Required:
(a) Provide a reasoned estimate of the cost of capital that Tisa Co should use to calculate the net present value
of the two processes. Include all relevant calculations. (8 marks)
(b) Calculate the internal rate of return (IRR) and the modified internal rate of return (MIRR) for Process Omega.
Given that the IRR and MIRR of Process Zeta are 26·6% and 23·3% respectively, recommend which
process, if any, Tisa Co should proceed with and explain your recommendation. (8 marks)
(c) Elfu Co has estimated an annual standard deviation of $800,000 on one of its other projects, based on a normal
distribution of returns. The average annual return on this project is $2,200,000.
Required:
Estimate the project’s Value at Risk (VAR) at a 99% confidence level for one year and over the project’s life
of five years. Explain what is meant by the answers obtained. (4 marks)
(20 marks)
65 Kilenc Co, a large listed company based in the UK, produces pharmaceutical products which are exported around the
world. It is reviewing a proposal to set up a subsidiary company to manufacture a range of body and facial creams in
Lanosia. These products will be sold to local retailers and to retailers in nearby countries.
Lanosia has a small but growing manufacturing industry in pharmaceutical products, although it remains largely
reliant on imports. The Lanosian government has been keen to promote the pharmaceutical manufacturing industry
through purchasing local pharmaceutical products, providing government grants and reducing the industry’s corporate
tax rate. It also imposes large duties on imported pharmaceutical products which compete with the ones produced
locally.
Although politically stable, the recent worldwide financial crisis has had a significant negative impact on Lanosia. The
country’s national debt has grown substantially following a bailout of its banks and it has had to introduce economic
measures which are hampering the country’s ability to recover from a deep recession. Growth in real wages has been
negative over the past three years, the economy has shrunk in the past year and inflation has remained higher than
normal during this time.
On the other hand, corporate investment in capital assets, research and development, and education and training,
has grown recently and interest rates remain low. This has led some economists to suggest that the economy should
start to recover soon. Employment levels remain high in spite of low nominal wage growth.
Lanosian corporate governance regulations stipulate that at least 40% of equity share capital must be held by the
local population. In addition at least 50% of members on the Board of Directors, including the Chairman, must be
from Lanosia. Kilenc Co wants to finance the subsidiary company using a mixture of debt and equity. It wants to raise
additional equity and debt finance in Lanosia in order to minimise exchange rate exposure. The small size of the
subsidiary will have minimal impact on Kilenc Co’s capital structure. Kilenc Co intends to raise the 40% equity
through an initial public offering (IPO) in Lanosia and provide the remaining 60% of the equity funds from its own
cash funds.
Required:
(a) Discuss the key risks and issues that Kilenc Co should consider when setting up a subsidiary company in
Lanosia, and suggest how these may be mitigated. (15 marks)
(b) The directors of Kilenc Co have learnt that a sizeable number of equity trades in Lanosia are conducted using
dark pool trading systems.
Required:
Explain what dark pool trading systems are and how Kilenc Co’s proposed Initial Public Offering (IPO) may
be affected by these. (5 marks)
(20 marks)
