Financial Management

Master Chemicals is planning its financing needs for the next 5 years. The balance sheet for the year 2015 and 2016 and the income statement for the year 2016 are as shown below:

	2016	2015
Net working capital	190	140
Fixed Assets:
Gross Fixed Assets	350	320
Less accumulated depreciation	100	80
Net Fixed Assets	250	240
Total Net Assets	440	380
Long term debt	90	60
Net worth (Paid up capital plus retained earnings)	350	320
Long term Liabilities and Net Worth	440	380

	2016
Revenues	2200.00
Costs	2055.00
Depreciation	20.00
EBIT	125.00
Interest	5.00
Tax	60.00
Net Income	60.00

The manager has forecast the following:

 The sales are expected to increase by 20% every year for years 2017, 2018, 2019, 2020 and 2021

 The costs will be 92% of the revenue

 Depreciation will be 9% of net fixed assets at start of the year

 Dividend will be 60% of net income

 Net working capital will be 11% of revenues

 Investment in net fixed assets will be 12.5% of revenues

 Tax rate is 50%

 All additional capital needed will be financed through debt

 Interest will be charged at 10% of long term debt at the beginning of the year

Question 1

(a) Prepare the Pro forma income statement for years 2017 to 2021.

(15 marks)

(b) Estimate the additional financing required for each of the 5 years.

(15 marks)

(c) Prepare the Pro forma balance sheet for years 2017 to 2021.

(15 marks)

Question 2

Analyse the issues that arise when estimating the external financing needed using the above model.

(10 marks)

Question 3

Calculate the debt to total net asset ratio for the years 2016 to 2021 and evaluate the decision to fund the external financing needs through debt.

(10 marks)

Question 4

Master Chemicals is planning a proposal for manufacturing fertiliser. This project requires an investment of $10 million in plant and machinery. The project is expected to last for 7 years at the end of which the machinery can be sold for $1.949 million. The accountants will have depreciated the equipment over 6 years using a salvage value of $500,000 at the end of year 6 using straight line depreciation. The income statement (in ‘000s) is shown as below:

	0	1	2	3	4	5	6
Capital investment	10000
Accumulated depreciation		1583	3166	4749	6332	7915	9500
Year-End book value		8417	6834	5251	3668	2085	500
Working capital		550	1289	3261	4890	3583	2002
Sales		523	12887	32610	48901	35834	19717
Cost of Goods sold (cash costs)		837	7729	19552	29345	21492	11830
Other cash costs	4000	2200	1210	1331	1464	1611	1772
Depreciation		1583	1583	1583	1583	1583	1583
Pre-tax profits		-4097	2365	10144	16509	11148	4532
Tax (35%)		-1434	828	3550	5778	3902	1586
Profit after tax		-2663	1537	6594	10731	7246	2946

The beta of Master Chemicals is 1.2; the risk-free rate is 4% and the market risk premium is

7%. The target capital structure for Master Chemicals is 30% debt and Master Chemicals raises debt at 10% interest rate. Assume the marginal tax rate is 35%.

(a) Compute the cost of equity.

(6 marks)

(b) Compute the after-tax cost of debt.

(4 marks)

(c) Calculate the weighted average cost of capital.

(5 marks)

(d) Calculate the net present value of this project.

(20 marks)

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