Reference no: EM133065131
AFIN253 Financial Management
Question 1
Semilon Ltd is a company funded by a mixture of debt, equity and preference capital. The marginal tax rate of Semilon is 30%.
The company expects to pay a dividend of $2 next year and achieve a growth rate of 3%. The current market price of the share is $12 and the Beta of the stock is .7. There are currently 1 million shares on issue.
The company also has debt with a maturity of 5 years that pays annual coupons. The coupon rate is 6% and the bond was issued with a face value of $1000 and is currently priced at $1000. There are presently 6000 bonds on issue.
Preference shares have a face value of $100 and pay an annual dividend of 8%. The current market price of the preference share is $80. When the share was issued at face value the value of the stock issued was $2m.
(a) Calculate the weights of the ordinary shares, bonds and preference shares that would be used in a WACC calculation for Semilon Ltd.
(b) Calculate the cost of equity of the ordinary shares.
(c) Calculate the cost of debt on an after tax basis.
(d) Calculate the cost of equity of the preference shares.
(e) Calculate the WACC on an after tax basis.
Question 2
Toblerone Ltd is a leading manufacturer of Swiss Clocks but is looking to expand into the production of watches. A business opportunity has presented itself and has the following cash flows.
Period 0 -$5m USD
Period 1-3 0
Periods 4 - 6 $1m USD per year
Periods 7-9 $2m USD per year
Period 10 $4m USD.
The discount rate used by the company is 8% per annum.
a) Calculate the payback period. If the company accepts all projects with a payback less than 8 years should the project be accepted?
|
Year
|
Cash flows
|
Cumulative cash flows
|
|
0
|
-5m
|
-5m
|
|
1
|
0
|
-5m
|
|
2
|
0
|
-5m
|
|
3
|
0
|
-5m
|
|
4
|
1m
|
-4m
|
|
5
|
1m
|
-3m
|
|
6
|
1m
|
-2m
|
|
7
|
2m
|
0
|
|
8
|
2m
|
2m
|
|
9
|
2m
|
4m
|
|
10
|
4m
|
8m
|
b) I) Calculate the discounted payback period. If the company accepts all projects with a discounted payback less than 8 years should the project be accepted?
II) Calculate the cash flow required in year 10 for the project to have a zero NPV
c) The head of finance has informed you that "any project with a payback of less than 8 years is guaranteed to generate shareholder wealth".
• Is she correct?
• Why or Why not?
• How would you respond to such a statement?
Question 3
a) Assume the market can have five possible states: very good, good, neutral, bad and very bad. The probabilities for each of the states are given in the table below, and so are the returns of two assets, Asset 1 and Asset 2 for each of these states:
|
State
|
Probability
|
Asset 1 returns
|
Asset 2 returns
|
|
Very good
|
0.1
|
14%
|
8%
|
|
Good
|
0.2
|
8%
|
5%
|
|
Neutral
|
0.4
|
2%
|
2%
|
|
Bad
|
0.2
|
-4%
|
-4%
|
|
Very bad
|
0.1
|
-10%
|
-8%
|
(i) Calculate the expected return of Asset 1 and Asset 2. Using the two assets, how could you construct a portfolio with expected return of 1.7%?
(ii) Calculate the standard deviation of returns for Asset 1.
(iii) Assuming that the standard deviation of Asset 2 is 1% and the correlation between returns from Asset 1 and Asset 2 is ρ=0.94, what is the standard deviation of a portfolio with equal weights w1= w2=0.5?
b) The CAPM describes the relationship between risk and expected return of a particular asset. Explain why we choose to use beta instead of standard deviation to measure risk in the model.
Question 4
a) Explain how a trader could use forward rates to earn a profit in the foreign exchange market.
b) Describe the process of ‘International Capital Budgeting'.
Describe three factors and difficulties other than exchange rate risk that need to be taken into account in the decision-making process for evaluating overseas capital projects?
Question 5
Grace Kang Ltd sells jigsaw puzzles for $50 per puzzle. With the current production technology, the total fixed costs are $17,500,000 per annum, and the depreciation and amortisation for the company is $5,000,000. It costs $10 to produce one puzzle and the forecast sales next year will be 1,500,000 units.
The company is considering changing its production technology. Sales are expected to be the same regardless of which production technology the company chooses. However, if a new production line is adopted, the fixed costs will increase to $20,000,000, and the variable cost per unit will be reduced to $7 per puzzle. Assume the depreciation and amortisation expense is unchanged.
a) Use the above information to calculate the accounting DOL for the current technology as well as the new technology.
b) Which technology has a higher accounting DOL? Compare the two technologies and explain why that is the case.
c) Calculate the EBIT break-even points for both technologies.
d) What is the number of puzzles for which the cash flow operating profit is the same, regardless of the technology choice? Calculate the crossover level of unit sales for EBITDA.