The University has also provided your class with two components of its most recent financialstatements of its machine-shop that produces chairs. Prior to COVID-19, the machine-shopcontributed 4% to the University’s income; the trend appears to be falling since.The University is contemplating purchasing some additional equipment at an initial cost of$30 million, which they hope will turn around the earnings fortunes of the machine-shop.Statement of Income for the period ending December 31:2019 2018$000 $000Revenue 50,000 50,000Cost of sales 31,000 30,000Gross profit 19,000 20,000Distribution costs 1,000 750Administrative expenses 3,000 1,750Operating profit before interest & tax 15,000 17,500Interest 4,000 3,800Operating before tax 11,000 13,700Taxation 3,300 4,000Profit for the year 7,700 9,700Statement of Financial Position as at December 31:2019 2018Assets $000 $000Property, plant & equipment 65,000 64,000Current assetsInventories 11,700 10,000Receivables 8,500 9,000Cash & cash equivalents 1,300 1,000Total current assets 21,500 20,000Total assets 86,500 84,000Equity & liabilitiesOrdinary share capital $1 each 35,000 35,000Reserves 5,000 1,200Total equity 40,000 36,20010% Loan notes (2014) 35,000 35,000Current liabilities 11,500 12,800Total equity & liabilities 86,500 84,000The purchase of the equipment is expected to increase annual sales by 55,000 chairs.Investment in replacement equipment would be needed after five-years. The financial data onthe additional units to be sold is as follows:5Selling price per unit $5,000Cost of production $2,000 Variable administrative and distributive expenses are expected to increase by$2,200,000 per year as a result of the increase in capacity. In addition to the initial investment in new equipment, $4,000,000 would need to beinvested in working capital The full amount of the initial investment in new equipment of $30,000,000 will giverise to capital allowances on a 25% per years reducing balance method. The scrapvalue of the equipment after five years is expected to be negligible. Tax liabilities are in the year in which they arise and the University machine-shoppays tax at 30% of annual profits. The Finance Director of the machine-shop has proposed that the $30.4 millioninvestment should be financed by an issue of loan notes at a fixed rate of 8% perannum. The machine-shop uses the after tax discount rate of 12% to evaluate investmentproposals. Straight- line depreciation method is used over the expected life of fixedassets. Average data for chair-making industry is as follows:o Gearing 100%o Interest covers 4 timeso Current ratio 2:1o Inventory days 90 days.Required:a) Suggest alternative sources of finance that the University could use, outlining theadvantages and disadvantages of each.b) Analyse and comment on the recent performance of the University machine-shopc) Calculate the effect on the gearing and interest cover of the University machine-shop offinancing the proposed investment with an issue of loan notes and compare your resultswith the sector averages.
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The University has also provided your class with two components of its most recent financial statements of its machine-shop that produces chairs. Prior to COVID-19, the machine-shop contributed 4% to