ANSWER ALL QUESTIONS
- Hard Wood Manufacturing Ltd constructs a range of solid wooden garden furniture and sheds for a range of wholesalers and private customers across Scotland. Regardless of the type of customer, all sales that Hard Wood Manufacturing Ltd makes are on credit. Their most recent financial statements for the year ended 31 December 2017 are as follows: –
| Statement of Profit or Loss for the year ended 31 December 2017 | |||||
| £ | £ | ||||
| Revenue | 904,000 | ||||
| Less Costs of Sales: | |||||
| Opening Stock | 187,500 | ||||
| Purchases | 511,500 | ||||
| Closing Stock | 224,500 | (474,500) | |||
| Gross Profit | 429,500 | ||||
| Taxation & Other Expenses | (198,000) | ||||
| Net Profit | 231,500 | ||||
| Statement of Financial Position as at 31 December 2017 | |||||
| £ | |||||
| Non-Current Assets | |||||
| Land & Buildings | 420,000 | ||||
| Fixtures & Fittings | 75,000 | ||||
| Vehicles | 156,000 | ||||
| 651,000 | |||||
| Current Assets | |||||
| Trade Receivables | 234,500 | ||||
| Stock | 224,500 | ||||
| Cash | 45,000 | ||||
| 504,000 | |||||
| _______ | |||||
| Total Assets | 1,155,000 | ||||
| Equity & Liabilities | |||||
| Equity | |||||
| Ordinary Share Capital | 140,000 | ||||
| Retained Profit | 230,000 | ||||
| 370,000 | |||||
| Non-Current Liabilities | |||||
| Bank Loan | 600,000 | ||||
| Current Liabilities | |||||
| Trade Payables | 65,000 | ||||
| Bank Overdraft | 120,000 | ||||
| 185,000 | |||||
| ______ | |||||
| Total Liabilities | 785,000 | ||||
| Total Equity & Liabilities | 1,155,000 | ||||
Required:
(a) Assuming a 360-day year, calculate the cash operating cycle for Hard Wood Manufacturing Ltd for the year ending 31 December 2017.
(5)
(b) The directors at Hard Wood Manufacturing Ltd are concerned about the length of time it is taking to receive payment from their trade debtors. They are considering offering a 1% discount to all customers who pay within 20 days. Assuming that they use their bank overdraft as finance until receivables are paid, at an overdraft interest rate of 10%, calculate whether the discount is worth offering on the assumption that half of the debtors will take up the offer and pay within 20 days.
(6)
(c) The directors at Hard Wood Manufacturing Ltd are also considering factoring their trade debtors. Explain what is meant by factoring in this context and critically discuss the advantages and disadvantages of Hard Wood Manufacturing Ltd factoring their trade debtors.
(14)
(25)
- Globo Tech Plc is evaluating the purchase of a new machine to produce their latest product, Mobile Fitness. Mobile Fitness (M&F) is a new state of the art watch which has a dual purpose of being a fitness tracker. Due to rapidly changing technology the M&F watch is expected to have a short product life-cycle. The machine required to produce M&F is expected to cost £3.8 million. Production and sales of M&F forecast to be as follows:
| Year | 1 | 2 | 3 | 4 |
|
Production and Sales(units/year) |
70,000 |
106,000 |
150,000 |
72,000 |
The selling price of M&F will be £40 per unit, while the variable cost of the product will be £24 per unit. No increase in existing fixed costs is expected since Globo Tech Plc has spare capacity in both space and labour terms.
Producing and selling M&F will call for increased investment in working capital. Analysis of historical levels of working capital within Globo Tech Plc indicates that at the start of each year, investment in working capital for M&F will need to be 7% of sales revenue for that year.
Globo Tech Plc pays tax of 30% per year in the year in which the taxable profit occurs. Liability to tax is reduced by tax allowable depreciation on machinery, which Globo Tech Plc can claim a straight-line basis over the four year-life of the proposed investment. The new machine is expected to have no scrap value at the end of the four-year period.
Globo Tech Plc uses an after-tax cost of capital of 12% for investment appraisal purposes.
Ignore Inflation.
Required
- Calculate the net present value of the proposed investment in M&F.
(10)
- “Sound financial management is necessary for the survival of the firm and for its growth…Many business decisions do not involve a conflict between the objectives of each of the stakeholders. However, there are occasions when someone has to decide which claimants are to have their objectives maximised, and which are merely to be satisficed – that is, given just enough of a return to make their contributions.”
(Arnold, 2013)
With reference to academic literature, critically discuss the conflicting interest that may arise between various stakeholders of an organisation which uses shareholder wealth maximisation as its main aim.
(15)
(25)
- You have been asked to carry out a valuation of Maybot plc, a listed company on the main London stock market. The company’s most recent statement of financial position is summarised below.
Statement of Financial position as at 30 September 20X8 (£million)
Non-Current Assets 300
Current Assets
Inventories 70
Debtors 120
Cash at bank 90
280
Liabilities
Creditors: trade creditors due within one year (400)
Creditors due after more than a year (50)
Net assets = Shareholders Funds 130
Details of the company’s earnings per share and dividends per share are as follows:
Year ending 30/9 Earnings (p per share) Dividends (p per share)
20X8 20 10.0
20X7 18 9.5
20X6 17 9.0
20X5 16 8.0
20X4 13 7.0
20X3 12 6.0
20X2 10 5.5
20X1 10 5.0
Additional Information
1,000 million shares have been issued, all in 20X0 or earlier.
The company’s required return on equity is 12.5 %.
The growth rate of earnings per share and dividends per share over the period 20X1 to 20X8 is expected to continue.
You have secured an independent valuation of Maybot’s non-current assets of £350 million.
You believe that the value of inventories is overstated by £30 million, and that a quarter of the debtors should be written off.
Required:
- Calculate the net asset value per share
(3)
- Assuming the 20X8 dividend has just been paid, and that the 20X9 dividend will be payable in a year’s time, calculate the value of one share using the dividend valuation model.
(5)
- Calculate the prospective price earnings ratio using the share price computed in (b).
(3)
- “The concept of value is at the heart of financial management…Inability to make precisely accurate valuations complicates the task of financial managers”.
(Pike et al., 2012)
Critically evaluate the various methods available for valuing shares.
(14)
(25)
- A U.K company exports machinery to a South African company on three month’s credit. It is a condition of the deal that the invoice will be in rand, and it is issued at R150 million. Exchange rates have been volatile in recent months, and the directors of the U.K company are concerned that the spot rate (currently R7.46/£) may increase over the next three months, making the deal unprofitable. They are considering two hedging strategies, a forward market hedge and a money market hedge.
Additional information
The three-month forward rate is R7.5/£
Three-month interest rates for sterling and rand are 7.8%p.a. and 10%p.a. respectively.
Required:
- Calculate the value receivable in sterling in three months’ time using a forward market hedge.
(2)
- Calculate the value receivable in three months’ time using a money market hedge.
(6)
- Which hedge is preferable?
(3)
- Explain the meaning of Interest Rate Parity.
(2)
- If all other rates remained the same, what would the forward rate need to be for Interest Rate Parity to hold?
(2)
- “Shifts in foreign exchange rates have the potential to undermine the competitive position of the firm and destroy profits”
(Arnold, 2013)
Outline the various forms of exchange rate risk facing companies, and critically discuss ways in which they can be mitigated.
(10)
(25)
(End of Paper)
5FM
FORMULA SHEET
1 Expected return on a 2 security portfolio is given by
RP = aRA + (1-a)RB
Where a is the proportion of share A in the portfolio
2 Standard deviation on a 2 security portfolio is given by
sP = Ö a2sA2 + (1-a)2sB2 + 2a(1-a)RABsAsB
Where a is the proportion of share A in the portfolio
3 The proportion a of share A in the minimum risk portfolio is given by
Note
cov(RA, RB) = RABsAsB
5 Cost of equity is given by
5 The growth rate in above is derived from
6
Weighted Average cost of capital is given by
WACC = Ke() + Kd()
Where Ke is the cost of equity capital
“ Kd is the cost of debt
Ve is the value of equity capital
Vd is the value of debt capital.
APA
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