Question 1 60 Marks

Midnight Oil and Gas is considering building a pipeline from a remote source of gas with only a 10-year supply of reserves. This qualifies the pipeline for a CCA rate of 20 percent rather than the normal 4 percent. The pipeline will cost $1 million; accompanying buildings will cost another $200,000. The buildings are Class 1 with a CCA rate of 4 percent.

Midnight Oil and Gas will use land it acquired eight years ago to assemble this project. The land was purchased for $500,000, and it is now worth $2 million. Annual cash flows before amortization from the pipeline and taxes for the 10-year period are estimated at $625,000.

In 10 years the buildings and pipeline will be worthless, but the land will be worth $4.5 million. Environmental clean-up costs at the end of the project are expected to be $1.2 million. Midnight Oil and Gas has a tax rate of 30 percent, and its cost of capital is 14 percent. Capital gains are taxed at 50 percent of the gain.

Required

Prepare a report to the Board of Directors which includes :

A recommendation with regards to building the pipeline?

Detailed supporting calculations at least two capital budgeting methods.

Other non-financial factors to consider for the project.

Any other issues that you want to highlight.

Question 2 40 Marks

Lyle Communications had finally arrived at the point where it had a sufficient excess cash flow of $2.4 million to consider paying a dividend. It had 2 million shares outstanding and was considering paying a cash dividend of $1.20 per share. The firms total earnings were $8 million, providing $4 in EPS. Lyle Communications shares traded in the market at $64. However, Liz Crocker, the chief financial officer, was not sure that paying the cash dividend was the best route to go. She had recently read a number of articles in The Globe and Mail about the advantages of stock repurchases and, before she made a recommendation to the board of directors, she decided to do a few calculations.

Required

Assist Liz in the following analysis.

1. What is the firms P/E ratio?
2. If the firm paid the cash dividend, what would be its dividend yield and dividend payout per share?
3. If a shareholder held 100shares and received the cash dividend, what would be the total value of the shareholder's portfolio?
4. Assume that instead of paying the cash dividend, the firm used the $2.4 million of excess funds to purchase shares at $65.20, slightly over the current market price. How many shares could be repurchased? (Round to the nearest share.)
5. What would be the new EPS under the share repurchase alternative?
6. If the P/E ratio stayed the same under the share repurchase alternative, what would be the share value? What would be the value of the shareholders portfolio, which included 100shares?