Reference no: EM132630525

BUACC5936 Financial Management - Federation Business School

Question 1

a) Should small or high-growth firms have higher betas than larger and more mature firms? Discuss.

b) Due to the distinctive nature of unsystematic risk, it can be reduced or eliminated through diversification. Do you agree with this statement? Explain.

Question 2

Sakura PLC is a leading investment company in Australia and you the below details relating to the capital structure of the company.

 

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	2019 - Proposed Dividend
Dividend History	$4.63	2019
	$4.29	2018
	$3.97	2017
	$3.68	2016
	$3.40	2015

 

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
	33%
Tax Rate
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. (2020-2027) 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
2010	520000
2011	530000
2012	540000
2013	560000
2014	565000
2015	590000
2016	600000
2017	610000
2018	615559
2019	659000
2020	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
2010	2000	$15.00
2011	2400	$25.00
2012	2900	$33.00
2013	3500	$40.00
2014	4200	$45.00
2015	5000	$55.00
2016	5900	$62.00
2017	6000	$68.00
2018	6100	$74.00
2019	6200	$80.00
2020	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 3

 

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 4

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 5
The homo economics 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?