You must answer ALL the questions.

Carson Electronics is a company based in California. It produces electronic equipment and components, and sells them within USA and other countries. It considers BGT Electronics, also located in California, as the industry leader. The income statement and balance sheet of Carson Electronics and BGT Electronics are shown in Exhibit 1.

Carson is planning to introduce a new equipment that would reduce electricity consumption by 40 percent. It has already conducted a market research study at a cost of $3 million and the results of the study were encouraging. The details of the revenue and costs relating to this new product are shown in Exhibit 2.

Carson feels that its debt ratio is very high at 48%. It would like to reduce the debt ratio to 35% by issuing additional equity through a rights issue.

The beta of Carson Electronics is estimated as 1.25. The risk-free rate based on the T-bill rate is 3% and the market risk premium is estimated as 8%.

Question 1 -

The finance manager of Carson has calculated the various ratios as shown in Exhibit 3 in order to compare the performance of Carson in relation to BGT. Analyse the financial performance of Carson by:

(a) Identifying the reasons why the return on equity of Carson is different from that of BGT.

(b) Indicating the areas in which Carson should improve its performance.

Question 2 -

You are asked to analyse the new product introduction and recommend to the Carson management about the viability of this product. In this you are required to estimate the relevant cash flows and calculate the following:

(a) the cost of equity for this project

(b) the initial investment needed

(c) the schedule of annual cash flows

(d) the terminal cash flow

(e) the net present value of this project               

Question 3 -

(a) For the new product that is being contemplated, appraise the following:

(i) Break-even point in sales

(ii) Cash flow break-even point

(b) Analyse the difference between the following:

(i) Break-even point and cash flow break-even point

(ii) Break-even point and NPV break-even point

Question 4 -

If Carson decides to recapitalise the capital structure such that the interest bearing debt comes down to 35% of total assets, apply the technique of rights financing and

(a) Assess the amount that is to be raised through new equity issue, (5 marks)

(b) Assess the number of new shares to be issued if the subscription price is set 15% below the current market price.

(c) Compute value of a right.

Question 5 -

Currently, Carson pays a dividend of $1 per share. Its dividends are expected to grow at 6% per year over a long period of time. Calculate the fair value per share and recommend whether investment in this company is a good decision.

Question 6 -

Analyse the impact of leverage by:

(a) Calculating the degree of operating leverage, degree of financial leverage and the degree of total leverage for Carson.

(b) Calculating the approximate new earnings per share if the sales are expected to increase by 10%.

Attachment:- Assignment.rar