Question 1 (50marks)
Maple plc is financed by a mixture of ordinary share and loan capital. The following information is available concerning the business for the year
to 30 November Year 200X:
Mapleplc
Profit for the year £2.0m
Gross dividends £1m
Market value per ordinary share £4.00
Number or ordinary shares 5m
Gross interest yield on loan capital 8%
Market value of loan capital £10m
The annual growth rate in dividends is 2% for Maple plc. Assume a 25% tax rate. The book value and the market value of the loan capital are the
same.
Required:
Calculate the weighted average cost of capital (WACC) for Maple plc. (20 marks)
Using your results from (a) where appropriate, explain what is meant by the term ‘weighted average cost of capital’. (10 marks)
Assess the arguments for and against whether a company should use their weighted average cost of capital as the discount rate when
assessing the acceptability of a new project?(10 marks)
Marpleplc wishes to pursue a large scale expansion programme. Critically discuss the major factors that should be taken into account when
deciding on the appropriate mix of long term and short term borrowing necessary to finance an expansion programme. (10 marks)
Total 50 marks
End of Question 1
Question 2 (50marks)
Oak Ltd operates a marketing agency. It has annual turnover of £20 million before taking into account bad debts of £0.1 million. All sales are on
credit and, on average; the settlement period for trade debtors is 70 days. The company is currently reviewing its credit policies. To encourage
prompt payment the credit control department has proposed that customers should be given a 1% discount if they pay within 30 days. For those who
do not pay within this period a maximum of 50 days’ credit should be given.
The credit department believes that 40 per cent of customers will take advantage of the discount by paying at the end of the discount period and
the remainder will pay at the end of 50 days. The credit department believes that bad debts can be eliminated by adopting the above policies and
by employing stricter credit investigation procedures which will cost an additional £10,000 per year. The credit department is confident that
these new policies will not result in any reduction in sales. The business uses an overdraft facility to fund its credit sales, on which it pays
annual interest of 10%.
Required:
Explain the meaning of the term ‘working capital’. (5 marks)
Calculate the net annual cost or benefit to the company of abandoning its existing credit policy and adopting the proposal of the credit
control department.(18 marks)
Which credit policy would you recommend and why?(2marks)
The Board of Oak Ltd has found out that a competitor company, AshPlc, is experiencing liquidity problems due to overtrading.Here is some further
information about Ash Plc:
EXTRACT FROM BALANCE SHEET Ash plc
£000
Inventories 1,500
Trade receivables 600
Trade payables (100)
EXTRACTS FROM INCOME STATEMENT
Sales 15,000
Cost of sales 12,000
Purchases of goods for resale 10,000
Explain the term ‘overtrading’ and state how overtrading might occur.(5 marks)
Discuss the kinds of problems that overtrading can create for a business. (10 marks)
Calculate the cash conversion cycle for Oak Ltd. (4 marks)
State the ways in which Oak Ltd business may overcome the problem of overtrading.(6 marks)
Total 50 marks
End of Question 2
Question 3 (50marks)
Part A. The capital structure debate has two major schools of thought.
Required: Critically discuss the “traditionalist” and “modernist” views on capital structure. (10 marks)
Part B.ThefollowingsummarisedbalancesheetinformationisavailablefortwoUKcompanies,which operate in the same sector, with the same total capital
employed:
EXTRACT FROM BALANCE SHEET Roseplc£000 Acerplc£000
Non-current assets 3,200 3,200
Current assets less current liabilities 400 400
Total net assets 3,600 3,600
LESS: Creditors due after oneyear-10%debentures (1,600) (800)
2,000 2,800
Financed by
Ordinary Shares 200 2,800
12%preferenceshares 1,800 0
2,000 2,800
Nointerest was receivablebyeither ofthe companies, andthe profitbeforeinterest and tax (PBIT)forboth companies was £200,000.
Part BRequired:
Calculate thegearing forbothcompanies. (4 marks)
Calculate the interest cover for both companies. (4 marks)
Evaluateona comparative basis the current financing ofbothcompanies as faras the informationavailable allows. (12marks)
Part C. Acer plc has provided you with the following additional information about its inventory. Acerplc uses 20,000 units per year of a
particular item of inventory. It costs £28 for each order placed with the supplier and the annual cost of holding each of the units is £1.20. The
lead time on orders is two weeks. Demand for the inventory is steady throughout the year. The business maintains a buffer inventory of 100 units.
Part C Required:
Calculate the reorder point for Acer plc.(4 marks)
Calculate economic order quantity (EOQ) and the total annual cost of managing inventories for this business assuming costs are minimised.
(10 marks)
Part D. Vasililisplc’s (another company in the sector) cost of ordinary shares (15%) was estimated using the dividend growth model. A dividend has
just been paid (5 pence) and the share price of 61 pence is based on the assumption that this will increase at a fixed rate each year in the
future.
Required: What growth rate has been assumed for the business’s ordinary share dividend?(6 marks)
Total 50 marks
End of Question 3
FORMULA SHEET
COST OF CAPITAL
Description Formula
For Ordinary Shares
Where:
K0 = Cost of ordinary shares to the business
D1 = Annual dividend per share in year 1
g = Growth rate of dividends
Po = Current market value of the share
K_0=D_1/P_0 +g
For Preference Shares
Where:
Kp = Cost of preference shares to the business
Dp = Annual Dividend Payment
Pp = Current Market Price of the preference shares
K_p=D_p/P_p
Irredeemable Loan Capital
Where:
Kd = Cost of Loan Capital to the Business
I = Annual Rate of Interest on the Loan Capital
t = Rate of Corporation Tax
Pd = Current Market Value of the Loan Capital
K_d=I(1-t)/P_d
GEARING
Gearing ratio (%) =
( Preference shares & Long term (non current) loans)/( Share capital + reserves+ long term (non current) loans )x 100%
Degree of financial gearing = ( % change in EPS)/( % change in PBIT )
Where:
EPS = earnings per share
PBIT = profit before interest and tax
INTEREST COVER
Interest cover ratio =
( PBIT+interest receivable)/( Total interest payable )
Where:
PBIT = Profit Before Interest and Tax
WORKING CAPITAL MANAGEMENT
Economic Order Quantity =
EOQ = √(2DC/H)
Total annual cost of managing inventory = DC + EOQ*H
EOQ 2
Where:
EOQ= Economic Order Quantity
D=the annual demand for the inventories items
C= the cost of placing an order
H=the cost of holding one unit of inventory item for one year
Cash or Operating Conversion Cycle (CCC or OCC) =
Inventory days + Accounts Receivable Days– Accounts Payable Days
Where:
Inventory days = Inventories/Cost Of Goods Sold (COGS) x 365
Accounts (Trade) receivable days = Trade receivables/turnover x 365
Accounts (Trade) payable days = Trade payables/purchases x 365
Place this order with us and get 18% discount now! to earn your discount enter this code: special18 If you need assistance chat with us now by clicking the live chat button.