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STUDY QUESTION BANK – ADVANCED FINANCIAL MANAGEMENT (P4)

Required:

(a)Discuss whether or not Beela electronics should use the technique suggested by the

(b)Discuss briefly how Beela might manage political risk if it decides to invest in Africa.

(7 marks)

(15 marks)

Question 38 POLYCALC

Polycalc plc is an internationally diversified company. It is presently considering undertaking a capital investment in Australia to manufacture agricultural fertilisers. The project would require immediate capital expenditure of A$ 15m, plus A$ 5m of working capital which would be recovered at the end of the project’s four year life. It is estimated that an annual revenue of A$ 18m would be generated by the project, with annual operating costs of A$ 5m. Straight-line depreciation over the life of the project is an allowable expense against company tax in Australia which is charged at a rate of 50%, payable at each year-end without delay. The project can be assumed to have a zero scrap value.

Polycalc plans to finance the project with a £5m 4-year loan at 10% plus £5m of retained earnings. The proposed financing scheme reflects the belief that the project would have a debt capacity of two-thirds of capital cost. Issue costs on the debt will be 2½% and are tax deductible.

In the UK the fertiliser industry has an equity beta of 1.40 and an average debt: equity gearing ratio of 1:4. Debt capital can be assumed to be virtually risk-free. The current return on UK government stock is 9% and the excess market return is 9.17%.

Corporate tax in the UK is at 35% and can be assumed to be payable at each year-end without delay. Because of a double-taxation agreement, Polycalc will not have to pay any UK tax on the project. The company is expected to have a substantial UK tax liability from other operations for the foreseeable future.

The current spot rate is A$ 2.00 per £ and the A$ is expected to depreciate against the £ at an annual rate of 10%.

Required:

(a)Using the Adjusted Present Value technique, advise the management of Polycalc on the

(b)Comment briefly on the company’s intended financing plans for the Australian project.

(c)What are the limitations and difficulties of using the Capital Asset Pricing Model to

(16 marks)

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ADVANCED FINANCIAL MANAGEMENT (P4) – STUDY QUESTION BANK

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