Question 1 a. If the goal of a firm is to maximise the shareholders’ wealth, does it mean profit…


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Question 1 a. If the goal of a firm is to maximise the shareholders’ wealth, does it mean profit is not important at all? Explain your answer. b. What are the advantages and disadvantages of the three principal forms of business organisation? c. Briefly explain the term “agency costs” as related to a corporation. How can agency problem be minimised when a company uses debt? d. In pursuing the goal of a firm, why is corporate governance important? Question 2 a. The Capital Asset Pricing Model (CAPM) is a widely used concept in finance. The Model is expressed graphically by the Security Market Line (SML). Within the context of investment, explain how CAPM can be useful to investors. b. Explain Efficient Market Hypothesis (EMH) and the different types of market efficiency. Do stock market anomalies contradict the concept of market efficiency? Explain. c. The distributions of rates of return for Security AA and Security BB are given below: State of Probability of Security Economy State Occurring AA BB Boom 0.2 30% -10% Normal 0.6 10 5 Recession 0.2 -5 50 Based on the above information can we conclude that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB. Why? ] Question 3 a. The following information should be used to answer the following questions: Sandy River Bhd. Income Statement for the year ended 31 Dec 2013 ($ in thousands) Net sales 5,680 Less: Cost of goods sold 4,060 Less: Depreciation 420 Earnings before interest and taxes 1,200 Less: Interest paid 30 Taxable Income 1,170 Less: Taxes 410 Net income 760 Sandy River Bhd. Balance Sheets As at Dec 2011 and 2013 ($ in thousands) 2012 2013 2012 2013 Cash 70 180 Accounts payable 1,350 1,170 Accounts rec. 980 840 Long-term debt 720 500 Inventory 1,560 1,990 Common stock 3,200 3,500 Total 2,610 3,010 Retained earnings 940 1,200 Net fixed assets 3,600 3,360 Total assets 6,210 6,370 Total liabilities & equity 6,210 6,370 i.) In 2013, how many days on average did it take Sandy River Bhd. to sell its inventory? ii.) What is the debt-equity ratio for 2013? [3 marks] iii.) What is the time interest earned ratio for 2013? [3 marks] iv.) What is the equity multiplier for 2013? [3 marks] v.) What is the return on equity for 2013? b. Daisy Corp currently has $1,000,000 in accounts receivable. Its day’s sales outstanding (DSO) is 50 days (based on a 365-day year). Assume a 365-day year. The company wants to reduce its DSO to the industry average of 32 days by putting more pressure to its customers to pay their bills on time. The company’s Chief Financial Officer estimates that if this policy is adopted the company’s average sales will fall by 10 percent. Assuming that the company adopts this change and succeeds in reducing its DSO to 32 days and does lose 10 percent of its sales, what will be the level of accounts receivable following the change? Question 4 a. Your grandmother invested one lump sum 17 years ago at 4.25% interest. Today, she gave you the proceeds of that investment which totaled $5,539.92. How much has your grandmother originally invested? b. One year ago, the Beauty Skins Bhd deposited $3,600 in an investment account for the purpose of buying new equipment four years from today. Today, it is adding another $5,000 to this account. It plans to make a final deposit of $7,500 to the account next year. How much will be available when it is ready to buy the equipment, assuming it earns a 7% rate of return? c. You have some property for sale and have received two offers. The first offer is for $189,000 today in cash. The second offer is the payment of $100,000 today and an additional $100,000 two years from today. If the applicable discount rate is 8.75%, which offer should you accept and why? d. You borrow $149,000 to buy a house. The mortgage rate is 7.5% and the loan period is 30 years. Payments are made monthly. Determine the monthly interest payment that you have to make to settle the loan. e. You are willing to pay $15,625 to purchase a perpetuity which will pay you and your heirs $1,250 each year, forever. If your required rate of return does not change, how much would you be willing to pay if this were a 20-year, annual payment, ordinary annuity instead of a perpetuity? Question 5 a. The Lutfus Corp offers a 6% bond with a current market price of $875.05. The yield to maturity is 7.34%. The face value is $1,000. Interest is paid semiannually. How many years is it until this bond matures? b. A corporate bond with a face value of $1,000 matures in 4 years and has a 8% coupon paid at the end of each year. The current price of the bond is $932. What is the yield to maturity for this bond? c. The Chocolate Factory Inc. is expecting its ice cream sales to decline due to the increased interest in healthy eating. Thus, the company has announced that it will be reducing its annual dividend by 5% a year for the next two years. After that, it will maintain a constant dividend of $1 a share. Two weeks ago, the company paid a dividend of $1.40 per share. What is the current worth of the stock if you require a 9% rate of return d. Active Planet Bhd. is preparing to pay its first dividends. It is going to pay $1.00, $2.50, and $5.00 a share over the next three years, respectively. After that, the company has stated that the annual dividend will be $1.25 per share indefinitely. What is the current worth of this share if you require a 7% rate of return? e. Your portfolio consists of $100,000 invested in a stock which has a beta = 0.8, $150,000 invested in a stock which has a beta = 1.2, and $50,000 invested in a stock which has a beta = 1.8. The risk-free rate is 7 percent. Last year this portfolio had a required rate of return of 13 percent. This year nothing has changed except for the fact that the market risk premium has increased by 2 percent (two percentage points). What is the portfolio’s current required rate of return? Question 6 a. An investor has $5,000 invested in a stock which has an estimated beta of 1.2, and another $15,000 invested in the stock of the company for which she works (Her total portfolio is worth $20,000). The risk-free rate is 6 percent and the market risk premium is also 6 percent. The investor calculates that the required rate of return on her total portfolio is 15 percent. What is the beta of the company for which she works? b. A company’s balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.50 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects? c. Mercu Jaya Bhd. is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm’s after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period? [5 marks] d. Briefly discuss the concept of relevant cash flows when evaluating a new project. [5 marks] [TOTAL: 20 MARKS

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