ASSIGNMENT, Questions 1,2 and 3 (23 marks) of this assignment MUST be completed on an Excel Spreadsheet
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Semester 2-2019
ASSIGNMENT
This assignment is to be completed in groups of three and carries 30 per-cent of the marks in this unit.
The following considerations will be applied when evaluating the submission:
Questions 1,2 and 3 (23 marks) of this assignment MUST be completed on an Excel Spreadsheet.
The use of an accurate Excel (for Windows) model:
1. The setting and presentation.
2. Accuracy of calculations and Analysis.
Question 1. (11 marks)
Information concerning raising new capital
Bonds $1,000 Face value
13% Coupon Rate (Annual Payments)
20 Term (Years)
$25 Discount offered (required) to sell new bonds
$10 Flotation Cost per bond
Preference Shares 11% Required rate to sell new preference shares
$100 Face Value
$3 Flotation cost per share
Ordinary Shares $83.33 Current Market Price
$4.00 Discount on share price to sell new shares
$5.40 Flotation Cost per bond
$5.00 2018 – Proposed Dividend
Dividend History $4.63 2017
$4.29 2016
$3.97 2015
$3.68 2014
$3.40 2013
Current Capital Structure
Extract from Balance Sheet $1,000,000 Long-Term Debt
$800,000 Preference Shares
$2,000,000 Ordinary Shares
Current Market Values $2,000,000 Long-Term Debt
$750,000 Preference Shares
$4,000,000 Ordinary Shares
Tax Rate 33%
Risk Free Rate 5%
a) Calculate the cost associated with each new source of finance. The firm has no retained earnings available.
b) Calculate the WACC given the existing weights
The financial controller does not believe the existing capital structure weights are appropriate to minimise the firm’s cost of capital in the medium term and believes they should be as follows
Long-term debt 40%
Preference Shares 15%
Ordinary Shares 45%
c) What impact do these new weights have on the WACC?
The firm is considering the following investment opportunity. (2019-2026)
Data is as follows
Initial Outlay $1,600,000
Upgrade $700,000 End of Year 4
Upgrade – 350,000 Increased sales units per annum – (Year 5-8)
Working Capital $45,000 Increase required
Estimated Life 8 Years
Salvage Value $60,000
Depreciation Rate 0.125 For tax purposes
The machine is fully depreciated by the end of its useful life
Other Cash Expenses $60,000.00 Per annum (Years 1-4)
Other Cash Expenses $76,000.00 Per annum (Years 5-8)
Production Costs $0.15 Per Unit
Sales price $0.75 Per Unit (Years 1-4)
Sales price $1.02 Per Unit (Years 5-8)
Prior sales estimates
Year Sales
2008 520000
2009 530000
2010 540000
2011 560000
2012 565000
2013 590000
2014 600000
2015 610000
2016 615559
2017 659000
2018 680000
d) Calculate the Net Present Value, Internal Rate of Return and Payback Period
The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 per cent.
Year Stock Market Share
Index Price
2008 2000 $15.00
2009 2400 $25.00
2010 2900 $33.00
2011 3500 $40.00
2012 4200 $45.00
2013 5000 $55.00
2014 5900 $62.00
2015 6000 $68.00
2016 6100 $74.00
2017 6200 $80.00
2018 6300 $83.33
e) Calculate the CAPM
f) Explain why this figure may differ from that calculated above (i.e. Cost of equity – Ordinary Shares)
Question 2. (6 marks)
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 3. (6 marks)
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 4. (7 marks)
The homo economicus view of man’s behaviour as applied to the bulk of finance theory portrays decision makers and being both self-interested and rational. Neoclassical economics makes some fundamental assumptions about people:
1. People have rational preferences across possible outcomes or states of nature.
2. People maximize utility and firms maximize profits.
3. People make independent decisions based on all relevant information.
In light of the following hypothetical experiments, discuss the above
Experiment 1:
Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a taker in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any part of their $20 to a taker in Room Y. Takers can either choose to keep the amount sent, in which case the amount proposed is final or else reject the amount sent, in which case both individuals receive nothing. That is, you can send any dollar amount from $0 to $20 and the taker can accept this offer, or reject it, in which case you both receive nothing. For example, If the taker accepts and you send $10, you keep $20 – $10.
You are a giver. How much do you give?
Experiment 2:
Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a receiver in Room Y although they will not know the identity of the other. Givers in Room X have been given $20 and can transfer any part of their $20 to a taker in Room Y. The taker cannot reject the amount sent.
You are a giver. How much do you send? For example, If you send $10, you keep $20 – $10.
Experiment 3:
Ten people are in Room X (givers) with a further ten people in Room Y (returnee). Each giver in Room X will be paired with a returnee in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any portion of their $20 to a returnee in Room Y.
Every dollar sent by a giver is tripled on receipt by the returnee. Returnees have the ability to send money back to the givers which would range between $0 and three times the amount received.
You are a giver. How much do you send?
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