0 1 2

Sales revenue(W1) $ 2,474,750 $ 2,714,410

Variable costs(W2) $ -1,097,250 $ -1,323,000
Fixed costs $ -154,500 $ -159,135
Taxable cash flows $ 1,223,000 $ 1,232,275
Tax liability $ -269,060
Tax relief(W3) $ 99,000
Initial investment $ -1,800,000
Net cash flows $ -1,800,000 $ 1,223,000 $ 1,062,215
DF 12% 1 0.893 0.797
PV $ -1,800,000 $ 1,091,964 $ 846,791
NPV $ 2,508,550
 3 4 5 Sales revenue(W1)
$ 4,412,328 $ 4,774,478
$ -2,083,725 $ -2,370,237 Sales units
$ -163,909 $ -168,826 Inflated salling price
$ 2,164,694 $ 2,235,415 Sales revenue
$ -271,101 $ -476,233 $ -491,791
$ 74,250 $ 55,688 167,063 Variable costs(W2)

$ 1,967,843 $ 1,814,869 $ -324,729 Sales units

0.712 0.636 0.567 Inflated variable costs
$ 1,400,672 $ 1,153,382 $ -184,260 Total variable costs

Tax relief(W3)

T0
T1

T2

T3

T4
 1 2 3 4
95,000 100,000 150,000 150,000
26 27 29 32
2,474,750 2,714,410 4,412,328 4,774,478

1 2 3 4
95,000 100,000 150,000 150,000
12 13 14 16
1,097,250 1,323,000 2,083,725 2,370,237

Tax relief
Investment 1,800,000
TAD 450,000 99,000 T2
WD value 1,350,000
TAD 337,500 74,250 T3
WD value 1,012,500
TAD 253,125 55,688 T5
WD value 759,375
Scrap value -
Balancing allowance 759,375 167,063 T6
 $000
Years 0 1 2 3
Sales revenue(W1) 16,224 20,248 24,196
Variable costs(W2) - 5,356 - 6,752 - 8,313
Fixed costs - 700 - 735 - 779
Taxable cash flows - 10,168 12,760 15,104
Tax liability - 3,050 - 3,828
Tax relief(W3) 1,875 1,406
Scrap proceeds
Initial investment - 25,000
Net cash flows - 25,000 10,168 11,585 12,682
DF 12% 1 0.893 0.797 0.712
PV - 25,000 9,079 9,235 9,027
NPV 10,474

Discounted Payback

Year Cash flows

0- 25,000 - 25,000
1 9,079 - 15,921
2 9,235 - 6,686
3 9,027 2,341
4 9,465
5- 1,332

2.74 years or 2 years 9 months

 4 5 Sales revenue(W1)
27,655 1
- 9,694 Sales volume(units) 520,000
- 841 Selling price(inflated) 31
17,121 - Sales rvenue 16,224,000
- 4,531 - 5,136
1,055 2,789 Variable costs(W2)
1,250 1
Sales volume(units) 520,000
14,894 - 2,347 Variable costs(unit)(inflated) 10
0.636 0.567 Total variable costs 5,356,000
9,465 - 1,332
Tax relief(W3)
T0 Initial investment
T1 TAD
WD value
T2 TAD
WD value
T3 TAD
WD value
T4 Scrap proceeds
Balancing allowance

years 9 months
 2 3 4
624,000 717,000 788,000
32 34 35
20,247,552 24,195,825 27,655,456

2 3 4
624,000 717,000 788,000
11 12 12
6,752,416 8,312,779 9,693,827

Tax relief
25,000,000
6,250,000 1,875,000 T2
18,750,000
4,687,500 1,406,250 T3
14,062,500
3,515,625 1,054,688 T4
10,546,875
1,250,000
9,296,875 2,789,063 T5
NPV in nominal terms
$000
0 1 2 3
Sales revenue(W1) 39,375 58,763 85,085
Variable costs(W2) - 22,046 - 31,183 - 41,327
Contribution 17,330 27,580 43,758
Fixed costs(inflated) - 3,180 - 3,483 - 3,811
Taxable cash flows 14,150 24,097 39,947
Tax liability - 3,679 - 6,265 - 10,386
Initial investment - 20,000
Tax relief(W3) 1,300 975 731
Net cash fows - 20,000 11,771 18,807 30,292
DF 12% 1 0.893 0.797 0.712
PV - 20,000 10,509 14,992 21,561
NPV 33,338

NPV in real terms

0 1 2 3
Nominal cash flows before tax 14,150 24,097 39,947
Real cash flows before tax(W4) 13,645 22,408 35,822
Tax liability - 3,548 - 5,826 - 9,314
Initial investment - 20,000
Tax relief 1,300 975 731
Net cash flows - 20,000 11,397 17,557 27,239
DF 8% 1 0.926 0.857 0.794
PV - 20,000 10,553 15,052 21,623
NPV 33,722
 4 Sales revenue(W1)
32,089 1 2
- 17,924 Sales units 300,000 410,000
14,165 Selling price(inflated) 131 143
- 3,787 Sales revenue 39,375,000 58,763,250
10,378
- 2,698 Variable costs(W2)
1 2
2,194 Sales units 300,000 410,000
9,873 Variable costs per unit(inflated) 73 76
0.636 Total variable costs 22,045,500 31,183,360
6,275
Tax relief(W3)

T0 Initial invesment 20,000

4 T1 TAD 5,000
10,378 WD value 15,000
8,974 T2 TAD 3,750
- 2,333 WD value 11,250
T3 TAD 2,813
2,194 WD value 8,438
8,834 T4 Scrap proceeds -
0.735 Balancing allowance 8,438
6,494
Real cash flows before tax(W4)
1 2
Nominal cash flows before tax 14,150 24,097
Deflation factor 1.037 1.075
Real cash flows before tax 13,645 22,408
 3 4
525,000 220,000
162 146
85,085,438 32,089,365

3 4
525,000 220,000
79 81
41,327,459 17,924,309

Tax relief

1,300 T1

975 T2

731 T3

2,194 T4

3 4
39,947 10,378
1.115 1.156
35,822 8,974
a) Investment funds $ 800,000

Project name Investment needed NPV Profitability Index Rank

Project 1(W1) $ 300,000 $ 32,717 11% 3
Project 2(W2) $ 450,000 $ 57,584 13% 2
Project 3(W3) $ 400,000 $ 77,763 19% 1

(i) If all projects are divisible

Project 1 0
Project 2 89%
Project 3 100%

NPV $ 128,949

(ii) none of the projects are divisibe

Project 1 and Project 2

NPV $ 90,301

Project 1 and Project 3

NPV $ 110,480
Project 1(W1)
Year 0 1 2 3 4
Cash flows $ 85,000 $ 90,000 $ 95,000 $ 100,000
Initial investment $ -300,000
DF 12% 1 0.893 0.797 0.712 0.636
PV $ -300,000 $ 75,893 $ 71,747 $ 67,619 $ 63,552
NPV $ 32,717

Project 2(W2)
Initial invesment $ -450,000
Annual cash flows $ 140,800
Annuity factor 3.605
PV of annual cash flows $ 507,584
NPV $ 57,584

Project 3(W3)
Year 0 1 2 3 4
Cash flows(inflated) $ 124,320 $ 128,796 $ 133,432 $ 138,236
Initial investment $ -400,000
DF 12% 1 0.893 0.797 0.712 0.636
PV $ -400,000 $ 111,000 $ 102,675 $ 94,974 $ 87,851
NPV $ 77,763
 5
$ 95,000

0.567
$ 53,906

5
$ 143,212

0.567
$ 81,262
 Buy
$000
Years 0 1 2 3
Initial investment - 1,000
Licence fee - 104 - 108 - 112
Scrap proceeds
Tax relief(W1) 106 89
Net cash flows - 1,000 - 104 - 2 - 24
DF 6,02% 1 0.943 0.890 0.840
PV - 1,000 - 98 - 2 - 20
NPV - 975
Lease
$000
Label Years Cash flows DF PV
Lease payments 0-3 - 380 3.673 - 1,396
Tax relief 2-5 114 3.267 372
NPV - 1,023

b) Nominal terms NPV analysis

$000
Year 1 2 3 4
Cost savings(W2) 365 480 638 564
Tax liability - 110 - 144 - 191
Net cash flows 365 370 494 373
DF 11% 0.901 0.812 0.731 0.659
PV 329 300 361 245
PV of total benefits 1,136
PV of costs - 975
NPV 161
 Tax relief(W1)

4 5 T0 Initial investment
T1 TAD
- 117 WD value
100 T2 TAD
76 132 WD value
59 132 T3 TAD
0.792 0.747 WD value
47 98 T4 Scrap proceeds
Balancing allowance

Post-tax DF 6.02%

Cost savings(W2)
1
5 Production units 60,000
Cost saving per unit(inflated) 6.1
- 169 Total cost savings 365,400
- 169
0.593
- 100
$000 Tax relief
1,000
250 75 T2
750
188 56 T3
563
141 42 T4
422
100
322 97 T5

2 3 4
75,000 95,000 80,000
6.4 6.7 7.0
479,588 637,851 563,995
Buy

Bank Loan - 160,000

0 1 2 3
Purchase cost - 160,000
Maintenance cost - 8,000 -8000 - 8,000
Residual value 40,000
Net cash flows - 160,000 - 8,000 - 8,000 32,000
DF 8% 1 0.926 0.857 0.794
PV - 160,000 - 7,407 - 6,859 25,403
NPV - 148,863

Lease Years Cash flows Discount rate PV

Lease payments 0-2 - 55,000 2.783 - 153,065

Three-year operation
0 1 2 3
Purchase cost - 160,000
Maintenance cost - 8,000 -8000 - 8,000
Residual value 40,000
Net cash flows - 160,000 - 8,000 - 8,000 32,000
DF 10% 1 0.909 0.826 0.751
PV - 160,000 - 7,273 - 6,612 24,042
NPV - 149,842
EAC - 60,254

Four-year operation
0 1 2 3
Purchase cost - 160,000
Maintenance cost - 12,000 -12000 - 12,000
Residual value
Net cash flows - 160,000 - 12,000 - 12,000 - 12,000
DF 10% 1 0.909 0.826 0.751
PV - 160,000 - 10,909 - 9,917 - 9,016
NPV - 190,525
EAC - 60,105
 4

- 12,000
11,000
- 1,000
0.683
- 683
BUY

Years 0 1 2 3
Initial investment - 750,000
Servicing costs - 23,000 - 23,000 - 23,000
Tax relief for servicing costs 6,900 6,900
Tax relief for TAD(W1) 56,250 42,188
Scrap proceeds
Net cash flows - 750,000 - 23,000 40,150 26,088
DF 6% 1 0.943 0.890 0.840
PV - 750,000 - 21,698 35,733 21,904
NPV - 597,269

LEASE

Label Year Cash flows DF 6% PV

Lease payments 0-3 - 200,000 3.673 - 734,600
Tax relief 2-5 60,000 3.267 196,050
NPV - 538,550

Benefit 58,718

According to the calculations of Net present values of project costs in terms of both lease an
Lease is more attractive than buy option. Because it has lower NPV of total costs which would
$538 550 benefit
 After-tax interest rate 6%

4 5 Tax relief for TAD(W1)

- 23,000 T0 Initial investment 750,000

6,900 6,900 T1 TAD 187,500
31,641 79,922 WD value 562,500
50,000 T2 TAD 140,625
65,541 86,822 WD value 421,875
0.792 0.747 T3 TAD 105,469
51,914 64,878 WD value 316,406
T4 Scrap proceeds 50,000
Balancing allowance 266,406

terms of both lease and buy

otal costs which would provide
Tax relief

56,250 T2

42,188 T3

31,641 T4

79,922 T5
a) (i) Project B
$000
Years 0 1 2
Sales income(inflated) 754 827
Costs(inflated) - 152 - 185
Initial outlay - 1,500
Net cash flows - 1,500 602 642
DF 10% 1 0.909 0.826
PV - 1,500 547 531
NPV 561

(ii) $000
Capital constraint 5,000

Projects Initial outlay NPV Profitability index

A 1,000 390 39%
B 1,500 561 37%
C 750 325 43%
D 1,125 590 52%
E 1,850 840 45%
F 1,300 635 49%

Optimum Combination D,F,E and 72,5% of A

Project Percentage Initial outlay NPV

D 100.0% 1,125 590
F 100.0% 1,300 635
E 100.0% 1,850 840
A 72.5% 725 283
Total 5,000 2,348
 3 4
996 716
- 234 - 114

762 602
0.751 0.683
572 411

Rank
5
6
4 Mutually-exclusive
1
3 Mutually-exclusive
2
a) $000
Years 0 1 2 3 4
Sales revenue(W1) 1,600 1,600 1,600 1,600
Variable costs - 1,100 - 1,100 - 1,100 - 1,100
Fixed costs - 160 - 160 - 160 - 160
Taxable cash flows 340 340 340 340
Tax liability - 102 - 102 - 102
WC required - 90
Initial investment - 800
Scrap proceeds
Net cash flows - 890 340 238 238 238
DF 11% 1 0.901 0.812 0.731 0.659
PV - 890 306 193 174 157
NPV 104

The project is financially acceptable as it has a postive net present value of $104 000

b) IRR through Linear Interpolation

Net cash flows - 890 340 238 238 238

DF 18% 1 0.847 0.718 0.609 0.516
PV - 890 288 171 145 123
NPV - 40

IRR 16

c) Sensitivity to selling price 2.41%

- 1 2 3 4
Taxable cash flows 1,600 1,600 1,600 1,600
Tax liability - 480 - 480 - 480
Net cash flows 1,600 1,120 1,120 1,120
DF 11% 1 0.901 0.812 0.731 0.659
PV - 1,441 909 819 738
NPV 4,315

Sensitivity to discount rate 45%

 $000
5 6 Sales revenue(W1)
1,600 Years 1 2
- 1,100 Production units 100,000 100,000
- 160 Selling price 16 16
340 Total revenue 1,600,000 1,600,000
- 102 - 102
90

40
368 - 102
0.593 0.535
218 - 55

value of $104 000

368 - 102
0.437 0.370
161 - 38

5 6
1,600
- 480 - 480
1,120 - 480
0.593 0.535
665 - 257
 3 4 5
100,000 100,000 100,000
16 16 16
1,600,000 1,600,000 1,600,000
 $000
Years 0 1 2 3
Sales revenue(W1) 4,524 7,842 13,048
Nominal variable costs - 2,385 - 4,200 - 7,080
Incremental overheads(inflated) - 440 - 484 - 532
Taxable cash flows 1,699 3,158 5,436
Tax liability - 510 - 947 - 1,631
Initial investment - 5,000
Scrap value
Tax relief(W2) 338 338 338
Net cash flows - 5,000 1,527 2,548 4,143
DF 11% 1 0.901 0.812 0.731
PV - 5,000 1,375 2,068 3,029
NPV 3,805
 4 Sales revenue(W1)
10,178
- 5,730 Expected selling price 29
- 586
3,862 Year 1 2
- 1,159 Production units 150,000 250,000
Selling price(inflated) 30 31
500 Sales revenue 4,524,000 7,841,600
338
3,541
0.659 Tax relief(W2)
2,333 TAD 1,125
Tax relief 338
 3 4
400,000 300,000
33 34
13,048,422 10,177,769
 $000
Years 0 1 2 3
Sales revenue(W1) 12,068 16,791 23,948
Variable costs(W2) - 5,491 - 7,139 - 9,719
Contribution 6,577 9,653 14,229
Fixed costs - 1,100 - 1,121 - 1,155
Taxable cash flows 5,477 8,532 13,074
Tax liability - 1,534 - 2,389
Initial investment - 20,000
Tax relief(W3) 1,400 1,050
Net cash flows - 20,000 5,477 8,398 11,736
DF 10% 1 0.909 0.826 0.751
PV - 20,000 4,979 6,941 8,817
NPV 2,848

As NPV is positive at $2,85 m this project is considered financially acceptable.

 4 5 Sales revenue(W1)
11,934 1
- 5,615 Sales volume(units) 440,000
6,319 Salling price per unit(inflated) 27
- 1,200 Sales revenue 12,068,100
5,119
- 3,661 - 1,433 Variable costs(W2)
Expected variable cost per unit 12
788 2,363
2,246 929 1
0.683 0.621 Sales volume(units) 440,000
1,534 577 Variable costs(inflated) 12
Total variable costs 5,491,200

cially acceptable. Tax relief(W3) $000

T0 Initial investment
T1 TAD
WD value
T2 TAD
WD value
T3 TAD
WD value
T4 Sacrap proceeds
Balancing allowance
 2 3 4
550,000 720,000 400,000
31 33 30
16,791,452 23,948,306 11,934,239

2 3 4
550,000 720,000 400,000
13 13 14
7,138,560 9,718,825 5,615,321

Tax relief
20,000
5,000 1,400 T2
15,000
3,750 1,050 T3
11,250
2,813 788 T4
8,438
-
8,438 2,363 T5
 Year 1
Cash flows Discount factor PV Probability
1,000,000 0.893 892,857 0.1
2,000,000 0.893 1,785,714 0.5
3,000,000 0.893 2,678,571 0.4

Investment - 3,500,000

Year 1 Probability Year 2 Probability Total PV

892,857 10% 1,594,388 30% 2,487,245
892,857 10% 2,391,582 60% 3,284,439
892,857 10% 3,985,969 10% 4,878,827
1,785,714 50% 1,594,388 30% 3,380,102
1,785,714 50% 2,391,582 60% 4,177,296
1,785,714 50% 3,985,969 10% 5,771,684
2,678,571 40% 1,594,388 30% 4,272,959
2,678,571 40% 2,391,582 60% 5,070,153
2,678,571 40% 3,985,969 10% 6,664,541

(i) Mean(expected) NPV of the project

865,434

(ii) Probability of having negative NPV

24%

(iii) NPV of most likely outcome

677,296

(iv) Comment:

Firstly mean NPV of the proposed investment is positive at $865 434

most likely outcome is also positive at $677 296. Lastly, probability of h
is only 24%. All of this three factors are enough to make this investment proj
 Year 2
Cash flows Discount factor PV Probability
2,000,000 0.797 1,594,388 0.3
3,000,000 0.797 2,391,582 0.6
5,000,000 0.797 3,985,969 0.1

Joint Prob PV*JP NPV

3% 74,617 - 1,012,755
6% 197,066 - 215,561
1% 48,788 1,378,827
15% 507,015 - 119,898
30% 1,253,189 677,296
5% 288,584 2,271,684
12% 512,755 772,959
24% 1,216,837 1,570,153
4% 266,582 3,164,541
100% 4,365,434

ment is positive at $865 434. Secondly, NPV of

296. Lastly, probability of having negative NPV
make this investment project financially acceptable.
a) Share price $ 7.50
Right issue price $ 6.00
Number of shares needed to issue 15,000,000

Number of shares Share price

1$ 6.00
4$ 7.50
5$ 7.20
TERP

b) Nominal value of loan notes redeemed $ 80,000,000

Interest saved by redeeming loan notes $ 6,400,000
Revised profit before tax $ 45,400,000
Revised profit after tax(earnings) $ 31,780,000
Revised EPS $ 0.42
Current EPS $ 0.45
Current PE ratio 16.67
Revised share price $ 7.06

c) After buying back loan notes

Decrease in loan notes $ 80,000,000
Decrease in finance cost $ 6,400,000

Revised SPL figures

Finance cost $ 3,600,000

Ratio Before paying loan notes

Interest cover 4.9
Debt to equity 89%
 1 for 4 right issue

Total
$ 6.00
$ 30.00
$ 36.00

less than TERP

Revised SFP figures

Ordinary shares $ 75,000,000
Share premium $ 75,000,000
Reserves $ 80,000,000
Loan notes $ 45,000,000

After paying loan notes

13.6
19.6%
a) Finance needed $ 2,000,000
(i) Current share price $ 5
Right issue share price $ 4
Number of shares issued 500,000

Number of share Price Total

1 $ 4 $ 4
5 $ 5 $ 25
6 $ 4.83 $ 29
TERP

(ii) After using equity finance

Revised SPL figures

PBIT $ 1,916,400
Finance costs $ -315,000
Taxation $ -352,308
Profit after tax(earnings) $ 1,249,092

Total number of shares 3,000,000

Revised EPS $ 0.42

(iii) After using debt finance

Revised SPL figures

PBIT $ 1,916,400
Finance costs $ -475,000
Taxation $ -317,108
Profit after tax(earnings) $ 1,124,292

Number of share 2,500,000

Revised EPS $ 0.45

(iv) Using equity finance

Share price $ 5.20

 Using debt finance

P/E ratio 12.50

Share price $ 5.62

(v) Evaluation whether to use equity finance or debt finance

Gearing(using book values)

Increase in Finance cost 160000
a) (i)
Investment required $ 25,480,000
Current share price $ 2.6
Right issue price $ 1.82
Number of shares needed to issue 14,000,000 This means 1 for 5
Current number of shares 70,000,000 right issue

Number of shares Share price Total

1 $ 1.82 $ 1.82
5 $ 2.6 $ 13.00
6 $ 2.47 $ 14.82
TERP

(ii)
Value of the right $ 0.65
Value of the right per existing share $ 0.13

b) (i) Financing with the right issue

P/E ratio 11 times

Revised Financial statements figures

Profit from operations $ 30,000,000

Profit after tax $ 20,160,000
Share capital $ 42,000,000
Share premium $ 18,480,000

Total number of shares 84,000,000

EPS $ 0.24
Share price $ 2.64

(ii) Financing with the loan notes

Revised Financial statements figures

Profit from operations $ 28,471,200

Profit after tax $ 18,936,960
Share capital $ 35,000,000

Total number of shares 70,000,000

EPS $ 0.27
Share price $ 2.98
Increase in Profit from operations $ 4,500,000
Increase in taxation $ 900,000
Net increse in profit after tax $ 3,600,000

Value of loan notes 25,480,000

Finance cost 1,528,800

Increase in Profit from operations $ 2,971,200

Increase in taxation $ 594,240
Net increse in profit after tax $ 2,376,960
a) Cost of equity Cost of debt
Equity beta 1.15 Before tax rate
Risk-free rate 4% Tax rate
Equity risk premium 6% After-tax rate
Ke 10.9%
Years
0
1
2
3
4
5
6

IRR

WACC at nominal values

Label Nominal value Proportion Cost of capital

Ordinary shares 200,000,000 19% 10.9%
Reserves 650,000,000 62% 10.9%
Loan notes 200,000,000 19% 4.7%
1,050,000,000 WACC

WACC at market value

Label Nominal value Proportion Cost of capital

Ordinary shares 2,340,000,000 92% 10.9%
Loan notes 207,000,000 8% 4.7%
2,547,000,000 WACC
Cost of debt
6%
25%
4.5%

Cash flows
-103.5
4.50
4.50
4.50
4.50
4.50
110.50

4.7%

2.1%
6.7%
0.9%
9.7%

10.0%
0.4%
10.4%
 Cost of ordinary shares Cost of preferance shares
Ex-div market price 7.07 Dividend
Cum-div market price 7.52 Market price
Dividend 0.449999999999999 Kp
Growth in dividends 5%
Ke 11.7%

Label Market value Proportion Cost of capital

Ordinary shares 169,680,000 91% 11.7%
Preference shares 3,100,000 2% 8%
Long-term borrowings 10,234,000 6% 5.4%
Bank loan 3,000,000 2% 5.4%
186,014,000
t of preferance shares Cost of long term borrowing
0.025 Years Cash flows
0.31 0 -102.34
8.06% 1 4.9
2 4.9
3 4.9
4 109.9

IRR 5.4%

10.7%
0.1%
0.3%
0.1%
11.19%
 Cost of equity Cost of preference shares
Risk-free rate(Rf) 3.50% Dividend
Risk premium 6.80% Ex-div market price
Equity beta(Be) 1.25 Kp
Ke 12.00%

Label Market value Proportion Cost of capital

Ordinary shares 91,500,000 83% 12.00%
Preference shares 5,120,000 5% 7%
Loan notes 8,280,000 8% 7.3%
Bank loan 5,000,000 5% 7.3%
109,900,000 WACC
preference shares Cost of debt
$ 0.045 Years Cash flows
$ 0.64 0 $ -103.5
7.03% 1$ 6.4
2$ 6.4
3$ 6.4
4$ 6.4
5 $ 116.4

IRR 7.27%

9.99%
0.33%
0.55%
0.33%
11.20%
a) Project A
$000
0 1 2
Sales revenue(W1) 1,575 1,654
Selling costs(W2) - 32 - 33
Variable costs(W3) - 624 - 649
Taxable cash flows 920 972
Tax liability - 276
Working capital(W4) - 250 - 11 - 12
Initial investment - 3,500
Tax relief(W5) 263
Net cash flows - 3,750 908 947
DF 10% 1 0.909 0.826
PV - 3,750 826 782
NPV - 755

Using this method, net present value(NPV) of the project calculated having a negative
it would be considered financially unacceptable to invest in. However, there are som
might influenced the negativity of the NPV. One of them is appraising limited period o
its whole life and other factors would be not considering working capital recovery and ba

b) Project B

GZ Co CJ Co
Equity beta(Be) 1.5 MV of equity
MV of equity 90,000,000 MV of debt
MV of debt 30,000,000

Asset beta(Ba) 1.22 Be

Risk-free rate
Equity risk premium

Cost of equity
 Sales revenue(W1)

3 4 5 Sales units
1,736 1,823 Selling price(inflated)
- 35 - 36 Sales revenue
- 675 - 702
1,027 1,085 Selling costs(W2)
- 292 - 308 - 325
- 12 - 13 Sales units
Selling costs per unit(inflated)
197 148 443 Total selling costs
920 912 118
0.751 0.683 0.621 Variable costs(W3)
691 623 73
Sales units
Variable costs per unit(inflated)
Total variable costs

alculated having a negative cash flow and Working capital(W4)

n. However, there are some factored that
appraising limited period of the project not
ing capital recovery and balancing allowance. Working capital required
Movement in WC

Tax relief(W5)

T0
180,000,000 T1
45,000,000
T2

1.43 T3
4%
6% T4

12.6%
 1 2 3 4
750,000 750,000 750,000 750,000
$ 2.10 $ 2.21 $ 2.32 $ 2.43
1,575,000 1,653,750 1,736,438 1,823,259

1 2 3 4
750,000 750,000 750,000 750,000
$ 0.04 $ 0.04 $ 0.05 $ 0.05
31,500 33,075 34,729 36,465

1 2 3 4
750,000 750,000 750,000 750,000
$ 0.83 $ 0.87 $ 0.90 $ 0.94
624,000 648,960 674,918 701,915

0 1 2 3 4
250,000 261,250 273,006 285,292 298,130
- 250,000 - 11,250 - 11,756 - 12,285 - 12,838

Tax relief
Initial investment 3,500,000
TAD 875,000 262,500 T2
WD value 2,625,000
TAD 656,250 196,875 T3
WD value 1,968,750
TAD 492,188 147,656 T4
WD value 1,476,563
Scrap proceeds -
Balancing allowance 1,476,563 442,969 T5
a) Ex-div market value $ 7.16 Year Dividends per share
Dividend $ 0.62 20X3 $ 0.551
20X4 $ 0.579
Growth rate(g) 4% 20X5 $ 0.591
20X6 $ 0.620
Cost of equity(Ke) 13%
There have been three years between
the fist dividend and the last dividend

c) Cost of redeemable loan notes Label

Ordinary shares
Year Cash flow Irredeemable loan notes
0 -103.42
1 5.95
2 5.95
3 5.95
4 5.95
5 105.95

IRR 5.2%

d) Proxy company Card Co

Equity beta(Be) 1.038 Risk-free rate(Rf)

Equity 75% Equity risk premium
Debt 25% Equity beta

Asset beta(Ba) 0.842 New equity beta(Be)

Cost of equity
three years between
nd the last dividend

Market value Proportion Cost of capital

$ 57,280,000 92% 12% 11.01%
$ 5,171,000 8% 5.2% 0.43%
$ 62,451,000 WACC 11.43%

4%
5%
1.6

0.895

8.5%
a) Using debt finance

Loan note 15,000,000

Interest rate 8%
Extra finance cost 1,200,000

Total number of shares 12,000,000

Revised SPL figures

$000
Profit before interest and tax 15,648
Finance charges 1,440
Profit before tax 14,208
Taxation 4,262
Profit for the year(earnings) 9,946

Current EPS $ 0.75

EPS after expansion $ 0.83
Increase in EPS $ 0.08

Current P/E ratio 8.4

Revised share price $ 6.94
Capital gain $ 0.69

Calculating the effect of both debt finance and equity finance, debt finance is
increase in earnings per share by 8 cents and no changes in share price. On the con
to finance the new project would result in decrease in both share price and EPS by $0,0
Therefore, it is suggested that Spine Co should use debt finance for its new project to
wealth.
 Using share issue

Number of shares to issue 3,000,000

Right-issue share price $ 5.00
Current share price $ 6.25

Number of shares Price Total

1 $ 5.00 $ 5.00
4 $ 6.25 $ 25.00
5 $ 6.00 $ 30.00
TERP

Decrease in Share price $ 0.25

Revised SPL figures

$000
Profit before interest and tax 15,648
Finance charges 240
Profit before tax 15,408
Taxation 4,622
Profit for the year(earnings) 10,786

Current EPS $ 0.75

EPS after expansion $ 0.72
Decrease in EPS $ -0.03

Current P/E ratio 8.4

Revised share price $ 6.02
Capital gain $ 0.02

t finance and equity finance, debt finance is going to result in

nts and no changes in share price. On the contrary using right issue
decrease in both share price and EPS by $0,03 and $0,25 respectively
should use debt finance for its new project to maximise shareholder
wealth.
a) (i) Cash operating cycle at the start of January 20X7

Inventory $ 455,000
Trade receivables $ 408,350
Trade payables $ 186,700

Sales $ 3,500,000
Cost of sales $ 2,100,000

(ii) During January 20X7

Increase in Sales $ 350,000

Increase in Inventory $ 52,250
Increase in Payables $ 119,310

November 20X6
Credit sales $ 270,875
Cash inflow

Receivables
Receivables at the start of January 20X7 $ 408,350
Payment by credit cutomers $ -288,350
Credit sales during January $ 350,000
Receivables at the end of January 20X7 $ 470,000

Increase in receivables $ 61,650

Overall decrease in Working capital $ -5,410

(iii) SFP figures at the start of 20X7

Inventory $ 455,000
Trade receivables $ 408,350
Trade payables $ 186,700
Overdraft $ 240,250

Ratios Start of January 20X7

Current ratio 2.02
Quick ratio 0.96
e start of January 20X7

Inventory holding period 78

Receivable collection period 42
Payables payment period 32

Cash operating cycle 88

Decrease in payables(payment) $ 130,690

Increase in payables(credit purchase) $ 250,000
Net increase $ 119,310

December 20X6 January 20X7

$ 300,000 $ 350,000
$ 162,525 $ 288,350

Overdraft at start of January 20X7 $ 240,250

Decrease from Working capital movements $ -5,410
Interest payment $ 70,000
Operating cash outflow $ 146,500
Overdraft expected at the end of January 20X7 $ 451,340

Revised SFP figures at the end of January 20X7

Inventory $ 507,250
Trade receivables $ 470,000
Trade payables $ 306,010
Overdraft $ 451,340

End of January 20X7

1.29
0.62
days
Current SPL fugures $000
Sales 80,768
Cost of sales 27,700

Changes after expansion $000

Sales 95,872
Cost of sales 31,638
Profit after tax 6,818

Increase in non-current assets 5,948

Cash balance 700
Decrease in overdraft 500

Forecast statement of Financial Position afer expansion

Assets $000
Non-current assets 60,018
Current assets
Inventories 4,394
Trade receivables 15,979
Cash and cash equivalents 700
Total assets 81,090
Equity and liabilities
Equity 6,000
Reserves 40,818
Total equity 46,818
Non-current liabilities 26,000
Trade payables 5,273
Overdraft 3,000
Total equity and liabilities 81,091
Inventory holding period 50 days
Trade payable payment period 60 days
Trade receivable payment period 60 days

Inventory 4,394
Payables 5,273
Receivables 15,979
a) (i)
Component K
Annual demand(units) 1,500,000
Price per unit $ 14
Total purchase $ 21,000,000

Annual number of orders 12

Units per order 125,000
Cost of ordering(Co) $ 252
Cost of holding(Ch) $ 0.63

Total annual holding cost $ 39,375

Total annual ordering cost $ 3,024

(ii)
EOQ 34,641

Inventory management system EOQ Current

Purchase cost $ 21,000,000 $ 21,000,000
Cost of ordering $ 10,912 $ 3,024
Cost of holding $ 10,912 $ 39,375
Total costs $ 21,021,824 $ 21,042,399

Net benefit of EOQ $ 20,575

(iii) Bulk order discount

Discount rate 0.50%

Units per order 250,000

Inventory management system EOQ Current

Purchase cost $ 21,000,000 $ 21,000,000
Cost of ordering $ 10,912 $ 3,024
Cost of holding $ 10,912 $ 39,375
Total costs $ 21,021,824 $ 21,042,399

Net benefit of Bulk discount:

Compared to Current position $ 67,137
Compared to EOQ $ 46,562

According to calculations bulk order discount should be selected as new inventory

management sysem, as it is $67137 cost saving than current position and $46562 than
EOQ.
Bulk order discount
$ 20,895,000
$ 1,512
$ 78,750
$ 20,975,262
ected as new inventory
position and $46562 than
b) (i)

Months 1 2
$000 $000
Cash operating receipts 4,220 4,350
Cash operating payments - 3,950 - 4,100
Monthly interest - 200
Overdraft - 19 - 18
Capital investment
Net cash flows 251 32
Opening balance - 3,800 - 3,549
Closing balance - 3,549 - 3,517

(ii)
Current receivable days 65
Proposed receivable days 53
Reduction in Receivable days 12
Monthly reduction 2
Each receivable days equivalent to 135,000
Monthly reduction in account receivables 270,000

Current inventory holding period 80

Each inventory days equivalent to 102,000
Monthly reduction in inventory 204,000

Months 1 2
$000 $000
Cash operating receipts 4,220 4,350
Cash operating payments - 3,950 - 4,100
Monthly interest - 200
Monthly reduction in inventory 204 204
Monthly reduction in receivables 270 270
Overdraft - 19 - 16
Capital investment
Net cash flows 725 508
Opening balance - 3,800 - 3,075
Closing balance - 3,075 - 2,567
 3
$000
3,808
- 3,750

- 18
- 2,000
- 1,960
- 3,517
- 5,477

3
$000
3,808
- 3,750

204
270
- 13
- 2,000
- 1,481
- 2,567
- 4,048
a) Working capital ratios Sector average Wobling Co 20X5 Wobling Co 20X6
Current ratio 1.7 1.5 1.2
Quick ratio 1.1 0.9 0.7
Inventory holding period
55 days 60 75 days
Trade receivables
collection period 60 days 61 80 days
Trade payables payment
period 85 days 90 100 days
Sales revenue/net
working capital 10 times 11 15 times
Cash operating cycle 30 31 55 days

Wobling Co's working capital ratio in 20X5 shows some symptoms of undercapitalization as its current and quick ratio wa
lower than sector average at 1.5 and 0.9 respectively.However, its cash operating cycle and sales revenue/net working
capital ratios was not highly different from sector average.
Unfortunately, during 20X6 Wobling Co's working capital ratios worsened dramatically making cash operating cycle almo
twice longer than previous year at 55 days. Furthermore, its sales revenue/net working capital also increased from 11 tim
to 15 times and this would be due rapid increase in revenue and significant decrease in net working capital. Difference
between sector average's and Woblig Co current and quick ratios become remarkable and this would lead to some liquid
problems for the company if its current liabilities fall due.
 its current and quick ratio was
nd sales revenue/net working

ing cash operating cycle almost

tal also increased from 11 times
et working capital. Difference
his would lead to some liquidity