Financial Reporting and Corporate Finance

(11BSB660) Coursework
20 November 2011 Introduction to the Coursework The objective of the coursework is to revise the corporate finance concepts learnt in class, and to apply the tools learnt to a case study. Students will have to carry out some independent study beyond the core readings to be able to complete the assignment. The Case Zulu is a privately owned company whose financial year-end is in December. It is 1 January 2011, and Zulu plans expanded its business by acquiring another company called Yankee. The net assets of Yankee are worth $30 million, and Zulu has agreed to pay $40 million for the business. Zulu estimates that it needs $50 million in total in order to fund this acquisition and related capital expenses. It is contemplating four ways to raising the required funds, namely i. ii. iii. iv. Using internal funds, by selling off $50 million of its long term investments. Issuing 50 million new common shares to the public at $1 per share in an Initial Public Offering (IPO). It expects to pay $0.03 dividend per ordinary share this financial year. Taking up a bank loan for the full amount of $50 million. Issuing 50 million preference shares to private investors at $1 per share, which promises a preference dividend of $0.03 per share.

Zulu has prepared a pro-forma set of financial statements (in the Appendix), on how they would look at financial year-end 2011, under each funding scenario.

Required (Part 1 Financial Statement Analysis): 1. Calculate the key financial ratios of Zulu as at 31 December 2011, under the four funding scenarios. (20 marks) 2. Comment briefly on any differences in the financial ratios, and compare the impact on Zulus financial condition, under the four scenarios. (20 marks)

3. What is the estimated value of Zulus i) property/plant/ equipment and ii) net assets, before the acquisition of Yankee? If Zulu paid $40 million for Yankee, whose net assets are only worth $30 million, what does the difference represent and how is it reflected in the accounts? How was this value reflected in the accounts of Zulu and Yankee before the acquisition? (10 marks)

4. Discuss the assumptions made and limitations of your analysis as a basis for measuring the performance of the two companies and the new group (10 marks)

Required (Part 3 Cost of Capital & CAPM) Suppose you are given the following additional information Risk Free Rate = 3% Market Return = 8% Yield on 30-year bonds = 4% Beta of Equity = 1.3 Beta of Preference = 1.1 Marginal Tax Rate = 18% Share Price of Zulu = $0.60 Preference Price of Zulu = $0.60 Market Value of Zulus Debt = $1.20 for every $1 in the balance sheet

(i) Using Book Values: Based on the book values given in the financial statements only, and not using any of the data in the above table, estimate the Weighted Average Cost of Capital (WACC) of Zulu as at December 2011. (ii) Using Capital Asset Pricing Model: Now recalculate the Costs of Equity, Debt & Preference Shares by using the relevant additional information in the given table. (iii) Using Market Values: According to your Coursework Readings, WACC should be based on market values and not book values of the respective capital used. Using the costs of capital based on the CAPM method, and the market values of Zulus capital, recalculate Zulus WACC. (20 marks)

6. Comment critically on the values of the cost of equity, debt and preference shares based on the book value and CAPM methods, and which method gives values of WACC that make more sense, based on what you have read. (20 marks)

Financial Statements of Zulu

Internal FY12/11
10,000 (4,000) 6,000 (2,000) (200) 3,800 (1,150) 2,650 (477) 2,173 0 (600) 1,573 20,000

Profit & Loss Statement (SGD 000)

Total Revenue Cost of Revenue Gross Profit Depreciation Selling/General/Admin. Expenses EBIT Interest Expense (5%) Profit Before Tax Provision for Income Tax (18%) Net Profit After Tax Dividends - Preference ($0.03) Dividends - Ordinary ($0.03) Retained Earnings No of Shares

IPO FY12/11
10,000 (4,000) 6,000 (2,000) (200) 3,800 (1,150) 2,650 (477) 2,173 0 (2,100) 73 70,000

Debt FY12/11
10,000 (4,000) 6,000 (2,000) (200) 3,800 (3,650) 150 (27) 123 0 (600) (477) 20,000

Pref Share FY12/11

10,000 (4,000) 6,000 (2,000) (200) 3,800 (1,150) 2,650 (477) 2,173 (1,500) (600) 73 20,000

Internal Balance Sheet (SGD 000)

Cash Accounts Receivable Inventory Other CA (Balancing Item) Total Current Assets Property/Plant/Equipment Goodwill Long Term Investments Total Assets Accounts Payable Current Portion of LT Debt Income Taxes Payable Total Current Liabilities

IPO FY12/11
8,973 3,000 200 (123) 12,050 45,000 10,000 50,000 117,050 7,000 3,000 477 10,477

Debt FY12/11
6,923 3,000 200 927 11,050 45,000 10,000 50,000 116,050 7,000 3,000 27 10,027

Pref Share FY12/11

8,973 3,000 200 (123) 12,050 45,000 10,000 50,000 117,050 7,000 3,000 477 10,477

FY12/11
8,973 3,000 200 1,377 13,550 45,000 10,000 0 68,550 7,000 3,000 477 10,477

Long Term Debt Other Liabilities Total Liabilities Retained Earnings Preference Shares Common Stock Total Equity Total Liabilities & Shareholders' Equity Total Common Shares ($1)

20,000 6,500 36,977 11,573 0 20,000 31,573 68,550 70,000

20,000 6,500 36,977 10,073 0 70,000 80,073 117,050 70,000

70,000 6,500 86,527 9,523 0 20,000 29,523 116,050 20,000

20,000 6,500 36,977 10,073 50,000 20,000 80,073 117,050 20,000

Internal Cash Flow (SGD 000)

Net Profit After Tax Depreciation Change in Working Capital Cash from Operating Activities Purchase of Fixed Assets Acquisition of Business Cash from Investing Activities Issuance of Common Stock ($1) Issuance of Pref Shares ($1) Sale of Long Term Investments Long Term Debt Issued Cash from Financing Activities Net Change in Cash Net Cash - Beginning Balance Net Cash - Ending Balance

IPO FY12/11
2,173 2,000 (200) 3,973 (5,000) (40,000) (45,000) 50,000 0 0 0 50,000 8,973 0 8,973

Debt FY12/11
123 2,000 (200) 1,923 (5,000) (40,000) (45,000) 0 0 0 50,000 50,000 6,923 0 6,923

Pref Share FY12/11

2,173 2,000 (200) 3,973 (5,000) (40,000) (45,000) 0 50,000 0 0 50,000 8,973 0 8,973

FY12/11
2,173 2,000 (200) 3,973 (5,000) (40,000) (45,000) 0 0 50,000 0 50,000 8,973 0 8,973

Notes: The data highlighted in yellow is to alert you to the key data which are different from the other corresponding columns.