Financial Management Assignment: Dex Co. and Wheels Co. Analysis

This document provides comprehensive solutions to a financial management assignment. It includes answers to multiple-choice questions, detailed explanations of factors influencing interest rates on bonds, and an evaluation of dividend policy considerations for a stock exchange-listed company. The assignment analyzes the costs and benefits of factoring services for Wheels Co., discusses factors determining working capital investment, and calculates the cost of equity for Dex Co. using the dividend growth model and the Capital Asset Pricing Model (CAPM). It also compares the dividend growth model and CAPM, calculates the weighted average cost of capital (WACC), and evaluates the impact of capital structure changes on the cost of capital and company value. These solutions offer a valuable resource for students studying financial management.

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 it is considered as most essential factor. During the time of issuing new
bonds management department take decision regarding their issuing new bonds. On the
basis of identifying interest rate value the rate has been directly impacted and influenced
by many factors which include price as well as economic factor. Due to changes in prices
of Bond the value of interest rate getting high and on the other side during the time of
inflation the rate of interest is getting high as the economy is not in strong position and
the cash inflow rate is also getting down both are factors impact on issuing new bonds.

(b) Evaluate the factors to be considered in formulating the dividend policy of a stock
exchange listed company.
Following are the factors which impact when management department take decision to
formulate dividend policy
Profitability: This is considered as the most essential factor as on the basis of revenue
incurred by organization within given time period management department take decision to
distribute their dividend. High rate of profitability directly impact on increase the dividend
distribution rate and vice versa.
Business cycle: At the stage where organization runs their business is directly impact on the
formulation of dividend policy. When company is at their starting stage they are not able to
distribute dividend with high rate and on the other side when organization is at their boom
stage of business life cycle they distribute high rate of dividend to their shareholders.
Expectation of shareholders: Shareholders are considered as most essential factor according
to their expectations organization to decision to distribute dividend.
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: Optimization of working capital factoring company help in
systematically and optimistically utilize value of current assets.
Credit protection: Organization suffers from lack of working capital due to non management
of their Credit Policy. By agreement with factoring company business corporations able to
feel secure regarding their Credit Policy as this company take guarantee to provide credit
protection to their customers.
Increase debt capacity: They also help in increase that capacity of the business corporation
which is further beneficial for attending their business goals.

(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: It is directly impact on the working capital investment organization
which is run their business in service sector does not require high rate of working capital
investment on the other side those organization which is related with manufacturing sectors
required high rate of capital investment.
Size of business: Organization which run their business in international market required
huge working capital investment and small sized businesses does not required large amount
to invest for their working capital.
Capacity of cash flow: The ability of generating cash is also impact on investment regarding with
working capital. That organization which have high rate of cash inflow activities can able to
manage their organization in effective manner as well as invest in working capital large amount.
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 is considered as best method for calculate cost of capital as
by using this method manager able to recognize all element and impact of financial as
well as non financial resources. At the time of calculate cost required for capital they also

include the entire structure element which directly impact on cost of capital. Thus
management department need to select Capital Asset pricing model over dividend growth
model because this model help in fulfilling all limitation of dividend growth model
(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 is the essential element for structure of any organization. Success
of Business Corporation depends on how effectively manager formulates their capital
structure. Reduction in cost of capital as value of issuing shares distributing dividend
redemption of preference share all cost required to engaging within these activities has
been reduced thus the value of company increase.