Question 1.
Brown Ltd operates outdoor amusement centres in a number of country towns. The company has decided to build another centre that is expected to generate a permanent increase in EBIT of $100,000 pa. Current EBIT is $350,000. Brown currently has a capital structure that utilises bonds, ordinary equity and preference shares. The $200,000 of issued bonds pay 8% pa. Preference shares pay an annual fixed dividend of $150,000. Currently 250,000 ordinary shares have been issued and are trading at $2 per share. The company pays tax at 30%.
a) Brown needs to raise $500,000 to construct the new amusement centre. Assuming the company can issue new shares at the current market price, what is the impact on EPS if new shares are issued to fund the centre?
b) If new debt can be raised at a 10% interest rate, what is the impact on EPS of using debt rather than a new equity issue?
Brown Ltd depends on mainly on sunny weather to generate its expected EBIT. Using the information above together with the two following scenarios calculate the impact of the debt and equity financing alternatives if:
a)Weather is good which will increase attendances and increase EBIT to $600,000
b)Weather is poor which will decrease attendances and reduce EBIT to $320,000
c)Calculate the indifference point
Question 2.
You are considering the following two stocks for your portfolio and have observed the following.
The risk free rate is 0.04 and you are considering investing 60% of your funds in Stock A and 40% in Stock B.
Calculate the following.
a) Expected Return of Stock A
b) Expected Return of Stock B
c) Standard Deviation of Stock A
d) Standard Deviation of Stock B
e) Coefficient of Variation of Stock A
f) Coefficient of Variation of Stock B
g) Covariance of Stocks A and B
h) Correlation Coefficient of Stocks A and B
i) Portfolio Return
j) Portfolio Standard Deviation and Variance
k) Weights of the Minimum Variance Portfolio
l) Proof that these weights lead to the Minimum Variance Portfolio
m) Weights of the Optimal Risky Portfolio with a risk-free asset
n) Proof that these weights lead to the Optimal Risky Portfolio
o) Discussion on what you would do with this portfolio