Reference no: EM132416755

Corporate Finance - London School of Business and Finance

Learning Outcomes

On successful completion of this assignment you will be able to:

1. Summarise key principles and tools for financial decision-making.
2. Compare various investment decision rules and apply the process of capital budgeting.
3. Analyse the concept of corporate capital structure and compute cost of capital.
4. Determine and critically evaluate the economic benefit of various types of financing.
5. Explain the concept of risk management and analyse the role of derivative instruments in mitigating risks.

Your Task

Question 1

The ABC company has a dividend pay-out ratio of 35% and has maintained this pay-out ratio for several years. The current dividend per share of the company is 60p per share, and it expects that its next dividend per share, payable in one year's time, will be 65p per share.

The capital structure of the company is as follows:

	£ m	£m
Equity
Ordinary shares (nominal value £1 per share)	30
Reserves	30
	30	60
Debt
Bond A (nominal value £100)
Bond B (nominal value £100)	15
		45
		105

Bond A will be redeemed at nominal value in ten years' time and pays annual interest of 10%. The cost of debt of this bond is 10.7% per year. The current ex interest market price of the bond is £96.02.

Bond B will be redeemed at nominal value in four years' time and pays annual interest of 7%. The cost of debt of this bond is 6.52% per year. The current ex interest market price of the bond is
£105.04.

ABC has a cost of equity of 14.4%. Ignore taxation.

Required:

Part 1

Calculate the following:

1. Ex dividend share price, using the dividend growth model
2. Capital gearing (debt divided by debt plus equity) using market value
3. Market value weighted average cost of capital

Part 2

Having undertaken your calculations, you should discuss what these calculations tell us about the health of the ABC company and how these results may affect future decision making within the company.

Question 2

You have been asked to evaluate the proposed purchase of a new machine by your company, Sprockets and Widgets. The price of the new machine is £300,000, and it will cost an additional £20,000 to adapt it to the company's purpose. The company might try to sell the machine after 5 years, but it is very unlikely to get a meaningful (material) price. Depreciation is based on the straight-line method.

Use of the machine would require an increase in Net Working Capital of £15,000, which would be recovered in the final year of the investment.

The machine is expected to save the firm £50,000 per year in operating costs. The corporate tax rate is 40%.

Required:

1. What is the initial investment outlay associated with the machine purchase?
2. What is the terminal cash flow in year 5?
3. Critically examine the treatment of working capital in the above case.
4. If the project's required rate of return is 15%, should the equipment be purchased?
5. Undertake a detailed critical evaluation of how Sprockets and Widgets could increase the NPV of the project by using debt finance.

Question 3

Critically discuss the use of derivative instruments within firms and how these can be used in order to mitigate financial risks. Provide examples to support your answers.