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Paper F9
ZSE Co is concerned about exceeding its overdraft limit of $2 million in the next two periods. It has been experiencing
considerable volatility in cash ows in recent periods because of trading difculties experienced by its customers, who
have often settled their accounts after the agreed credit period of 60 days. ZSE has also experienced an increase in bad
debts due to a small number of customers going into liquidation.
The company has prepared the following forecasts of net cash ows for the next two periods, together with their
associated probabilities, in an attempt to anticipate liquidity and nancing problems. These probabilities have been
produced by a computer model which simulates a number of possible future economic scenarios. The computer model
has been built with the aid of a rm of nancial consultants.
Period 1 cash flow
$000
8,000
4,000
(2,000)
Probability
10%
60%
30%
Probability
30%
50%
20%
the
the
the
the
Discuss whether the above analysis can assist the company in managing its cash flows.
(13 marks)
(b) Identify and discuss the factors to be considered in formulating a trade receivables management policy for
ZSE Co.
(8 marks)
(c) Discuss whether profitability or liquidity is the primary objective of working capital management. (4 marks)
(25 marks)
YGV Co is a listed company selling computer software. Its profit before interest and tax has fallen from $5 million to
$1 million in the last year and its current financial position is as follows:
$000
Non-current assets
Property, plant and equipment
Intangible assets
Current assets
Inventory
Trade receivables
$000
3,000
8,500
11,500
4,100
11,100
15,200
26,700
Total assets
Current liabilities
Trade payables
Overdraft
Equity
Ordinary shares
Reserves
5,200
4,500
9,700
10,000
7,000
17,000
26,700
YGV Co has been advised by its bank that the current overdraft limit of $45 million will be reduced to $500,000
in two months time. The finance director of YGV Co has been unable to find another bank willing to offer alternative
overdraft facilities and is planning to issue bonds on the stock market in order to finance the reduction of the overdraft.
The bonds would be issued at their par value of $100 per bond and would pay interest of 9% per year, payable at the
end of each year. The bonds would be redeemable at a 10% premium to their par value after 10 years. The finance
director hopes to raise $4 million from the bond issue.
The ordinary shares of YGV Co have a par value of $100 per share and a current market value of $410 per share.
The cost of equity of YGV Co is 12% per year and the current interest rate on the overdraft is 5% per year. Taxation is
at an annual rate of 30%.
Other financial information:
Average gearing of sector (debt/equity, market value basis):
Average interest coverage ratio of sector:
10%
8 times
Required:
(a) Calculate the aftertax cost of debt of the 9% bonds.
(4 marks)
(b) Calculate and comment on the effect of the bond issue on the weighted average cost of capital of YGV Co,
clearly stating any assumptions that you make.
(5 marks)
(c) Calculate the effect of using the bond issue to finance the reduction in the overdraft on:
(i) the interest coverage ratio;
(ii) gearing.
(4 marks)
(d) Evaluate the proposal to use the bond issue to finance the reduction in the overdraft and discuss alternative
sources of finance that could be considered by YGV Co, given its current financial position.
(12 marks)
(25 marks)
[P.T.O.
The following draft appraisal of a proposed investment project has been prepared for the nance director of OKM Co by
a trainee accountant. The project is consistent with the current business operations of OKM Co.
Year
Sales (units/yr)
Contribution
Fixed costs
Depreciation
Interest payments
Taxable prot
Taxation
Prot after tax
Scrap value
Aftertax cash ows
Discount at 10%
Present values
1
250,000
$000
1,330
(530)
(438)
(200)
162
2
400,000
3
500,000
162
$000
2,128
(562)
(438)
(200)
928
(49)
879
$000
2,660
(596)
(437)
(200)
1,427
(278)
1,149
162
0909
147
879
0826
726
1,149
0751
863
4
250,000
$000
1,330
(631)
(437)
(200)
62
(428)
(366)
250
(116)
0683
(79)
5
$000
(19)
(19)
(19)
0621
(12)
A shareholder of QSX Co is concerned about the recent performance of the company and has collected the following
nancial information.
Year to 31 May
Turnover
Earnings per share
Dividend per share
Closing ex dividend share price
Return on equity predicted by CAPM
2009
$68m
589c
400c
$648
8%
2008
$68m
642c
385c
$835
12%
2007
$66m
617c
370c
$740
One of the items discussed at a recent board meeting of QSX Co was the dividend payment for 2010. The nance
director proposed that, in order to conserve cash within the company, no dividend would be paid in 2010, 2011
and 2012. It was expected that improved economic conditions at the end of this three-year period would make it
possible to pay a dividend of 70c per share in 2013. The nance director expects that an annual dividend increase of
3% per year in subsequent years could be maintained.
The current cost of equity of QSX Co is 10% per year.
Assume that dividends are paid at the end of each year.
Required:
(a) Calculate the dividend yield, capital gain and total shareholder return for 2008 and 2009, and briefly discuss
your findings with respect to:
(i) the returns predicted by the capital asset pricing model (CAPM);
(ii) the other financial information provided.
(10 marks)
(b) Calculate and comment on the share price of QSX Co using the dividend growth model in the following
circumstances:
(i) based on the historical information provided;
(ii) if the proposed change in dividend policy is implemented.
(7 marks)
(c) Discuss the relationship between investment decisions, dividend decisions and financing decisions in the
context of financial management, illustrating your discussion with examples where appropriate.
(8 marks)
(25 marks)
[P.T.O.
Formulae Sheet
Economic order quantity
2C0D
CH
MillerOrr Model
Return point = Lower limit + (
1
spread)
3
1
Spread = 3 4
interest rate
(( ) )
()
E ri = Rf + i E rm Rf
Vd 1 T
Ve
a =
e +
d
V
+
V
T
V
V
1
+
1
T
d
d
e
e
))
))
Po =
D0 1 + g
(r
e
d
ke +
k 1 T
WACC =
Ve + Vd
Ve + Vd d
(1 + i) = (1 + r ) (1 + h)
Purchasing power parity and interest rate parity
S1 = S0
(1 + h )
(1 + h )
c
F0 = S0
(1 + i )
(1 + i )
c
r = discount rate
n = number of periods until payment
Discount rate (r)
Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
1
2
3
4
5
0990
0980
0971
0961
0951
0980
0961
0942
0924
0906
0971
0943
0915
0888
0863
0962
0925
0889
0855
0822
0952
0907
0864
0823
0784
0943
0890
0840
0792
0747
0935
0873
0816
0763
0713
0926
0857
0794
0735
0681
0917
0842
0772
0708
0650
0909
0826
0751
0683
0621
1
2
3
4
5
6
7
8
9
10
0942
0933
0923
0941
0905
0888
0871
0853
0837
0820
0837
0813
0789
0766
0744
0790
0760
0731
0703
0676
0746
0711
0677
0645
0614
0705
0665
0627
0592
0558
0666
0623
0582
0544
0508
0630
0583
0540
0500
0463
0596
0547
0502
0460
0422
0564
0513
0467
0424
0386
6
7
8
9
10
11
12
13
14
15
0896
0887
0879
0870
0861
0804
0788
0773
0758
0743
0722
0701
0681
0661
0642
0650
0625
0601
0577
0555
0585
0557
0530
0505
0481
0527
0497
0469
0442
0417
0475
0444
0415
0388
0362
0429
0397
0368
0340
0315
0388
0356
0326
0299
0275
0305
0319
0290
0263
0239
11
12
13
14
15
(n)
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
1
2
3
4
5
0901
0812
0731
0659
0593
0893
0797
0712
0636
0567
0885
0783
0693
0613
0543
0877
0769
0675
0592
0519
0870
0756
0658
0572
0497
0862
0743
0641
0552
0476
0855
0731
0624
0534
0456
0847
0718
0609
0516
0437
0840
0706
0593
0499
0419
0833
0694
0579
0482
0402
1
2
3
4
5
6
7
8
9
10
0535
0482
0434
0391
0352
0507
0452
0404
0361
0322
0480
0425
0376
0333
0295
0456
0400
0351
0308
0270
0432
0376
0327
0284
0247
0410
0354
0305
0263
0227
0390
0333
0285
0243
0208
0370
0314
0266
0225
0191
0352
0296
0249
0209
0176
0335
0279
0233
0194
0162
6
7
8
9
10
11
12
13
14
15
0317
0286
0258
0232
0209
0287
0257
0229
0205
0183
0261
0231
0204
0181
0160
0237
0208
0182
0160
0140
0215
0187
0163
0141
0123
0195
0168
0145
0125
0108
0178
0152
0130
0111
0095
0162
0137
0116
0099
0084
0148
0124
0104
0088
0074
0135
0112
0093
0078
0065
11
12
13
14
15
[P.T.O.
Annuity Table
(1 + r)n
Present value of an annuity of 1 i.e. 1
r
Where
r = discount rate
n = number of periods
Discount rate (r)
Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
1
2
3
4
5
0990
1970
2941
3902
4853
0980
1942
2884
3808
4713
0971
1913
2829
3717
4580
0962
1886
2775
3630
4452
0952
1859
2723
3546
4329
0943
1833
2673
3465
4212
0935
1808
2624
3387
4100
0926
1783
2577
3312
3993
0917
1759
2531
3240
3890
0909
1736
2487
3170
3791
1
2
3
4
5
6
7
8
9
10
5795
6728
7652
8566
9471
5601
6472
7325
8162
8983
5417
6230
7020
7786
8530
5242
6002
6733
7435
8111
5076
5786
6463
7108
7722
4917
5582
6210
6802
7360
4767
5389
5971
6515
7024
4623
5206
5747
6247
6710
4486
5033
5535
5995
6418
4355
4868
5335
5759
6145
6
7
8
9
10
11
12
13
14
15
1037
1126
1213
1300
1387
9787
1058
1135
1211
1285
9253
9954
1063
1130
1194
8760
9385
9986
1056
1112
8306
8863
9394
9899
1038
7887
8384
8853
9295
9712
7499
7943
8358
8745
9108
7139
7536
7904
8244
8559
6805
7161
7487
7786
8061
6495
6814
7103
7367
7606
11
12
13
14
15
(n)
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
1
2
3
4
5
0901
1713
2444
3102
3696
0893
1690
2402
3037
3605
0885
1668
2361
2974
3517
0877
1647
2322
2914
3433
0870
1626
2283
2855
3352
0862
1605
2246
2798
3274
0855
1585
2210
2743
3199
0847
1566
2174
2690
3127
0840
1547
2140
2639
3058
0833
1528
2106
2589
2991
1
2
3
4
5
6
7
8
9
10
4231
4712
5146
5537
5889
4111
4564
4968
5328
5650
3998
4423
4799
5132
5426
3889
4288
4639
4946
5216
3784
4160
4487
4772
5019
3685
4039
4344
4607
4833
3589
3922
4207
4451
4659
3498
3812
4078
4303
4494
3410
3706
3954
4163
4339
3326
3605
3837
4031
4192
6
7
8
9
10
11
12
13
14
15
6207
6492
6750
6982
7191
5938
6194
6424
6628
6811
5687
5918
6122
6302
6462
5453
5660
5842
6002
6142
5234
5421
5583
5724
5847
5029
5197
5342
5468
5575
4836
4988
5118
5229
5324
4656
4793
4910
5008
5092
4486
4611
4715
4802
4876
4327
4439
4533
4611
4675
11
12
13
14
15