Questions related to Strategic Financial Management

Dabrue Ltd is a provider of machinery tools. In the recent yesteryear, the company has experienced along-run fiscal planning job. The company has more debt capital at the terminal ofDecember 2006 and the company adviser has been pressing for a decrease in debt load,get downing from March 2007.

The company is unwilling to raise equity capital unless there is anecessity. The balance sheet of the concern as at 30 December 2006 is as follows:Rs. 000 Rs. 000 Rs. 000Fixed AssetssFreehold land and premises at cost 2,250Less Accumulated depreciation 250 2,000Fixtures and adjustments at cost 1,640Less Accumulated depreciation 480 1,1603,160Current AssetssStock at cost 1,400Debtors 1,600Cash 8003,800Creditors: sums due within the twelvemonthTrade creditors 1,250Bank overdraft 150Corporate Tax 200 ( 1,600 ) 2,2005,360Capital and MilitiasRs.10/= ordinary portions 2,200Net income and loss history 1602,36012 % Redeemable unsecured bonds 3,0005,360Society of Certified Management Accountants of Sri Lanka 1Professional II Stage – Strategic Financial Management ( SFM )– — — — — — — — — — — — — — — — — — — – 2The undermentioned projections for the following three months ended 31March 2007are available.

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1. Gross saless and purchases for the three months ended 31 March 2007 will be as follows:

.

Gross saless PurchasesRs. 000 Rs.

000January 2,400 1,920February 2,800 2,100March 3,000 2,4602. 50 % of gross revenues are on recognition and they are collected in the undermentioned month. All purchasesare on two hebdomads recognition.

3. Monthly wages are Rs. 300,000 and will increase by 10 % as from March 2007. Allwages are paid in the last hebdomad of the same month.4. The gross net income per centum on goods sold is 25 % .5. Administration disbursals are expected to be Rs.

150,000 in January and will increase by20 % from the subsequent month. This figure includes a monthly charge of Rs. 5,000 inregard of depreciation of fixed assets. Administration disbursals are paid in the monththey are incurred.6.

Selling and distribution disbursals are expected to be Rs. 100,000 per month except forMarch 2007 when an advertisement run bing Rs. 120,000 will be paid for. Theadvertisement run will get down at the beginning of 2007. Selling disbursals whichare about half of selling and distribution disbursals, are paid for in the month theyare incurred and the staying balance will be paid in the subsequent month.

7. The company intends to buy and pay for new fixtures and adjustments at the terminal of April2007, bing Rs. 28,000.The company ‘s adviser suggests the followers at the beginning of January 2007, which mayaid to get the better of the job of the debt load.“ To deliver Rs. 1.5 million unsecured bonds of Rs.100/- each transporting a involvement rate of 12 %thstcollectible semi-annually, 30 September and 31 March.

They have been issued in 2002for a period of 10 old ages.However, the adviser estimated that the Beta of the company ‘s portions is 1.2 and therequired rate of return on the market portfolio is 16 % while the hazard free rate is 6.5 % .“ To cut down recognition gross revenues to 40 % and to detain payment of trade creditors by an extratwo hebdomads.“ To settle the OD balance in February.You are required to:st( a ) Fix a hard currency flow projection for the company for each of the three months to 31March 2007.

( 12 Marks )st( B ) Fix a jutting net income and loss history for the three months to 31 March 2007.( 10 Marks )( degree Celsius ) If the company implements the adviser ‘s suggestions, discuss and fix astatement with computations, which include the ways in which the company maycut down the corporate debt, as required by the adviser. ( 12 Marks )( vitamin D ) Compute the Company ‘s cost of debt, cost of equity and leaden mean cost of capital( WACC ) before and after implementing the adviser ‘s suggestions. State anypremises that you make. ( 6 Marks )( Entire 40 Marks )End of Section AngstromSociety of Certified Management Accountants of Sri Lanka 2Professional II Stage – Strategic Financial Management ( SFM )– — — — — — — — — — — — — — — — — — — – 3Section BAnswer any three ( 3 ) inquiriesQuestion No. 2 ( 20 Marks )( 1 ) De Mel and Company Ltd issued a new series of bonds on January 1, 1982. The bondswere sold at par value of Rs 1,000 each, transporting 12 % voucher, and to maturate in 30 old ages.

Coupon payments are made semi-annually on June 30 and December 31.You are required to reply the followers:( a ) What was the Output to Maturity ( YTM ) of De Mel ‘s bonds on January 1, 1982?( B ) What was the monetary value of the bond on January 1, 1987, 5 old ages subsequently, presuming that thedegree of involvement rates had fallen to 10 % ?( degree Celsius ) Find the current output and capital additions yield on the bond on January 1, 1987, giventhe monetary value as determined in portion ( B ) .( vitamin D ) On July 1, 2000, De Mel ‘s bonds were sold for Rs. 916.42.

What was theYTM at that day of the month? ( 10 Marks )( 2 ) La Mel Company is sing a period of rapid growing. Net incomes and dividends areexpected to turn at a rate of 15 % during the following 2 old ages, at 13 % in the 3rd twelvemonth, and at achangeless rate of 6 % thenceforth. La Mel ‘s last dividend was Rs. 1.15 and the needed rate ofreturn on the stock is 12 % .

You are required to:Thursday( a ) Calculate the value of the stock as at 17 March 2007.( B ) Calculate the monetary values of the stock as a consequence of different dividend growing rates.( degree Celsius ) Calculate the dividend output and capital additions yield for old ages one, two and three.

( 10 Marks )( Entire 20 Marks )Question No: 3 ( 20 Marks )( a ) Harrison Company is sing buying a smaller company, Morrison, in the samehazard category. Morroson ‘s Analyst undertakings that the amalgamation will ensue in incremental net hard currencyflows of Rs. 1.5 million in twelvemonth 1, Rs. 2 million in twelvemonth 2, Rs 3 million in twelvemonth 3 and Rs 5million in twelvemonth 4.

Morrison ‘s hard currency flows are expected to turn at a changeless rate of 5 % aftertwelvemonth 4. The acquisition would be made instantly and if it were undertaken, Morrison ‘spostmerger beta is estimated to be 1.5, and its postmerger revenue enhancement rate would be 40 % . The risk-free rate is 6 % , and the market hazard premium is 4 % .You are required to gauge the value of Morrison & A ; Harrison.

( 12 Marks )( B ) Rising star company plans to enlarge its capacity during the following twelvemonth. The addition incapacity will necessitate Rs 40,000,000 in extra assets. The house anticipates a net incomeof Rs 20,000,000 and follows a 60 % dividend payout policy. If lifting star desires tokeep its debt/assets ratio of 40 % , how much external equity and debt funding will berequired? ( 8 Marks )( Entire 20 Marks )Society of Certified Management Accountants of Sri Lanka 3Professional II Stage – Strategic Financial Management ( SFM )Question No: 4 ( 20 Marks )The Finance manager of Damian Villa Company expects to spread out its activities utilizing externalfinancess. The enlargement will be Rs 50 million with 5 old ages life clip.

The company ‘s current capital construction consists of Rs 30 million drifting rate loan, Rs. 50million 12 % unsecured bonds redeemable in 5 old ages, Rs 15 million nominal value of common portions ofRs.5 each, and Rs. 80 million militias. The company wishes to keep its capital construction afterthe new enlargement.The company ‘s current portion monetary value is Rs.

50, and debenture monetary value ex-interest is Rs.150. Unsecured bondsare to be redeemed at its par value of Rs 100 each.

Publishing costs of equity are expected to be 8 % of the sum raised. Unless there is a lower limitcapital of Rs 20 million is received, the publishing cost will increase well. Publishing costs ofnew unsecured bonds are estimated to be 4 % .Beta of Equity, of the company ex- dividend is Rs.12. Current dividend per portion is Rs 1 anddividends have grown by about 4 % per twelvemonth for the last four old ages. The market hazard freerate of return is 8 % and the market return is 12 % per twelvemonth.The corporate revenue enhancement rate is 30 % .

You are required to gauge the cost of capital of the new investing if:( a ) The internal beginnings of equity are used and debt finance is raised by a 7.5 % drifting ratebank loan with negligible publishing cost( B ) New unsecured bonds are issued at par of Rs 100 and equity are used. New equity may beassumed to be issued at the current market monetary value. Comment upon your findings. Stateclearly any premises that you make. ( Entire 20 Marks )Question No: 5 ( 20 Marks )st( a ) ABC Co Ltd ‘s balance sheet as at 31 December 2006 is shown below.ABC Ltd.

stBalance sheet as at 31 December 2006Rs 000 Rs 000Common stock 19,000 Plant and equipment 40,000Retained net incomes 25,000 Inventory 5,600Debt 3,600 Accounts receivable 10,000Current liabilities 10,000 Cash 2,00057,600 57,600Directors of ABC Ltd expect to declare dividends. In this accounting period ABC Ltd had a netincome of Rs. 5,000,000. It employs Rs. 3,600,000 debt transporting 10 % involvement charges. Theoverall capitalisation rate applicable to ABC Ltd is 15 % .

( I ) Briefly explain, as to how much ABC Ltd ‘s board of managers can lawfully pay dividends.( two ) Estimate the likely maximal dividend ABC Ltd can pay if it seeks to keep aminimal hard currency balance of Rs 1,000,000 and other plus balances at present degrees.( three ) Assuming that ABC Ltd is a quickly turning company that faces terrible trouble in raisingneeded capital and significant extra recognition gross revenues have been approved, is declaringdividends likely or improbable? ( 10 Marks )Society of Certified Management Accountants of Sri Lanka 4Professional II Stage – Strategic Financial Management ( SFM )– — — — — — — — — — — — — — — — — — — – 5( B ) Alex is an investor in the equity market of Sri Lanka. His current major portion ownership is900,000 portions of Magfin Company which late announced a 3-for-1 stock split ( wherethe par value of a portion is reduced to 1/3 ) . At the clip of the proclamation, the house ‘sstock monetary value of Rs.60 per portion represented a P/E ratio of 20.

The house follows a 50 % payoutdividend policy.You are required to:( I ) State what the market value of Alex ‘s shareholding will be, when the stock splitwas announced?( two ) Assuming that the Rs.60 monetary value has non impeded trading of the stock, what will bethe likely monetary value per portion of Alex ‘s stock, after the split?( three ) Compute the net incomes per portion before and after the stock split.( four ) If the Rs 60 stock monetary value has retarded trading of the stock, is Alex probably to profitfrom the split? ( 10 Marks )( Entire 20 Marks )Question No: 6 ( 20 Marks )( a ) Bower Company presently uses a truck that was purchased two old ages ago. It has six old agesof staying life. It can be sold for Rs. 300,000 now, or for Rs.

40,000 six old ages from now.Bower is offered a replacing truck that has a cost of Rs 800,000. Both trucks are of thesame type.

The replacement truck permits an end product enlargement, such that gross revenues would liftby Rs. 25,000 per twelvemonth. Further, the new truck has much greater efficiency to dooperating disbursals to worsen by Rs 15,500 per twelvemonth.Bower ‘s effectual revenue enhancement rate is 50 % , and its cost of capital is 15 % .You are required to:( I ) Advise Bower Company whether the replacing of the truck would be good.

( two ) How would your reply be changed if the six annual incremental grosss wereRs 20,000 yearly. ( 15 Marks )( B ) Discuss why struggles of involvement might be between stockholders and debt holders andtheir possible influence on the aims of the house. ( 5 Marks )( Entire 20 Marks )End of Section BEnd of Question Paper