Management Consultancy - Solutions Manual Chapter 19

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MANAGEMENT CONSULTANCY - Solutions Manual

CHAPTER 19 SOURCES OF INTERMEDIATE AND LONG-TERM FINANCING: DEBT AND EQUITY I. Questions 1. The bond agreement specifies such basic items as the par value, the coupon rate, and the maturity date. 2. The priority of claims can be determined as follows: senior secured debt, junior secured debt, senior debenture, subordinated debenture, preference shares, ordinary shares. 3. Bond conversion. 4. The advantages of debt are: a. Interest payments are tax deductible. b. The financial obligation is clearly specified and of a fixed nature. c. In an inflationary economy, debt may be paid back with cheaper pesos. d. The use of debt, up to a prudent point, may lower the cost of capital to the firm. The disadvantages are: a. Interest and principal payment obligations are set by contract and must be paid regardless of economic circumstances. b. Bond indenture agreements may place burdensome restrictions on the firm. c. Debt, utilized beyond a given point, may serve as a depressant on outstanding ordinary shares. 19-1

Chapter 19

Sources of Intermediate and Long-term Financing: Debt and Equity

II. Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. D D D B A C C E D B C D D A D 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. D C B A C A C B B B A A C C B 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. A C D A C C A A D C C A D B C

Supporting computations: 16. Px =

where Px Po N S

= = = =

value of a share5 (Po x N) + ex-rights market value of share rights-on N + 1 number of rights required to purchase one share subscription price per share

Hence, Px

=

=

=

P72

360 (P75 x 4) + P60 5 the term loan: 5 18. The following schedule applies for Beginning Balance P5000 Interest x (1 – Tc ) P195 19-2 Principal Payment P1000 Ending Balance P4000

Year 1

Sources of Intermediate and Long-term Financing: Debt and Equity

Chapter 19

2 3 4 5

4000 3000 2000 1000

156 117 78 39

1000 1000 1000 1000

3000 2000 1000 -0-

The present value of interest after taxes at 12% is calculated to be P453.49. 19. After the tax benefit, the annual cost of leasing is P1,400 (1 – .35) = P910. The present value annuity factor for four years at 12% is 3.0373. The present value cost of the lease is the cost of the first payment plus the present value of the four future payments, or P910 + P910 (3.0373) = P3,673.94. 20. The present value annuity factor for five years at 12% is 3.6048. Therefore, the present value of principal payments is P1,000 (3.6048) = P3,604.80. The present value cost of the purchase option is the present value of principal payments or P3,604.80 plus P453.49 which equals P4,058.29.

III. Problems PROBLEM 1 (CAM FURNITURE COMPANY) a. Proposal 1: 10 year 12 percent bonds CAM FURNITURE COMPANY 19-3

Chapter 19

Sources of Intermediate and Long-term Financing: Debt and Equity

Income P30,000 Statement For the Year Ended December 31, 2005 3* Estimated sales levels Sales......................................... P400,000 P600,000 P800,000 540,000 720,000 Operating costs ........................ 360,000 Operating income .................... 40,000 60,000 80,000 14,000 14,000 Interest charges ........................ 14,000 Net income before taxes .......... 26,000 46,000 66,000 23,000 33,000 Income taxes ............................ 13,000 P 23,000 P 33,000 Net income............................... P 13,000 Outstanding shares = = 10,000

* EPS (P36 market value – price earnings ratio of 12) Earnings per share P1.30 Price-earnings ratio 10 times Estimated market value P100,000 P13 33 - 1/3 Proposal 2: Ordinary share issue to yield P33-1/3 P2.30 10 times P23 P3.30 10 times P33

CAM FURNITURE COMPANY Income Statement For the Year Ended December 31, 2005 Sales......................................... Operating costs ........................ Operating income .................... Interest charges...
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