MGT201 Final Term Subjective by Uzair Husnain

MGT201 Subjective Material

Q50. Management Buyouts is a form of buyouts. Explain this term in your own words. (3 marks)

Solution:- Management buyouts are similar in all major legal aspects to any other acquisition of a company. The particular nature of the MBO lies in the position of the buyers as managers of the company, and the practical consequences that follow from that. In particular, the due diligence process is likely to be limited as the buyers already have full knowledge of the company available to them. The seller is also unlikely to give any but the most basic warranties to the management, on the basis that the management know more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company.

Q51. Company XYZ wants to issue more Common Stock of Face Value Rs 12. Next Year the Dividend is expected to be Rs. 3 per share assuming a Dividend Growth Rate of 10% pa. (5 marks)

The Lawyer’s fee and Stock Brokers’ Commissions will cost Rs 1 per share. Investors are confident about Company ABC so the Common Share is floated at a Market Price of Rs 18 (i.e. Premium of Rs 6).

If the Capital Structure of Company ABC is entirely Common Equity, then what is the Company’s WACC? Use New Stock Issuance Approach to calculate the results.

Solution:- DIVI = 3 Po = 18 g = 10%

r = (DIV1/Po) + g r = 3/18 + 0.10 r = 0.1666 + 0.1 r = 0.2666 *100 r = 26.67%

Net Proceeds = Flotation Price - Flotation Costs Net Proceeds = 18 – 1 Net Proceeds = 17

DIVI = 3 NP = 17 g = 10%

r =(DIV1/NP) + g r = 3/17 + 0.10 r = 0.176 + 0.1 r = 0.276 *100 r = 27.64%

Q52. What is the purpose of residual dividend model and what is the procedure to be followed while using this model? (5 marks)

Solution:- Residual Dividend Model

• Residual Dividend Model: Best Practical Model for numerical calculations of optimal Dividend Policy. Sets Long-Term Target Dividend Payout Ratio from which to back-calculate short-term Dividends.
• Steps in Residual Dividend Model (RDM):
• Forecast Capital Budget, Earnings, Cash Flows (for next 5 years)
• Conservatism: To be on safe side, underestimate the Free Cash Flows
• Determine Target optimal Capital Structure (or Practically Speaking, “Range” for Debt

Ratio) and forecast required Equity (for next 5 years)

• Use Retained Earnings (internal capital) to finance most of the required Equity because

RE is less costly than external financing (higher transaction costs). Retained earnings cost less than loans to acquire finance.

• Leftover or “Residual” Earnings can be safely paid Out as Dividends in Long Term.

Then divide this into Small Yet Regular (may be quarterly) and Steadily Increasing Dividend Payouts.

Q53. Differentiate forward market and future market. (5 marks)

Solution:

The forward market is the over-the-counter financial market in contracts for future delivery, so called forward contracts. Forward contracts are personalized between parties (i.e., delivery time and amount are determined between seller and customer). The forward market is a general term used to describe the informal market by which these contracts are entered into. Standardized forward contracts are called futures contracts and traded on a futures exchange.

A futures market or derivatives exchange is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future.

Q49. Why do firms need to invest in net working capital? (3 marks)

Solution:- There is a need to invest in net working capital because net working capital represents the surplus working capital left with the company after payment of current liabilities; hence more net working capital means company has surplus money for its day to day operations

Q50. What kind of dividend policy is the best one for a firm? (Give answer in bulleted from only) (3 marks)

Solution:- Most managers believe the best dividend policy is one that minimizes the weighted average cost of capital.

• This policy should provide stable payments.
• This policy should maintain investor’s confidence.
• This policy should give good signals to investors about the ability of