专业课资料 练习题 真题 00-04Principles of Finnce Finl Exms Series solutions Principles of Finnce Finl Exms Series2000

光华人 向上的精神 PART II SECOND AND FINAL YEAR ACCOUNTING AND FINANCE AcF 214 PRINCIPLES OF FINANCE 2 hours 15 minutes reading time Answer two questions Q1 from Section A and one question from Section B All questions carry equal marks You may use a financial calculator but make sure the calculator s memory does not contain test materials Section A Q1 in this section is a compulsory question 1 a Is each of the following statements true or false Explain or qualify as necessary No marks will be given if you simply state true or false i When a firm significantly increases its proportion of debt financing the cost of capital will reduce but the cost of debt and the cost of equity will remain constant Assume the corporate tax rate is 35 4 marks ii A firm s weighted average cost of capital can be used to value all its new projects 4 marks iii A firm s capital structure affects the stability of its operating income 4 marks iv According to the Pecking Order Theory of capital structure firms usually issue debt first and equity next when additional funding is required because of the lower transaction cost involved in debt financing 4 marks Please turn over 光华人 向上的精神 b In March 2001 the management team of Londonderry Air LA met to discuss a proposal to purchase five short haul aircraft at a total cost of 25 million There was general enthusiasm for the investment and the new aircraft were expected to generate an annual cash flow of 4 million for 20 years The focus of the meeting was on how to finance the purchase LA had 20 million in cash and marketable securities but Ed Johnson the Chief Financial Officer pointed out that the company needed at least 10 million in cash to meet normal outflow and as a contingency reserve This meant that there would be a cash deficiency of 15 million which the firm would need to cover either by the sale of common stock or by additional borrowing While admitting that the arguments were finely balanced Johnson recommended a stock issue He pointed out that the airline industry was subject to wide swings in profits and the firm should be careful to avoid the risk of excessive borrowing He estimated that in market value terms the long term debt ratio was about 62 and that a further debt issue would raise the ratio to 64 Balance Sheet million Bank debt 50Cash 20 Other current liabilities 20Other current assets 20 10 bond due 2020 100Fixed assets 250 Stockholders equity 120 Total liabilities 290Total assets 290 Income Statement million Gross profit 57 5 Depreciation 20 0 Interest 7 5 Pretax profit 30 0 Tax at 35 10 5 Net profit 19 5 Dividend 6 5 Retained earnings 13 0 Notes The yield to maturity on LA debt is currently 5 LA has 10 million shares outstanding with a market price of 10 a share LA s equity beta is estimated at 1 25 the market risk premium is 8 and the Treasury bill rate is 4 Johnson s only doubt about making a stock issue was that investors might jump to the conclusion that management believed that stock was overpriced in which case the announcement might prompt an unjustified sell off by investors He thought however that demand for the issue would be enhanced if at the same time LA increased its dividend payment Please turn over 2 光华人 向上的精神 These suggestions did not go down well with LA s chief executive Jane Austin Ed she said I know that you are the expert on all these but everything you say violates common sense Why should we want to sell more equity when our stock has fallen over the past year by nearly a fifth Our stock is currently offering a dividend yield of 6 5 which makes equity an expensive source of capital Increasing the dividend would simply make it more expensive What s more I don t see the point of paying out more money to the shareholders at the same time that we are asking them for cash If we increase the dividend we will need to increase the amount of the stock issue so we will just be paying the higher dividend out of the shareholders own pockets You are also ignoring the question of dilution Our equity currently has a book value of 12 a share it s not playing fair by our existing shareholders if we now issue stock for around 10 a share Look at the alternative We can borrow today at 5 We get a tax break on the interest so the after tax cost of borrowing is 0 65x5 3 25 That s about half the cost of equity We expect to earn a return of 15 on these new aircraft If we can raise money at 3 25 and invest it at 15 that s a good deal for me You finance guys are always talking about risk but as long as we don t go bankrupt borrowing doesn t add any risk at all In any case my calculations show that the debt ratio is only 45 which doesn t sound excessive to me Ed I don t want to push my views on this After all you are the expert We don t need to make a firm recommendation to the board until next month In the mean time why don t you look at the whole issue of how we should finance the deal and what return we need to earn on these planes REQUIRED i Demonstrate and comment briefly on the derivations of the following key variables mentioned in the case questions Jane s dividend yield of 6 5 The cost of equity Hint use the equation for the Security Market Line The market value for the 10 bond The 15 project rate of return produced by Jane The long term debt to equity ratio compare your answer with those produced by Jane and Ed The correct weighted average cost of capital for the firm The net present value of the investment in new aircraft 14 marks ii Critically evaluate Jane s comments in italics and bold on further stock issue and additional dividend payment debt as a cheaper source of finance and costs associated with the risk of a bankruptcy In your discussion you should make relevant references to the key variables you derived from part i above and all relevant theories and practical issues concerning corporate capital structure and corporate dividend policy 5 marks each 15 marks total iii What would be your recommendations Carefully explain and support your case 5 marks Please turn over 3 光华人 向上的精神 Section B Answer only ONE question from this section 2 a Is each of the following statements true or false Explain or qualify as necessary No marks will be given if you simply state true or false i If a stock s returns are volatile then the stock has substantial amount of unique risk Hence it does not offer diversification potential 4 marks ii Only portfolios of stocks face macro risk exposure Individual stocks are not exposed to unique risk 4 marks iii The slope of the security market line equals beta 4 marks iv If a project is plotted above the security market line one should always accept the project The unique risk of the project is unimportant and irrelevant as it can be diversified away 4 marks b You are interested in investing in an investment trust called Aberdeen Asset Management AAM that specialises in British blue chip stocks Unlike unit trusts investment trusts usually gear up their investments by external borrowing Although no information is available on borrowings you have just found out that this fund has invested heavily in five stocks listed below Company nameBetaAmount invested Barclays Bank 1 58 2 0m Glaxo Wellcome 0 90 1 5m British Telecom 0 84 1 4m Prudential 0 80 1 0m Rail Track 0 24 0 6m Total 6 5m i Calculate the beta of AAM s equity portfolio and its required rate of return given that the Treasury bill rate is 6 p a and the market risk premium is 8 7 p a 5 marks ii The FTSE index is a value weighted index constructed from prices of the top 100 blue chip stocks listed on the London Stock Exchange If the return on the FTSE index has a standard deviation of 0 20 per year suggest what the standard deviation of AAM is likely to be 5 marks iii Assume that AAM s expected rate of returns is 21 Based on this information alone explain if you think AAM as an investment trust having the ability to borrow will make a good investment Suggest a way in which you might be able to replicate or outperform AAM 12 marks iv What other information would you like to have before committing yourself into investing in AAM Explain clearly how this information helps you make a better decision 12 marks Please turn over 4 光华人 向上的精神 3 a What are the features of an efficient capital market 8 marks b Critically evaluate the implications of capital market efficiency on i Individuals investment prospects in financial markets 5 marks ii Corporate debt policy 6 marks iii Corporate dividend policy 6 marks iv Investment decisions of industrial firms 5 marks c Long Term Capital Management LTCM an infamous hedge fund was managed by two Nobel prize laureates Myron Scholes and Robert Merton among others The key feature of LTCM s investment strategy is risky arbitrage by betting on the narrowing of the spreads between interest rates default risk premia and take over buyers and targets Unlike the portfolio insurance technique that contributed to the world wide stock market crash in 1987 the LTCM type arbitrage strategy is not trend following In fact it stabilizes markets to the extent that it narrows perceived mispricings Other riskier strategies of LTCM include the adoption of a heavy gearing ratio in 1996 its leverage ratio reached thirty to one a substantial derivative position in equity and interest rate swaps that peaked at 1 25 trillion in notional value a directional bet in volatility by shorting billions of pounds of European equity options and an intriguingly heavy investment on call options written on LTCM s own value Much of this information was not disclosed to the public because LTCM as a private investment partnership did not face the extensive disclosure requirements of public investment funds The collapse of LTCM was spectacular There were also controversies over the Federal Reserve s role in the LTCM bailout and the Fed s Chairman Alan Greenspan had to testify before the Congress on October 1st According to Greenspan Had the failure of LTCM triggered the seizing up of markets substantial damages could have been inflicted on many market participants including some not directly involved with the firm and could have potentially impaired the economies of many nations including our own The consequences of a fire sale triggered by cross default clauses should LTCM fail on some of its obligations risked a severe drying up of market liquidity REQUIRED Critically evaluate the notion of capital market efficiency in relation to the activities and the rise and fall of LTCM 20 marks Please turn over 5 4 Caspian Autos operates a dealership for a major Japanese car manufacturer Caspian s owner Peter Caspian attributed much of the business s success to its no frills policy of competitive pricing and immediate cash payment The business was basically a simple one the firm imported cars at the end of the quarter for sales in the next quarter The revenue from the sales of these cars covered the payment to the manufacturer and the expenses of running the business as well as providing Peter Caspian with a return on his investment 光华人 向上的精神 By the fourth quarter of 2001 i e 2001 Q4 sales were running at 250 cars a quarter But the year 2002 was not a happy year for car importers in the United States Recession led to a general decline in auto sales while the fall in value of the pound shaved profit margins for many dealers in imported cars Caspian more than most firms foresaw the difficulties ahead and reacted at once by offering 6 months free credit while holding the sale price of its car constant Wages and other costs were cut by 25 to 150 000 a quarter and the company effectively eliminated all capital expenditures The policy appeared successful Unit sales fell by 20 to 200 units a quarter but the company continued to operate at a satisfactory profit see tables below The slump in sales lasted for 6 months but as consumer confidence began to return auto sales began to recover The company s new policy of 6 months free credit was proving sufficiently popular that Peter Caspian decided to maintain the policy In 2002 Q3 sales had recovered to 225 units by 2002 Q4 they were 250 units and by 2003 Q1 they had reached 275 units It looked as if by 2003 Q2 that the company could expect to sell 300 cars Earnings before interest and tax were already in excess of their previous high and Peter Caspian was able to congratulate himself on weathering what looked to be a very tricky period Over the 18 month period i e from 2001 Q4 to 2003 Q1 the firm had earned net profits of over half a million pounds and the equity had grown from 1 5 million to 2 million Summary Income Statement All figures except unit sales are in thousands of pounds Year 20012002200220022002 2003 Quarter 41234 1 1 Number of cars sold 250200200225250 275 2 Unit price 2020202020 20 3 Unit cost 1818181818 18 4 Revenue 1 x 2 5 0004 0004 0004 5005 000 5 500 5 Cost of goods sold 1 x 3 4 5003 6003 6004 0504 500 4 950 6 Wages and other costs 200150150150150 150 7 Depreciation 8080808080 80 8 EBIT 4 5 6 7 220170170220270 320 9 Net interest 4076153161 178 10 Pretax profit 8 9 2161709467109 142 11 Tax 35 x 10 7660332338 50 12 Net profit 10 11 140111614471 92 Please turn over 6 光华人 向上的精神 Summary Balance Sheet Figures are in thousands of pounds End of 3rd Quarter 2001 End of 1st Quarter 2003 Cash 10 10 Receivables 010 500 Inventory 4 500 5 400 Total current assets 4 51015 910 Fixed assets net of depreciation 1 760 1 280 Total assets 6 27017 190 Bank loan 230 9 731 Payables 4 500 5 400 Total current liabilities 4 73015 131 Shareholders equity 1 540 2 059 Total liabilities 6 27017 190 Peter Caspian was first and foremost a superb salesman and always left the financial aspect of the business to his financial manager However there was one feature of the financial statements that disturbed Peter Caspian the mounting level of debt which by the end of 2003 Q1 had reached 9 7 million This unease turned to alarm when the financial manager phoned to say that the bank was reluctant to extend further credit and was even questioning its current level of exposure to the company Caspian found it impossible to understand how such a successful year could have landed the company in financial difficulties The company had always had good relationships with its bank and the interest rate on its bank loans was a reasonable 8 a year or about 2 a quarter compounded quarterly Surely Caspian