Finance-AW472

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Question 1
 
Mr. Chen is not sure what cost of capital is to be used in evaluating the purchase of Athletic Optical. The alternatives he is considering are
 

1) Cost of equity for Athletic Optical.
2) Weighted average cost of capital for Athletic Optical.
 
3) Cost of equity for Century Optical.
4) Weighted average cost of capital for Century Optical.
 
Explain to Mr. Chen the appropriate cost of capital that should be used to evaluate the purchase of Athletic Optical. Also explain why the others are not applicable.
 

Question 2
 
Should Mr. Chen go ahead with purchase of Athletic Optical? Assume that the value of Athletic Optical will equal the book value of assets plus present value of future cash flows projected for 5 years using the cost of equity of Athletic Optical.
 

Question 3
 
Assuming that the value of Century Optical will increase by the net present value of the investment, which of the two offers, that is, cash offer and cash and stock offer would be advantageous for Mr. James, owner of
 
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Related Services

 

Athletic Optical.
 

Question 4
(a) Assume that borrowed funds will be used to meet the net of ‘capital investment less depreciation’ funding needs during 2014, 2015, and 2016, how would the decision to purchase change? You need not do calculations, but explain how you would take this into account in your investment decision.
 

(b) Athletic Optical currently uses credit terms of net 75, and the average collection
period is 90 days, as many of the customers pay late. Mr. Chen has conducted an analysis of accounts receivables and found the following aging of receivables
 

Days outstanding Amount Outstanding Percentage Outstanding
 
($000)
1-10 924.65 5%
11-30 1849.30 10%
31-60 2773.95 15%
61-90 2773.95 15%
91-120 4623.50 25%
121+ 5547.90 30%
 
This analysis shows that 55% of the receivables are more than 90 days old. However, Mr. Chen believes that the average collection period can be brought down to 45 days. What strategies can Mr. Chen use to lower the average collection period?
 

Question 5
 
The company you currently work for wants to raise $2 million for further investment.You are to advise whether debt or equity financing should be used in the present market
conditions.

 
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