Section A暂缺Section B – ALL FIVE questions are compulsory and MUST be attemptedCrago Co i

existing machine which is becoming out of date and which has no resale value. The forecast levels of production and sales for the goods produced by the new machine, which has a maximum capacity of 400,000 units per year, are as follows:

The new machine will incur fixed annual maintenance costs of $145,000 per year. Variable costs are expected to be $3·00 per unit and selling price is expected to be $5·65 per unit. These costs and selling price estimates are in current price terms and do not take account of general inflation, which is forecast to be 4·7% per year.

It is expected that the new machine will need replacing in four years’ time due to advances in technology. The resale value of the new machine is expected to be $200,000 at that time, in future value terms.

The purchase price of the new machine is payable at the start of the first year of the four-year life of the machine. Working capital investment of $150,000 will already exist at the start of the four-year period, due to the operation of the existing machine. This investment in working capital is expected to increase in nominal terms in line with the general rate of inflation.

Argnil Co pays corporation tax one year in arrears at an annual rate of 27% and can claim 25% reducing balance tax-allowable depreciation on the purchase price of the new machine. The company has a real after-tax weighted average cost of capital of 6% and a nominal after-tax weighted average cost of capital of 11%.

Required:

(a) Using a nominal terms net present value approach, evaluate whether purchasing the new machine is financially acceptable. (10 marks)

(b) Discuss the reasons why investment finance may be limited, even when a company has attractive investment opportunities available to it. (5 marks)

ne possibility, which is an issue of 8% loan notes. Extracts from the financial statements of KQK Co are as follows.

It is expected that investing $20 million in the business will increase income by 5% over the first year. Approximately 40% of cost of sales and other expenses are fixed, the remainder of these costs are variable. Fixed costs will not be affected by the business expansion, while variable costs will increase in line with income.

KQK Co pays corporation tax at a rate of 30%. The company has a policy of paying out 40% of profit after tax as dividends to shareholders.

Current liabilities are expected to increase by 3% by the end of the first year following the business expansion.

Average values of other companies similar to KQK Co:

Required:

(a) Assess the impact of financing the business expansion by the loan note issue on financial position, financial risk and shareholder wealth after one year, using appropriate measures. (10 marks)

(b) Discuss the circumstances under which the current weighted average cost of capital of a company could be used in investment appraisal and indicate briefly how its limitations as a discount rate could be overcome. (5 marks)

d a net profit margin of 10%. Due to fierce competition, ZXC Co has lost market share and is looking for ways to win back former customers and to keep the loyalty of existing customers. The sales director has pointed out that a major competitor of ZXC Co currently offers an early settlement discount of 0·5% for settlement within 30 days, while ZXC Co itself does not offer an early settlement discount. He suggests that if ZXC Co could match this early settlement discount, annual income from credit sales would increase by 20%.

Credit customers of ZXC Co take an average of 51 days to settle invoices. Approximately 0·5% of the company’s credit sales have historically become bad debts each year and written off as irrecoverable. The finance director has been advised that offering an early settlement discount of 0·5% for payment within 30 days would increase administration costs by $35,000 per year, while 75% of credit customers would be likely to take the discount. The credit controller believes that bad debts would fall to 0·375% of credit sales if the early settlement discount were introduced.

ZXC Co has an average short-term cost of finance of 4% per year. Assume that there are 360 days in each year.

Required:

(a) Evaluate whether ZXC Co should introduce the early settlement discount. (6 marks)

(b) Discuss TWO ways in which a company could reduce the risk associated with foreign accounts receivable. (4 marks)

x months in three months’ time. The lending bank will fix the interest rate for the loan period at its prevailing lending interest rate when the loan is taken out. The finance director of GXJ Co believes this lending interest rate could be a minimum of 3·5% per year or a maximum of 5·5% per year. The uncertainty regarding the future interest rate is caused by the volatile state of the economy and impending elections which could lead to a change in political leadership and direction. Interest on the euro loan would be payable at the end of the loan period.

The finance director of GXJ Co would like to hedge the interest rate risk arising from the future loan and the company’s bank has offered a 3–9, 4·5%–3·5% forward rate agreement.

The finance director is also concerned about the foreign currency risk associated with the euro interest payment which would be due in nine months’ time.

The following exchange rates are available:

Required:

(a) Evaluate the proposed forward rate agreement as a way of managing the interest rate risk anticipated by GXJ Co. (3 marks)

(b) Analyse the foreign currency risk associated with the future interest payment of GXJ Co and briefly discuss ways that this risk might be hedged. (4 marks)

(c) Explain the nature of four-way equivalence in the relationship between spot exchange rates, forward exchange rates and future (expected) spot rates. (3 marks)

Section A暂缺

Section B – ALL FIVE questions are compulsory and MUST be attempted

Gemlo Co is a company listed on a large stock market. Extracts from its current statement of financial position are as follows:

Gemlo Co is planning an expansion of existing business operations costing $10 million in the near future and is assessing its current financial position as part of preparing a business case in support of seeking new finance. The business expansion is expected to increase the profit before interest and tax of Gemlo Co by 20% in the first year.

The planned business expansion by Gemlo Co has already been announced to the stock market. Information on the expected increase in profit before interest and tax has not yet been announced and the company has not decided on how the expansion is to be financed.

The ordinary shares of the company are currently trading at $3·75 per share on an ex dividend basis. The irredeemable loan notes have a cost of debt of 7%. The 7% loan notes have a cost of debt of 6% and will be redeemed at a 5% premium to nominal value after seven years. The interest cover of Gemlo Co is 6 times.

Companies operating in the same business sector as Gemlo Co have an average debt/equity ratio of 40% on a market value basis and an average interest cover of 9 times.

Required:

(a) Calculate the debt/equity ratio of Gemlo Co based on market values and comment on your findings. (4 marks)

(b) Gemlo Co agrees with a bank that its business expansion will be financed by a new issue of 8% loan notes. The company then announces to the stock market both this financing decision and the expected increase in profit before interest and tax arising from the business expansion. Required:

Assuming the stock market is semi-strong form. efficient, analyse and discuss the effect of the financing and profitability announcement on the financial risk and share price of Gemlo Co. Note: Up to 2 marks for relevant calculations. (6 marks)

n preparation for this the company has decided to calculate its weighted average cost of capital. Tinep Co has the following capital structure:

The ordinary shares of Tinep Co have a nominal value of 50 cents per share and are currently trading on the stock market on an ex dividend basis at $5·85 per share. Tinep Co has an equity beta of 1·15.

The loan notes have a nominal value of $100 and are currently trading on the stock market on an ex interest basis at $103·50 per loan note. The interest on the loan notes is 6% per year before tax and they will be redeemed in six years’ time at a 6% premium to their nominal value.

The risk-free rate of return is 4% per year and the equity risk premium is 6% per year. Tinep Co pays corporation tax at an annual rate of 25% per year.

Required:

(a) Calculate the market value weighted average cost of capital and the book value weighted average cost of capital of Tinep Co, and comment briefly on any difference between the two values. (9 marks)

(b) Discuss the factors to be considered by Tinep Co in choosing to raise funds via a rights issue. (6 marks)

evaluating an investment proposal to manufacture Product K3J. The initial investment of $1,800,000 will be payable at the start of the first year of operation. The following draft evaluation has been prepared by a junior employee.

The junior employee also provided the following information:

1. Relevant fixed costs are forecast to be $150,000 per year.

2. Sales and production volumes are the same and no finished goods inventory is held.

3. The corporation tax rate is 22% per year and tax liabilities are payable one year in arrears.

4. Uftin Co can claim tax allowable depreciation of 25% per year on a reducing balance basis on the initial investment.

5. A balancing charge or allowance can be claimed at the end of the fourth year.

6. It is expected that selling price inflation will be 4·2% per year, variable cost inflation will be 5% per year and fixed cost inflation will be 3% per year.

7. The investment has no scrap value.

8. The investment will be partly financed by a $1,500,000 loan at 10% per year.

9. Uftin Co has a weighted average cost of capital of 12% per year.

Required:

(a) Prepare a revised draft evaluation of the investment proposal and comment on its financial acceptability. (11 marks)

(b) Explain any TWO revisions you have made to the draft evaluation in part (a) above. (4 marks)

different countries. The company expects to receive €1,200,000 in six months’ time from a foreign customer. Current exchange rates in the home country of PZK Co are as follows:

Required:

(a) Calculate the loss or gain compared to its current dollar value which PZK Co will incur by taking out a forward exchange contract on the future euro receipt, and explain why taking out a forward exchange contract may be preferred by PZK Co to not hedging the future euro receipt. (4 marks)

(b) If the interest rate in the home country of PZK Co is 4% per year, calculate the annual interest rate in the foreign customer’s country implied by the spot exchange rate and the twelve-month forward exchange rate. (2 marks)

(c) Discuss whether PZK Co should avoid exchange rate risk by invoicing foreign customers in dollars. (4 marks)

Recent information on the earnings per share and share price of Par Co is as follows:

The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year.

The ordinary shares of Par Co have a nominal value of $1 per share and have been traded on a large stock exchange for many years. Listed companies similar to Par Co have been recently reported to have an average price/earnings ratio of 12 times.

Required:

(a) Calculate the market price of the convertible loan notes of Par Co, commenting on whether conversion is likely. (5 marks)

(b) Calculate the share price of Par Co using the price/earnings ratio method and discuss the problems in using this method of valuing the shares of a company. (5 marks)

Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March. The following sales volumes have been forecast:

Notes:

1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one month’s credit.

2. Production of goods for sale takes place one month before sales.

3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is held. Raw material purchases are on one months’ credit.

4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of production.

5. The opening cash balance at 1 January is expected to be $40,000.

6. A long-term loan of $300,000 will be received at the beginning of March.

7. A machine costing $400,000 will be purchased for cash in March.

Required:

(a) Calculate the cash balance at the end of each month in the three-month period. (5 marks)

(b) Calculate the forecast current ratio at the end of the three-month period. (2 marks)

(c) Assuming that Flit Co expects to have a short-term cash surplus during the three-month period, discuss whether this should be invested in shares listed on a large stock market. (3 marks)