Problem - Master Chemicals is planning its financing needs for the next 5 years. The balance sheet for the year 2015 and 2016 and the income statement for the year 2016 are as shown below:
|
|
2016
|
2015
|
|
Net working capital
|
190
|
140
|
|
Fixed Assets:
|
|
|
|
Gross Fixed Assets
|
350
|
320
|
|
Less accumulated depreciation
|
100
|
80
|
|
Net Fixed Assets
|
250
|
240
|
|
Total Net Assets
|
440
|
380
|
|
|
|
|
|
Long term debt
|
90
|
60
|
|
Net worth (Paid up capital plus retained earnings)
|
350
|
320
|
|
Long term Liabilities and Net Worth
|
440
|
380
|
|
|
2016
|
|
Revenues
|
2200.00
|
|
Costs
|
2055.00
|
|
Depreciation
|
20.00
|
|
EBIT
|
125.00
|
|
Interest
|
5.00
|
|
Tax
|
60.00
|
|
Net Income
|
60.00
|
The manager has forecast the following:
- The sales are expected to increase by 20% every year for years 2017, 2018, 2019, 2020 and 2021
- The costs will be 92% of the revenue
- Depreciation will be 9% of net fixed assets at start of the year
- Dividend will be 60% of net income
- Net working capital will be 11 % of revenues
- Investment in net fixed assets will be 12.5% of revenues
- Tax rate is 50%
- All additional capital needed will be financed through debt
- Interest will be charged at 10% of long term debt at the beginning of the year
Question 1 -
(a) Prepare the Pro forma income statement for years 2017 to 2021.
(b) Estimate the additional financing required for each of the 5 years.
(c) Prepare the Pro forma balance sheet for years 2017 to 2021.
Question 2 - Analyse the issues that arise when estimating the external financing needed using the above model.
Question 3 - Calculate the debt to total net asset ratio for the years 2016 to 2021 and evaluate the decision to fund the external financing needs through debt.
Question 4 - Master Chemicals is planning a proposal for manufacturing fertiliser. This project requires an investment of $10 million in plant and machinery. The project is expected to last for 7 years at the end of which the machinery can be sold for $1.949 million. The accountants will have depreciated the equipment over 6 years using a salvage value of $500,000 at the end of year 6 using straight line depreciation. The income statement (in '000s) is shown as below:
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
|
Capital investment
|
10000
|
|
|
|
|
|
|
|
Accumulated depredation
|
|
1583
|
3166
|
4749
|
6332
|
7915
|
9500
|
|
Year-End book value
|
|
8417
|
6834
|
5251
|
3668
|
2085
|
500
|
|
Working capital
|
|
550
|
1289
|
3261
|
4890
|
3583
|
2002
|
|
Sales
|
|
523
|
12887
|
32610
|
48901
|
35834
|
19717
|
|
Cost of Goods sold (cash costs)
|
|
837
|
7729
|
19552
|
29345
|
21492
|
11830
|
|
Other cash costs
|
4000
|
2200
|
1210
|
1331
|
1464
|
1611
|
1772
|
|
Depreciation
|
|
1583
|
1583
|
1583
|
1583
|
1583
|
1583
|
|
Pre-tax profits
|
|
-4097
|
2365
|
10144
|
16509
|
11148
|
4532
|
|
Tax (35%)
|
|
-1434
|
828
|
3550
|
5778
|
3902
|
1586
|
|
Profit after tax
|
|
-2663
|
1537
|
6594
|
10731
|
7246
|
2946
|
The beta of Master Chemicals is 1.2; the risk-free rate is 4% and the market risk premium is 7%. The target capital structure for Master Chemicals is 30% debt and Master Chemicals raises debt at 10% interest rate. Assume the marginal tax rate is 35%.
(a) Compute the cost of equity.
(b) Compute the after-tax cost of debt.
(c) Calculate the weighted average cost of capital.
(d) Calculate the net present value of this project.