FINANCE351

ACCOUNTING AND FINANCE

TERMS TEST 2012
Finance 351 FC - ADVANCED FINANCIAL MANAGEMENT
(Time allowe! 1 "o#$ an 20 min#%e&'
In&%$#c%ion& %o S%#en%&!
(RITE your F)LL NAME (surname first) and ST)DENT ID number in the space
provided at the top of each page of this boo!et"
#his e$amination paper comprises SEVEN %uestions" A&& %uestions are
C*M+)LS*R, and shou!d be ans'ered"
(ars may be DED)CTED if you fai! to sho' comp!ete 'orings"
(RITE NEATL, in the space provided ) i!!egib!e ans'ers 'i!! N*T be mared"
ADDITI*NAL (RITING S+ACE is provided at the end of the paper" *ou must record
the number of the %uestion"
I- an. /#e&%ion i& no% clea$ 0lea&e &%a%e all a&&#m0%ion& .o# ma1e2
F*RM)LAE are provided in the A++ENDI3"
S#$name!+++++++++++++++++++++++++++++++++++++++++++++++++++++++
Fi$&% Name!444444444444444444444444444444444444444444444444444444
S%#en% ID!+++++++++++++++++++++++++++++++++++++++++++++++++++++
C,N#IN-E.
/urname0++++++++++++++++++++++++ 1 FINANCE351
First Name0++++++++++++++++++++++
5#e&%ion Ma62
Ma$1
Ma$1
1 7
2 7
3 3
8 7
5 5
9 12
: 9
To%al 50
T;E REST *F T;IS +AGE IS <LAN=
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 3 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 1
(a' &ist and brief!y discuss t'o se!fish strategies that shareho!ders and2or managers may use to
e$propriate debtho!ders3 'ea!th4 'hich may deviate from a firm3s optima! investment po!icy" A!so
brief!y describe 'hat ind of deviation is associated 'ith each se!fish strategy"
5rite neat!y in no mo$e than the space provided"
(6 mars)
Sel-i&" S%$a%e>. *ne
Sel-i&" S%$a%e>. Two
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 6 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 1 ? con%in#e
(@' 7ome 8ui!der /upp!y4 a retai!er in the home improvement industry4 current!y operates seven
retai! out!ets in 9eorgia and /outh Caro!ina" (anagement is contemp!ating bui!ding an eighth
retai! store across to'n from its most successfu! retai! out!et" #he company a!ready o'ns the !and
for this store4 'hich is current!y occupied by an abandoned 'arehouse" &ast month4 its mareting
department spent :1;4;;; on maret research to determine the number of potentia! of customers
for the ne' store" 7ome 8ui!der /upp!y can thus decide 'hether to bui!d and open the ne' store
no'"
5hich of the fo!!o'ing shou!d be inc!uded as part of the incrementa! earnings for the proposed
ne' retai! store<
i" #he costs of demo!ishing the abandoned 'arehouse and c!earing the !ot"
ii" #he !oss of sa!es in the e$isting retai! out!et4 if customers 'ho previous!y drove across to'n
to shop at the e$isting out!et become customers of the ne' store instead"
iii" #he cost of :1;4;;; spent in maret research to eva!uate the potentia! number of customers"
iv" #he current maret va!ue of the !and if so!d"
8rief!y discuss your ans'ers" 5rite neat!y in no mo$e than the space provided"
(8
ma$1&'
i2 T"e co&% & o- emoli&"in> %"e a@anone wa$e"o#&e an clea$in> %"e lo%
ii2 T"e lo&& o- &ale& in %"e e6i&%in> $e%ail o#%le%
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 5 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 1(@' ? con%in#e
iii2 T"e co&% &0en% in ma$1e% $e&ea$c" %o eAal#a%e %"e 0o%en%ial n#m@e$ o- c#&%ome$ &
iA2 T"e c#$$en% ma$1e% Aal#e o- %"e lan i- &ol
(To%al -o$ 5#e&%ion! 7 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ = FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 2
Neon Corporation>s stoc returns have a covariance 'ith the maret portfo!io of ;";6?" #he
standard deviation of the returns on the maret portfo!io is 1; percent4 and the e$pected maret
ris premium is @"5 percent per annum" #he company a!so has 5 mi!!ion shares of common stoc
outstanding4 each so!d for A1;" #he company>s CE, considers that the firm>s current debtBe%uity
ratio is optima!" #he corporate ta$ rate is 3; percent4 and the yie!d of government bonds is
current!y 5"= percent per annum"
Neon Corporation has bonds outstanding 'ith a tota! maret va!ue of A15 mi!!ion and a coupon
rate of @ percent" Neon3s bonds4 'hich have credit rating of 8884 are not traded in the secondary
maret" ,n average4 corporate bonds rated 'ith 888 have 16; basis points (bps) spread over
government bonds"
Ca!cu!ate Neon3s cost of e%uity and its 'eighted average cost of capita! (5ACC) using the
frame'or of the capita! asset pricing mode! (CAC()"
(7 ma$1&'
Neon Co$0o$a%ionB& co&% o- e/#i%.
5#e&%ion 2-con%in#e
N eon Co$0o$a%ionB& wei>"%e aAe$a>e co&% o- ca0i%al
C,N#IN-E.
/urname0++++++++++++++++++++++++++ @ FINANCE351
First Name0++++++++++++++++++++++++
(To%al -o$ 5#e&%ion! 7 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ ? FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 3
A firm has an asset used in a fourByear proDect4 'hich fa!!s in the fiveByear (odified Acce!erated
Cost Eecovery /ystem ((ACE/) c!ass for ta$ purposes" #he firm incurred :1 mi!!ion to ac%uire
the asset and 'i!! se!! it for :1?;4;;; at the end of the proDect" If the ta$ rate is 3; percent4 'hat is
the afterBta$ sa!vage va!ue of the asset<
.epreciation (in percent) under (odified Acce!erated Cost Eecovery /ystem ((ACE/)
Eecovery Ceriod ) 5 *ears
*ear 1 1 3 6 5 =
.epreciation "1;; "31; "1F1 "115 "115 ";5?
(3 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ F FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 8
*ou are re%uired to compare t'o stocs !isted on the Ne' Gea!and /toc E$change (ain 8oard
(NG/H)0 the 5arehouse 9roup &imited (57/) and 8riscoe 9roup &imited (89E)" 8oth
companies are department stores in the service sector of NG/H" *ou have co!!ected financia! data
regarding their stoc prices etc"4 as fo!!o's0
Company (1) Crice
(1) 51B'ee
Change
(3) (aret
Cap (mi!)
(6) 8oo
Ia!ue2/har
e
(5) .2E
Eatio
(=) IC2FC
(@) Average
,CF (mi!)
(?)Io!ati!ity
in ,CF (mi!)
#he 5arehouse
9roup &imited
:1"@6 B1?"3@J :?6@"F= :;"?? =@"?1J 1"1= :13F :3?"@3?
8riscoe 9roup
&imited
:1"55 1;"?@J :31F"11 :;"=; ; 1"?? :1? :13"16;
(1) Crice K (ost recent stoc price"
(1) 51B'ee Change K #he percentage change in price from 51 'ees ago"
(3) (aret Cap K Current (aret Crice per /hare $ Number of /hares ,utstanding"
(6) 8oo Ia!ue per /hare K #ota! Common E%uity 2 #ota! Common /hares ,utstanding"
(5) .2E Eatio K #ota! debt2 #ota! e%uity"
(=) IC2FC K #he ratio of variab!e costs to fi$ed costs"
(@) Average ,CF K Average annua! operating cash f!o's in the past four years"
(?) Io!ati!ity in ,CF K #he standard deviation of net operating cash f!o's in the past four years"
#here are t'o parts to this %uestion"
(a) 8ased on the LsiMe effectN asserted by 8anM (1F?1) and the Lva!ue effectN indicated by Fama
and French (1FF?)4 'hich stoc is e$pected to perform better in the !ong term (e"g" 5 years)<
8rief!y discuss your reasons using the data from the above tab!e in no mo$e than the space
provided"
(5 ma$1&'
("ic" com0an. i& e60ec%e %o 0e$-o$m @e%%e$ in %"e lon>-$#nC
SiDe E--ec%
5#e&%ion 1(a' ? con%in#e
Val#e e--ec%
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1; FINANCE351
First Name0++++++++++++++++++++++++
(@' /upposed that based on your ca!cu!ations4 the fourByear e%uity beta coefficients of 57/ and
89E are ;"=5 and 1";54 respective!y" 5hich factor do you thin is the most important one 'hich
!eads to this difference< Coint out the ey factor using data from the #ab!e to brief!y discuss your
reasons in no mo$e than the space provided"
(3 ma$1&'
(To%al -o$ 5#e&%ion! 7 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 11 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 5
(arov (anufacturing recent!y spent :1 mi!!ion to purchase some e%uipment used in the
manufacture of dis drives" #he firm e$pects that this e%uipment 'i!! have a usefu! !ife of five
years4 and its margina! corporate ta$ rate is 1;J" #he company p!ans to use straightB!ine
depreciation and its management decides the appropriate discount rate to be 1;J per annum"
After the company starts producing its products using the ne' e%uipment4 over the fo!!o'ing 5
years4 it 'i!! incur fi$ed costs of :1"5 mi!!ion each year" Each dis drive se!!s for :15;4 and the
variab!e cost per drive is :1;;" Assume that a!! operating cash inf!o's from product sa!es occur at
the end of each year" Income ta$ credit 'i!! be refunded immediate!y in case the company incurs a
!oss in that year"
#here are t'o parts to this %uestion"
(a' If (arov (anufacturing 'ants this proDect to be financia!!y breaBeven4 ho' many units of
dis drives shou!d this company se!! per year< Assume the same number of dis drives 'i!! be so!d
each year"
(3 ma$1&'
T"e -inancial @$ea1-eAen &ale& Aol#me
5#e&%ion 5(a' ? con%in#e
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 11 FINANCE351
First Name0++++++++++++++++++++++++
(@' No' suppose that the annua! fi$ed cost is :1"= mi!!ion4 instead of :1"5 mi!!ion" 7o' does this
change affect the financia! breaBeven sa!es vo!ume< E$p!ain your ans'er neat!y in no mo$e than
the space provided" .etai!ed numerica! ca!cu!ations a$e no% re%uired"
(2 ma$1&'
T"e c"an>e in %"e -inancial <EE &ale&
(To%al -o$ 5#e&%ion! 5 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 13 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 9

(a)
#here are three parts to this %uestion"
(a' ,!d /choo! Corporation has an e$pected E8I# (earnings before interest and ta$es) of :1"5
mi!!ion per year in perpetuity" #he company current!y has no debt4 and its cost of e%uity is 15
percent per year" If the corporate ta$ rate is 15 percent4 'hat is the va!ue of the firm<
(2 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 16 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 9
- con%in#e
(@' ,!d /choo! Corporation has decided to repurchase part of its common stoc by issuing
perpetua! corporate bonds 'orth of := mi!!ion" #he company3s cost of debt is ? percent per year"
/uppose the on!y capita! maret imperfection is corporate ta$es"
After the repurchase announcement4 'hat 'i!! be the debtBe%uity ratio of ,!d /choo!
Corporation< 5hat 'i!! be its e%uity cost of capita!< Ca!cu!ate the firm3s e%uity cost of capita! by
using Moi>liani an Mille$F& +$o0o&i%ion& wi%" co$0o$a%e %a6e& 2
(7 ma$1&'
T"e e@%-e/#i%. $a%io o- *l Sc"ool Co$0o$a%ion a-%e$ $e&%$#c%#$in>
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 15 FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion 9
(@'
(b) - con%in#e
*l Sc"oolF& co&% o- e/#i%. acco$in> %o MGM +$o0o&i%ion& wi%" co$0o$a%e %a6e&
5#e&%ion 9
- con%in#e
(c' According to Moi>liani an Mille$F& +$o0o&i%ion& wi%"o#% %a6e& 4 'hat is the debtBe%uity
ratio that 'i!! ma$imiMe the va!ue of a firm< 8rief!y discuss your ans'ers in no mo$e than the
space provided"
(2 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1= FINANCE351
First Name0++++++++++++++++++++++++
(To%al -o$ 5#e&%ion! 12 ma$1&'
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1@ FINANCE351
First Name0++++++++++++++++++++++++
5#e&%ion :
Ang E!ectronics4 Inc" is e$amining a 5Byear proDect to deve!op a ne' .I.E 'ith t'o stages of
investment" #he 1
st
stage the proDect4 the research and deve!opment (EO.) stage4 !asts for one
year" #he 1
nd
stage of the production and sa!es for the ne' .I.E !asts for 6 years" Ang
E!ectronics4 Inc" e$pects to incur :1"1 mi!!ion for the initia! EO. cost in the beginning of the
proDect" #he company 'i!! incur :1 mi!!ion for producing the ne' product in one year after the
company starts the EO. testing" #he EO. resu!ts 'i!! be revea!ed 'ithin one year4 i"e"4 before
the company starts producing the ne' .I.E"
If the initia! EO. is successfu!4 this proDect can generate operating cash f!o's :F;;4;;; per year
for four consecutive years starting from the end of the 1
nd
year of the proDect" 7o'ever4 if the
initia! EO. fai!s4 the company3s operating cash f!o's 'i!! fa!! to :5;;4;;; per year" /uppose that
there is a =; percent chance of success and a!! operating cash inf!o's occur at the end of each
year" #he proper discount rate is 1; percent per annum"
#here are t'o parts to this %uestion"
(a' 5hat is the traditiona! net present va!ue (NCI) of this proDect 'hen the company is e$pected
to proceed 'ith 1 stages of investment< 5i!! you suggest this company conduct the EO. testing
of the ne' .I.E< (3
ma$1&'
N+V Aal#e an &#>>e&%ion
5#e&%ion :(a' ? con%in#e
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1? FINANCE351
First Name0++++++++++++++++++++++++
(@' 5hat is the va!ue of this proDect based on the decision tree ana!ysis (.#A)4 'here the
company has the f!e$ibi!ity to change their strategies after the information regarding the resu!t of
EO. is revea!ed< 5i!! you suggest this company conduct the EO. testing of the ne' .I.E<
(3 ma$1&'
DTA Aal#e an &#>>e&%ion
5#e&%ion :(@' ? con%in#e
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1F FINANCE351
First Name0++++++++++++++++++++++++
(To%al -o$ 5#e&%ion! 9 ma$1&'
END *F TEST 5)ESTI*NS
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 1; FINANCE351
First Name0++++++++++++++++++++++++
ADDITI*NAL (RITING S+ACE
Remem@e$ %o w$i%e %"e n#m@e$ o- %"e /#e&%ion .o# a$e an&we$in>
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 11 FINANCE351
First Name0++++++++++++++++++++++++
ADDITI*NAL (RITING S+ACE
Remem@e$ %o w$i%e %"e n#m@e$ o- %"e /#e&%ion .o# a$e an&we$in>
C,N#IN-E.
/urname0++++++++++++++++++++++++++ 11 FINANCE351
First Name0++++++++++++++++++++++++
ADDITI*NAL (RITING S+ACE
Remem@e$ %o w$i%e %"e n#m@e$ o- %"e /#e&%ion .o# a$e an&we$in>
C,N#IN-E.
/urname0++++++++++++++++++++++++ 13 FINANCE351
First Name0++++++++++++++++++++++
A++ENDI3
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