国财务财务管理原理第二次作业

Keep all final results two decimal places!

1.(16 marks).Suppose we are considering a capital investment that costs $800,000 and provides annual net cash flows of $250,000 for the first four years and $326,000 at the end of the fifth year. The firm’s required rate of return is 10%, calculate the followings:

(1) Net present value; (2) Profitability index;

(3) Internal rate of return (try 18% first); (4) Payback period. Answer:

2.(20 marks).Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises needs someone to supply it with 140,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $1,800,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that in five years this equipment can be salvaged for $150,000. Your fixed production costs (not including depreciation) will be $265,000 per year, and your variable production costs should be $8.50 per carton. You also need an initial investment in net working capital of $130,000. Your tax rate is 35 percent and you require a 14 percent return on your investment.

(1) What’s the initial outlay (IO) of this project?

(2) What’s the amount of terminal cash flow (TCF, including disposal of fixed assets and withdrawal of working capital)?

(3) When the NPV of this project is zero, what’s the amount of operational cash flow (OCF) for each year of this project?

(4) What bid price should you submit?

(5) Why can’t you get a positive NPV? How can you get profitable projects? Answer:

3. (20 marks).AX Co. will finance a project in the proportions shown below. Issue costs would be: (a) 2% of market value for a new bond issue; (b) 15 cents per share

for ordinary shares; (c) 10 cents per share for preference shares. The ordinary share dividends for next year will be 80 cents and are projected to have an annual growth rate of 5%. What is the weighted cost of capital? Market prices are $110 for bonds, $5 for preference shares and $8 for ordinary shares. There will be $15,000 of retained earnings available. The company tax rate is 30%.

Type of financing Percentage of future financing Bonds (8%, $100 par, 10-year maturity) 30

Preference shares 20

(6,000 shares outstanding, 30 cents dividend) Ordinary equity 50 Total 100 Answer:

4.(10 marks).AX Company has a revolving credit agreement with its bank. The company can borrow up to $1 million under the agreement at an annual interest rate of 9%. AX is required to maintain a 10% compensating balance on any funds borrowed

under the agreement and to pay a 0.5% commitment fee on the unused portion of the credit line. Assume that AX has no funds in the account at the bank that can be used to meet the compensating balance requirement. Determine the annual financing cost of borrowing each of the following amounts under the credit agreement.

(1) $250000; (2) $500000; (3) $1000000. Answer:

5. (16 marks). Four engineers are forming their own company. Two financing plans are being studied.

Plan A requiresthe firm to sell $1 million of bonds with an effective interest rate (yield) of 14%. In addition, $5 million would be raised by selling ordinary shares at $5 each.

Plan B also involves raising $6 million. This would be accomplished by selling $3 million of bonds at an effective interest rate of 16%. The other $3 million would come from selling ordinary shares at $5 each.

In both cased the use of financial leverage is considered to be a permanent part of the firm’s capital structure, so no fixed maturity date is used in the analysis. The firm considers a 30% tax rate appropriate for planning purposes.

(1) Find the EBIT indifference level associated with the two financing plans.

(2) A detailed financial analysis of the firm’s prospects suggests that long-term EBIT will be above $1,188,000 annually. Taking this into consideration, which plan will generate the higher EPS?

(3) Suppose that long-term EBIT is forecast to be $1,188,000 per year. Under Plan

A a price-earnings ratio of 13 would apply, and under Plan

B a price-earnings ratio of

11 would apply. If this set of financial relationships does hold, which financing plan would you recommend be implemented?

(4) Assume an EBIT level of $1,188,000. What price-earnings ratio applied to the EPS of Plan B would provide the same share price as that projected for Plan A? Answer:

6. (18 marks).AX Company has an all-ordinary-share capital structure. Selected financial data for the company are shown below:

Ordinary shares outstanding =2,000,000 Ordinary share price, P0=$10 per share Expected level of EBIT =$5,000,000 Dividend payout ratio =100%

In answering the following questions, assume that corporate income is not taxed.

(1) Under the present capital structure, what is the total value of the company?

(2) What is the cost of ordinary equity capital, K E? What is the composite cost of capital K0?

(3) Now, suppose that AX sells $1 million of long-term debt with an interest rate of 8%. The proceeds are used to retire the outstanding shares. According to the independence hypothesis:

(a) What will be the dividend per share flowing to the firm’s ordinary shareholders?

(b) By what percentage has the dividend per share changed owing to the capital-structure change?

(c) What will be the company’s cost of ordinary equity after the capital-structure change?

(d) By what percentage has the cost of ordinary equity changed as a result of the capital-structure change?

(e) What will be the composite cost of capital after the capital-structure change? Answer: