Fill This Form To Receive Instant Help

Help in Homework
trustpilot ratings
google ratings


Homework answers / question archive / Humber College ITAL Financial Controllership II ACCT352 Test # 2B Winter 2021           ***INSTRUCTIONS*** All solutions should be prepared in proper form

Humber College ITAL Financial Controllership II ACCT352 Test # 2B Winter 2021           ***INSTRUCTIONS*** All solutions should be prepared in proper form

Finance

Humber College ITAL

Financial Controllership II

ACCT352 Test # 2B Winter 2021

          ***INSTRUCTIONS***

All solutions should be prepared in proper form.

Show all calculations.

You may use the reverse side of the test pages if necessary.  Please label accordingly.

(Full marks may NOT be assigned to correct answers without showing all of your work.)

Question # 1 (6 Marks)

A company’s capital structure is made up of 200,000 common shares and $1,000,000 debt at 12 percent interest. The company’s tax rate is 40 percent. An additional $500,000 has to be raised, and the following financing alternatives are available:

Common shares: The company can sell additional shares to net $10 a share.

Preferred Shares can be issued at 10 percent.                   

Management has advised that they expect EBIT to average $350,000 for the next five years.

Required:

Calculate the break-even EBIT for the two financing options. Which financing option would you recommend and why.

Question # 2 (7 Marks)

Coppell Timber Company had total earnings last year of $5,000,000 but expects total earnings to drop to $4,750,000 this year because of a slump in the housing industry. There are currently 1,000,000 shares of common stock outstanding. The company has $4,000,000 worth of investments to undertake this year. The company finances 40 percent of its investments with debt and 60 percent with equity capital. The company paid $3.00 per share in dividends last year.

a)            If the company follows a pure residual dividend policy, how large a dividend will each shareholder receive this year?

b)            If the company maintains a constant dividend payout ratio each year, how large a dividend will each shareholder receive this year?

c)            If the company follows a constant dollar dividend policy, how large a dividend will each shareholder receive this year?

Question # 3 (9 Marks)

Lucille has just purchased a call option on YYY Corp.  Shares of YYY are trading at $20 each, and the exercise price on the call is $19.  The option expires in 75 days and during this period, Lucille can invest at the risk-free rate of 3.5%, continuously compounded.  Upon careful review of the company’s history, Lucille has determined that the variance of returns on YYY shares is 0.14. Your assistant has prepared some preliminary calculations and has determined that N(d1)=.6663  and N(d2)=.6026

Required:

 

  1. Using the Black-Scholes option pricing model, determine the value of the call option that would be appropriate given the characteristics described above.

 

  1. Explain and calculate the time value of the call option. 

 

  1. If the time to expiry were 150 days instead of 75 days, describe the impact this would have on the time value of the call option (do not recalculate).

 

  1. Calculate the appropriate price for a put option on YYY Corp. shares if it also expires in 75 days and has an exercise price of $19. 

 

  1. When would Lucille be interested in purchasing a put option rather than a call option?

Question # 4 (12 Marks)

A company is assessing two alternatives for new debt financing that have been suggested by an underwriting firm. An issue of $5 million is needed to support projected capital outlays for the coming year. The company already has $1,500,000 of 10% straight debt outstanding as well as 100,000 common shares with a total book value of $2 million. Two alternatives for the new debt issue have been suggested:

1.            A $3 million, 10-year, 10% convertible debenture with a $40 conversion price and $1,000 par value.

2.            A $3 million, 10-year, 11% straight bond issue. Each $1,000 bond has a detachable warrant to purchase 10 shares for $40 per share.

The issuing company has projected EBIT of $1,250,000 and a 40% tax rate.

REQUIRED:

Using the attached table, analyze the two financing opportunities presented by the underwriting firm.

a)            Show how the current capitalization of the company would be immediately affected by each proposed debt issue.

b)            Also calculate the projected earnings per share for the coming year, assuming that no conversion or exercise of warrants occur.

c)            Show the effect on the capitalization of the company and on earnings per share if:

 

                i)             conversion occurs immediately for the convertible debt alternative

 

                ii)            warrants are exercised immediately for the bond plus warrants package.

 

d)            Discuss the advantages and disadvantages of the two proposed debt issues, and make recommendations to the issuing company.

Question # 5 (12 Marks) 

Big Bucks Inc. (BBI) has decided to replace its outdated information system, which has no resale value. It is now considering 2 choices: 1) purchase the necessary data network infrastructure equipment and desktop computers, or 2) lease all the equipment and computers.

Purchase option

The data network infrastructure equipment costs $1 million, while the desktop computers cost $200,000.  The CCA rates are: equipment = 30% and computers = 45%. BBI can finance the $1.2 million purchase with a 4-year bank term loan at a stated interest rate of 10% per year. The network equipment will be kept forever but the computers will be sold for $10,000 (relatively uncertain) at the end of year 4.  BBI will incur pre-tax maintenance costs of $20,000 per year. These operating costs are incurred at the end of a year and are for the purchase option only.

Lease option

The lease provided by the manufacturer will require payments of $350,000 per year for 4 years, to be paid at the beginning of each year (the first payment will be made at the same time as the lease contract is signed), while operating cash flows and the tax payments will occur at the end of each year. The maintenance costs are included in the lease contract. The required rate of return for the manufacturers’ leasing division is 15%.

BBI has a corporate income tax rate of 35% and its debt ratio is 40%.  The controller advises that BBI’s levered cost of equity is 20.67%

Required:

Calculate the net present value of Leasing and the Equivalent Loan amount.

Determine whether BBI should buy or lease these machines based on your analysis.

NOTE:  (SHOW ALL CALCULATIONS)

Question # 6 (12 Marks)

B & S Inc. has been notified that it has lost a lawsuit against a competitor in Europe for copyright  infringement. Terms of the judgement stipulate that payment of 300,000 Euros will be made by

B & S Inc. at the end of twelve months.

The controller of B & S Inc. has called you in to assist him in assessing options as to what course of action should be followed to take best manage the judgement.  You determine that the current 12-month forward rate for Euros is 1.46 Canadian dollars for one Euro, while the current spot rate for Euros is 1.47 Canadian dollars.

The firm's line of credit with its Canadian bankers calls for interest of 5%, while the interest on borrowed money in Europe is 6%.  The firm can invest in Canadian GIC's at 3.8% and in Europe at the rate of 4.2 %.

The controller tells you that he estimates the spot rate for Euros will be 1.45 Canadian dollars for one Euro twelve months from now.

Required:

a)            Advise the controller of B & S Inc. as to the course of action he should follow; explain the reasoning behind your decision. Show all relevant calculations, and state any assumptions necessary.

b)            In addition to part (a), the controller has asked for your advice on how he could use options or futures to best manage the payment on the lawsuit.

 

Purchase A New Answer

Custom new solution created by our subject matter experts

GET A QUOTE