MN-2004: Corporate Finance 1 2022
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DEGREE EXAMINATIONS: JANUARY / 2022
SCHOOL OF MANAGEMENT
MN-2004: Corporate Finance 1
Section 1
Multiple choice (Each question carries 3 marks and 30 marks in total)
There is one and only one correct answer for each question. Please write down the question number and your answer (either A, B, C or D) on the answer book (Workings are not required).
Question 1
Which of the following is the correct interpretation of the terms of sale “A customer is granted credit with terms of net 40.”?
A The customer has 40 days from the invoice date to pay and 40% discount is offered for
early payment.
B The customer has 60 days from the invoice date to pay and 40% discount is offered for
early payment.
C The customer has 40 days from the invoice date to pay and no discount is offered for
early payment.
D The customer has 60 days from the invoice date to pay and no discount is offered for
early payment.
Question 2
Which of the following is a main drawback of Gordon growth model?
A It cannot be applied on firms who did not pay dividends.
B It does not consider the time value of money.
C It does not consider the discount rate.
D It does not consider the pattern of future dividends.
Question 3
Which of following formulae correctly describes bond price?
A Dirty price = Clean price – Accrued interest
B Dirty price = Accrued interest
C Dirty price = Clean price + Accrued interest
D Dirty price = Coupon +Accrued interest
Question 4
Which of the following statements is correct?
A An asset is said to be overpriced if the market price is above its present value. B An asset is said to be underpriced if the market price is above its present value. C An asset is said to be priced fairly if the market price is above its present value. D None of the above
Question 5
Which of the following is not a main drawback of the internal rate of return (IRR) approach?
A No consideration on time value of money.
B Ranking issues
C Multiple solutions
D Confusion over investing type and financing type cash flows
Question 6
Assuming the Capital Asset Pricing Model (CAPM) holds, what is the beta value of market portfolio assumed to be?
A 0
B 1
C -1
D It changes over time.
Question 7
Which of the following is not an element of statement of financial position? A Assets
B Liabilities
C Shareholders’ equity
D Current share price
Question 8
Which of the following statements about portfolio diversification is not correct? A Total risk can be diversified if assets are perfectly positively correlated. B Total risk can be diversified if assets are perfectly negatively correlated.
C Total risk can be diversified if assets are not correlated.
D Diversification can diversify unique risk.
Question 9
Which of the following statements about cash dividends is not correct?
A Firms may pay regular cash dividends.
B Firms may pay extra cash dividends.
C Paying cash dividends reduces the corporate cash and retained earnings . D Cash dividends are not taxable.
Question 10
Which of the following is not a general assumption of Modigliani and Miller proposition I and II in a perfect market?
A No taxation
B No risk
C No transaction costs
D No bankruptcy costs
Section 2
Calculation and analysis (70 marks in total)
Please write down the question number, necessary workings and answers on the answer book. (Rounding to two decimal places if necessary)
Question 1 (20 marks in total)
(a) A five-year annuity due offers constant annual payments of £1,200. Assuming an alternative investment offers a rate of return at 15%, what is the present value of this annuity due? [5 marks]
(b) Stock A is expected to pay a dividend of £1 at the end of year 1, £2 at the end of year 2, with dividend growth expected to be 3% per annum thereafter. If the required return on similar equities is 10%, calculate the fair market price of stock A. [6 marks]
(c) Datasoft plc. has bonds on the market with 12.5 years to maturity and a yield to maturity of 10% per annum. The bonds make semi-annual payments with the next coupon payment £20 due in 6 months. The face value of these bonds is £1,000. What is the fair market price of the bond? [9 marks]
Question 2 (30 marks in total)
(a) Given the risk-free rate is 2% and market risk premium is 5% in the market, share B has a beta of 1.6 and an expected return of 12%, share C has a beta of 1.2 and an expected return of 6%. Assuming Capital Asset Pricing Model (CAPM) holds and share B and share C are in the same market. Briefly discuss what is likely to happen to the market prices and expected returns of share B and share C, and use calculations to support the discussion. [14 marks]
(b) Yuzhi plc. is equally financed (50% by debt and 50% by equity). Given the cost of equity and cost of debt of Yuzhi plc. are 10% and 8%, respectively, and corporate tax rate is 20%. Calculate the weighted average cost of capital (WACC) of Yuzhi plc. [6 marks]
(c) Mr. Davies invests in a two-asset portfolio which is consisted of two risky assets, x1 and x2 . The proportions of x1 and x2 held in the portfolio are 30% and 70%, respectively. The expected return of x1 and x2 are 10%; and 8%, respectively. Standard deviations of x1 and x2 are 75% and 50%; respectively. The correlation between x1 and x2 is -0.7. Calculate the expected return and standard deviation of this two-asset portfolio. [10 marks]
Question 3 (20 marks in total)
(a) Vineet plc. is considering two investment projects (mutually exclusive) whose cash flows are shown below:
Points in time (yearly intervals)
0
1
2
3
4
Project A (£)
-240,000
120,000
90,000
84,000
36,000
Project B (£)
-240,000
30,000
90,000
110,000
120,000
Given the cost of capital of Vineet plc. is 15% and no threshold figure is set, use the discounted payback method to advise the company which project should be taken and briefly discuss the popularity of payback methods. [10 marks]
(b) Hark plc. is a pharmaceutical company and the following financial information about this company is available to investors:
Current share price |
£3 per share |
Number of shares outstanding |
100,000 |
Shareholder’s equity |
£200,000 |
Net income |
£50,000 |
Days in inventory |
35 days |
Days in receivables |
45 days |
Days in payables |
40 days |
Use the available information, calculate operating cycle, cash cycle, earnings per share (EPS), price earnings (PE) ratio and market to book ratio of Hark plc. [10 marks]
2023-01-13