Question 47

An unlevered firm, U, operates in a perfect market and has a net operating income of GHC250,000.00 and required rate of return on assets for firms in the industry is 12.5%. The firm issues GHC1,000,000.00 worth of debt with a required return of 5% and uses the proceeds to repurchase outstanding shares. The firm U operates in a perfect market without corporate or personal taxes.

1. Estimate the market value and required return of the firms shares before the repurchase transaction
2. Estimate the market value and required return of the firms remaining shares after the repurchase transaction

Question 48

Mr. Tee is the newly recruited financial analyst of Kelewele Ltd. He has been asked to analyze a proposal to acquire a drilling machine. He received the appropriation capital request. Kelewele Ltd can purchase the drilling machine for GHC100,000. Von Mining Company Lt. Kelewele Ltd can also lease the drilling machine for GHC24,400 a year for a 5-year period from Frisky Ltd. The expected life of the machine is given as 5 years and expected to have a salvage value of GHC10,000 in 5 ears time. The mining company intends to buy the drilling machine at a fair market value at that time. If the mining company decides to buy the machine, it can acquire financing at 20%.it will cost the Mining Company GHC12,000 in maintenance and insurance of the drilling machine. The tax rate is 4%. Assume depreciation is on straight line basis and lease rentals are tax deductible. (Assume payment is made at the end of the year)

1. Calculate NPV to Kelewele Ltd of the lease proposal.
2. What advice will Mr. Tee give to Kelewele Ltd?
3. Discuss five (5) features of a finance lease and explain their implications for the operations of firms.