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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.

4

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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

6

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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