COURSE TITLE: DIPLOMA IN BUSINESS ADMINISTRATION
- (ACCOUNTING & FINANCE)
- (BANKING & FINANCE)
MODULE TITLE: FINANCIAL MANAGEMENT
EXAM DATE: 27 JUNE 2017
ANSWER ALL QUESTIONS (25 MARKS EACH)
Write your answers in the answer booklet provided, starting your answer to each question on a new page. Number your answers according to the question number, and also enter these numbers on the frontpage of the answer booklet.
1. Castall Inc. purchased a machine 2 years ago for $80 000. When it was
purchased, the machine had an expected useful life of 5 years, and an estimated scrap value of $10 000 at the end ofits useful life. The machine is depreciated using a straight line method, and can currently be sold for $35 000. The finance manager is considering the feasibility of buying a new machine with an operational life of 4 years. The forecasted cash flows arising from this new machine is given as follows
• Initial cost outlay of $100 000, with a further $10 000 to install it.
• Sales will be expanded from the $40 000 to $45 000 per year.
• Annual operating costs will be reduced from $12 000 to $8 000.
• A positive change in net working capital of $12 000.
• Zero scrap value at end of operational life.
Castall Inc has a cost of capital of 10%.
a) Calculate the Net Present Value (NPV) if Castall Inc continues to operate the old machine. (9 marks)
b) Calculate the initial investment associated with the acquisition of the new machine. (4 marks)
c) Using your result in part (b), calculate the Net Present Value (NPV) if
Castall Inc purchase the new machine now. (10marks)
d) Should Castall Inc continue to operate the old machine or purchase the new machine now? Why? (2 marks)
2. a) Duffet Corporation has a $1 000 par value bond with a 6.5% coupon rate.
The bond matures in 20 years. Suppose coupons are paid annually.
The required return is 9%. Compute the value of the bond. (6 marks)
b) BuzzMart Inc. issued a 30-year, 7 % coupon interest rate, $1 000 par value bond that pays interest semi-annually. The required return is currently 6%. Compute the value of the bond. (6 marks)
c) Tsuz Industries has paid a dividend of $3.50 per share for the past year (D0 = $3.50). The Chief Finance Officer expects the dividend to grow at a rate of 5% per annum for the foreseeable future. Assume investors require a rate of return of 12%.
(i) Calculate the current price of the stock. (2 marks)
(ii) If the stock currently trades at $53, would you buy it? (1 mark)
d) Rainbow Airways is in the 40% tax bracket. Information on the company’s debt, preferred stock and common stock are as follows:
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Debt
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The company can issue bonds at a yield to maturity of 8.25%.
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Preferred Stock
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The company can sell 9% preferred stock at its $55 per share par-value. Floatation costs are $5 per share.
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Common Stock
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Price per share is currently $50. Dividends are
projected at $4 per share next year with a dividend growth rate of 5%. There are no floatation costs.
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(i) Calculate the cost of debt. (2 marks)
(ii) Calculate the cost of preferred stock. (2 marks)
(iii) Calculate the cost of common stock. (2 marks)
(iv) Rainbow Airways’ capital structure is 20% debt, 40% preferred stock and 40% common stock. Calculate the weighted average cost of capital (WACC). (4 marks)
3. Hyclo Ltd is an underwater ship hull cleaning company. The management is concerned about the firm’s management of working capital.
a) The average collection period and average payment period are 41.5 days
and 35.8 days respectively. The firm turns over its inventory 18 times each year (assume 360 days year), and the firm currently has annual sales of $38.5 million.
(i) Calculate the firm’s operating cycle and cash conversion cycle, correct to 1 decimal place. (5 marks)
(ii) Determine the amount of resources needed to support the firm’s cash conversion cycle. (4 marks)
b) Hyclo Ltd purchases 86 000 units per year of a chemical used in the
underwater cleaning of ship hull. The cost per order is $51, while the carry cost is $15 per unit per year.
(i) Calculate the economic order quantity. (4 marks)
(ii) Using your answer in (i), calculate the ordering cost, carrying cost and total inventory cost. (8 marks)
c) Suppose Hyclo Ltd operates a 250 days per year, and maintains a minimum inventory level of 500 units of safety stock. If the lead time to receive orders ofthe component is 5 days, calculate the reorder point. (4 marks)
4. a) State the FIVE steps in planning personal financial affairs. (10 marks)
b) List any THREE financial plans, and identify the goal associated with each financial plan. (6 marks)
c) The following is an extract of Betty Soh’s financial position as at 31 December 2015.
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Asset ($)
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Liabilities and Net Worth ($)
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Liquid Assets
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33 000
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Total Liabilities
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357 000
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Other Assets
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745 000
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Net Worth
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421 000
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Total Assets
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778 000
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Total Liabilities and Net Worth
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778 000
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Betty’s Total Liabilities include a $288 000 housing loan and a $53 500 car loan. His total income for the year 2015 was $76 000.
Calculate the following financial ratios for Betty, correct to 2 decimal places.
(i) Solvency ratio
(ii) Liquidity ratio
(iii) Gearing ratio (9 marks)