Please write a 200-word report plan for each of the following questions:
1. Discuss how the concepts of agency theory can be used to explain the relationship that exists between the managers of a listed company and the providers of its equity finance. Your answer should include an explanation of the following terms:
(a) asymmetry of information;
(b) agency costs;
(c) the free-rider problem.
2. Distinguish between a primary and a secondary capital market and discuss the role played by these markets in corporate finance.
What are the desirable features of primary and secondary capital markets?
3. A company is planning to offer a discount for payment within 10 days to its customers, who currently pay after 45 days. Only 40 per cent of credit customers would take the discount, although administrative cost savings of €4,450 per year would be gained. If credit sales, which are unaffected by the discount, are €1.6m per year and the cost of short-term finance is 8 per cent, what is the maximum discount that could be offered?
4. Brand plc generates profit after tax of 15 per cent on shareholders’ funds. Its current capital structure is as follows:
Ordinary shares of 50c each 200,000
The board of Brand plc wishes to raise 160,000 from a rights issue in order to expand existing operations. Its return on shareholders’ funds will be unchanged. The current ex dividend market price of Brand plc is 1.90. Three different rights issue prices have been suggested by the finance director: 1.80, 1.60 and 1.40.
Determine the number of shares to be issued, the theoretical ex-rights price, the expected earnings per share and the form of the issue for each rights issue price. Comment on your results.
5. Bugle plc has some surplus funds that it wishes to invest. It requires a return of 15 per cent on corporate bonds and you have been asked for advice on whether it should invest in either of the following bonds which have been offered to it.
(a) Bond 1: 12 per cent bonds redeemable at nominal at the end of two more years. The current market value per £100 bond is £95.
(b) Bond 2: 8 per cent bonds redeemable at £110 at the end of two more years. The current market value per £100 bond is also £95.
6. LJH plc is planning to buy a machine which will cost £900,000 and which is expected to generate new cash sales of £600,000 per year. The expected useful life of the machine will be eight years, at the end of which it will have a scrap value of £100,000. Annual costs are expected to be £400,000 per year. LJH plc has a cost of capital of 11 per cent.
(a) Calculate the payback period, return on capital employed, net present value and internal rate of return of the proposed investment.
(b) Discuss the reasons why net present value is preferred by academics to other methods of evaluating investment projects.
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