QUESTION ONE a. The current sales of Pioneer Limited are $100 million. The company classifies its customers into 4 credit categories, 1 to 4. Credit rating diminishes as one goes from category 1 to 4. Pioneer presently extends unlimited credit to customers in category 1 and 2, limited credit to customers in category 3, and no credit to customers in category 4. As a result of this credit policy, the company is foregoing sales to the extent of $10 million to customers in category 4. The firm is considering the adoption of a liberal policy under which customers in category 3 would be extended unlimited credit and customers in category 4 would be extended limited credit. Such relaxation would increase the sales by $15 million on which bad debt losses would be 10%. The contribution margin ratio, (1-V) for the firm is 20%, average collection period, ACP, is 40 days, and the post-tax cost of funds, k, is 10% The tax rate is 40%. Required: Advise whether the company should change its credit standards. [NB Use formula : ∆RI = [∆S(1-V) - ∆Sbn] (1-t) – k∆I where ∆I = ∆S/360 x ACP x V]
(10 marks) b. (i) The following data relate to a local manufacturing company: U = annual sales = 20 000 units F = fixed costs = $2 000 P = purchase price per unit = $12 C = carrying cost = 25% of inventory value Required: Calculate the economic order quantity. (5 marks) (ii) Identify and explain any five factors that may influence the level of stock holding in a firm. (10 Marks)
QUESTION TWO a. Vasivenyu Engineering currently has a target debt-equity ratio of 4:5. It is evaluating a proposal to expand capacity which is expected to cost $4,5 million and generate after-tax cash flows of $1 million per year for the next 10 years. The tax rate for the company is 25%. Two financing options are being looked at: Issue of equity stock.. The required return on the company’s new equity is 18%, The issuance cost will be 10%. Issue of debentures carrying a yield of 12%. The issuance cost will be 2%.
Required Compute the NPV of the expansion project. (10 marks)
2 b. Highlight and briefly explain any five factors which may affect the weighted average cost of capital (WACC) of a firm. (10 marks)
c. Briefly describe any five misconceptions surrounding the cost of capital.
( 5 marks)
QUESTION THREE The expected cash flows of a project are as follows; Year Cash Flow 0 -$100 000 1 20 000 2 30 000 3 40 000 4 50 000 5 30 000 He cost of capital is 12%. Required: Calculate the following: (a) Net present value (b) Benefit-cost ratio (c) Internal rate of return (d) Modified internal rate of return (e) Payback period (f) Discounted payback period [25 marks] QUESTION FOUR a. Consider an 8-year, 12 percent coupon bond with a par value of $100 on which interest is payable semi-annually. The required return on this bond is 14. What is the value of the bond? b. Consider a $1 000 par value bond, carrying a coupon rate of 9%, maturing after 8 years. The bond is currently selling for $800. What is the YTM on this bond? c. Consider an 8 year, 10% preference stock with a par value of $1 000. The required return is 9%. What is the value of the preference stock? d. Cornet's equity share is expected to provide a dividend of $2,00 and fetch a price of $18,00 a year hence. What price would it sell for now if the investor’s required rate of return is 12%? e. The expected dividend of Econet share is $2,00. The dividend per share of Econet has grown over the past five years at the rate of 5% per year. The growth rate will continue in future. Further the market price of the share, too, is expected to grow at the same rate. What is the fair estimate of the intrinsic value of the Econet share if the required rate of return is 15%? f. The expected dividend per share of Edgars is $5,00. The dividend is expected to grow at the rate of 6% per year. If the price per share now is $50,00, what is the expected rate of return?
3 g. The current dividend on an equity share of International Computers Ltd is $3,00. The present growth rate is 50%. However, this will decline linearly over a period of 10 years and then stabilise at 12%. What is the intrinsic value per share of International Computers Limited, if the investors require a return of 16%?
