Faculty of Business oO Session 2010/11 Semester 1 No: Course: Me Finance and Investment/Banking Mode: Full-Time and Part-Time Level: 7 Uni Corporate Financial Management MFI-M-114 Date: ‘Wednesday, 19 January 2011 Time: 10:00 Time Available: Three Hours Tnstuctions to Candidates Answer EOUR questions, All quistion earry equal mark, Please check NOW that there are w unnuthorized materia (nates ec) om the desktop o on your person. Iyou find any such materials immediately ale one of the invigiatrs you do tot do thie and aay materials are subsequently discovered by the iviiltors this Will Constitute academic misconduct and may have serious consequence, including termination dies. Caleulators may be usod provided they are noiseless, cores, not pre-programmed by the candidate and cannot receive or tansmit data remotely. Mobile phones may not be used as alealatrs All work must be done in ink Workin pencil may not be marked. All bags, coats and sweaters ete, and other persona! belongings, inchding pencil eases and ‘ther containers, must be placed avay om desks (an invgilatoe wil direct you)- Personal belongings inclide MOBILE PHONES ~ thee are NOT allowed on desks but must be ‘itched off an placed in your bag, Food and drink are NOT allowed on des (Overseas students (whan English snot their fit language) are allowed one simple paper “word for word dictionary. ELECTRONIC DICTIONARIES ARE NOT ALLOWED. ‘You must NOT sttemptto communicate wih exer students during the exam.‘Capote Financial Management anion ‘Question 1 a » 2 a Explain te difference betweenthe nominal interest ate andthe real ate of {interest In the absence of inflaton the rate of interest would be 4 percent Given a rate of inflation of 3 per cent what would the interest rate have to be 10 compensate a lender fully fr the consequences of inflaton? Explain why inflation i an important determinant of interest rate. (Smarks) ‘You are considering buying # one-bedroom apartment in Central London for £400,000. You pla to make a £100,000 down payment and borrow the ‘remaining amount to be repaid in equal monthly instalments over 20 years to cover both interest andthe repayment ofthe loan. Determine the value ofthe ‘monthly instalments ifthe interest rate is Sper cent (Assume that the interest ‘te will remain constant for 20 years) What will be the value of loan ‘outstanding atthe end of 20% itstlment? (Smasis) ‘The prenuptial agroements are likely to become legal inthe United Kingdom, (Clvstine is negotiating @ prenuptial agreement with Christopher and under this agreement she wil be receiving Oper cent of £1 million every five years with te first payment occuring five yeas after the wedding, Christopher claims, if the marrage lass for 30 years, Christine will be worth £lmilion atthe time of ‘wedding. Christine has studied course in finance during her undergraduate studies and she has no doubt tht she will be worth significantly less than £lmillion. Why is Christine right? What will be her worth a the time of her wedding i the annual interest rte is 4 per een (Assume that the interest rate ‘ill main constant for 30 yeas of mariage)? (Smasks) Discuss the limitations of profit maximisation as an objective for a company ‘and consider the extent to whic value maximisation is a more appropriate objective (10 marks) Total: 25 marks Page 1067Corpor Financial Management ant Question? ‘akewell Industrial Holdings is expected to generate earings of £400 milion inthe ‘upcoming year. The company finnces all of its investments through retained camings. Over the next year, analyss believe the company will retain SOper cent of its earnings for new investment, and that its projects are likely to generate a retumn of| {Sper cent, Over the next two years, the retum on new investments inthis company is likely to decline to L6per cent and I4per cent respectively. Therefore, the frm is also expected to lower is retention mo to Oper cent in these years. For all future Years, the return on investment is expected to remain stable at 12per cent. AC this ‘rie of return, analysts believe the frm will ehaose to retain only 40per cent of is ceamings. Bakewell has 200 million shares in issue, and its required rate of retum is 10per cent Required 8) Given this information, what do you consider tobe the fair value forthe shares of this company? Explain the assumptions made by the model you have used tw estimate the share price. Discuss how these assumptions affect the uty of ‘the model in practic. (13 masks) b) Am investor in the shares of the company intends holding the shares for one ‘year and antieipates arate of return of 10 percent, Determine and comment ‘9 the composition of the expected return, (@marks) ©) Determine the companys prct-eamings ratio and compare this with the price- ceamnings ratio you would expect if the company had no profitable growth prospects. (4maris) €) A member of the board sugges identifying an appropriate price-eamings ratio for the company and using tis as a multiplier to derive a value for the ‘company. Comment on this suggestion (marks) ‘Totals 25 marks Paget?‘Coport Fun Managenent oro ‘Meter Sem! ‘Question 3 [ible ple is considering entering the convenience food market. uring the lst 6 months, Edible has spent £1 million developing a new quality control process that ‘would virtually guarantee ther mieowave products to be ffee of infection. The ‘compaay’ as also spent £1 million on market rescarch that indicates a healthy ‘demand for “safe” convenience foods. The new product is being considered over a 5-year period, which isthe anticipated commercial life of the newiy developed process. It will require an initial ouday of| £6 million in new capital equipment Production will take place in a building that ‘the company already ovns, and which is curenly being rented out to anoter firm or £500,000 per year. ‘The new fast food products are expected to sell for £4.50 per unt, The variable production costs are expected to te £2.50 per unit, of which food ingredients account for £2.14, packaging 12p and operating costs 24p. Fixed costs of production will be £1 million each yea The firm expects t sll 2 million units in {he first three years ofthe project and three milion units inthe remaining two years. ‘Working capital requirements for this projet will be £390,000 forthe fist three years, and £535,000 for the raining two Years. ‘The capital expenditure on plant and machinery can be written off on a straight-line basis over 5 years for tax purposes At the end of the project’ life, the capital equipment is expected to be worthles, ‘The rate of corporation tx is 30 per >ent and the discount rate for projets similar to this one is 15 percent Required 8) Eaible ple adopt this project? Discuss the basis for your recommendation. (16 mais) 1b) Explain how inflation can pose problems when appraising capital expenditure proposals, and how these problms may be dealt with (marks) “Totals 28 marks Prge30f7Corporat Financial Management anion MeN Sem Questions ‘The market portfolio has yielded 12per cent on average over past years. Its ‘expected to offer a risk premium in future yeas of 7 percent. The standard deviation ofits retun is 8 por eent. The riskefrec rate is 5 percent Required 8) Determine the expected return from the market portfolio? Draw a diagram to show the location ofthe eal marke ine. (marks) by Whats the expected retur ad the risk of a portfolio comprising 50 per cent invested in the macket portfolio snd 50 percent invested inthe rsk-fiee 4 marks) ©) Whats the market trade-off tetween portfolio risk and retum suggested by these figures? (mats) 4) Explain the differences among the capital marke line, the security market line andthe security characte lin and what are they used for. (13 marks) ‘Total: 25 marks Page dof‘Corporate Fala Management anja Mat ‘Seu! Question S (On 13 October 2010, Standard Chartered PLC announced a Rights Issue to rise approximately £3,258 million ata dicount of 32.921 per cent tothe Closing Prive of| 1,908 pence on 13 October 2010 (the last business day prior tothe date of this announcemen), Ifa qualifying sharerolder does not take up the offer of new ‘ordinary shares, hishher proportionate shareholding wil be diluted by 11.11 per cent, “According tothe Board of Ditestors the Rights Issue will enable Standard Chartered to continue to seize opportunities across Asi, Africa and the Middle East, 1 ‘continue focusing on iis organie growth stategy, whilst also giving the Group treater capacity to meet the Basel Ill countereylical butter and the ensanced capital requirements for systemically import institutions. Standard Chartered PLC had 2,036.25 million shares outstanding on 12 October 2010, which were collectively ‘Valued at £38, 851.65 million. The Rights Issue is fully underwritten by J.P. Morgan Cazenove, Goldman Sachs Inerational and UBS Investment Bank (you may ignore the undersiting costs in your calculitons) The Directors intend to take up their cntitements in fll Required 18) Assume tha, the issue is likely to be fly subscribe, calculate the terms of, the offer, the value ofa right aad the impact of the issue on the ex rights price ofthe firm's shares (marks) 'b) A security analyst expresses the view that with the deep discount (32.9per ‘ent price, shareholders are more likely to sell their rights than t exercise them. Using aumericalcaleulations, discuss whether this view is true or false ‘Comment on the statement “Ifa Qualifying Shareholder does ot take up the offer of New ordinary Shares, his/her proportionate shareholding will be diluted by 11.11 per cent.” (6 marks) ©) Discuss the role the underwriters can playin rights issues. What would you regard as being their most significant conebution tothe firms value? (11 marks) Total: 25 marks Page $07Corporat Financial Management anion MANIA sent Question 6 ‘Merton pe has 400 million shares inissue and its curent earings before tax are £1,000 milion, Merton has no deb ad the market value of its equity is £10,000 zillion. The corporate tax rate is 28 pr cent. Merton decides to raise £2,000 million ‘worth of risk free perpetual debt thereby this debt level is maintsined indefinitely. Ignore personal taxes and cost of financial diss, Required: 8) If Merton ple uses all the funds raised withthe debt isve to repurchase shares, ‘what wil be is share price aftr the share repurchase, What wil be Mercn's share price instead it invests he proceeds ofthe debt issue in sae perpetual {government bonds? In which ofthese stuation(s), Merton's shareholders will be bttr off (12 marks) ') How will your answer change if we assume now that there i a personal tax rate on debt earings of 40 per ent and an effective personal tax rate of 28 por ‘ent on equity earings? Explain your answer inthe context ofthe analysis, ‘developed by Modigiani and Mille, (13 marks) ‘Total: 25 marks END OF EXAMINATION PAPER. Page 087anion ‘Sem nai roe Pv oizwioi+wiclt2wwipo io, Where PV =Present Value FV=Future Value n= Number of Periods m= Prequency of Compounding r= Inmerest Rate tem Effective Rate of Interest d= Anmual Payment 4d, Payment Next Year '8> Growth Rate of Payments Page 7 0f7