PART 2 WEDNESDAY 13 DECEMBER 2006
QUESTION PAPER Time allowed 3 hours This paper is divided into two sections Section A This ONE question is compulsory and MUST be answered TWO questions ONLY to be answered
Formulae Sheet, Present Value and Annuity Tables are on pages 7, 8 and 9.
Do not open this paper until instructed by the supervisor This question paper must not be removed from the examination hall
The Association of Chartered Certified Accountants
Section A – This ONE question is compulsory and MUST be attempted 1 Hendil plc, a manufacturer of electronic equipment, has prepared the following draft financial statements for the year that has just ended. These financial statements have not yet been made public. Profit and loss account Turnover Cost of sales Gross profit Operating expenses Profit before interest and tax Interest Profit before tax Taxation Profit after tax Dividends Retained profit Balance Sheet Fixed assets Current assets Stocks Debtors Cash Current liabilities Trade creditors Dividends Overdraft £000 9,600 5,568 –––––– 4,032 3,408 –––––– 624 156 –––––– 468 140 –––––– 328 300 –––––– 28 –––––– £000 £000 £000 2,250
1,660 2,110 780 –––––– 4,550 750 300 450 –––––– 1,500 –––––– 3,050 –––––– 5,300 1,200 –––––– 4,100 –––––– 1,000 3,100 –––––– 4,100 ––––––
Net current assets Total assets less current liabilities 10% debenture, repayable 2015
Capital and reserves Ordinary shares, par value 50p Profit and loss
Hendil plc pays interest on its overdraft at an annual rate of 6%. The 10% debenture is secured on fixed assets of the company. Hendil plc plans to invest £1 million in a new product range and has forecast the following financial information: Year Sales volume (units) Average selling price (£/unit) Average variable costs (£/unit) Incremental cash fixed costs (£/year) 1 70,000 40 30 500,000 2 90,000 45 28 500,000 3 100,000 51 27 500,000 4 75,000 51 27 500,000
The above cost forecasts have been prepared on the basis of current prices and no account has been taken of inflation of 4% per year on variable costs and 3% per year on fixed costs. Working capital investment accounts for £200,000 2
of the proposed £1 million investment and machinery for £800,000. Hendil uses a four-year evaluation period for capital investment purposes, but expects the new product range to continue to sell for several years after the end of this period. Capital investments are expected to pay back within two years on an undiscounted basis, and within three years on a discounted basis. The company pays tax on profits in the year in which liabilities arise at an annual rate of 30% and claims capital allowances on machinery on a 25% reducing balance basis. Balancing allowances or charges are claimed only on the disposal of assets. Average data on companies similar to Hendil plc: Interest cover Long-term debt/ equity (book value basis) Long-term debt/ equity (market value basis) 6 times 50% 25%
The ordinary shareholders of Hendil plc require an annual return of 12%. Its ordinary shares are currently trading on the stock market at £1·80 per share. The dividend paid by the company has increased at a constant rate of 5% per year in recent years and, in the absence of further investment, the directors expect this dividend growth rate to continue for the foreseeable future. Required: (a) (i) Calculate the ordinary share price of Hendil plc, predicted by the dividend growth model. (4 marks)
(ii) Explain the concept of market efficiency and distinguish between strong form efficiency and semi-strong form efficiency. (6 marks) (iii) Discuss why the share price predicted by the dividend growth model is different from the current market price. (4 marks) (b) (i) Using Hendil plc’s current average cost of capital of 11%, calculate the net present value of the proposed investment. (14 marks)
(ii) Calculate, to the nearest month, the payback period and...