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QUESTION 1 [24 MARKS] 1.1 a) Given the information below, calculate the current ratio. Dollars Sundry debtors 400,000 Inventory 160,000 Marketable securities 80,000 Cash 120,000 Prepaid expenses 40,000 Bill payables 80,000 Sundry creditors 160,000 Debentures 200,000 Outstanding Expenses 160,000 b) Using the same information provided above, calculate the quick (acid-test) ratio. (6) Version_1 © Regenesys Business School 3 1.2 Ratio 1999 1998 1997 1999- Industry Average Long-term debt 0.45 0.40 0.35 0.35 Inventory Turnover 62.65 42.42 32.25 53.25 Depreciation/Total Assets 0.25 0.014 0.018 0.015 Days’ sales in receivables 113 98 94 130.25 Debt to Equity 0.75 0.85 0.90 0.88 Profit Margin 0.082 0.07 0.06 0.075 Total Asset Turnover 0.54 0.65 0.70 0.40 Quick Ratio 1.028 1.03 1.029 1.031 Current Ratio 1.33 1.21 1.15 1.25 Times Interest Earned 0.9 4.375 4.45 4.65 Equity Multiplier 1.75 1.85 1.90 1.88 You have been hired as an analyst for Mellon Bank and your team is working on an independent assessment of Daffy Duck Food Inc. (DDF Inc.). DDF Inc. is a firm that specialises in the production of freshly imported farm products from France. Your assistant has provided you with the following data for DDF Inc. and their industry. a. In the annual report to the shareholders, the CEO of DDF Inc. wrote, “1997 was a good year for the firm with respect to our ability to meet our short-term obligations. We had higher liquidity largely due to an increase in highly liquid current assets (cash, account receivables and short-term marketable securities).” Is the CEO correct? Explain and use only relevant information in your analysis. b. What can you say about the firm’s asset management? c. You are asked to provide the shareholders with an assessment of the firm’s solvency and leverage. (12) 1.3 Case Study: Small Business Inc. Small Business Inc. provide consulting services and equipment to corporate clients. The company has been doing well and has been growing. Needless to say, the entrepreneur that started the company is very happy with its performance. However, the company’s president, John Sullivan, is concerned about the company’s financial position. Small Business Inc. mainly serves mid-size and larger companies. As part of its contract with these companies, Small Business Inc. has agreed to offer a 35 day credit term. The clients have a good corporate credit rating, so John is confident that they will pay. However, they pay slowly. Unfortunately, the company has invested most of its working capital in growing and does not have any meaningful financial reserves to deal with payment delays. Because of that, John is hesitant (6) Version_1 © Regenesys Business School 4 to take on new clients because he can’t afford the additional slow payments. John estimates that he has walked away from about $135,000 worth of new opportunities. Let’s take a quick look at Small Business Inc.’s current position. This report has been simplified and summarised to make it easy to understand. Initial financial report – Small Business Inc. Yearly Sales $345,000 Lost Sales Opportunities $135,000 Total Sales $345,000 Variable Costs (60%) $207,000 Fixed Costs (rent, etc) $45,000 Total Costs $252,000 Profit (Sales – Cost) $93,000 Given this situation, Small Business Inc. will not be able to grow and take on new clients until it builds a cash reserve in the bank. This reserve covers operating costs while waiting for payment. Building a reserve can take time, so plans to grow the company will go on the back burner for a while. Instead, John decides to get an accounts receivable financing line to cover new sales only. This last point is important, he is only interested in using the factoring company to finance growth opportunities. After careful negotiations, he gets the following terms: • Initial advance: 85% • Factoring rate: 2% for 40 days Question: Should Small Business Inc. accept John’s decision to factor new sales? Support your answer with relevant calculations. QUESTION 2 [34 MARKS] 2.1 The managers of B-Systems are considering the introduction of new equipment that costs $100 million and is expected to generate after-tax (net) cash flows of $20 million for the next 10 years. The plan and equipment are not expected to have any residual value at the end of the tenth year. The financial position of B-Systems is given below: (16) Version_1 © Regenesys Business School 5 Balance sheet (December, 31, 2014) in million Assets Equity and Liabilities Cash/Marketable securities $10 Inventory 90 Net fixed assets 400 Long-term debt $100 (10-year bond, 8% annual coupon rate, 9% yield to maturity) Common stock ($10 par) 400 Total assets 500 Total equity and liabilities 500 Income statement (December, 31, 2014), in million Sales $250 Cost of goods sold 150 Gross profit 100 Operating expenses 50 Operating profit (EBIT) 50 Interest expense 8 Taxes 14.7 Net income $27.3 Financial Market Data: The current market price of B-Systems’ stock of $34 per share will remain unchanged. The firm has just paid a dividend (D0) of $4.00 per share and there is an expectation that dividends will grow at an annually compounded rate (g) of 2%. The expected levels of EBIT are projected to be either $50,000,000 or $150,000,000, both with equal probability (50:50). The investment bankers advise that the firm’s financial manager uses only one financing source rather than using a combination of debt and equity at the same time. If the company uses only one source of financing the cost of capital from different sources remain the same. a. Calculate the firm’s cost of capital using the market weights of different sources of financing in the current capital structure. b. If the project carries the same level of risk as the firm, calculate the project’s NPV and IRR for each capital structure (all equity and all debt), and discuss the financial feasibility of the investment. c. Conduct an EPS – EBIT analysis to determine which financial alternative is preferred. Run the analysis for each of the two capital structures. d. Calculate the indifference level of EBIT and the break-even levels of EBIT for each of the financing plans. 2.2 When answering the questions that follow, be sure to indicate your calculations. 1. Operating cycle: Trend Foods distributes its products to more than 100 restaurants and delis. The company’s collection period is 32 days, and it keeps its inventory for 10 days. What is Trend’s operating cycle? a. 22 days b. 32 days c. 42 day

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