FIN2101 Business Finance
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FIN2101 Business Finance
SECTION A
Answer ALL questions.
Question 1
(a) “Shareholders’ main priority in seeking new investments is to raise the company’s
share value. Management may pursue job security, corporate luxury and higher remuneration” . This clearly depicts how agency problems exist between the owners and the management of a company.
Discuss TWO (2) ways in which such agency problems may be managed. (4 marks)
(b) Lux Paint and Japan Paint are competitors in the paint industry. You are provided
with selected financial information of Lux Paint in the table below:
Item |
Lux Paint |
|
|
Total Assets |
$500,000 |
Total Common Equity |
$380,000 |
Total Liabilities |
$120,000 |
|
|
|
|
Gross Profits |
$300,000 |
Earnings Before Interest and Tax |
$240,000 |
Earnings After Tax |
$160,000 |
|
|
|
|
Number of Outstanding shares |
30,000 |
Price Per Share |
$18 |
|
|
(i) Copy the table below to your answer script and calculate the stipulated ratios (to 2 decimal places) for Lux Paint.
|
Lux Paint |
Japan Paint |
Earnings Per Share |
|
$4.50 |
Price Earnings Ratio |
|
2.67x |
Book Value Per Share |
|
$12.00 |
Market Book Ratio |
|
1.00x |
(4 marks)
(ii) Based on the information given and your answers in part (i), evaluate which
company has performed better and provide your reasons. (8 marks)
(c) Financial ratio analysis is useful for evaluating a company’s performance over time and against its competitors. However, there are also limitations that we must be aware of when using ratio analysis. Discuss THREE (3) such limitations. (6 marks)
(d) Co. Alpha is a firm with $120,000 equity capital and $180,000 debt capital. It is considering an opportunity that will provide a net operating profit after-tax (NOPAT) of $48,000. Its corporate tax rate is 32% and after-tax weighted average cost of capital (WACC) is 12%.
Calculate the firm’s Economic Value Added (EVA) and evaluate if the firm should accept or reject this investment opportunity. (3 marks)
Question 2
(a) DMS Workspace forecasted its total funding requirements for the coming year as shown in the table below:
Month |
Total funding requirements (S$) |
January |
40,000 |
February |
120,000 |
March |
60,000 |
April |
50,000 |
May |
70,000 |
June |
70,000 |
July |
100,000 |
August |
60,000 |
September |
40,000 |
October |
70,000 |
November |
60,000 |
December |
100,000 |
The company was informed by its bank that short-term loans cost 5.5% p.a. and long-term loans cost 8.2% p.a. Calculate the costs of financing if the company were to adopt each of the following strategy:
(i) Aggressive funding strategy. (4 marks)
(ii) Conservative funding strategy. (4 marks)
(b) It is known that savings deposit accounts in Singapore generate very low returns,
some of which earn as little as 0.05% p.a. Despite this, companies may still place a significant amount of cash with banks.
(i) State THREE (3) reasons why a company needs to hold cash. (3 marks)
(ii) What is the alternative to holding cash if a company needs to maintain a
certain level of liquidity and yet improve its returns? Explain your choice. (3 marks)
(c) Meatfree Farm has a supplier offering credit terms of 2/45 net 60 for an invoice of $140,000.
(i) Calculate the cost of giving up the cash discount from the supplier. If the firm’s bank borrowing rate is 9.5%p.a., evaluate if the firm should take up or give up the cash discount. (3 marks)
(ii) When and how much should the firm pay its supplier? (2 marks)
(d) ABC Pte Ltd needs a $150,000 loan to digitalise its business and is currently evaluating two loan options.
(i) Bank X is willing to grant a 2-year fixed-rate loan at a premium of 1.2% and the PRIME rate is currently at 4.5%p.a. What is the interest rate that ABC must pay now? What happens to this interest rate if PRIME increases to 5.8%p.a. in one year’s time? (3 marks)
(ii) Bank Y offers ABC a one-year loan at a stated interest rate of 5.5% p.a. What
is the effective interest rate of the loan if the interest is to be paid at the beginning of the loan? (3 marks)
SECTION B
Answer ALL questions.
Question 3
(a) Sanctuary Ltd is considering an investment in a garden mowing machine that costs
$650,000. The machine would be fully depreciated to zero value over five years using the straight-line depreciation method.
With the new machine, the firm is projected to generate an additional $350,000 annually in sales revenue and an additional annual cost of $120,000. It also needs an additional net working capital of $60,000 to fund its accounts receivable, accounts payable and inventories. The firm’s cost of capital is 5% and tax rate is 20%.
(i) State the THREE (3) key motives for capital expenditures. (3 marks)
(ii) Calculate the Initial Investment (II) of this investment. (3 marks)
(iii) Calculate the annual Operating Cash Flow (OCF) over the next five years. (3 marks)
(iv) If the firm can sell the machine for $50,000 at the end of the fifth year, calculate the Terminal Cash Flow (TCF). (3 marks)
(v) Given your answers above, calculate the investment’s Net Present Value
(NPV). Should the firm go ahead with the purchase of the machine? Why? (6 marks)
(b) Delta Investment Ltd is currently evaluating two projects, each costing S$500,000.
The projected cash inflows from the projects are shown below:
|
Project A |
Project B |
Year |
Cash Inflow ($) |
Cash Inflow ($) |
1 |
$140,000 |
$180,000 |
2 |
$140,000 |
$150,000 |
3 |
$140,000 |
$120,000 |
4 |
$140,000 |
$110,000 |
(i) Compute the payback periods for the TWO (2) projects. (4 marks)
(ii) If the firm can only undertake ONE project, which project should the firm accept based on the payback periods? Explain. (3 marks)
Question 4
(a) Digital Inc. needs to raise funds to buy a new building to expand its business. It is
considering the use of either long-term debt or common equity to finance this investment proposal.
(i) Discuss TWO (2) differences between debt and common equity as a source of financing. (4 marks)
(ii) If Digital Inc. wishes to use common equity to finance the investment, it may
do so via a RIGHTS ISSUE or a PRIVATE PLACEMENT. Discuss these two methods of raising equity, including the differences in the investors and the reasons for raising funds via such methods. (6 marks)
(iii) Instead of buying the building, Digital Inc. could also consider leasing it.
Discuss TWO (2) advantages and TWO (2) disadvantages of leasing the building versus buying it. (4 marks)
(b) Canvas Ltd is a semiconductor company in Singapore that exports most of its
products overseas. The company has just received an order to export A$250,000 worth of goods to Australia and will receive the payment in Australian dollars in one month’s time. The current spot rate is A$1 = S$1.00.
To hedge against this foreign currency transaction, Canvas has been advised to enter into a forward transaction with its bank at a rate of A$1 = S$0.98
(i) Name THREE (3) factors that may affect the exchange rate risk that Canvas is exposed to. (3 marks)
(ii) If the firm hedges its foreign currency risk, what is its cost of hedging via the forward transaction? (4 marks)
(iii) If the firm chooses not to hedge its foreign currency risk, what is its exchange
gain or loss (in Singapore dollars) in one month’s time if the prevailing spot rate then is A$1 = S$1.03? (4 marks)
2023-02-27