FM303. CHAPTERS COVERED : CHAPTERS 5, 8 and 9. LEARNER GUIDE : UNITS 1, 2 and 3.1 to 3.3. DUE DATE : 3:00 p.m. 19 MARCH 2013

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1 Page 1 of 11 ASSIGNMENT 1 ST SEMESTER : FINANCIAL MANAGEMENT 3 () CHAPTERS COVERED : CHAPTERS 5, 8 and 9 LEARNER GUIDE : UNITS 1, 2 and 3.1 to 3.3 DUE DATE : 3:00 p.m. 19 MARCH 2013 TOTAL MARKS : 100 INSTRUCTIONS TO CANDIDATES FOR COMPLETING AND SUBMITTING ASSIGNMENTS The complete Instructons to Students for Completng and Submttng Assgnments must be collected from any IMM GSM offce, the relevant Student Support Centre or can be downloaded from the IMM GSM webste. It s essental that the complete nstructons be studed pror to commencng your assgnment. The followng ponts hghlght only a few mportant notes. 1. You are requred to submt ONE assgnment per subject. 2. The assgnment wll contrbute 20% towards the fnal examnaton mark, and the other 80% wll be contrbuted by the examnaton, however, the examnaton papers wll count out of 100%. 3. Although your assgnment wll contrbute towards your fnal examnaton mark, you do not have to earn credts for admsson to the examnatons; you are automatcally accepted on regsterng for the exam. 4. Number all the pages of your assgnment (e.g. page 1 of 4) and wrte your name and surname, student number and subject at the top of each page. 5. The IMM GSM requres assgnments to be presented n a typed format, on plan A4 paper. Unless otherwse specfed, ths assgnment must be completed wthn a lmt of 1500 words, excludng the bblography. Students who exceed the word lmt may fnd that only part of the submtted assgnment wll be marked. 6. A separate assgnment cover, whch s provded by the IMM GSM, must be attached to the front of each assgnment. 7. Retan a copy of each assgnment before submttng, n case the orgnal does not reach the IMM GSM. 8. The assgnment due date refers to the day up to whch assgnments wll be accepted for markng purposes. The deadlne s 3:00 p.m. on 19 March Late assgnments wll be accepted, but 25 marks wll be deducted from the maxmum mark, f receved after 3:00 p.m. on 19 March 2013 and up to 5:00 p.m. the followng day, after whch no assgnments wll be accepted. 9. If you fal to follow these nstructons carefully, the IMM Graduate School of Marketng cannot accept responsblty for the return of the assgnment. It may even result n your assgnment not beng marked. Results wll be avalable on the IMM GSM webste, on 3 May 2013.

2 Page 2 of 11 SPECIFIC INSTRUCTIONS: Answer ALL questons The use of calculators s permtted. Show ALL calculatons. Read all questons carefully to determne exactly what s requred before attemptng to answer. Number your answers clearly and set them out under approprate headngs and sub-headngs. QUESTION 1 [40] For each of the questons below you are provded wth alternatves, a- e. You are requred to select the most approprate/ correct answer by wrtng only the queston number and the respectve letter for the answer n your assgnment. Each correct answer s awarded two marks. E.g b 1.1 Whch of the followng best descrbes free cash flow? a. Free cash flow s the amount of cash flow avalable for dstrbuton to all nvestors after all necessary nvestments n operatng captal have been made. b. Free cash flow s the amount of cash flow avalable for dstrbuton to shareholders after all necessary nvestments n operatng captal have been made. c. Free cash flow s the net change n the cash account on the balance sheet. d. Free cash flow s equal to net ncome plus deprecaton. e. Free cash flow s equal to the cash flow from non-taxable transactons. 1.2 An analyst has acqured the followng nformaton regardng Company A and Company B: Company A has a hgher net cash flow than Company B. Company B has hgher net ncome than Company A. Company B has a hgher operatng cash flow than Company A. The companes have the same tax rate, the same level of captal, and the same cost of captal (WACC). Assume that non-cash revenues equal zero for both companes, and that deprecaton s the only non-cash expense for both companes. Whch of the followng statements based on the nformaton gven s most correct? a. Company A has a hgher deprecaton expense. b. Company A has a lower level of operatng ncome (EBIT). c. Company A has a lower EVA. d. No fnancal conclusons can be drawn from the nformaton gven. e. Company A should be declared nsolvent.

3 Page 3 of Olver Shpyard has R20 mllon n total operatng captal. The company s WACC s 10 percent. The company has the followng statement of comprehensve ncome: R mllon Sales 10.0 Operatng costs (6.0) Operatng ncome (EBIT) 4.0 Interest expense (2.0) Earnngs before taxes (EBT) 2.0 Taxes (40%) (0.8) Net ncome 1.2 What s Olver s EVA? a. R b. -R c. R d. R e. R Hayes FOOD has R300 mllon worth of ORDINARY equty on ts statement of fnancal poston, and 6 mllon ssued shares. The frm s Market Value Added (MVA) s R162 mllon. What s the frm s share prce? a. R 23 b. R 32 c. R 50 d. R 77 e. R Byrd Lumber has 2 mllon ssued shares. On the balance sheet the company has R40 mllon worth of ordnary equty. The frm s share prce s R15 a share. What s the frm s Market Value Added (MVA)? a. (R80 mllon) b. (R20 mllon) c. (R10 mllon) d. R20 mllon e. R80 mllon

4 Page 4 of A company has the followng statement of fnancal poston. Cash 10 Accounts payable 20 Short-term nvestments 20 Accruals 30 Accounts recevable 30 Notes payable 20 Inventory 40 Current labltes 70 Current assets 100 Long-term debt 30 Net fxed assets 80 Ordnary equty 10 Retaned earnngs 70 Total assets 180 Total labltes & Equty 180 What s ts net operatng workng captal? a. R10 b. R20 c. R30 d. R40 e. R A company has the followng statement of comprehensve ncome. R Sales Operatng costs (700) Deprecaton (100) Operatng ncome (EBIT) 200 Interest expense (50) Earnngs before taxes (EBT) 150 Taxes (40%) (60) Net ncome 90 What s ts net operatng proft after taxes (NOPAT)? a. R 90 b. R120 c. R150 d. R180 e. R Bates Motors has the followng nformaton for the prevous year: Net ncome R 200 Net operatng proft after taxes (NOPAT) R 300 Total assets R Total operatng captal R 800 The nformaton for the current year s: Net ncome R 500 Net operatng proft after taxes (NOPAT) R 400 Total assets R Total operatng captal R 900

5 Page 5 of 11 Usng the nformaton provded on the prevous page, what s the free cash flow (FCF) for the current year for Bates Motors? a. R100 b. R200 c. R300 d. R400 e. R Casey Motors recently reported the followng nformaton: Net ncome R Tax rate 40% Interest expense R Operatng captal R 9 mllon After-tax cost of captal 10% What s the EVA for Casey Motors? a. (R ) b. (R ) c. R0 d. R e. R Whch of the followng statements s NOT correct? a. The corporate valuaton model can be used even for a company that does not pay dvdends. b. The corporate valuaton model dscounts free cash flows by the requred return on equty. c. The corporate valuaton model can be used to fnd the value of a dvson. d. An mportant step n applyng the corporate valuaton model s forecastng the pro forma fnancal statements. e. Free cash flows must grow at a constant rate n order to fnd the horzon, or termnal, value A company forecasts free cash flow of R40 mllon n three years. It expects the free cash flow to grow at a constant rate of 5 percent thereafter. If the weghted average cost of captal s 10 percent and the cost of equty s 15 percent, what s the horzon value to the nearest mllon? a. R280 mllon b. R400 mllon c. R420 mllon d. R800 mllon e. R840 mllon

6 Page 6 of Usng the corporate valuaton model, the value of a frm s operatons s R750 mllon. The company s balance sheet shows R50 mllon n short-term nvestments that are unrelated to operatons. The balance sheet also shows R100 mllon n accounts payable, R100 mllon n notes payable, R200 mllon n long-term debt, R40 mllon n ordnary equty (par plus pad-n-captal), and R160 mllon n retaned earnngs. What s your best estmate for the market value of equty? a. R200 mllon b. R300 mllon c. R400 mllon d. R500 mllon e. R600 mllon 1.13 A company forecasts the followng free cash flows. If the weghted average cost of captal s 13 percent and the free cash flows are expected to contnue growng at the same rate after Year 3, what s the Year 0 value of operatons to the nearest mllon? Year Free cash flow (R mllon) - R 20 R 40 R 42 a. R382 mllon b. R425 mllon c. R460 mllon d. R475 mllon e. R488 mllon If a person requres a greater return when rsk ncreases, that person s sad to be: a. rsk-seekng. b. rsk-ndfferent. c. rsk-averse. d. rsk-aware. e. All of the above Last year Mke bought 100 of Blue Rbbon Corporaton ordnary shares for R53 per share. Durng the year he receved dvdends of R1.45 per share. The shares are currently sellng for R60 per share. What rate of return dd Mke earn over the year? a percent b percent c percent d percent e percent.

7 Page 7 of The of an asset s the change n value plus any cash dstrbutons expressed as a percentage of the ntal prce or amount nvested. a. return b. value c. rsk d. probablty e. varance Rsk averson s the behavor exhbted by managers who requre a(n). a. ncrease n return, for a gven decrease n rsk b. ncrease n return, for a gven ncrease n rsk c. decrease n return, for a gven ncrease n rsk d. decrease n return, for a gven decrease n rsk e. None of the above The of an event occurrng, s the percentage chance of a gven outcome. a. dsperson b. standard devaton c. probablty d. relablty e. varance probablty dstrbuton shows all possble outcomes and assocated probabltes for a gven event. a. A dscrete b. An expected value c. A bar chart d. A contnuous e. A skewed Gven the followng expected returns and standard devatons of assets B, M, Q, and D, whch asset should the prudent fnancal manager select? Asset Expected Return Standard Devaton B 10% 5% M 16% 10% Q 14% 9% D 12% 8% a. Asset B b. Asset M c. Asset Q d. Asset D e. Assets B and D (20 x 2) (40)

8 Page 8 of 11 QUESTION 2 [15] Jacques-Lous s searchng for a share to nclude n hs current share portfolo. He s nterested n Idon Ltd. He has been mpressed wth the company s computer products and beleves Idon s an nnovatve market player. However, Jacques-Lous realses that any tme you consder a so-called hgh-tech share, rsk s a major concern. The rule he follows s to nclude only securtes wth a coeffcent of varaton of returns below Jacques-Lous has obtaned the followng prce nformaton for the perod 2006 through Idon shares, beng growth-orented, dd not pay any dvdends durng these four years. Share Prce Year Begnnng End 2006 R R R R R R R R Requred: (Show all workngs and round all answers to two decmal places.) Calculate the rate of return for each year ( ) for Idon shares. (4) Assume each year s return s equally probable. Calculate and clearly ndcate the average return over ths tme perod. (1) Calculate the varances for each year ( ) for Idon shares. (4) (The followng headngs are provded n order to layout your answers.) Share Prce (2.1.1) (2.1.3) Year Begnnng End Movement % Return Varance (Return Avg Return) Usng the varances calculated n Calculate the standard devaton of returns ( r ) over the past four years (Treat ths data as a sample). (2) Indcate the followng tems clearly n your workngs for r : Sum of varances Sample dvsor Varance 2.3 Based on your answers to and 2.2 determne the coeffcent of varaton (CV) of returns for the securty. (2) 2.4 How would you descrbe the Idon share n term of ts rsk and volatlty? (1) 2.5 Gven the calculaton n 2.3 and your vew on the rsk and volatlty of the share, what would you advse Jacques-Lous regardng the ncluson of Idon shares n hs portfolo? (1)

9 Page 9 of 11 QUESTION 3 [25] Three assets, F. G and H, are currently beng consdered by Polokwane Industres. The probablty dstrbutons of expected returns for these assets are shown n the followng table: Asset F Asset G Asset H j Prj Return, rj Prj Return, rj Prj Return, rj % % % % % % % % % % 0.2 0% % % 3.1 Calculate the expected value of return for each of the three assets. Indcate clearly whch asset provdes the largest expected return. (10) (The followng table s provded n order to layout your answer.) Rate of return Probablty Weghted value (2 Decmal places) Expected return r P r r P r n r r P 1 r Asset F Asset G Asset H

10 Page 10 of Calculate the standard devaton for each of the three assets returns. Go on to dscuss whch asset appears to have the greatest rsk? (11) (The followng table s provded n order to layout your answer. In each column the requred decmal places are gven for calculaton purposes.) Asset Asset F F r r ( r 2 ) 2 r ( r r ) P r P s 2 r r r s 2 s r s r (2 decmal places.) (4 decmal places.) (5 decmal places.) (4 decmal places.) Asset F Asset Asset G G Asset Asset H H Asset G Asset H 3.3 Calculate the coeffcent of varaton for each of the three assets returns. Whch asset appears to have the greatest relatve rsk? (4) QUESTION 4 [11] Phllp and Mary have been dreamng about ownng a boat for some tme and have decded that estmatng ts cash flows wll help them n ther decson process. They expect to have a dsposable annual ncome of R Ther cash flow estmates for the boat purchase are as follows: Negotated prce of new boat R Boat trade-n R0 Estmated value of new boat n 4 years R Estmated monthly repar and mantenance R8 000 Estmated monthly dockng fee R5 000 Usng these cash flow estmates, calculate the followng: 4.1 The ntal nvestment. (1) 4.2 Operatng cash flow. (3)

11 Page 11 of Termnal cash flow. (1) 4.4 Summary of annual cash flows. (A suggested layout s provded below.) (3) Summary of cash flows Year Cash flows Y 0 Y 1 Y 2 Y 3 Y Based on ther dsposable annual ncome, what advce would you gve Phllp and Mary regardng the proposed boat purchase? (3) (It s vtal that you use a +/- sgn to desgnate postve/negatve cash flows.) QUESTION 5 [9] Nova Products has a 5 year maxmum acceptable payback perod. The frm s consderng the purchase of a new machne and must choose between two alternatves. The frst machne requres an ntal nvestment of R and generates annual after-tax cash nflows of R for each of the next seven years. The second machne requres an ntal nvestment of R and provdes an annual cash nflow after taxes of R for 20 years. 5.1 Determne the payback perod for each machne. (2) 5.2 Comment on the vablty of the machnes, assumng that they are ndependent projects, by dentfyng whch machne the frm should accept. Explan the reasons behnd the chosen machne. (3) 5.3 Do the machnes n ths problem llustrate any of the weaknesses of usng payback perod as a form of captal budgetng? Dscuss. (4) ASSIGNMENT TOTAL: 100

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