Financial Management Assignment: Costs, Benefits, and Capital

This document presents a comprehensive solution to a financial management assignment, covering various aspects of corporate finance. Section A includes multiple-choice questions, while Section B delves into more complex topics. The assignment explores factors influencing bond interest rates and dividend policies, along with a cost-benefit analysis of factoring services. It also addresses determinants of working capital investment and calculates the cost of equity using the dividend growth model and capital asset pricing model. Furthermore, the solution evaluates the use of these models and calculates the weighted average after-tax cost of capital (WACC). Finally, it examines the impact of capital structure changes on the cost of capital and evaluates a project-specific cost of equity for a joint venture.

Financial Management

Section A
Question Option
1 A
2 C
3 B
4 B
5 B
6 C
7 A
8 D
9 A
10 C
11 C
12 D
13 C
14 C
15 C
Section B
Question 1
(a) Explain the factors that will influence the rate of interest charged on a new issue of
bonds.
Interest rate has been affect from many factors. However they are directly influence
from price charged and pay for bond. When price of bond are high then the rate of
interest is charged at low and vice versa. It also impacted from the economy factors as
during the time of inflation the interest rate are high when company issue bond
(b) Evaluate the factors to be considered in formulating the dividend policy of a stock
exchange listed company.

Dividend is considered as essential part of company. Following are the factors which direct
impact during the time of formulates dividend policy:
Leverage: This is essential factor on the basis of that manager formulate their policy of
distribute dividend. The level of financial as well as operating leverage impact of taken
decision regarding dividend.
Profitability: Dividend distribution is depending on the profitability rate. Company
distribute dividend on the basis of recognize value of their net profit available. They also
find out record of past profit and on the basis of that they took decision for formulate
provision regarding dividend.
Business cycle: Stage at which company run during the business lifecycle is also impact of
formulating dividend policy. At initial stage organization not able to distribute high rate of
dividend.
Expectation of shareholders: This is also effect and management department take decision
of dividend on the basis of recognizes expectations of their shareholder.
Organization takes decision and formulae policy of dividend according to their requirement
of future objective, if they invest in big project then the rate of dividend is comparatively
low.
Question 2
(a) Calculate the costs and benefits of each of Option 1 and Option 2 and comment on your
findings.
Option 1
Costs
Factor Service Fees 140000
(28000000*0.5%)
Increased Interest Costs 214804

(28000000*7%*30/365)-(5370000*7%)
Total Costs 354804
Benefits
Sabing in Admin costs 30000
Saving in Bad debts 560000
(28000000*2%)
Total Benefits 590000
Net Benefit 235196
Option 2
Costs
Factor Service Fees 140000
(28000000*0.5%)
Increased Interest Costs 4602.74
(28000000*80%*30/365*9%) - (28000000*7%*30/365)
Total Costs 144602.7

Benefits
Sabing in Admin costs 30000
Saving in Bad debts 560000
(28000000*2%)
Total Benefits 590000
Net Benefit 445397.3
(b) Discuss reasons (other than costs and benefits already calculated) why Wheels Co may
benefit from the services offered by the factoring company.
Following are the benefits Wheels Company has if they contract with factoring company
Optimization of working capital: This will useful for properly use current as well as current
liabilities in effective manner, which control cash outflow activities.
Credit protection: Factoring companies give guarantee that the protect the of credit and
give surety with securities regarding credit protection.
Increase debt capacity: This will help in enhance debt capacity of organization which
beneficial for company.

(c) Discuss THREE factors which determine the level of a company’s investment in working
capital.
Following are factor which determine working capital investment
Nature of business: This will directly impact on the investment decision. It totally
depend whether organization is related with service sector or non service sector. Field they
work operation activities. All these required large amount of working capital.
Size of business: Small size organization doesn’t need to require high amount for
investing working capital.
Production policy: This is totally depend on the organization‘s working as well as
production policy that they impact on investment decision.
Capacity of cash flow: High cash inflow business activities help organization to invest large
amount of working capital and vice versa
Question 3

(a) Calculate the cost of equity of Dex Co using the dividend growth model.
Cost of equity :( D1/Re-G)+ (D2/Re-G)+ (D3/Re-G)+ (D4/Re-G)
D1 55.1
D2 57.9
D3 59.1
D4 62.0
G (Growth rate): 4%
Re: Risk premium*Beta + Risk free return
= 1.6*5%+4%
= 12%
Cost of equity: [55.1/ (12-4)]+ [57.9/(12-4)]+ [59.1/(12-4)]+ [62/(12-4)]
= 6.89+7.24+7.38+7.75
= 29.26%
(b) Evaluate whether the dividend growth model or the capital asset pricing model should be
used to calculate the cost of equity.

Capital asset pricing model help in calculate cost of capital is reflected manner as
compare to dividend growth model as in case of dividend growth model management
department only concern with dividend and focus on divided element, however in case of
capital asset pricing model it tool all the essential element during the time of calculate value
of cost of capital.
(c) Calculate the weighted average after-tax cost of capital of Dex Co using a cost of equity
of 12%.
WACC=E/V Re+ D/V Rd (1−Tc)∗ ∗ ∗
Where:
Re = Cost of equity
Rd = Cost of debt
E = Market value of the firm’s equity
D = Market value of the firm’s debt
V = E + D = Total market value of the firm’s financing
E/V = Percentage of financing that is equity
D/V = Percentage of financing that is debt
Tc = Corporate tax rate
Cost of equity: 29.26%
Cost of debt: Interest expense*(1-tax rate)

= 12.52%
Market value of equity: 57,280,000 (7.16*8000000)
Market value of the firm’s debt: 517,100,000 (103.52*5000000)
Total market value: 57,280,000+517,100,000
= 574,380,000
WACC: 57,280,000/574,380,000*29.26%+517,100,000/574,380,000*12.52%*(1-30%)
= 2.92%+11.27%*(1-0.3)
= 14.19*0.7
= 9.93%
(d) Calculate a project-specific cost of equity for Dex Co for the planned joint venture
Cost of equity :( D1+Re-G)+ (D2+Re-G)+ (D3+Re-G)+ (D4+Re-G)
D1 55.1
D2 57.9
D3 59.1
D4 62.0
G (Growth rate): 4%
Re: Risk premium*Beta + Risk free return
= 1.038*5%+4%
= 9.19%
Cost of equity: [55.1/(12-9.19)]+ [57.9/(12-9.19)]+ [59.1/(12-9.19)]+ [62/(12-9.19)]

= 19.60+20.60+21.03+22.06
= 83.29%
(e) Evaluate whether changing the capital structure of a company can lead to a reduction in
its cost of capital and hence to an increase in the value of the company.
Capital structure directly impact on the reduction of cost o capital as change in
financial resource, the way company investment their money. All element is directly impact
which lead in reduction the value.