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FINANCIAL MANAGEMENT

Time allowed 3 hours Total marks 100 N.B. Questions must be answered in English. Figures in the margin indicate full marks. All workings are to be submitted. Examiner will take account of the quality of language and of the manner in which the answers are presented. Different parts, if any of the same questions must be answered in one place in order of sequence. Marks 1. (a) Whilst the financial plans of the business are based on a single objective, it faces a number of constraints that put pressure on the company to address more than one objective simultaneously. Requirement: What types of constraints might the company face when assessing its long-term plans? Specifically refer in your answer to: (i) Responding to various stakeholder groups; and (ii) The difficulties associated with managing organizations with multiple objectives. 6 (b) What is simulation? What are its advantages and disadvantages? 4 (c) Investors are not risk averse on average, but rather are either risk indifferent or even like risk is it a valid statement? Explain in light of the risk-return concept. 4 (d) You are an investment analyst and trying to evaluate a two year life project using NPV. There is uncertainty as to the level of sales in unit in each of the two years: Year-1 Probability 0.3 Year-2 Probability 0.2 0.8

Sales (unit) 10,000

15,000

0.7

Sales unit 8,000 10,000 (If sales in yr-1 are 10,000 units) 20,000 10,000 (if sales in yr-1 are 15,000 units

0.6 0.4

Requirement: (i) Compute the expected level of sales in year 1 and year 2. (ii) The project outlay is Tk. 2.3 million and each unit sold has a contribution of Tk. 100. Cost of capital is 15%. Compute the Projects expected NPV and suggest whether the project should be accepted. 2. (a) Distinguish between the following valuation concepts: (i) Liquidation value versus going concern value (ii) Market value versus intrinsic value (b) Pran Cola Company just finished making an annual dividend payment of Tk 20 per share on its ordinary share. Its ordinary share dividend has been growing at an annual rate of 10 percent. F. Karim requires a 16 percent annual return on the stock. What intrinsic value should Karim place on one share of Pran Cola ordinary share under the following three situations? i. Dividends are expected to continue growing at a constant 10 percent annual rate. ii. The annual dividend growth rate is expected to decrease to 9 percent and to remain constant at that level. iii. The annual dividend growth rate is expected to increase to 11 percent and to remain constant at the level. (c) Discuss the concept of yield to maturity.

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2 (d) The Modern Industries has non-callable, perpetual bonds outstanding. When originally issued, the perpetual bond sold for Tk. 955 per bond; today (1 January) their current market price is Tk.1,120 per bond. The company pays a semi-annual interest payment of Tk. 45 per bond on June 30 and December 31 each year. i. As of today (1 January), what is the implied semi-annual yield on his bond? 2 ii. What is the nominal annual yield and effective annual yield on these bonds? 2 iii. Assume everything is same above except that the bonds are not perpetual. Instead, they have a Tk. 1,000 par value and mature in 10 years. 4 What is the implied semi-annual yield to maturity on these bonds? 3. ( a) The cost of equity finance is the same, irrespective of whether the equity is new share, a rights issue or retained profit. Examine the views. 4 (b) Zaman Ltd. is an equity financed company. It has in issue 5 million shares. These are currently quoted at Tk.55 each cum-dividend. The dividend proposed for the current year is Tk.5 per share. No increase in this dividend is anticipated unless new projects are accepted. There is no long term debt. The companys cost of equity is 10%. One such project is currently under consideration. This project would involve investing Tk. 5,000,000 immediately. It would generate a cash surplus of Tk. 1,000,000 in one years time and annually there after in perpetuity. The project cash flows are known to the market, and do not alter the companys risk. All of the project cash flows would be paid as dividends. The NPV of the project is (Tk. 5,000,000)+Tk. 1,000,000/0.1= Tk. 5,000,000. You are asked to evaluate three alternative sources of finance from the point of view of the existing shareholders: i. A reduction in the current years dividend to Tk. 40 per share, so as to release Tk. 500,000 of internally generated funds. 3 ii. A right issue on a one-for-ten basis at Tk. 10 per share. 3 iii. A new issue of shares. These would be identical to existing ordinary shares and would first rank dividend in one years time. 3 Ignore taxation and issue cost.

(c) Discuss the synergy effect of merger with examples. (d) Dhansiri is a chain of restaurants, is considering going private. The president Sakil Ahmed believes that with the elimination of shareholder servicing costs and other costs associated with public ownership, the company could save Tk. 800,000 per annum before taxes. In addition the company believes management incentives and, hence, performance will be higher as a private company. As a result, annual profits are expected to be 10% greater than present after tax profit of 9 million. The effective tax rate is 30 percent; The price earning ratio of the stock is 12; There are 10 million shares outstanding. Requirements: (i) What is the present market price per share? (ii) What is the maximum Taka premium above this price that the company could pay to take the company private?

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4. (a). If the capital markets are efficient, this has implications for corporate finance. Discuss the implications for the financial manager of a large company that is trying to maximize the wealth of its shareholders. 4

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3 (b) It is now January 1, 2013. Grameen Solar Ltd (GSL) has just developed a solar panel capable of generating 200 percent more electricity than any solar panel currently on the market. As a result, GSL is expected to experience a 15% annual growth rate for the next 5 years. By the end of 5 years, other firms will have developed comparable technology, and GSLs growth rate will be slow to 5% per year indefinitely. Stockholders require a return of 12% on GSLs stock. The most recent annual dividend (Do), which was paid yesterday, was Tk 1.75 per share. 18 (i) Calculate GSLs expected dividend for 2013,2014,2015,2016 and 2017. (ii) Calculate the value of the stock today, Po. Proceed by finding the present value of the dividends expected at the end of 2013,2014,2015,2016 and 2017 plus the present value of the stock price that should exist at the end of 2017. (iii) Calculate the expected dividend yield, D1/Po, the capital gains yield expected in 2013, and the expected total return for 2013. Also calculate these same three yields for 2018. (iv) How might an investors tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does GSLs stock become mature in this example. (v) Suppose your boss tells you she believes that GSLs annual growth rate will be only 12% during the next 5 years and that the firms normal growth rate will be only 4%. Without doing any calculations, what general effect would these growth-rate changes have on the price of GSLs stock? (vi) Suppose your boss also tells that she regards GSL as being quite risky and that she believes the required rate of return should be 14%, not 12%. Again, without doing any calculations, how would the higher required rate of return affect the price of the stock,its capital gains yield, and its dividend yield? Again, assume that the firms normal growth rate will be 14%. 5. Mr. Rahman is the Finance Manager of Prime Financial Services (PFC), who has been asked to perform a lease versus buy analysis of a Computer Network System. The system would be used for office automation. The equipment costs Tk. 1,200,000 and if it is purchased, PFC could obtain a term loan for the full amount at 10%. The loan would be amortized over the four years life of the equipment with payment at the end of each year. The equipment is classified as special purpose equipment and shall be allowed 25% depreciation on written down value for tax purpose. If the equipment is purchased, a maintenance contract must be obtained at a cost of Tk. 25,000 payable at the beginning of each year. After four years the equipment will be sold, and Rahmans best estimate of the residual value is Tk.125,000. Because technology is changing rapidly in computerized system, however, the residual value is uncertain. As an alternative, National Leasing Company (NLC) is willing to write a four year lease on the equipment, including maintenance, for payments of Tk. 340,000 at the beginning of each year. PFCs marginal tax rate is 40 percent. Advise Mr. Rahman on the following situation. (i) What is PFCs present value cost of owning the equipment? (ii) What is PFCs present value cost of leasing the equipment? (iii) What your analysis support? Should the equipment be bought or leased? 3 3 4

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