannot sell or lease any major assets

without approval of lender. The company must periodically furnish audited

financial statements to the lender. Lastly, the company must maintain any

collateral or security in good condition.

Capital Structure Outcome

The analysis of Broadcom’s current capital structure and the calculation of its WACC for

various combinations of equity and debt weights allowed us to determine the best choice to

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finance the Bluetooth investment project. It is clear to us that for a small project in the amount

of $30M, Broadcom should maintain their current method of funding, using equity or cash. As

we have illustrated in our ratio analysis, Broadcom’s strength to this point, is evidenced by its

excellent leverage ratio. With its large cash reserves and zero debt Broadcom will have no

problem meeting its obligations and avoiding situations that may lead to bankruptcy. With this

information in hand, any credit rating agencies will give Broadcom an excellent credit rating.

This facilitates a low cost to borrow if necessary in the future.

Pricing Structure

Broadcom’s $30 million investment opportunity for Bluetooth Earpiece – Voice to Text

will have a considerable low risk and moderate to high return, with a payback period of one year

and Net Present Value (NPV) of $152 million over a six (6) year period of annual sales.

Considering the price per unit increase of 3%, and a projected annual growth of 5%, the

initial investment, supra, will be recovered at the lowest price per unit within the first year of the

six (6) year period of projected sales, reflected on the PVIF sensitivity analysis and the worst

case best case scenarios prepared by Joshua Roller in §2 Capital Budgeting, ante, reflect a

payback period of one year. The increase per unit price during the following years will

accommodate the annual rate of inflation of two point seven (2.7%) percent with the three

percent (3%) price per unit.

There forecast of units for year one is 1 million units, each unit is projected to be sold at

$85.00 totaling $85 million in revenue as reflected on the capital budget for year 2010. The total

operating cash flow (OCF) after depreciation is $41,640,000. The base price for year one is set at

$170.00, consequently the margin of projected sales of $170 million doubles excepted annual

revenue and more than triples projects OCFs for year 2010.

Year two, forecast of units of 1,050,000 units; at $87.55 with revenue projections of

$91,927,500 allow for a reduced markup of 10% form year 2010 will give a competitive edge to

compete against emerging Bluetooth competitor with a product line already on the market for

one year, 90% markup, being $166.35, provides greater opportunities to afford longer cash

discount periods and increase discount percentages without increasing risk to OCFs of

$46,091,400 after depreciation for year 2011.

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Forecast of units for year 2011 of 1,102,500 units, each unit projected sale price of

$90.18 permits a reduced markup of 85% resulting in a marginal increase in base price from the

previous annual cycle. Base price revenues are projected to reach $99 million. OCF for year

three have been estimated at $48 million. Base price sales project double the list price revenues,

at $209 million using a discount of 15% on all sales.

Risk exposure has been set at 20% of overall sales for year one, each consecutive year

will use the 20% exposure scenario to assess for loss in revenues based on contract

nonperformance of at a loss of 50% of that contract. Loss of revenues exposure is based on the

maximum order allowed within a given quarter.

A three year Sales proposal Pricing Structure, Terms and Conditions s for contracts will

be assessed quarterly within each year, a new contract will be generated annually at the end of

the fourth quarter; quarterly stipulation criteria will reduce loss of revenue due to termination of

contract, sunk cost and wind down. Contract stipulations are fixed and the penalty for non-

performance to contract is based on individual basis per order and previous year interactions with

consumer(s).

The effective date of pricing starts at the beginning of the annual physical period. The

invoice date is the beginning of the billing date and the shipping date is based upon receipt of

payment reflected on cash discount periods delineated below.

The assumption for the example written below is a contract made with Samsung Unite

States. Samsung has made an order for 200,000 units of Bluetooth earpieces that will have Voice

over Internet Protocol (VoIP) to connect with their new line of LED HDTVs coming to the

market in the fall of this year. Their order is based on two phases, 100,000 units each phase.

Samsung will make payment on the first 100,000

Upon receipt of invoice, payment may be made within the first ten (10) days (cash

discount period), receipt of invoice is the billing date not he shipping date. The credit period

granted under these pricing stipulations is in effect the buyer’s payable period. Unit discounts are

given as follows:

Orders per unit sale price is $85.00, the pricing structure being used in the price discount

calculator below reflects a 100% markup and each unit will be listed for $170.00, the maximum

order permitted per quarter is 200,000 units, the cash discount period will be 15 percent discount

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from the base price if paid within 10 or else pay the full amount within 30 days, i.e., 15/10, net

30.

The initial markup is necessary to avoid drawing funds away from OCF. The example

below shows an order placed for 200,000 units and the breakdown of the sale price + initial

markup = the list price, hereinafter referred to as the base price (Please see Appendix 4).

Terms and Conditions

No company may place order proposals exceeding 200,000 units per given quarter, the

contract period of 30 days, or within a 90 day period in a given quarter, beginning at the start of

each quarter period. New orders must be placed in advance of fifteen (15) days before the

beginning of the new quarter period.

Orders of 200,000 units will be shipped in two phases, 100,000 units will ship upon

receipt of promise of payment, starting with the cash discount period and ending with the credit

period (net credit period) stipulations. Failure to make payment at the end of cash discount

period will result in a 7% penalty interest fee added to the base price. Breach of contract for

nonperformance of promise of payment will result in stop of service; a legal filing will be

submitted to recover operating cost equal to percent of ordered units minus unpaid unit

subtracted from projected annual sales.

Termination

To maintain security and interest of assets the Termination Cost includes:

Cost Items as determined within the operating expenses annual cost

Parts

Assets

One-Time Costs

Third Party Contracts

Wind Down Services

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A risk exposure sample of Samsung order of 200,000 units shows a breakdown of a

termination cost based on a sales proposal pricing structure, terms and conditions (Please see

Appendix 5).

Pricing Structure Outcome

Determining loss of revenues at 20% of overall sales shows Broadcom’s resilience to

economic fluctuations in current market trends. The initial markup of 100% for year one does not

place Broadcom at risk of loss of market shares given Broadcom’s innovative edge in Blue

Tooth technology, holding of patent, and reputation for quality.

Financial Project Outcome

An objective of this project was to gain insight of the corporate world through financial

analysis. This simulated business project enabled us to look at all aspects of Broadcom in terms

of long-term strategic and operations objectives, as well as short-term profit and return

commitments through the process of strategic long range planning. A ratio analysis was

conducted to determine Broadcom’s strengths and weaknesses. From our analysis we found that

Broadcom is a leader in their target markets, has strong cash flow from operations, and has no

long term debt. We then picked the advanced Bluetooth earpiece as an investment project to gain

a better understanding of Broadcom’s cash flows. After running the capital budgeting scenarios,

we concluded that the Bluetooth earpiece was an appropriate investment opportunity, since it

would add profit to the firm and increase the shareholder’s value. Business planning was

conducted where operating plans outlined where the business is going and how it was going to

get there. Then, a capital budgeting and financing structure was conducted for the investment

project. We learned about the options available for a company with a lack of long term debts and

higher equity. A pricing model was developed to help us understand the underlying risk, possible

exposure, and the financial impacts of customers’ contract pricing. We learned of the importance

of having detailed terms and conditions that would protect the company, for example in the case

of acquisitions and non performance.

References:

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Broadcom Corporation. (2009). 4th Quarter Earnings Statement. [PDF]. Retrieved from Broadcom Corporation website: http://files.shareholder.com/downloads/BRCM/857600130x0x348778/17187e0e-c6e4-4f38-9c1e-b94fb49ff41a/BRCM_News_2010_2_3_Corporate_News.pdf

2 Broadcom Corporation. (2009). Corporate Overview. [PowerPoint slides]. Retrieved from Broadcom Corporation website: http://www.broadcom.com/docs/company/corporate_overview.pdf

3 Broadcom Corporation. (2009). Fact Sheet. Retrieved from Broadcom Corporation website: http://www.broadcom.com/docs/company/company_factsheet.pdf

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APPENDIX 1: (Broadcom’s Balance Sheet for 2006, 2007, 2008 and 2009)

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CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

December 31,

2009 2008 2007 2006

Assets

Current assets:

Cash and cash equivalents 1,397,093$ 1,190,645$ 2,186,572$ 2,158,110$

Short-term marketable securities 532,281 707,477 141,728 522,340

Accounts receivable (net of allowance for doubtful accounts

of $6,787 in 2009, $5,354 in 2008, $5,472 in 2007 and $6,894 in 2006 ) 508,627 372,311 369,004 382,823

Inventory 362,428 366,106 231,313 202,794

Prepaid expenses and other current assets 113,903 114,674 125,663 85,721

Total current assets 2,914,332 2,751,213 3,054,280 3,351,788

Property and equipment, net 229,317 234,691 241,803 164,699

Long-term marketable securities 438,616 - 75,352.00 121,148.00

Goodwill 1,329,614 1,279,243 1,376,721 1,185,145

Purchased intangible assets, net 150,927 61,958 46,607 29,029

Other assets 64,436 66,160 43,430 24,957

Total assets 5,127,242$ 4,393,265$ 4,838,193$ 4,876,766$

Liabilities and Shareholders' Equity

Current liabilities:

Accounts payable 437,353$ 310,487$ 313,621$ 307,972$

Wages and related benefits 190,315 151,551 147,853 104,940

Deferred revenue and income 87,388 12,338 15,864 1,873

Accrued liabilities 433,294 242,727 280,271 263,916

Total current liabilities 1,148,350 717,103 757,609 678,701

Commitments and contingencies

Long-term deferred revenue 608 3,898 8,108 0

Other long-term liabilities 86,438 65,197 36,328 6,399

Shareholders' equity:

Convertible preferred stock, $.0001 par value:

Authorized shares - 6,432 - none issued and outstanding - - - -

Class A common stock, $.0001 par value:

Authorized shares - 2,500,000

Issued and outstanding shares -

438,557 in 2009, 426,095 in 2008, 468,858 in 2007 and 473,533 in 2006 44 43 47 48

Class B common stock, $.0001 par value:

Authorized shares - 400,000

Issued and outstanding shares -

56,999 in 2009, 62,923 in 2008, 68,400 in 2007 and 74,781 in 2006 6 6 7 7

Additional paid-in capital 11,153,060 10,930,315 11,576,042 11,948,908

Accumulated deficit (7,259,069) (7,324,330) (7,539,124) (7,757,202)

Accumulated other comprehensive income (loss) (2,195) 1,033 (824) (95)

Total shareholders' equity 3,891,846 3,607,067 4,036,148 4,191,666

Total liabilities and shareholders' equity 5,127,242$ 4,393,265$ 4,838,193$ 4,876,766$

Date Filed: Feb 03, 2010

BROADCOM CORP

BALANCE_SHEET

Form Type: 10-K

Period End: Dec 31, 2009

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APPENDIX 2: (Broadcom’s Income Statement Sheet for 2006, 2007, 2008 and 2009)

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

Year Ended December 31,

2009 2008 2007 2006

Net revenue:

Product revenue 4,272,726$ 4,485,239$ 3,739,312$

Income from Qualcomm Agreement (see Note 2) 170,611 - -

Licensing revenue 46,986 172,886 37,083

Total net revenue 4,490,323 4,658,125 3,776,395 3,667,818

Costs and expenses:

Cost of product revenue 2,210,559 2,213,015 1,832,178 1,795,565

Research and development 1,534,918 1,497,668 1,348,508 1,117,014

Selling, general and administrative 479,362 543,117 492,737 504,012

Amortization of purchased intangible assets 14,548 3,392 1,027 2,347

Impairment of goodwill and other long-lived assets 18,895 171,593 1,500 0

Settlement costs, net 118,468 15,810 - -

Restructuring costs (reversals) 7,501 (1,000) - -

In-process research and development - 42,400 15,470 5,200

Charitable contribution 50,000 - - -

Total operating costs and expenses 4,434,251 4,485,995 3,691,420 3,424,138

Income from operations 56,072 172,130 84,975 243,680

Interest income, net 13,901 52,201 131,069 118,997

Other income (expense), net 2,218 (2,016) 3,412 3,964

Income before income taxes 72,191 222,315 219,456 366,641

Provision for income taxes 6,930 7,521 6,114 12,400

Net income 65,261$ 214,794$ 213,342$ 379,041$

Net income per share (basic) 0.13$ 0.42$ 0.39$ 0.69$

Net income per share (diluted) 0.13$ 0.41$ 0.37$ 0.64$

Weighted average shares (basic) 494,038 512,648 542,412 545,724

Weighted average shares (diluted) 512,645 524,208 577,682 588,318

Date Filed: Feb 03, 2010

BROADCOM CORP

INCOME_STATEMENT2

Form Type: 10-K

Period End: Dec 31, 2009

APPENDIX 3: (Broadcom’s Ratio Analysis/Calculations for 2006, 2007, 2008 and 2009)

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Key items(amounts in thousands) 2006 2007 2008 2009

Texas Instr. QualcommSales 3,667,818 3,776,395 4,658,125 4,490,323 10,427,000 10,568,000 net income 379,041 213,342 214,794 65,261 1,470,000 2,091,000 Cost of goods sold 1,795,565 1,832,178 2,213,015 2,210,559 5,428,000 3,242,000

cash 2,158,110 2,186,572 1,190,645 1,397,093 1,182,000 3,660,000 receivables 382,823 369,004 372,311 508,627 1,277,000 616,000 inventory 202,794 231,313 366,106 362,428 1,202,000 350,000 current assets 3,351,788 3,054,280 2,751,213 2,914,332 6,114,000 13,574,000 total assets 4,876,766 4,838,193 4,393,265 5,127,242 12,119,000 28,903,000 current liabilities 678,701 757,609 717,103 1,148,350 1,587,000 2,948,000 long term debt 6,399 44,436 69,095 87,046 810,000 3,775,000 total liabilities 685,100 802,045 786,198 1,235,396 2,397,000 7,550,000 total equity 4,191,666 4,036,148 3,607,067 3,891,846 9,722,000 21,353,000

Liquidity ratios 2006 2007 2008 2009 Industry comparisonCurrent ratio 4.94 4.03 3.84 2.54 lower TimesQuick ratio 4.64 3.73 3.33 2.22 lower TimesINDUSTRY 3.66

3.27

Leverage ratios 2006 2007 2008 2009 Industry comparisonDebt ratio 14.05% 16.58% 17.90% 24.09% higher percentageDebt to equity ratio 16.34% 19.87% 21.80% 31.74% higher percentageINDUSTRY 23.33%

30.59%

Activity ratios 2006 2007 2008 2009 Industry comparisonInventory turnover 18.09 16.33 12.72 12.39 lower TimesAverage collection period 38.10 35.67 29.17 41.34 higher DaysAsset turnover 0.75 0.78 1.06 0.88 higher TimesINDUSTRY 17.09

35.77 0.70

Profitability ratios 2006 2007 2008 2009 Industry comparisonProfit margin ratio 10.33% 5.65% 4.61% 1.45% lower percentageROA 7.77% 4.41% 4.89% 1.27% lower percentageROE 9.04% 5.29% 5.95% 1.68% lower percentageINDUSTRY 11.78%

6.88%8.86%

Profitability ratios 2006 2007 2008 2009 Industry comparisonEPS 0.64 0.37 0.41 0.13 lower DollarsPE ratio* 50.15 70.78 41.42 247.21 higher TimesGross Margin 51.05% 51.48% 52.49% 50.77% PercentageINDUSTRY 0.84

111.08 56.01%

*Use close price as of December 31: source: Yahoo Finance

Industry (2009)

APPENDIX 4: (Initial Pricing Markup)

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Base Price Discounted PriceSale Price 85.00$

I nitial markup 100%List Price 170.00$

Units Request Order 200,000 200,000

Cash Discount 15%

Savings per base unit 25.50$

Total Price 144.50$

Lump sum total 34,000,000$ 28,900,000$

Tax 34%

Shipping and handling 25,000$ 25,000$

Total 45,585,000$ 38,751,000$

Total Savings 6,834,000$

Shipping & Handling per Units 1 13.99$ Minimum Order10 32.99$

100 189.99$ 1000 643.99$

10000 1,250.00$ Maximum Order

APPENDIX 5: (Breakdown of Termination Costs)

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Samsung-United States

Termination Costs

Cost Items: Percent From Operating ExpensesSalary (Office & Overhead) 316,770.87 0.0834Payroll (Taxes etc.) 3,167.71 0.0083Outside Services 24.99 0.0007Supplies (Office Operation) 30.03 0.0008Repairs/ Maintenance 337.30 0.0027Advertising 2,317.10 0.0071Vehicle, Delivery and Travel 1,110.66 0.0049Accounting and Legal 356.61 0.0028Building Lease 20,058.74 0.0210Telephone/Internet/IT Service 1,658.99 0.0060Utilities 136.91 0.0017Insurance 232,407.93 0.0714Taxes 14,389.63 0.0178Depreciation 34,770.55 0.0276Parts:Depreciation 34,770.55 0.0276Assests:Unearned Discount 6,834,000.00 0.1500Equipment Lease 22,097.25 0.0220One-time Costs:Transaction Fees (POS) 2,611.06 0.0076Professional Services 3,101.37 0.0082

Third Party Contracts:Vehicle Lease 4,084.89 0.0095Armoured Car Contracts 4,956.97 0.0104Litigation 192,596.63 0.0650Consulting Services 1,382.06 0.0055Wind Down Services:Service Continuation (RMA) 12,624.60 0.02Professional Services 273,801.00Consulting to New Supplier 102,549.00

Risk @ 20% 22,792,500$

Grand Total of Cost 30,908,613$

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