Mock One

Advanced Financial
l
oManagement
o
hP4AFM-MK1-Z16-Q
c
Sy
d
ut
Time allowed: 3 hours 15 minutes
SThis paper is divided into two sections
r
Section A This ONE question is compulsory and MUST be attempted
Section B TWO questions e ONLY to be attempted
Formulae k
and tables are on pages 9 13.
Do NOT c open this paper until instructed by the supervisor.
e
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Section A This ONE question is compulsory and MUST be attempted

1
Trosoft Co, a company listed on the Singapore Stock Exchange and whose home curr
ency is
the Singapore dollar (S$), specialises in the development of business software.
The
companys managers believe that its future growth potential in the software sector
is limited,
and are considering diversifying into other activities. One suggestion is intern
et auctions, and
a member of the management team has produced the following draft financial propo
sal.
Internet auctions project
S$000
l
Auction Year
fees
0

4,300
1
6,620
2
8,100
3
o 8,200
4
Outflows:
IT Telephone
maintenance costs

1,215
1,210
o
1,850
1,910
2,230
1,920

2,420
2,125
Wages and salaries

1,860
h 2,070
2,280
2,380
Allocated Marketing
head office overhead
500

c
420
85
200
90
200
95
100

Rental Market Royalty of research

payments premises
for use of technology
110
680
S 280
500
290
300
300
200
200
310

Total Profit outflows

before tax
y
(1,290)
1,290
(1,270)
5,570
6,710
(90)
7,225
875
7,535
665
Tax
Other outflows:
d
316
311
22
(214)

(163)
Working IT infrastructure
capital
u 2,700
400
24
24
25
26

t
Net flows
(4,074)
(983)
(92)
636
476
Additional information:
S

(i)
r
All data include the estimated effects of inflation on costs and prices where r
elevant.
Inflation in Singapore is forecast to be 2% per year for the foreseeable future.
(ii)
e The investment in information technology (IT) infrastructure and the initial
working
k
capital will be will financed be financed from existing by a 6 cash year flows.
55% fixed rate term loan. Other initial outlays
c (iii)
The Singapore government is expected to give a 1% annual subsidy towards the
e
cost of the loan to support the creation of jobs associated with this project.
B (iv)
Highly annual project.
skilled loss of IT S$80,000 staff would in pre-tax need to contribution be take
n from for other the activities first three resulting years of in the
an
(v)
(vi)
Head office cash flows for overheads will increase by S$50,000 as a result of th
e
project in year one, rising by S$5,000 per year after year one.
Corporate tax is at a rate of 245% per year, payable in the year that the tax lia
bility
arises. The company has other profitable projects.
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2
(vii)
Tax-allowable depreciation on IT infrastructure is 20% for the first year, and
straight line thereafter. The IT infrastructure has an expected working life of

six
years after which it would have zero residual value and major new investment
would be required.
(viii)
(ix)
The companys current weighted average cost of capital is 78%.
The companys equity beta is 105.
(x)
The average equity beta of companies in the internet auctions sector is 142.
l
(xi)
The market return is 95% per year and the risk-free rate is 4% per year.
o(xii)
Trosoft Cos capital gearing is:
Book value 55% equity, 45% debt
o
Market value 70% equity, 30% debt
h(xiii)
debt The average by market gearing values.
of companies in the c
internet auction sector is 67% equity, 33%
(xiv)
The market research was undertaken three S weeks ago.
(xv)
After-tax operating cash flows after year 4 are expected to stay approximately
terms.
constant in real terms. The royalty y
payment will remain at S$200,000 in nominal
(xvi)
Issue costs on debt d
are 15%. These costs are not tax-allowable.
Other corporate developments
uTrosoft Co is also t
reviewing the approach that it should take to remunerating its executive
there directors is now and other concern S senior that managers. competition The
from companys overseas share entrants price into has the performed domestic well
market although
will
have a significant impact on the firms profitability. Traditionally, management h
as been
rewarded by salary, a generous system of benefits, and a bonus scheme of up to 4
% of
turnover. r
The directors are now considering the introduction of a generous share option
scheme e with a five year vesting period.
In addition to its software design business Trosoft Co also owns an extensive po
rtfolio of
k
commercial properties. There is also a view, expressed by some of the companys p
rincipal
equity investors, that the company should consider returning cash to them throug
h the sale of
c its property holdings. A sale and leaseback, or the listing of a separate prop
erty company that
would rent the property to Trosoft Co at commercial rates, are two suggestions t
hat have been
e
made at investor meetings. Either approach, it is suggested, would return value
to investors
and create a supply of capital for further expansion.

B Controversy surrounds the company following a recent report in the financial p

ress. The
newspaper claims that Trosoft Co has been paying large software licence fees to
a whollyowned subsidiary located in an overseas tax haven. Journalists visited the regis
tered office of
the subsidiary but found no more than a name plate on the wall and no evidence o
f any
employees or business being conducted.
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3
Required:
(a)
(b)
Prepare a report to the board of directors of Trosoft Co on the proposed
diversification of the company into internet auctions. The report must include:
(i)
A suitable financial analysis. You should use the adjusted present
value (APV) method for this purpose.
(19 marks)
(ii)
Discussion of other financial and non-financial factors, including real
options, that Trosoft Co might consider prior to making the
investment decision.
(12 marks)
l
Professional marks will be awarded in part (a) for the format, o structure and
presentation of the report.
(4 marks)
Discuss the strategic, financial and ethical implications o
of the other corporate
developments within Trosoft Co.
h (15 marks)
c
(50 marks)
Sy
d
ut
Sr
ek
ce
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4
Section B TWO questions ONLY to be attempted
2
Assume that it is now 1 July. Polytot Co, a UK based firm, has received an expor
t order
valued at 675 million Grobbain pesos from a company in Grobbia, a country that h
as recently
been accepted into the World Trade Organisation, but which does not yet have a f
reely
convertible currency.
The Grobbian company only has access to sufficient US$ to pay for 60% of the goo
ds, at the
official US$ exchange rate. The balance would be payable in the local currency,
the Grobbian
peso, for which there is no active foreign exchange market. Polytot Co is due to
receive
payment in four months time and has been informed that an unofficial market in Gr
obbian

l
pesos exists in which the peso can be converted into sterling. The exchange rate
in this market
is 15% worse for Polytot than the official rate of exchange between the peso o and
sterling.
Exchange rates
US$ per
o
Spot
3 months forward
15475 15362 15510
15398
h1 year forward
15140 15178
Grobbian c
peso per
Official spot rate
Grobbian S 15630
peso per US$
Official spot rate
9820
Exchange-traded currency options
y
Contract size: 31,250, exercise d
price quotation: US$ per 1, premium: cents per 1
CALLS
PUTS
15250
295
Sept
u 335 Dec March
365
200
Sept
325 Dec March
435
15500
t
180
225 265
330
460 575
Exchange-traded S currency futures
Contract size: 62,500, price quotation: US$ per 1
September
r
15350
December
e 15275
Assume that options and futures contracts mature at the relevant month end.
k
Required:
c (a)
Discuss the alternative forms of currency hedge that are available to Polytot C
o
e
hedges. and calculate Provide the expected a reasoned revenues, recommendation
in sterling, as as to a which result hedge of each should of these
be
selected.

(19 marks)
B (b)
The Grobbian company is willing to undertake a counter-trade deal whereby 40% o
f
the cost of the goods is paid for by an exchange of three million kilos of Grobb
ian
strawberries. A major UK supermarket chain has indicated that it would be willin
g
to pay between 50 and 60 pence per kilo for the strawberries.
Discuss the issues that Polytot Co should consider before deciding whether or
not to agree to the counter-trade.
(6 marks)
(25 marks)
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3
(a)
Shegdor Co has subsidiaries in three countries Umgaba, Mazila and Bettuna. The
subsidiary in Umgaba manufactures specialist components, which may then be
assembled and sold in either Mazila or Bettuna. Production and sales volume may
each be assumed to be 400,000 units per year no matter where the assembly and
sales take place. Shegdor Co expects 60% of any profits from subsidiaries to be
remitted direct to the parent company each year.
The following additional information is also relevant:
Manufacturing costs in Umgaba are $16 per unit and fixed costs (for the
normal range of production) $18 million.
l
Assembly costs in Mazila are $9 per unit, and in Bettuna o $75 per unit.
Fixed costs are $700,000 and $900,000 respectively.
The unit sales price in Mazila is $40 and in o
Bettuna $37.
Corporate taxes on profits are at the rate of h 40% in Umgaba, 25% in
Mazila, credit is 32% given in by Bettuna, the home and country c
30% in tax Shegdor authorities Cos for home profit country. tax paid
Full
Tax-allowable overseas.
import duties S of 10% are payable on all goods imported
into Mazila.
A withholding tax of y
15% is deducted from all dividends remitted from
Umgaba.
d
Required:
uEvaluate the amounts retained in each subsidiary and the dividends remitted
to Shegdor t
if:
(i)
S the transfer price from Umgaba is based on fixed cost plus variable
cost and assembly and sales take place in Mazila;
r
(ii)
the transfer price from Umgaba is based on fixed cost plus variable
e cost and assembly and sales take place in Bettuna;
k

(iii)
cost the transfer plus a mark-up price from of Umgaba 30% and is assembly based
on and fixed sales cost take plus variable
place in
c Mazila;
(iv)
the transfer price from Umgaba is based on fixed cost plus variable
e
cost plus a mark-up of 30% and assembly and sales take place in
Bettuna;
B and explain which transfer price and location for assembly and sales should be
chosen.
(14 marks)
(b)
Comment upon the likely attitude of the governments of each of the four
countries if the transfer price is based upon fixed cost plus variable cost and
assembly takes place in Mazila.
(4 marks)
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(c)
Retro Co, a UK based firm, has manufacturing subsidiaries in three overseas
countries:
Country
Corporate tax rate
Proposed net dividend
000
Subsidiary 1
Mopia
40%
600
Subsidiary 2
Blueland
35%
800
Subsidiary 3
Saddonia
20%
1,500
The UK corporate tax rate is 30%. Bilateral tax treaties exist between the UK an
d
the countries where each of the subsidiaries are located, which allow a tax cred
it
against UK corporate tax liability up to a maximum of the UK tax l
liability. This tax
haven.
credit may be assumed to be available even when dividends are channelled o via
a tax
UK corporate taxation on overseas earnings may be o
assumed to be based upon the
total dividends remitted to the UK from each overseas country (grossed up by
multiplying by 1/(1 the relevant national tax rate). h If dividends are channell
ed
through a tax haven the dividend is treated as coming from one source rather tha
n
three individual sources
c
Evaluate Required:
whether or not Retro Co S would benefit from using a tax haven
holding company through which dividends would be channelled.

(7 marks)
y
(25 marks)
d
ut
Sr
ek
ce
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7
4
Ewade Co has recently issued zero-coupon convertible loan notes at a price of $7
110 per
loan note. Each loan note is redeemable at nominal value of $100 after seven yea
rs.
Conversion may take place at any time after three years from the issue date. The
conversion
terms are 12 ordinary shares of Ewade Co for each loan note.
The annual yield to maturity on Ewade Cos 8% coupon non-convertible debt with sev
en
years until maturity, and redeemable at nominal value of $100, is 6%. This non-c
onvertible
debt pays semi-annual interest.
Required:
(a)
Estimate the yield to maturity of the convertible loan l
notes (assuming
market redemption value for of cash the occurs convertible after loan seven note
s years), and and Ewade the difference Cos o non-convertible
between the
(b)
debt. Assume Explain that in the three reasons years for time the the different
yield to market maturity o
values of the and convertible yields. loan (8 marks)
notes
is 6% and the market price of an ordinary share of Ewade h Co is:
(i)
$550 per share
(ii)
$710 per share
c
Required:
SFor each share price, estimate the market value of the convertible loan notes.
(4 marks)
y
(c)
If Ewade Co held an investment portfolio including loan notes with warrants
(share explain options) how knowledge d
attached of and thewished warrants to protect delta value the value and theta of
the value warrants,
might
assist in this.
u (6 marks)
(d)
Discuss t
the advantages and disadvantages of using the Euromarkets to access
international S debt finance.
(25 (7marks)
marks)
r

ek
ce
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8
Formulae
Modigliani and Miller Proposition 2 (with tax)
Vd
ke = kei + (1 T) (kei kd)
Ve
The Capital Asset Pricing Model
E(ri) = Rf + i[E(rm) Rf]
l
The asset eta formula
oa =
V e
e

Vd V

e
+
V e V
d
Vd 1
T o
d

1 T

The Growth Model

hD O
1
g c
PO =
re
g
SGordons growth approximation
g y
= re
The d
weighted average cost of capital
WACC u =
V
e
k e +
V
d
k d
t
V
e
V
d

V
e
V d
S The Fisher formula
(1 + i) = (1 + r) (1 + h)
r
Purchasing power parity and interest rate parity
e 1
h c
1
i c
k
S1 = S0
1
h
F0 = S0
1
i
ce
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9
Modified Internal Rate of Return
1
MIRR =
PVR
n
1
r e
1
PVI
The Black-Scholes option pricing model
c = PaN(d1) PeN(d2)e-rt
l
Where:
2 o1 n (P a /P e )
r
0.5s
t
d1 =
s t
o
d2 = d1 s t
hc
The Put Call Parity S relationship
p = c Pa + Pee-rt
y
d
ut
Sr
ek
ce
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10
Present value ta le
Present value of 1 i.e. (1 + r)n
where
r = discount rate
n = num er of periods until payment
Discount rate (r)
Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%

9%
10%
l
1
0.990
0.980
0.971
0.962
0.952
0.943
0.935
0.926
0.917
o 0.909
1
2
0.980
0.961
0.943
0.925
0.907
0.890
0.873
0.857
0.842
0.826
2
3
4
0.961
0.971
0.942
0.924
0.888
0.915
0.855
0.889
0.823
0.864
0.840
0.792
0.816
0.763
0.735
0.794
o
0.772
0.708
0.751
0.683
3
4
5
0.951
0.906
0.863
0.822
0.784
0.747
0.713

0.681
h 0.650
0.621
5
6
7
0.933
0.942
0.871
0.888
0.837
0.813
0.790
0.760
0.711
0.746
0.705
0.665
c
0.623
0.666
0.583
0.630
0.596
0.547
0.513
0.564
6
7
9
10
8
0.905
0.923
0.914
0.853
0.837
0.820
0.766
0.744
0.789
0.703
0.676
0.731
0.645
0.614
0.677
0.592
0.558
0.627
S 0.544
0.508
0.582
0.540
0.500
0.463
0.422
0.460
0.502
0.424

0.386
0.467
10
8
9
12
11
0.887
0.896
0.788
0.804
0.722
0.701
0.625
0.650
0.557
0.585
y
0.497
0.527
0.475
0.444
0.429
0.397
0.356
0.388
0.350
0.319
12
11
13
14
0.879
0.870
0.773
0.758
0.661
0.681
0.577
0.601
d
0.505
0.530
0.442
0.469
0.388
0.415
0.340
0.368
0.326
0.299
0.290
0.263
14
13
15
0.861
0.743
0.642
0.555

u 0.481
0.417
0.362
0.315
0.275
0.239
15
(n)
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
t
1
2
0.901
0.812
0.797
0.893
0.885
0.783
S 0.769
0.877
0.870
0.756
0.743
0.862
0.855
0.731
0.847
0.718
0.706
0.840
0.694
0.833
1
2
3
0.731
0.712
0.693
0.675
0.658
0.641
0.624
0.609
0.593
0.579
3
4
0.659
r
0.636
0.613

0.592
0.572
0.552
0.534
0.516
0.499
0.482
4
5
0.593
0.567
0.543
0.519
0.497
0.476
0.456
0.437
0.419
0.402
5
6
0.535
e 0.507
0.480
0.456
0.432
0.410
0.390
0.370
0.352
0.335
6
7
8
k
0.482
0.434
0.452
0.404
0.425
0.376
0.351
0.400
0.327
0.376
0.305
0.354
0.285
0.333
0.314
0.266
0.249
0.296
0.233
0.279
8
7
10
9
c 0.391

0.352
0.322
0.361
0.295
0.333
0.270
0.308
0.247
0.284
0.227
0.263
0.243
0.208
0.191
0.225
0.176
0.209
0.194
0.162
10
9
e
11
0.317
0.287
0.261
0.237
0.215
0.195
0.178
0.162
0.148
0.135
11
B 12
14
13
0.258
0.286
0.232
0.229
0.257
0.205
0.231
0.181
0.204
0.182
0.208
0.160
0.163
0.187
0.141
0.168
0.145
0.125
0.130
0.111
0.152
0.137
0.116

0.099
0.124
0.088
0.104
0.078
0.112
0.093
13
14
12
15
0.209
0.183
0.160
0.140
0.123
0.108
0.095
0.084
0.074
0.065
15
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11
Annuity ta le
1
(1
r) n
Present value of an annuity of 1 i.e.
r
where
r = discount rate
n = num er of periods
Discount rate (r)
Periods
l
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
o 10%
1
0.990
0.980
0.971
0.962
0.952
0.943
0.935
0.926
0.917
0.909
1
3
2
2.941

1.970
1.942
2.884
1.913
2.829
1.886
2.775
1.859
2.723
2.673
1.833
1.808
2.624
1.783
2.577
o
2.531
1.759
1.736
2.487
2
3
4
5
3.902
4.853
3.808
4.713
4.580
3.717
4.452
3.630
3.546
4.329
4.212
3.465
3.387
4.100
3.312
3.993
h 3.240
3.890
3.170
3.791
5
4
6
5.795
5.601
5.417
5.242
5.076
4.917
c
4.767
4.623
4.486
4.355
6
8

7
6.728
7.652
7.325
6.472
7.020
6.230
6.733
6.002
6.463
5.786
5.582
6.210
S 5.389
5.971
5.747
5.206
5.033
5.535
4.868
5.335
7
8
9
8.566
8.162
7.786
7.435
7.108
6.802
6.515
6.247
5.995
5.759
9
10
9.471
8.983
8.530
8.111
7.722
7.360
7.024
6.710
6.418
6.145
10
11
10.37
9.787
9.253
8.760
8.306
y
7.887
7.499
7.139
6.805
6.495
11

12
13
11.26
12.13
11.35
10.58
9.954
10.63
9.986
9.385
d
9.394
8.863
8.853
8.384
8.358
7.943
7.536
7.904
7.161
7.487
6.814
7.103
13
12
14
15
13.87
13.00
12.85
12.11
11.94
11.30
11.12
10.56
u 10.38
9.899
9.712
9.295
9.108
8.745
8.244
8.559
7.786
8.061
7.367
7.606
15
14
t
(n)
11%
12%
13%
14%
15%
16%
17%
18%
19%

20%
S1
0.901
0.893
0.885
0.877
0.870
0.862
0.855
0.847
0.840
0.833
1
2
1.713
r
1.690
1.668
1.647
1.626
1.605
1.585
1.566
1.547
1.528
2
3
2.444
2.402
2.361
2.322
2.283
2.246
2.210
2.174
2.140
2.106
3
5
4
3.696
3.102
e 3.037
3.605
2.974
3.517
2.914
3.433
2.855
3.352
3.274
2.798
3.199
2.743
3.127
2.690
2.639
3.058
2.589
2.991

5
4
6
k
4.231
4.111
3.998
3.889
3.784
3.685
3.589
3.498
3.410
3.326
6
7
8
c 4.712
5.146
4.968
4.564
4.423
4.799
4.288
4.639
4.160
4.487
4.344
4.039
4.207
3.922
3.812
4.078
3.706
3.954
3.605
3.837
7
8
e
9
10
5.889
5.537
5.650
5.328
5.426
5.132
4.946
5.216
4.772
5.019
4.607
4.833
4.659
4.451
4.494
4.303
4.339
4.163

4.192
4.031
10
9
B 11
12
6.207
6.492
6.194
5.938
5.918
5.687
5.660
5.453
5.421
5.234
5.197
5.029
4.836
4.988
4.793
4.656
4.586
4.611
4.439
4.327
11
12
13
6.750
6.424
6.122
5.842
5.583
5.342
5.118
4.910
4.715
4.533
13
14
6.982
6.628
6.302
6.002
5.724
5.468
5.229
5.008
4.802
4.611
14
15
7.191
6.811
6.462
6.142
5.847
5.575
5.324

5.092
4.876
4.675
15
2016 DeVry/Becker Educational Development Corp. All rights reserved.
12
Standard normal distri ution ta le
000
001
002
003
004
005
006
007
008
009
00
00000
00040
00080
00120
00160
00199
00239
00279
00319
00359
01
00398
00438
00478
00517
00557
00596
00636
00675
00714
00753
02
00793
00832
00871
00910
00948
00987
01026
01064
01103
01141
03
01179
01217
01255
01293
01331
01368
01406
01443
01480

01517
l
04
01554
01591
01628
01664
01700
01736
01772
01808
01844
o 01879
05
01915
01950
01985
02019
02054
02088
02123
02157
02190
02224
06
07
02257
02580
02611
02291
02324
02642
02357
02673
02703
02389
02422
02734
02764
02454
02486
02794
o
02823
02517
02549
02852
08
09
02881
03159
03186
02910
03212
02939
02967
03238
02995
03264
03023

03289
03051
03315
03078
03340
h 03365
03106
03133
03389
10
03413
03438
03461
03485
03508
03531
c
03554
03577
03599
03621
11
12
03643
03849
03665
03869
03888
03686
03907
03708
03925
03729
03749
03944
S 03770
03962
03790
03980
03997
03810
04015
03830
13
04032
04049
04066
04082
04099
04115
04131
04147
04162
04177
14
04192
04207
04222
04236
04251

04265
04279
04292
04306
04319
15
04332
04345
04357
04370
04382
y
04394
04406
04418
04429
04441
17
16
04452
04554
04463
04564
04573
04474
04484
04582
d
04591
04495
04505
04599
04515
04608
04616
04525
04535
04625
04633
04545
18
19
04641
04713
04649
04719
04726
04656
04732
04664
u 04671
04738
04678
04744
04686
04750
04693
04756
04761
04699

04767
04706
t
20
04772
04778
04783
04788
04793
04798
04803
04808
04812
04817
21
22
04821
04861
04864
04826
04868
04830
S 04871
04834
04875
04838
04842
04878
04881
04846
04850
04884
04854
04887
04890
04857
23
04893
04896
04898
04901
04904
04906
04909
04911
04913
04916
24
04918
r
04920
04922
04925
04927
04929
04931
04932
04934
04936
25

26
04938
04953
e 04955
04940
04941
04956
04943
04957
04959
04945
04960
04946
04948
04961
04949
04962
04951
04963
04952
04964
27
28
k
04965
04974
04966
04975
04967
04976
04977
04968
04977
04969
04978
04970
04971
04979
04979
04972
04973
04980
04974
04981
29
c 04981
04982
04982
04983
04984
04984
04985
04985
04986
04986
e
30 04987 04987
04987 04988
04988 04989 04989 04989 04990 04990
B This Black-Scholes table can be model used of to option calculate pricing. N(d

), If the di> cumulative 0, add 05 normal to the relevant distribution number fun
ctions above. needed If di< 0, for subtract
the
the relevant number above from 05.
End of Question Paper
2016 DeVry/Becker Educational Development Corp. All rights reserved.
13