no need do question 2.........................................................................................................

You must answer ALL the questions. (Total 100 marks) Heavy Machinery manufacturing Company (HMM) manufactures and sells heavy equipment used in mining, construction and shipbuilding industries. The management is concerned about its financial performance. It considers Metal Stamping Company (MS) as a major player in the industry and would like to compare its performance with that of MS. One of the managers suggests that it is also useful to compare the performance with that of Hi-tech Software Company (HTS) to get a better picture. HTS is involved in providing software solutions to Machinery manufacturing companies. The balance sheet, income statement and relevant ratios for HMM, MS and HTS are shown in Exhibit 1. The management of HMM is planning to introduce a new machine in the market. The details of this investment are shown in Exhibit 2. Exhibit 1 - Balance Sheet, Income Statement and Relevant Ratios Balance Sheet ($'000) Current Assets Cash Accounts Receivables Inventory Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Total Assets Accounts Payables Long-term debt Total Liabilities Common Stock Retained earnings Total equity Total Liabilities and Equity HMM 25,000 5,000 10,000 10,000 85,000 10,000 MS 12,000 4,000 5,000 3,000 80,000 12,000 HTS 20,000 7,000 10,000 3,000 100,000 20,000 75,000 100,000 20,000 68,000 80,000 10,000 80,000 100,000 10,000 40,000 60,000 15,000 25,000 40,000 100,000 40,000 50,000 10,000 20,000 30,000 80,000 0 10,000 25,000 65,000 90,000 100,000 Income Statement ($'000) Sales Cost of goods sold Gross Profit Selling and Administrative Expenses Operating Profit Interest Expenses Earnings Before taxes HMM MS 75,000 45,000 30,000 20,000 50,000 35,000 15,000 HTS 100,000 20,000 80,000 40,000 5,000 10,000 3,000 7,000 10,000 3,000 7,000 40,000 0 MS 2,800 HTS Taxes HMM 2,800 Net Income 4,200 4,200 16,000 24,000 HMM 10.50% 4.20% 0.75 3 MS 14.00% 5.25% 0.625 4.17 HTS 26.67% 24.00% 1 5 1 40.00% 13.33% 0.74 30.00% 20.00% 1.25 80.00% 40,000 Ratios Return on equity Return on Assets Total Asset Turnover Current Asset Turnover Fixed Asset Turnover Gross Profit margin Operating profit margin Net profit margin Total Liabilities/assets Long-term debt to assets 40.00% 5.60% 60.00% 40.00% 8.40% 62.50% 50.00% 24.00% 10.00% 0.00% Long-term debt to equity Interest Coverage Inventory turnover Average Collection period Accounts Payables Turnover Net working capital turnover Equity Multiplier 100.00% 133.33% 0.00% 3.33 4.50 3.33 11.67 36.00 NA 6.67 36.00 3.50 2.00 15.00 25.00 10.00 2.50 2.67 48.00 2.25 1.11 Exhibit 2 - Details of the Project Investment in new machinery $10,000,000 Useful life of the machinery 5 years Depreciated using straight line depreciation to zero salvage value over the useful life of machinery Expected life of the project 4 years Expected incremental annual sales in the next 4 years $12,500,000 Cost of goods sold 60% of sales Fixed Operating Expenses per year $500,000 Estimated selling price at the end of 4 years $1,750,000 Working capital needs to support sales of $12,500,000 $3,000,000 Working capital will be provided at the beginning of the project and recouped at the end of project Tax rate 40% Beta of HMM 1.5 Risk-free rate 3% Market risk premium 6% After tax cost of debt 6% Target debt ratio 40% Page 4 of 6 Question 1 (a) Analyse the difference in the return on equity of HMM and MS during 2015. Use the Du Pont system. (15 marks) (b) Analyse whether comparing the performance of HMM against HTS will be meaningful. (5 marks) Question 2 (a) HMM is looking at investment in the new machine. In order to evaluate the project, estimate the relevant cash flows and calculate the following: (i) Weighted average cost of capital (8 marks) (ii) Initial Investment (Investment in net working capital of $3,000,000 is at the start of the project and recovered at the end of the project) (4 marks) (iii) Annual cash flows (8 marks) (iv) Terminal Cash flows (4 marks) (v) Net present value (4 marks) (b) Recommend whether the project should be undertaken. (2 marks) Page 5 of 6 - July Semester 2016 Question 3 HMM is looking at the working capital policy. (a) Analyse the need for working capital and calculate the cash conversion cycle for HMM. (6 marks) (b) Analyse the importance of cash conversion cycle for management. (3 marks) (c) HMM is being offered a credit policy of 2/10 net 40 by its suppliers. The opportunity cost for HMM is 12%. Analyse the offer and advice whether discount should be taken. (6 marks) Question 4 The company would like to prepare a cash budget for the months of April, May, and June. The relevant details are given below (figures given are in $000): Sales Purchases Operating Expenses January 5,000 3,000 1,600 February 8,000 6,000 1,600 March 10,000 8,000 1,600 April 12,000 10,000 1,600 May 10,000 8,000 1,600 June 15,000 12,000 1,600 20% of sales every month is for cash. 80% of credit sales are collected in the month following sales and the rest during the second month after sales. 40% of purchase are for cash and credit purchases are paid in the following month. Operating expenses are paid in the month in which it is incurred. HMM will pay a dividend of $10,000,000 in the month of June. Cash balance as of April 1 is $6,000,000 (a) Prepare a cash budget for the months April, May, and June. (15 marks) (b) Discuss the use of cash budgets. (5 marks) Page 6 of 6 - July Semester 2016 Question 5 HMM is debating whether to issue a callable bond or a convertible bond to raise funds. (a) Discuss the circumstances under which callable bond will be issued and when these bonds will be called back. (5 marks) (b) Discuss when the company will issue a convertible bond and when the bond will be converted by shareholders. (5 marks) (c) Discuss which of these bonds will have a higher yield to maturity and why? (5 marks) ----- END OF PAPER -----