FIMP.L-IV-Solution-April-2019-.pdf - ICMAB

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THE INSTITUTE OF COST AND MANAGEMENT ACCOUNTANTS OF BANGLADESH CMA APRIL, 2019 EXAMINATION

PROFESSIONAL LEVEL-IV

SUBJECT: 401. FINANCIAL MANAGEMENT Model Solution

Solution to the question No. 01

(c) Answer: 300,000 - 275,000 = 25,000 units decline in sales Price = P = $4,200,000/300,000 = $14

Variable cost per unit = VC/PU = $3,300,000/300,000 = $11 Reduction in profit contribution from decline in sales

= (300,000 - 275,000 units) × ($14 - $11) = $75,000 Cost of marginal investment in A/R:

Turnover of A/R with proposed plan = 360/30 = 12

Average investment with proposed plan = = $252,083 Turnover of A/R with present plan = 360/36 = 10

Average investment with present plan = = $330,000 Reduced investment in A/R = ($330,000-$252,083) = $77,917

Reduction in cost of marginal investment in A/R = 77,917 × (0.15) = $11,688 Reduction in marginal bad debts:

Bad debts with present plan = (0.012) ×($4,200,000) = $50,400 Bad debts with proposed plan = (0.008) × ($275,000) × (14) = $30,800 Reduction in bad debts = $19,600 Net loss from implementing proposed plan = - $75,000 + $11,688 + $19,600 = - $43,712

This proposal is not recommended.

(d)

Solution to the question No. 2 (b)

(i) Market Cap = 60 million shares × $20 share = $1200 million

(ii) Market Cap = (60 million shares × $20 share) - $200 million Debt - $200 million Cash =

$800 million

(iii) Number of shares repurchased = = 20 million

(iv) Number of shares repurchased = = 20 million

i

ii

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Number of Shares outstanding = 60 million - 20 million repurchased = 40 million shares

(v) Number of shares repurchased = = 20 million

Number of Shares outstanding = 60 million - 20 million repurchased = 40 million shares Price per share = ($1200 million - $300 million - $100 million)/40 million shares = $20 share (vi) d'Anconia Copper's = = 1:4

=

= 0.20

→for every $1 invested you need $0.80 in equity and $0.20 in debt

Pre levering your portfolio consisted of 300 shares × $20 = $6000 in stock. Of this you need to sell 20% to reinvest into bonds so you need to sell ($6000 × .2 = $1200/$20 per share = 60 shares of stock and then lend this money out.

Solution to the question No.2 (c)

(i) OED: ri = rrf + β(rm - rrf) = .03 + 1.4(.05) = .10 or 10.0%

ORD: ri = rrf + β(rm - rrf) = .03 + 1.1(.05) = .085 or 8.5%

(ii) OED: V = = = $7500

GCSD: ri = rrf + β(rm - rrf) = .03 + 0.8(.05) = .07 or 7.0%

V = = = $15,000

(iii) Oil Exploration Division:

ri = rrf + β(rm - rrf) = .03 + 1.4(.05) = .10 or 10.0%

V = = = $7,500

Oil Refining:

ri = rrf + β(rm - rrf) = .03 + 1.1(.05) = .085 or 8.5%

V = = = $8,750

Convenience Store; V = $15,000

Total Value = 7,500 + 8,750 + 15,000 = $31,250 (iv) Value of Oil Exploration Division: $7,500

Value of Oil Refining Division: $8,750 Value of Convenience Store: $15,000

Total Value = 7500 + 8750 + 15,000 = $31,250 βWO = wOEβOE+ wORβOR + wCSβCS

= x(1.4) + x(1.1) + x(0.8) = 1.028

(v) Cost of Capital of Oil Exploration Division: 10.0%

Cost of Capital of Oil Refining: 8.5%

Cost of Capital of Convenience Store: 7.0%

Total Value = 7500 + 8750 + 15,000 = $31,250 rWO = wOE rOE+ wOR rOR + wCS rCS

= (.10) + (.085) + (.07) = .0814

Solution to the question No.3 (b)

(i) Explanation: βu = βE + βD

Using the comparable firm βu = (1.8) + (0.4) = 0.96 Now plugging in this for Nielson gives us

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βu= 0.96 = (βE) + (0) →βE =0.96 × 1.5 = 1.44

(ii) Using the CAPM model, Equity cost of capital (re) = rf + βE(rm - rf) = 5% + 1.44(10% - 5%) = 12.2%

(iii) rwacc = re + rd(1 - Tc) = (.122) + (.05)(1 - .40) = 9.1333%

Value = = = 779.22 of this amount or is equity Equity = 779.22 × 2/3 = $519.48 million/25 million shares = $20.78 per share

Solution to the question No 3 (c)

(i) Shares = = 6,250,000 new shares (ii) Shares = = 5,000,000 new shares (iii) Shares = = 6,250,000 new shares

Total shares = 20M (existing) + 6.25M new = 26.25 million.

Total Value = existing value + $100M new factory

Total Value = $20 per share (true value) × 20 million shares + $100 M = $500 million Price per share = = $19.05

(iv) Shares = = 5M new shares

Total shares = 20M (existing) + 5M new = 25 million.

Total value = existing value + $100M new factory

Total value = $20 per share (true value) × 20 million shares + $100 = $500 million Price per share = = $20.00

Solution to the question No 3 (d) (i)

(ii) The firm should lease the aircraft. Because this option requires less investment.

CFt

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Solution to the question No.4 (b)

(i) αi = E[rs] - rf - βi(rm - rf), where rf - βi(rm - rf) is the CAPM return Stock

Expected

Return Volatility Beta

CAPM

Return Alpha

Taggart Transcontinental 8% 28% 1.2 9.00% -1.00%

Rearden Metal 13% 40% 1.7 11.50% 1.50%

Wyatt Oil 7% 20% 0.8 7.00% 0.00%

Nielson Motors 10% 32% 1.3 9.50% 0.50%

(ii) Both Rearden Metal and Nielson Motors represent buying opportunities due to their positive expected alphas. Only Taggart Transcontinental represents a selling opportunity due to its negative expected alpha.

Solution to the question No. 4 (c)

(i) The maximum dividend per share the firm can pay is:

$11,600,000/2,000,000 shares = $5.80/share

(ii) 2-for-1 Cash dividend Stock dividend

*(4,000,000 shares at $0.50 par)

**(2,100,000 shares at $1 par) (iii) (1) $10/share

(2) $19.05; 2,000,000 shares × $20/share = $40,000,000 market value No. of shares after the stock dividend = 2,100,000 shares

Stock price per share = $40,000,00/2,100,000 = $19.05

Solution to the question No, 5 (a)

(i) = (1 + ) - 1 = (1.102) - 1 = .093636 or 9.36%

(ii) NPV£ = -20 + + + = £14.613 million

(iii) NPV£ = -20 + + + = £14.613 million NPV$ = NPV£ × S = £14.613 × 1.8862/£ = $27.562 million

Solution to the question No.5 (b)

(i) First, since Martin is paying for the merger with stock we need to calculate the number of shares that Martin must issue:

Number of new shares = = = 1.25 million

shares. So the total number of shares in the new merged firm equals 5 million (existing Martin shares) + 1.25 million new shares = 6.25 million shares.

Total earnings for the merged firm = earnings from Martin + earnings from Luther.

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Earnings from Martin = EPS × shares outstanding = $3.00 × 5 million = $15 million Earnings from Luther = EPS × shares outstanding = $2.50 × 2 million = $5 million Total earnings = $15 + $5 = $20 million

EPS merged firm = = $3.20

(ii) Pre-merger P/E = = 10.67 Post-merger P/E:

We know from req (i) EPS = $3.20 Post merger P/E = = 10.00

Solution to the question No. 5 (c)

(i) If Nico purchases the stock at $22 and sells at $30 for 100 shares, he will earn a profit of $8 per share or $800 in total.

(ii) If Nico were to purchase the option rather than the underlying stock, Nico would be able to sell the stock for $3,000 (100 shares × $30 per share) after purchasing the option for $2,500 (100 shares × $25 per share) earning a gross margin of $500 on the transaction. Of course, Nico has to consider that the option originally cost him $200.

Therefore, Nico's net profit is only $300.

(iii) To break even on the option transaction, the stock price would have to rise to $27 per share. [exercise price $25 plus option cost per share $2 (i.e. $200/100)]

(iv) Based on parts (i) and (ii) above, Nico should buy the stock rather than the option.

= THE END =