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# BFN1014 Financial Management I (Semester 53) GROUP ASSIGNMENT II Question 1: Assume that you are an assistant to Fernandez, senior

vice presidents of a mutual fund company. Your company had been recently requested by a major client to present an investment seminar, and Fernandez, who will make the actual presentation, have asked you to help him. To illustrate the common stock valuation process, Fernandez has asked you to analyze the ABC Berhad (ABC), a semiconductor manufacturer. You are to answer the following questions. a) Describe briefly the legal rights and privileges of common stockholders. b) i. Write out a formula that can be used to value any stock, regardless of its dividend pattern. ii. What is a constant growth stock? How are constant growth stocks valued? c) Assume that ABC has a beta coefficient of 1.2, that the risk-free rate is 7%, and that the required rate of return on the market is 12%. What is ABCs required rate of return? d) Assume that ABC is a constant growth company whose last paid dividend (D ) was
0

RM2.00 and whose dividend is expected to grow indefinitely at a 6% rate. i. What is the firms expected dividend stream over the next 3 years? ii. What is its current stock price? iii. What is the stocks expected value 1 year from now? e) Now assume that the stock is currently selling at RM30.29. What is its expected rate of return? f) What would the stock price be if its dividends were expected to have zero growth? g) Now assume that ABC is expected to experience non-constant growth of 30% for the next 3 years, then to return to its long-run constant growth rate of 6%. What is the stocks value under these conditions? What are their expected dividend yield in Year 1? Year 4? h) Suppose ABC is expected to experience zero growth during the first 3 years and then to resume its steady-state growth of 6% in the fourth year. What would its value be then? What would its expected dividend yield be in Year 1? In Year 4?

Question II: Ahmad Car Wash is contemplating the purchase of a new high-speed washer to replace the existing washer. The existing washer was purchased two years ago at an installed cost of RM120,000; it was being depreciated under MACRS using a 5-year recovery period. The existing washer is expected to have a usable life of five more years. The new washer costs RM210,000 and requires RM10,000 in installation costs; it has a 5-year usable life and would be depreciated under MACRS using a 5-year recovery period. The existing washer can currently be sold for RM140,000 without incurring any removal or cleanup costs. To support the increased business resulting from purchase of the new washer, accounts receivable would increase by RM80,000, inventories by RM60,000, and accounts payable by RM116,000. At the end of five years, the existing washer is expected to have a market value of zero; the new washer would be sold to net RM58,000 after removal and cleanup costs and before taxes. The firm pays taxes at a rate of 40 percent on both ordinary income and capital gains. The firms current cost of capital is 15%. The firm requires all projects to have a maximum payback period of 4 years. The estimated profits before depreciation and taxes over the five years for both the new and the existing washer are shown in the following table. Profits before Depreciation and Taxes Year New Existing Washer Washer 1 RM86,000 RM52,000 2 RM86,000 RM48,000 3 RM86,000 RM44,000 4 RM86,000 RM40,000 5 RM86,000 RM36,000 To Do: 1. Calculate the initial investment associated with the replacement of the existing washer with the new one. 2. Determine the terminal cash flow expected at the end of year 5 from the proposed washer replacement. (Hint: Consider the salvage value of new washer in year 5) 3. Calculate the incremental operating cash inflows associated with the proposed washer replacement. (Note: Be sure to consider the terminal value and working capital recovery in year 5) 4. Use your findings in part 1, 2 and 3 to depict on a time line the relevant cash flows associated with the proposed washer replacement. 5. Use the payback period to assess the acceptability of the proposed washer-replacement decision. 6. Use the following sophisticated capital budgeting techniques to assess the acceptability of the proposed washer-replacement decision. (a) Net Present Value (NPV) (b) Internal Rate of Return (IRR) 7. Use the findings in part 5 & 6, what would be your recommendation to Ahmad Car Wash? Explain.

QUESTION 3 GBC Corp. has annual sales of RM50,735,000 and maintains an average inventory level of RM15,012,000. The average accounts receivable balance outstanding is RM10,008,000. The company makes all purchases on credit and has always paid on the 30th day. The company is now going to take full advantage of trade credit and pay its suppliers on the 40th day. If sales can be maintained at existing levels but inventory can be lowered by RM1,946,000 and accounts receivable lowered by RM1,946,000, what will be the net change in the cash conversion cycle? (Assume there are 365 days in the year.)

QUESTION 4 Coleman Technologies is considering a major expansion program that has been proposed by the companys information technology group. Before proceeding with the expansion, the company needs to develop an estimate of its cost of capital. Assume that you are an assistant to Jerry Lehman, the financial vice-president. Your first task is to estimate Colemans cost of capital. Lehman has provided you with the following data, which he believes may be relevant to your task: The firms tax rate is 40 percent. The current price of Colemans 12 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is \$1,153.72. Coleman does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firms 10 percent, \$100 par value, quarterly dividend, perpetual preferred stock is \$111.10. Colemans common stock is currently selling at \$50 per share. Its last dividend (d0) was \$4.19, and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. Colemans beta is 1.2, the yield on t-bonds is 7 percent, and the market risk premium is estimated to be 6 percent. For the bond-yield-plus-risk-premium approach, the firm uses a 4 percentage point risk premium. Colemans target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60 percent common equity.

To structure the task somewhat, Lehman has asked you to answer the following questions. a. What sources of capital should be included when you estimate Colemans weighted average cost of capital (WACC)? b. Should the component costs be figured on a before-tax or an after-tax basis? c. Should the costs be historical (embedded) costs or new (marginal) costs? d. What is the market interest rate on Colemans debt and its component cost of debt? e. Should you use the nominal cost of debt or the effective annual cost? f. What is the firms cost of preferred stock?

g. Colemans preferred stock is riskier to investors than its debt, yet the preferred yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Hint: think about taxes.) h. Why is there a cost associated with retained earnings? i. j. What is Colemans estimated cost of common equity using the CAPM approach? What is the estimated cost of common equity using the cash flow approach?

k. What is the bond-yield-plus-risk-premium estimate for Colemans cost of common equity? l. What is your final estimate for ks?

m. Explain in words why new common stock has a higher percentage cost than retained earnings. n. Coleman estimates that if it issues new common stock, the flotation cost will be 15 percent. Coleman incorporates the flotation costs. What is the estimated cost of newly issued common stock, taking into account the flotation cost? o. What is Colemans overall, or weighted average, cost of capital (WACC)? ignore flotation costs. p. What factors influence Colemans composite WACC?

IMPORTANT NOTE: The assignment must be submitted to your respective lecturers room BEFORE 5PM on THURSDAY, 2 MAY 2013. All works should be typewritten. (Times New Roman 12; 1.5 spacing). The SUBMISSION FORM must be attached together with the hardcopy as the cover during submission. Please note that this is a GROUP ASSIGNMENT, individual assignment will not be accepted under any circumstances. ANY LATE SUBMISSION WILL NOT BE ACCEPTED UNDER ANY CIRCUMSTANCE. Please be reminded that plagiarism is a very serious offence. Only original works will be accepted for assessment. IN THE CASE OF PLAGIARISM, THE GROUP INVOLVED SHALL RECEIVE ZERO MARK FOR THIS ASSESSMENT WITHOUT FUTHER NEGOTIATION.