Assignment Task 1: Able Business Company:
The partial balance sheet for the Able Business Company (ABC) for 2018 along with other financial information is presented below.
1. During 2018, the earnings available to common shareholders were $850,000.
2. Average dividend on preferred shares is 10 percent with 20,000 preferred shares outstanding.
3. ABC paid common share dividends of $1.25 per share in 2018. (250,000 shares)
4. The cost of new issue of long-term debt would be 12 percent.
5. The cost of reinvested profit (retained earnings) is 16 percent.
6. The cost of new issue of preferred share for ABC would be 10 percent.
7. ABC has a tax rate of 40 percent.
8. In 2019, the reinvested profits are expected to increase by 20 percent.
9. ABC plans to invest $5 million in assets during the 2019 fiscal year.
Portion of Balance sheet December 31, 2018
Long-term debt $1,400,000
Preferred Equity (20,000 shares) 350,000
Common Shares (250,000) 350,000
Retained Earnings 1,400,000
Total $3,500,000
Required:
Q1. ABC's net income after tax, and their reinvested profits in 2018.
Q2. Calculate the reinvested profit ABC expected to generate in 2019.
Q3. Determine the overall cost of capital ABC should use to evaluate the planned acquisition of $5 million in 2019.
Assignment Task 2: Centennial Catering Services
Centennial Catering Services (CCS) is considering two mutually exclusive investments. The company wishes to use two different evaluation methods for the two projects for a 4-year period as follows:
1. Certainty Equivalent (CE)
2. Risk-adjusted discount rate (RADR).
The cost of capital for CCS is 12% and current risk-free rate is 7%. Cash flows for the projects are as follows:
|
|
Project A
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Project B
|
|
Investment costs
|
$70,000
|
$80,000
|
|
Year
|
Cash flows
|
|
1
|
30,000
|
22,000
|
|
2
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30,000
|
32,000
|
|
3
|
30,000
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38,000
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|
4
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30,000
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46,000
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Required:
Q1. Use CE approach to calculate the Net Present Value of both projects:
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Project A
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Project B
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|
Year 1
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0.85
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0.95
|
|
Year 2
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0.9
|
0.9
|
|
Year 3
|
0.95
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0.85
|
|
Year 4
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0.95
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0.8
|
Q2. Use RADR approach to evaluate the Net Present Value of the two projects. Use the following equation, based on Capital Asset Prici9ng Model, to calculate the Risk Adjusted Discount Rate (RADR)
RADR = Risk-free rate + [Risk Facto rβ x (Cost of Capital - Risk-free Rate)]
The risk Factor 1 for Project A is 1.20 and for Project B, β is 1.40.
Q3. Briefly comment on the effect of the two methods. What else would you analyze before your selection. Which project would you choose? Justify your choice.
Assignment Task 3: Mantel Products Limited
Mantel Products Limited (MPL) sells complementary products at an average price of $7.50 per unit. The firm is planning to produce 100,000 units of items it produces. The financial manager for MPL has compiled the following information for producing 100,000 units in 2020: (All figures are in $1,000).
Management Salaries $100
Factory Direct Labour 200
Direct Materials 200
Factory Overhead - Variable 50
Amortization 180
Marketing expenses (All Fixed) 50
Rent (Fixed) 100
Maintenance (50% fixed, 50% variable) 40
Total $920
Required:
Q1. Calculate the total fixed costs and variable cost per unit.
For all the remaining questions, assume that fixed costs remain fixed at all levels of production. Determine the break-even volume.
Q2. What is MPL's EBIT at a production volume of 100,000 units?
Q3. Calculate MPL's breakeven in units and total dollar sales.
Q4. Calculate the selling price MPL must charge just to break even at a production volume of 100,000 units.
Q5. Assume the fixed and variable costs will be same (as above) for 2020. For a production volume of 100,000, calculate:
- the Degree of Operating Leverage (DOL),
- the Degree of Financial Leverage (DFL) and
- the Degree of Total Leverage (DTL) for the firm.
Assignment Task 4: Hamilton Sports Limited
Hamilton Sports Limited (HSL), a supplier of high-end fitness equipment, has some investment opportunities. HSL has the following information to consider:
It can spend up to $2,000,000 in new investment opportunities as presented below:
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Investment Opportunity Schedules
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Opportunity to Invest
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Expected Return
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Costs
|
|
Project A
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15%
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$300,000
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Project B
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13%
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500,000
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Project C
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12%
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500,000
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Project D
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11%
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600,000
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Project E
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14%
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700,000
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The preferred capital structure for HSL is: Debt @ 50%; Preferred @ 10% and Equity @ 40%. The financial manager has also determined that HSL has $120,000 available in reinvested profit and they can borrow $250,000 debt without incurring additional financing costs. The cost of debt, preferred shares and equity are currently at 6%, 10% and 18% net of taxes respectively.
The range of new financing costs beyond break points is as follows:
First break point: Debt 8%; Preferred 10% (no change) and Equity 18%.
Second Break point: Debt 10%; Preferred 10% (no change); Equity 20%.
Required:
Q1. Compute the Weighted Average Cost of Capital (WACC) and complete the Marginal Cost of Capital (MCC) for the various range of financing.
Q2. Draw the firm's marginal cost of capital (MCC) and the Investment Opportunity Schedule (lOS).
Q3. Which of the projects they should be selecting? Why?
Q4. Calculate the overall cost of capital for HSL.
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