A. Operating leverage (15 marks)
(i) Given the fixed overheads are reported as $106,730,000 for the year 2015 and using the data in Exhibit 1, calculate the pre-tax cash flow operating leverage for 2015.
(ii) In what circumstance, will it be preferable to have low pre-tax cash flow operating leverage?
B. Capital structure: financing capital expenditure and working capital (20 marks)
(i) Exhibit 4 shows the capital expenditure by the company and Exhibit 5 shows the extent of using debt to finance the firm’s capital expenditure. What are two major benefits of using debt rather just equity to finance capital expenditure.
(ii) Referring to the balance sheet from the annual report for the year 2015 and assess the current asset strategy (flexible or restrictive strategy) used by the company. [2015 annual report: http://www.duluxgroup.com.au/Investor-Centre/Reports/Report-s/default.aspx]
C. Dividend valuation model (25 marks)
(i) Referring to Exhibit 5, calculate the cost of equity using the Capital Asset Pricing Model (CAPM).
(ii) Calculate the average growth rate in earnings per share over the last 4 years till 2015.
(iii) Assuming the dividends will grow at a constant rate till perpetuity equivalent to the average growth rate in earnings per share as determined in C(ii), use Gordon’s growth dividend valuation model, determine the share price (i. e.: fundamental value) as at today. [ please record the current date of doing the assignment as “today”]
(iv) Your manager asks you to recalculate the share price (i.e.: fundamental value) with a revised growth rate till perpetuity of 2.14% per annum.
(v) Dulux’ share is currently trading at $6.50 [at close of business on 5th May 2015]. Using your findings in C(iv), determine whether you will recommend buying the share.
3. Case study: Corporate bond market [ 30 marks]
Many Australian miners are buying back their bonds. On 22 April 2016, the price of iron has risen to $70.46 relatively to the price of $38.3. Bonds of RIO Tinto are currently trading at par value. Fortescue Metals group will buyback the bonds at a discount and the price of April 2022 bond is priced at $88 for every $100 of the par value.