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Question 1.

Zorco Ltd produces widgets that sell for $180 each. Unit sales are presently 7,000 and variable cost per unit is $88.60. Fixed operating costs are $320,000 per year. The firm currently has outstanding debt of $1,200,000 with an interest cost of 10% per annum. It has 10,000 ordinary shares on issues and has forecast an interim dividend of $1 per share. The firm is expecting a 10 percent increase in sales and pays tax at the rate of 30 percent.

Based on the firm`s current sales per year and an expected 10% increase in sales calculate the firm`s DOL, DFL and DTL.

Question 2.

Time that the investment is made Financing method

New share issue New debt issue

Before the share market learns the true value of the existing assets Scenario 1 Scenario 3

After the share market learns the true value of the existing assets Scenario 2 Scenario 4

Sophie Pharmaceuticals Ltd has 9.6 million ordinary shares on issue. The current market price is $12.50 per share. However, the company manager knows that the results of some recent drug tests have been remarkably encouraging, so that the `true` value of the shares is $13 Unfortunately because of confidential patent issues Sophie Pharmaceuticals cannot yet announce these test results. In addition, Sophie Pharmaceuticals has a property investment opportunity that requires an outlay of $15 million and has a net present value of $2.5 million. At present, Sophie Pharmaceuticals has little spare cash or marketable assets, so if this investment is to be made it will need to be financed from external sources. The existence of this opportunity is not known to outsiders and is not reflected in the current share price.

a) Should Sophie Pharmaceuticals make the new investment?

b) If so, should the investment be made before or after the share market learns the true value of the company`s existing assets?

c) Should the investment be financed by issuing new shares or by issuing new debt?

Question 3.

Previous Years

Sales 1400 Retained Earnings 170

Costs 900 Dividends 180

Tax rate 0.3

Assets Liabilities/Equity

Current Assets Current Liabilities

Cash 460 Creditors 600

Debtors 540 Short Term Notes 100

Inventory 600

Non-Current Assets Non-Current Liabilities

PP&E 2000 Debentures 900

Total Assets 3600

Owner’s Equity

Retained Profits 1000

Ordinary Shares 1000

3600

Percentage of Sales Approach – Assume all spontaneous variables move as a percentage of sales.

a) Given an expected increase in sales of 12%, what is the amount of external funding required?

b) To maintain the current debt/equity ratio how much debt and how much equity is required?

c) Assuming the company is only operating at 95% capacity, how much new funding (if any) is required?

Question 4.

Previous Years

Sales 1100 Retained Earnings 80

Costs 800 Dividends 130

Tax rate 0.3

Assets Liabilities/Equity

Current Assets Current Liabilities

Cash 400 Creditors

Debtors Short Term Notes

Inventory

Non-Current Assets Non-Current Liabilities

PP&E 600 Debentures 500

Total Assets 1000

Owners’ Equity

Retained Profits 500

Ordinary Shares

1000

a) Given an expected increase in sales of 13%, what is the amount of external funding required?

b) At this growth rate what is the addition to retained earnings?

c) Calculate the Sustainable Growth Rate (SGR)

d) At the SGR what external funding is required?

e) What would be the growth rate at which no external financing would be required?

Question 5.

a) A Ltd wishes to maintain a growth rate of 10 per cent per year and a dividend payout of 20 per cent. The ratio of total assets to sales is constant at 2, and profit margin is 10 percent. What must the debt/equity ratio be?

b) B Ltd wishes to maintain a growth rate of 5 per cent per year, a debt-to-equity ratio of 0.5, and a dividend payout of 60 per cent. The ratio of total assets to sales is constant at 2. What profit margin must it achieve?

c) C Ltd wishes to maintain a growth rate of 4 per cent per year, a debt-to-equity ratio of 0.5, and a dividend payout of 80 per cent. If the profit margin is 8 per cent and next year`s sales are projected at $1500, what is the total asset projection?

Question 6.

Sad Ltd is considering the installation of a new computer. Because of uncertainty as to its future computing requirements and the prospect of advancements in computing technology, it is evaluating the acquisition of the computer by either purchasing it, or leasing it. Information relevant to the company`s evaluation is as follows:

Purchase - Loan

The company applies straight line depreciation. The Tax Commissioner allows a 33.33% depreciation rate on computer capital acquisitions. Sad Ltd plans to operate the computer for a maximum of 5 years. The computer`s disposal value at the end of 5 years is estimated to be $85,000. Mad would borrow the $1,500,000 to cover the purchase cost with a 5 year loan at 10% per annum

Lease

There would be five annual lease payments payable with the first payment made at time zero..

A residual payment of $90,000 would be made at the end.

The company income tax rate is 30 cents in the dollar.

a) Calculate the lease payment.

b) Should the company purchase or lease the asset?

Question 7.

Ben owns 800 shares in Black Enterprises whose current share price (cum rights) is $3 per share. Black Enterprises wishes to raise $3 million through a rights issue at a subscription price of $2.40. They currently have issued 10 million shares.

a) Calculate the value of a right to buy 1 new share.

b) The ex-rights share price

c) The value of the investment cum rights and ex-rights.

Question 8.

Details of the following two bonds are as follows.

A B

Compounding Periods per annum

4 4

Yield to Maturity .12 .12

Face Value $500,000 $500,000

Coupon Rate .10 .06

a) Calculate the duration of each bond.

b) If interest rates move to 13% calculate the change in price of the two bonds predicted by their calculated durations.

Question 9.

Crosscut Ltd has announced a rights offer to raise $80 million for a new operation in Homeland. The share currently sells for $7.50 and there are 200 million shares outstanding.

a) What is the maximum possible subscription price? What is the minimum?

b) If the subscription price is set at $6.25 per share, how many shares must be sold? How many shares will provide the right to one new share?

c) What is the ex-rights price? What is the value of a right?

d) Show how a shareholder with 100 shares and no desire (or money) to buy additional shares is not harmed by the rights offer.

Question 10.

Loan Amount $700,000

Annual Interest rate 8.5%

Term in Years 5

Payments per year 12

a) Prepare an amortisation schedule premised upon payments that are treated as a deferred annuity

b) Immediately after the 30th payment the bank advised an increase in the annual interest rate to 8%.

Question 11.

Calculate the price of commercial paper with a face value of $1 million and 180 days to maturity if the yield is 8.9 per cent per annum.

Question 12.

Debenture Face Value $3000

Coupon Rate 12.5%

30% probability that rates will fall to 11%

70% probability that rates will increase to 13%

Par value $2800

a) Calculate the Market Price of the Non-Callable Debenture

b) What would the coupon rate need to be for the debentures to sell at par?

c) Calculate the cost of the call provision

Question 13.

The Thompson Paint Company uses 70 000 litres of pigment per year. The cost of ordering pigment is $200 per order and the cost of carrying the pigment in inventory is $1.00 per litre per year. The firm uses pigment at a constant rate every day throughout the year.

a) Calculate the economic order quantity (EOQ).

b) Calculate the ordering cost.

c) Calculate the ordering days

d) Calculate the holding cost

e) Calculate the average inventory

f) Calculate the annual total cost

g) Assuming that it takes 15 days to receive an order once it has been placed, determine the reorder point in terms of litres of pigment. (Note: Use a 365-day year.)

Question 14.

The finance officer has estimated that Flippers Ltd will require 30,000 units of product over the next 12 months. She has estimated that the cost of acquisition is $2.50 per unit and the carrying cost is 55 cents per unit. The cost per unit of product is $11.

What would be the economic order quantity for Slippers?

Question 15.

Calculate the Black—Scholes price for a call option with the following features: share price $25.00, exercise price $23.50, term to expiry 1 year, risk-free interest rate 5. 5 per cent per annum (compounding annually) and volatility (variance) 0.09 per annum.

Question 16.

Determine the profit and/or loss to the following:

1 Call Options- Buyer/Holder and Seller/Writer

Market Price $10.50

Exercise Price $9.00

Call Premium $0.50

2 Put Options- Buyer/Holder and Seller/Writer

Market Price $8.25

Exercise Price $19.75

Call Premium $0.70

Question 17.

Cash Price per Unit $ 61.00

Variable Cost per Unit $ 32.00

Current Quantity Sold per Month 2000

Quantity Sold under New Policy 2200

Monthly Required Return 2.75%

Terms 30 days

The company is planning to switch from a cash basis to offering credit terms.

a) Calculate the cost of switching using both the One Shot Approach and the Accounts Receivable Approach.

b) If the new Credit price was set at $63 per Unit and 2.5% of sales were uncollectable, calculate the NPV of the switch.

c) Calculate the default rate that makes NPV equal to zero.

d) Calculate the NPV associated with a One-Time Sale.

e) Calculate the percentage chance the company would have of collecting given the one time sale extension of credit.

f) Calculate the NPV associated with a repeat sale.

Question 18.

Busy Ltd is considering the acquisition of Bee Finance. The values of the two companies as separate entities are $8 million and $4 million, respectively. Busy estimates that by combining the two companies it will reduce selling and administrative costs by $250,000 per annum in perpetuity. Busy can either pay $5.25 million cash for Bee or offer Bee a 50 per cent holding in Busy. If the opportunity cost of capital is 10 per cent per annum:

(a) what is the gain, in present value terms, from the merger?

(b) what is the net cost of the cash offer?

(c) what is the net cost of the share alternative?

(d) what is the NPV of the acquisition under:

• the cash offer?

• the share offer?

Question 19.

You are an analyst for Black Ltd which is considering the acquisition of Beard Ltd.

You have identified the following effects of the takeover:

Investment of $500,000 will be required immediately to upgrade some of Beard`s older assets; Asset upgrading, economies of scale and improved efficiency will increase net operating cash flows by $320,000 per annum in perpetuity;

Some of Beard`s assets which have been producing a cash inflow of $90,000 per annum will be sold. The new owners of these assets should be able to use them more profitably and sale proceeds are expected to be $810,000;

New plant costing $1.35 million will be purchased and is expected to generate net operating cash flows of $240,000 per annum in perpetuity.

Beard`s activities are all of the same risk and the required rate of return is 11 per cent per annum.

Beard has 5 million shares on issue with a market price of $2..25 Assuming that the market price equals value as an independent entity:

a) Estimate the gain from the takeover; and

b) Estimate the maximum price that Endeavour should be prepared to pay for Beard`s shares.