Financial Management- Solution Manual-Assignment Answers

Q4) Portfolio Analysis

  1. Briefly describe the main two Types of Risk of an Investor and state the factors generating those Risks.

Briefly explain CAPM and Coefficient of Systematic Risk - Beta. Also state the 3 types of Beta with one liner definition.

  • Briefly explain how an Efficient Portfolio reduces the Risk of an Investor.
  1. Security A has an expected Return of 20% and standard deviation of 25% whereas Security B has an expected Return of 30% and standard deviation of 35%.

The Covariance of the Returns on these two securities is 230

Requirement

Determine the expected Return & Risk of a Portfolio made up of 30% of A and 70% of B.

  1. If the Average Variance of securities is 280 and the Average Co Variance is 150.

Requirement

Determine the expected Risk of an Equally Weighted Portfolio made up of 50 Securities.

Q5) Valuation of Securities

  1. Briefly explain the different basis of Valuation of Shares.

 

  1. Easy plc has just paid the dividend of 50p. The expected Return is 20% and 60% of the Profits are divided. Average Market Returns are 12% and the Return on Govt. Bond is 4% and Beta of the Security is 1.2

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Requirement

Determine the Market Price of the Share.

Q 6 Cost of Capital

Berap plc is financed by 7m $1 Ordinary Shares and $8m 8% Redeemable Debentures. Market Values are $1.20 Ex Dividend and 90% Ex Interest.

Apart from above Company has a Bank Loan of $2m at 8% and $1 Preference Shares of $1m with 12 p per share agreed dividend.

Company also has 3m Irredeemable Debentures at 12%.

An Ordinary Dividend of 10p has just been paid and future ordinary dividends expect to grow by 5%. Debentures are Redeemable in 5 Years’ time.

Requirement

  1. Calculate the Capital Structure of the Company
  2. Calculate the WACC of the Company

Q 7 Investment Appraisal

Robo Clean Co is a recently established innovation company. It currently has one product on the market, the ‘Robovac’, a robotic floor cleaner. This has been extremely successful. The company is currently developing a new robotic cleaner called ‘Robomum’ that vacuums, dusts and presses.

To date $120,000 has been spent on developing the product. The company has also incurred $250,000 of market research costs, although the invoice for these costs has only just been received and will be paid in January.

Since the set-up costs are substantial, a final decision now needs to be made as to whether it is viable to manufacture and sell ‘Robomum’. The following revenues and costs have been estimated:

  1. A new factory, to be used solely for the production of ‘Robomum’, will need to be This will take nearly a year to build and is expected to cost $11·75 million in total, payable in two instalments. The first instalment of

$6m will be paid at the start of the building work and the second instalment for the remaining balance will be paid when the building work has been completed at the end of the year.

  1. Robo Clean Co will immediately enter into a one-year contract with a project management company, who will oversee the building of the The total cost of this during the year will be $250,000.

Two production lines will need to be installed in the factory at a further cost of $1,500,000 payable at the end of the build in one year’s time.

  1. The machinery for the production of ‘Robomum’ also needs to be built-to-order and is expected to cost $2·5m, payable in one year’s time. Its terminal value is nil. Depreciation will be charged as soon as production commences (as soon as the build finishes in one year’s time) at 10% per annum on a straight-line basis. Maintenance costs for the machinery are estimated at $250,000 per
  2. Production and Sales will commence in the year following the Sales quantities and prices for ‘Robomum’ are expected to be as follows:
Years 1 2 3 & 4 5 to 9

Sales volume (’000 units)

5

10

(each year)

30

(each year)

50

Sales price ($) 1,000 800 700 500

It is anticipated that by the beginning of year 10, a new robotic helper will have replaced ‘Robomum’, hence there will be no further sales.

  1. Material costs for ‘Robomum’ are estimated at $125 per
  2. Labour costs are estimated at $100 per
  3. Fixed production overheads on the new factory are estimated at $240,000 per Variable production overheads are expected to be $50 per unit.
  4. Head office costs of $4·5m per annum will be allocated to ‘Robomum’ when production Of these costs, only $3·7m is incremental.
  5. The introduction of ‘Robomum’ is expected to adversely affect sales of ‘Robovac’. It is thought that, for every two units of ‘Robomum’ sold, one unit of ‘Robovac’ will be ‘Robovac’ is currently sold for $150 per unit and generates a net cash flow of $50 per unit.
  6. The company’s cost of capital is 5%.
  7. Assume that all cash flows occur at the end of the year, unless stated
  8. All workings should be in $’000, to the nearest $’000.

Required:

  • Using the discount tables, calculate the net present value (NPV) of the project at the company’s cost of Conclude as to whether Robo Clean Co should proceed with the Project.
  • Explain the main principles to differentiate between relevant and irrelevant costs for investment Wherever possible, use the costs of ‘Robomum’ to illustrate your answer.
  • Calculate the Payback (Simple & Discounted) of the Project.

Calculate the IRR of the Project.

  • Calculate the Profitability Index – PI of the following Projects and state which Project to be undertaken and why.

PV of Inflows Investment

Project A $5m $30m

Project B $3m $15m

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