Sample/practice exam PDF

Preview

Summary

2020 Practice Exam...

Description

FNCE20005 CORPORATE FINANCIAL DECISION MAKING 2020 PRACTICE TEST for FINAL EXAM

Please do not assume that only the content covered in the following practice test will be examinable. This test is only intended to provide you with a sense of what the actual test will look like and help you to review the material to a certain degree.

The University of Melbourne Department of Finance Practice Final Exam FNCE20005 CORPORATE FINANCIAL DECISION MAKING Semester ONE, 2020 Exam Duration: Three (3) Hours writing time 30 minutes for uploading answers Instructions to Candidates 1.

This is an OPEN BOOK examination.

2.

There is NO reading time.

3.

Once commenced, you MUST answer all the questions and upload the answers within three and half (3.5) hours.

4.

This examination contains TWO SECTIONS for a total of 100 marks. Marks Total Questions Required Section A 40 10 Attempt ALL questions 60 7 Attempt ALL questions Section B Total 100 17 Attempt ALL questions

5.

For Section A, select True or False for each question, and provide an explanation and/or a calculation using your preferred way, such as writing on pages or on digital devices. An incorrect or missing reason/explanation means NO MARKS. Answers need to be uploaded for each corresponding question. All answers MUST BE HANDWRITTEN, typed answers will be awarded ZERO marks.

6.

For Section B, answer questions using your preferred way, such as writing on pages or on digital devices. In order to get marks, you need to show your workings along with the final answer. Answers need to be uploaded for each corresponding question. All answers MUST BE HANDWRITTEN, typed answers will be awarded ZERO marks.

7.

Please scan your answers using a scanner or a mobile device. Detailed instructions about scanning on mobile devices are available under “Final Exam Information” in CANVAS. All submitted answers MUST BE LEGIBLE, as illegible (unreadable) answers will be awarded ZERO marks.

8.

Collusion between students is absolutely forbidden and will result in very serious consequences.

9.

The discussion board in CANVAS will be available during the exam period, subject coordinators and the tutor-in-charge will be there assisting in resolving issues related to exam contents.

10.

Once you have commenced the exam, you must complete it within the time constraints. If you experience any technical issues, and you are able to quickly resolve them, you can enter back into the system within the remaining allocated time. If you are not able to resolve the issue and complete the exam, please email the head tutor ([email protected]) immediately, with a description of the issue, time that the issue was encountered and screenshots of the error.

2

SECTION A ANSWER ALL QUESTIONS • Indicate whether each of the following 10 statements is TRUE or FALSE by selecting the appropriate answer. Provide an explanation and/or a calculation and upload them to Gradescope. • An incorrect or missing reason/explanation means NO MARKS. • Each question is worth 4 marks for a total of 40 marks. Answers MUST BE HANDWRITTEN and uploaded to the corresponding question.

A1.Seller of a call option is going to sell the underlying asset at the exercise price, therefore a farmer who expects that his corn crop will be ready for sale in October 2020 should short a call option on corn expiring in October 2020 to lock in the selling price of his crops. True False

A2. Ian owns shares in Myers Ltd whose current share price (cum rights) is $10 per share. Myers Ltd

makes a one for eight rights issue with a subscription price of $1 per share. The ex-right share price in the market will always be $9. True False

A3. Divestitures may provide a benefit to shareholders as they can result in a reduction in the cross-

subsidisation between "good" and "poor" performing business units. True False

A4. The trade-off theory of capital structure implies that companies only ever increase the amount of

debt to achieve an optimal capital structure. True

False

A5. A limitation of the WACC approach is that it can give misleading results if it is used to analyse

financing decisions rather than investment decisions. True False

A6. A company may engage in share buybacks due to reasons relating to signalling, financial

flexibility, and employee share options. True

False

A7. Debt holders are only allowed to include negative covenants in debt contracts.

True

False

A8. Only market risk can be managed, it is impossible for companies to manage operational and

external event risks. True

False 3

A9. Melbourne Ltd. announces a fully franked cash dividend of $1 per share in a market where the

applicable corporate tax rate is 30%. Henry is a resident shareholder in Melbourne Ltd. (holding just one share) and pays tax at a marginal tax rate of 50%. Henry’s after-tax net return from the dividend will be $0.71. True False

An economic rational reason for takeovers is to allow bidder management to retain poorly performing target management. True False

A10.

4

SECTION B ANSWER ALL QUESTIONS • This section consists of 7 questions. Attempt ALL questions. • All answers MUST BE HANDWRITTEN and uploaded to the corresponding question on Gradescope. • In order to get marks, you need to show your workings along with the final answers. • Marks per question are as indicated for a total of 60 marks. Question B1 Sirius Music Company is looking to invest in a facility that will allow it to manufacture audiophile quality vinyl records. The management has conducted market research and determined that the initial investment needed is $500,000 and the fixed costs associated with such a facility will be $200,000 per annum. Additional information regarding the project is provided in the table below: Estimates Item Sales (units) Selling price ($) Variable operating costs per unit ($) Life of the facility (years)

Pessimistic 12500 63 50

Most Likely 15000 70 48

Optimistic 17000 76 46

9

10

12

Sirius’s cost of capital is 10% per annum. Sirius’s CEO is concerned about the variability in the selling price and the life of the facility and their effect on the project NPV. She wants you to conduct appropriate analysis and based on your analysis, identify major uncertainties associated with the project. Show all your work. [10 marks]

Question B2

Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $0.5 million per year in perpetuity. Velcro Saddles is informed that Pogo wants Velcro either to pay $14 million cash for Pogo or to offer Pogo a 50% shareholding in the new Velcro Saddles combined with Pogo. The opportunity cost of capital is 10%. Given this information, answer the following questions: (a) (b) (c) (d)

What is the gain from the acquisition? What is the NPV of the acquisition to Velcro Saddles under the suggested cash offer? What is its NPV of the acquisition to Velcro Saddles under the suggested stock offer? What is the maximum shareholding (instead of 50%) Velcro Saddles could offer to Pogo in a stock swap transaction? [2+2+3+3 = 10 marks]

Question B3 You are analyzing a private company that makes tires. You expect net income of $25 million for the private company next year. There is a public company called Htires traded on the ASX that operates in the same industry. Both companies have a cost of equity of 10%. Analysts expect growth of 4% per year for Htires. Htires has a payout rate of about 85%, which is expected to remain constant in the future. Given this information, (a) What is Htires’ forward P/E ratio? (b) Assume that you found a forward P/E ratio of 20 in part (a). Do not use your actual answer from part (a). If the private company and Htires are good comparables, what is your estimate of the private company’s market capitalization? [3+4 = 7 marks]

Question B4 Ambev is considering introducing a soft drink to the U.S. market. The drink will initially be introduced only in the metropolitan areas of the U.S. and the cost of this “limited introduction” is $500 million. A financial analysis of the cash flows from this investment suggests that the present value of the cash flows from this investment to Ambev will be only $400 million. If the initial introduction works out well, Ambev could go ahead with a full-scale introduction to the entire market with an additional investment of $1 billion any time over the next 5 years. While the current expectation is that the cash flows from having this investment is only $750 million, there remains considerable uncertainty about the sales potential of the drink, leading to significant variance in this estimate. (a) What is the NPV of the project (“limited introduction”) today based on the expected future cash flows from the project? (b) What is the real option that Ambev has in this situation? Can we describe the situation by making an analogy with a financial option (call option or put option)? Identify the value of the underlying asset, the exercise price, and the expiration date of the financial option. (c) Suppose that you estimated the value of the financial option to be $234 million on the basis of a financial option pricing technique. Should Ambev invest in the project, that is, invest in the “limited introduction” of the soft drink today? [1+4+2 = 7 marks]

6

Question B5 NewCap Corporation, a news media company, is re-examining its policy of financing all its projects entirely with equity. An analysis of its cost of capital suggests that the (after-tax) cost of capital will be 1.50% lower than the current one if the firm moves to a 30% debt ratio (D/V). The current beta of the firm is 0.90, the current Treasury bond (risk free) rate is 7% and the market risk premium is 5.5%. The current earnings before interest and tax is $100 million, and net capital expenditures (capex – depreciation) and net working capital spending are zero; the cash flows are expected to grow at 5% forever. Assume that the expected future cash flows will not be affected by any capital structure change. The applicable tax rate is 40%. Given this information, (a) Estimate the value of the firm under the current debt ratio. (b) Estimate the value of the firm under the optimal debt ratio [4+4 = 8 marks]

Question B6 You are a consultant who has been employed by a transport company, Arbed Ltd. The company is bidding for a license to transport silicate from mines located in the south-east of the Northern Territory to the wharves of Darwin. If the company succeeds in obtaining a license, then they must acquire a custom-made silicate transport vehicle (STV). The management of Arbed Ltd. has sought your guidance as to whether they should purchase such a vehicle by borrowing money or lease it. They have supplied you with the following information. STV Purchase Price Effective Life of STV Effective tax rate Before-tax cost of an equivalent loan Required rate of return (after-tax) from the investment in the STV Annual lease payment required in advance Annual operating cash inflow from operating STV (occurring at year end) Annual operating cash outflow from operating STV (occurring at year end) Salvage value of STV at conclusion of effective life

$85,000 5 years 30.00% 15.00% p.a. 19.00% p.a. $16,150 $55,250 $13,813 $12,750

The management team also tells you that if they purchase the STV they will fully depreciate it, for taxation purposes, using the straight-line method, and that all cash flows have been quoted on a before-tax basis. Assuming that Arbed Ltd. was going to acquire the STV, would you recommend that they purchase by borrowing or lease it? What is the incremental wealth associated with your decision?

[10 marks]

7

Question B7 The company PDR Ltd is listed on the Australian Securities Exchange (ASX). The company conducted an off-market share buyback on October 21, 2011. This share buyback was under tax determination TD 2004/22. The relevant corporate tax rate is 30%. Shareholders were invited to tender their shares between $7.50 and $9.20. PDR’s Volume Weighted Average Price over the five days before the first announcement of the buy-back was $8.60. PDR's opening share price on the day of the announcement was $8.57, and its closing share price on the day of the announcement was $8.66. Over the period from the announcement to the close of the buyback, the market index rose 1.25%. P DR announced the buyback price to be $7.50. The fully franked dividend component of the buyback was $4.00. John is an Australian resident shareholder of PDR Ltd who bought one share for $5.20 in 2008. Assume that John’s personal income tax rate is 50%. What were the total after-tax proceeds that John received from the buyback? Show all your work. [8 marks]

END-OF-EXAM

8...