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managerial_finance_questions_2008
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1. Meatcan Canning Company Ltd is considering expansion of its facilities, Its current
income statement is as follows:
Sales
Variable expenses
Fixed expenses
EBIT
Interest at 10%
Earnings before tax (EBT)
Income tax at 30%
Earnings after tax
N$
5,000,000
(2,500,000)
(1,800,000)
700,000
(200,000)
500,000
(150,000)
350,000
Shares of common stock
outstanding 200,000
Earnings per share (EPS)
The company is currently financed with 50 percent debt and 50 percent equity (common
stock, par value of N$10). In order to expand the facilities, the director of the company,
estimates a need for N$2 million in additional funds. The company’s investment banker
has laid out three alternatives to be considered.
1. Sell N$2 million of debt at 13 percent interest
2. Sell N$2 million of common stock at N$20 per share.
3. Sell N$1 million of debt at 12 percent interest and N$1 million of common stock
at N$25 per share.
Variable costs are expected to stay at 50 percent of sales, while fixed expenses will
increase to N$2 300 000 per year. The director is not sure how much this expansion will
add to sales, but he estimates that sales will rise by N$1 million per year for the next five
years.
The director is interested in the thorough analysis of the company’s expansion plans and
methods of financing and consults you to help him.
Required
a) Determine the break-even point before and after expansion in sales dollars (4
marks)
b) Calculate the degree of operating leverage before expansion (2 marks)
c) Calculate the degree of operating leverage after expansion at sales of N$6
million (2 marks)
d) Calculate the degree of financial leverage before expansion (2 marks)
e) Calculate the degree of financial leverage after expansion for all three
alternative financing plans at sales of N$6 million (12 marks)
f) Calculate EPS under all three financing plans after expansion at N$6 million in
sales (12 marks)
2. Milton Ltd expects cash flows of N$6 million each year. Its corporate tax rate is 35
percent, and its unlevered cost of capital is 15 percent. The firm also has outstanding debt
of N$19.05 million, and it expects to maintain this level of debt permanently.
Required
a) Calculate the value of Milton Ltd without leverage (2 marks)
b) Calculate the value of Milton Ltd with leverage (2 marks)
_~uestion 2 (23 marks)
p) The Falcon Ltd has been reviewing its credit policies. The credit standards it has been
; applying have resulted in annual credit sales of N$5 million. Its average collection
period is 30 days, with a bad debt loss ratio of 1 percent. Because persistent inflation
has caused deterioration in the financial position of many of its customers, Falcon Ltd
is considering a reduction in its credit stapdards. As a result it expects incremental
credit sales of N$400 OOC on which the average collection period would be 60 days
and on which the bad debt ass would be 3 percent. The variable cost ratio to sales for
Falcon Ltd is 70 .oercent, The required return on investment in receivables is 15
percent.
Required
Advise Falcon Ltd if it should reduce its credit standards (use 365-day year) (8 marks)
b) Instead of relaxing its credit standards, Falcon Ltd is considering simply lengthening
the credit terms from net 20 to net 50, a procedure that would increase the average
collection period from 30 days to 60 days. Under the new policy, Falcon Ltd expects
incremental sales to be N$500 000 and the new bad debt loss to rise to 2 percent on all
sales.
Required
Should FalconLtd lengt~n its credittermS?~1~~:-~s~” Jl. ”
Question 3 (19 marks).tlm GO Ct I tlCtl11) I} 1.:J L 1.1) ??
. Starve Ltd has estimated Its sales and purchase requirements for the last half of the
coming year. Past experience indicates that it will collect 20 percent of its sales in the
month of the sale, .so percent of the remainder 1 month after the sale, and the balance in
the second month following the sale. Starve Ltd prefers to pay for half its purchases in the
month of purchase and the other half in the following month. The labour, expense for each
month is expected to equal 5 percent of that month’s sales, with cash payment being
made in the month in which the expense is incurred. ‘
Depreciation expense is N$ 5 000 e:r month; miscellaneous cash expenses are N$4 000
Pel Ill.Qflth and are paid in the month incurred. General and administrative expenses ot
N$50 OOQ are recognised and paid monthly. A N$60 000 truck is to be purchased in
August and is to be depreciated on a straight line basis over 10 years with no expected
salvage value. The company is also expected to pay a N$9 000 cash dividend to its
shareholders in July. The company feels that a minimum cash balance of N$30 ooo should
be maintained. Any borrowing will cost 12 percent annually, with interest paid in the month
following the month in which the funds are borrowed. Borrowing takes place at the
beginning of the month in which the need for funds arises. Cash on hand as on June 30
was N$30 000. Actual and estimated sales and purchases are shown as follows:
2
Month Sales (N$) Purchases (N$)
Actual
May 100000 60000
June 100000 60000
Estimated
July 120 000 50 000
August 150000 40000
September 110000 30000
Required
\ __\\ Prepare a cash budget for Starve Ltd for the months of July and August.
