Wealth management is considered a more reasonable argument for financial management than profit maximization. Contrast the objectives of maximizing earnings with that of maximizing wealth. (10 marks) Question 2 Franc 007 is a 7-year bond issued in October 2013 by a small company based in France. The bond coupon is 2.5% and a face value of $1000. It pays a yearly coupon of $25 (25% X $1000) and face value is to be paid in October 2020 when it matures. The cash flows are as tabulated below:
Q P - A S M - 0 0 1 | R e v 0 0 6 E f f D a t e : 1 8 - 0 3 - 2 0 2 1 Page 1 of 4 Faculty Business and Accounting Assessment Name (Eg: End/Sup) End Paper Code B7-CFI- 17/A21/E Module Name Corporate Finance Module Code B7-CFI-17 Semester ( E.g Jul-Dec-2021) Jan – June 21 Submission Mode (E.g Turnitin, blackboard, hardcopy) Blackboard Total Marks 100 Duration N/A Assessment Type (Eg: Written/Practical/Submission) Written Exam/Submission Date 17 – 20 May 21 Instructions 1. Your Student ID and Name must be indicated on the answer sheet. Failure to do so will mean that your work cannot be marked. 2. Answer ALL questions in Section A, answer any two questions in Section B and Section C is compulsory. 3. Use Microsoft Word to write your answers. 4. Use Microsoft Excel for drawing graphs. 5. Due: 17 – 20 May 21 through Blackboard SafeAssign Only. Q P - A S M - 0 0 1 | R e v 0 0 6 E f f D a t e : 1 8 - 0 3 - 2 0 2 1 Page 2 of 4 SECTION A Answer all questions in this section, total marks = 40 Question 1 Wealth management is considered a more reasonable argument for financial management than profit maximization. Contrast the objectives of maximizing earnings with that of maximizing wealth. (10 marks) Question 2 Franc 007 is a 7-year bond issued in October 2013 by a small company based in France. The bond coupon is 2.5% and a face value of $1000. It pays a yearly coupon of $25 (25% X $1000) and face value is to be paid in October 2020 when it matures. The cash flows are as tabulated below: October 2014 October 2015 October 2016 October 2017 October 2018 October 2019 October 2020 €25 €25 €25 €25 €25 €25 €25 Calculate the present value of the bond if the annual interest rate is 2.5%. (10 marks) Question 3 a. Northern Corporation’s stock has a beta of 1.4. Short term government securities yield 5% and the market portfolio offers an expected return of 14%. Find the required return on Northern’s stock. (2 marks) b. Borethe Ltd stock currently sells for $20. It is expected to pay a dividend of $1 a year from now and sell for $23 at year-end. Find the expected return on the stock. (2 marks) c. Suppose the price for the stock is correct at $20 and 30 000 shares are outstanding. Borethe also has a $20 000 debt with a yield to maturity of 9%. The firm is in the 35% marginal tax brackets. Find the proportions of debt and equity and the weighted average cost of capital (WACC). (6 marks) Question 4 Describe the types of covenants that are usual in debt contracts? Explain the role they play in debt and equity financing. (10 Marks) SECTION B Answer any two questions in this section, total marks = 40 Question 1 A. Mathenthenyana Tyre Services must choose between two modern machines for wheel alignment services for its new garage in Gaborone. The machines are to be purchased from China. Machine A costs less than machine B but will not last as long. The two machines will generate the same cash flow for the company. Q P - A S M - 0 0 1 | R e v 0 0 6 E f f D a t e : 1 8 - 0 3 - 2 0 2 1 Page 3 of 4 Machine A costs $500 000 and lasts three years. There will be maintenance expenses of $120 000 to be paid at the end of each of the three years. Machine B costs $600 000 and lasts four years. There will be maintenance expenses of $100 000 to be paid at the end of each of the four years. Revenues per year will be the same regardless of the machine and the appropriate discount rate is 10%. Using either the Matching Cycle or the Equivalent Annual Cost methods, demonstrate which machine will be preferred by Mathenthenyana Tyre Services based on the cost of acquisition? (10 marks) B. MDC is a drilling company that has been contracted to drill an oil well near Maseru on behalf of the government. The drilling rig is estimated to costs $300 000 today and the company believe that there is a 50% chance of success in year one. The present value of the successful payoff at year one is $575 000 and should the well be unsuccessful in year one, the present value of the unsuccessful payoff will be $0. i) Calculate the NPV of the project and based on this, advise if the drilling should proceed or abandoned. (5 marks) ii) MDC engineers believe that the drilling rig can be sold for $250 000 and such information should be factored in the decision making. Calculate the NPV and should the project proceed or be rejected? Question 2 Lion Park and Boroko Enterprises are both seasonal businesses. Lion Park runs an amusement park facility and a chain of papa & serobe restaurants while Boroko is a tour company that specializes in cultural tourism. Economy State Lion Boroko Strong Downturn -10% 2% Mild Downturn -4% 7% Slow Growth 4 6% Moderate Growth 12 4% Strong Growth 20 4% a. Find the mean and Variance of return for each company. (10 marks) b. Find the covariance and correlation of returns for the two companies. (6 marks) c. If Lion Park and Boroko are combined in a portfolio with 50% invested in each, find the portfolio’s expected return and standard deviation. (4 marks) Question 3 A. The following extracts are from the financial statements of Manong Holdings, a textile company on the outskirts of Gaborone: Equity $15 million Debt $1 million The interest on the debt is 5% and the equity holders expect a return of 19%. The company tax is 24%. Calculate the cost of capital for the company using the weighted average cost of capital (WACC). (5 marks) B. It is frequently argued that a company’s beta is stable and can be estimated by looking at the whole industry. Studies have however shown that betas can be influenced by company-specific factors. Discuss in detail the 3 determinants of Beta that will influence a firm’s beta to change over time. (15 marks) Q P - A S M - 0 0 1 | R e v 0 0 6 E f f D a t e : 1 8 - 0 3 - 2 0 2 1 Page 4 of 4 Section C Answer all questions in this section, total marks = 40 Molapo Industries is a manufacturer of electrical cables for the mining industry and is looking at the potential of a new division, manufacturing batteries for the car industry. Management estimates the equipment to have a five-year life and the project may be wound up after that. The estimated sales for the new division are, for year 1, $30 million; year 2, $36 million; year 3, $44 million; year 4, $44 million; year 5, $40. The cost of production runs at 60% of the sale for the first three years and then 65% for the final two years. The project will require an investment of $25 million in equipment which will be depreciated straight-line to a salvage value of 5 million. Management have produced a summary profit and loss account for the project in millions, which is shown below: 1 2 3 4 5 -- -- -- -- -- Sale 30 36 44 44 40 Production costs 18 21.6 26.4 28.6 26 Interest payments 2 2 2 2 2 Market research 2 Depreciation 4 4 4 4 4 Overheads 3.5 3.5 3.5 3.5 3.5 ---- ---- ---- ---- --- Pre-tax Profit/Loss 0.5 4.9 8.1 5.9 4.5 Tax @ 30% 0.15 1.47 2.43 1.77 1.35 ------ ------ ------ ------ ------ Net income 0.35 3.43 5.67 4.13 3.15 Management have usually based investment decisions on return on investment (Average Accounting Rate of Return). This is then compared to an arbitrary hurdle rate set by management for new projects, and this is 12%. If the return on investment exceeds this rate, then the project is selected. Management is looking at seeking external funding for the project and Mr Thabo the CFO want the company to issue a zero-coupon bond. You are a newly appointed employee in the finance department and the CEO has asked you to prepare a report detailing the return on investment and what the recommendation is for the project. Required: 1. Calculate the return on investment for the project and what will be the recommendation to management based on this? (10 marks) 2. Write a short report highlighting why the above method is inferior to the NPV appraisal method. (6 marks) 3. Briefly discuss the advantages of a zero-coupon bond to the company and the investor. (4 marks)