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UNIVERSITY OF GHANA

(All rights reserved)

B.se ADMINISTRATION SECOND SEMESTER 2016/2017

FINC 302: BUSINESS FINANCE II (3 credits)

TIME ALLOWED: 3 HOURS

INSTRUCTIONS

1. This is a closed book exam

2. You are to provide proof of all answers in the answer booklet provided where
calculations are needed.
3. For the multiple choice section, write the letter that corresponds to your answer in
the answer booklet provided.
4. You are permitted to use calculators
5. You are to attempt all questions
6. Use the answer booklet provided for all answers

Examiners: Dr. Vera O. L. Fiador & Prof. K. Adom-Frimpong Page 1 of9

 SECTION A

Part One: Indicate whethe r the statemen ts below are True (T) or F alse (F )

1. The payment of dividends by corporations is considered a business expense.

2. Dividends are normally considered deductible for corporate tax purposes.
3. Capital budgeting decisions are long term decLions .
4. Capital budgeting decisions are reversible in nature.
5. Capital budgeting decisions do not affect the future stability of the firm.

Part Two: Fill in th e correct answers

6. The stated interes t payments made on a bond 1S typically referred to a

7. The legal document that stipulates the terms and conditions under which a bond
is issued and outlines the agreement bet:\veen the borrower (issuer) and its
creditors is known as ..... . . .. . . ........ . .. . ... . .... . ....... .. . .

8. Payments by a corporation to shareholders, made in either cash or stock are

referred to as ........... . .. . .. .. ... .. .. . . .. ........ .. .. .

9. Merton E nt. has bonds on the market making annual coupon payment, with
14years to maturity and currently selling at 950. If the bonds are expected to
yield 7.5%, vd1at must the coupon rate be on these bonds if face value is
1,000 .............. .... .. .... .. . ...... ... . . .

Examine r s: Dr. Ve ra O. L. Fiador & Prof. K. Ado m·Frimpon g Page 2 of 9

 \ L-\
10. When the coupon rate is greater than the YTM, the pnce of the bond
is ..................... the face value of the bond and such a bond is sold at
a ........... . ............ .. .. .

11. The risk that arises for bond owners from fluctuating interest rates is called

12. The bond's coupon payment divided by the price of the bond is referred to
as ... ~ ..... . ............... . .... . .. . ......... .

13. All other things being equal, the longer the term to maturity of the bond, the
......... . ...... . .. .... .. the interest rate risk.

14. The complete absorption of one company by another, wherein the acquiring
flIm retains its identity and the acquired firm ceases to exist as a separate entity,
is called a ...... ... .......... .

lS.A cost that has already been incurred and cannot be removed and therefore
should not be considered in an investment decision is referred to as

16. A basic measure of risk-return trade off that divides the total risk, i.e., standard
devia tion by the expected return IS referred to as the

17. In an ...................... . . . ...... . ....... . ..... . .. . ..... . , security prices fully reflect
available information.

Examiners: Dr. Vera o. L. Fiador & Prof. K. Adom-Frimpong Page 3 of9

 IS
18. There are .. ... . .... .... ..... .. . .. . .... forms of market efficiency, namely
(i) ..... ................ .. ........ .. ...... ..... ........ . .
(ii) ... . ...................... ...... .. ... ... ............. .
(iii) ..................................................... .

19. The argument that stocks attract particular groups of investors based on dividend
yield and the resulting tax effects IS referred to as the
. ........ ..... . ... ......... ..... . effect.

20. The date on which the board passes the resolution to pay dividends is known as
.. .. .... ... ................. ......... .. ... ...... date.

22. Investment A has expected return of 25% and standard deviation of 13, if
investment B has standard deviation of 18, what minimum expected rate of
return ,vill make an investor indifferent between options A and B, using

coefficient of variation? ........................................... ..

Part 3: Select the letter that represents your answer or provide your own
answer

23. A merger in which an entirely new firm is created and both the acquired and
acqullmg firms cease to exist is called a:
a. divestiture.
b. consolidation.
c. tender offer.
d. spinoff.
e. conglomeration

24. Firms can payout cash to their shareholders in the following ways:
(I) Dividends
(II) Share repurchases
(III) Interest payments
a. I only

Exam iners: Dr. Vera O. L. Fiador & Prof. K. Adom-Frimpong Page 4 of9
 16
b. II only
c. III only
d. I and II only
e......... ... ........... .. .

25. The payments made by a fIrm to repurchase shares of its outstanding stock from
an individual investor in an attempt to eliminate a potential unfriendly takeover
attempt are referred to as:
a. a golden parachute.
b. standstill payments.
c. greenmaiL
d. a poison pill.
e. a white knight.

26. One key assumption of the Miller and Modigliani dividend irrelevance is that:
a. Future stock prices are certain
b. There are no capital gains taxes
c. Capital markets are efficient
d. All investments are risk-free
e. Investors are not interested in dividends

27. A T-bill pays 5 percent rate of return. Would risk-averse investors invest in a
risky portfolio that pays 8 percent with a probability of 40 percent or 3 percent with
a probability of 60 percent?
a. Yes, because they are rewarded with a risk premium.
b. No, because they are not rewarded with a risk premium.
c. No, because the risk premium is smalL
d. Cannot be determined.
e. None of the above.

28. In a well-diversifIed portfolio

a. market risk is negligible.
b. systematic risk is negligible.
c. unsystematic risk is negligible.
d. non-diversiflable risk is negligible.
e. none of the above.

29. Your opinion is that security A has a current rate of return of 0.125. It has a beta
of 1.5. The risk-free rate is 0.04 and the market expected rate of return is O.1l.
According to the Capital Asset Pricing Model (CAPM), this security is
a. underpriced.
b. overpriced.
c. fairly priced.
d. cannot be determined from data provided.

Examiners: Dr. Vera o. L. Fiador & Prof. K. Adom-Frimpong Page 5 of9

 e. none of the aboye.

30. The optimal capital s tr~ c tur e has been achieved when the:
a. debt-equity ratio is equal to 1.
b. debt-equity ratio is equal to 2.
c. cost of equity is minimized given a pre-tax cost o f debt.
d. debt-equity ratio is such rlut the cost of debt is equal to the cost of equity.
e. debt-equity ratio selected results in the lowest pos sible \veighed average cost of
capital.

31. All else equal, the payb ck period for a proj ect will decrease whenever the:
a. initial cost increases.
b. required return fo r a project increases.
c. assigned discount rate decreases.
d. duration of a project is lengthened.
e. none of the above

32 . The capital structure o f a fIrm includes bonds with a coupon rate of 12% and
an after-tax cost of debt of 9.8%, what the pre-ta..x cost of debt a yield to maturity of
14% . The corporate tax rate is 30%. What is the fum' s \y/ACC if cost of equity is
16% with an equally \veighted capital structure?

a.8.4%
b.9.8%
c.12.9%
d.14%
e ... ..... . . ..... . . . ..... . ... .. . .. . . . .... .... . . .. ... .

33. An investment h as th e follovvi.ng estimated returns for years 1-5 respectively:

10%, 12% , -8%, 15% ar:.d 25%. What is the h olding period return for this
investment?

a.1.6293
b. 10.26%
c.0.6293
d.1.1025 %
e .. . .. .. . . . . . . .. ... .. . .. ... .. .. .

34. A fully-funded equity Elm1 that is currently experiencing constant growth of

5.5%, has its stock sellilJg for Ghs 28. Its most recent dividend r as Ghs 3. What is
tl1e firm's cost of equity?

Examine rs: Dr. Vera O. L. Fiador & Prof. K. Adom- Frimpo ng Page 6 of9
 a. 15.71
b. 16.25
c. 16.80
d. 11.25
e... . .............. . ........... .. .. ... .... . .

35. A fum's newest project is expected to provide 25,000 in cash flows in perpetuity.
If the initial investment is 183,823, what is the IRR of the project?

a.15%
b.14.8%
c.13.6%
d.16.3%
e.14.5%

36. Ama wants to know the geometric mean return on an investment that is expected
to provide the following returns over its economic life: 25%, 22%, 18% and 15%.
(round to the nearest whole)

a.80%
b.20%
c.18.9%
d. 2.0694%

e ... ..... . ... . ... .... . . ...... . . .. ......... . ... .. . . .

37. The Tullien Oil Company (TOC) is considering a project that will cost $50
million and have a year-end after-tax cost savings of $7 million in perpetuity. TOC's
after-tax cost of debt is 6.6%
and its cost of equity is 16%. The project has risk similar to that of the operation of
the firm, and
the target deb t-equity ratio is 1.5. What is the NPV for the project?
a. $17.568 Million.
b. $ 6.452 Million.
c. $11.947 Million.
d. $ 7.189 Million.
e. none 0 f the above.

38. At what cost of capital will a project provide an NPV of 201,707 given annual
cash inflows Ghs 34,000 for 10 years and an initial cost of 28,000?

a. 11.5%

Examiners: Dr. Vera O. L. Fiador & Prof. K. Ad om-Frimpong Page 7 of9

b.9.89%
\9
c. 12.0%
d.l0.5%
e. l1.0%

39. At an initial cost of SO million, what should be the minimum annual cash inflow
on a project with a five-year econornic life so it can provide an NPV of 20 million if
cost of capital is 15% ?

a. approximately 15.89 million

b . approximately 20.88 million
c. approximately 18.89 million
d. approximately 19.89 million

e . .... ........... ... ... . .............. .

40. QWC Ltd. has cash of $200,000 that will be invested in an equity investment tl::lt
has a beta of 2.25. T he current risk-free rate in the market is 2.5%, and the 111?rJ.:et
requires an 8% risk premium for equity securities . What return should Q\VC Ltd.
expect to earn?
a. $29,750
b. $41,000
c. $23,625
d.$20,500

e . . .. . . . .. ...... .. . . .. . ....... . . ..... ..

Examiners: Dr. Vera O. L. Fiador & Prof. K. Adom- Frimpon g

 ::2-0
Section B (50 marks)

State of the economy Prob. Stock A Stock B

Recession 0.10 -22% 20%
Normal 0.60 15% 30%
Boom 0.30 65% 50%

1. Based on the table above, compute the expected returns of Stock A and Stock B.
(5 marks)
2. Compute the standard deviations of both stocks A and B. (5 marks)
3. Compute the covariance and correlation coefficient between the two stocks (5 marks)
4. What is the standard deviation of a portfolio constructed with a 50/50 weighting in each
of the stocks. (5 marks)
5. What coupon rate will cause you to be indifferent between the following bond offers which
are be priced to yield 15% and have a face value of Gh 1000. One of the bonds (Q) matures
in 10years and pays 12% coupon. The other is expected to mature is 8years.
(5 marks)

6. Define the following:

a. Ex-dividend date (2.5 marks)

b. Record date (2.5 marks)

c. Golden Parachute (2.5 marks)

d. White Knight (2.5 marks)

e. Bond (2.5 marks)

7. QYX is a 9-year bond currently trading on the market. It pays 6% coupons and is priced at
795. The face value is 1000. What is the current yield on this bond? (2.5 marks)

8. LPY Ltd. has cash of $500,000 that will be used to create an investment portfolio. The portfolio
will be invested evenly in two assets: an equity investment that has a beta of 1.70 and a one-year
risk-free interest bearing certificate. The current risk-free rate in the market is 3% and the
market requires a 6% risk premium for equity securities. What one-year return should LPY Ltd.
expect to earn on its portfolio? (5 marks)

9. Moussawi Ltd's outstanding bonds have a $1,000 par value, and they mature in 5 years. Their
yield to maturity is 9%, based on semi-annual compounding, and the current market price is
$853.61. The firm also has equity in its capital structure, with beta of 0.8 in a market that has
an equity premium of 10% and a risk-free rate of 3% . What is the firm's weighted average cost
of capital if it's debt-to-asset ratio is 0.35? (The firm is enjoying a tax holiday) (5 marks)

Examiners: Dr. Vera O. L. Fiador & Prof. K. Adom-Frimpong Page 9 of9