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MA514 Business Finance

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MA514 Business Finance

MA514 Business Finance

1.       You have been hired by Bank of Sydney as a financial analyst. One of your first job assignments is to analyse the present financial condition of Bradley Stores, Pty Ltd. You are provided with the following 2016 balance sheet and income statement information for Bradley Stores. In addition, you are told that Bradley Stores has 10,000,000 ordinary shares outstanding, currently trading at $9 per share, and has made annual purchases of $210,000,000. 

Your assignment calls for you to calculate certain financial ratios and to compare these calculated ratios with the industry average ratios that are provided. You are also told to base your analysis on five categories of ratios: (a) liquidity ratios, (b) activity ratios, (c) debt ratios, (d) profitability ratios, and (e) market ratios.

Balance Sheet (in 000s)

______________________________________________________________

Cash                                         $    5,000            Accounts payable                         $  15,000

Accounts receivable              20,000            Notes payable                                    20,000

Inventory                                   40,000            Total current liabilities                $  35,000

Total current assets           $  65,000            Long-term debt                              100,000

Net fixed assets                    135,000            Shareholders’ equity                       65,000

Total assets                           $200,000            Total liabilities and equity         $200,000

 

Income Statement (in 000s)

____________________________________________________________

Net sales (all credit)                                                                                                    $300,000

Less cost of goods sold                                                                                                 250,000

Earnings before interest and taxes                                                                       $  50,000
Less interest                                                                                                                       40,000

Earnings before taxes                                                                                                 $  10,000

Less taxes (40%)                                                                                                                  4,000

Net income                                                                                                                     $    6,000

____________________________________

Industry Averages for Key Ratios:

        Net profit margin                                                               6.4%

        Average collection period (365 days)                         30 days

        Debt ratio                                                                              50%

        P/E ratio                                                                                 23

        Inventory turnover ratio                                                 12.0

        ROE                                                                                          18%

        Average payment period (365 days)                          20 days

        Times interest earned ratio                                           8.5

        Total asset turnover                                                         1.4

        Current ratio                                                                        1.5

        Assets-to-equity ratio                                                      2.0

        ROA                                                                                         9%

        Quick ratio                                                                            1.25

        Fixed asset turnover ratio                                              1.8

Use the following guidelines to complete this job assignment. First, identify which ratios you need to use to evaluate Bradley Stores in terms of its (a) liquidity position, (b) business activity, (c) debt position, (d) profitability, and (e) market comparability. Next, calculate these ratios. Finally, compare these ratios to the industry average ratios provided in the problem and answer the following questions. 

a.    Based on the provided industry average information, discuss Bradley Stores’ liquidity position. Discuss specific areas in which Bradley compares positively and negatively with the overall industry.

b.    Based on the provided industry average information, what do Bradley Stores’ activity ratios tell you? Discuss specific areas in which Bradley compares positively and negatively with the overall industry.

c.     Based on the provided industry average information, discuss Bradley Stores’ debt position. Discuss specific areas in which Bradley compares positively and negatively with the overall industry.

d.    Based on the provided industry average information, discuss Bradley Stores’ profitability position. As part of this investigation of company profitability, include a DuPont analysis. Discuss specific areas in which Bradley compares positively and negatively with the overall industry.

e.    Based on the provided industry average information, how is Bradley Stores viewed in the marketplace? Discuss specific areas in which Bradley compares positively and negatively with the overall industry.

f.     Overall, what are Bradley’s strong and weak points? Knowing that your boss will approve new loans only to companies in a better-than-average financial position, what is your final recommendation (approval or denial of loan)?

(10 Marks)

 

2.       On your first day as an intern at Tri-Star Management Pty Ltd the CEO asks you to analyse the following information pertaining to two ordinary share investments, Tech.com and Sam’s Grocery. You are told that a one-year Treasury note will have a rate of return of 5% over the next year. Also, information from an investment advisory service lists the current beta for Tech.com as 1.68 and for Sam’s Grocery as 0.52. You are provided a series of questions to guide your analysis.

                                                                 Estimated Rate of Return

Economy                   Probability               Tech.com        Sam’s Grocery           ASX 200

Recession                          30%                           –20%                            5%                        – 4%

Average                             20%                             15%                            6%                          11%               

Expansion                         35%                             30%                            8%                          17%

Boom                                  15%                             50%                          10%                          27%

1.    Using the probabilistic approach, calculate the expected rate of return for Tech.com, Sam’s Grocery, and the ASX 200 Index.

2.    Calculate the standard deviations of the estimated rates of return for Tech.com, Sam’s Grocery, and the ASX 200 Index.

3.    Which is a better measure of risk for the ordinary share of Tech.com and Sam’s Grocery – the standard deviation you calculated in Question 2 or the beta?

4.    Based on the beta provided, what is the expected rate of return for Tech.com and Sam’s Grocery for the next year?

5.    If you form a two-share portfolio by investing $30,000 in Tech.com and $70,000 in Sam’s Grocery, what is the portfolio beta and expected rate of return?

6.    If you form a two-share portfolio by investing $70,000 in Tech.com and $30,000 in Sam’s Grocery, what is the portfolio beta and expected rate of return?

7.    Which of these two-share portfolios do you prefer? Why?

(10 Marks)

3.       Contact Manufacturing Ltd is considering two alternative investment proposals. The first proposal calls for a major renovation of the company’s manufacturing facility. The second involves replacing just a few obsolete pieces of equipment in the facility. The company will choose one project or the other this year, but it will not do both. The cash flows associated with each project appear below and the firm discounts project cash flows at 15%.

Year             Renovate                  Replace

    0              –$9,000,000              –$2,400,000

    1                   3,000,000                   2,000,000

    2                   3,000,000                       800,000

    3                   3,000,000                       200,000

    4                   3,000,000                       200,000

    5                   3,000,000                       200,000

 

1.    Calculate the payback period of each project and based on this criterion, indicate which project you would recommend for acceptance.

2.    Calculate the net present value (NPV) of each project and based on this criterion, indicate which project you would recommend for acceptance.

3.    Calculate the internal rate of return (IRR) of each project and based on this criterion, indicate which project you would recommend for acceptance.

4.    Calculate the profitability index (PI) of each project and based on this criterion, indicate which project you would recommend for acceptance.

5.    Overall, you should find conflicting recommendations based on the various criteria. Why is this occurring?

6.    Chart the NPVprofiles of these projects. Label the intersection points on the x- and y-axes and the crossover point.

7.    Based on this NPVprofile analysis and assuming the WACC is 15%, which project would you recommended for acceptance? Why?

8.    Based on this NPVprofile analysis and assuming the WACC is 25%, which project is recommended? Why?

9.    Discuss the important elements to consider when deciding between these two projects. 

(10 Marks)

4.        Higher and Higher Constructions Pty Ltd in Melbourne is considering some new equipment. This new equipment will generate sales revenues but it will not replace any existing equipment. The equipment has a 3-year life for depreciation purposes under Australian company tax regulations would be fully depreciated by the prime cost method over those years. It is planned to close down the project at the end of Year 3.  The company will need to increase its net operating working capital at the beginning of the project but no further increases are foreseen. Revenues and other operating costs are expected to be constant over the project's life. 

 

Required return for projects of this risk level                                                 12.0%

New investment in fixed capital                                                                               $160,000

Additions to inventories at outset of project                                                  $32,000

Additions to trade accounts receivable at outset of project                         $24,000

Additions to trade accounts payable at outset of project                             $26,000

Annual additions to sales revenue                                                                     $154,000

Annual additions to cash operating costs                                                         $64,000

Expected pre-tax salvage value                                                                          $10,000

Company tax rate                                                                                                  30.0%

(a)    What is the project's NPV? (7 marks)

(b)   What is an estimate of the project’s IRR? (1 marks)

(c)    With appropriate justification, briefly explain whether Better Media should undertake the project or not (2 marks)



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