MANAGEMENT SCHOOL 2019/20

MGT250 Financial Management Mock II Exam Paper 3

Hours

INSTRUCTIONS: Answer ALL questions from SECTION A and TWO

questions from SECTION B.
QUESTION 1
Bread Products Co is considering the replacement policy for its industrial size
ovens which are used as part of a production line that bakes bread. Given its
heavy usage each oven has to be replaced frequently. The choice is between
replacing every two years or every three years. Only one type of oven is used,
each of which costs £24,500. Maintenance Costs and resale values are as
follows:
Year Maintenance Resale
Per annum Value
1 500
2 800 15,600
3 1500 11,200

Original cost, maintenance costs and resale values are expressed in current
prices. That is, for example, maintenance for a two year old oven would cost
£800 for maintenance undertaken now. It expected that maintenance costs will
increase at 10% per annum and oven replacement cost and resale values at 5%
per annum. The money discount rate is 15%.
Required
a. Calculate the preferred replacement policy for the ovens in a choice
between a two-year or three-year replacement cycle.
[10 marks]
b. Highlight some key assumptions considered in your computation of
the EAC replacement costs above
[5 marks]
c. When raising long term finance critically discuss aspects the firm
(Corporation) and the bond investor (Institutional Investor) will
consider when raising Debt finance.
[10 marks]
25marks
QUESTION 2
Eclairs sales are £24 million per annum, and average receivables are 5million.
One way of speeding up collection from receivables is to use a factoring
service. The factor will operate on a service-only basis, administering and
collecting payment from Eclairs customers. This is expected to generate
administrative savings of £150,000 each year. The factor has undertaken to pay
outstanding debts after 55 days, regardless of whether the customers have
actually paid or not. The factor will make a service charge of 2.5% of Eclairs
revenue. Eclairs can borrow at an interest rate of 9% per annum.
Required
Determine the relative cost and benefits of using the factor in this scenario
[6 marks]
Discuss the advantages and disadvantages of Factoring
[4 marks]
10marks

QUESTION 3
AMH Co wishes to calculate its current cost of capital for use as a discount rate
in investment appraisal. The following financial information relates to AMH
Co:

Financial position statement extracts as at 31 Dec 2012

£000 £000
Equity
Ordinary shares (nominal value 50 cents) 4,000
Reserves 18,000 22,000

Long-term liabilities
4% Preference shares (nominal value £1) 3,000
7% Bonds redeemable after six years 3,000
Long-term bank loan 1,000 7,000
 29,000

The ordinary shares of AMH Co have an ex div market value of £4.70

per share and an ordinary dividend of 36.3 pence per share has just been
paid. Historic dividend payments have been as follows:

Year 2008 2009 2010 2011

Dividends per share (pence) 30.9 32.2 33.6 35.0

The preference shares of AMH Co are not redeemable and have an ex div
market value of 40pence per share. The 7% bonds are redeemable at 5%
premium to their nominal value of £100 per bond and have an ex interest
market value of £104.50 per bond. The bank loan has a variable interest
rate that has averaged 4% per year in recent years.
AMH Co pays profit tax at an annual rate of 30% per year.
Required
Calculate the Market value weighted Average Cost of Capital of
AMH Co
[15
marks]

50
Marks

SECTION B ANSWER ANY TWO QUESTIONS

QUESTION 4
Zentric is a firm based in the UK. The firm received 14,340,000 CLN (Chilean
pesos) cash settlement from its Chilean client. However, considering Pesos is
often viewed in the market as a soft currency, Zentric financial manager is
considering selling it to receive the Sterling equivalent as soon as possible.
The quote of the dealer branch near the firm has its quote today as

GBP/CLN 934.8750- 937.8770

The bank usually holds £50,000 for daily buying and selling of currency.
Required
i. How much British sterling will Zentric receive if he sells the
pesos today
ii. After the transaction with Zentric will the dealer branch
still have enough for daily transactions?
[4 marks]

b. Two companies in different industries have different capital structures.

XY plc has a debt: equity ratio of 1:3 and the equity beta of 1.2. While
PQ has a debt: equity ratio of 2:3. Corporation tax is 30%
PQ seeks to acquire XY, what is the appropriate equity beta for PQ
plc to apply? [4
marks]

c. What is Corporate Governance and how institutional investors can

apply the ESG model to make an investment decision (selecting a
stock), highlighting examples of how this will be carried out within
an industry?
[9
marks]
d. Critically discuss ways a corporation can manage or mitigate Foreign
Exchange Risk when carrying out trade overseas.
[8marks]

QUESTION 5
a. An equity has a beta of 1.19 and an expected return of 15 per cent. A risk-
free asset with (0) beta currently earns 5 per cent.
i. What is the expected return on a portfolio that is equally invested in
the two assets?
ii. If a portfolio of the two assets has a beta of 0.71, what are the
portfolio weights?
iii. If a portfolio of the two assets has an expected return of 7.2 per cent,
what will be their weights?
[6 marks]
b. Describe the roles and responsibilities of Executive directors and
Non-executive directors. Highlighting the types of board structures
and how including NEDs in a board can help a company achieve
 good corporate governance.

[8 marks]
c. From the M&M theories answer the following:

- if a company, in a perfect market with no taxes, incorporates

increasing amounts of debt into its capital structure without changing
its operating risk, what will the impact be on its WACC?
- According to M&M why will the cost of equity always rise as the
company gears up?
- In a perfect capital market but with taxes, two companies are
identical in all respects, apart from their levels of gearing. A has
only equity finance, while B has 50% debt finance. Which firm
would M&M argue was worth more?
[11 marks]
25 marks
QUESTION 6
a. An investor is considering investing in a small-cap stock fund and a general
bond fund. Their returns and standard deviations are given below and the
correlation between the two fund returns is 0.10

Expected Annual Standard Deviation of

Return (%) Returns (%)
Small-cap fund, S 19% 33%
Bond fund, B 8% 13%

If the investor requires a portfolio return of 12%, what should the

proportions in each fund be?
What is the standard deviation of the portfolio constructed in above?
[6 marks]

b. Describe green policies such as the Green Bond and how issuing these
instruments can enhance attractiveness of a corporation to an investor and/or
increase the Firms Market value.
[7marks]
c. Critically discuss some of the challenges faced by SME’s in raising finance
and other alternatives that can be considered as sources of finance
[7 marks]

d. State the assumptions of CAPM and DVM model in estimating the Cost of
Equity of a firm
[5 marks]

25marks
50marks for this section

END OF PAPER