SCHOOL OF BUSINESS, ECONOMICS AND MANAGEMENT

AFIN 209 - CORPORATE FINANCE AND FINACIAL MODELLING

END OF SEMESTER FINAL EXAMINATION

Monday 14th, December 2015

Time allowed: 3 HOURS plus 5minutes reading time

Instructions to Candidates:

1. Check that you have the correct examination in front of you.

2. There are FIVE (5) questions in this paper. Answer ALL.

3. All questions must be answered on the answer sheet only.

4. Begin each question on a new page.

5. Discount tables have been provided

6. There shall be no form of communication between students during the

examination. Any students caught doing this will be disqualified.

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Question 1
A. What are the main differences between a mutually exclusive project and an
independent project? (2 marks)

B. Which one of the following statements is correct concerning the weighted

average cost of capital (WACC)? (1 mark)

i. The WACC may decrease as a firm's debt-equity ratio increases.

ii. When computing the WACC, the weight assigned to the preferred stock is based on
the coupon rate multiplied by the par value of the stock.

iii. A firm's WACC will decrease as the corporate tax rate decreases.

iv. The weight of the common stock used in the computation of the WACC is based on
the number of shares outstanding multiplied by the book value per share.

v. The WACC will remain constant unless a firm retires some of its debt.

C. What are the major weaknesses of the WACC methodology and the main
factors that influence a company’s WACC? (5 marks)

D. With reference to investor attitude, discuss the benefits of investing in shares.

(4 marks)

E. What is the fundamental concept/theory of foreign exchange? (2 marks)

F. What is the difference between a Spot and a Forward rate? (2 marks)

G. Use the table to answer questions (i) and (ii) below:

i. At what rate would tha bank buy $ 20, 000 from a Zambian exporter?
(2 marks)
ii. How much Kwacha would R 10, 000 translate to at the current rate?
(4 marks)
[22 Marks]

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Question 2
Check A and B, for A, theres no time and for B discounted stock value at p5 gives a negative

A. Finance Bank provides you with a loan of K1000 and you agree to repay the
loan in three equal instalments that include principal paid at the end of each
period with 6% interest compounded annually. Prepare an amortization
schedule. (9 marks)

B. A company’s required rate of return is 12% and the dividend grows at a rate of
25% for 5 years and then it drops to a constant growth rate of 15% thereafter.
The most recently paid dividend was K2.85. Find the value of the stock?
(6 marks)

C. Dr. Lucy’s stock currently sells at K 38 per share. Its previous selling price
was K35 with the last paid dividend of K3.75. Find the total return. (4 marks)

D. The yield to maturity on a one year zero coupon bond is currently 7%, and the
yield to maturity on a two year zero coupon bond is 8%. The Treasury plans to
issue a two year maturity coupon bond, paying coupons once per year with a
coupon rate of 9%. The face value of the bond is K100.

i. At what price will the bond sell? (1 mark)

ii. What will the yield to maturity on the bond be? (3 marks)

E. What are the main differences between Unsystematic risk and Systematic
Risk? Specify which is which. (2 marks)

[25 Marks]

Question 3

A. Cameron Industries is expected to pay an annual dividend of K 1.30 per

share next month. The current market price of the stock is K 24.80 and the
growth rate is 3 percent. What is the firm's cost of equity? (2 marks)

B. Old Country Lemonade has a beta of 0.9, a stock price of K28, and has
recently paid an annual dividend of K1.10 per share. The dividend growth
rate is 3 percent. The market has an 11 percent rate of return and a risk
premium of 7 percent. What is the average expected cost of equity for Old
Country Lemonade? (3 marks)

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 C. The Seasing Company has 1,500 bonds outstanding that are selling for
K1,060 each. The company also has 5,000 shares of preferred stock at a
market price of K32 each. The common stock is priced at K26 a share and
there are 36,000 shares outstanding. What is the weight of the common
stock as it relates to the firm's weighted average cost of capital? (4 marks)

D. Hilltop, Inc. has a capital structure which is based on 30 percent debt, 10

percent preferred stock, and 60 percent common stock. The pre-tax cost
of debt is 8 percent, the cost of preferred stock is 9 percent, and the cost
of common stock is 11 percent. The company's tax rate is 34 percent. The
company is considering a project that is equally as risky as the overall firm.
Calculate the WACC. (4 marks)

[13 Marks]

Question 4

A. Explain why management should separate investment and finance decisions.

(4 marks)

B. A company has the following profits from a project over a five year period;
K3500, K2500, K2000, K1500 and K5000. The initial investment is K35, 000
with a salvage value of K 2000. The company’s target accounting rate is 40%.
Find the ARR and determine whether to accept or reject the project. (3 marks)

C. Bamako Corporation is considering the purchase of a plant costing K5 million.

Assume a cost of capital of 10% and the following cash flow schedule:

- Year 1: K900,000
- Year 2: K950,000
- Year 3: K850,000
- Year 4: K800,000
- Year 5: K800,000
- Year 6: K700,000

i. Calculate the project's NPV (2 marks)

ii. Calculation the project's IRR. (4 marks)
iii. Briefly discuss whether this project is viable or not. (2 marks)

[15 Marks]

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Question 5

A. Explain the use of the Security Market Line to an investor. (2 mark)

B. A stock has a beta of 1.4 and the risk premium for this stock is 8%.Given that
T bills offer 10% risk free return, what will be the required rate of return that
investors will demand on this stock? (1 mark)

C. A stock has an expected return of 12.25 percent. The beta of the stock is
1.15 and the risk-free rate is 5 percent. What is the market risk premium?
(2 marks)

D. An Economic market has a 40% probability of operating as a capitalist

economy, 20% probability of it being a communist economy and 40%
probability of it being a mixed economy. Within all three states, Stock A will
yield returns of 30%, -12% and 20% respectively, while Stock B will yield
returns of 20%, 5% and 20% respectively. A portfolio holds both of these
stocks with a 65% investment in Stock A and a 35% investment in Stock B. In
choosing the investment with the least amount of risk, find the following for
both stocks:

i. Coefficient of Variation (7 marks)

ii. Correlation (7 marks)
iii. Standard Deviation of the Portfolio (5 marks)
iv. Which is the least risky investment? (1 mark)

[25 Marks]

END OF EXAMINATION PAPER

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 FORMULAS

Vb=I(PVIFA r,t)+MV(PVIF r,t) YTM=I+[(MV-Vb)/N]/[(2Vb+MV)/3]

PVa=a(PVIFA r,t) P0= D0(1+g)/Ks-g = D1/ks-g

PVa = a (1- 1/(1+r)t)/r (Pt = Dt(1+g)/Ks-g= Dt+1/ks-g)

FVa= a(FVIFA r,t) D1= D0(1+g)

FVa= a ((1+r) t – 1)/r P0 = DivP / kP

CY=I/price KS = ( D1 / P0 ) + g

FV=PV (1+r)t KS =Rf + (ERm–Rf) β

FV=PV (FVIF r,t)

PV = FV (PVIF r,t) IRR = A1 + NPV1 x (B2 - A1)

(NPV1 – NPV2)

Expected rate of return = ER =  Pi r i

COV (Ra ,Rb ) =∑Pi(Ra-ERa )(Rb- ERb)

Standard deviation =  =  (r - ER ) P .
2
i i

 σ P = wa2 σ a2  wb2 σ b2  2wa wbCov(Ra , Rb )

Coefficien t of variation (CV) = .
ER

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