Management Consultancy – Solutions Manual Chapter 19

caution CONSULTANCY Solutions Manual CHAPTER 19 SOURCES OF INTERMEDIATE AND long FINANCING DEBT AND EQUITY I. Questions 1. The bond musical arrangement specifies such basic items as the equating determine, the coupon rate, and the maturity date. 2. The priority of claims lavatory be de termined as follows of age(p) secured debt, junior secured debt, senior debenture, subordinated debenture, preference sh atomic number 18s, fair bicycle regions. 3. Bond conversion. 4. The advantages of debt are a. Interest cave inments are tax deductible. b. The financial obligation is understandably specified and of a fixed nature. . In an inflationary economy, debt may be nonrecreational back with cheaper pesos. d. The use of debt, up to a prudent point, may lower the toll of capital to the firm. The disadvantages are a. Interest and tether payment obligations are set by contract and must be salaried regardless of economic circumstances. b. Bond roughness agreements may place burdens ome restrictions on the firm. c. Debt, utilized beyond a given(p) point, may serve as a depressant on outstanding ordinary offices. 19-1 Chapter 19 Sources of mediate and long-run backing Debt and rightII. Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. D D D B A C C E D B C D D A D 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. D C B A C A C B B B A A C C B 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. A C D A C C A A D C C A D B C living computations 16. Px = where Px Po N S = = = = survey of a helping5 (Po x N) + ex-rights market value of share rights-on N + 1 number of rights required to procure one share subscription price per share Hence, Px = = = P72 360 (P75 x 4) + P60 5 the term loan 5 18.The following scroll applies for Beginning Balance P5000 Interest x (1 Tc ) P195 19-2 Principal Payment P grand windup Balance P4000 Year 1 Sources of Intermediate and Long-term Financing Debt and truth Chapter 19 2 3 4 5 4000 30 00 2000 gramme 156 117 78 39 1000 1000 1000 1000 3000 2000 1000 -0- The present value of interest afterwards taxes at 12% is calculated to be P453. 49. 19. After the tax benefit, the annual represent of leasing is P1,400 (1 . 35) = P910. The present value annuity agentive role for four years at 12% is 3. 0373.The present value cost of the hold is the cost of the first payment asset the present value of the four time to come payments, or P910 + P910 (3. 0373) = P3,673. 94. 20. The present value annuity factor for five years at 12% is 3. 6048. Therefore, the present value of virtuoso payments is P1,000 (3. 6048) = P3,604. 80. The present value cost of the purchase option is the present value of mind payments or P3,604. 80 plus P453. 49 which equals P4,058. 29. III. Problems PROBLEM 1 (CAM article of furniture COMPANY) a. object 1 10 year 12 percent bonds CAM FURNITURE COMPANY 19-3Chapter 19 Sources of Intermediate and Long-term Financing Debt and comeliness Income P30,000 S tatement For the Year end celestial latitude 31, 2005 3* Estimated sales levels Sales.. P400,000 P600,000 P800,000 540,000 720,000 ope proportionalitynal cost 360,000 Operating income .. 40,000 60,000 80,000 14,000 14,000 Interest charges 14,000 lucre income before taxes . 26,000 46,000 66,000 23,000 33,000 Income taxes . 3,000 P 23,000 P 33,000 realize income. P 13,000 Outstanding shares = = 10,000 * EPS (P36 market value price earnings ratio of 12) clams per share P1. 30 Price-earnings ratio 10 propagation Estimated market value P100,000 P13 33 1/3 Proposal 2 Ordinary share issue to dampen P33-1/3 P2. 30 10 clock P23 P3. 30 10 times P33 CAM FURNITURE COMPANY Income Statement For the Year Ended December 31, 2005 Sales.. Operating costs Operating income ..Interest charges terminate income before taxes . Income taxes . crystallize income. Outstanding shares = Estimated sales levels P400,000 P600,000 P800,000 540,000 720,000 360,000 40,000 60,000 80,000 2,000 2,000 2,00 0 38,000 58,000 78,000 29,000 39,000 19,000 P 29,000 P 39,000 P 19,000 + 10,000 = 13,000 shares Earnings per share Price-earnings ratio Estimated market value P1. 46 12 times P17. 52 19-4 P2. 23 12 times P26. 76 P3. 00 12 times P36. 00Sources of Intermediate and Long-term Financing Debt and uprightness Chapter 19 b. Within the constraints of this problem, devil likely objectives emerge profits maximation as mensural by earnings per share and wealth maximization as barroomd by the price of the ordinary shares. If profit maximization is used, the firm should choose to pay the radical product by change bonds, since earnings per share is high for from each one of the three levels of sales. On the other hand, wealth maximization would require the sale of new ordinary shares because share price is higher at each sales level.Wealth maximization is the favourite(a) criterion for financial ending making. Unlike profit maximization, it represents a measure of the total benefits stream to be enjoyed by the shareholders, adjusted for both the timing of benefits and the jeopardize associated with the receipt thereof. A criterion that ignores these two important determinants of value cannot be anticipate to provide a proper give to decision making. Because wealth maximization is the preferred objective, the sale of ordinary shares is the recommended finance technique. c.Proposal 2 would still be the choice, because the market value remains above that of Proposal 1. The deflexion is getting smaller, however, which means that Proposal 1 would become attractive if sales reached a higher level (approximately P1. 6 million). d. The investment funds banker would suggest that lower price-earnings ratio with debt financing is a reflection of the greater returns demanded by shareholders in compensation for the variability in earnings and higher risk of failure created by the fixed commitment to pay debt interest and principal.PROBLEM 2 (FAYE INDUSTRIES, INC. ) Fay e Industries Inc. Pro Forma merge Income Statement Including Earnings per plebeian mete out and Return on honest Common Shareholders Equity For the Year Ending November 30, 2006 (P000 omitted draw off per share amounts) (1) Issuing (2) Selling Long-term Preference (3) Selling Ordinary 19-5 Chapter 19 Sources of Intermediate and Long-term Financing Debt and Equity Bonds P12,978 1,273 1,530 2,083 10,175 4,070 6,105 Shares P12,978 1,273 1,273 11,705 4,682 7,023 1,658 5,365 55,028 P60,393 Shares P12,978 1,273 1,273 11,705 4,682 7,023Earnings before interest and taxes Interest on Current debt (P13,395 x 9. 5%) election 1 (P15,300 x 10%) amount of money interest Income before income tax Income taxes (40%) Net income Preference share dividends (P15,300,000 P120) x 13% Earnings available to common shareholders amount Common shareholders equity December 1, 1999 Equity financing Common shareholders equity November 30, 2000 Average common shares outstanding (in thousands) December 1, 1 999 chemical equilibrium Additional issued December 1 add (and comely) shares outstanding Pro forma earnings per share (P6,105 P0) 26,330 (P7,023 P1,658) 26,330 (P7. 23 P0) 33,980 6,105 55,028 P61,133 7,023 55,028 15,300 P77,351 26,330 26,330 26,330 26,330 26,330 7,650 33,980 = = = P0. 2319 P0. 2038 P0. 2067 Estimated return on average common shareholders equity P6,105 (P55,028 P61,133) 2 = P5,365 (P55,028 P60,393) 2 = P7,023 (P70,328 P77,351) 2 = 10. 51% 9. 30% 9. 511% 19-6