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BMMF5103/JAN13/F-WB

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PART A

INSTRUCTIONS: 1. THERE ARE TWO (2) QUESTIONS IN THIS PART.
2. ANSWER BOTH QUESTIONS.

Question 1

a. The expected returns of Purnama Bhds stock are highly dependent on the state
of the economy as follows:

State of Economy Probability Returns
Depression .05 -50%
Recession .10 -15%
Mild Slowdown .20 5%
Normal .30 15%
Broad Expansion .20 25%
Strong Expansion .15 40%

Based on the information above, calculate the:
(i) expected return. (2 marks)
(ii) standard deviation (6 marks)
(iii) coefficient of variation (2 marks)

b. An investor has invested RM5,000 in a stock which has an estimated beta of 1.2,
and another RM15,000 in the stock of her own company. The risk-free rate is 6
percent and the market risk premium is also 6 percent. If the investor requires 15
percent rate of return for her total (RM20,000) portfolio, what is the beta of her
company?
(5 marks)

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c. What is the difference between unsystematic risk and systematic risk? Describe
the sources of unsystematic risk. What will the required rate of return for an asset
if the level of its systematic risk is high?
(5 marks)
[Total: 20 Marks]

Question 2
a. Your boss has asked you to monitor the financial performance of a company.
You have gathered the following information pertaining to the company.

Net income: RM240
Sales: RM10,000
Total assets: RM6,000
Debt ratio: 75%
TIE ratio: 2.0
Current ratio: 1.2
BEP ratio: 13.33%

You have just discovered that the company could streamline its operations, cut
the operating costs and raise the net income to RM300, without affecting sales or
the balance sheet (the additional profits will be paid out as dividends). How much
would the companys ROE increase due to your latest finding?
(6 marks)

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a. Perkasa Bhd has forecast the following numbers for this upcoming year:

Sales RM1,000,000
Total Costs 600,000
Interest Expense 100,000
Net Income 180,000

The company is in the 40 percent tax bracket. Its total costs always represent 60
percent of its sales. The companys CEO is unhappy with the forecast and wants
the firm to achieve a net income equal to RM240,000. Assume that the
companys interest expense remains constant. In order to achieve this level of
net income, what level of sales(RM) should the company achieve?
(6 marks)
b. What is a liquid asset and why is it necessary for a firm to maintain a reasonable
level of liquid assets?
(4 marks)

c. Explain why the income statement is not a good representation of cash flow.
(4 marks)
[Total: 20 Marks]







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PART B

INSTRUCTIONS: 1. THERE ARE FIVE (5) QUESTIONS IN THIS PART.
2. ANSWER THREE (3) QUESTIONS ONLY.

Question 1
a. What are agency costs and how do these costs come about?
(4 marks)
b. What are the three principal forms of business organisation? What are the
advantages and disadvantages of each?
(6 marks)
c. Discuss the three levels of market efficiency which are distinguished by the
degree of information reflected in security prices.
(6 marks)
d. Discuss the limitations of using the financial ratios to evaluate the financial
position and performance of a company.
(4 marks)
[Total: 20 Marks]
Question 2
a. One year ago, the Brilliant Minds Bhd has deposited RM3,600 in an investment
account for the purpose of buying a new equipment four years from today.
Today, it is adding another RM5,000 to this account. It plans to put in a final
deposit of RM7,500 to the account next year. How much will be available in its
investment account when it is ready to buy the equipment, assuming it earns a
7% rate of return?
(6 marks)

b. You borrow RM149,000 to buy a house. The mortgage rate is 7.5% and the loan
period is 30 years. Payments are made monthly. At the end of 30 years, how
much total interest you have paid?
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(6 marks)

c. (i) Using an example of a savings account, explain the difference between the
effective annual rate and the annual percentage rate.
(4 marks)

(ii) Discuss why a ringgit tomorrow cannot be worth less than a ringgit the day
after tomorrow.
(4 marks)
[Total: 20 Marks]

Question 3

a. The risk-free rate of return is 8 percent; the expected rate of return on the market
is 12 percent. Stock X has a beta coefficient of 1.3, an earnings and
dividend-growth rate of 7 percent, and a current dividend of RM2.40. If the stock
is selling for RM35, should you purchase the stock? Why?
(6 marks)

b. Two stocks each pay a RM1.00 dividend that is growing annually at 8 percent.
Stock I has a beta of 1.3 and Stock II's beta is 0.8.

(i) Which stock is more volatile? Why? (2 marks)

(ii) If treasury bills yield 6 percent and you expect the market return to rise to 12
percent, what is your risk-adjusted required rate of return for each stock?
(3 marks)
(iii) Using the dividend-growth model, what is the maximum amount you would be
willing to pay for each stock?
(3 marks)

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c. A number of publicly traded firms pay no dividends, yet investors are willing to
buy shares in these firms. How is this possible? Does this violate our basic
principle of stock valuation? Explain your answer.
(6 marks)
[Total: 20 Marks]

Question 4

a. A bond is called a premium bond when the selling price is higher than its par
value. Theoretically, why do premium bonds exist?
(4 marks)
b. What is a callable bond? What is the importance of a sinking fund? Should the
issuing company exercise the option to call the bond when the interest rate
rises? Why or why not?
(6 marks)
c. A zero coupon bond has a yield to maturity of 6.33 percent and 12 years until it
fully matures. What is the current price of this bond if the face value is RM1,000?
(4 marks)

d. An annual, ten-year bond is currently selling for RM1,037.86 and has a yield to
maturity of 6.23 percent. What is the coupon rate of this bond if the face value is
RM1,000?
(6 marks)
[Total: 20 Marks]




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Question 5
a. A corporation is considering a capital project for the coming year. The project has
an internal rate of return of 14 percent. If the firm has the following target capital
structure and costs, should it accept the project? Why?

Source of Capital Proportion After-Tax
Cost
Long-term debt 0.40 10%
Preferred stock 0.10 15%
Common stock
equity
0.50 20%
(4 marks)
b. Your company is considering a machine which will cost RM50,000 at Time 0 and
can be sold for RM10,000 after 3 years time. RM12,000 must be invested at
Time 0 in inventories and receivables and this output will be recovered when the
operation is closed at the end of Year 3. The machine will severate sales
revenues of RM50,000/year for 3 years; variable operating costs (excluding
depreciation) will be 40 percent of sales. No fixed costs will be incurred.
Operating cash inflows will begin 1 year from today (at t = 1). The machine will
have depreciation expenses of RM40,000, RM5,000, and RM5,000 in Years 1, 2,
and 3 respectively. The company has a 40 percent tax rate, enough taxable
income from other assets to enable it to get a tax refund on this project if the
project's income is negative, and a 15 percent cost of capital. Inflation is zero.
What is the project's NPV? Should the machine be purchased? Why/Why not?
(8 marks)
c. (i) Should financing costs be included as an incremental cash flows in capital
budgeting analysis? Explain your answer.
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(4 marks)

(ii) Explain the difference between a sunk cost and an opportunity cost by using
appropriate examples.
(4 marks)
[Total: 20 Marks]



QUESTION PAPER ENDS HERE















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APPENDIX

List of formula:








k = RFR + (R
m
RFR) k = (D
1
/P
0
) + g
E(R) = p
i
x R
i

2
= p
i
x (R
i
E(R))
2

=
2(1/2)
CV = / E(R)
E(R)
port
= w
i
x E(R)
I

port
= w
i
x
i

WACC = (w
d
)(k
d
)(1 tax rate) + (w
ps
)(k
ps
) + (w
cs
)(k
cs
)

Current Ratio = Current Assets/Current Liabilities
Quick Ratio = (Current Assets -Inventories)/Current Liabilities
Days Sales Outstanding = Account Receivables/(Sales/365)
Inventory Turnover = Sales/Inventory
Debt ratio = Total Debt/Total Assets
Times Interest Earned = EBIT/interest expense
Gross profit margin = Gross Profit/Sales
Net profit margin = Net Income/Sales
Basic Earning Power = EBIT/Total Assets
Return On Assets = Net Income/Total Assets
Return On Equity = Net Income/Owners Equity