Question 5 (20 marks) Answer any TWO parts a. (10 marks) Zocco Co which manufactures sports equipment, consists of several operating divisions. Division A has decided to go outside the company to buy materials since Division Bplans to increase its selling price for the same materials to $200. Information for Division A and Division B follows: Outside price for materials Division A's annual purchases Division B's variable costs per unit Division B's fixed costs, per year Division B's capacity utilization $150 10,000 units $140 $1,250,000 100% Required: (1) Will the company benefit if Division A purchases outside the company? Assume that Division B cannot sell its materials to outside buyers. (2 marks) (2) Assume that Division B can save $200,000 in fixed costs if it does not manufacture the materials for Division A. Should Division A purchase from the outside market? (2 marks) (3) Assume the situation in requirement (1). If the outside market value for the materials drops $20, should Division A buy from the outside? Explain. (2 marks) (4) What are the advantages of a negotiated transfer price policy? (4 marks) b. (10 marks) Barry Fast Foods Company has been experiencing low profitability in recent years. The CEO is currently reviewing the working capital management policy. The company's sales are all on credit and the current credit term is 1/10, net 30. The CEO is considering easing the credit term to 2/10, net 40. By easing the term, it is expected that the sales may increase from $400 million to $550 million. Other expected changes are as follows: Proposed 4% Bad debt as % of sales Days sales outstanding Percentage of sales taking discount Present 2% 34 days 10 45 days 20 The variable cost ratio is 70% and cost of fund is 10%. Analyze the proposed change in credit policy and recommend whether the change should be adopted. (10 marks) c. (10 marks) Bluegrass Company is an unlevered firm with expected earnings before taxes of $23.5 million in perpetuity. The current required return on the firm's equity is 11% and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.9 million shares of common stock outstanding and the corporate tax is 20%. The firm is planning a recapitalization under which it will issue $35 million of perpetual debt at 6% and use the proceeds to buy back shares. Required: (1) Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the announcement? What is the price per share. (3 marks) (2) Use the Adjusted Present Value method to calculate the company value after the recapitalization plan is announced. What is the equity value after the announcement? What is the new price per share after the announcement? (3 marks) (3) How many shares will be repurchased at the new price? What is the value of equity after the repurchase has been completed? What is the price per share after the repurchase has been completed? (4 marks) Question 5 (20 marks) Answer any TWO parts a. (10 marks) Zocco Co which manufactures sports equipment, consists of several operating divisions. Division A has decided to go outside the company to buy materials since Division Bplans to increase its selling price for the same materials to $200. Information for Division A and Division B follows: Outside price for materials Division A's annual purchases Division B's variable costs per unit Division B's fixed costs, per year Division B's capacity utilization $150 10,000 units $140 $1,250,000 100% Required: (1) Will the company benefit if Division A purchases outside the company? Assume that Division B cannot sell its materials to outside buyers. (2 marks) (2) Assume that Division B can save $200,000 in fixed costs if it does not manufacture the materials for Division A. Should Division A purchase from the outside market? (2 marks) (3) Assume the situation in requirement (1). If the outside market value for the materials drops $20, should Division A buy from the outside? Explain. (2 marks) (4) What are the advantages of a negotiated transfer price policy? (4 marks) b. (10 marks) Barry Fast Foods Company has been experiencing low profitability in recent years. The CEO is currently reviewing the working capital management policy. The company's sales are all on credit and the current credit term is 1/10, net 30. The CEO is considering easing the credit term to 2/10, net 40. By easing the term, it is expected that the sales may increase from $400 million to $550 million. Other expected changes are as follows: Proposed 4% Bad debt as % of sales Days sales outstanding Percentage of sales taking discount Present 2% 34 days 10 45 days 20 The variable cost ratio is 70% and cost of fund is 10%. Analyze the proposed change in credit policy and recommend whether the change should be adopted. (10 marks) c. (10 marks) Bluegrass Company is an unlevered firm with expected earnings before taxes of $23.5 million in perpetuity. The current required return on the firm's equity is 11% and the firm distributes all of its earnings as dividends at the end of each year. The company has 1.9 million shares of common stock outstanding and the corporate tax is 20%. The firm is planning a recapitalization under which it will issue $35 million of perpetual debt at 6% and use the proceeds to buy back shares. Required: (1) Calculate the value of the company before the recapitalization plan is announced. What is the value of equity before the announcement? What is the price per share. (3 marks) (2) Use the Adjusted Present Value method to calculate the company value after the recapitalization plan is announced. What is the equity value after the announcement? What is the new price per share after the announcement? (3 marks) (3) How many shares will be repurchased at the new price? What is the value of equity after the repurchase has been completed? What is the price per share after the repurchase has been completed? (4 marks)