Federation Business School
Assessment Task 2
Semester 2, 2020
BUACC5936 Financial Management
This assignment carries 25 per-cent of the marks in this unit.
Questions 2,3 and 4 (25 marks) of this assignment MUST be completed on an Excel Spreadsheet.
The following considerations will be applied when evaluating the submission:
1. The use of an Excel (for Windows) worksheet
2.
The setting and presentation.
3. Accuracy of calculations and Analysis.
Question 1 ( 10 marks)
a) Should small or high-growth firms have higher betas than larger and more mature firms? Discuss.
b) Due to the distinctive nature of unsystematic risk, it can be reduced or eliminated through diversification. Do you agree with this statement? Explain.
Question 2 (15 marks)
Sakura PLC
is a leading investment company in Australia and you the below details relating to the capital structure of the company.
Information concerning raising new capital
Bonds
|
$1,000
|
Face value
|
|
13%
|
Coupon Rate (Annual Payments)
|
|
20
|
Term (Years)
|
|
$25
|
Discount offered (required) to sell new bonds
|
|
$10
|
Flotation Cost per bond
|
Preference Shares
|
11%
|
Required rate to sell new preference shares
|
|
$100
|
Face Value
|
|
$3
|
Flotation cost per share
|
Ordinary Shares
|
$83.33
|
Current Market Price
|
|
$4.00
|
Discount on share price to sell new shares
|
|
$5.40
|
Flotation Cost per bond
|
|
$5.00
|
2019 - Proposed Dividend
|
Dividend History
|
$4.63
|
2019
|
|
$4.29
|
2018
|
|
$3.97
|
2017
|
|
$3.68
|
2016
|
|
$3.40
|
2015
|
Current Capital Structure
Extract from Balance
|
|
|
Sheet
|
$1,000,000 Long-Term Debt
|
|
$800,000 Preference Shares
|
|
$2,000,000 Ordinary Shares
|
Current Market Values
|
$2,000,000 Long-Term Debt
|
|
$750,000 Preference Shares
|
|
$4,000,000 Ordinary Shares
|
Tax Rate
|
33%
|
Risk Free Rate
|
5%
|
a)
Calculate the cost associated with each new source of finance. The firm has no retained earnings available.
b) Calculate the WACC given the existing weights
The financial controller does not believe the existing capital structure weights are appropriate to minimise the firm’s cost of capital in the medium term and believes they should be as follows
Long-term debt
|
|
40%
|
Preference Shares
|
|
15%
|
Ordinary Shares
|
|
45%
|
c)
What impact do these new weights have on the WACC?
The firm is considering the following investment opportunity. (2020-2027) Data is as follows
Initial Outlay
|
$1,600,000
|
|
Upgrade
|
$700,000
|
End of Year 4
|
Upgrade -
|
350,000
|
Increased sales units per annum - (Year 5-8)
|
Working Capital
|
$45,000
|
Increase required
|
Estimated Life
|
8
|
Years
|
Salvage Value
|
$60,000
|
|
Depreciation Rate
|
0.125
|
For tax purposes
|
The machine is fully depreciated by the end of its useful life
Other Cash
|
|
|
Expenses Other Cash
|
$60,000.00
|
Per annum (Years 1-4)
|
Expenses
|
$76,000.00
|
Per annum (Years 5-8)
|
Production Costs
|
$0.15
|
Per Unit
|
Sales price
|
$0.75
|
Per Unit (Years 1-4)
|
Sales price
|
$1.02
|
Per Unit (Years 5-8)
|
Prior sales estimates
Year
|
Sales
|
2010
|
520000
|
2011
|
530000
|
2012
|
540000
|
2013
|
560000
|
2014
|
565000
|
2015
|
590000
|
2016
|
600000
|
2017
|
610000
|
2018
|
615559
|
2019
|
659000
|
2020
|
680000
|
d)
Calculate the Net Present Value, Internal Rate of Return and Payback Period
The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 per cent.
Year
|
Stock Market
|
Share
|
|
Index
|
Price
|
2010
|
2000
|
$15.00
|
2011
|
2400
|
$25.00
|
2012
|
2900
|
$33.00
|
2013
|
3500
|
$40.00
|
2014
|
4200
|
$45.00
|
2015
|
5000
|
$55.00
|
2016
|
5900
|
$62.00
|
2017
|
6000
|
$68.00
|
2018
|
6100
|
$74.00
|
2019
|
6200
|
$80.00
|
2020
|
6300
|
$83.33
|
e)
Calculate the CAPM f)
Explain why this figure may differ from that calculated above (i.e. Cost of equity – Ordinary Shares)
Question 3 (5 marks)
Previous Years
|
|
|
|
Sales
|
1400
|
Retained Earnings
|
170
|
Costs
|
900
|
Dividends
|
180
|
Tax rate
|
0.3
|
|
|
Assets
Current Assets
|
|
Liabilities/Equity
Current Liabilities
|
|
Cash
|
460
|
Creditors
|
600
|
Debtors
|
540
|
Short Term Notes
|
100
|
Inventory
|
600
|
|
|
Non-Current Assets
|
|
Non-Current Liabilities
|
|
PP&E Debentures 900
Total Assets
Owner’s Equity
Retained Profits 1000
Ordinary Shares 1000
3600
Percentage of Sales Approach – Assume all spontaneous variables move as a percentage of sales.
a) Given an expected increase in sales of 12%, what is the amount of external funding required?
b) To maintain the current debt/equity ratio how much debt and how much equity is required?
c) Assuming the company is only operating at 95% capacity, how much new funding (if any) is required?
Question 4 (5 marks)
Previous Years
|
|
|
|
Sales
|
1100
|
Retained Earnings
|
80
|
Costs
|
800
|
Dividends
|
130
|
Tax rate
|
0.3
|
|
|
Assets
Current Assets
|
|
Liabilities/Equity
Current Liabilities
|
|
Cash
|
400
|
Creditors
|
|
Debtors
|
|
Short Term Notes
|
|
Inventory
|
|
|
|
Non-Current Assets
|
|
Non-Current
Liabilities
|
|
PP&E Debentures 500
Total Assets
Owners’ Equity
Retained Profits 500
Ordinary Shares
1000
a) Given an expected increase in sales of 13%, what is the amount of external funding required?
b) At this growth rate what is the addition to retained earnings?
c) Calculate the Sustainable Growth Rate (SGR)
d) At the SGR what external funding is required?
e) What would be the growth rate at which no external financing would be required?
Question 5 (15 marks)
The homo economics view of man’s behaviour as applied to the bulk of finance theory portrays decision makers and being both self-interested and rational. Neoclassical economics makes some fundamental assumptions about people:
1. People have rational preferences across possible outcomes or states of nature.
2. People maximize utility and firms maximize profits.
3. People make independent decisions based on all relevant information. In light of the following hypothetical experiments, discuss the above
Experiment 1:
Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a taker in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any part of their $20 to a taker in Room Y. Takers can either choose to keep the amount sent, in which case the amount proposed is final or else reject the amount sent, in which case both individuals receive nothing. That is, you can send any dollar amount from $0 to $20 and the taker can accept this offer, or reject it, in which case you both receive nothing. For example, If the taker accepts and you send $10, you keep $20 - $10.
You are a giver. How much do you give?
Experiment 2:
Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a receiver in Room Y although they will not know the identity of the other. Givers in Room X have been given $20 and can transfer any part of their $20 to a taker in Room Y. The taker cannot reject the amount sent.
You are a giver. How much do you send? For example, If you send $10, you keep $20 - $10.
Experiment 3:
Ten people are in Room X (givers) with a further ten people in Room Y (returnee). Each giver in Room X will be paired with a returnee in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any portion of their $20 to a returnee in Room Y.
Every dollar sent by a giver is tripled on receipt by the returnee. Returnees have the ability to send money back to the givers which would range between $0 and three times the amount received.
You are a giver. How much do you send?