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The company expects that its dividend will grow at 6% every year indefinitely.The long term debt is made up of 10-year 10% bonds issued 5 years back

Price:
$16.99
SKU:
701544


Product Description

Modern Furnitures was established in 2000. Its products include household and office
furniture. It has grown organically with new designs of furniture as well as through
acquisition of other furniture companies. It has high cash balance in order to provide funds
for these opportunities. Its financial statements are shown in Exhibit 1 and 2.
Exhibit 1 Income Statement for the year ending December 31, 2016
Sales Revenue
Cost of goods sold
Gross Profit
Operating expenses
Depreciation
EBIT
Interest
Earnings before tax
Tax (20%)
Net income
Dividend payment
Addition to retained earnings 6,000,000
-1,800,000
4,200,000
-2,000,000
-200,000
2,000,000
-120,000
1,880,000
-376000
1,504,000
-601600
902,400 Exhibit 2 Balance Sheet as at December 31, 2016
Assets
Cash and Cash Equivalents
Receivables
Inventory
Total current assets
Gross Fixed assets
Accumulated Depreciation
Net fixed assets 1,200,000
560,000
500,000
2,260,000
1,350,000
-550,000
800,000 Total assets 3,060,000 Liabilities and Shareholder equity
Payables
Short-term debt
Current Liabilities
Long-term debt
Total Liabilities
Paid up capital
Retained Earnings
Total equity
Equity + Liabilities 400,000
150,000
550,000
1,000,000
1,550,000
1,000,000
510,000
1,510,000
3,060,000 The number of shares outstanding is 1,000,000.
The company expects that its dividend will grow at 6% every year indefinitely. The long term
debt is made up of 10-year 10% bonds issued 5 years back. The coupon will be paid once a
year. The current yield to maturity on these bonds is 9%
The beta of furniture industry is 1.2; the risk-free rate is 4% and the expected market risk
premium is 7%. The market price per share is $9.50. Modern Furnitures is planning to launch a new bedroom suite. They have been doing research
for this product for the past 8 months and have spent $200,000 in research expenses. This
project will last for 4 years.
The manufacture and sale of new bedroom suites will begin in January 2018 and the expected
demand for the next 4 years will be:
Year
2018
2019
2020
2021 Demand in Units
3,200
4,000
4,800
5,600 The variable cost is estimated as 50% of sales. Other operating expenses are fixed costs which
will be $600,000 a year. The unit price at which the suite can be sold is $1,800. The cost of
the new machinery is $9,000,000. The machinery will be fully depreciated over its useful of 5
years. At the end of the project, the machinery has a salvage value of $2,500,000. The
working capital needed for each year is 30% of the sales. Question 1
(a) Calculate the weighted average cost of Modern Furnitures using market value
weights.
(20 marks) (b) Explain the conditions under which WACC of Modern Furnitures can be used to
appraise the new project?
(5 marks) Question 2
Examine whether the new product should be introduced.
(25 marks) Question 3
Compute the expected share price if sales are expected to increase by 10%. Assume that the
operating expenses are fixed costs and P/E ratio based on the current market price per share.
(20 marks) 2 Question 4
Modern Furnitures is considering three options to raise the needed funds for the investment.
Modern Furnitures feels that the true value of their shares is $9.94. Modern Furnitures also
would like to keep the debt ratio at a maximum of 50% of total capital. The three options are:
1. Issue convertible bond for $9 million with a coupon rate of 3% at a par value of $100.
The YTM on this bond is 4%. The maturity of the bond is 5 years. Coupon will be
paid at the end of every year. The bond can be converted with a conversion price of
$10.2 after 1 year. The management believes that the price of shares will increase
causing all convertible bond to be converted. 2. Issue a bond with no convertible provision. The coupon rate will be 3% at a par value
of $100. Coupon will be paid at the end of every year. The YTM of this bond is 4.3%.
These bonds will also mature after 5 years. 3. Issue equity at a discount of 10% to the current market price. (a) Discuss why the YTM on convertible bond is lower than that of a bond with no
convertible provision when coupon rate and maturity are the same.
(5 marks) (b) Assess the funds needed to be raised from outside sources to take up the project using
the values from your answer to Question 2 and the information in financial
statements.
(5 marks) (c) Explain why Modern Furnitures should not go with debt issue for the whole amount
needed.
(5 marks) (d) If the company wants to issue addition shares to finance the need, calculate the issue
price and the number of new shares to issue.
(5 marks) (e) Calculate the number of bonds that the company needs to issue to finance the needs.
3 (4 marks) (f) Explain why issue of convertible is a better choice as compared to issue of new stock.
(6 marks)


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