Requirement: Answer all questions keenly explaining your responses appropriately.
On 1 January 2008 an investor has a choice of two projects A and B. Project A involves an initial cost of $100,000 and provides income annually in arrear of f5,000 at the end of the first year, inflating at 7% pa, the last payment being on 31 December 2015. The investor will be able to sell the ongoing rights to the project at 31 December 2015 after the payment then due for $130,662. Project B also involves an initial cost of 100,000 and provides no income, but the investor will be able to sell the rights to the project at 31 December 2015 for $197,750. (i) Calculate the internal rates of return for each project as at 1 January 2008, correct to the nearest 0.1%. [6] (ii) The investor has no capital for investing in either project, but can borrow f100,000 from a bank at 7% pa interest payable annually in arrear. The loan would be repayable on 31 December 2015 at par with no early repayment option. If further loans are required they will also be granted at 7% pa repayable at par on 31 December 2015 with no early repayment option. However, interest on further loans is rolled up to 31 December 2015. If the investor has any surplus proceeds after paying interest on the original loan as it becomes due, these can be invested at an interest rate of 4% pa effective up to 31 December 2015. Calculate the accumulated profit on each project at 31 December 2015. [14] [Total 20]9 The directors of Gryffe have been approached by Subb, a potential customer who wishes to seek a substantial trade credit facility. Subb is a small company, but it is a member of the Parrent Group, a major corporation. Gryffe's accountant has ascertained the following: . Subb was founded seven years ago. It has grown slowly but steadily ever since. . Parrent purchased its 40% holding of Subb's equity two years ago. The terms of the agreement reached with Subb's existing shareholders are that Parrent will have the right to appoint a number of directors to Subb's board. Subb's chief buyer has submitted the latest financial statements of both Subb and the Parrent Group. Subb's financial position appears to be rather weak, but the Parrent Group is large, profitable and liquid. The chief buyer's covering letter indicates that Gryffe should evaluate the application for trade credit on the basis of Parrent's consolidated financial statements. Subb's chief buyer also asks that attention be paid to the external auditor's report in both sets of financial statements because the auditor has issued an unmodified report in both cases. Gryffe's directors have asked for an explanation as to why Subb can claim to be part of the Parrent Group when Parrent is a minority shareholder. (i) Describe the factors that would indicate whether Subb is, indeed, a member of the Parrent Group. [5] (ii) Explain the suitability of the Parrent Group's consolidated financial statements for the purpose of determining whether Gryffe should advance trade credit to Subb. [5] (iii) Explain the relevance of the external auditor's report to Gryffe in deciding whether to grant trade credit to Subb. [5] (iv) Recommend, with reasons, safeguards that Gryffe could put in place to manage the security of the receivable due from Subb in the event that it grants Subb's request. [5] [Total 20]
