Question

Question No: 01

In line with the end result of the Kunt and Maks model, The Middle East Company (MEC) has estimated its financial needs in 2021. The EFN is anticipated to be $215,000,000 which will increase the total liabilities by 20% and the financial leverage will be 57%. The management is planning to raise 40,000,000 from the City Bank under nominal interest rate of 5%. To issue bonds, the MEC has given incentive to bond investors by giving 10% more on the prevailing RRR of 14%. The bond face value is $1,000 and it is projected that 50,000 will be purchased. The MEC Co. has maintained a retained earning ratio of 65% coming to the total of $76,000,000. MEC management opts for the option to invite Ramada Corporation as a preference shareholder under dividend per share of $200 and share value of 1,500 for 40,000 preference shares.

The RRR of the common shareholder is built around CAPM in the sense that the rf is projected to be 7% which equals 72% of the ERM under 1.62 Beta. The Co. will issue common shares for the remaining part of its financial needs under RRR of 10%. MEC is operating business in the tax-oriented economy with BPT of 16% and tax exemption of 40%.

Required:

1. Find out the WACOC of the MEC in securing its financial needs.

2. What would be the case if Ramada declines the offer and the common shareholders take the role under the same RRR of common shares?

3. What would be the WACOC if the EFN increased by 12% and the incremental fund will be secured by more bank borrowing under the 6% interest rate. Other things remain the same.

Question No: 02

2 (a). Omron Enterprise is planning to use trade credit as short-term finance. The owner has approached your company to buy goods on credit. The value of stock including the profit is around $920,000. Omron Enterprise records in 2019 were as follows:

1. The quick ratio deviated from the min and max rate by 35%.

2. The financial leverage equals the rate of the minimum under CART Model.

2. The Times-Interest-Earned (TIE) equals 5.4.

Required:

As a specialist, you have been requested to provide a reliable opinion on to give or not to give credit facilities to Omron Enterprise, bearing in mind that Omron Enterprise was established as active enterprise on 24 December 2011.

2 (b). Masen Enterprise is operating business in the gulf. To cope the competitiveness of the GCC’s market, Masen Enterprise is looking for optimal capital structure and good operational and financial indicators. The following information was derived from the enterprise records of 2019.

Sales (Q)	450,000
Price per unit	$25
Contribution margin ratio	45%
Gross profit ratio	32%
Fixed operating cost	1,200,000
Interest amount	190,000
Tax rate	15%

Required:

Compute DOL, DFL and DCL of the Masen Enterprise in 2019. Provide complete elaboration to the derived results of DFL, DOL and DCL.

Question No: 03

3 (a). The capital structure of Al Kawthar Corporation is built around the financial leverage of 35% against total capitalization of $140,000,000. The foxed asset intensity is around 46%. The corporation is planning to expand its total assets by 20% under the prevailing ROTA of 16%. Before the expansion policy the relationship between b and DPR was built around the ratio 4 to 5 respectively. Under the expansion plan the DPR will be reduced by 10%. Al Kawthar Corp. is operating business in a very short-term finance market in the sense that current liabilities represent 90% of the total liabilities before expansion.

Required:

1. Based on Kunt and Maks Model, develop the financing scenario and expected growth profile of Al Kawthar Corporation.

2. What would be the required external fund if shareholders forgo dividend for the coming five years.

3 (b). Cairo Corporation is facing financial difficulties in the light of devaluation of the Egyptian pound. The Board of Directors are targeting to maintain zero EPS to get out of the bottleneck. The Corp.’s obligations towards interest on bank borrowing was amounted to $14,500,000 and obligation of interest to bond holders amounted 140% of banking finance cost. Al MENA Corp. joined Cairo Corp. as preference shareholders with the dividend amount as obligation EP 10,500,000. The outstanding common shares are 190,000.

Required:

1. Find out the EBIT that will qualify the Corp. to maintain zero EPS.

2. What would be the EBIT if the obligation to bond holders reduced by 14%?

Answer 1

Solution :-

The external financing need (EFN) of $215,000,000 will be fulfilled in the following manner

Source	Amount
Citi	40,000,000
Bonds	50,000,000
Ramada Corp	60,000,000
Total Debt	150,000,000
EFN	215,000,000
Equity Funding	65,000,000

However ,the cost of this debt will reduce the retained earnings availble and additional eqiuity financing will have to be raised to account for the cost of debt.

Cost of bonds is 10% above RRR of 14% ,which works out to 15.4% (14+1.4).

Cost of Ramada Corp preference shares is 200/1500 = 13.33%

Tax rate = 16% , however tax excemptions amounting to 40% bring the effective tax rate to 9.6% {16% *(1-40%) }

The additional amount of equity to be raised will be :

Source	Amount	Rate	Debt Cost	Taxed @ 9.6%	Effective cost of Debt
Citi	40,000,000	5.00%	2,000,000	192,000	1,808,000
Bonds	50,000,000	15.40%	7,700,000	739,200	6,960,800
Ramanda Corp	60,000,000	13.33%	8,000,000	0	8,000,000
Aditional Eqity to be raised	16,768,800

Total eqiuity to be raised = 65,000,000 + 16,768,800

= 81,768,800

(1). Weighted Average Cost of Capital (WACOC) can be copmuted as :

RRR on equity is given as 10%

Source	Amount	Rate	Cost	Taxed saved @9.6%	Final Cost
Citi	40,000,000	5.00%	2,000,000	192,000	1,808,000
Bonds	50,000,000	15.40%	7,700,000	739,200	6,960,800
Ramada Corp	60,000,000	13.33%	8,000,000	0	8,000,000
Equity	81,768,800	10%	8,176,880	0	8,176,880
Total	231,768,800

The WACOC = 24,945,680 / 231,768,800

WACOC = 10.76%

(2) In case Ramanda Corp declines the offer

The equity to be raised will be 81,768,800 + 60,000,000 (Ramada Corp's Portion ) - 8,000,000 (Cost of Ramada Corp's potion) = 133,768,000

Source	Amount	Rate	Cost	Tax saved @ 9.6%	Final Cost
Citi	40,000,000	5.00%	2,000,000	192,000	1,808,000
Bonds	50,000,000	15.40%	7,700,000	739,200	6,960,800
Equity	133,768,800	10.00%	13,376,880	0	13,376,880

The WACOC = 22,145,680 / 223,768,800

WACOC = 9.9%

(3) EFN increased by 12% secured by bank borrowing at 6%

Additional EFN = 215,000,000 * 12% = 25,800,000

Additional equity to be raised to cover cost of debt = 25,800,000 * 6% (1 - 9.6%)

Additional equity = 1,399,392

Total Equity = 81,768,800 + 1,399,392

= 83,168,192

Source	Amount	Rate	Cost	Tax saved @9.6%	Final Cost
City	40,000,000	5.00%	2,000,000	192,000	1,808,000
Bonds	50,000,000	15.40%	7,700,000	739,200	6,960,800
Additional Borrowing	25,800,000	6.00%	1,548,000	148,608	1,399,392
Ramada Corp	60,000,000	13.33%	8,000,000	0	8,000,000
Equity	83,168,192	10.00%	8,316,819	0	8,316,819
Total Equity	258,968,192				26,485,011

The WACOC = 26,485,011 / 258,68,192

WACOC = 10.23%