Reference no: EM132370870

ASSIGNMENT

Question 1

a) Calculate the cost associated with each new source of finance. The firm has no retained earnings available.

b) Calculate the WACC given the existing weights

The financial controller does not believe the existing capital structure weights are appropriate to minimise the firm’s cost of capital in the medium term and believes they should be as follows

Long-term debt                       40%

Preference Shares                    15%

Ordinary Shares                      45%

c) What impact do these new weights have on the WACC?

The firm is considering the following investment opportunity. (2019-2026)
Data is as follows

d) Calculate the Net Present Value, Internal Rate of Return and Payback Period

The financial controller is considering the use of the Capital Asset Pricing Model as a surrogate discount factor. The risk-free rate is 5 per cent.

e) Calculate the CAPM

f) Explain why this figure may differ from that calculated above (i.e. Cost of equity – Ordinary Shares)

Question 2

Percentage of Sales Approach – Assume all spontaneous variables move as a percentage of sales.

a) Given an expected increase in sales of 12%, what is the amount of external funding required?

b) To maintain the current debt/equity ratio how much debt and how much equity is required?

c) Assuming the company is only operating at 95% capacity, how much new funding (if any) is required?

Question No 3

a) Given an expected increase in sales of 13%, what is the amount of external funding required?

b) At this growth rate what is the addition to retained earnings?

c) Calculate the Sustainable Growth Rate (SGR)

d) At the SGR what external funding is required?

e) What would be the growth rate at which no external financing would be required?

Question 4.

The homo economicus view of man’s behaviour as applied to the bulk of finance theory portrays decision makers and being both self-interested and rational. Neoclassical economics makes some fundamental assumptions about people:

1. People have rational preferences across possible outcomes or states of nature.

2. People maximize utility and firms maximize profits.

3. People make independent decisions based on all relevant information.

In light of the following hypothetical experiments, discuss the above

Experiment 1:

Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a taker in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any part of their $20 to a taker in Room Y. Takers can either choose to keep the amount sent, in which case the amount proposed is final or else reject the amount sent, in which case both individuals receive nothing. That is, you can send any dollar amount from $0 to $20 and the taker can accept this offer, or reject it, in which case you both receive nothing. For example, If the taker accepts and you send $10, you keep $20 - $10.
You are a giver. How much do you give?

Experiment 2:

Ten people are in Room X (givers) with a further ten people in Room Y (takers). Each giver in Room X will be paired with a receiver in Room Y although they will not know the identity of the other. Givers in Room X have been given $20 and can transfer any part of their $20 to a taker in Room Y. The taker cannot reject the amount sent.
You are a giver. How much do you send? For example, If you send $10, you keep $20 - $10.

Experiment 3:

Ten people are in Room X (givers) with a further ten people in Room Y (returnee). Each giver in Room X will be paired with a returnee in Room Y although they will not know the identity of the other. Givers have been given $20 and can transfer any portion of their $20 to a returnee in Room Y.

Every dollar sent by a giver is tripled on receipt by the returnee. Returnees have the ability to send money back to the givers which would range between $0 and three times the amount received.

You are a giver. How much do you send?