Department of Accounting and Finance

AG215 Business Finance

Tuesday 10th August 2021 12.00pm – 15.45pm (3 hours 45 mins) The exam contains three sections. You must answer ONE question from Section A. You must answer TWO questions from Section B. You must answer TWO questions from Section C. Calculators must not be used to store text and/or formulae nor be capable of communication. Invigilators may require calculators to be reset.

SECTION A - Answer ONE QuestionQuestion 1On 21st May 2020, Premier Inn owner Whitbread Plc launched a rights issue to existing investors to raise in the region of £1.01bn. An edited snapshot of key information relating to the rights offer released by the company was as follows: • 1 for 2 fully underwritten rights issue of 67,266,667 new shares; • raise gross proceeds of approximately £1,009 million; • issue price of 1500 pence per new share; • closing price of 2843 pence on 20th May 2020 (being the last business day prior to the date of this announcement); The issue proceeds figure is an approximations and you should not be concerned with minor rounding issues in the subsequent calculations. When answering parts a and b you should ignore any costs associated with the rights issue discussed in part c. Keep all workings to four decimal places in pounds (i.e. £0.7000). Required: a) Specify the remaining key terms of the rights offer not discussed above: (i) the number of existing shares, (ii) the discount that new shares are being offered at relative to existing shares, (iii) the theoretical ex-rights price, and (iv) the value of a right to purchase one new share in the company. (6 marks) b) Show that, in theory, the wealth of an investor holding 1,000 shares in the company prior to the announcement will be unaffected by the rights issue irrespective of whether they (i) take up their rights, (ii) sell their rights, or (iii) tail swallow (sell off rights to fund the purchase of the maximum number of additional share with no new investment). (8 marks) c) Re-calculate the terms of the offer if it had been made at a conventional 20 per cent discount to the current market price (note: the exchange ratio of new shares for old will not convert to a convenient figure and can be omitted from your calculations). (4 marks)

The rights issue was set at a deep discount to the current market price. Despite this, the company arranged for the issue to be fully underwritten by JP Morgan Cazenove and Morgan Stanley. On 10th June the company reported that the issue was taken up by 91 per cent of investors and described the offer as successful. d) Explain the factors that companies should consider in choosing whether to use a deep discounted rights issue, an underwritten issue, or both and explain how these arguments could explain Whitbread’s decision to both underwrite and have a deep discounted offer despite the apparent high cost of underwriting. (12 marks) (Total 30 marks) Question 2Dykes Plc is a quoted retail company that has been targeted for acquisition by Clarke Inc. You have been asked to prepare a range of potential valuations for Dykes Plc based on the information provided below. Income statement information 2017-2020 Year 2017 2018 2019 2020 Profit after tax (£m) 20.0 24.0 26.0 18.0 Total dividends (£m) 5.0 5.5 6.0 6.0 Balance sheet for 2020 £m £m Non-current assets 150.0 Current assets Inventory 16.0 Accounts receivable 4.0 20.0 Total assets 170.0 Equity finance Ordinary shares 60.0 Reserves 50.0 110.0 Non-current liabilities Bank loans 50.0 Current liabilities 10.0 Total liabilities 170.0 The shares of Dykes Plc have a nominal (par) value of £3.00 and a market value of £18.00 per share. The cost of equity for the company is 12 percent. The business sector in which Dykes Plc operates has an average price/earnings ratio of 8 times, and recent takeover transactions have been completed at price/earnings ratios of 10 times. The expected net realisable values of non-current assets and inventory are £130m and £10m respectively. In the event of liquidation only £2m of the trade receivables are expected to be collectable. Required: a) Calculate the value of Dykes Plc using the following methods: i. Market capitalisation; (2 marks) ii. Book value of net assets (2 marks) iii. Net realisable value of assets; (6 marks iv. Price/earnings valuations using the business sector average(4 marks)v. Dividend growth model using the constant growth model (6 marks) b) Discuss the relative merits of the different valuation methods employed when valuing a business for a takeover and recommend a potential bidding range for completion of the acquisition of Dykes Plc. Discuss any additional information that could be added to improve your valuation and explain how the results for 2020 financial year may have skewed the outcome of your valuation exercise. (10 marks) (Total 30 marks) [END OF SECTION A, SECTION B CONTINUES ON THE NEXT PAGE]

SECTION B - Answer TWO questionsQuestion 3Robertson Ltd is considering the choice between two different pieces of machinery to replace an existing machine. Model L costs £500,000, will last for four years. Annual operating expenses will be £75,000 in year 1 and will increase with inflation at 4 per cent per annum. Model P costs £750,000 and will last for five years. Model P has annual operating expenses of £50,000 in year 1 and expenses will increase at a higher rate of 6 per cent per year. Both machines should be depreciated at 20 per cent per annum on a reducing balance basis over their expected useful lives. You should assume that both machines have a scrap value of zero at the end of their expected useful life. The company pays corporate tax at a marginal rate of 30 per cent and tax is paid during the year in which it arises. Both machines are evaluated with a nominal discount rate of 10 per cent. a) Compute the equivalent annual cost (EAC) for both machines and recommend which one the company should go ahead with. (13 marks) b) Clearly state any assumptions made in your analysis (2 marks) (Total 15 marks) Question 4PJ McGinn Inc uses 5,000 boxes of high-grade widgets per year. The widgets are supplied in boxes of 50 and the unit cost of one box is £1500. The cost of placing an order with the supplier is £500. The annual holding cost per box is 10 per cent of the unit cost. Required: a) Calculate the economic order quantity, annual holding costs, annual order costs and optimal order period. (4 marks) b) It has been suggested that for administrative purposes it would be more convenient to order 150 or 250 boxes per order rather than the EOQ derived above. What is the effect on annual inventory costs of moving to either of the suggested order sizes? Advise the company on which order size is preferable. (4 marks) A new supplier has entered the market for this product and also supplies widgets in boxes of 50 with the following prices: Number of boxes ordered Price per box 1-99 £1600.00 100-299 £1500.00 300 or more £1400.00 c) Assuming that order costs remain £500 and holding costs remain 10 per cent of unit cost, what is the minimum total cost of the McGinn Inc’s inventory policy, including the purchase cost of the widgets? Comment on your answer. (7 marks) (Total 15 marks）

Question 4PJ McGinn Inc uses 5,000 boxes of high-grade widgets per year. The widgets are supplied in boxes of 50 and the unit cost of one box is £1500. The cost of placing an order with the supplier is £500. The annual holding cost per box is 10 per cent of the unit cost. Required: a) Calculate the economic order quantity, annual holding costs, annual order costs and optimal order period. (4 marks) b) It has been suggested that for administrative purposes it would be more convenient to order 150 or 250 boxes per order rather than the EOQ derived above. What is the effect on annual inventory costs of moving to either of the suggested order sizes? Advise the company on which order size is preferable. (4 marks) A new supplier has entered the market for this product and also supplies widgets in boxes of 50 with the following prices: Number of boxes ordered Price per box 1-99 £1600.00 100-299 £1500.00 300 or more £1400.00 c) Assuming that order costs remain £500 and holding costs remain 10 per cent of unit cost, what is the minimum total cost of the McGinn Inc’s inventory policy, including the purchase cost of the widgets? Comment on your answer. (7 marks) (Total 15 marks

SECTION C - Answer TWO questionsQuestion 6Explain the main strategies for the management of a firm’s overall working capital. Explain the relative costs and benefits of each strategy. (20 marks) Question 7 Differentiate between the main forms of lease financing available to companies and critically evaluate the main reasons provided by companies for entering into a lease contract. (20 marks) Question 8 Differentiate between the three main forms of the efficient markets hypothesis. Your answer should outline the main assumptions of market efficiency and explain its implications for financial managers. (20 marks) Question 9 Explain what is meant by the trade-off model of capital structure. Explain the relative costs and benefits of debt under the model and its predictions for those factors that affect a firm’s capital structure in practice. (20 marks) END OF EXAMINATION PAPER (Examiner – Dr Patrick McColgan)