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TJNIYERSITY OF KELANIYA Si'r'

FACULTY OF COMMERCE AND MANAGEMENT STUDIES

MASTER OF BUSINESS ADMINISTRATION DEGREE EXAMINATION
Academic Year - 201612017

Year I Semester II
MBA 52093/NIBA 52093 (R)/MBA 61043 (R) - Corporate Finance
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Time: Three (03) Hours

Number of Questions: Eight (08)

Number of Pages: Eight (08)
This question paper consists of three parts i.e. Part A, B and C. Candidates are required r'{'q

to answer any fivS (05) questions, selecting at least a one (01) question from each part.
Every answer should start from the new sheet and answers must follow the sequential
order.

PARTA fift

Question 01
a) Distinguish befween finance and co{porate finance?
(06 Marks)
b) Describe how has financial management as a separate discipline developed from early
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1900's to the present? Justify your answsr by providing examples. !

(04 Marks)
c) How do you differentiate goal of Financial Management from other possible goals of a
corporate concem?
(05 Marks)
d) State how an agency relationship arises in a corporate concern and what types of agency r{t{

costs are emerging?

(05 Marks)
(Total 20 Marlrs)

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Question 02
a) Distinguish between diversifiable and non-diversifiable risk by providing two examples
for each type ofrisks.
(06 Marks) -si",

b) Stock X and Y have the following probability distributions of expected returns.

Probabilify X return Y return

(%) (%)
0. I ( l0) (3s) tFilil
$

4.2 2 0

0.4 t2 2A

0.2 20 25

0.1 38 45

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(i) Calculate the expected rate of return for stock X and Y
l.

(ii) Calgulate the standard deviation of expected retum for stock X and Y
(iii) Which company do you recommend for an investment
(10 Marks)
c) Suppose you are the fund manager of a Rs. 4 million invested fund. The fund consists of 4
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stocks with the following investments and betas: F

Stock Investment Beta

A Rs. 400,000 1.5

B Rs. 600,000 (0.50)

C Rs. 1,000,000 1.25 *s#

D Rs.. 2,000,000 0.75

If the market required rate of return is 14 percent and the risk free rate is 6 percent, what is

the fund's required rate of return?

(04 Marks) r$F

(Total20 Marks) '

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Question 03
a) What is meant by firms cost of capital and describe its significance to a listed company and
its shareholders.
(06 Marks)

b) Kelani Valley Plantations Plc. (KVP Plc) is considering to diversify'its manufacturing ,I.

operations to produce biscuits by importing required machinery from India to commence

its production. KVP Plc. is currently has the following capital structure, which it considers

to be optimal.
Debt 30%
Preferred stock l0o/o .r,
Common Stock 600/o

Total 100

KVP's tax rate is 40 percent and investors expect earnings and dividends to grow at
constant rate of 9 percent in the future. KVP Plc paid a dividend of Rs. 3.60 per share last
year (De), and its stock currently sells at a price of Rs. 60, per share. "{

Government Treasury bills yield is 7 percent; an average stock has a 15 percent expected
rate of return; and KVP's beta is 1.52. These terms would apply to new security offerings.

New preferred stocks could be sold to the public at a price of 100 per share, with a dividend
of Rs.10. Floatation cost of 5% would be incurred per share. De.bt could be sold at an ,.l
interest rate of I I percent.

You are required to calculate KVP Plc's;

(i) Component cost of debt, preferred stock, and common stock.
(ii) Calculate the WACC? Round offthe calculated value of WACC to next decimal value. i*
' (10 Marks)
c) "Retained earnings does not contain any cost" Therefore, cost of retained earnings is zero
to a firm. Comment.
(04 Marks)
(Total20 Marks)
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PART B

Question 04
You have decided to commence computer training institution at Kiribathgoda town to cater
the
growingdemandofstudentsaswellasadults.Youhavefoundanabandonedbuildingwhichwill
meet your needs and rent for Rs. 750,000 a year.

You estimate that it will initially cost Rs. 400,000 to renovate the place according to your
requirements. This entire cost is fully depreciable equally over five years with no
salvage value. It
will cost Rs. 2000,000 for the required equipment of the institution. They will be depreciated
equally over five years so that there will be Rs. 200,000 salvage value at the end
of 5th year. Other
out ofpocket fixed cost per year will be Rs. 300,000.

Your institution is planning to offer one year computer training programs. you have
done a market
survey which leads you to believe that you will get 150 students in the first year
and 25A in the
second year and 300 in next three years. Course fee per annum is
Rs. 22500. To start with, you are t
going to hire 3 instructors for Rs. 600,000 per year per instructor.
From third year, the number of
instructors will be increased up to five. At this point 3 senior instructors
will be paid at the rate of
Rs, 700,000 a year while two new instructors will be paid at the rate
of Rs. 600,000 a year. Other
variable costs are estimated to be 15% of the annual revenue.

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As you expect to run the institution as a private company the tax rate
applicable to your company
is30%o. The required rate of return for the project is l2%o.

a) Estimate the annual net cash flows of the project

b) Find the Payback Period of the project and determine whether the project
is acceptable if
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you want to pay back the investment within 4 years maximum. L,

c) Find the NPV of the project and determine whether the project
is acceptable.

(Total20 Marks)

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Question 05
Mr. Sarath is 30 years old and expects to retire when he reaches age 60. If he is to retire today, he
would like a fixed income of Rs. 600,000 per year for a retirement life of 15 years. However he
realizes that price inflation will erode the purchasing power of the rupee over 30 years and wants
to adjust the desired retirement income at the age of 60 to reflect the decline in the purchasing
power ofthe rupee. His retirement income will have to begin after one year from the day he retires,
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that is 31st year from today and then it will continue up to l5 annual payments. Inflation is expected :'

to be 6Yo per year from today forward. He currently has Rs. 1000,000 savings and he expects to
eam a return on his savings of 12 percent per year, annual compounding. Further, he plans to save

an equivalent amount of money at the end of every year for next 30 years to meet his retirement
goal.

a) Find the amount of money he should receive as his retirement benefit in the first year of r{

his retirement (3I*t year from today) according to the above plan.
b) Find the size of the retirement fund he should have at the beginning of his retirement
c) What will be the value of the current savings at the end of the 30th year (60n birthday)?.
d) What will be the savings deficit at the end of 30e year to meet his retirement goal? If he

does not save any money during the first 30 years. r.

e) What is the size of instalment he has to make at the end of every year within frrst 30 years 5

to meet his retirement goal according to the above plan.

(Total 20 Marla)

Question 06
a) What is a derivative instrument and how are they important? Jf'l

(05 Marks)
b) Explain the "Zero Cost Collar" strategy of Ceylon Petroleum Corporation oil hedging
agreement. ?

(05 Marks)
c) Anish is bearish about the market and spot price Nifty Stands at Rs. 1250. He decides to Jr{
5

buy one three month Nifty put option contract with a strike price of Rs. 1245 at a premium
of Rs. 15. Three months later the index closes at Rs. 1225.lVhat is his pay off position?
(03 Marks)

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d) Assume that Mr. X holds 1000 shares of HLL. He plans to sell the shares three months later

as he would need the money to get his daughter married. Today HLL trades at Rs. 232 in

the spot market. Mr. X worried about a fall in price of HLL three months later, when
he

would actually need the money. He could of course sell the shares today and get Rs.
232

price
for them, however he does not want to lose on the possibility of an increase in share
but does
three months later. How can he ensure that he gets profits from a price increase
not suffer losses frorn a price decrsass?
(07 Marks)

{Total 20 Marks}

PART C

Question 07
a) Merging and acquisition is a value creation process that happens in an economy. List five
intentions of mergers and acquisitions.
(05 Marks)

b) Company A is to acquire company T. Company A has market capialization of Rs 5 billion

and that of company T is Rs I billion. Share price of company A is Rs 50. Board of

to
directors of the company A believe it is fair to give 25o/o of merged firm's ownership
shareholders of company T.If the merged firm worth 7 billion, calculate economic
advantage transferred to owners of company T'
(05 Marks)

c) Mr. Nimal is planning to start a business of assembling ornamental item for export purpose'

In project feasibility study, he has gathered following information.

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Amount per unit (Rs.)
Estimated cost per unit ofproduction is:

Raw Material 50
Direct Labour 15

Overheads (exclusive of depreciation) 30

Total cost 95
Addi t i onal Inform at io n

Selling Price I l0
Level of activity 150,000 unit per annum

Raw Material in stock Average 4 weeks

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work in progress (assume 50% labour and l00yo material) Average 2 weeks

Finish goods in stock Average 2 weeks

Credit allowed by suppliers Average 4 weeks
Credit allowed to debtors Average g weeks I
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Lag in payment of wages Average 2 weeks

Cash at bank is expected to be 200,000

calculbte how much Mr. Nimal has to invest as working capital.

Marks)
(10
*s
(Total20 Marks) 5

Question 08
a) Foreign exchange rate of two currencies is the rate at which one currency will be exchanged
for another. Which is in essence relative to value of currencies? What are the factors which
affect relative value of cunencies?

(05 Marks) I*
b) Forward Rate Agreements (rRA) are used by importers/exporters in fixing exchange rates.

I
Suppose an importer is having USD million obligation after six months. Current
LKRruSD rate is 155. Expected inflation in Sri Lanka during next year is forecasted to be
l0o/o andthat of USA is expected tobe 4ya.

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75
 (i) calculate the USD/LKR exchange rate the importer agree in FRA.

(03 Marks)
(ii) If actual exchange rate is 160 on LKR/USD basis, has the importer benefited in this
agreement?

(02Marks)
c) Mr. Suranga is a marketing execute in Consumer Products PLC (CPL). Being young
executive he saved part of his salary and invest in equity market. He started investing in
the Colombo Stock Exchange in 2009.

Even though some research reports did not recommend buying CPL shares, large part of
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his invesfinents are in CPL. Suranga was one among group of friends who subscribed every

initial public offering until the market started crashing. However, he was confident that he
made the right decision claiming it is short-term situation in the market. By end of 2011,
Suranga had lost 60% of his investments.

(i) Explain two cognitive errors demonstrated by Mr. Suranga. TI

(05 Marks)
(ii) "Cognitive Errors can be mitigated, however Emotional Biases can't be avoided,,
explain this statement.

(05 Marks)
(Total 20 Marks)
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