1 JUNE 2012 EXAMINATION P2. Financial Management Instructions to candidates 1. Time allowed is 3 hours and 10 minutes, which includes 10 minutes reading time. 2. This is a closed book examination. 3. Use of a silent, non-programmable calculator, which is NOT part of a mobile phone or any other device capable of communication, is allowed. 4. Put your candidate number on the top of each answer page. 5. Start each new question on a new page. 6. Include any workings. Answer ANY FOUR questions 25 marks available per question IFA Financial Management June 2012 2 Question1 The Board of Directors of BesTaste, a medium size company, wants to expand its catering business that has been growing over the past six years. The local authority has granted the business planning permission to extend its current premises. The company will invest $1,000,000 in buildings and non-current assets. It will also require financial support for working capital. The Board of Directors has asked you, the Chief Finance Officer (CFO), to evaluate the following sources of finance and report back before the next meeting. Required: (a) Compare and contrast a rights issue of shares and loan notes. (10 marks) (b) Explain which source of finance in (a) above would be more beneficial for the buildings and non-current assets. (6 marks) (c) Advise the Board of Directors on a source of finance for working capital. (3 marks) (d) Evaluate various types of government aid for which the company might be able to apply. (6 marks) (Total 25 marks) IFA Financial Management June 2012 3 THIS PAGE IS INTENTIONALLY BLANK IFA Financial Management June 2012 4 Question 2 Part A HyDryl, a medium size company, Statement of Financial Position as at 31 March 2011 is as follows: $'000 Non-current assets 4,000 Investments 2,500 6,500 Current assets 1,800 Total assets 8,300 Equity and liabilities: Ordinary shares at $1 each Reserves Current liabilities Total equity and liabilities 3,000 4,200 7,200 1,100 8,300 HyDryl pays tax at 30%. The company is considering investing in a project. It has $3,000,000 of ordinary $1 shares in issue and wants to raise a further $1,000,000 to fund the project. The Board of Directors has two alternative financial plans: (i) Issue a further 500,000 of ordinary shares at $2 each or (ii) Issue $1,000,000 in 6% loan stocks at par. The project will deliver a return before interest and tax of 12% The company has a dividend cover ratio of two times and the market capitalisation (or value of the company) is $9,000,000. The income tax rate is 30% IFA Financial Management June 2012 5 Required: (a) Profit before interest and tax (PBIT) and the proposed investment is $720,000; calculate the company's current earnings per share (EPS). (2marks) (b) Calculate the company's EPS for the two alternative projects and comment on the change in EPS from the original EPS and the EPS of the alternative financial plans. (6 marks) (c) Advise the Board of Directors which of the financial plans might best benefit the shareholders. (4 marks) (d) Identify the limitations of the dividend growth model in the calculation of an organisations cost of capital. (5 marks) Part B ExPlor is a medium size company that trades and invests in alternative energy for domestic use. Recent research and development (R&D) have established the following financial information: (i) The expected return on future projects (ii) The risk free rate (iii) The Beta value 11% 4% 1.1 Required: (a) Calculate the capital asset price model (CAPM) rate. (4 marks) (b) Identify the problems with applying the CAPM to future projects. (4 marks) (Total 25 marks) IFA Financial Management June 2012 6 Question 3 HoTelCariB is a medium size organisation based in the Caribbean providing food, leisure and accommodation to tourists from all over the world. The Board of Directors is considering growth by acquisition of other similar organisations in other parts of the world. The Chief Executive Officer (CEO) is in negotiations on the possible takeover of a chain of hotels in Asia or Europe. The capital outlay to be invested now and the future net cash inflows for the next four years are shown below: 1. 2. Hotel chain in Asia: Investment now Return on investment: (a) Payback period (b) Accounting rate of return (c) Net present value $7,500,000 2 years 35% $1,875,000 Hotel chain in Europe: Investment now Revenue for 1st year Revenue for 2nd year Revenue for 3rd year Revenue for 4 th year $8,000,000 $25,000,000 10% increase on the 1st year 12% increase on the 2nd year 11% increase on the 3rd year Net profit for each year is Depreciation 10% on revenue $95,000 per year The company's cost of capital is 8%. Extract from present value tables of $1 @ 8%: Year 1 Year 2 Year 3 Year 4 0.926 0.857 0.794 0.735 IFA Financial Management June 2012 7 Required: (a) Explain the benefits of net present value (NPV) method of appraisal. (5 marks) (b) Use the following investment appraisal techniques to calculate for the European investment opportunity: (i) (ii) (iii) The payback period. (2 marks) The accounting rate of return (the average net profit to capital investment outlay). ( 2 marks) The net present value. ( 6 marks) (c) Using your answers to part (b) evaluate each investment opportunity and make your recommendation to the Board of Directors. Use a report format. (10 marks) (Total 25 marks) IFA Financial Management June 2012 8 Question 4 BrandArt is a small company operating in a niche market in the art industry. The company gets its business through word-of-mouth advertising and its products are customised to customers' orders. As a small company it relies on the bank for an overdraft facility to be able to purchase inventory and pay its suppliers on time. Some suppliers of inventories have warned the company that they will withdraw their credit if there is no improvement to the payment terms agreed. However, the bank would like the business to ensure that customers are paying within their agreed credit terms which on average is 30 days. As a requirement for the overdraft facility, the bank has received the latest financial statements for the year ended 30 September 2011, but would also appreciate an analysis of the performance of the business. The accountant has provided the relevant figures extracted from the financial statements as follows: $ Revenue 1,750,000 Cost of sales 500,000 Closing inventories 190,000 Trade receivables 300,000 Trade payables 195,000 Bank overdraft 80,000 Required: (a) Prepare a report calculating the ratios relevant for the preparation of the working capital cycle and provide an analysis of each ratio explaining the implications for the company's performance (ratios to be calculated to two decimal places). (10 marks) (b) Determine the number of days for the working capital to the nearest whole day. (6 marks) (c) Interpret the result obtained from (b) above. (3 marks) (d) Explain the symptoms of over-trading and over-capitalisation and the possible effects on the company's liquidity position. (6 marks) (Total 25 marks) IFA Financial Management June 2012 9 Question 5 A UK importer has noticed that there is greater demand for the special fabrics she purchases from India. The scarce supply of these fabrics will mean they become more expensive in the future. On 1 June she arranged with her bank to undertake a forward exchange contract whereby the bank will sell to the importer on 1 September 500,000 Indian Rupee (INR) at a fixed rate of 78.64 to the US($). Required: (a) Determine the amount of US($) the importer would exchange with the bank on 1 September. (3 marks) (b) If the spot rate on 1 September is lower than the fixed rate of 78.64 Indian Rupee (INR), decide whether the importer has benefitted from the fixed exchange rate contract made on 1 June. (3 marks) (c) Assume the spot rate on 1 September turns out to be higher than fixed rate of 78.64 Indian Rupee (INR) and decide whether or not the importer has benefitted from the fixed exchange rate contract made on 1 June. (3 marks) (d) Explain the elements that make up a forward contract. (4 marks) (e) Explain the actions that can be taken by the importer if the supplier does not satisfy the contract as specified. (6 marks) (f) Identify and explain a type of risk that the importer is likely to face when dealing with foreign currency transactions. (6 marks) (Total 25 marks) IFA Financial Management June 2012