Question 1
Nakami Limited is evaluating whether or not to produce a new line of portable wireless
speakers. If the firm decides to embark on this project, it needs to invest $3.2 million on
production equipment.
The forecasted selling price is $100 per unit and this will increase in line with general
inflation of 3% per year. Forecasted sales and production have been estimated as follows:
Year 1 2 3 4
Sales and production (units) 27,000 30,000 35,000 25,000
Due to rapid advancement in technology of audio products, the operations will cease at the
end of four years.
Variable costs are about 60% of selling price. Incremental overheads, which includes
primarily rental, is estimated to be $200,000 per year. Net working capital amounting 15% of
sales is required at the beginning of each year. This will be fully recovered when the
operations cease and scrap value of equipment is about 5% of its cost.
Depreciation is computed on a straight-line basis over the four-years. The rate of corporation
tax is 17%. Nakami has traditionally used a discount rate of 11% per year for investment
appraisal.
(a) Calculate the accounting break-even and cash break-even for each of the four (4)
years.
(10 marks)
(b) Calculate the NPV break-even for this investment opportunity.
Hint: The number of units sold must be same in each of the four years.
(8 marks)
(c) Calculate the degree of operating leverage (DOL) for the first year of operations.
Using the DOL you have computed, determine the net operating income (or EBIT) if
sales increase by 10%.
(6 marks)
FIN309 Assignment 2
SIM UNIVERSITY Assignment 2 – Page 3 of 5
(d) Since it is a new product, Nakami is not sure about the forecast. On further research,
the marketing department has made the following demands in units forecasts based on
the probability.
Probability Year 1 Year 2 Year 3 Year 4
0.5 22,000 25,000 30,000 20,000
0.5 32,000 35,000 40,000 30,000
Expected 27,000 30,000 35,000 25,000
The probabilities are for the series of demand in units.
Given this refinement in forecast, discuss the strategies Nakami can follow in relation
to this project. Assume that the company will install a capacity of 27,000 units based
on the expected demand in units at the current time.
(8 marks)
Question 2
The latest available financials of Nakami Limited is shown below:
Statement of Profit or Loss Statement of Financial Position
For the year ended 31 Dec 2015 As at 31 Dec 2015
$’000 $’000
Revenue * 12,790 Current assets
Cost of sales # (3,438) Cash and bank balances 3,534
Gross profit 9,352 Trade receivables 3,266
Operating expenses (1,456) Inventories 843
Profit before income tax 7,896 7,643
Income tax expense (1,357)
Profit for the year 6,539 Non-current assets
Plant and equipment 3,214
* All on credit terms. Total assets 10,857
# Beginning inventories is $702,000.
Current liabilities
Trade payables 651
Income tax payable 1,349
2,000
Capital and reserves
Share capital 6,000
Retained earnings 2,857
8,857
Total liabilities and equity 10,857
Sharon, the finance director of Nakami is looking to improve the firm’s working capital
management. She is thinking of extending an early settlement discount of either 2/15, net 90
or 1/10 net 60 for all customers. Regardless of which proposal is implemented, the level of
trade receivables is expected to reduce by the same amount.
FIN309 Assignment 2
SIM UNIVERSITY Assignment 2 – Page 4 of 5
(a) Calculate the cash conversion cycle for FY 2015.
(13 marks)
(b) Calculate the cost of implementing the trade credit scheme (in percentage). Analyse which credit terms should Nakami extend to its customers.
(7 marks)
(c) In using percent of sales method of financial planning, it is assumed that all items including working capital items are expected to vary with sales at the same percentage. However, inventory is based on cost of goods sold and payables are based on purchases. Discuss how inventory and payables can be expressed as percent of sales.
(8 marks)
Question 3
Currently, Nakami does not have any borrowings. Management forecast that revenue for FY 2016 will increase to $13.5 million, while gross profit margin remains constant. Operating expenses will increase by 3% and corporate tax rate remains at 17%.
Sharon met up with the firm’s bankers recently and understand that they are willing to extend a term loan of $10 million to Nakami and the borrowing rate is 8%. The proceeds from this loan will be used for share repurchase.
She wants to evaluate the firm’s optimal capital structure. Currently, there are 6 million ordinary share outstanding and each share is valued at $5.00.
(a) Calculate the earnings per share for FY 2016 under the following scenarios:
(i) Without any borrowings
(ii) If the firm borrows $5 million
(iii) If the firm borrows $10 million
Advise Sharon which capital structure the firm should adopt and why.
(12 marks)
(b) Discuss whether the company can issue bonds to repurchase the shares advisable and whether use of earnings per share as the criterion is appropriate in capital structure decision.
(6 marks)
(c) Generally, companies with high operating leverage will tend to have a high financial leverage. Critically analyse this statement.
(8 marks)
FIN309 Assignment 2
SIM UNIVERSITY Assignment 2 – Page 5 of 5
Question 4
Nakami has been profitable in FY 2015 and the Board is planning to declare dividends to its shareholders. They intend to declare a cash dividend of $2 million at the forthcoming annual general meeting. However, the Board is unsure whether this is an appropriate level of dividends to declare.
(a) Calculate the dividend pay-out ratio and the ex-dividend share price.
(6 marks)
(b) Shareholders of a company are eligible to receive dividends when declared while bondholders are eligible to receive interest payments which is mandatory. Based on this, shares are considered as riskier compared to bonds and the required rate of return on shares is higher than that on bonds.
However, in reality, bondholders face more risk than shareholders. Examine how this could arise and how the impact can be reduced.
(8 marks)
