UNIVERSITY OF NAMIBIA NAMIBIA BUSINESS SCHOOL FINANCIAL MANAGEMENT STRATEGY Semester 2 2020 Triple D Corporation is all equity financed with total assets valued at $1 million, which are assumed constant. The corporations ordinary shares are valued at $25 each, and the firm is in the 40 percent tax bracket. The corporation wishes to analyze five possible capital structures- 0, 15, 30, 45, and 60 percent debt-equity ratios. Exhibit 1 shows the additional data which have been gathered for use in analyzing the five capital structures under consideration. Exhibit 1: Triple D Corporations alternative capital structures Capital structure debt-equity ratio Interest rate on debt 0% 0.0% 15 8.0 30 10.0 45 13.0 60 17.0 The companys income statements for the previous three years are indicated in Exhibit 2. The balance Sheets for the same period are shown in Exhibit 3. Exhibit 2 TRIPLE D CORPORATION Income Statements 2017 2018 2019 Sales (all on credit) $1,500,000 $1,800,000 $2,160,000 Cost of goods sold 950,000 1,120,000 1,300,000 Gross profit 550,000 680,000 860,000 Selling and administrative expense 380,000 490,000 590,000 Operating profit 170,000 190,000 270,000 Interest expense..... 30,000 40,000 85,000 Net income before taxes 140,000 150,000 185,000 Taxes 46,120 48,720 64,850 Net Income.. $93,880 $101,280 $120,150 Shares 40,000 40,000 46,000 2 Exhibit 3 Triple D CORPORATION Balance Sheets Assets 2017 2018 2019 Cash $20,000 $30,000 $20,000 Marketable securities 30,000 35,000 50,000 Accounts receivable 150,000 230,000 330,000 Inventory 250,000 285,000 325,000 Total Current Assets 450,000 580,000 725,000 Net Plant and equipment 550,000 720,000 1,169,000 Total Assets.. $1,000,000 $1,300,000 $1,894,000 Liabilities & Equity Accounts payable. $100,000 $225,000 $200,000 Notes payable (bank) 100,000 100,000 300,000 Total Current liabilities 200,000 325,000 500,000 Long-term liabilities 250,000 331,120 550,740 Total liabilities 450,000 656,120 1,050,740 Common stock ($10 par) 400,000 400,000 460,000 Capital paid in excess of par. 50,000 50,000 80,000 Retained earnings 100,000 193,880 303,260 Total stockholders equity.. 550,000 643,880 843,260 Total liabilities and stockholders equity $1,000,000 $1,300,000 $1,894,000 The actual sales and purchases for Triple D Corporation for September and October 2019, along with its forecast sales and purchases for the period November 2019 through April 2020 are as follows. Exhibit 4: Triple D corporations Projected sales and purchases Year Month Sales Purchases 2019 September $210,000 $120,000 2019 October 250,000 150,000 2019 November 170,000 140,000 2019 December 160,000 100,000 2020 January 140,000 80,000 2020 February 180,000 110,000 2020 March 200,000 100,000 2020 April 250,000 90,000 The firm makes 20 percent of all sales for cash and collects on 40 percent of its sales in each of the two months following the sale. Other cash inflows are expected to be $12,000 in September and April, $15,000 in January and March, and $27,000 in February. The firm pays cash for 10 percent of its purchases. It pays for 50 percent of its purchases in the following month and for 40 percent of its purchases two months later. 3 Wages and salaries amount to 20 percent of the preceding months sales. Rent of $20,000 per month must be paid. Interest payments of $10,000 are due in January and April. A principal payment of $30,000 is also due in April. The firm expects to pay cash dividends of $20,000 in January and April. Taxes of $80,000 are due in April. The firm also intends to make a $25,000 cash purchase of fixed assets in December. Triple D Corporation is considering to bring out one of two games this season. The Signs Away game has a higher initial cost but also a higher expected return. Monopolistic Competition, the alternative, has a slightly lower initial cost but also lower expected return. The present values and probabilities associated with each game are listed in Exhibit 5: Exhibit 5: Triple D Corporations investment choices Game Initial Investment Present value of cash inflows Probabilities Sign Away $140,000 1.00 $320,000 0.30 220,000 0.50 -80,000 0.20 Monopolistic Competition $120,000 1.00 $260,000 0.20 200,000 0.45 -50,000 0.35 Required: Question 1 (25 marks) (a) Calculate the amount of debt, the amount of equity, and the number of outstanding shares for each of the capital structures being considered.(5 marks) (b) Calculate the annual interest on debt under each of the capital structures being considered. (5 marks) (c) Calculate the earnings per share (EPS) associated with $150,000 and $250,000 of EBIT for each of the five capital structures. (5 marks) (d) Calculate the level of EBIT at the point of indifference. (3 marks) (e) Calculate the earnings per share for each of the capital structures. (5 marks) 4 (f) Calculate the dividend payout ratio for each of the capital structures being considered.(2 marks) Question 2 (25 marks) (a) Calculate the net profit margin ratio for each year. 3 marks) (b) Calculate the asset turnover ratio for each year. (3 marks) (c) Calculate the equity multiplier ratio for each year. (3 marks) (d) Using your answers to (a) (c), explain the factors which influenced the return of equity between 2017 and 2019. (6 marks) (e) Construct the common size Balance Sheet for Adams Corporation for 2017 through 2019. (6 marks) (f) Prepare Indexed Balance Sheet for Adams Corporation with 2019 as the base year. (4 marks) Question 3 (30 marks) (a) Determine the total cash receipts for each moth, November through April. (9 marks) (b) Determine the total cash payments for each moth, November through April. (9 marks) (c) Assuming that the firm has a cash balance of $22,000 at the beginning of November 2019, determine the end- of-month cash balances for each month, November through April. (9 marks) (d) Assuming that the firm wishes to maintain a $15,000 minimum cash balance, determine the monthly total financing requirements or excess cash balances. (3 marks) Question 4 (20 marks)[Exhibit 4] (a) What is the expected value NPV for each game? (4 marks) (b) What is the expected profitability index for each game? (4 marks) (c) What is the standard deviation for each alternative? (9 marks) (d) Which alternative will you choose? Explain your answer. (3 marks)