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MAF302 – 2009 Exam Marking Guide 
Question 1.
Part i.
In most large corporations, ownership and management are separated. What are the main implications of this separation?
Part ii.
A parcel of land costs $300,000. For an additional $500,000 you can build an office building on the property. The land and office building should be worth $900,000 next year. Suppose that common stocks with the same risk as this investment offer a 9% expected return per year. Would you construct the building? Why or why not?

Part iii.
Define the following terms:
a) LBO
b) Spin-off
c) Privatisation
d) Carve out
e) Leveraged restructuring
Part iv.
What impact would the following features have on the value of a corporate bond? a) The borrower has the option to repay the loan before maturity b) The bond is secured by a mortgage on real estate

(1) + (3) + (5) + (1) = 10 marks
SOLUTIONS
Part i.
Agency problems
Amplified by asymmetric information

(0.5 marks)
(0.5 marks)

Part ii.
NPV = C0 + C1/(1+r)
NPV = -800,000 + 900,000/1.09
NPV = $25,688
Yes you would build the office because the NPV is positive

(2 marks)
(1 mark)

Part iii
a) LBO – Leverage Buyout – Purchase of a business using mostly debt financing. (1 mark)
b) Spin-off – A parent company creates a new company with part of its assets and operations. Shares in the new business are distributed to the parent’s stockholders (1 mark)
c) Privatisation – A government-owned business is sold to private investors (1 mark) MAF302 Exam Marking Guide 09 

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MAF302 – 2009 Exam Marking Guide 
d) Carve out – Simil;ar to a spin-off, except shares in the new company (subsidiary) are offered to the public. (1 mark)
e) Leveraged restructuring – A company moves to a much higher debt ratio. Proceeds of additional borrowing are paid out to stockholders (1 mark) Part iv
a) Less
b) More
(0.5 marks for each, total 1 mark)
Question 2.
Part i.
The following table represents the yearly cash flows for Crinko Limo’s four year financial lease.

Lease Cash Flow

Year 0
+64,000

Year 1
-25,000

Year 2
-23,750

Year 3
-16,200

These cash flows reflect all costs, depreciation tax shields and the after-tax lease payments. Ignoring any salvage value, assume the firm can borrow at 10% p.a. and have a marginal tax rate of 40%.

a) What is the value of the equivalent loan?
b) What is the value of the lease?
c) Assume the vehicle’s NPV under normal financing is -$4,000. Should Crinko Limo sign the lease?
Part ii.
Which of the following reasons for leasing rational and which are irrational? a) The lessee’s need for the asset is only temporary
b) Specialised lessors are better able to bear the risk of obsolescence c) Leasing reduces the transaction cost of obtaining external financing d) Leasing avoids restrictions on capital expenditures

Part iii.
Six month call and put options for AFNZ Ltd are currently trading on the ASX. The company does not pay dividends. Both options are worth $8.50 and both have a strike price of $50. If the risk-free rate of return in 12% p.a., calculate the stock price for AFNZ Ltd. Part iv.

How does the price of a call option respond to the following changes, other things being equal?
a) Stock price decreases
b) Volatility of the stock price falls
c) Exercise price is increased
d) Risk-free rate decreases
(2 + 1 + 1) + (2) + (2) + (2) = 10 marks

MAF302 Exam Marking Guide 09 

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MAF302 – 2009 Exam Marking Guide 
SOLUTIONS
Part i.
a. The lease cash flows for years 1, 2 and 3 are discounted at: 0.10 × (1 – 0.4) = 0.06 = 6% (0.5 marks)
The value of the equivalent loan is the present value of the cash flows for years 1, 2 and 3:
Year
1
2
3

Cash Flow
-25,000
-23,750
-16,200

Disc Factor
0.943
0.890
0.840
Total
(1.5 marks – Please allow rounding differences)

PV
-23,575
-21,137.50
-13,608
-58,320.50

b. The value of the lease is: $64,000 – $58,320.50= $5,679.50 (1 mark)
c. Crinko should...
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