Trimester 1, 2012

71303 Corporate Finance Final Examination

Time allowed

Three hours, plus 10 minutes to read this paper.

Instructions

1. 2. 3. 4. Answer all questions. Read each question carefully. Start each question on a new page. Show all of your workings.

Mark allocation

Question Part A Part B 1. 2. 3. 4. 5. Cost of capital Risk and return Investment timing real option Capital structure Dividend policy 14 12 15 20 15 Total 100 Topic Multiple-choice questions Marks 24

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Useful formulae FV PV PVCF PVperp EAR YTM Yield CV Po Or; Po rs re rd ri WACC g BPre S V Or; V VB VU VL rsL (Proposition II) rsL bL = = = = = = = = = = = = = = = = = = = = = = = = = = PV(1 + r)n FV / (1 + r)n n n ⎛ 1 ⎞ Σ _ CFt ⎜1 + i⎟ ⎝ ⎠ t=1 PMT / r [1 + (rNm/m)]m – 1 [I + (M – V)/n] / [(M + 2V)/3] (D1 + P1 - P0) / P0 σ/r D1/(rs – g) S/no. of shares (D1 / P0) + g [D1 / P0(1 - F)] + g i(1 - t) rRF + bi (rM - rRF) wdrd (1 - t) + weke ROE(Retention ratio) Retained earnings / Equity fraction [(EBIT - rdD)(1 - T)] / rs D + [(EBIT - rdD)(1 - T)] / rs D+S n Σ⎡_ INT/(1 + Kd)t ⎤ + M/(1 + rd)n ⎢ ⎥ ⎣t = 1 ⎦ EBIT(1 -t) / rsU Vu + TD - PV(distress + agency costs) rRF + bu(rM - rRF) + bu(rM - rRF)(1 - T)(D / S) rsU + (rsU –rd)(1 – T)(D/S) bu[1 + (1 - T)(D / S)]

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Carrying cost = AFN Carrying cost AFN = = =

DSO(sales / day)(VCR)(WACC) (A*/S0)ΔS0 - (L*/S0)ΔS - MS1(RR) DSO(sales / day)(VCR)(WACC) (A*/SO)ΔSO - (L*/SO)ΔS - MS1(RR)

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Part A: Multiple-choice questions

Each question is worth 3 marks. (1.5 marks for correct answer, 1.5 marks for your explanation or workings.) To gain these marks, you must give the correct answer and an explanation or your workings. Portfolio return 1. The risk-free rate, rrf, is 6% and the market risk premium, (rm – rrf), is 5%. Assume that required returns are based on the CAPM. Your $1 million portfolio consists of $700,000 invested in shares that have a beta of 1.2 and $300,000 invested in shares that have a beta of 0.8. Which of the following statements is most correct? A B The portfolio’s required return is less than 11%. If the risk-free rate remains unchanged, but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. If the market risk premium remains unchanged, but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. If the share market is efficient, your portfolio’s expected return should equal the expected return on the market, which is 11% None of the above answers is correct.

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D E

Beta coefficient calculation 2. Security A has a beta of 1.5 and Security B has a beta of 0.5. Assuming market equilibrium, which of the following statements about these securities must be true? A B C D E When held in isolation, Security A has a greater risk than Security B. The expected return on Security B will be greater than the expected return on Security A. The expected return on Security A will be greater than the expected return on Security B. Security B would be a more desirable addition to a portfolio than Security A. Security A would be a more desirable addition to a portfolio than Security B.

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Time value concepts 3. Which of the following statements is most correct? A The first payment under a 3-year, annual payment, amortized loan for $1,000 will include a smaller percentage (or fraction) of interest if the interest rate is 5% than if it is 10%. If you...