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B1 Solving Set 1 May 2018 - Online

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41 views3 pages

B1 Solving Set 1 May 2018 - Online

Uploaded by

Hassan
Copyright
© © All Rights Reserved
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COVENANT FINANCIAL CONSULTANTS - CPA (T) & ACCA REVIEWS

PROBLEM SOLVING SESSION FOR FINANCIAL


MANAGEMENT (B1)

(SET 1)

Prepared By
Emmanuel Christopher [MBA (Finance), BCom Accounting (Hons), CPA (T)] &
Godson Mkaro [MSc. Finance &Investments, BSc in Computer Science (Hons), ATEC II, CPA (T)]

Please visit our website at www.covenantfinco.com 0713/0767 499 621 or 0714 965 564 or 0752 643 388 Page1
COVENANT FINANCIAL CONSULTANTS - CPA (T) & ACCA
REVIEWS

QUESTION 01

a. Stuart the great, a second-year MBA student, has just been offered a job at $80,000 a
year. He anticipates his salary increasing by 9 percent a year until his retirement in
40 years. Given an interest rate of 20 percent, what is the present value of his
lifetime salary?

b. Your aunt owns an auto dealership. She promised to give you $3,000 in trade-in value
for your car when you graduate one year from now, while your roommate offered
you $3,500 for the car now. The prevailing interest rate is 12 percent. If the future
value of benefit from owning the car for one year is expected to be $1,000, should
you accept your aunt’s offer?

c. Assume that you inherited some money. A friend of yours is working as an unpaid
intern at a local brokerage firm, and her boss is selling some securities that call for 4
payments, $50 at the end of each of the next 3 years, plus a payment of $1,050 at the
end of Year 4. Your friend says she can get you some of these securities at a cost of
$900 each. Your money is now invested in a bank that pays an 8 percent nominal
(quoted) interest rate, but with quarterly compounding. You regard the securities as
being just as safe, and as liquid, as your bank deposit, so your required effective
annual rate of return on the securities is the same as that on your bank deposit. You
must calculate the value of the securities to decide whether they are a good
investment. What is their present value to you?

d. You are planning to retire 15 years from now. You have estimated that you will have
25 years to live after your retirement. Your objective is to set up an individual
retirement fund that will provide shs. 800,000 each month to meet your living costs
after retirement. Your investigation has shown that it is possible to set up the fund by
depositing a fixed amount from your salary in a special retirement account that earn
4.8% p.a. You have also estimated that this interest rate will remain constant for the
first 15 years and then increase to 6% p.a. thereafter. How large does your monthly
deposit needs to be for you to achieve your objective assuming interest compounds
monthly?

QUESTION 02

a. Explain the following terms: incremental cash flow, sunk cost and cannibalization, giving
example of each. (3 marks)
b. After discovering a new gold vein in the Mtwara region, Acacia Mining Corporation must
decide whether to mine the deposit. The most cost-effective method of mining gold is
sulfuric acid extraction, a process that results in environmental damage. To go ahead with
the extraction, Acacia must spend Tsh. 900 Million for new mining equipment and pay
Tsh. 165 million for its shipment and installation. The gold mined will net the firm an
estimated Tsh. 350 million each year over the 5-year life of the vein. Acacia’s cost of
capital is 14 percent. Assume that the cash inflows occur at the end of the year.

Please visit our website at www.covenantfinco.com 0713/0767 499 621 or 0714 965 564 or 0752 643 388 Page2
COVENANT FINANCIAL CONSULTANTS - CPA (T) & ACCA
REVIEWS

i. What is the NPV and IRR of this project?


ii. Should this project be undertaken, ignoring environmental concerns? Why?
iii. How should environmental effects be considered when evaluating this, or any
other, project? How might these effects change your decision in part ii?
c. Eisenhower Communications is trying to estimate the first-year operating cash flow
(at t = 1) for a proposed project. The financial staff has collected the following
information:
Projected sales Tsh. 10 million
Operating costs (excluding depreciation) Tsh. 7 million

QUESTION 03

Safari Company wishes to calculate its Weighted Average Cost of Capital (WACC) and the
following is the current information relating to the company.

Number of ordinary shares 2 million


Number of 5% Tshs 100 non-callable preferred stock 1 million
Book value of 10%, Tshs 1,000 irredeemable bonds Tshs 20 million
Market price of ordinary shares Tshs 50 cum dividend
Market price of 5% Tshs 100 non-callable preferred stock Tshs 43ex dividend
Total dividend just paid Tshs 4 million
Market price of 10% Tshs 1,000, irredeemable debt 105 percent ex interest
Equity beta of Safari company 1.5
Treasury bill rate 5%
Expected return on the market 12%

Additional information

1. The corporate tax rate applicable to Safari company is 15%


2. The dividends of Safari Company are expected to grow at an average rate of 6%

REQUIRED

(a) Estimate the Safari Company’s equity risk premium and the cost of equity using the
Capital Asset Pricing Model (CAMP) ( 3 marks)

(b) Calculate the market value Weighted Average Cost of Capital of Safari Company
using
(i) The dividend growth model
(ii) The Capital Asset Pricing Model (12 marks)

(c) Discuss whether the dividend growth model of the CAMP offers the better estimate of
the cost of equity of a company

Please visit our website at www.covenantfinco.com 0713/0767 499 621 or 0714 965 564 or 0752 643 388 Page3

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