Pages: 19 (2150 words) Published: February 9, 2013

Semester 2, 2012

Semester 2, 2012
Sample Final Exam 1
Note:

This is an edited and revised version of a previous final exam. The reading time for this sample exam is 15 minutes and the writing time is 120 minutes. On this semester’s final exam you will be required to write your answers in the exam booklet and you will be provided with adequate space to do so. Note also that the format of this semester’s final exam will differ from the sample exam’s format. Further details on the format of this semester’s final exam will be available from the LMS. The answers to these questions are not being made available as some questions from this sample final exam may be used on this semester’s final exam. The formula sheet will contain all the formulas shown in class on the lecture slides entitled “Formula Sheet”.

Question 1

[12  3 = 36 marks]

Indicate whether each of the following statements is true or false by circling the appropriate answer. Provide a 2-3 sentence reason and/or calculation and/or diagram to justify your answer. Note that no reason/explanation implies no marks.

Answers must be written on ruled spaces. All other writing will not be graded. Unruled pages may be used for rough work.

a)

The only difference between the capital market line (CML) and the security market line (SML) is that in the CML risk is measured using the standard deviation of returns while in the SML risk is measured using the beta.

b)

The value of an option at expiration is the maximum of its intrinsic value and zero.

c)

Speculators try and identify mispricing is futures markets to make riskfree profits.

d)

The value of a company is normally defined as the market value of its equity plus the net present value of its investment projects.

e)

Modigliani and Miller’s proposition 1 states that the value of a firm’s equity does not change regardless of the level of debt in its capital structure.

f)

In an efficient market, it is always possible for some investors to earn abnormal returns.

g)

A pure residual dividend policy sets the payout ratio equal to the terminal value of all investment projects divided by earnings.

Sample Final Exam 1

1

Semester 2, 2012

h)

The payback period method of project evaluation discriminates against projects with long establishment periods and large cash flows later in their lives.

i)

A necessary condition for multiple internal rates of return is that the future cash flows change sign at least two times.

j)

The CAPM is like a one factor APT model because the market portfolio is often one of the factors priced in the APT model.

k)

The TCL Company relies on preference shares, bonds, and ordinary shares for its long-term finance. The rank, in ascending order (that is, 1 = lowest and 3 = highest), of the likely component costs of the long-term financing is: 1 = preference shares, 2 = ordinary shares, 3 = bonds.

l)

Financing charges such as interest and dividends should not be included in the calculation of a project’s net cash flow.

Question 2

[6 + 8 = 14 Marks]

The proposition that a company’s dividend policy has no effect on shareholder wealth was first made by Modigliani and Miller (1961).
a)

List three important assumptions which underpin Modigliani and Miller’s analysis with a brief explanation as to why each assumption is important.

b)

Briefly explain the intuition behind Modigliani and Miller’s dividend irrelevance argument. Your answer must include reference to sources and uses of funds.

Question 3

[10 Marks]

The management of FinBiz Ltd wants to know the cost of capital associated with an expansion of their manufacturing operations. Management has provided selected accounting and market information to assist you in your task. An extract from the firm’s most recent balance sheet is as follows....