Financial Management-AW496

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Question 1

Sunrise Boards is a small company that manufactures and sells surfboards in Taiwan. The company has been growing steadily, thanks to word of mouth among professional surfers. Sales have picked up rapidly and the company is considering a major expansion. Its plans include opening another surfboard store in Gao Xiong as well as supplying surfboard to other sellers.

Balance Sheet of Sunrise Boards as at 31.12.2014 (all figures are in thousands) Cash 17165 Accounts Receivables 8620 Inventory 18140 Fixed Assets 105000 Total Assets 148925 Accounts Payable 21500 Accrual Payable 9800 Long term Debt 53000 Total Liabilities 84300 Capital 15000 Retained Earnings 49625 Total Equity 64625 Total Liabilities & Equity 148925

Income Statement of Sunrise Boards in the Year 2014 (all figures are in thousands) Sales 166000 Cost of Good Sold (40% of Sales) 66400 Gross Profit 99600 Selling and Adminstrative Expenses (Fixed) 10000 Selling and Adminstrative Expenses (Variable, 30% of sales) 49800 Depreciation 23800 Earnings Before Interest & Tax 16000 Interest Expense 6000 Earnings Before Tax 10000 Income Tax (20%) 2000 Earnings After Tax 8000 Number of Ordinary Shares Outstanding 15000

Sunrise Boards expansion plans require a significant investment, which it plans to finance with additional debt financing at 8% p.a. It has been forecasted that the expansion plan will have sales grow 40% from the current level. To support this growth, current assets and fixed assets* will increase by 30%, and 40% respectively. Fixed costs such as rental and wages will increase too. Current liabilities would increase by 10% spontaneously.

To promote the goodwill and rapport with its customers, Sunrise would strive to keep the net profit margin at the current level. The Board of directors does not intend to pay any dividends in the foreseeable future. Also, it plans to boost the Return on Equity (ROE) by repurchasing 5 million shares from the market at $1.00 apiece.

(a) Analyse and compute the additional discretionary financing needed for FY 2015.

(b) Compute the Degree of Operating Leverage (DOL) and Degree of Financial Leverage (DFL) before the expansion.

(c) Determine the new fixed costs after the expansion.

(d) Compute the Degree of Operating Leverage (DOL) and Degree of Financial Leverage (DFL) after the expansion.

(e) Plot the EBIT (X-axis) vs EPS (Y-axis) chart before and after expansion.


(f) Determine the accounting break-even point i.e. sales level at which the company would neither be better off nor worse off if it adopted the expansion plan.
(g) Define Degree of Total Leverage (DTL) as DTL = DOL x DFL. What is the DTL of Sunrise after expansion?

(h) Compute the Earning Per Share (EPS) if sales dropped by 15% after expansion.
(Note: without computing the EPS from scratch)

(i) Given the EBIT is normally distributed with mean $23,000(K) and standard deviation $2,300(K). (i.e. 95% probability with the EBIT falling within 2 standard deviations of the mean). Evaluate whether Sunrise should go ahead with the expansion plan.

(j) ‘Financial Leverage will maximise the value of a firm.’ Discuss your views of this statement in a balanced manner.

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Question 2

Belton Company is considering relaxing its credit standards to boost its currently sagging sales. It expects its proposed relaxation will increase sales by 20 percent from the current annual level of $10 million. The firm’s average collection period is expected to increase from 35 days to 50 days and bad debts are expected to increase from 2 percent of sales to 7 percent of sales as a result of relaxing the firm’s credit standards as proposed. The firm’s variable costs equal 60 percent of sales and their fixed costs total $2.5 million per year. Belton’s opportunity cost is 16 percent. Assume a 365-day year.

(a) Analyse and compute the benefit of relaxing its credit policy.

(b) Compute the cost of relaxing its credit policy and recommend whether Belton should proceed to implement this new policy.

Question 3

Discuss a firm’s cash conversion cycle and relate it to a financial manager’s goal.
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