Bachelor of Business (Incorporating Graduate Diploma and Graduate Certificate in Business)
Question # 00108547
Posted By:
Updated on: 09/26/2015 11:02 AM Due on: 10/26/2015
Bachelor of Business
(Incorporating Graduate Diploma and Graduate Certificate in Business)
Managerial Finance (367910)
Semester two, 2015
Individual Assignment
Weighting:
Hard copy to be handed in on Level one drop box by Tuesday 6th October,
2015, 12 noon The assignment should have a bar coded cover sheet.
25%
Type:
Individual assignment
Length:
Approximately 600-1000 words for theory questions. All workings to be
shown clearly.
Bar-coded or Non Bar-coded, and submitted to Turnitin in the same week it is
due
The specific question(s) for this assignment will be posted on Blackboard
AUT Online in the Assignment folder. The topic for the first assignment will
be those covered in weeks 5-9
This assessment event is compulsory.
Due Date:
Submission:
Requirements:
Compulsory:
Be self-directed reflective learners
Be knowledgeable in their major field of study
Be effective communicators (written and oral)
Paper Learning
Outcomes:
Programme
Learning Goals:
Be critical enquirers and problem solvers
This assessment event measures paper learning outcomes 1 to 6 stated above
in 3.3.
Page 1 of 7
Question 1
(22 marks)
O’Hagan Apparel Company was founded 30 years ago when Tipene O’Hagan, a descendant of an
Irish immigrant who realised that fashionable clothing styled on indigenous lines could be a “winner”
amongst both young fashion-conscious environmentalists and tourists.
Today, O’Hagan Apparel Company is a medium-sized manufacturer of fabrics and clothing based on
indigenous Maori and Aboriginal designs. In 2014, the Pahiatua-based company experienced sharp
increases in both domestic (Australasian) and European markets, resulting in record earnings. Sales
rose from $7.7 million in 2012 to $9.2 million in 2014, with earnings per share (EPS) of $0.33 and
$0.38, respectively. In 2015, EPS is expected to rise to $0.44. (Selected income statement items are
presented in Table 1).
Because of recent growth, the Chief Financial Officer (CFO), is concerned that the projected
$650,000 of internally generated funds that would be available in 2015 would be insufficient to meet
the company’s expansion needs.
Management has set a policy to maintain the capital structure of O’Hagan Apparel Company at 65%
equity capital, 25% interest bearing debt and 10% preference share capital for at least the next three
years.
Table 1
SELECTED INCOME STATEMENT ITEMS
2012
Net profits after tax
Earnings per share ( EPS)
Dividend Per Share
2014
Projected 2015
$6 930 000
Net sales
2013
$7 745 000
$9 165 000
$10 540 000
760 000
875 000
1 010 000
1 161 000
0.29
0.33
0.38
0.44
0.115
0.131
0.154
0.176
The CFO has been presented with several competing investment opportunities by division and product
managers. However, because funds are limited, choices of which projects to accept must be made.
The investment opportunities schedule (IOS) is shown in Table 2. To analyse the effect that the
increase in financing requirements would have on the weighted average cost of capital, the CFO
contacted a leading investment banking firm, which provided the financing cost data given in Table 3.
O’Hagan is in the 30% tax bracket.
Table 2
INVESTMENT OPPORTUNITIES SCHEDULE ( IOS)
Investment Opportunity
Internal Rate of Return (IRR)
Initial Investment
A
17.50%
$200 000
B
15.5
100 000
C
19
350 000
D
20
250 000
E
14
100 000
F
18.5
350 000
G
13.5
275 000
Page 2 of 7
Table 3: COST DATA FOR ADDITIONAL FINANCE
Interest-bearing debt
The firm can raise $250 000 of additional debt by selling ten-year, $1000, 9% annual interest rate
bonds to net $980 after flotation costs. Any debt in excess of $250 000 will have a before-tax cost,
(Rd), of 12%.
Preference Shares
Preference shares, regardless of the amount sold, can be issued for $10 with an 11% annual dividend
rate, and will net $9.50 per share after flotation cost.
Ordinary shares
The firm expects its dividends and earnings to continue to grow at a constant rate of 15% per year.
The firm's shares are currently selling for $3.50 per share. The firm expects to have $650 000 of
available retained earnings. Once the retained earnings have been exhausted, the firm can raise
additional funds by selling new ordinary shares, netting $2.8 per share after under-pricing and
flotation costs.
Required:
1. Over the relevant ranges noted in the following table, calculate the after-tax cost of each source of
financing needed to complete the table.
(8 marks)
Source of Capital
Range of new financing
Interest-bearing debt
After-tax cost (%)
$0- $250 000
$250 000 and above
Preference shares
$0 and above
Ordinary shares
$0- $650 000
$650 000 and above
2. Calculate the Weighted Average Cost of Capital (WACC) if the CFO wishes to raise the funds
needed to invest in investment opportunities:
a. A to E
b. A to G, specified in table 2.
(8 marks)
3. Based on your computation above in 2 (a) and (b), which investment opportunities would you
recommend that the CFO should consider investing in? Why?
(4 marks)
4. Assuming that the specific financing costs do not change, what effect would a shift to a more
highly leveraged capital structure consisting of 50% long-term interest-bearing debt, 10% preference
shares and 40% ordinary shares have on your previous findings? (Hints: rework questions 2 and 3
using these capital structure weights)
(6 marks)
5. Which capital structure – the lowly leveraged or the highly leveraged one seems better? Why?
(4 marks)
Page 3 of 7
Question 2
(30 Marks)
Tampa Ltd, an established producer of printing equipment, expects its sales to remain flat for the next
three to five years due to both a weak economic outlook. On the basis of this scenario, the firm’s
management has instituted programs that will allow it to operate more efficiently, earn higher profits
and, most importantly, maximise share value. The firm’s chief executive officer (CEO), Jon Lawson,
has been charged with evaluating the firm’s capital structure. Lawson believes that the current capital
structure, which contains approximately 11% debt, may not be taking full advantage of the borrowing
capacity of the firm. The firm’s bankers have indicated that the firm can borrow up to $ 5 million at
the current interest rate of 7.5%. Lawson has gathered the following data on two possible capital
structures that he would like to consider.
Source of Capital
Interest bearing debt
Coupon interest rate
Number of ordinary shares
Required return on equity (Rs)
CAPITAL STRUCTURES
Current
Alternative “A” Alternative “B”
$1,000 000
7.5%
90,000 shares
8.47%
$3,000 000
7.5%
70,000 shares
8.64%
$5,000 000
7.5%
50,000 shares
8.88%
Lawson expects the firm’s earnings before interest and taxes (EBIT) to remain at its current level of
$1.2 million. The firm pays tax at the rate of 30%.
Required:
1. Use the current level of EBIT to calculate the "Times Interest Earned (TIE)” ratio for each of the
capital structures. Based on the TIE which capital structure would be preferred by the debt holders?
Why?
(6 marks)
2. Prepare a single EBIT-EPS graph showing the current and two alternative capital structures.
(6 marks)
3. On the basis of the graph in question 2, which capital structure will maximise Tampa’s Earnings
per Share (EPS) at the expected level of EBIT of $1.2 million? Why might this not be the best capital
structure?
(6 marks)
4. Using the zero growth share valuation model, find the market value of Tampa’s equity under each
of the three capital structures at the expected level of EBIT of $1.2 million?
(6 marks)
5. Compute the Weighted Average Cost of Capital (WACC) for each of the options and explain how
your findings correspond with the Modigliani and Miller proposition on capital structure when taxes
are present.
(6 marks)
Page 4 of 7
Question 3,
(30 marks)
Stanley, a financial analyst for Chargers products, a manufacturer of stadium benches, must evaluate
the risk and return of two assets – X and Y. the firm is considering adding these assets to its
diversified asset portfolio. To assess the return and risk of each asset, Stanley gathered data on the
annual cash flow and beginning and end – of –year values of each asset over the immediately
preceding 10 years, 2001-2010. These data are summarised in the following table. Stanley’s
investigation suggests that both assets, on average, will tend to perform in the future just as they have
during the past 10 years. He therefore believes that the expected annual return can be estimated by
finding the average annual return for each asset over the past 10 years.
Stanley believes that each asset’s risk can be assessed in two ways: (a) in isolation and (b) as part of
the firm’s diversified portfolio of assets. The risk of the assets in isolation can be found by using the
standard deviation and coefficient of variation of returns over the past 10 years. The capital asset
pricing model (CAPM) can be used to assess the asset’s risk as part of the firm’s portfolio of assets.
Applying some sophisticated quantitative techniques, he estimated betas for assets X and Y of 1.60
and 1.10, respectively. In addition, he found that the risk-free is currently 7% and the market return is
10%.
RETURN DATA FOR ASSETS X AND Y , 2001-2010
Asset X
Cash flow
During the Beginning
Ending
Year
year ($)
Value ($)
Value($)
2001
1,000
20,000
2,000
Asset Y
Cash flow
During the
Beginning
Ending
year($)
Value ($)
Value ($)
1,500
20,000
20,000
2002
1,500
22,000
21,000
1,600
20,000
20,000
2003
1,400
21,000
24,000
1,700
20,000
21,000
2004
1,700
24,000
22,000
1,800
21,000
21,000
2005
1,900
22,000
23,000
1,900
21,000
22,000
2006
1,600
23,000
26,000
2,000
22,000
23,000
2007
1,700
26,000
25,000
2,100
23,000
23,000
2008
2,000
25,000
24,000
2,200
23,000
24,000
2009
2,100
24,000
27,000
2,300
24,000
25,000
2010
2,200
27,000
30,000
2,400
25,000
25,000
Page 5 of 7
Required:
1. Calculate the annual rate of return for each asset in each of the 10 preceding years, and using those
values to find the average annual return for each asset the 10-year period.
(5 marks)
2. Use the returns calculated in question 1, to find (a) standard deviation and (b) the coefficient of
variation of the returns of reach asset over the 10-year period 2001-2010.
(4 marks)
3. Use your findings in questions 1 and 2 to evaluate and discuss the return and risk associated with
each asset. Which asset appears to be preferable? Explain.
(5 marks)
4. Use Capital Asset Pricing Model (CAPM) to find the required return for each asset. Compare this
value with the average annual returns calculated in question 1.
(4 marks)
5. Compare and contrast your findings in questions 3 and 4, what recommendations would you give
Stanley with regard to investing in either of the two assets? Explain to Stanley under what
circumstances would he should use beta than the standard deviation and coefficient of variation to
assess the risk of each asset.
(4 marks)
6, Rework questions 4 and 5 under each of the following circumstances and advice Stanley whether
he should invest in either asset:
6a. A rise of 1% in inflationary expectations causes the risk-free rate to rise to 8% and the
market return to rise to 11%
(4 marks)
6b. As a result of favourable political events, investors suddenly become less risk-averse,
causing the market return to drop by 1% to 9%.
(4 marks)
Page 6 of 7
Question 4
(18 marks)
High electricity costs have made Farmer Corporation’s chicken-plucking machine economically
worthless. Farmer Corporation could choose any of the following to replace its ageing machine:
(a) The International Plucking Machine (IPM) model is available only on a lease basis. The lease
payments will be $65,000 for five years, due at the beginning of each year. This machine will
save Farmer $15,000 per year through reductions in electricity costs.
(b) As an alternative, Farmer can purchase a more energy-efficient machine from Basic machine
Corporation (BMC) for $330,000. This machine will save $25 000 per year in electricity
costs. A local bank has offered to finance the remaining balance and will require five annual
principal payments of $66,000. Farmer has a target debt-to-asset ratio of 67 percent.
Farmer is in the 34 percent tax bracket. After five years, both machines will be worthless. The
machines will be depreciated on a straight-line basis.
Required:
a. Should Farmer lease the IPM machine or purchase the more efficient BMC machine?
(10 marks)
b. Does your answer depend on the form of financing for direct purchase?
(4 marks)
c. How much debt is displaced by this lease?
(4 marks)
~END~
Page 7 of 7
(Incorporating Graduate Diploma and Graduate Certificate in Business)
Managerial Finance (367910)
Semester two, 2015
Individual Assignment
Weighting:
Hard copy to be handed in on Level one drop box by Tuesday 6th October,
2015, 12 noon The assignment should have a bar coded cover sheet.
25%
Type:
Individual assignment
Length:
Approximately 600-1000 words for theory questions. All workings to be
shown clearly.
Bar-coded or Non Bar-coded, and submitted to Turnitin in the same week it is
due
The specific question(s) for this assignment will be posted on Blackboard
AUT Online in the Assignment folder. The topic for the first assignment will
be those covered in weeks 5-9
This assessment event is compulsory.
Due Date:
Submission:
Requirements:
Compulsory:
Be self-directed reflective learners
Be knowledgeable in their major field of study
Be effective communicators (written and oral)
Paper Learning
Outcomes:
Programme
Learning Goals:
Be critical enquirers and problem solvers
This assessment event measures paper learning outcomes 1 to 6 stated above
in 3.3.
Page 1 of 7
Question 1
(22 marks)
O’Hagan Apparel Company was founded 30 years ago when Tipene O’Hagan, a descendant of an
Irish immigrant who realised that fashionable clothing styled on indigenous lines could be a “winner”
amongst both young fashion-conscious environmentalists and tourists.
Today, O’Hagan Apparel Company is a medium-sized manufacturer of fabrics and clothing based on
indigenous Maori and Aboriginal designs. In 2014, the Pahiatua-based company experienced sharp
increases in both domestic (Australasian) and European markets, resulting in record earnings. Sales
rose from $7.7 million in 2012 to $9.2 million in 2014, with earnings per share (EPS) of $0.33 and
$0.38, respectively. In 2015, EPS is expected to rise to $0.44. (Selected income statement items are
presented in Table 1).
Because of recent growth, the Chief Financial Officer (CFO), is concerned that the projected
$650,000 of internally generated funds that would be available in 2015 would be insufficient to meet
the company’s expansion needs.
Management has set a policy to maintain the capital structure of O’Hagan Apparel Company at 65%
equity capital, 25% interest bearing debt and 10% preference share capital for at least the next three
years.
Table 1
SELECTED INCOME STATEMENT ITEMS
2012
Net profits after tax
Earnings per share ( EPS)
Dividend Per Share
2014
Projected 2015
$6 930 000
Net sales
2013
$7 745 000
$9 165 000
$10 540 000
760 000
875 000
1 010 000
1 161 000
0.29
0.33
0.38
0.44
0.115
0.131
0.154
0.176
The CFO has been presented with several competing investment opportunities by division and product
managers. However, because funds are limited, choices of which projects to accept must be made.
The investment opportunities schedule (IOS) is shown in Table 2. To analyse the effect that the
increase in financing requirements would have on the weighted average cost of capital, the CFO
contacted a leading investment banking firm, which provided the financing cost data given in Table 3.
O’Hagan is in the 30% tax bracket.
Table 2
INVESTMENT OPPORTUNITIES SCHEDULE ( IOS)
Investment Opportunity
Internal Rate of Return (IRR)
Initial Investment
A
17.50%
$200 000
B
15.5
100 000
C
19
350 000
D
20
250 000
E
14
100 000
F
18.5
350 000
G
13.5
275 000
Page 2 of 7
Table 3: COST DATA FOR ADDITIONAL FINANCE
Interest-bearing debt
The firm can raise $250 000 of additional debt by selling ten-year, $1000, 9% annual interest rate
bonds to net $980 after flotation costs. Any debt in excess of $250 000 will have a before-tax cost,
(Rd), of 12%.
Preference Shares
Preference shares, regardless of the amount sold, can be issued for $10 with an 11% annual dividend
rate, and will net $9.50 per share after flotation cost.
Ordinary shares
The firm expects its dividends and earnings to continue to grow at a constant rate of 15% per year.
The firm's shares are currently selling for $3.50 per share. The firm expects to have $650 000 of
available retained earnings. Once the retained earnings have been exhausted, the firm can raise
additional funds by selling new ordinary shares, netting $2.8 per share after under-pricing and
flotation costs.
Required:
1. Over the relevant ranges noted in the following table, calculate the after-tax cost of each source of
financing needed to complete the table.
(8 marks)
Source of Capital
Range of new financing
Interest-bearing debt
After-tax cost (%)
$0- $250 000
$250 000 and above
Preference shares
$0 and above
Ordinary shares
$0- $650 000
$650 000 and above
2. Calculate the Weighted Average Cost of Capital (WACC) if the CFO wishes to raise the funds
needed to invest in investment opportunities:
a. A to E
b. A to G, specified in table 2.
(8 marks)
3. Based on your computation above in 2 (a) and (b), which investment opportunities would you
recommend that the CFO should consider investing in? Why?
(4 marks)
4. Assuming that the specific financing costs do not change, what effect would a shift to a more
highly leveraged capital structure consisting of 50% long-term interest-bearing debt, 10% preference
shares and 40% ordinary shares have on your previous findings? (Hints: rework questions 2 and 3
using these capital structure weights)
(6 marks)
5. Which capital structure – the lowly leveraged or the highly leveraged one seems better? Why?
(4 marks)
Page 3 of 7
Question 2
(30 Marks)
Tampa Ltd, an established producer of printing equipment, expects its sales to remain flat for the next
three to five years due to both a weak economic outlook. On the basis of this scenario, the firm’s
management has instituted programs that will allow it to operate more efficiently, earn higher profits
and, most importantly, maximise share value. The firm’s chief executive officer (CEO), Jon Lawson,
has been charged with evaluating the firm’s capital structure. Lawson believes that the current capital
structure, which contains approximately 11% debt, may not be taking full advantage of the borrowing
capacity of the firm. The firm’s bankers have indicated that the firm can borrow up to $ 5 million at
the current interest rate of 7.5%. Lawson has gathered the following data on two possible capital
structures that he would like to consider.
Source of Capital
Interest bearing debt
Coupon interest rate
Number of ordinary shares
Required return on equity (Rs)
CAPITAL STRUCTURES
Current
Alternative “A” Alternative “B”
$1,000 000
7.5%
90,000 shares
8.47%
$3,000 000
7.5%
70,000 shares
8.64%
$5,000 000
7.5%
50,000 shares
8.88%
Lawson expects the firm’s earnings before interest and taxes (EBIT) to remain at its current level of
$1.2 million. The firm pays tax at the rate of 30%.
Required:
1. Use the current level of EBIT to calculate the "Times Interest Earned (TIE)” ratio for each of the
capital structures. Based on the TIE which capital structure would be preferred by the debt holders?
Why?
(6 marks)
2. Prepare a single EBIT-EPS graph showing the current and two alternative capital structures.
(6 marks)
3. On the basis of the graph in question 2, which capital structure will maximise Tampa’s Earnings
per Share (EPS) at the expected level of EBIT of $1.2 million? Why might this not be the best capital
structure?
(6 marks)
4. Using the zero growth share valuation model, find the market value of Tampa’s equity under each
of the three capital structures at the expected level of EBIT of $1.2 million?
(6 marks)
5. Compute the Weighted Average Cost of Capital (WACC) for each of the options and explain how
your findings correspond with the Modigliani and Miller proposition on capital structure when taxes
are present.
(6 marks)
Page 4 of 7
Question 3,
(30 marks)
Stanley, a financial analyst for Chargers products, a manufacturer of stadium benches, must evaluate
the risk and return of two assets – X and Y. the firm is considering adding these assets to its
diversified asset portfolio. To assess the return and risk of each asset, Stanley gathered data on the
annual cash flow and beginning and end – of –year values of each asset over the immediately
preceding 10 years, 2001-2010. These data are summarised in the following table. Stanley’s
investigation suggests that both assets, on average, will tend to perform in the future just as they have
during the past 10 years. He therefore believes that the expected annual return can be estimated by
finding the average annual return for each asset over the past 10 years.
Stanley believes that each asset’s risk can be assessed in two ways: (a) in isolation and (b) as part of
the firm’s diversified portfolio of assets. The risk of the assets in isolation can be found by using the
standard deviation and coefficient of variation of returns over the past 10 years. The capital asset
pricing model (CAPM) can be used to assess the asset’s risk as part of the firm’s portfolio of assets.
Applying some sophisticated quantitative techniques, he estimated betas for assets X and Y of 1.60
and 1.10, respectively. In addition, he found that the risk-free is currently 7% and the market return is
10%.
RETURN DATA FOR ASSETS X AND Y , 2001-2010
Asset X
Cash flow
During the Beginning
Ending
Year
year ($)
Value ($)
Value($)
2001
1,000
20,000
2,000
Asset Y
Cash flow
During the
Beginning
Ending
year($)
Value ($)
Value ($)
1,500
20,000
20,000
2002
1,500
22,000
21,000
1,600
20,000
20,000
2003
1,400
21,000
24,000
1,700
20,000
21,000
2004
1,700
24,000
22,000
1,800
21,000
21,000
2005
1,900
22,000
23,000
1,900
21,000
22,000
2006
1,600
23,000
26,000
2,000
22,000
23,000
2007
1,700
26,000
25,000
2,100
23,000
23,000
2008
2,000
25,000
24,000
2,200
23,000
24,000
2009
2,100
24,000
27,000
2,300
24,000
25,000
2010
2,200
27,000
30,000
2,400
25,000
25,000
Page 5 of 7
Required:
1. Calculate the annual rate of return for each asset in each of the 10 preceding years, and using those
values to find the average annual return for each asset the 10-year period.
(5 marks)
2. Use the returns calculated in question 1, to find (a) standard deviation and (b) the coefficient of
variation of the returns of reach asset over the 10-year period 2001-2010.
(4 marks)
3. Use your findings in questions 1 and 2 to evaluate and discuss the return and risk associated with
each asset. Which asset appears to be preferable? Explain.
(5 marks)
4. Use Capital Asset Pricing Model (CAPM) to find the required return for each asset. Compare this
value with the average annual returns calculated in question 1.
(4 marks)
5. Compare and contrast your findings in questions 3 and 4, what recommendations would you give
Stanley with regard to investing in either of the two assets? Explain to Stanley under what
circumstances would he should use beta than the standard deviation and coefficient of variation to
assess the risk of each asset.
(4 marks)
6, Rework questions 4 and 5 under each of the following circumstances and advice Stanley whether
he should invest in either asset:
6a. A rise of 1% in inflationary expectations causes the risk-free rate to rise to 8% and the
market return to rise to 11%
(4 marks)
6b. As a result of favourable political events, investors suddenly become less risk-averse,
causing the market return to drop by 1% to 9%.
(4 marks)
Page 6 of 7
Question 4
(18 marks)
High electricity costs have made Farmer Corporation’s chicken-plucking machine economically
worthless. Farmer Corporation could choose any of the following to replace its ageing machine:
(a) The International Plucking Machine (IPM) model is available only on a lease basis. The lease
payments will be $65,000 for five years, due at the beginning of each year. This machine will
save Farmer $15,000 per year through reductions in electricity costs.
(b) As an alternative, Farmer can purchase a more energy-efficient machine from Basic machine
Corporation (BMC) for $330,000. This machine will save $25 000 per year in electricity
costs. A local bank has offered to finance the remaining balance and will require five annual
principal payments of $66,000. Farmer has a target debt-to-asset ratio of 67 percent.
Farmer is in the 34 percent tax bracket. After five years, both machines will be worthless. The
machines will be depreciated on a straight-line basis.
Required:
a. Should Farmer lease the IPM machine or purchase the more efficient BMC machine?
(10 marks)
b. Does your answer depend on the form of financing for direct purchase?
(4 marks)
c. How much debt is displaced by this lease?
(4 marks)
~END~
Page 7 of 7
-
Rating:
/5
Solution: Bachelor of Business (Incorporating Graduate Diploma and Graduate Certificate in Business)