MGMT2023, Semester 2, 2022 – Individual Assignment – Units 7 and 8
INSTRUCTIONS TO CANDIDATES
1. This is an individual assignment and will be available from March 14, 2022
2. All questions are mandatory.
3. This assignment is worth 30% of the total assessment.
4. Your submission should include a student accountability statement.
5. Plagiarism in any form is a serious offense and applicable penalty will be applied as per UWI plagiarism policy if any part of your work is plagiarized.
6. Late submissions carry penalties as prescribed in the course guide. Plan your work and time to avoid such an eventuality.
7. The due date for submission is April 8, 2022
8. Submissions should be made by uploading your documents to the dropbox designated for this activity. No email submissions can be entertained.
Question 1 (20 marks)
A 5-year project will require an investment of $100 million. This comprises of plant and machinery worth $80 million and a net working capital of $20 million. The entire outlay will be incurred at the project’s commencement.
Financing for the project has been arranged as follows:
80,000 new common shares are issued, the market price of which is $500 per share. These shares will offer a dividend of $4 per share in year 1, which is expected to grow at a rate of 9% per year for an indefinite tenure.
Remaining funds are borrowed by issuing 5-year, 9% semi-annual bonds, each bond having a face value of $1,000. These bonds now have a market value of $1,150 each.
At the end of 5 years, fixed assets will fetch a net salvage value of $30 million, whereas the net working capital will be liquidated at its book value.
The project is expected to increase revenues of the firm by $120 million per year. Expenses, other than depreciation, interest and tax, will amount to $80 million per year. The firm is subject to a tax rate of 30%
Plant and machinery will be depreciated at the rate of 25% per year as per the written-downvalue method.
You are required to:
1. Compute the cost of equity for this project (2 marks)
2. Compute the relevant cost of debt for this project. (2 marks)
3. Compute the WACC (4 marks)
4. Determine the initial cash flow for the project. (1 mark)
5. Determine the earnings before taxes for years 1 through 5 (2 marks)
6. Compute the OCF for years 1 through 5 (3 marks)
Prepared and Released by the CC, MGMT2023, Semester 2, 2022
Release date: March 14, 2022, Due Date: April 8, 2022
7. Compute the Terminal cash flow. (1 mark)
8. Compute the FCF for years 1 through 5 (1 mark)
9. Compute the project’s NPV and IRR (3 marks)
10. Should the project be accepted or rejected? (1 mark)
Question 2 (10 marks)
Cross-Ocean Boats Ltd. is in the 30% tax bracket. It is interested in determining the minimum return that its stakeholders (investors) will accept. Since you have applied for an internship with them, they have assigned this task to you.
To get started with your work, you compile some information as follows:
1. Cross-Oceans has 3000, 6% semi-annual coupon bonds outstanding. These bonds will mature in 12 years and they sell for 80% of their par value as of now.
2. The firm is also partly equity financed. It has 100,000 outstanding common shares and 19,000 shares of preferred stock. The common shares command a market price of $55 per share and the beta of Cross-Ocean stock is 1.20. Preference shares offer a 6% fixed dividend and sell for $110 per share.
3. The risk-free rate is 4% and the market risk premium is 6%
Armed with this information, compute:
1. The minimum required return by Cross-Ocean’s debtholders (2 marks)
2. The minimum required return by Cross-Ocean’s common shareholders (2 marks)
3. The minimum required return by Cross-Ocean’s preferred shareholders (2 marks) 4. The overall minimum required return for Cross-Ocean’s stakeholders. (4 marks)
Prepared and Released by the CC, MGMT2023, Semester 2, 2022
Release date: March 14, 2022, Due Date: April 8, 2022