School Business School

Module Code 2BMF02

Module Name Corporate Finance

Module Director Doug Meikle

Exam Period Semester 2 2020-21

Date and time of

exam 2 hours +
09:30 12 May 2021 Duration
30 minutes

Open Book

Items permitted in Books, lecture notes or other external

the exam material are permitted
Module & ● This exam is worth 60% of your overall
question weighting module mark
● The maximum mark for this paper is 100
● Section A is worth 40% and section B is
worth 60%
Instructions to ● Answer in the booklet provided
students ● Start a new page for each question
● You should answer the question from
Section A and any two questions from
Section B
● All workings should be shown
● Present value tables are at the end of the
examination paper
● Cross out any work you do not wish to be
marked
● If you do not follow the paper’s instructions
the procedures laid out in the Code of Practice
for Assessment will be applied.

Page 1 of 10
Section A
Question 1 Ratios (Compulsory)
The summary financial statements for Amble plc are stated below:

Summary financial statements for Amble plc

Income statement 2019 2020
£'00
£'000
0
Operating profit 46.8 43.9
Interest charge (3.5) (5.2)
Profit before tax 43.3 38.7
Tax (8.9) (7.5)
Profit after tax 34.4 31.2
Dividends (8.2) (8.2)
Net profit 26.2 23.0

Statement of Financial Position 2019 2020

£'00
£'000
0
Share Capital (£0.50 ordinary shares) 50 50
Retained Earnings 15 38
Non-current liabilities (loans) 45 90
110 178
Share price at end of year (p) 450 385

Required:
a) Calculate the following ratios for 2019 and 2020
● Return on Equity
● Return on Capital Employed
● Earnings per share
● Price Earnings ratio
● Dividend Cover
● Gearing ratio
● Interest Cover
(20 marks)
b) Explain what these ratios tell an investor about Amble plc’s performance.
(10 marks)
c) Explain the shortcomings of using ratios to determine the performance
of a company.
(10 marks)

Page 2 of 10
 Total: 40 marks

Page 3 of 10
SECTION B

Answer TWO out of FOUR questions

Question 2 Capital Investment appraisal

Bywell plc makes beer in a brewery in Morpeth. Its sales have significantly
increased and wishes to expand. It has already spent £15,000 on architect’s
fees to draw up plans for a new building. They now have to decide whether or
not to proceed with the project.
The initial investment will be £200,000 which must be spent now. The project is
expected to last for four years. Some of the equipment should have a resale
value of £18,000 at the end of the project.
They expect to generate additional sales of £800,000 per annum. Contribution
is expected to be 25%. The accountant has calculated that the project will incur
additional fixed costs of £50,000 per year relating to additional staff costs and
heating/lighting etc. This includes £10,000 additional share of existing head
office costs.
Depreciation is calculated on a straight-line basis.
The business has a cost of capital of 12% and projects are required to meet a
payback threshold of 3 years.

Required:
a) Identify the relevant cash flows and give reasons where appropriate why
a cost or revenue should not be included.
(10 Marks)
b) Calculate the net present value of the investment.
(5 marks)
c) Calculate the discounted payback period.
(5 marks)
d) Estimate the Internal rate of return.
(5 marks)
d) State with reasons whether Bywell plc should proceed with the project.
(5 marks)
Total: 30 marks

Page 4 of 10
Question 3 Weighted average Cost of capital
Craster plc presently has a capital structure that is 40 per cent debt and 60
per cent equity. The cost of debt before tax shield benefits is 8 per cent and
the cost of equity is 12 per cent. The firm's future cash flows, after tax but
before interest, are expected to be £60m in perpetuity. The tax rate is 20 per
cent. 
 
Required: 
a) Calculate the WACC and the value of the firm.
(6 Marks)
b) The directors are considering the partial replacement of equity finance
with borrowings so that the borrowings make up 60 per cent of the total
capital.  
● Director A believes that the cost of equity capital will remain constant
at 12 per cent. 
● Director B believes that shareholders will demand a rate of return of
15 per cent. 

Required: Calculate the WACC and the value of the firm under each of
the directors' estimates. Assume the cost of borrowings before income
taxes does not change.
(10 marks)

c) Discuss your results in the light of the work of Modigliani and Miller as it
relates to the level of gearing and the cost of capital.
(14 marks)
Total 30 marks

Page 5 of 10
Question 4 Valuing shares

Elsdon plc is an unquoted company that owns a chain of corner shops. They
have been approached by a large supermarket with a view to a take-over. The
Directors of Elsdon wish to value their company so they can enter negotiations.
Extracts from the most recent accounts of Elsdon plc are shown below.

Balance Sheet as at 31 Dec 2020 

£m  £m 
Fixed assets at Net Book Value
Freehold land & premises 12.0
Equipment 4.8
  16.8
Current assets 
Stock at cost  8.0
Debtors  3.0
Bank  2.1
  13.1
Creditors due within one year: 
Trade creditors  (4.0)
Dividends  (1.5)
Corporation tax  (3.0)
  (8.5)
Net current assets  4.6
Total assets less Current liabilities  21.4
Creditors due after one year 
20% secured loan stock (bonds)  (14.0)
Net Assets  7.4

Share capital and reserves 

Ordinary shares - par value £1 6.0
Reserves  1.4
Shareholders' funds  7.4

Page 6 of 10
 Income Statement for y/e 31 Dec 2020
£m 
Profit before interest and tax  7.5
Interest  (1.5)
Profit before taxation  6.0
Corporation tax @30%  (3.0)
Net profit after taxation  3.0
Dividend  (2.0)
Retained profit  1.0

Further information
● The accountant has estimated Elsdon plc’s future free cash flow (FCF) to
be £4m each year into perpetuity. 
● The Directors feel that dividend growth of 3% can be sustained.
● Shareholders require a return of 10%.
● Elsdon plc have recently had their assets valued at the following
amounts:
  £m 
Freehold land and premises  20 
Equipment  0.9 
Stock   6 
● The current resale values of the remaining assets are considered to be in
line with their book values.
● A company which is listed on the Stock Exchange and is in the same
business as Elsdon plc has a P/E ratio of 11 times. 
● Assume a corporation tax rate of 20%.

Required: Estimate the value of one share in Elsdon plc using following
methods: 
a) Net Asset Value
b) Dividend growth model
c) P/E ratio 
d) Discounted Cash Flow
(4 x 4 marks)
e) State with reasons which method you consider to the most valid.
(14 Marks)
Total 30 Marks

Page 7 of 10
Question 5 Dividend policy
You are working for a firm of investment advisors and one of your clients has
questions about the dividend policies of two of the companies she has invested
in. Details of these are below.

Wark plc Matfen plc

Y/e 31 Ord shares Profit for Ord share Ord shares Profit for Ord share
Dec in issue year dividends in issue year dividends

‘000 £'000 £'000 `000 £'000 £'000

2016 600 865 450 500 865 450
2017 600 1,209 473 500 1,209 605
2018 1,000 1,510 827 500 1,510 755
2019 1,100 2,140 955 750 2,140 1,070
2020 1,100 2,680 1,003 750 2,680 1,340

Required:

a) Calculate the dividends per share and dividend payout ratio for each
company and identify their dividend policy.
(10 marks)

b) Critically evaluate the ideas of Modigliani and Miller in respect to dividend

policy.
(20 Marks)
Total 30 marks

End of examination

Page 8 of 10
 Present Value of £1 at a discount rate of r%
Yea
3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
r
1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
0
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
0.97 0.96 0.95 0.94 0.93 0.92 0.91 0.90 0.90 0.89 0.88 0.87 0.87 0.86 0.85 0.84 0.84 0.83
1
1 2 2 3 5 6 7 9 1 3 5 7 0 2 5 7 0 3
0.94 0.92 0.90 0.89 0.87 0.85 0.84 0.82 0.81 0.79 0.78 0.76 0.75 0.74 0.73 0.71 0.70 0.69
2
3 5 7 0 3 7 2 6 2 7 3 9 6 3 1 8 6 4
0.91 0.88 0.86 0.84 0.81 0.79 0.77 0.75 0.73 0.71 0.69 0.67 0.65 0.64 0.62 0.60 0.59 0.57
3
5 9 4 0 6 4 2 1 1 2 3 5 8 1 4 9 3 9
0.88 0.85 0.82 0.79 0.76 0.73 0.70 0.68 0.65 0.63 0.61 0.59 0.57 0.55 0.53 0.51 0.49 0.48
4
8 5 3 2 3 5 8 3 9 6 3 2 2 2 4 6 9 2
0.86 0.82 0.78 0.74 0.71 0.68 0.65 0.62 0.59 0.56 0.54 0.51 0.49 0.47 0.45 0.43 0.41 0.40
5
3 2 4 7 3 1 0 1 3 7 3 9 7 6 6 7 9 2
0.83 0.79 0.74 0.70 0.66 0.63 0.59 0.56 0.53 0.50 0.48 0.45 0.43 0.41 0.39 0.37 0.35 0.33
6
7 0 6 5 6 0 6 4 5 7 0 6 2 0 0 0 2 5
0.81 0.76 0.71 0.66 0.62 0.58 0.54 0.51 0.48 0.45 0.42 0.40 0.37 0.35 0.33 0.31 0.29 0.27
7
3 0 1 5 3 3 7 3 2 2 5 0 6 4 3 4 6 9
0.78 0.73 0.67 0.62 0.58 0.54 0.50 0.46 0.43 0.40 0.37 0.35 0.32 0.30 0.28 0.26 0.24 0.23
8
9 1 7 7 2 0 2 7 4 4 6 1 7 5 5 6 9 3
0.76 0.70 0.64 0.59 0.54 0.50 0.46 0.42 0.39 0.36 0.33 0.30 0.28 0.26 0.24 0.22 0.20 0.19
9
6 3 5 2 4 0 0 4 1 1 3 8 4 3 3 5 9 4
0.74 0.67 0.61 0.55 0.50 0.46 0.42 0.38 0.35 0.32 0.29 0.27 0.24 0.22 0.20 0.19 0.17 0.16
10
4 6 4 8 8 3 2 6 2 2 5 0 7 7 8 1 6 2
0.72 0.65 0.58 0.52 0.47 0.42 0.38 0.35 0.31 0.28 0.26 0.23 0.21 0.19 0.17 0.16 0.14 0.13
11
2 0 5 7 5 9 8 0 7 7 1 7 5 5 8 2 8 5
0.70 0.62 0.55 0.49 0.44 0.39 0.35 0.31 0.28 0.25 0.23 0.20 0.18 0.16 0.15 0.13 0.12 0.11
12
1 5 7 7 4 7 6 9 6 7 1 8 7 8 2 7 4 2
0.68 0.60 0.53 0.46 0.41 0.36 0.32 0.29 0.25 0.22 0.20 0.18 0.16 0.14 0.13 0.11 0.10 0.09
13
1 1 0 9 5 8 6 0 8 9 4 2 3 5 0 6 4 3
0.66 0.57 0.50 0.44 0.38 0.34 0.29 0.26 0.23 0.20 0.18 0.16 0.14 0.12 0.09 0.08 0.07
14 0.111
1 7 5 2 8 0 9 3 2 5 1 0 1 5 9 8 8
0.64 0.55 0.48 0.41 0.36 0.31 0.27 0.23 0.20 0.18 0.16 0.14 0.12 0.10 0.09 0.08 0.07 0.06
15
2 5 1 7 2 5 5 9 9 3 0 0 3 8 5 4 4 5
0.62 0.53 0.45 0.39 0.33 0.29 0.25 0.21 0.18 0.16 0.14 0.12 0.10 0.09 0.08 0.07 0.06 0.05
16
3 4 8 4 9 2 2 8 8 3 1 3 7 3 1 1 2 4

Page 9 of 10
 0.60 0.51 0.43 0.37 0.31 0.27 0.23 0.19 0.17 0.14 0.12 0.10 0.09 0.08 0.06 0.06 0.05 0.04
17
5 3 6 1 7 0 1 8 0 6 5 8 3 0 9 0 2 5
0.58 0.49 0.41 0.35 0.29 0.25 0.21 0.18 0.15 0.13 0.09 0.08 0.06 0.05 0.05 0.04 0.03
18 0.111
7 4 6 0 6 0 2 0 3 0 5 1 9 9 1 4 8
0.57 0.47 0.39 0.33 0.27 0.23 0.19 0.16 0.13 0.11 0.09 0.08 0.07 0.06 0.05 0.04 0.03 0.03
19
0 5 6 1 7 2 4 4 8 6 8 3 0 0 1 3 7 1
0.55 0.45 0.37 0.31 0.25 0.21 0.17 0.14 0.12 0.10 0.08 0.07 0.06 0.05 0.04 0.03 0.03 0.02
20
4 6 7 2 8 5 8 9 4 4 7 3 1 1 3 7 1 6
0.53 0.43 0.35 0.29 0.24 0.19 0.16 0.13 0.11 0.09 0.07 0.06 0.05 0.04 0.03 0.03 0.02 0.02
21
8 9 9 4 2 9 4 5 2 3 7 4 3 4 7 1 6 2
0.52 0.42 0.34 0.27 0.22 0.18 0.15 0.12 0.10 0.08 0.06 0.05 0.04 0.03 0.03 0.02 0.02 0.01
22
2 2 2 8 6 4 0 3 1 3 8 6 6 8 2 6 2 8
0.50 0.40 0.32 0.26 0.21 0.17 0.13 0.11 0.09 0.07 0.06 0.04 0.04 0.03 0.02 0.02 0.01 0.01
23
7 6 6 2 1 0 8 2 1 4 0 9 0 3 7 2 8 5
0.49 0.39 0.31 0.24 0.19 0.15 0.12 0.10 0.08 0.06 0.05 0.04 0.03 0.02 0.02 0.01 0.01 0.01
24
2 0 0 7 7 8 6 2 2 6 3 3 5 8 3 9 5 3
0.47 0.37 0.29 0.23 0.18 0.14 0.11 0.09 0.07 0.05 0.04 0.03 0.03 0.02 0.02 0.01 0.01 0.01
25
8 5 5 3 4 6 6 2 4 9 7 8 0 4 0 6 3 0

Page 10 of 10