Section A – Answer ALL Questions
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).
Which of the following is not the main factor to be considered when a firm sets up credit period?
A The probability that the customer will not pay B The extent to which the goods are perishable C The size of the account
D Total asset requirement
Assuming all other factors remain unchanged, what is likely to happen if a firm pays out all earnings as dividend?
A The firm will stop growing. B The firm will keep growing.
C The size of the firm will drop.
D The firm will be under financial distress.
A bond is quoted at £925 in the bond market. Given the accrued interest is £25, what is the dirty price of this bond?
A £950 B £900 C £975 D £875
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Which of the following is a characteristic of an ordinary annuity?
A Annual payments are not identical.
B Annuity holders receive annual payments in a full period hence. C Annuity holders receive annual payments immediately.
D Annual payments are paid in perpetuity.
Which of the following is a main technique used in real options?
A Option to expand B Put option
C Call option
D American option
Which of the following statement best describes the security market line?
A It is the graphical depiction of the market portfolio.
B It is the graphical depiction of the capital market line.
C It is the graphical depiction of the Capital Asset Pricing Model (CAPM). D It is the graphical depiction of the opportunity set of all risky assets.
Which of the following is a primary financial statement?
A External auditor report B Statement of acquisition
C Statement of financial position. D Internal auditing report
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Which of the following is a form of income in total return?
A Cash dividends
B Closing price of a share C Asking price of a share D Opening price of a share
Which of the following is not a commonly used type of share repurchase?
A Open market purchase B Terms of sale
C Targeted repurchase D Tender offer
Which of the following theory concludes that changes in capital structure benefit shareholders if and only if the value of the firm increases?
A Modigliani and Miller proposition I B Modigliani and Miller proposition II C Portfolio theory
D The pie theory
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Section B – Answer ALL questions
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 ten-year annuity offers identical annual payment of £1,000 with the first payment due in one year. Assuming an alternative investment offers a rate of return at 10%, what is the present value of this annuity?
(b) Stock Ais expected to pay no dividend next year and then a dividend of £3 from the end of year 2 forever. If the required return on similar equities is 8%, calculate the fair market price of stock A.
(c) Mr. Davies has just been offered a job at £50,000 a year (assuming the salary is to be made at the end of the year). He anticipates his salary increasing by 9% per year until his retirement in 40 years. Given an interest rate of 20%, what is the present value of all his salary in his career?
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Question 2 (30 marks in total)
(a) Atwo-asset portfolio is consisted ofa £200 investment inthe marketportfolio and a £800 investment in the risky asset B. Asset B has a beta of 2.4 and expected return of 16%. Given the return of the market portfolio is expected to be 7% and assuming the capital asset pricing model (CAPM) holds, calculate the expected return and beta of this two-asset portfolio.
(b) Mike plc. has two projects to consider. It cannot take both as they aremutually exclusive. The cash flows for both projects are shown below
Points in time (yearly intervals) 0
1 2 3 4
Project A (£) -420,000 150,000 150,000 150,000 150,000
Project B (£) -100,000
Given Mike plc’s cost of capital is 12%, use net present value (NPV) approach to advise Mike plc. which project to take and briefly discuss the drawback of internal rate of return (IRR) approach in project appraisal.
(c) Joy plc. has shares priced at £20 per share in the market, with 1.5 million shares outstanding. In the meanwhile, Joy plc. also has £10 million debt (corporate bonds) outstanding with AA rating and a yield of 6%. Given the market risk premium and risk-free rate are 5% and 4%, respectively, the equity beta for Joy plc. is 0.85 and corporate tax rate is 40%. Calculate the unlevered beta and weighted average cost of capital (WACC) of Joy plc.
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Question 3 (20 marks in total)
Nadar plc. is a manufacturing company with following information available to investors:
Annual cash demand for next year Transaction cost of selling securities Annual opportunity cost for holding cash Operating cycle
Days in inventory
£100,000 £10 per trade
2.5% per annum 99 days
69 days 50 days
The operation director of the firm believes Baumol model is the appropriate cash management model. Use above information, calculate:
[8 marks] ii) Number of transactions to be made next year in order to restore cash balance
[4 marks] iii) Average cash balance of the firm over next year
[4 marks] iv) Days in receivables and days in payables of the firm
End of Paper – An appendix of 2 pages follows
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PV = 𝐴 ∙ [ 𝑅−𝑔 ]
Pre − tax weighted average cost of capital = 𝐸 + 𝐷 𝑟 + 𝐸 + 𝐷 𝑟
Unlevered beta = 𝐸 + 𝐷 𝛽 + 𝐸 + 𝐷 𝛽
10.Present value of a share with zero growth dividends PV = D1/R
11.Present value of a share with constant growth dividends PV = D1/(R-g)
12.Present value of a consol PV = C/R
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Present value of a level coupon bond
𝑃𝑉 = 𝐶 ∙ 𝐴𝑇 + (1 + 𝑅)𝑇
13.Formulae for Beta 𝑐𝑜𝑣(𝑅𝑚,𝑅𝑖)
𝑖 ( 𝑅𝑚)2
14.Capital asset pricing model E(𝑅𝑖) = 𝑅 + 𝛽 ∙ (𝐸(𝑅𝑚) − 𝑅)
16.Average cash balance of Baumol Model 𝐴 = 𝐶/2
17.Number of transactions to be made (Baumol Model) 𝑁 = 𝑇/𝐶
Z = é3(F)(s 2 )ù1/3 + L ë û
19.Upper control limit of Miller-Orr Model 𝑈 = 3𝑍 − 2𝐿
20.Average cash balance of Miller-Orr Model 𝐴 = (4𝑍 − 𝐿)/3
21.Debt yield and default equation (Cost of debt for low rating bonds) 𝑟 = 𝑦 − 𝑝 ∙ 𝐿
22.Operating cycle = Inventory period + Accounts receivable period
23.Cash cycle = Operating cycle – Accounts payable period