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QUESTION ONE<br/>Serina Bay Valley (SBV) Ltd. is evaluating whether

it should produce a new synthetic steel that will require billions of dollars to develop. According to Bill Bates, the CEO of SBV LTD, the synthetic steel should substantially boost both the sales and net income of SBV Ltd. Mary, who has worked in the capital budgeting area for six years, has been asked to estimate the relevant cash flows that the synthetic steel is expected to generate.
 
During the past few weeks, Mary has had quite a few conversations with the company's engineers, production manager and vice president of marketing. With the information she compiled through her conversations with the aforesaid people and additional information she received from independent sources, Mary put together a detailed forecast of the synthetic steel's relevant cash flows. The final report, which includes only the forecasted cash flows and explanations for the forecasts, was submitted to the chief investment officer yesterday. The report does not include NPV or IRR analysis of the new product because such analyses are conducted by the investment officer.
 
Today, the investment officer called Mary to tell her that he thought that the forecasts she submitted were incorrect. Mary explained that her forecasts were based on a large amount of data that she had collected and corroborated in combination with analysts' predictions concerning the potential success of the synthetic steel. As she told the investment officer, her forecasts were based on optimistic growth rates in sales for the synthetic steel during the next 15 years. The investment officer said that he thought the growth of such a revolutionary product could be higher than Mary estimated. The investment officer asked her to reconsider her cash flow estimates. Although she had reviewed the numbers dozens of times and Mary is convinced that her forecasts are reliable, Mary agreed to go over the forecasts one more time. Being a team player is important to Mary because she wants to move up the corporate ladder as quickly as possible, and she believes that her rise to the executive suite will be enhanced if she cooperates with her superiors, including the investment officer.
 
Because she set up her forecast on a spreadsheet, Mary knew it would be easy to change the growth rate of sales to get new cash flow forecasts for the synthetic steel. However, Mary did not think that growth rates higher than the ones she used in her original forecasts could be achieved, even if the synthetic steel proved to be a huge success. Despite this, she used the higher growth rates that the investment officer had suggested and generated a new set of forecasted cash flows for the synthetic steel. Even though she is convinced that the new growth rates are likely not attainable, Mary sent her new forecasts to the investment office a little while ago. She figured, 'What's the difference? I don't make the final decision anyway'.
 

-Identify the ethical dilemmas in the above stated situation.
-Was it appropriate for the investment officer to request Mary to change her cash flow estimates?
-Was it appropriate for Mary to change her cash flow estimates?
-What would you do if you were Mary? 
QUESTION TWO
New England Fastener Ltd makes a patented marine bulkhead latch that wholesales for $6.00. Each latch has variable operating costs of $3.50. Fixed operating costs are $50 000 per year. The firm pays $13 000 interest and preference dividends of $7000 per year. At this point, the firm is selling 30 000 latches a year and is taxed at 30%.
1.    Calculate New England Fastener's operating break-even point.


2.    Based on the firm's current sales of 40 000 units per year and its interest and preference dividend costs, calculate its EBIT and net profit available for ordinary shareholders.


a.    Calculate the firm's DOL.
b.    Calculate the firm's DFL.
c.    Calculate the firm's DTL.


3.    New England Fastener has entered into a contract to produce and sell an additional 15, 000 latches in the coming year. Use the DOL, DFL and DTL to predict and calculate the changes in EBIT and net profit available for ordinary shareholders. Check your work by a simple calculation of New England Fastener's EBIT and net profit available for ordinary shareholders using the basic information given.


QUESTION THREE
Simplified Systems has an outstanding issue of $1000-par-value bonds with a 12% coupon interest rate. The issue pays interest annually and has 16 years remaining to its maturity date.
1.    If bonds of similar risk are currently earning a 10% rate of return, how much should the Simplified Systems bond sell for today?

-Describe the two possible reasons why similar-risk bonds are currently earning a return below the coupon interest rate on the Simplified Systems bond.




-If the required return were at 12% instead of 10%, what would be the current value of Simplified Systems' bond? Contrast this finding with your findings in part a and discuss.QUESTION FOUR
Australian Products Ltd. is concerned about managing cash in an efficient manner. On average, inventories have an average age of 90 days and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm spends $30 million on operating cycle (OC) investments each year, at a constant rate. Assuming a 365-day year:
1.    Calculate the firm's OC.


2.    Calculate the firm's CCC.


3.     Calculate the amount of financing required to support the firm's CCC.


4.     Discuss how management might be able to reduce the CCC.


QUESTION FIVE                                                                                          
Woodlea Ltd.'s (hardwood selling company), CFO, Mr. Teak has been asked by CEO, Mr. Mahogany, to assist with an investment appraisal. They have recently completed a three-year feasibility study on whether, or not, to expand their market offerings and offer specially designed high-quality wooden furniture for upmarket customers and invest on capital infrastructure for the production line. The market research indicates no other competitors have ever sold this specially designed product before. It might open a completely new market for Woodlea Ltd. In addition, it was revealed that this specially designed high-quality wooden furniture can be sold via (e-trade) on-line trading system.
Woodlea Ltd. is considering a proposal to acquire new equipment (which has an expected useful life of 6 years). If the company decides to purchase the new equipment, it would receive $ 24,000 for the existing equipment in the year zero. The latter has been fully depreciated. The new equipment will be placed in service on 1 January 2020. The details regarding the proposal are as follows:
· Expected cost of the new equipment is $ 1,968,000
· Expected installation costs of the new equipment is $ 32,000.
· Expected increase in working capital at the beginning of operations $ 52,000 and expected working capital at the end of the project $ 38,000.
· Expected investment allowance (tax free) received from the government (end of year 1) is 10% of total amount of capital invested (excluding working capital investment).
· Expected salvage value at the end of year 6 is nil.
· Expected repairs to maintain production efficiency (end of year 3): $ 37,000.
· Working capital will be released at the end of year 6.
· Expected increase in annual cash revenue $560,000
· Expected increase in annual cash operating expenses $ 74,000
· It is assumed that all cash flows occur at the end of each year.
· The taxation depreciation on the equipment would be 20% straight line.
· The company is subject to a 30% tax rate and has an after-tax required rate of return of 12%.
 
Required:

-What type of investment is Woodlea Ltd making? Provide details as to why you came to this conclusion and other considerations in making the investment decision.
-

-Calculate the Net Present Value (NPV) of the proposed investment after tax.
-

-Advise Woodlea Ltd management whether they should proceed with the project. 

Step-by-step answer

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