CORPORATE FINANCIAL MANAGEMENT ASSIGNMENT
The assignment contains three parts: A to C. Complete all parts.
Part A -
Q1. You have just received your credit card bill, which has an outstanding balance of $2,248.80. The credit card carries a 24 per cent nominal interest rate, which is compounded monthly.
Required - If you pay $150 each month, how long will it take you to pay off the credit card bill? Assume that the only charge you incur from month to month is the interest that must be paid on the remaining balance outstanding.
Q2. You are considering buying a bond that:
- has a face value of $1,000
- pays coupon interest of six per cent per year
- matures in ten years.
Required - Calculate how much you would pay for this bond if you required a seven per cent yield to maturity.
Q3. Suppose you have just won the lottery and must choose one of the following (guaranteed) payoffs. Which one would you choose? The interest rate is six per cent per annum; ignore tax consequences.
(i) $1,000,000 paid today
(ii) $1,400,000 paid four years from today
(iii) $500,000 paid one year from today and $680,000 paid four years from today
(iv) Ten yearly payments of $140,000, with the first year's payment made today.
Part B -
Three years ago, Kevin and Annette borrowed $150,000, repayable by equal semi-annual installments over 15 years. The nominal interest rate at the time the money was borrowed was eight per cent per annum, calculated six-monthly. Following standard procedures, the lender calculated the semi-annual payments to be $8,674.53. Kevin and Annette have made all repayments on time and the balance owing is now $132,260.56. The general interest rate has been rising and the lender has now decided to increase the interest rate to ten per cent per annum, calculated six-monthly.
Required -
1 (i) Calculate the amount of the new six-monthly repayment if the term of the loan is unchanged.
(ii) If instead, the six-monthly repayment is left at $8,674.53, by how many repayments will the loan term increase?
2. Distinguish between simple interest and compound interest. Provide an example to illustrate your answer.
Part C -
PantherPrint is a small commercial printer of promotional material, brochures and books. The typical job is characterised by high quality promotional material, with production runs of around 5,000 units. It was established in 2013 to service the local business sector, and is located in the suburb of Heidleberg, Victoria. It currently has 30 regular clients.
PantherPrint has operated successfully since it was established and is profitable. However, there is concern that the company is in danger of losing its competitive edge as feedback has been received from some clients about the quality and reliability of their printing service. The existing printing press was purchased three years ago, and was expected to be useful for a total of eight years. However, competitors have recently purchased new presses that are more reliable, and with higher quality definition printing. It is believed that unless PantherPrint responds to the actions of its competitors, the company's profitability and loyal customer base will be eroded.
A consultant was employed to analyse the situation and a report was received from them, proposing that PantherPrint should upgrade its existing printing press with a large six-colour high quality press. The cost of the report was $6,000.
The following are relevant information extracted from the consultant's report.
Recommendation -
Replace the existing XR3500 Printing Press with the XS8600 Colour Press.
Details of the new XS8600 Colour Press
It is believed the new press will introduce cost savings through reductions in labour and electricity costs, while improving reliability and quality of the printing runs.
Cost of the new press - $900,000
Installation costs - $25,000 (these are immediately deductible for tax purposes)
Expected useful life - 5 years
Expected sale value after five years - $50,000
Tax depreciation per year - $164,000 (deduction per year as per tax act)
To finance the purchase of the new press, a loan of $900,000 from the Easi-Finance Company Ltd is available. The loan would be a fully secured interest only loan, with end-of-year interest repayments of $68,000.
The new press is a more efficient machine than the existing press. It is estimated that over the next five years, the net profit before taxes and depreciation of the company will increase to the following:
|
Year
|
Profit before taxes and depreciation
|
|
1
|
660,000
|
|
2
|
685,000
|
|
3
|
710,000
|
|
4
|
735,000
|
|
5
|
750,000
|
The new press requires a change to the working capital requirements of the company as it is a larger and operationally different machine to the existing press. The changes in working capital required are:
- cash on hand would need to increase by $25,000
- accounts receivable would increase by $128,000
- inventories would decline by $18,000
- accounts payable would increase by $120,000.
Details of the existing press and operations
The existing printing press was purchased three years ago and was expected to be useful for a total of eight years. The original cost of the press was $480,000. Estimated sale proceeds before any relevant taxes of the press are:
- if sold today: $110,000
- if sold at the end of its life: $5,000.
The current earnings of the company are:
|
Sales
|
1,675,000
|
|
Less cost of sales
|
905,000
|
|
Gross profit
|
770,000
|
|
Less expenses
|
|
|
Operating expenses
|
350,000
|
|
Depreciation of press
|
60,000
|
|
Profit before tax
|
360,000
|
Other relevant information
- After reviewing the business, you believe that if PantherPrint does not replace the existing press, the above profit before tax should be maintainable for the next five years.
- PantherPrint currently leases out part of its factory to a third party, for $105,000 per annum (this amount is not included in the existing earnings of the company above). The new press is much larger than the existing press. If PantherPrint purchases the new press, they will need to occupy the company's entire factory floor. The current lease can be cancelled immediately without any costs.
- PantherPrint is subject to a 30 per cent corporate tax rate on income.
- PantherPrint's required rate of return is 15 per cent.
Required - Write a brief report to the board of directors of PantherPrint, recommending if the company should purchase the new press. Your report should include justification of your decision by reference to capital budgeting techniques. (Suggested word limit for report is 1,500 to 1,800 words.)