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In the United Kingdom the traditional view has been for the interests of a firm to equate with those of the
current equity shareholders. But is it now recognized that this is much too narrow. The employees and
lenders to a business certainly have a legitimate interest, probably also the government. Some companies
would add a company?s suppliers and customers as part of the stakeholders. Perhaps the
general public also belongs to the list.
Each of the members of the above list has different key objectives. For example employees might want their
labour remuneration to be larger, while the shareholders want labour costs to be low so that higher profits
can lead to higher dividends. Shareholders might be uninterested whether the company invests
in „unethical?areas of business such as armaments or cigarettes, as long as their investment is profitable,
while certain sections of the public will discourage unethical products.
The value of an investment in terms of financial management theory is the present value of the cash returns
available from the investment. However this varies from investor to investor depending on personal discount
rate, tax position, period of investment, etc. For example the value of a share bought today and expected to
be sold in five years time will be the present value of the five years dividends plus the present value of the
expected net realizable value at the end of the holding period. So the value of the same share will be different
to different shareholders, and the job of the managers to maximize the total value becomes impossible.
A further problem arises in the conflict between short-term results and long-term viability. Managers might
be on annual service contracts and therefore are motivated to report the highest possible short-term profits.
This might involve cutting down on revenue investment such as maintaining fixed assets, advertising,
research costs, etc. Such a policy is in the best interests of management, since they will be paid a bonus for
reporting good results, but is not in the long-term interests of the company.
Financial managers often deal with the above conflicts by adopting a satisfying approach rather than an
optimizing approach. The hope to please everyone by following moderate policies which are not exclusively
in the interests of one of the sectional stakeholders of the business.
Kavungya answered the question on April 22, 2021 at 06:03
- Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but...(Solved)
Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but as a result of the closure of many coal mines and
depleted coal resources, is now considering what type of new power station to invest in. The alternatives
are a gas fueled power station, or a new type of efficient nuclear power station.
Both types of power station are expected to generate annual revenues at current prices of Sh.800 million.
The expected operating life of both types of power station is 25 years.
Other information:
(i) Whichever power station is selected, electricity generation is scheduled to commence in three
years time.
(ii) If gas is used most of the workers at the existing coal fired station can be transferred to the new
power station. After tax redundancy costs are expected to total Sh.4 million in year four. If nuclear
power is selected fewer workers will be required and after tax redundancy costs will total Sh.36
million, also in year four.
(iii) Both projects would be financed by Euro-bond issues denominated in Euros. The gas powered
station would require a bond issue at 8.5% per year, the bond for the nuclear project would be
at 10% reflecting the impact on financial gearing of a larger bond issue.
(iv) Costs of building the new power stations would be payable in two equal installments in one and two
years time.
(v) The existing coal fired power station would need to be demolished at a cost of Sh.10 million in
three years time.
(vi) The company‟s equity beta is expected to be 0.7 if the gas station is chosen and 1.4 if
the nuclear station is chosen. Gearing (debt to equity plus debt) is expected to be 35% with gas
and 60% with nuclear fuel.
(vii) The risk free rate is 4.5% per year and the market return is 14% per year. Inflation is currently 3%
per year in the UK and an average of 5% per year in the member countries of the Euro bloc in
the European Union.
(viii) Corporate tax is at the rate of 30% payable in the same year that the liability arises.
(ix) Tax allowable depreciation is at the rte of 10% per year on a straight line basis.
(x) At the end of twenty-five years of operations the gas plant is expected to cost Sh.25 million
(after tax) to demolish and clean up the site. Costs of decommissioning the nuclear plant are
much less certain, and could be anything between Sh.500 million and Sh.1,000 million (after tax)
depending upon what form of disposal is available for nuclear waste.
Required:
(a) Estimate the expected NPV of EACH OF investment in a gas fueled power station and
investment in a nuclear fueled power station.
State clearly any assumptions that you make.
(NB: It is recommended that annuity tables are used wherever possible)
(b) Discuss other information that might assist the decision process.
Date posted: April 22, 2021. Answers (1)
- Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.(Solved)
Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.
Date posted: April 22, 2021. Answers (1)
- Justify and criticize the usual assumption made in financial management literature that the objective of a
company is to maximize the wealth of its shareholders. (Do...(Solved)
Justify and criticize the usual assumption made in financial management literature that the objective of a
company is to maximize the wealth of its shareholders. (Do not consider how this wealth is to be measured).
Date posted: April 21, 2021. Answers (1)
- Discuss how government actions can influence the tasks of the financial manager and explain how these actions can affect the attainment of financial objectives.(Solved)
Discuss how government actions can influence the tasks of the financial manager and explain how these actions can affect the attainment of financial objectives.
Date posted: April 21, 2021. Answers (1)
- Maltec plc is a company that has diversified into five different industries in five different countries. The investments are each approximately equal in value. The...(Solved)
Maltec plc is a company that has diversified into five different industries in five different countries. The investments are each approximately equal in value. The company's objective is to reduce risk
through diversification, and it believes that the return on any investment is not correlated with the return on any other investment. The estimated risk and return (in present value terms) of the five investments are shown below:
Required:
(a) Estimate the risk and return of the portfolio of five investments, and briefly explain the significance of your results.
(b) Discuss the validity to investors of Maltec's objective of risk reduction through international
diversification.
Date posted: April 21, 2021. Answers (1)
- Discuss the main features of:
(i) Corporate share repurchases (buy-backs); and
(ii) Share (stock) splits;
and why companies might use them. Include in your discussion comment on the...(Solved)
Discuss the main features of:
(i) Corporate share repurchases (buy-backs); and
(ii) Share (stock) splits;
and why companies might use them. Include in your discussion comment on the possible effects on share
price of share repurchases and share (stock) splits in comparison to the payment of dividends.
Date posted: April 21, 2021. Answers (1)
- The finance department of Beela Electronics has been criticized by the company's board of
directors for not undertaking an assessment of the political risk of the...(Solved)
The finance department of Beela Electronics has been criticized by the company's board of
directors for not undertaking an assessment of the political risk of the company's potential
direct investments in Africa. The board has received an interim report from a consultant that provides
an assessment of the factors affecting political risk in three African countries. The report assesses key variables on a scale of –10 to +10, with –10 the worst possible score and +10 the best.
The consultant suggests that economic growth and political stability are twice as important as the
other factors.
The consultant states in the report that previous clients have not invested in countries with a total weighted score of less than 30 out of a maximum possible 100 (with economic growth and political stability double weighted). The consultant therefore recommends that no investment in Africa should be undertaken.
Required:
(a) Discuss whether or not Beela electronics should use the technique suggested by the consultant in
order to decide whether or not to invest in Africa.
(b) Discuss briefly how Beela might manage political risk if it decides to invest in Africa.
Date posted: April 21, 2021. Answers (1)
- Give the reasons on why mergers and acquisitions should be undertaken to achieve corporate diversification
only.(Solved)
Give the reasons on why mergers and acquisitions should be undertaken to achieve corporate diversification
only.
Date posted: April 20, 2021. Answers (1)
- Outline the potential problems in the achievement of synergies.(Solved)
Outline the potential problems in the achievement of synergies.
Date posted: April 20, 2021. Answers (1)
- Explain the possible synergies that might occur in mergers and acquisitions.(Solved)
Explain the possible synergies that might occur in mergers and acquisitions.
Date posted: April 20, 2021. Answers (1)
- Assume that your company has invested in 100,000 shares of Unglow plc, a manufacturer of light bulbs. You are concerned about the recent volatility in...(Solved)
Assume that your company has invested in 100,000 shares of Unglow plc, a manufacturer of light bulbs. You are concerned about the recent volatility in Unglow's share price due to the unpredictable weather
in the United Kingdom. You wish to protect your company's investment from a possible fall in
Unglow's share price until winter in three months time, but do not wish to sell the shares at present. No dividends are due to be paid by Uniglow during the next three months.
Market data:
Uniglow's current share price: Sh.20
Call option exercise price: Sh.20
Time to expiry: 3 months
Interest rates (annual): 6%
Volatility of Uniglow's shares 50% (standard deviation per year)
Assume that option contracts are for the purchase or sale of units of 1,000 shares.
Required:
(i) Devise a delta hedge that is expected to protect the investment against changes in the share price
until winter. Delta may be estimated using N(d1).
(ii) Comment upon whether or not such a hedge is likely to be totally successful.
Date posted: April 20, 2021. Answers (1)
- Briefly discuss the meaning and importance of the terms 'delta', 'theta' and 'vega' (also known as
kappa or lamba) in option pricing.(Solved)
Briefly discuss the meaning and importance of the terms 'delta', 'theta' and 'vega' (also known as
kappa or lamba) in option pricing.
Date posted: April 20, 2021. Answers (1)
- The managers of Strayer plc are investigating a potential Sh.25 million investment. The investment would be a diversification away from existing mainstream activities and into...(Solved)
The managers of Strayer plc are investigating a potential Sh.25 million investment. The investment would be a diversification away from existing mainstream activities and into the printing industry. Sh.6 million of the investment would be financed by internal funds, Sh.10 million by a rights issue and Sh.9 million by long term loans. The investment is expected to generate pre-tax net cash flows of approximately Sh.5 million per year, for a period of ten years. The residual value at the end of year ten is forecast to be Sh.5 million after tax. As the investment is in an area that the government wishes to develop, a subsidized loan of Sh.4 million out of the total Sh.9 million is available. This will cost 2% below the company's normal cost of long-term debt finance, which is 8%.
Strayer's equity beta is 0.85, and its financial gearing is 60% equity, 40% debt by value. The average
equity beta in the printing industry is 1.2, and average gearing 50% equity, 50% debt by market value.
The risk free rate is 5.5% per annum and the market return 12% per annum.
Issue costs are estimated to be 1% for debt financing (excluding the subsidized loan), and 4% for
equity financing. These costs are not tax allowable.
The corporate tax rate is 30%.
Required:
(a) Estimate the Adjusted Present Value (APV) of the proposed investment.
(b) Comment upon the circumstances under which APV might be a better method of evaluating a
capital investment than Net Present Value (NPV).
Date posted: April 20, 2021. Answers (1)
- Summarized financial details of Jetter plc are shown below:
Reserves ...(Solved)
Summarized financial details of Jetter plc are shown below:
Reserves 122
12% debentures June 2006 71
243
The company's ordinary shares are currently trading at Sh.22.00, and the debentures at
Sh.105.50. The debenture is redeemable at its par value of Sh.100.
The company's equity beta is 1.25.
Jetter plc is considering investing in one of three projects. The company has Sh.50 million that is currently earning 5.8% in short-term money market deposits. Any surplus funds after the investment in one of the projects will continue to be invested in the money market.
The company has employed an external consultant to estimate risk/return data relevant to the three projects.
Required:
(a) Evaluate which project should be selected. Do not use information provided later in the question
requirements in your evaluation.
State clearly any assumptions that you make in all parts of this question.
(b) Estimate Jetter's cost of capital prior to undertaking the investment. Briefly discuss (do not
calculate) what effect the project selected in (a) is likely to have on Jetter's cost of capital.
The profitability index of 1.3 also relates to this part of the question.
(c) The consultant has suggested that beta estimates should be adjusted by using the formula: [(0.67 x
unadjusted beta) + 0.33] in any estimate of required returns.
Briefly discuss the reason for using an adjusted beta such as this:
Date posted: April 20, 2021. Answers (1)
- Summarized financial data for TYR plc is shown below:
TYR's cost of equity is estimated to be 11%.
Required:
(a) Explain, with supporting evidence, the current dividend policy...(Solved)
Summarized financial data for TYR plc is shown below:
TYR's cost of equity is estimated to be 11%.
Required:
(a) Explain, with supporting evidence, the current dividend policy of TYR plc, and briefly discuss
whether or not this appears to be successful.
(b) Identify and consider additional information that might assist the managers of TYR in assessing
whether the dividend policy has been successful.
(c) Evaluate whether or not the company's share price at the end of 2001 was what might have
been expected from the Dividend Growth Model. Briefly discuss the validity of your findings.
Date posted: April 20, 2021. Answers (1)
- Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of Sh.2 par value common stock outstanding. When CMC's founder, who has...(Solved)
Components Manufacturing Corporation (CMC) has an all-common-equity capital structure. It has 200,000 shares of Sh.2 par value common stock outstanding. When CMC‟s founder, who has also its research director and most successful inventor; retired unexpectedly to the South Pacific in late 2000, CMC was left suddenly and permanently with materially lower growth expectations and relatively few attractive new investment opportunities. Unfortunately, there was no way to replace the founder's contributions to the firm.
Previously, CMC found it necessary to plow back most of its earnings to finance growth, which averaged 12 percent per year. Future growth at a five percent rate is considered realistic, but that level would call for an increase in the dividend payout. Further, it now appears that new investment projects with at least the 14 percent rate of return required by CMC's stockholders (ks= 14%) would amount to only Sh.800,000 for 2001in comparison to a projected Sh.2,000,000 of net income. If the existing 20 percent dividend payout were continued, retained earnings would be Sh.1.6 million in 2001, but as noted, investments that yield the 14 percent cost of capital would amount to only Sh.800,000.
The one encouraging thing is that the high earnings from existing assets are expected to continue, and
net income of Sh.2 million is still expected for 2001. Given the dramatically changed
circumstances, CMC's management is reviewing the firm's dividend policy.
(a) Assuming that the acceptable 2001 investment projects would be financed entirely by earnings
retained during the year, calculate DPS in 2001 if CMC follows the residual divided policy.
(b) What payout ratio does your answer to part a imply for 2001?
(c) If a 60 percent payout ratio is maintained for the foreseeable future, what is your estimate of
the present market price of the common stock? How does this compare with the market price
that should have prevailed under the assumptions existing just before the news
about the founder's retirement? If the two values of P0 are different, comment on why.
(d) What would happen to the price of the stock if the old 20 percent payout were continued? Assume
that if this payout is maintained, the average rate of return on the retained earnings will fall to 7.5
percent and the new growth rate will be
g = (1.0 – Payout ratio)(ROE)
= (1.0 – 0.2)(7.5%) = (0.8)(7.5%) = 6.0%
Date posted: April 20, 2021. Answers (1)
- Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal:
LEI's expected net income this year is Sh.34,285.72; its established dividend payout...(Solved)
Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal:
LEI's expected net income this year is Sh.34,285.72; its established dividend payout ratio is 30
percent; its marginal tax rate is 40 percent; and investors expect earnings and dividends to grow at a
constant rate of nine percent in the future. LEI paid a dividend of Sh.3.60 per share last hear, and its stock currently sells at a price of Sh.60 per share.
LEI can obtain new capital in the following ways:
Common: New common stock has a flotation cost of ten percent for up to Sh.12,000 of new stock and
20percent for all common stock over Sh.12,000.
Preferred: New preferred stock with a dividend of Sh.11 can be sold to the public at a price of Sh.100
per share. However, flotation costs of Sh.5 per share will be incurred for up to Sh.7,500 of preferred stock, and flotation costs will rise to Sh.10 per share, or ten percent, on all preferred stock over Sh.7,500.
Debt: Up to Sh.5,000 of debt can be sold at an interest rate of 12 percent; debt in the range of Sh.5,001 to Sh.10,000 must carry an interest rate of 14 percent; and all debt over Sh.10,000 will have an interest rate of 16 percent.
LEI has the following independent opportunities:
(a) Find the break points in the MCC schedule
(b) Determine the cost of each capital structure component.
(c) Calculate the weighted average cost of capital in the interval between each break in the
MCC schedule.
(d) Calculate the IRR for Project E.
(e) Construct a graph showing the MCC and IOS schedules.
(f) Which projects should LEI accept?
Date posted: April 20, 2021. Answers (1)
- Summarized below are financial data in respect of Kevinko Ltd:
As a result of recent capital expansion, market analysts expect pre-tax earnings to increase at the...(Solved)
Summarized below are financial data in respect of Kevinko Ltd:
As a result of recent capital expansion, market analysts expect pre-tax earnings to increase at the rate of 25% for the next two years before reverting to the company's existing growth rate.
The company's overall beta is 0.763 while the beta for debt is 0.20. The risk free rate is 12%
and the market return is 17%. Currently, the shares of the company are selling at Sh.21.70 on the stock
exchange cum 1996 dividend. The debentures are selling at Sh.8 9.50 ex-interest.
The corporate tax is 35%.
Required:
a) Using the dividend growth model, estimate what a fundamental analyst might consider to be the
intrinsic value of Kevinko's shares. Comment on this value.
b) If interest rates were to go by 5% what would be the effect of this increase on the company's share
price?
c) What is the difference between fundamental analysis and a chartist's analysis in the valuation of
shares?
Date posted: April 20, 2021. Answers (1)
- Dove Construction Company Ltd made a Sh.100 million bondage 5 years ago when interest rates were
substantially high. The interest rates have now fallen and the...(Solved)
Dove Construction Company Ltd made a Sh.100 million bondage 5 years ago when interest rates were
substantially high. The interest rates have now fallen and the firm wishes to retire this old debt and replace it with a new and cheaper one. Given here below are the details about the two bond issues:
Old Bonds: The outstanding bonds have a nominal value of Sh.1,000 and 24% coupon interest rate. They
were issued 5 years ago with a 15-year maturity. They were initially sold a their nominal value of Sh.1,000 and the firm incurred Sh.390,000 in floatation costs. They are callable at Sh.1,120.
New Bonds: The new bonds would have a Sh.1,000 nominal value and a 20% coupon interest rate. They
would have a 10-year maturity and could be sold at their par value. The issuance cost of the new bonds
would be Sh.525,000.
Assume the firm does not expect to have any overlapping interest and is in the 35% tax bracket.
Required:
a) Calculate the after-tax cash inflows expected from the unamortized portion of the old bond's
issuance cost.
b) Calculate the annual after-tax cash inflows from the issuance of the new bonds assuming the 10-year
amortization.
c) Calculate the after-tax cash outflow from the call premium required to retire the old bonds.
d) Determine the incremental initial cash outlay required to issue the new bonds.
e) Calculate the annual cash-flow savings, if any, expected from the bond refunding.
f) If the firm has a 14% after-tax cost of debt, would you recommend the proposed refunding and
reissue? Explain.
Date posted: April 20, 2021. Answers (1)
- Explain the types of political risks that face multi-national firms in foreign countries.(Solved)
Explain the types of political risks that face multi-national firms in foreign countries.
Date posted: April 20, 2021. Answers (1)