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UNIVERSITY OF MAURITIUSFACULTY OF LAW AND MANAGEMENT
FIRST SEMESTER EXAMINATIONS
MSC FINANCE YEAR I
DATE
THURSDAY4 DECEMBER
2003
SERIES
NOVEMBER 2003
MODULE
CORPORATEFINANCIAL
MANAGEMENT[ACF 5102]
TIME
!30 " 12!30 P!M!
INSTRUCTIONS TO CANDIDATES
TIME ALLOWED# 3 HOURS
NO! OF $UESTIONS SET# FOUR %4&
NO! OF $UESTIONS TO BE ATTEMPTED# FOUR %4&
PRESENT VALUE TABLE, ANNUITY TABLE AND LIST OF
FORMULAE ARE ATTACHED
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CORPORATE FINANCIAL MANAGEMENT[ACF 5102]
ANSWER ALL QUESTIONS
$'()*+,- 1
Alpha Ltd has details of two machines which could fulfill thecompanys future production plans. nly one of thesemachines will !e purchased.
"he #standard model costs Rs 500,000, and the #de$lu%e &s''0(000( paya!le immediately. )oth machines would re*uire
the input of &s100(000 wor+in, capital throu,hout theirwor+in, li-es( and !oth machines ha-e no e%pected scrap-alue at the end of their e%pected wor+in, li-es of four yearsfor the standard machine and si% years for the e$Lu%emachine.
"he forecast pre$ta% operatin, net cash flows in &s000associated with the two machines are/
ear 1 2 5 3
4tandard
205 22 22 2
e$Lu%e
200 20 20 250 50 00
"he two machines are identical in terms of capacity and *ualityof wor+.
"he rele-ant discount rate is 126.
"he company is proposin, to finance the purchase of eithermachine with a term loan at a fi%ed interest rate of 106 peryear.
"a%ation at 206 is paya!le on operatin, cash flows one year in
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arrears( and capital allowances are a-aila!le at 25 % per yearon a reducin, !alance !asis.
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"he pay!ac+ and the net present -alue 789:; for the e$lu%emodel ha-e !een calculated !y the accountant as !ein, years and &s 10'(000 respecti-ely.
R(.'+/(#
7a; Calculate for the standard machine/
7i; pay!ac+ periodhat is meant !y a profita!ility inde%? [2mar+s]
7ii; @%plain why it is not a helpful approach in multi$period capital rationin, situations?
[2mar+s]
7d; )eta 9lc has a limit of &s10m of in-estment finance thisyear( and it has the followin, possi!le in-estmentopportunities/
P/,(*I-()*(-*
/(.'+/( *+)6(7/
N(* P/()(-*V78'(
&sm '.0 .: .2 0.> 5. 1.2B 2.0 0.5 .5 2.0 0.5 0.
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Assume that the capital shorta,es relate only to thecurrent year and that each proDect can !e underta+en inpart.
R(.'+/(#
Calculate the profita!ility inde% of each proDect and outline theoptimal in-estment strate,y.
[3mar+s]
[T,*78# 25 7/9)]
$'()*+,- 2
7a; "he finance director of Eamma plc wishes to find thecompanys optimal structure.
"he cost of de!t -aries accordin, to the companys creditratin,( which depends( amon,st other factors( upon thele-el of ,earin, of the company.
: D(;* %D(;*
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7!; elta plc is an all e*uity company with an e*uili!riummar+et -alue of &s25 million and a cost of capital of1'6 per year.
"he company proposes to purchase and cancel &s50million of e*uity and to replace it with 106 irredeema!leloan stoc+.
eltas earnin,s !efore interest and ta% are e%pected to!e constant for the foreseea!le future. Corporate ta% is atthe rate of 06. All profits are paid out as di-idends.
R(.'+/(#
Assumin, that the assumptions of Godi,liani and Giller 7in aworld with ta%es;( how will the capital restructurin, affect/
(i) the mar+et -alue(ii) the cost of e*uity(iii) the firms wei,hted cost of capital
of elta plc.[ mar+s]
7c; >hat are the factors that are li+ely to influence a firms
decision on capital ,earin,?[5 Gar+s]
7d; @%plain how the pec+in, order theory ar,ues a,ainst anoptimal de!tHe*uity ratio.
[5 mar+s]
[T,*78# 25 7/9)]
$'()*+,- 3
7a; "he financial controller of "heta plc is re-iewin, thecompanys stoc+ mana,ement procedures. 4toc+ has,radually increased to 256 of the companys total assetsand( with finance costs at 16 per annum( currently coststhe company &s5 million per year( includin, all orderin,and holdin, costs.
emand for the companys maDor product is not su!Dect to
seasonal fluctuations. "he product re*uires &s 30 million ofstandard semi$finished ,oods annually which are
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purchased in e*ual *uantities from three separate suppliersat a cost of &s200 per unit. "hree suppliers are currentlyused to pre-ent pro!lems that could result from industrialdisputes in a sin,le supplier.
4toc+ costs &s20 per unit per year to hold( includin, insurancecosts and financin, costs( and each order made costs &s1(000fi%ed cost and &s1.00 per unit -aria!le cost. "here is a leadtime of one month !etween the placin, of an order anddeli-ery of the ,oods.
R(.'+/(#
7i; Calculate the e%istin, economic order *uantity for the
semi$finished ,oods. [ mar+s]
7ii; Calculate the chan,e in annual stoc+ mana,ement coststhat would result if the ,oods were !ou,ht from ,-86 ,-(supplier.Assume that no *uantity discounts are a-aila!le.
[3 mar+s]
7iii; "he financial controller feels that the I=" 7Dust in time; stoc+mana,ement mi,ht !e useful for the company.)riefly discuss three possi!le ad-anta,es of I=".
[mar+s]
7!; me,a Company has recently offered their customers anincenti-e to pay promptly.
4ales durin, the ne%t year are forecast to !e &s11.2million and '06 of sales are on credit terms. n a-era,ecustomers ta+e 5 days to ma+e payment.
All companies settlin, their in-oices within days of thein-oice date are offered 1.56 cash discount on the in-oiceprice. "he discount would cost an additional &s 25(000 peryear to administer( and reduce !ad de!ts from 0.56 to0.506 of credit sales.
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=t is e%pected that 06 of credit customers would use thecash discount.
"he current short$term deposit interest rate is 15 6 p.a.
R(.'+/(#
Ad-ise me,a company as to the economic -ia!ility of thecash discount offer.
[5Gar+s]
7c;7i; @%plain the si,nificance of the cash operatin, cycle in
relation to wor+in, capital mana,ement. [ mar+s]
7ii; "he followin, information relates to :e,a 9lc for the lastyear/
R)
9urchases of raw materials 3sa,e of raw materials 35
4ales of finished ,oods 7all on credit; 250Costs of sales of finished ,oods 1'0A-era,e creditors 1A-era,e raw material stoc+ 12A-era,e wor+$in$pro,ress 10A-era,e finished ,oods stoc+ 21A-era,e de!tors
R(.'+/(#
Calculate the len,th of the cash operatin, cycle?
[5 mar+s]
$'()*+,- 4
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7a; @%plain the term a,ency relationships and discuss theconflicts that mi,ht e%ist in the relationships !etweenshareholders and mana,ers.>hat steps mi,ht !e ta+en to o-ercome these conflicts?
[3mar+s]
7!;7i;>hat do you understand !y the term #homemadedi-idends in the conte%t of GG? >hy mi,ht a shareholderwant such di-idends?
[ mar+s]
7ii;>hy firms attract a #clientele of shareholders as a resultof their di-idend policy?[ mar+s]
7c; @psilon plc is e%pected to enDoy an a!o-e a-era,eperformance for three years( with di-idends ,rowin, at106 per annum. After that time( !ecause of competitionand the company losin, its present technolo,icalleadership( the ,rowth in di-idends will re-ert to 56.
"he current di-idend is &s 1 per share.
@psilons asset !eta is 0.3( the !eta of de!t is 0.20 andits financial ,earin, is 306 e*uity and 06 de!t !ymar+et -alue.
"he ris+ free rate is 3.06 per annum and the mar+etreturn is 126 per annum.
"he corporation ta% rate is 06.
R(.'+/(#
i. Calculate the current share price of @psilon 9LC.[ mar+s]
ii. Comment on the limitations of the di-idend ,rowthmodel.
[ mar+s]
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iii. Calculate an appropriate !ase case discount rate inorder to e-aluate future cash flows for a potentialin-estment of &s 25 million. "he in-estment would !ean e%pansion of @psilons acti-ities and it is e%pectedthat the financial ,earin, would chan,e as a result ofthe e%pansion.
[2 mar+s]
[T,*78# 25 7/9)]
END OF $UESTION PAPER
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FORMULA SHEET
1. F: J 9: 71 K r;n
2. 9resent :alue of an annuity
9:oJ CF1% A.F
. 9resent :alue of a perpetuity
9:oJr
CF1
. 9resent :alue of a perpetuity with ,rowth
9:oJg-r
CF1
5. A&& JInvestmentAverage
taxaninterest!e"#re$r#"itse$)%#st(ann&a'Average
3. )(%
%*+,I,,
*+,
*+, LDRHDRNPVHDR
+=
. #&t'aInitia'(%)
%.I=
'. @*ui-alent annual annuity 7@AA; approach
A.Fact#r
%AA=
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. CA9G
( )em
/,-,,ffe
K +=
10. i-idend :aluation model
8o ,rowthe0
=
oP
Constant ,rowth( )
g-
g1
e
# +=oP
11. >ACC J ( )+.
+t-1
+.
.
+
++
eK
12. Capital ,earin, JED
D
+
1. =ncome ,earin, JPBIT
Interest
1. peratin, ,earin, Jsa'esinc2ange3
/I4inc2ange3
15. Cost of e*uity in a ,eared company
( ) ( )t-1.
+ee && dg KKe +=
13. Gar+et :alue of a ,eared company
:,J :uK t
1. Cost of capital in a ,eared company
2
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+=
ED
Dt1e5acc &
1'. @conomic rder *uantity
H
o
C
DCQ
2=
1.
( )
dK
tID
=
1
20.( ) ( )
( )
( )
( ) ( )nd
n
n
ddd k
R
k
tI
k
tI
k
tID
+
+
+
+
+
+
+
=
11
1................
1
1
1
1
2
21.( ) )1(
)1(
)1 tDE
tDB
tDE
EBB dea
+
+
+
=
3
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4