BUSI4567-E1
A LEVEL 4 MODULE, AUTUMN SEMESTER 20xx-20xx
BUSI4567 CORPORATE FINANCIAL MANAGMENT
Question 1
(a) Compare the advantages of debt financing over equity financing when a corporation is issuing a bond to raise capital for projects. 10 marks
(b) What are credit ratings for bonds? How the credit ratings affect the yields of bonds? 10 marks
(c) You are required to price a Treasury bond with a coupon rate of 4% and paid annually. The par value of the bond is $1,000. The maturity of the bond is 3 years.
i. State the principles of bond valuation. 8 marks
ii. What is the price of the bond when the yield to maturity of the bond is 6% annually? 7 marks
iii. What is the cost of debt capital when the yield to maturity is 6%? Elaborate your answer. 8 marks
iv. What is the relation between bond prices and interest rates? Use a diagram to illustrate the relationship between them. 7 marks
Total 50 marks
Question 2
The expected return for the US stock market is 8.0 percent per annum and the expected risk- free rate is 3 percent. The following information is available for each of five stocks:
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Share
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Beta
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Realised returns (% p.a.)
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|
US Petroleum
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0.9
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6.0
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Google
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1.3
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7.5
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Bank of America
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0.5
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9.5
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Delta Airlines
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1.1
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10.0
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US Mobile
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1.0
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8.0
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(a) Calculate the expected return per annum for each of the five stocks 10 marks
(b) Calculate the market risk premium. What does it represent? 6 marks
(c) Using the CAPM to assess which stocks are undervalued and which are overvalued; 14 marks
(d) What will result in an efficient market if a stock is incorrectly valued? Explain the process by which this error will be corrected, using the five stocks above to illustrate. 10 marks
(e) Identify the basic difficulties with using CAPM to calculate required rate of return on assets. 10 marks
Total 50 marks
Question 3
Company Smiths Group has 60 million shares outstanding with a market price of $5 and no debt. The beta of its equity is 1.5 . The rate of return of the risk free asset is 3% annually. The rate of return on the market is 6% annually. Smiths Group has had consistently stable earnings. The company pays at a 35% tax rate. Management plans to borrow a permanent debt of $100 million to replace $100 million of equity. (Assume MM theory with tax is correct) :
(a) What is the required rate of return by shareholders before the issuance of the permanent debt? 4 marks
(b) If the cost of debt is 3%. What is the required rate of return by shareholders after the debt financing? 5 marks
(c) What are the Weighted Average Costs of Capital (WACC) for the company before and after the debt financing? 7 marks
(d) What are the values of the firm before and after the debt financing? 7 marks
(e) What are the values of the equity before and after the debt financing? 8 marks
(f) Who will benefit from this debt financing and by how much? 7 marks
(g) To what extent the MM theory with tax is reasonable? Discuss. 12 marks
Total 50 Marks
Question 4
(a) Suppose the current dividend for ABC Company is £1.40. Shareholders require a 12% rate of return on the company and its dividend increases by 4% every year forever in the future. What is the price of ABC’s stock today? 10 marks
(b) Briefly comment on the following statement:
“Companies should always prefer to repurchase stocks rather than paying dividend
because stock repurchase could reduce the number of shares and increase earnings per share.” 10 marks
(c) Discuss and analyse the controversy on the effects of dividend policy in the real world. 30 marks
Total 50 marks
Question 5
(a) An investment of £500 will generate one of two outcomes: £400 in one year and £500 in two years OR £350 in one year and £300 in two years. Each outcome has a 50% probability. The discount rate is 15%.
i. What is the expected NPV of the investment? 10 marks
ii. Assume you have an option to abandon in one year for £300. If you abandon, you keep that as the year one cash flow and give up the year two cash flow. Is the abandonment rational for either outcome? What is the NPV of the investment assuming rational abandonment and the value of the abandonment option? 10 marks
(b) Describe four types of real options often encountered in investment opportunities. 10 marks
(c) Identify the problems of the discounted cash flow (DCF) analysis for valuing a project and explain the reasons that managers might use real options analysis. 20 marks
Total 50 marks
Question 6
(a) Briefly define and discuss the following theories on the merger and acquisition phenomena:
i. Synergy hypothesis
ii. Agency theory (e.g., Hold-up problems) 8 marks
(b) What are main objectives of horizontal acquisitions, vertical acquisitions and conglomerate acquisitions respectively? 10 marks
(c) The Company Oriental Express is investigating a possible merger with Company EuroToys. The below is basic financial information about the two companies:
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Oriental Express
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EuroToys
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Price per share
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$3
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$2
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Number of shares outstanding
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50 million
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27.5 million
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Both Oriental Express and EuroToys are mature firm will be $225 million. Oriental Express plans merger.
i. What is the synergy of the merger? 5 marks
ii. Where does the synergy come from? 8 marks
iii. What is the cost to Oriental Express? 5 marks
iv. What are the gain and stock price change of Oriental Express? 8 marks
v. What are the gain and stock price change of EuroToys? 6 marks
firms. The market value of the merged to pay EuroToys $64 million for the
Total 50 marks