09 May CALCULATE THE DEBT EQUITY AND NUMBER OF SHARES UNDER EACH OF THE CAPITALSTRUCTURES UNDER CONSIDERATION.
QUESTION 1 [25 marks]Xelo Ltd whose current sales consist of fixed operating costs of R140 000 andvariable operating costs equal to 22% of sales has made the following two salesestimates with their noted probabilities.Sales ProbabilitiesR450 000 0.35R710 000 0.65Xelo Ltd is currently 100% equity financed with a total market value of R450 000 consisting of ordinary shares trading at R5 each. Xelo Ltd pays all its net income asdividends and is in a 15% tax bracket. The firm is considering using one of thefollowing capital structures:Debt ratio Before-tax cost of debt (kd) Required30% 4% 17E% 7% 20%REQUIRED(a) Calculate the debt equity and number of shares under each of the capitalstructures under consideration. [5](b) Calculate expected earnings per share (E/EPS) for the proposed capitalstructures. [7](c) Use the valuation model to estimate share value of both capital structures. [4](d) Based on the long-term and short-term goals of financial management whichcapital structure would you recommend? [4](e) Based on the long-term goal at what overall capitalisation rate would youcapitalise the company and why? [5]FIN4801 20162QUESTION 2 [25marks]ABC Ltd is attempting to project its financial requirements for the next 10-yearperiod. The company is a relative newcomer to the industry having been in thebusiness for only three years. Initially the company was totally unknown and foundfinancing particularly of a permanent nature quite difficult to obtain. As a result thecompany was literally forced to structure its sources of financing as follows:Trade credit payable R200 000Short-term borrowing R240 000Ordinary shares R440 000R880 000In the three years the company has been very successful increasing its totalcapitalisation by R120 000 as a result of retained earnings. It is now in a positionwhere it could obtain a long-term loan for ten years from a financing house at a rateof 10% in place of all or any of its present short-term borrowings. Alternatively itcould renew its existing R240 000 or any part thereof with a one year loan from thebank at a rate of 8%. The company has a tax rate of 32%.The company’s financial director is considering three possible financing plans:1. Renew the one-year loan with the bank2. Borrow R240 000 from a financing house3. Borrow R120 000 from each of the 2 above alternativesThe financial director has estimated short-term riskless rates the premiums that thecompany may have to pay over the riskless rate for the three possible states of theeconomy and the probability of each. The average rates that the company would belikely to pay over the next ten years on its short-term borrowings are as follows:State of theeconomy EBIT (R) Risk less rate(%) Premium (%) Joint ProbabilityGood 300 000 3 2 0.125Good 300 000 5 2 0.125Average 160 000 5 4 0.250Average 160 000 7 4 0.250Bad 20 000 7 10 0.125Bad 20 000 9 10 0.125REQUIRED:(a) Calculate the expected value of the short-term interest rate. [5](b) Calculate expected profit under each of the financial manager’s threeproposed financing plans (Ignore possible growth effects and assume anexpected EBIT of R160 000 under each plan.) [6](c) Determine the worst and best after-tax profit outcome which would result fromeach of the financing plans. Briefly interpret the results and recommend afinancing plan for the company. Where applicable use tabular formats topresent your findings. [14]ASSIGNMENT 02 QUESTION 1 [25 marks]Use the statement of financial position and statement of comprehensive income forAmolatina Ltd to answer the questions that follow. Assume all sales are on credit and365 days for 2015.STATEMENT OF FINANCIAL POSITION FOR AMOLATINA LTD AS AT31 DECEMBER 2015Assets (R) Equity andliabilities(R)Cash 24 000 000 Accounts payable 15 000 000Marketable securities 14 000 000 Notes payable 21 000 000Accounts receivables 26 000 000 Other current liabilities 10 000 000Inventories 81 000 000Total current assets 145 000 000 Total current liabilities 46 000 000Non-current assets 115 000 000 Long-term debt 25 000 000Less depreciation 9 000 000 Total liabilities 71 000 000Net non-current assets 106 000 000 Ordinary shares 80 000 000Retained earnings 100 000 000Total shareholders’ equity 180 000 000Total assets 251 000 000 Total liabilities and equity 251 000 000STATEMENT OF COMPREHENSIVE INCOME FOR AMOLATINA LTD FOR YEARENDED 31 DECEMBER 2015Net sales 410 000 000Cost of goods sold 150 000 000Gross profit 260 000 000Selling expenses 24 000 000Depreciation expense 5 000 000EBIT 231 000 000Interest expense 11 000 000Net income before tax 220 000 000Taxes (30%) 66 000 000Net income 154 000 000FIN4801 20164INDUSTRY AVERAGE RATIOSCurrent ratio 3:1 Sales/fixed assets 4 timesDebt/total assets 25% Sales/total assets 5 timesTimes interest earned 5 times Net profit margin 6%Sales/Inventory 8 times Return on assets 11?ys’ sale outstanding 20 days Return on equity 13.5%REQUIRED(a) Calculate the Du Pont equation for Amolatina Ltd. [4](b) Compare the Du Pont equation calculated in (a) with the composite equation forthe whole industry. [6](c) Briefly comment on a comparison between the Amolatina Ltd and industry withspecific regard to liquidity solvency and asset management. [5]1.2 Study BRIDS Ltd’s statement of financial position and statement ofcomprehensive income are given below:Statement of financial position for BRIDS Ltd as at 31 December2015R RCash 75 000 Accounts payable 160 000Accounts receivable 110 000 Notes payable 140 000Inventory 450 000Total current assets 635 000 Total current liabilities 300 000Net Non-Current assets 465 000 Long-term (12%) 350 000Ordinary shares equity (45000 shares)450 000Total assets 1 100 000 Total liabilities & equity 1 100 000Statement of comprehensive Income for BRIDS Ltd for the yearended 31 December 2015Sales 800 000Cost of goods sold 310 000Earnings before interest and tax (EBIT) 490 000Interest expense 65 000Earnings before tax (EBT) 425 000Taxes (10%) 42 500Net income 382 500The industry average inventory turnover is 8 and the interest rate on the firm’s longtermdebt is 12%. 45 000 shares are outstanding. BRIDS Ltd plans to change itsinventory methods so as to operate at the industry average inventory turnover ratio.The funds generated from this change will be used to retire long-term debt and it isassumed that the company’s sales the cost of goods sold and the share price willremain constant. Assume that inventory turnover is given as a ratio of sales toinventory.REQUIREDDetermine the percentage change in the BRIDS’s return on equity (ROE) once thesechanges are effected. [10]QUESTION 2 [25 marks]Xola Ltd is evaluating the feasibility of introducing a new product. They would haveto investR300 000 at time t = 0 for the design and testing of the new product. Managementbelieves that there is a probability of 80% that this phase will be successful and thatthe project will continue. If stage 1 is not successful the project will have to beabandoned with zero salvage value.The next stage if undertaken would consist of making moulds and producing twoprototypes. This would cost R2 500 000 at time t = 1. Production will commence ifthe tests are successful. The moulds and prototypes could be sold for R765 000 ifthe product fails the testing phase. Management estimates the probability of theproduct passing the testing phase as 90% and that phase 3 will then be undertaken.Phase 3 consists of converting the unused production line to produce the newdesign. This would cost R3 500 000. If the economy is strong at this point the valueof sales of the final product would be R16 000 000. If the economy is weak the salesvalue of the final product would be R2 500 000. Both sales values occur at time t = 3 and each state of the economy has a probability of 0.5. The required return of XolaLtd is 8%. The firm only accepts investments if the coefficient of variation of theproposed project is less than 5.REQUIRED(a) Use a decision tree to determine the project’s expected net present value(NPV). [10](b) Calculate the project’s variance and standard deviation of the NPV. [7](c) Calculate the project’s coefficient of variation (CV) of the NPV . [4](d) Should the project be accepted or rejected? Substantiate your answer [4]ASSIGNMENT 03: SELF-EVALUATION ASSIGNMENT [45 marks]Please note that this is a self-marking assignment; it should therefore not besubmitted to the university for marking. After you have attempted the assignment check your answers against the suggested solutions in Tutorial Letter 202. You willneed to have a general overview of all the prescribed chapters in your textbook tocomplete this assignment successfully.QUESTION 1 [10marks]Suppose you manage a R4 million portfolio that consists of four stocks with thefollowing investments.Stock Investment (R) BetaA 400 0000 1.5B 600 000 -0.5C 1 000 000 1.25D 2 000 000 0.75RequiredIf the market’s required rate of return is 14% and the risk free rate is 6% what is theportfolio’s required rate of return? [10]QUESTION 2 [5 marks]Assume asset A has an expected return of 10 per cent and a standard deviation of20 per cent. Asset B has an expected return of 16 per cent and a standard deviationof 40 per cent.RequiredIf the correlation between A and B is 0.35 what is the expected return and standarddeviation for a portfolio comprised of 30 per cent asset A and 70 per cent asset B? [5] FIN4801 20167QUESTION 3 [8 marks]The earnings dividends and stock price of FML Ltd are expected to grow at 7% peryear in the future. FML Ltd’s common stock sells for R23 per share its last dividendwas R2 per share and the company will pay a dividend of R2.14 per share at the endof the current year.Required(a) Calculate FML Ltd’s cost of equity using the discounted cash flow approach.[5](b) What would be the firm’s cost of equity based on the CAPM approach if thefirm’s beta is 1.6 risk free rate is 9% and the expected return on the market is13%? [3]QUESTION 4 [7 marks]Kay Ltd’s current earnings per share (EPS) is R6.50. Five years ago EPS wasR4.42. The company pays out 40% of its earnings as dividends and the stock sellsfor R36.Required(a) Calculate the historical growth rate in earnings. (Hint: This is a 5-year growthperiod). [3](b) Calculate the next expected dividend per share D1. [Hint: D0 = 0.4(R6.50) =R2.60]. Assume that the past growth rate will continue. [2](c) What is Kay Ltd’s cost of equity? [2]QUESTION 5 [15marks]Dube Scientific Products produces satellite earth stations which sell for R100 000each. The firm’s fixed costs F are R2 million. Fifty earth stations are produced andsold each year while profits total R500 000 and the firm’s assets (all equity financed)are R5 million. The firm estimates that it can change its production process addingR4 million to investment and R500 000 to fixed operating costs.This change will• reduce variable costs per unit by R10 000 and • increase output by 20 units but • the sales price on all units will have to be lowered to R95 000 to permit sales ofthe additional output.The firm has a tax loss carried forward meaning that its taxes are zero. Its cost ofequity is 15 per cent and it uses no debt.RequiredEvaluate whether this firm should make this change. [15]
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