Response to the following:
Question 1:
A listed company is confident of raising external long-term sources of finance to cover its expansion plans related to its product market strategy. Its board of directors is considering the following forms of funding:
a) Ordinary shares issued at full market value.
b) Rights issue at @20 % discount of the market price.
c) Issue of 10 % Debentures redeemable at par in 10 years
d) Issue of 7 % Convertible Debentures, redeemable at par or convertible in 10 years' time.
e) 10 year Bank loan, with a variable interest charge of 6 % above the base lending rate.
Required:
Critically evaluate ALL of the above external long-term sources of finance from the company's perspective. You may assume that the company currently has both equity and debt in line with industry average and available debt capacity.
Question 2:
A firm has identified 7 projects for possible investment Summary information on the projects is provided in the table, below. All projects are divisible. The firm's cost of capital is 10%.
|
Projects
|
A
|
B
|
C
|
D
|
E
|
F
|
|
Outlay £000
|
200
|
300
|
550
|
900
|
150
|
400
|
|
NPV £000
|
20
|
37
|
58
|
120
|
12
|
(2)
|
|
IRR (%)
|
11
|
11
|
13.2
|
12.1
|
10.4
|
9.5
|
Required:
a) Rank the seven projects (A to F) according to the Net Present Value (NPV) and Internal Rate of Return (IRR) criteria.
Discuss the main reasons why the ranking may differ?
b) The maximum funds currently available to the firm are limited to £2 million. State, giving reasons, which projects you would advise the firm to undertake. What is the cost of capital rationing?
c) Critically distinguish between hard and soft capital rationing.
d) Explain the term default risk.