I have attached the question plesae do all the question show working step by step for all the question.

JULY 2012 You must answer ALL the questions. (Total 100 marks) Modern Equipment Company (MEC) was founded in 1995 by Jerome, an engineer, specialising in electronic components used in digital devices. With increased demand for android phones, digital cameras, computers and computer accessories, demand for the products of MEC has increased over time. By 2011, MEC had grown to 450 employees and generated approximately $40 million of revenue and $4.2 million of operating profit. Exhibits 1 through 4 show the financial statements: Exhibit 1 - Income Statements for the years 2009, 2010, and 2011 ending December 31 Exhibit 2 - Balance Sheets for the years ending December 31, 2009, 2010, and 2011 Exhibit 3 - Common Size Income Statement for years 2009, 2010, and 2011 Exhibit 4 - Common Size Balance Sheet for years 2009, 2010, and 2011 On January 1, 2012, Jerome is considering introducing a new product accessory that can be used in digital equipments which would increase the efficiency of these equipments. This product is expected to last 5 years and then it will be terminated. Introduction of this new product will require purchase of new plant and equipment costing $1,500,000. The sales for the next 5 years are projected to be as follows: Year Units Sold 1 70,000 2 120,000 3 120,000 4 80,000 5 70,000 The selling price per unit will be $30 in years 1 to 4 and $25 in year 5. The variable costs per unit will be $14. Annual fixed costs will be $70,000. The investment in net working capital will be equal to 10% of the dollar value of sales of the next year and this amount will have to be provided at the beginning of the year. All working capital will be liquidated at the termination of the project at the end of year 5. The plant and equipment will be depreciated to zero salvage value using straight line method. FIN303 Copyright 2012 SIM University Page 3 of 23 Examination - July Semester 2012 Cost of Capital MEC uses the weighted average cost of capital as the discount rate in the capital budgeting process. The company has a target capital structure of 50% debt and 50% equity. The company's long-term debt was issued at par in 2009 with a coupon rate of 8%. On January 1, 2012, the yield to maturity on these bonds was 12%. The beta of MEC is estimated as 1.2. However, it is considered that this new product and accessory is slightly more risky and a premium of 1.6% should be added to the cost of equity calculated using the company beta. The risk-free rate is estimated as 4% and the market risk premium is estimated as 7%. The company's tax rate is 50%. Exhibit 1 Income statements for the year ending December 31 (Figures in Thousands) 2009 2010 2011 Sales (all credit) 12,500 18,750 40,000 Cost of goods sold -7,500 -11,250 -24,000 Gross profit 5,000 7,500 16,000 Fixed cash expenses -2,350 -3,150 -5,250 variable operating expenses -1,250 -1,875 -4,000 Depreciation expenses -590 -675 -1,440 -4,190 -5,700 -10,690 Earnings Before Interest and Taxes (EBIT) 810 1,800 5,310 Interest Expense -720 -571.8 -909.4 Operating expenses Total operating expenses Earnings Before Tax (EBT) 90 4,400.6 -614.1 Taxes 1,228.2 2,200.3 -45 Net Income $45 $614.1 $2,200.3 Dividend paid $34 $4,60 $1,308.6 Page 4 of 23 July Semester 2012 Exhibit 2 Balance Sheets as of December 31 (Figures in Thousands) 2009 2010 2011 Cash 2,696.1 1,125.0 64.9 Accounts Receivables 1,025.0 1,562.5 2,080.0 Inventories 2,700.0 3,625.0 5,915.0 Total Current Assets 6,421.1 6,312.5 8,059.9 Land 2,500.0 2,500.0 3,380.0 Building and Equipment 7,500.0 8,750.0 13,000.0 Less Accumulated Depreciation -2,825.0 -3,500.0 -4,940.0 Total Fixed Assets 7,175.0 7,750.0 11,440.0 Total Assets $13,596.1 $14,062.5 $19,499.9 Accounts Payables 895.0 1,312.5 2,860.0 Short-term Bank Notes 1,824.0 2,125.0 5,576.0 Total Current Liabilities 2,719.0 3,437.5 8,436.0 Long-term Debt Common Stock 4,000.0 3,937.5 3,593.8 3,937.5 3,141.0 3,937.5 Retained Earnings 2,939.6 3,093.7 3,985.4 Common Equity 6,877.1 7,031.2 7,922.9 Total Debt and Equity $13,596.1 $14,062.5 $19,499.9 2009 2010 2011 Sales (all credit) 1.000 1.000 1.000 Cost of goods sold -0.600 -0.600 -0.600 Gross profit 0.400 0.400 0.400 Fixed cash expenses -0.188 -0.168 -0.131 Variable operating expenses -0.100 -0.100 -0.100 Depreciation expenses -0.047 -0.036 -0.036 Total operating expenses -0.335 -0.304 -0.267 Earnings Before Interest and Taxes (EBIT) 0.065 0.096 0.133 Interest Expense -0.058 Earnings Before Tax (EBT) 0.007 0.066 0.110 Taxes -0.004 -0.033 0.055 Net Income 0.004 0.033 0.055 Exhibit 3 Common Size Income Statements Operating expenses University Page 5 of 23 July Semester 2012 -0.030 -0.023 Exhibit 4 Common Size Balance Sheet 2009 2010 2011 Cash 0.198 0.080 0.003 Accounts Receivables 0.075 0.111 0.107 Inventories 0.199 0.258 0.303 Total Current Assets 0.472 0.449 0.413 Land 0.184 0.178 0.173 Building and Equipment 0.552 0.622 0.667 Less Accumulated Depreciation -0.208 -0.249 -0.253 Total Fixed Assets 0.528 0.551 0.587 Total Assets 1.000 1.000 1.000 Accounts Payables 0.066 0.093 0.147 Short-term Bank Notes 0.134 0.151 0.286 Total Current Liabilities 0.200 0.244 0.433 Long-term Debt 0.294 0.256 0.161 Common Stock 0.290 0.280 0.202 Retained Earnings 0.216 0.220 0.204 Common Equity 0.506 0.500 0.406 Total Debt and Equity 1.000 1.000 1.000 University Page 6 of 23 July Semester 2012 Question 1 Compute the missing ratios in Table 1. Assume that debt consist of both short-term and long-term debt. (5 marks) Table 1 Ratios 2009 2010 2011 Current Ratio 2.362 1.836 ..... Quick Ratio 1.369 0.782 0.254 Inventory Turnover Ratio 2.778 3.103 4.057 Days Sales Outstanding 29.930 30.417 ..... Fixed Asset Turnover 1.742 2.419 3.497 Total Asset Turnover 0.919 1.333 2.051 Gross Profit margin 0.400 0.400 0.400 EBIT Margin 0.065 0.096 0.133 Net Profit Margin 0.004 0.033 ..... ROA 0.003 0.044 ..... ROE 0.007 0.087 0.278 Debt/Total Asset Ratio 0.428 Debt/Equity Ratio 0.847 0.813 1.100 Times Interest Earned Ratio 1.125 3.148 5.839 0.407 ..... Accounts Payables Turnover 8.380 8.571 8.392 Show your calculations here. University Page 7 of 23 July Semester 2012 University Page 8 of 23 July Semester 2012 Question 2 Compute the cash flow for 2011 and complete Table 2. (10 marks) Table 2 Cash Flow Statement 2010 Net income 2011 2,200.3 614.1 Add depreciation 675.0 1,440.0 Inventory -925.0 ..... Receivables -537.5 ..... Payables 417.5 ..... Net change in working capital -1,045.0 ..... Operating cash flow 244.1 2,380.3 0 ..... Building and equipment -,250.0 ..... Investment cash flow -1,250.0 -5,130.0 Changes in working capital Investment cash flow Land Financing cash flow 301.0 ..... Short-term bank notes Long-term debt -406.2 ..... Dividend paid -460.0 -1,308.6 Net financing cash flow -565.2 1,689.6 Net cash flow -1,571.1 ..... Change in cash -1,571.1 ..... Show your calculations here. University Page 9 of 23 July Semester 2012 University Page 10 of 23 July Semester 2012 Question 3 Using the financial statements, common size statements, interpretation of ratios, and analysis of cash flow statement, analyse the financial performance of MEC. (25 marks) University Page 11 of 23 July Semester 2012 University Page 12 of 23 July Semester 2012 Question 4 Using the information about the new product, estimate the relevant cash flows from the project using the template provided in Table 3. (20 marks) Table 3 Capital Budgeting Cash Flows Year 0 1 2 3 4 5 Sales ..... 2100000 3600000 3600000 2400000 1750000 Working capital ..... ..... ..... ..... ..... ..... 2100000 3600000 3600000 2400000 1750000 Variable Costs 980000 1680000 1680000 1120000 980000 Fixed Cost 70000 70000 70000 70000 70000 Sales Depreciation ..... ..... ..... ..... ..... ..... Operating income ..... ..... ..... ..... ..... ..... Tax(50%) ..... ..... ..... ..... ..... ..... Net income ..... ..... ..... ..... ..... ..... Add Depreciation ..... ..... ..... ..... ..... ..... Operating cash flow ..... ..... ..... ..... ..... ..... Plant and equipment -1500000 ..... ..... ..... ..... ..... Additional working capital ..... ..... ..... ..... ..... ..... Total cash flow ..... ..... ..... ..... ..... ..... Show your calculations here. University Page 13 of 23 July Semester 2012 University Page 14 of 23 July Semester 2012 Question 5 Using the information about the new product, calculate the firm's cost of equity, cost of debt and overall cost of capital to be used in capital budgeting. (10 marks) University Page 15 of 23 July Semester 2012 University Page 16 of 23 Examination - July Semester 2012 Question 6 Using the information about the new product, compute the Net Present Value of this project and explain whether the project should be undertaken. Use the template provided in Table 4. (5 marks) Table 4 Year Total Cash Flow 0 ..... 1 ..... 2 ..... 3 ..... 4 ..... 5 ..... Cost of Capital ..... ..... ..... ..... ..... ..... PVIF ..... ..... ..... ..... ..... ..... PV of Cash Flows ..... ..... ..... ..... ..... ..... NPV ..... ..... ..... ..... ..... ..... Show your calculations here. University Page 17 of 23 July Semester 2012 University Page 18 of 23 July Semester 2012 Question 7 MEC is considering a change in accounts receivables policy. From its current credit terms of 30 days net, it plans to introduce cash discount for early payment. It plans to change the credit terms to 2/10 net 45. Based on the financial performance in the past 3 years, analyse the change in credit policy and explain whether the management should change the credit policy. (8 marks) Page 19 of 23 July Semester 2012 University Page 20 of 23 July Semester 2012 Question 8 The management is considering changing its target capital structure from 50% debt to 60% debt. It also plans to issue long-term bonds and pay of its short-term loans as well as buyback some of its equity. Evaluate this capital structure policy change. (9 marks) Page 21 of 23 July Semester 2012 University Page 22 of 23 July Semester 2012 Question 9 Apply Du Pont model and discuss the factors that can impact on the return on equity of the company that you work for or a company you are familiar with. In discussing this, provide details of the nature of operations of the company under consideration. (8 marks) Page 23 of 23 July Semester 2012 ----- END OF PAPER ----- FIN303 __________________________________________________________________________________ __ Time allowed: 2 hours __________________________________________________________________________________ __ You must answer ALL the questions. (Total 100 marks) Question 1 You recently joined a Multi-National Enterprise as a management trainee. Although your role is not specifically in finance, you are required to be familiar with the financial affairs of the firm. As such, your boss has asked you to assist on several matters in preparation for a meeting with senior management next week. The 3-year summary financial statements have been furnished to you. Income Statement FY 2014 FY 2013 $'000 $'000 FY 2012 $'000 Revenue 7,882 Cost of goods sold -5,036 -5,133 -5,073 2,846 2,829 2,937 Operating expenses -2,389 -2,216 -2,050 Net operating profit 458 613 888 Gross profit Interest expense 7,962 -45 -24 412 568 864 Income tax -270 -253 -346 Net income 143 315 Income before tax -46 8,010 518 Statement of Financial Position FY 2014 $'000 Current assets FY 2013 $'000 FY 2012 $'000 Cash and bank 951 1,300 1,494 Inventory 788 898 848 Trade receivables 305 317 278 ---------------------------------------------------2,044 2,515 2,620 Non-current assets: Property, plant and equipment 1,876 Other non-current assets 243 1,599 159 1,623 168 ------------------------------------------------2,119 Total assets 1,758 1,791 4,163 4,272 4,411 Trade payables 503 386 296 Accruals 630 Current liabilities 580 631 Other current liabilities 84 171 43 --------------------------------------------1,217 1,136 970 541 455 471 94 257 Non-current liabilities Borrowings Other non-current liabilities 25 --------------------------------------------------566 549 728 1,419 1,343 1,228 Equity Share capital Reserves 961 1,244 1,485 -----------------------------------------------------------2,380 Total liabilities and equity 2,587 2,713 4,163 4,272 4,411 Some financial ratios have been calculated by your colleague. You are required to take over from where she left off and then move on to analyse the firm's performance. (a) Compute the missing financial ratios using the table provided below. (10 marks) FY 2014 FY 2013 FY 2012 Liquidity Current ratio Quick ratio 2.21 1.03 2.70 1.82 Profitability Gross profit margin 36.1% Operating profit margin 5.8% 36.7% 7.7% Asset Utilisation Average inventory days 57 Average collection period 61 15 13 Average payment period 36 27 Cash conversion cycle 35 51 Fixed asset turnover 4.2 4.9 Interest-bearing debt to equity 0.25 0.17 Interest coverage ratio 10.1 52 Leverage 13.6 (b) Comment on the firm's financial performance. (15 marks) Question 2 Your boss wishes to calculate the firm's weighted cost of capital (WACC) and the following information has been given to you: Number of ordinary shares = 5 million Book value of 6% bond maturing in 2020 (in 5 years' time) = $0.5 million Yield-to-maturity of bond is currently 4.85% Market price of ordinary shares = $0.65 Market price of bond (with a face value of $100) = $105 Beta = 1.3 Risk-free rate = 3.0% Market risk premium = 5.5% Tax rate = 17% Additionally, she needs you to explain the circumstances under which WACC can be used for investment appraisal. (a) Calculate the firm's WACC. (20 marks) (b) Discuss the circumstances under which WACC can be used in appraising an investment (15 marks) Question 3 The firm has a new product (PLY 55) which has performed well in test marketing trials conducted recently by the research and development (R&D) department. The R&D costs were estimated to be about $200,000. The business development team has prepared the financial projects as follows: Year 1 2 3 4 5 Sales 220,000 310,000 450,000 410,000 340,000 Cost of sales -77,000 -108,500 -157,500 -143,500 -119,000 Gross profit (50%) 143,000 201,500 292,500 266,500 221,000 -60,000 -61,800 -63,000 -65,300 -67,500 -100,000 -100,000 -100,000 -100,000 Operating expenses Depreciation EBIT -100,000 -17,000 39,700 129,500 101,200 53,500 Tax @ 17% 2,890 -6,749 -22,015 -17,204 -9,095 Net income -14,110 32,951 107,485 83,996 44,405 Net working capital required 33,000 46,500 67,500 61,500 51,000 The initial investment in plant and equipment for this project is $500,000. The plant and equipment is fully depreciated over its useful life using the straight line method. Due to the nature of the product life cycle, this product will be rendered obsolete at the end of five years. At which time, the working capital will be fully recovered and plant and equipment can be sold for about $100,000. Your boss is unsure if the firm should proceed with this investment. Therefore, she needs you to evaluate this proposal. Assume a discount rate of 9% and tax rate of 17%. If this project proves to be financially viable, she needs to know whether equity or debt is suitable for financing this investment. (a) Calculate the free cash flows to firm for Years 0 to 5 for the proposed investment in the new product (PLY 55). (17 marks) Free Cash Flow to Firm Year 1 0 Initial investment Operating cash flows Cash flow impact of NWC Terminal value Free cash flow to firm Free cash flow to firm 2 3 4 5 Discount rate Discount factor NPV (b) Calculate the net present value (NPV). Recommend whether this potential investment is financially viable. (8 marks) Question 4 Analyse and discuss whether a rights issue or an issue of bonds is a suitable way of raising finance for the proposed investment. (15 marks) ----- END OF PAPER ----- Fin303 Jan 2015 past year paper Question 1 You recently joined a Multi-National Enterprise as a management trainee. Although your role is not specifically in finance, you are required to be familiar with the financial affairs of the firm. As such, your boss has asked you to assist on several matters in preparation for a meeting with senior management next week. The 3-year summary financial statements have been furnished to you. Revenue COGS Gross profit Op Exp Net Op Profit Int Exp EBT Tax Net income 3 Yr Income statement Fy2014 FY2013 $ 7,882 $ 7,962 $ (5,036) $(5,133) $7,882-$5036= $ 2,846 $ 2,829 $ (2,389) $(2,216) $2846-$2389=$ 457 $ 613 $ (46) $ (45) $457-$46=$ 411 $ 568 $ (270) $ (253) $411-$270=$ 141 $ 315 Statement of Financial Position Statement of Financial Position Fy2014 FY2013 Current Assets Cash & Bank $ 951 $ 1,300 Inventory $ 788 $ 898 Trade Rxables $ 305 $ 317 $ 2,044 $ 2,515 Non-Current Assets PP&E $ 1,876 $ 1,599 Other NCA $ 243 $ 159 Total Assets $ 4,163 $ 4,273 Current Liab : Trade Payables Acruals Other CL Total CL $ $ $ $ 503 630 84 1,217 Non CL Borroiwngs Other NCL Total NCL $ $ $ Equity Share capital Reserves Total Equity Total Liab & Equity $ $ $ $ FY2012 $ 1,494 $ 848 $ 278 $ 2,620 $ 1,623 $ 168 $ 4,411 $ 386 $ 580 $ 171 $ 1,137 $ $ $ $ 296 631 43 970 541 25 566 $ $ $ 455 94 549 $ $ $ 471 257 728 1,419 961 2,380 4,163 $ $ $ $ 1,343 1,244 2,587 4,273 $ $ $ $ 1,228 1,485 2,713 4,411 FY2012 $ 8,010 $ (5,073) $ 2,937 $ (2,050) $ 887 $ (24) $ 863 $ (346) $ 517 Some financial ratios have been calculated by your colleague. You are required to take over from where she left off and then move on to analyse the firm's performance. (a) Compute the missing financial ratios using the table provided below. (10 marks) Financial Ratios Fy2014 Liquidity Current ratio Quick ratio Profitability Gross profit margin Operating profit margin Asset Utilixation Avge Inv days Avge collection period Avge payment period Cash Conv cycle FA turnover Leverage Interest bearing debt to equity Interest coverage ratio FY2013 FY2012 2.21 1.42 2.70 1.83 35.53% 7.70% 36.70% 11.07% 1.68 1.03 36.10% 5.80% 57 14 36 35 4.2 64 15 27 51 5.0 0.25 10.1 0.18 13.6 61 13 =CA/CL =(CA-Inventory)/CL = Gross Profit/Sales =Operating profit/Sales 21 =365*Avge Inv/COGS =365*Acct Rx/Revenue =365*Acct Payable/COGS 4.9 =Sales/Net PP&E 52 0.17 37.0 =Borrowings/Total Equity =EBIT/Tax Curret Ratio = CA/CL = 2044/1217 = 1.68 Quick Ratio = (CA-Inventory)/CL = (2515-898)/1137 = 1.42 Gross Profit margin = GP/Sales = 2829/7962 = 35.53% Op Profit Margin = Op Profit/Sales = 887/8010 = 11.07% Avge Inv Days = 365*Avge Inv/COGS = 365*898/5133 = 64 days Avge collection period = 365*Acct Rx/Revenue = 365*305/7882 = 14 days Avge Payment period = 365*Acct Payable/COGS = 365*296/5073 = 21 days FA Turnover = Sales/Net PP&E = 7962/1599 = 5.0 Interest bearing debt to equity = Borrowing/Total Equity = 455/2587 = 0.18 Interest coverage ratio = EBIT/Tax = 887/24 = 37.0 (b) Comment on the firm's financial performance. (15 marks) Current Ratio has decreased from 2.70 to 1.68 indicating that Firm's Short Term solvency is worsening. Quick Ratio has also decreased from 1.83 to 1.03. This indicates that Firm's Liquidity position is worsening and it will find it difficult to meet its short term payment obligations. Gross Profit margin is almost stable at 36%. This indicates that Firm is able to maintain its position in the market. Operating profit margin has decreased from 11.07% to 5.80%. This indicates that Operating expenses had been increasing while sales had been falling. Average Inventory days had reduced from 61 to 57 indicating that Firm is able to cycle its inventory slightly faster than before. Average collection period is almost constant at 14 days indicating that its customers pay in time & results in a predictable cash flow. Average Payment period has increased from 21 to 36 days indicating that Firm is able to negotiate better payment terms from its suppliers Fixed Asset Turnover Ratio has reduced from 4.9 to 4.2. This indicates that Per dollar of Sales is reducing. It indicates idle capacity. Interest Bearing debt to Equity ratio has increased from 0.17 to 0.25. This indicates that Firm is borrowing more to meet its working capital requirements. Interest coverage ratio has decreased from 37 to 10 indicating that increased borrowings and reduced EBIt should be a cause of worry. Overall Firm's performance have worsened over 3 years. Question 2 Your boss wishes to calculate the firm's weighted cost of capital (WACC) and the following information has been given to you: Number of ordinary shares = 5 million Book value of 6% bond maturing in 2020 (in 5 years' time)= $0.5 million Yield-to-maturity of bond is currently 4.85% Market price of ordinary shares = $0.65 Market price of bond (with a face value of $100) = $105 Beta = 1.3 Risk-free rate = 3.0% Market risk premium = 5.5% Tax rate = 17% Additionally, she needs you to explain the circumstances under which WACC can be used for investment appraisal. (a) Calculate the firm's WACC. Cost of equity Ks = Krf + beta*MRP = 3.0% + 1.3*5.5% = 10.15% Cost of Debt = rate(nper,pmt,pv,fv) PMT = 6%*$100 = $6 So cost of debt Kd = rate(5,6,-100,105) = 6.87% Market value of Equity = $0.65*5million = $3,250,000 Market value of debt = $0.5*1000,000*$105/$100 = $525,000 SO Mkt Value of Fiem V = E+D = $3775,000 So Weight of Equity We = E/V = 86% Weight fo Debt Wd = D/V = 525,000/3775,000 = 14% So WACC = Wd*Kd*(1-T) + We*Ks So WACC = 14%*6.87%*(1-17%) + 86%*10.15% = 9.53% (20 marks) (b) Discuss the circumstances under which WACC can be used in appraising an investment (15 marks) While using WACC for appraising an investment, one should bear in mind that cost of capital depends on source of funds. Also the risk involved in the investment is to be considered while deciding on a suitable cost of capital. So WACC should be used only if the new investment which is being considered has similar risk characterises to firm as its existing investment projects. In this case, the investment is being made not in to expanding g an existing facility but in a totally new business which has a different risk characteristic. So we need to consider the Business risk & financial risk and accordingly add a certain risk percentage to WACC to evaluate the new investment. Question 3 The firm has a new product (PLY 55) which has performed well in test marketing trials conducted recently by the research and development (R&D) department. The R&D costs were estimated to be about $200,000. The business development team has prepared the financial projects as follows: Year 1 Sales COGS GP (50%) Op exp Dep $ 220,000 $ (77,000) $220,000=$77,000=$ 143,000 $ (60,000) $ (100,000) $143,000-$60,000=$100,000=$ EBIT (17,000) Tax@17% 17% x $17,000=$ 2,890 net income $(17,000)-$28,90= $ (14,110) NWC $ 33,000 23 $ 310,000 $(108,500) $ 201,500 $ (61,800) $(100,000) 4 $ 450,000 $(157,500) $ 292,500 $ (63,000) $(100,000) 5 $ 410,000 $(143,500) $ 266,500 $ (65,300) $(100,000) $ 340,000 $(119,000) $ 221,000 $ (67,500) $(100,000) $ 39,700 $ 129,500 $ 101,200 $ 53,500 $ (6,749) $ (22,015) $ (17,204) $ (9,095) $ 32,951 $ 107,485 $ 83,996 $ 44,405 $ 46,500 $ 67,500 $ 61,500 $ 51,000 The initial investment in plant and equipment for this project is $500,000. The plant and equipment is fully depreciated over its useful life using the straight line method. Due to the nature of the product life cycle, this product will be rendered obsolete at the end of five years. At which time, the working capital will be fully recovered and plant and equipment can be sold for about $100,000. Your boss is unsure if the firm should proceed with this investment. Therefore, she needs you to evaluate this proposal. Assume a discount rate of 9% and tax rate of 17%. If this project proves to be financially viable, she needs to know whether equity or debt is suitable for financing this investment. (a) Calculate the free cash flows to firm for Years 0 to 5for the proposed investment in the new product (PLY 55). (17 marks) Free Cash Flow to Firm Year Initial investment 0 1 2 3 4 $ (500,000) Operating cash flows $ 85,890 $ 132,951 $ (33,000) Cash flow impact of NWC $ (13,500) $ 207,485 $ (21,000 ) $85,890-$33,000=$ 52,890 $132,951-$13,500= $ 119,451 $ 186,485 $ 183,996 $ 6,000 NWC Terminal value Free cash flow to firm Discount rate $ (500,000) $183,996+$6,000= $ 189,996 $ 144,40 5 $ 10,500 $ 51,000 $ 83,000 $ 288,90 5 9% Discount factor NPV 5 0.9174 0.8417 0.7722 0.7084 0.6499 $115,429. 47 (b) Calculate the netpresent value (NPV). Recommend whether this potential investment is financially viable. (8 marks) After Tax Sale value = Sales value - Taxrate*(Sale Value - Book Value) $ 83,000 R&D cost are Sunk costs and is not relevant in Cash Flow analysis As NPV is positive, Firm should go for this Investment Question 4 Analyse and discuss whether a rights issue or an issue of bonds is a suitable way of raising finance for the proposed investment. (15 marks) A rights issue provides a way of raising new share capital by means of an offer to existing shareholders. This is done by inviting existing shareholders to subscribe cash for new shares in proportion to their existing holdings. A company making a rights issue usually set a price which is lower than current market price to secure the acceptance of shareholders, who are being asked to provide extra funds, but not too low, so as to avoid excessive dilution of the earnings per share. Rights issue is offered to existing shareholders of the firm to raise Cash for meeting Firm's capital requirements. As the Firm already has a Equity weight of 86%, further dilution of equity is not recommended. Bonds have a nominal value, which is the debt owed by the company, and interest is paid at a stated "coupon yield" on this amount. Issue of Bonds is an attractive source of finance because interest charges reduce the profits chargeable to corporation tax. Firm may be better off by issue of Bonds to meet its Long term capital requirements. The Interest payable on Bonds also is Tax deductible thus offering finds at a lower cost. Risk is fall in interest rates which may make the Bonds expensive. However as Firm has only 14% of Debt, it should take on more debt to finance its funds requirements.