UNAM Financial Management A (AMF 3871) Test 2 12 April 2019 QUESTION 1 40 MARKS The following income statement relates to XV Ltd for the year ended 31 March 2018: Sales (3 000 units at N$200) 600,000 Variable costs (3.000 units at N$100) _300,000 Contribution 300,000 Fixed costs 200,000 Earnings before interest and tax 100,000 Interest expense 50,000 Earnings before tax 50,000 Taxation 14,000 Earnings after tax 36,000 Required: (a) Calculate the degree of operating leverage. (2 marks) {b) Calculate the degree of financial leverage. (2 marks) {c) Calculate the degree of combined leverage, (2 marks) (d) Calculate the break-even point in units and in value (NS) (4 marks)QUESTION 2 20 MARKS is available and any one out of the following two projects A The following limited informatio and Bis to be selected. A B State of Economy Probability Cash Flow (N$m) Cash Flow (NS m) Strong 0.2 700 550 Normal os 400 400 Weak 03 200 300 Required: (a} Calculate expected returns, standard deviation and coefficient of variation for A and 8 projects. (12 marks) (b) Taking the role of an investment adviser, comment which one of the projects should ‘be selected. a (2 marks) (c) Define the following terms and explain the nature of risk being assessed? i, Business risk [3 marks] ii, Financial risk [3 marks] QUESTION 3 20 MARKS: Long Ld has an equity beta of 1,20. It is established that the expected return on the market equals 12.5% and the yield on government bonds is currently 7.5%, Long has issued bonds and its NS 100 par- value bond is currently trading at NS95. ‘The coupon rate is 8%. The maturity date is five years’ time and the corporate tax rate is 32%. Interest is payable annually in arrears. The company has just paid the coupon interest rate for the eurrent year, REQUIRED: MARKS 3.1. | What is Long’s cost of equity, based on CAPM? 4 3.2 _ | What is the after tax cost of debt? 6 Long paid dividend of NSO.12 per share and the dividend per share 3.3 _| 8 expected to grow at 7% indefinitely. The company share price is A NS$2,30. Calculate the company's cost of equity using dividend growth model. 43.4 _ | Whatis the weighted average cost of eapital (WACC) ifthe target a 4 | debt equity ratio is 50%? (Use cost of equity as per CAPM). TOTAL MARKS 20Financial Management A Suggested solutions 1. (a) Contribution’ EBM (00 000/100 000= 3 (b) EBIT/ EBIT-I= 100 000/50 000- 2 (©) DOL x DEL, 6 Test 2: 12 April 2019 (a) FC/Contribution per unit= 200 000/100= 2000 units Value 200 x 2000 = N$ 400 000 2 (a) Project A_ Probability [Cash | Expected | Deviation | Deviation ] Variance flow | value/return | (R-Re) | squared (NS m)_| (Sm) (R-Re)2 Strong [0.2 700 140 300 90000 18000 Normal [0.5 400 | 200 0 0 0 Weak 3 200 [60 (200) 40000 12000 400 : 30000 Expected Value/Return (R) = N$400m o*= 30000 = NS173.21m CV= o/R = 173,21/400= 0.433 x100 = 43.3% Project B Probability [Cash [Expected | Deviation [Deviation [Variance | flow | Value/return | (R-Re) | squared (N$m)_| (NS m) (R-Re)2 Strong | 0.2 550 110 150 22500 | 4500 Normal [0.5 400 [200 of 0 Weak [0.3 300 [90 | (100) 10000 | 3000 400 7500 Expected return (R) = NS. 400m = 7500 9= 86,60 CV= GIR = 86.60/400= 0.2165 x 100 = 21.65% (b) All the projects yield the same expected return of NS 400 million, However, project B is less risky than project A as its standard deviation is 86.6 million compared to project A With a standard deviation of 173.21 million and thus Project B should be selected.QuelShon 3 31 Ke= Res beta (marvel Rue fr Fea = Ts bya (last) = 754re(S) 2 $54 & 2 13S 7adéer est oP Acht = JasKobk = Gags A : y 0°32 a a? kes vt : - pagt Jj by = ola + DRX g = DI2Z+ OR KO oF — DAL + Cov BY = o0-1asy Ke - Olas oe Kiso 2 posse f oF = (2-58 [ ee Bu Capito Struc bare cost Wace 33) gag, oth Debt 33-33 ‘ tquily ooot {RSA 18 A ue fetes “Tool: Wot h — ——_——— note: AC deh equity is %, Then delet rece 6 bo dhol debt roo = 0-0 T+ 05BU AS grees Zot suggertect Select 5-19 IKHWEZI GROUP LIQUIDITY, 208 20.7 Current ratio 4,35 1,59 Quick ratio 0.60 0.76 Ikhwezi's liquidity position has deteriorated from 20.7 to 20.8. Ikhwezi is less able to meet its short-term obligations. If we analyse the structure of the current assets then it is evident that Ikhwezi has recorded a significant decline in its most liquid current asset, “bank balances, deposits and cash", which moved from R60.5m in 20.7 to R16.9m in 20.8. This is further evidenced by the significant increase in the “amounts due to bankers" from R16.1m in 20.7 to R71.7m in 20.8. Therefore, not only have the overall liquidity ratios reflected declines, but there has been a serious deterioration in Ikhwez''s cash position. The amount owing to creditors has increased by 35% which materially exceeds the increase in sales (22%). The increase in the "amounts due to bankers" and creditors does not appear to represent a switching of funding from long term to short-term sources of finance, as long term liabilities have also reflected a large increase. ASSET MANAGEMENT 20.8 207 Inventory Turnover 516 542 Average daily sales (365 days) 6.9214m 5.6627m Average Collection Period 52 days 49 days Fixed Asset Turnover 3.70 3.48 Total Asset Turnover 1.61 1.56 Ikhwezi has recorded a slight decline in its inventory turnover ratio from 5.42 in 20.7 to 5.16 in 20.8. Sales have grown less than inventory levels over the year. The average collection period has lengthened from 49 days in 20.7 to 52 days in 20.8. Ikhwezi is waiting slightly longer to receive its cash from its debtors. Ikhwezi has improved its utilisation of its fixed assets, as the Fixed Asset Turnover has increased from 3.48 to 3.70. The Total Asset Turnover has shown a slight increase, due to a slightly weaker management over current assets but improved management over the company's fixed assets. Fixed assets increased by 15%, while sale increased by 22%. DEBT MANAGEMENT 202, Debt Ratio [817.7/1568.9] 40.7% Times Interest Earned 13.4 Ikhwezi has increased its level of financial gearing. The debt ratio has increased from 40.7% in 20.7 to 52.1% in 20.8. This was primarily due to the acquisition of the remaining 46% of Metal Box’. with effect from 1 August 20.8. Most shareholders in Metal Box chose the cash offer, resulting in an increase in the debt ratio, but a substantial decline in outside shareholders' interest in the group. "This question is based on an actual company. Students were not told that the company hadl bought out the minority shareholders of « major subsidiary and therefore are not expected to include this section in their solution. However, it is useful to understand how acquisitions can change the ratios of a company and so we have included this fact here.Ikhwezi has recorded a slight increase in the Times Interest earned ratio from 13.1 in 20.7 to 14.6 in 20.8. As the acquisition of Metal Box took place in August 20.8, the increased interest charges are only reflected for 2 months of the financial year. ‘The Times Interest ratio is high, in absolute terms and the debt ratio is reasonable in relation to other industrial companies. 5-19 (continued) PROFITABILITY 20.8 20.7 Operating profit margin 12.3% 11.7% Return on Assets (operating profi/Total Assets) 19.9% 18.3% Return on Equity (ordinary shareholders) 25% 22% Ikhwezi has experienced a slight increase in the operating profit margin as a percentage of sales from 11.7% in 20.7 to 12.3% in 20.8. There have been increases in Ikhwezis Return on Assets and Return on Equity ratios from 20.7 to 2 ure Mi tare) (irs i au enc Net working capital (CA-CL) Total assets x Net working capitalltotal assets: 0.14488 1.2000 0.17385 Retained income 3447 Total assets x Rotained earningsiotal assets 0.21780 1.4000 0.30491 EBIT 310.9 Total assets 7568.9 EBITRotal assets 0.19816 3.3000 0.65304 Mkt cap (Share price x No.of shares) +Prea(Rtm) 4,199.4 Book value of debt (LT debt + curent Fblites) 87.7 Mkt Cap/Book value of debt 1.4594 0.6000 0.87564 Sales Total assets 7.5689 Sales/total assets 1.6102 1.0000 4.61024 z= 36Te9 As the Z score of 3,61698 is significantly above 2.99, the Ikhwezi group is very unlikely to fail in terms of Altman's original Z score model.Ge ‘Net working capital (CA-CL) 227.3 Total assets 7,568.9 Net working capital/total assets Retained income Total assets 7,568.9 Retained eamings/total assets BIT 310.9 Total assets 7,568.9 EBITiotal assets Book value of Equity (NAV) 6144 Book value of debt (LT debt + cucent fabities) eT Mkt Cap/Book value of debt 0.14488 0.21780 0.19816 0.7514 6.5600 3.2600 6.7200 0.95040 0.71001 1.33166 0.78894 78103 In terms of Altman's 2” model, the firm is unlikely to fail as the Z” score is above 2,60,