Homework answers / question archive / BS1136 Introduction to Finance Section B   Answer ANY THREE questions Question 2                     [25 marks]  Deep Space Nine is considering the manufacture of a new product which is expected to have a life of 5 years

BS1136 Introduction to Finance Section B   Answer ANY THREE questions Question 2                     [25 marks]  Deep Space Nine is considering the manufacture of a new product which is expected to have a life of 5 years

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BS1136 Introduction to Finance

Section B  

Answer ANY THREE questions

Question 2                     [25 marks]

 Deep Space Nine is considering the manufacture of a new product which is expected to have a life of 5 years. This will require the firm to purchase new production equipment costing £300,000. The equipment will be depreciated at 20 per cent using the reducing balance method. At the end of its life, the equipment can be sold for £25,000.  The firm’s existing buildings have a book value of £60,000 and can be sold for £200,000.  

 

The firm forecasts demand for the new product to be 5000 nits in year 1 and 6000 units per year over the remainder of the product’s life. The sales price of the product is expected to be £110 per unit while the fixed costs associated with its production is expected to be £50,000 per annum. Variable expenses will be £90 per unit. In year zero of the project, the firm will require an investment in working capital amounting to £80,000. This will increase to £100,000 in year 2 of the project. No further increases in working capital are required over the life of the project.   

 

The firm pays corporation tax at 25 per cent on its taxable profits. It evaluates new projects using the Net Present Value approach and requires a return of 10 per cent per annum on this type of project. Should the firm undertake the investment? Explain.

 

 

 

 

 

 

Question 3                                                                                 [25 marks]

3.1 Enterprise Inc is considering a five-year project that has a cost of £150,000. The project will generate after-tax cash flows of £33,000 in Year 1, £57,500 in Year 2, £72250 in Year 3, £80,000 in Year 4 and £82,650 in Year 5. Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%. 

 

1. Calculate and interpret project's payback period. If the firm imposes a payback cutoff of 2 years, should it accept the project according to the payback period criterion? Explain

(6 marks)

 

2. Calculate and interpret the project’s net present value (NPV). Should the project be accepted according to the NPV criterion? Explain.

(6 marks)

 

3. Do the payback period and NPV criteria lead to the same accept / reject decision regarding the project? If not, which criterion should the firm use to decide if the project should be accepted? Explain your answer.

(4 marks)

 

3.2 Explain the concept of a ‘Net Present Value (NPV) Profile’. Can an NPV profile slope upwards? Explain.

(4 marks)

 

3.3 You have invested in the UK Stock Market.  Details on the performance of the market are given below:

 

Date	UK
Jan-07	100.00
Jan-08	120.96
Jan-09	140.10
Jan-10	129.43
Jan-11	90.02
Jan-12	110.06
Jan-13	127.31
Jan-14	114.00

 

 

Calculate the geometric return on the UK and compare it to the arithmetic return.  Comment on and explain the differences between the UK arithmetic and geometric return.

(5 marks)

 

 

 

 

 

 

 

Question 4                  [25 marks]

4.1 You are given the following data regarding the returns on stocks A and B.

 

Scenario	Probability	Return on Stock A	Returns on Stock B
Severe Recession	0.25	- 0.40	0.12
Mild Recession	0.10	0.15	0.06
Normal Growth	0.30	0.20	0.01
Boom	0.35	0.50	- 0.03

 

 

What is the expected return and standard deviation of a portfolio that is formed by holding 30% in stock A and the remainder in stock B?

(12 marks)

 

4.2 Dean has savings of £50,000 that he would like to invest. Having followed the pharmaceutical firm Astrazeneca on the news, he plans to invest the entirety of his savings in Astrazeneca stock. 

 

1. Explain if Dean’s strategy of investing all of his savings in Astrazeneca stock is a good investment strategy. 

(3 marks)

 

2. Asset classes such as stocks and bonds have displayed varying performance over the past two decades. In contrast, cash has avoided any loss. Therefore, explain why investors do not simply hold cash. 

(2 marks)

 

 

4.3 Quark Inc has 6 million shares of common equity outstanding. The current price of these shares is £55 per share. The shares have a beta of 1.5. The firm also pays dividends of £10 per share on its preference shares, of which 500,000 are outstanding. The current market price of the preference shares is £60 per share.

The firm’s outstanding debt amounts to £8,000,000 with a pre-tax cost of 6.5%. Additionally, treasury bills currently yield 3% and the rate of return on the market is 14%. The company pays tax at 20%. Calculate and interpret the firm’s weighted average cost of capital? 

(8 marks)

 

 

 

 

Question 5                  [25 marks]

5.1 Hans Solo just borrowed £100,000. The loan is to be repaid in equal instalments at the end of each of the next five years and the interest rate is 12% per annum.

Set up an amortization schedule for the loan.

(14 marks)

 

5.2 Robert currently has the following investments. He hopes to have saved £250,000 at the end of his three-year investment horizon.

(a) Investment A : £90,000 growing at 5% p.a. compounded quarterly. (b) Investment B : £110,000 growing at 3% p.a. 

Has Robert achieved his savings goal? If not, determine the shortfall.

(11 marks)