Alternative Assessment

MGMT 2023 Financial Management

Section 1 - Compulsory (30 marks)

INSTRUCTIONS: Answer all questions in this section.

1. Evaluate the following diagram and explain how the players in the financial market collaborate

to acquire funding and ensure economic efficiency.

(4 marks)

2. Clarksville Printing Company sold 1,500 finance books for $85 each to University of the West

Indies (UWI) in 2019. These books cost Clarkesville $62 each to produce. In the marketing of the

books, the Company paid $4,600 to a marketing firm, and it also borrowed $50,000 on January 1,

2019, on which the Company paid 10 percent interest. Both interest and principal are paid on

December 21, 2019. Depreciation expense for the year was $8,000 and Clarksvilles tax rate is 25

percent.

a. Verify whether Clarksville Printing Company made a profit in 2019, by presenting an income statement in good form. (3 marks)

b. Explain the impact of the new loan of $50,000 and the depreciation expense on the cash flows. (2 marks)

c. Determine the Operating Cash Flow for Clarksville Company. What accounts for the difference in the net income and the operating cash flow? (2 marks)

3. As the Fund Manager for Bank of Trinidad and Tobago Limited, you are to advise the following

two (2) clients based on their respective financial situations.

a. Your best friend has asked to assist him in making the best investment out of the following

options. Which would you advise him to choose and why, considering the risks are the same

for all the options. Show all workings to support your answer.

Option 1: $12,000 in 5 years at 6 percent interest.

Option 2: $15,000 in 2 years at 9 percent interest.

Option 3: $15,000 today. No strings attached.

Option4: $5,000 each year for 2 years at 7 percent interest compounded semiannually.

(3 marks)

b. Betty Kay has a contract under which she will receive the following payment for the next 5

years: $1,000, $2,000, $3,000, $4,000 and $5,000. She will then receive an annuity of $8,500

a year for the end of the 6th through the end of the 15th year. She is offered $30,000 to cancel

the contract. If the payments are discounted at 14 percent should she cancel the contract? Show

all workings. (5 marks)

4. You work as the treasurer of a large manufacturing corporation where earnings are down

substantially as a result of COVID-19. In an environment where interest rates are going to decline

over the next three to six months, you want to invest in fixed-income securities to make as much

money as possible for the firm. The board recommends investing in one of the following securities:

Three-month Treasury Bill

Twenty-year Corporate Bonds

Twenty-year zero-coupon Treasury Bonds

Describe a suitable strategy based on your knowledge of bond theory, which may allow the

company to maximize its profit if it were to undertake one of these investments. Further, advise

the board on what is best for the company at this time given your knowledge of other investment

options in the market. (4 marks)

5. Rhea owns shares in Riko Corp. Currently, the market price of the stock is $36.34. The

company expects to grow at a constant rate of 6 percent for the foreseeable future. Its last dividend

was worth $3.25. Rheas required rate of return for such stocks is 16 percent. She wants to find

out whether she should sell her shares or add to her holdings. Calculate the value of this stock and

advise Rhea on what she should do. (3 marks)

6. You are trying to decide whether to invest in one or both of two different stocks. The market

risk premium and risk-free rate are 6 percent and 4 percent respectively.

Use your knowledge of the CAPM and the SML which you learnt in this course and determine

whether you should invest in either, one, or both of these stocks. Provide all workings to support

your answer. (4 marks)

Section 2 - CASE ANALYSIS (30 marks)

INSTRUCTIONS:

1. Read the case below carefully and answer ALL the questions which follow.

2. Your answers may be entered using a Microsoft Excel spreadsheet OR may be entered in a table

format using Microsoft Word.

HEALTHY OPTIONS INC.

Healthy Options is a Pharmaceutical Company which is considering investing in a new production line

of portable electrocardiogram (ECG) machines for its clients who suffer from cardiovascular diseases.

The company has to invest in equipment which costs $2,500,000 and falls within a MARCS

depreciation of 5 years, and is expected to have a scrap value of $200,000 at the end of the project.

Other than the equipment, the company needs to increase its cash and cash equivalents by $100,000,

increase the level of inventory by $30,000, increase accounts receivable by $250,000 and increase

accounts payable by $50,000 at the beginning of the project. Healthy Options expects the project to

have a life of five years. The company would have to pay for transportation and installation of the

equipment which has an invoice price of $450,000.

The company has already invested $75,000 in Research and Development and therefore expects a

positive impact on the demand for the new product line. Expected annual sales for the ECG machines

in years one to three are $1,200,000, and $850,000 in the following two years. The variable costs of

production are projected to be $267,000 per year in years one to three and $375,000 in years four and

five. Fixed overhead is $180,000 per year over the life of the project.

The introduction of the new line of portable ECG machines will cause a net decrease of $50,000 in

profit contribution after taxes, due to a decrease in sales of the other lines of tester machines produced

by the company. By investing in the new product line Healthy Options would have to use a packaging

machine which the company already has and which will be sold at the end of the project for $350,000

after-tax in the equipment market.

The companys financial analyst has advised Healthy Options to use the weighted average cost of

capital as the appropriate discount rate to evaluate the project. Information about the companys sources of financing is provided below:

The company will contract a new loan in the sum of $2,000,000 that is secured by machinery

and the loan has an interest rate of 6 percent. Healthy Options has also issued 4,000 new bond

issues with an 8 percent coupon, paid semiannually, and which matures in 10 years. The bonds

were sold at par, and incurred floatation cost of 2 percent per issue.

The companys preferred stock pays an annual dividend of 4.5 percent and is currently selling

for $60, and there are 100,000 shares outstanding.

There are 300,000 million shares of common stock outstanding, and they are currently selling

for $21 each. The beta on these shares is 0.95.

Other relevant information about the company follows:

The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium

to be 6.75 percent using the returns on stocks and Treasury Bonds from 2010 to 2019. Healthy Options

has a marginal tax rate of 25 percent.

As a recent graduate of the UWIOC, The General Manager of the company has hired you to work

alongside the Financial Controller of the company to help determine whether the company should invest

in the new product line. He has provided you with the following questions to guide you in your

assessment of the project and to present your findings to the Company.

REQUIRED:

7. Determine the weighted average cost of capital (WACC) for Healthy Options. (9 marks)

8. Calculate the initial investment cash-flows. (2 marks)

9. Calculate the after-tax operating cash-flows. (10 marks)

10. Determine the tax on salvage value of the equipment, then show the terminal year cash-flows.

(3 marks)

11. Identify three (3) relevant cash flows which were mentioned in the case and how they should

be treated in the capital budgeting decision. (3 marks)

12. Taking into consideration all the information given, determine the Net Present Value of the

project and advise the company on whether to invest in the new line of product. (3 marks)

(Use your answer to Q7 rounded to the nearest whole in the calculations of the other questions where

necessary.)