# 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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