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FINC 302 Assignment 3 Final

This document contains an assignment with 7 questions related to business finance. It discusses topics like weighted average cost of capital (WACC), systematic and unsystematic risk, capital structure, and cost of debt, preferred stock, and common equity. It provides background information on a company's capital structure, cash flows, tax rates, and risk factors to help answer questions calculating WACC, costs of different securities, and weights for an optimal capital structure.

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Mary Amo
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112 views4 pages

FINC 302 Assignment 3 Final

This document contains an assignment with 7 questions related to business finance. It discusses topics like weighted average cost of capital (WACC), systematic and unsystematic risk, capital structure, and cost of debt, preferred stock, and common equity. It provides background information on a company's capital structure, cash flows, tax rates, and risk factors to help answer questions calculating WACC, costs of different securities, and weights for an optimal capital structure.

Uploaded by

Mary Amo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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University of Ghana Business School

Department of Finance
2021/2022. FINC 302: Business Finance
Assignment 3
Submission deadline: 29th September 2022

1. STARWIN PRODUCTS LIMITED RENOUNCEABLE RIGHTS ISSUE

Following approval by Starwin Products Limited’s (“SPL” or the


“Company”) shareholders at their Annual General Meeting on 19 June 2013,
the Company embarked on a Renounceable Rights Issue (“Offer”) of
333,359,264 ordinary shares of no par value at GHS 0.03 per share to
interested shareholders.
The Securities and Exchange Commission (“SEC”) and the Ghana Stock
Exchange (“GSE”) approved SPL’s Offer Circular on 29 August 2014 and
on 4 September 2014, respectively. IC Securities (Ghana) Limited (“IC
Securities”) is the Financial Advisor and Sponsoring Broker for the Offer.
On 17 November 2014, a shareholder of the Company (“Applicant”) filed a
motion to restrain Starwin Products Limited and IC Securities from
proceeding with the issuance of additional shares described as a
Renounceable Rights Issue. On 8 December 2014, the Accra High Court
before Justice Samuel K.A. Asiedu, Justice of the High Court, dismissed the
motion on the basis of no merit in the evidence provided by the Applicant.
The Offer period closed, and all shareholders who took part in the Offer
received their subscriptions on 17 December 2014.
a) How much was SPL hoping to raise?
b) Before the rights issue, SPL had issued 259,647,284 shares which were
trading at GHS 0.04 per share. If all existing shareholders exercised their
rights, what was the value of SPL at the end of the rights issue (all things
equal)?
c) SPL is registered in Ghana. How many rights must have been issued?
d) Each right entitled the holder to buy how many new shares?

Godfred A. Bokpin & Eunice P. Offei


2. An investor is considering starting a new business whilst working with a
local government as an Accountant. The company would require GHS
500,000 of assets, and it would be financed entirely with common stock. The
investor will go forward only if he thinks the firm can provide a 15.0 percent
return on the invested capital, which means that the firm must have an ROE
of 15.0 percent. After operating the business for 5 years, he realized the
importance of debt and tax deductibility that comes with it. He then decided
to alter the capital structure whilst expanding the size of the business. His
total assets came to GHS 647m financed as follows:
Market value of Debt= GHS 194m with 11%
The market value of Equity= GHS 453m with the expected return of 17%

Just as he was about to obtain an additional loan in 2020, Covid-19 and its
containment measures (such as social distancing, staying at home etc)
affected his business which operated more with human interaction. The
three-week partial lockdown has affected the going concern of his business.
The government has set up the Coronavirus Alleviation Programme (CAP)
with seed money of GHS 1 billion. An amount of GHS 600 million of this
money is to be disbursed to vulnerable firms and GHS 400m to vulnerable
households. The government also announced free water for three months
(April to June 2020) to all citizens consistent with the health protocols of
washing hands as often as possible under running water though one-third of
the African population cannot wash their hands simply because of lack of
running water. For the three months, electricity has been zero-rated for
lifeline consumers (from 0-50 kilowatt-hours a month consumption) whilst all
other categories of consumers enjoy a 50% subsidy. Given the enhanced
exposure of frontline workers as a result of the pandemic, the government
also offered tax exemptions amounting to 50% of their basic salary for the
three months translating to fiscal loses of GHS 288.6m including additional
allowances for frontline health personnel covering March, April, May, and
June for the year 2020 (amounting to GHS 51 million). But the Accountant
has complained for his exclusion from the list of beneficiaries. Bank of
Ghana (BoG) also responded by reducing the policy rate by 150 basis points as
well as reducing the Primary Reserve Requirement from 10% to 8%. His
bank loan is indexed to the primary reserve requirement and varies
accordingly. Given the above and your own understanding of recent
development with respect to Covid-19: Attempt the following questions
(you are free to make reasonable assumptions)

Godfred A. Bokpin & Eunice P. Offei


A) How much net income must be expected to warrant starting the
business? (3 Marks)
B) Estimate the Weighted Average Cost of Capital (WACC) of the
business before and after the Bank of Ghana’s Covid-19 intervention
and interpret your results. Assume a tax rate of 25% (10 Marks)
C) Ascertain the minimum profit the business must make in order to
satisfy providers of capital before and after BoG’s Covid-19
intervention.
i. (5 Marks)
D) Using your understanding of risk and returns, is the complaint of his
exclusion from the tax rebate justified (3 Marks)
E) Discuss how the government’s Covid-19 fiscal stimulus would benefit
his business and how he can take advantage of them. (8 Marks)
F) In stock market analysis, with examples, briefly distinguish
fundamental analysis from technical analysis (6 Marks)

3. A) Explain the difference between systematic and unsystematic risk. Also,


explain why one of these types of risks is rewarded with a risk premium
while the other type is not (6 Marks). 
B) Stocks A and B each have an expected return of 15%, a standard
deviation of 20%, and a beta of 1.2. The returns on the two stocks have a
correlation coefficient of +0.6. Your portfolio consists of 50% A and
50% B. What is the expected return of the portfolio (10 Marks)
C) What does portfolio reduction mean and under what condition is this
possible (4 Marks)
4. A) What is the rationale for determining the optimal capital structure for a
corporation? What are the pros and cons of increasing levels of debt and
equity in the capital structure that any financial manager needs to consider in
arriving at this optimal capital structure?
B) Suppose company A has issued 10 million shares which are trading at
GHS 50 each: 4 million preference shares at GHS 40 and 1,500 bonds at
GHS 100,000 each.

i. What is this company’s capital structure? (5 Marks)


ii. How much must A generate annually to satisfy its 3 classes of investors if
the coupon rate on the bonds is 20%, the dividend rate on the preference
shares is 24% and equity holders require 30% on their investment? The
company’s tax rate is 30%. (5 Marks)
C) What is the weighted average cost of capital of A?

Godfred A. Bokpin & Eunice P. Offei


5. A company's perpetual preferred stock currently sells for $92.50 per share,
and it pays an $8.00 annual dividend. If the company were to sell a new
preferred issue, it would incur a flotation cost of 5.00% of the issue price.
What is the firm's cost of preferred stock?
6. Bartlett Company's target capital structure is 40% debt, 15% preferred, and
45% common equity. The after-tax cost of debt is 6.00%, the cost of
preferred is 7.50%, and the cost of common using reinvested earnings is
12.75%. The firm will not be issuing any new stock. You were hired as a
consultant to help determine their cost of capital. What is its WACC?

7. Glassmaker Corporation has a current capital structure consisting of $5


million (market value) of 11% bonds and $10 million (market value) of
common stock. Glassmaker's beta is 1.36. Glassmaker faces a 40% tax
rate. Glassmaker plans on making big changes in operation and capital
structure during the next several years. (Its tax rate will remain unchanged.)
Under these plans, the free cash flows for Glassmaker are estimated to be
$3.0 million for each of the next 4 years; the horizon value of the free cash
flows (discounted at the rate assumed by the compressed adjusted present
value (CAPV) approach) is $10.0 million at Year 4. The estimated tax
savings due to interest expenses are estimated to be $1 million for each of
the next 4 years; the horizon value of the tax shields (discounted at the rate
assumed by the CAPV approach) is estimated to be $5 million at Year 4.
Glassmaker has no nonoperating assets. Currently, the risk-free rate is 6.0%
and the market risk premium is 4.0%. Refer to data for Glassmaker
Corporation. What is Glassmaker's WACC, based on its current capital
structure?

Godfred A. Bokpin & Eunice P. Offei

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