FINAL EXAMINATION (50%) QUESTION 1 a. Explain the term random theory. (5 marks) b. Explain the term efficient market hypothesis Chapter 7 7 -11 (5 marks) C. Explain the term 'market is inefficient in weak form'. . 2. (5 marks) Discuss the implications of the EMH to the: ii. technical analysis fundamental analysis In Of m & Cham ARats Prices fullf reflect atta (5 marks) e. Describe the evidences or arguments that indicate that market could be inefficient. (10 marks) QUESTION 2 a) Grant Rule Ltd is contemplating the purchase of a new hoist to replace the existing hoist. The existing hoist has fully depreciated and can be sold for $59,800 net (after- tax proceeds). The new hoist would cost $105,000 and require $5,000 installation costs. The new hoist has a 5-year life. At the end of five years, the new hoist is expected to be sold for $29,000 (before-tax proceeds). The old hoist, being fully depreciated 5 years before, has no salvage or market value. Working capital is expected to increase by $12,000 to support the operation of the new hoist. Tax rate is 30%. Net operating cash inflows after tax are forecast as follows: Year Existing Hoist New Hoist $21,800 $36,700 N $20,400 $36,700 $19,000 $36,700 $14,000 $36,700 $12,600 $36,700 NRequired: Chapters Calculate the initial investment associated with the replacement of the existing hoist by the new one. (5 marks) ii. Determine the incremental operating cash inflows associated with the proposed hoist replacement. (8 marks) iii. Determine the terminal cash flow expected from the proposed hoist replacement. (4 marks) Julie's Roofing is considering two mutually exclusive projects, each with an initial investment of $150,000. The company's cost of capital is 9%. Project A will generate an annuity of $45,000 for 6 years. Project B will generate $75,000 in the first year and $60,000 in the second year. After that, the cash inflows from Project B will decrease to an annuity of $30,000 for the remaining 4 years. Evaluate the two projects using the NPV technique. Make a recommendation to the company. (10 marks) Lawrence & Sons' is considering two mutually exclusive projects, Retailing and Wholesaling. The cash flows of the two projects are as follows: Year Retailing Wholesaling -$736,369 -$736,369 $500,000 $5,000 $300,000 $7,000 $100,000 $8,000 NOUAUNE $20,000 $50,000 $5,000 $200,000 $5,000 $500,000 $5,000 $500,000 $5,000 $500,000 The company's cost of capital is 13%. The NPV and IRR of the two projects are given below: Retailing Wholesaling NPV $31,745.77 $59,069.65 IRR 16.05% 14.36%How do you rank the two projects using NPV and IRR techniques? What is your observation about the rankings of the two projects using the two different techniques and how do you resolve this? (6 marks) d) Discuss three (3) advantages of net present value technique over payback period. (6 marks) e) Explain why the internal rate of return technique is popular among the managers. (4 marks) QUESTION 3 Dixon Labs has asked its finance manager to find the cost of each of the specific type of capital as well as the WACC. The WACC is to be measured using the following weights: 30% long-term debt, 10% preference capital and 60% ordinary equity (retained earnings, new ordinary share equity, or both). The firm's tax rate is 30%. Debt: The firm can sell for $970 a 10 year, $1,000 par-value bond with a 9% annual coupon interest rate. A flotation cost of 3% of the par value would be required in addition to the discount of $30 per bond. 10 - 30= JLG Preference share capital: Six per cent (annual dividend) preference capital having par value of $10.00 can be sold for $7.50. An additional fee of $0.20 per share must be paid to the underwriters. Ordinary share equity: The firm's ordinary shares are currently selling for $5.10 per share. The current dividend paid is $0.40. Its dividend is expected to grow at a constant rate of 6% per annum. Required: i. Calculate the following Cost of debt after tax Cost of new preference capital Cost of ordinary capital (6 marks) ii. Determine the weighted average of cost of capital (WACC) of the firm. (2 marks) iii. Explain why the cost of financing with retained earnings is less than the cost of using newly issued ordinary shares? (3 marks) 4IV. You have just been told, 'Since we are going to finance this project with debt, its required rate of return must exceed the cost of debt.' Do you agree or disagree? Explain. (4 marks) b. Describe two (2) main benefits of debt financing. (4 marks) Explain the terms business risk and financial risk. How does each of them influence the firm's capital structure decision? (6 marks) d. What is the optimal capital structure? (5 marks) e. Fantastic Toys produces beach balls, selling 800,000 balls a year. Each ball produced has a variable cost of $1.68 and sells for $2. Fixed operating costs are $56,000. The firm has annual interest charges of $36,000, preference share dividend payments of $8,000 and 30% tax rate. Required: Calculate the degree of operating leverage and interpret your result. ii. Calculate the degree of financial leverage and interpret your result. iii. Determine the degree of total leverage and discuss the combined effect of operating leverage and financial leverage. (6 marks) QUESTION 4 a) What is short term financial management? Why is it important to manage current assets and current liabilities? (6 marks) b) MAX Company, a producer of paper dinnerware, has annual sales of $10 million, a cost of goods sold of 75% of sales and purchases that are 65% of cost of goods sold. MAX has an average age of inventory (AAI) of 60 days, an average collection period (ACP) of 40 days and average payment period (APP) of 35 days. LORequired: Calculate the operating cycle (OC) for MAX. ii. Calculate the cash conversion cycle (CCC) for MAX. iii. Calculate the amount of resources invested in this cash conversion cycle. (5 marks) c) Brett Electricity is currently using two suppliers. Supplier A's credit terms are 1/30 net 60 EOM. Supplier B's credit terms are 2/10 net 90 EOM. The company can borrow at a 10% interest rate. Required: i. Calculate the cost of forgoing the cash discount for Supplier A and Supplier B. ii. Do you recommend the company to take the cash discount offered by Supplier A or by Supplier B? Explain the reason for your recommendation. (4 marks) d) Dye Tools, a manufacturer of lathe tools, is currently selling a product for $12 per unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $8. The firm's total fixed costs are $100,000. The firm is considering a relaxation of credit standards that is expected to result in the following: A 5% increase in unit sales An increase in average collection period from its current level of 32 days to 43 days The firm's required rate of return on equal-risk investments in accounts receivable is 13%. Required: i. Calculate the effect on the firm's additional profit contribution from sales. (2 marks) ii. Calculate the effect on the firm's cost of the marginal investment in accounts receivable. (4 marks) 6