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A company's latest accounts show profit after tax of $20.0 million, after deducting interest of $5.0 million. The company expects earnings to grow at 5% per annum indefinitely.
The company has estimated its cost of equity at 12%, which is included in the company WACC of 10%.
Assuming that profit after tax is equivalent to cash flows, what is the value of the equity capital?
Give your answer to the nearest $ million.
$ ? million
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Answer:
300, 300000000Profit after tax this year = $20mGrowth rate = 5% → next year’s earnings E1=20×1.05=21E_1 = 20 \times 1.05 = 21E1=20×1.05=21Cost of equity ke=12%k_e = 12\%ke=12%Value of equity (Gordon growth model):VE=E1ke−g=210.12−0.05=210.07=300V_E = \frac{E_1}{k_e - g} = \frac{21}{0.12 - 0.05} = \frac{21}{0.07} = 300VE=ke−gE1=0.12−0.0521=0.0721=300 Answer:$300 million |
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A large, listed company in the food and household goods industry needs to raise $50 million for a period of up to 6 months.
It has an excellent credit rating and there is almost no risk of the company defaulting on the borrowings. The company already has a commercial paper programme in place and has a good relationship with its bank.
Which of the following is likely to be the most cost effective method of borrowing the money?
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D
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Explanation
In CIMA F3’s coverage of short-term financing, commercial paper (CP) is identified as a very cost-effective funding source for large, high-credit-quality companies. CP is an unsecured, short-term promissory note, typically issued for periods up to 270 days, making it ideal for a 6-month funding need. Because it is issued directly into the money markets by strong credits, the interest cost is usually lower than overdrafts or short-term bank loans, which include a bank’s margin. The scenario states that the company is large, listed, has an “excellent credit rating”, minimal default risk and already has a commercial paper programme. This matches the textbook profile of a company for which CP is the cheapest source of short-term borrowing. Treasury bills (C) are issued by governments, not companies, so they are an investment vehicle, not a borrowing method here. Bank overdrafts (A) are flexible but generally expensive and better for fluctuating day-to-day needs. A 6-month term loan (B) tends to involve higher arrangement fees and interest margins than CP. Therefore, option D is the most cost-effective choice. |
A company is considering whether to lease or buy an asset.
The following data applies:
• The bank will charge interest at 7.14% per annum
• The asset will cost $1 million
• Tax-allowable depreciation is available on a straight line basis over 5 years
• There is no residual value
• Corporate tax is paid at 30% in the year when the profit is earned
What is the NPV of the buy option?
Give your answer to the nearest $000.
$ ?
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Answer:
$740,000 (negative NPV of buy option)Under CIMA F3’s lease-or-buy framework, the buy option is evaluated by discounting the after-tax cash flows associated with owning the asset. When an asset is purchased, the immediate cash outflow is the purchase price, but ownership provides a benefit through tax-allowable depreciation, which creates an annual tax shield (a reduction in tax payable). Because corporate tax is paid in the same year that profit is earned, the depreciation tax shield arises each year from Year 1 to Year 5.Step 1: Initial cost (Year 0 outflow)Asset cost = $1,000,000 (cash outflow at time 0).Step 2: Annual tax depreciation and tax shieldStraight-line over 5 years, no residual value:Depreciation = 1,000,000/5=200,0001{,}000{,}000 / 5 = 200{,}0001,000,000/5=200,000 per year.Tax shield each year = 200,000×30%=60,000200{,}000 \times 30\% = 60{,}000200,000×30%=60,000.Step 3: Discount rateCIMA F3 applies the after-tax cost of debt when valuing tax-deductible flows funded by borrowing:After-tax discount rate = 7.14%×(1−0.30)=4.998%≈5%7.14\% \times (1 - 0.30) = 4.998\% \approx 5\%7.14%×(1−0.30)=4.998%≈5%.Step 4: Present value of tax shields (5-year annuity at 5%)Annuity factor = 1−(1.05)−50.05=4.32948\frac{1 - (1.05)^{-5}}{0.05} = 4.329480.051−(1.05)−5=4.32948.PV of tax shields = 60,000×4.32948=259,76960{,}000 \times 4.32948 = 259{,}76960,000×4.32948=259,769.Step 5: NPV of buy optionNPV=−1,000,000+259,769=−740,231≈−740,000NPV = -1{,}000{,}000 + 259{,}769 = -740{,}231 \approx -740{,}000NPV=−1,000,000+259,769=−740,231≈−740,000 So the buy option has an NPV of approximately –$740,000 (nearest $000).Questions no: 198327 |
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The CIMA F3 certification is a globally-acknowledged credential that is awarded to candidates who pass this certification exam by obtaining the required passing score. This credential attests and validates the candidates' knowledge and hands-on skills in domains covered in the CIMA F3 certification syllabus. The CIMA F3 certified professionals with their verified proficiency and expertise are trusted and welcomed by hiring managers all over the world to perform leading roles in organizations. The success in CIMA F3 certification exam can be ensured only with a combination of clear knowledge on all exam domains and securing the required practical training. Like any other credential, CIMA F3 certification may require periodic renewal to stay current with new innovations in the concerned domains.