Question 1

Minute Ltd. is a retailer of luxury watches, but the luxury watch market has been doing poorly of late. So Minute Ltd. is considering setting up a separate division to venture into the pastry retailing market, the stronghold of PastryChat Ltd., which has a weighted average cost of capital of 6%. Minute Ltd. issued 600,000 20-year, 12% semi-annual coupon bonds five years ago and these are currently trading at a premium of 10% to their $1,000 face value. Further, Minute Ltd.'s 425 million shares that are currently trading at $0.80 each have a beta of 0.75. The risk-free rate is 1.5% and the expected return on the market is 14.5%. The marginal corporate tax rate is 20%.

(a) Calculate Minute Ltd.'s cost of equity.

(b) Calculate Minute Ltd.'s cost of debt.

(c) Calculate Minute, Ltd.'s weighted average cost of capital and decide on a discount rate to be used by Minute Ltd. to assess its pastry retailing venture. Specify two (2) important considerations in making your decision.

(d) A credible newspaper reports that a Minute Ltd.'s store manager has stolen luxury watches amounting to half a million dollars. How will this affect its cost of equity?

(e) Minute Ltd. plans to issue some convertible bonds and use the proceeds to pay off some of its straight bonds. How will this affect its WACC?

Question 2

OCK, Ltd. is a manufacturer and retailer of popular snacks. The company is expecting $80,000 in sales for the coming year, along with $30,000 in variable costs, $15,000 in fixed costs and $10,000 in interest expenses. The marginal corporate tax rate is 20%.

(a) Calculate the degree of operating leverage (DOL), the degree of financial leverage (DFL), and the degree of total leverage (DTL) for OCK, Ltd.

(b) Suppose EBIT is 20% less than expected. Using a suitable result from part (a), find the percentage change in net income from expected.

(c) Use your result in part (b) to discuss the meaning of leverage.

(d) Under what circumstances will there be no financial leverage?

(e) Suppose OCK Ltd. would like to replace some of its full-time staff with part-time staff to better meet the erratic demand. Discuss the impact on DOL, DFL, and DTL.

Question 3

FlybyNight Inc. is a budget airline that is evaluating whether to lease an aircraft from Boing Inc. If FlybyNight does not lease the aircraft, its competitor will lease it today. If FlybyNight, Inc. does lease the aircraft, it will incur annual leasing cash outflows of $20 million for the next twelve years. There is currently a pandemic and a potential vaccine has been developed for the deadly virus. If the vaccine is effective, future cash inflows net of other non-leasing cash outflows is expected to be $25 million per year. Otherwise, the net cash inflows will be $18 million per year. As of today, both scenarios seem equally likely. Initial capital outlay associated with introducing a new route is $12 million and the discount rate is 10%.

a) Calculate the NPV to determine whether FlybyNight Inc. should lease the aircraft.

(b) Suppose the efficacy of the vaccine will be known in a year's time. At that time, Boing Inc. will give FlybyNight Inc. the right to lease an additional aircraft, provided that it leases an aircraft today.

(i) What is the present value of the option to lease an additional aircraft?

(ii) Given this option, should FlybyNight lease an aircraft today?

(c) Suppose the efficacy of the vaccine will be known in a little over a year's time. If it is ineffective, the pandemic would have become widespread to the point where no additional vaccine is worth developing. FlybyNight Inc. is negotiating with Boing Inc. for the right to terminate the lease once the efficacy of the vaccine is known.

(i) If Boing Inc. agrees to the early termination option, should FlybyNight Inc. lease an aircraft today?

(ii) If Boing Inc. requires payment in return for the early termination option, what is the maximum amount FlybyNight Inc. would be willing to pay for this option?

Question 4

For the most recent financial year, Company W had annual sales and cost of sales of $530 million and $400 million, respectively. In addition, the company ended the year with $52 million in inventory, $6 million in accounts receivables, and $54 million in accounts payables. Assume 365 days in a year.

a) Calculate the cash cycle for Company W.

(b) Under what circumstances will the cash cycle be negative? What does it mean?

(c) The CFO of Company W says that it is always in the best interest of the company to reduce its cash cycle. True or false? Explain.

(d) Suppose the median firm in Company W's industry has inventory, receivables, and payables periods of 100, 15, and 30 days, respectively. Is Company W likely to have a flexible or restrictive short-term financial policy? Justify your answer.

(e) Company W is either one of the largest retailers in the world or an automobile manufacturer using a just-in-time system. Which is Company W more likely to be? Justify your answer.