ECONM1007MScF&AExam

UNIVERSITY OF BRISTOLExamination for the Degree of M.Sc. in Accounting, Finance and Management,and in Economics, Finance and ManagementMAY/JUNE 2008EXAM PAPER NUMBER ECONM1007FINANCE AND ACCOUNTING (Module No. ECONM1007)Time allowed: THREE hoursAnswer THREE questions from the following FIVE ,TWO from Section A and ONE from Section B.Questions in Section A carry 35 marks each and questions in Section B carry 30 marks eachApproved electronic calculators may be used, but candidatesmust show the basis of all calculations.Interest tables are provided.You may find the following formulae helpful in the examination:MV g = MV u + DT cK eg = K eu + [(K eu - r d ) ⨯ (1-T c ) ⨯ (D /E )]()⎥⎦⎤⎢⎣⎡+⨯-=E D DT K K c eu 1βg = βu + βu (1-T c ) ⨯ (D /E )TURN OVERSECTION AAnswer TWO questions from this section.Answer all parts of the question you choose. Question 1The Directors of Blenheim plc are trying to find an appropriate cost of capital to usein appraising new projects. As a starting point they want to find the existing Weighted Average Cost of Capital (WACC) of the company.Blenheim plc has an authorised share capital of 10 million 50p ordinary shares, of which 7 million have been issued. The current ex div market price per ordinary share is 120p and a dividend of 15p per share has recently been paid. The company maintains a policy of paying 40% of its profits after tax as a dividend each year. Earnings retained produce a return of 10% when reinvested. Extracts from the latest balance sheet are given below:£’000Issued share capital 3,500Share premium 500Retained earnings 3,500Shareholders’ funds7,500Non Current Liabilities2.6% irredeemable debentures 1,0003% redeemable debentures 1,800Bank loans 2,600All debt interest is payable annually and interest payments have just been made on all the debentures. The current ex-interest market prices for £100 nominal value are £80.40 for the 2.6% debentures and £105.70 for the 3% debentures. The 3% debentures are redeemable at par in 20 years’ time.The bank loans bear interest at 2% above base rate, which is currently 6%, and are due for repayment in 6 years. The effective rate of corporation tax is 30%. Required:(a)Calculate the effective after tax WACC.[12 marks](b) What factors would Blenheim plc need to consider before using the WACCcalculated in 1(a) to appraise a new project?[8 marks](c) It has been argued that the pattern of dividends paid to shareholders isirrelevant when valuing the shares of a company. Explain this argument anddiscuss 3 factors relating to the financial aspects of a company which may, inpractice, influence the level of dividends a company distributes to itsshareholders.[15 marks]TURN OVERGreymouth plc is a United Kingdom (UK) based manufacturer of navigation equipment for aircraft. The company is currently considering whether or not to establish a new manufacturing division, which will produce passenger safety equipment for cars. The Board of Directors has asked the Finance Department to conduct a financial appraisal of the proposal. The company employs net present value analysis for the appraisal of all its long-term projects.The following information has been taken from the balance sheet of the company for the year just ended:£’mShareholders equity£1 ordinary shares 200Retained profits 8001,000Non Current Liabilities6% loan stock 300Bank loan 200500The ordinary shares have a current market value of £5.35 per share and the geared beta of the company is 1.2. The return from the market is 10.4% and the risk free rate is 5.1%. The loan stock is irredeemable and currently trading at £110 per £100 nominal valu e. It can be assumed that all of the company’s loan capital is risk free. The company will not need to raise new finance for the expansion.The Finance Department has identified a company which manufactures passenger safety equipment for cars. The company is financed 50% by equity and 50% by debt, based on market values, and has a geared beta of 1.6.The effective rate of company tax for both companies is 25%.Required:(a) Explain why the existing Weighted Average Cost of Capital (WACC) ofGreymouth should be adjusted when evaluating the new investment proposaland what problems may be encountered in making any adjustment.[8 marks](b)Using the Modigliani and Miller equations, calculate the WACC that shouldbe used as the discount rate when evaluating the new proposal.[12 marks](c)It has been suggested that the level of gearing employed by a company willhave no effect on its overall cost of capital. Discuss the arguments for andagainst this viewpoint.[15 marks]Methven plc is a manufacturer of electronic devices in the United Kingdom (UK). Ithas been approached by an American company who own the patent rights to a new device which is quickly becoming very popular in the United States of America. Methven plc have been offered exclusive rights to make and distribute the device inthe UK for an immediate payment of £3.2 million and a royalty of £1 for each device sold. Research was carried out, at a cost of £0.4 million, which showed that ifMethven plc charged £9 per device they would be able to sell 400,000 devices in eachof the next 4 years. After 4 years more advanced technology would render thedevices obsolete.Production would require equipment costing £1 million to be bought immediately.This equipment would have a residual value at the end of 4 years of £0.5 million. The variable costs of production (excluding the royalty payment) are estimated to be £3.25 per unit and the fixed costs are expected to be £1.325 per annum including straightline depreciation of the new production equipment. Half of the fixed costs, excluding depreciation, are a ‘fair share’ of the central overhead costs of the company, while the remainder relate directly to the production of the new device.Methven plc is financed 100% by equi ty and the company’s shares have a beta valueof 1.2. The market rate of return is 9% and the risk free rate is 4%.Required:(a)Based on a net present value analysis, advise Methven plc on whether theyshould produce and sell this new device.[13 marks](b)Carry out sensitivity analysis to show by how much each of the followingwould have to change before your decision in 3(a) changes:i.The residual value of the equipmentii.The number of devices sold per annumiii.The selling priceiv.The discount rateComment on the results of the sensitivity analysis.[16 marks](c) Discuss the assumptions you have made in estimating the cost of capital andcomment on whether you think these are reasonable in the current situation.[6 marks]TURN OVERSECTION BAnswer ONE question from this section. Answer all parts of the question you choose. Question 4(a) A company purchased a car on 1 April 2006 for £15,000, which is beingdepreciated over 5 years. Plant and machinery of £20,000 was purchased onthe same date. It is being depreciated by 25% on a reducing balance basis. On31 January 2008 the car is sold for £8000. What entries will there be, in thefinancial statements, in respect of these assets for the year ended 31 March2008? You may assume that there is no depreciation in the year of disposal,but a full year’s depreciation in the year of purchase.[6 marks](b) A company is to issue 300,000 £1 ordinary shares at an issue price of £3.(i) What entries will there be in the financial statements to reflect thistransaction?[3 marks] (ii) Discuss the differences between an offer for sale share issue and a rights issue.[3 marks](c)Picton Ltd was recently formed to import photocopiers from Asia. Thebalance sheet of the company at 31 May 2008 is as follows:Balance sheet Picton Ltd£Non-current assetsFreehold premises 116,000Equipment 54,000170,000Current assetsInventories 125,000Trade receivables 228,000Cash, short term deposits etc 22,000375,000Current LiabilitiesTrade payables (125,000)Accrued overheads (12,000)Dividends (22,000)(159,000)Net Current assets216,000Total Assets less current liabilities386,000Equity£1 Ordinary shares 350,000Retained profit 36,000386,000The level of sales has remained constant over the past three months and theSales Director has estimated that sales of photocopiers over the next 6 monthswill be as follows:Month Sales UnitsJune 50July 40August 60September 80October 80November 100The Sales Director is not very confident about the accuracy of these forecastsas the business is still relatively new and the market for photocopiers hasbecome very competitive in recent months.The photocopiers are sold for £2,850 each and cost £2,500 to buy. All salesare made on 2 months credit. The operating expenses of the company areexpected to be £15,000 in June 2008, rising to £18,000 for each of the next 4months and then rising again to £22,000 in November 2008. These operatingexpenses are paid 1 month after they are incurred and include a depreciationcharge of £1,500 per month.The company is given 1 months credit from its suppliers and buys thephotocopiers the month before they are sold. New equipment and vehiclescosting £55,000 will be purchased and paid for in November 2008. These willbe needed to cope with the forecast increase in sales.The company announces a dividend in May and November each year and thepolicy of the company is to pay dividends 2 months after they are announced.The dividend for November 2008 is planned to be £15,000.Required:(i) Prepare a cash flow forecast for each of the 6 months to 30 November2008.[12 marks](ii)Prepare a forecast profit and loss account for the 6 months to 30November 2008. (A monthly breakdown is not required.)[6 marks]TURN OVERQuestion 5(a)Discuss why companies usually include at least some of their fixed costs whencalculating the total cost of a product.[6 marks](b)Briefly explain how management accounting information can be used for 4different purposes within a company.[6 marks](c)Pine Foods plc runs a chain of medium sized supermarkets. 2 years ago thecompany was losing market share and decided to commence a project to refitsome of its major stores and to invest more in serving its customers. It hasrecently done some market research which showed a marked increase inconsumer satisfaction over the last year. Below are the most recent incomestatement, balance sheet and statement of changes in equity, together withcomparative figures for the previous year.Required:Write a report on the company’s financial position, making appropriate use ofaccounting ratios, for the benefit of a shareholder in the company. Includenotes of where you require further information.[18 marks] Income statements for the year ended 31st March2007 2008£m £mRevenue 6,850.4 8,780.6Cost of sales 6,444.6 8,174.7Gross profit 405.8 605.9Operating expenses 126.1 293.3Operating profit 279.7 312.6Interest payable 25.8 50.8Profit before tax 253.9 261.8Corporation tax 82.3 75.6Profit after tax 171.6 186.2The dividend, as shown in the Statement of Change in Shareholders’ Equity, for the year ended 31 March 2007 was £15.1m.Balance sheet as at 31 MarchStatement of changes in equity for the year ended 31 March 2008Share capitalRetained earningsRevaluation reserveTotal(£m) (£m) (£m)(£m)Balance at start of period1,008.074.2- 1,082.2 Changes in equity during period:Profit for the period186.2186.2 Total recognised income and expense for the period186.2186.2 Dividends(23.0) (23.0) Revaluation of property 882.0 882.0163.2 882.0 1,045.2 Balance at end of period1,008.0237.4 882.02,127.4TURN OVER2007 2008£m £m Non-current assetsFreehold property 1,118.0 2,000.0 Shop fittings 134.6 345.51,252.62,345.5Current assets Inventories423.7 846.2 Trade receivables0.6 0.7 Cash, short-term deposits etc 16.9 2.8441.2849.7Current liabilities Trade payables311.7 340.7 Bank and other short-term borrowing 45.6 203.9 Other liabilities 3.5 66.8360.8 611.4 Net current assets80.4 238.3 Total assets less current liabilities 1,333.0 2,583.8 Non-current liabilities 250.8 456.41,082.22,127.4EquityShare capital 1,008.0 1,008.0 Retained earnings 74.2 237.4 Other reserves - 882.0 1,082.2 2,127.4DISCOUNT FACTOR TABLESPresent value of £1 to be received n periods hence, discount rate r per period. DF(n, r ) = (1 + r)-n2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.8263 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.7514 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.6835 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.6216 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.5647 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.5138 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.4679 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.42410 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.38611% 12% 13% 14% 15% 16% 17% 18% 19% 20%0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.6943 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.5794 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.4825 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.4026 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.3357 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.2798 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.2339 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.19410 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 Present value of an annuity of £1 for n periods, discount rate r per period.()r rr n,n-+-=)1(1AF2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.7363 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.4874 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.1705 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.7916 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.3557 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.8688 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.3359 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.75910 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.14511% 12% 13% 14% 15% 16% 17% 18% 19% 20%0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.8332 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.5283 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.1064 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.5895 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.9916 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.3267 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.6058 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.8379 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.03110 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192END OF PAPER。