Paper Code: ACFI213 Page 1 of 10 EXAMINER: S. T. KIM DEPARTMENT: ULMS TEL. NO: 53725 SPECIMEN PAPER CORPORATE FINANCIAL MAANGEMENT FOR NON-SPECIALIST STUDENTS TIME ALLOWED: Two Hours INSTRUCTIONS TO CANDIDATES DO NOT REMOVE THIS PAPER FROM THE EXAMINATION ROOM. RETURN THIS PAPER TO INVIGILATORS AFTER THE EXAM. The use of a University approved calculator is permitted during this exam. The calculator must have been purchased from the Guild of Students and must be stamped with the University crest. The use of non-approved calculators is not permitted. Answer ALL questions. Enter your name and student ID number IN PENCIL on the computer sheet according to the instructions on that sheet. The digits should be entered in the boxes under “Student ID Number” and entered by means of horizontal lines in the appropriate boxes underneath, exactly as when answering questions. NAME OF CANDIDATE_____________________________________________________ STUDENT ID NUMBER____________________USUAL SIGNATURE________________ PAPER CODE NO: ACFI213 Paper Code: ACFI213 Page 2 of 10 ACFI213 Corporate Financial Management for Non-Specialist Students Specimen Exam Paper Answer ALL Questions (3.333 Marks for Each Question; 0.01 Mark Added) Question 1 Which of the following statements is true a) The risk that can be reduced by diversification is referred to as systemic risk. b) Security market line represents the combination between the expected return and risk measured as standard deviation of stochastic returns. c) Negative covariance indicates that returns of two assets tend to move in opposite directions. d) Arbitrage pricing theory (APT) tells investors in advance what the risk factors are. e) None of the others. Question 2 Consider the following statements. 1. Public limited company refers to a company that is listed in the Main market. 2. Issuing the non-voting shares increases the firm’s financial distress risk. Which of the following options is correct Statement 1; Statement 2 a) False; True b) True; False c) True; True d) False; False Question 3 offer their owners a fixed rate of dividend each year. If a firm has insufficient profits, then the amount paid to the owners of would be reduced, which does not lead to the firm’s bankruptcy. a) Ordinary shares b) Voting rights c) Warrants d) Preference shares e) None of the others Paper Code: ACFI213 Page 3 of 10 Question 4 Consider the conflict of interests between shareholders and managers of a given company. Choose what is not one of ways to align the actions of managers with the interests of shareholders a) Linking rewards of managers to shareholder wealth improvements b) Sackings c) Selling shares and the takeover threat d) Information flow e) None of the others Question 5 What is meant by the term ‘internal rate of return’ a) Length of time before the cumulated stream of forecasted cash flows equals the initial investment. b) The present value of future cash flows of a project net the initial cost of the project. c) A rate of return that equates the present value of future cash flows of a project with the initial cost of the project. d) Sum of discounted future cash flows of a project. e) None of the others. Question 6 You plan to invest ￡15,000 in the shares of a company. The value of the shares increases by 7.0 percent per year, and you will hold the shares for 5 years. What will be the 5-year holding period return (HPR) a) 7.0% b) 28.7% c) 35.0% d) 40.3% e) 42.8% Question 7 Which of the following statements is false a) Increasing the leverage ratio (i.e., higher debt-to-equity ratio) can sometimes increase the firm’s weighted average cost of capital by increasing the probability of financial distress. b) The cost of capital is the rate which companies must offer to persuade people to buy and hold their shares. c) The cost of capital is affected by the level of investors’ risk tolerance. d) Assume that CAPM holds. The greater the total risk of a share, the higher the cost of equity. e) None of the others. Paper Code: ACFI213 Page 4 of 10 Question 8 Which of the following statements is true a) The replicating portfolio method requires to use the correctly estimated required return so as to calculate the present value of future cash flows of the investment project (with managerial flexibility) of consideration. b) Consider the real option analysis. The replicating portfolio method requires to find the “twin security”, where such a twin security’s returns should be independent of the cash flows of the investment project (with managerial flexibility) of consideration. c) Consider the binomial process of the share price and the replicating portfolio method to calculate the premium of a call option to purchase one unit of the share. Changes in the up-state probability p do not affect the premium of the call option as long as the current share price is independent of the up-state probability p. d) Consider the European call option of which exercise date is the next period. If the next-period spot price of the share is lower than the exercise price, then the call option seller’s next-period cash flow is negative. e) None of the others. Question 9 Which of the following statements is true a) Real options method ignores the time value of money. b) In selecting one out of two mutually exclusive projects, a firm must select a project with the higher internal rate of return in order to maximize wealth of its shareholders. c) Discounted payback method does not take into account the time value of money. d) Traditional method of calculating the net present value (NPV) ignores the possibility that managers have a flexibility to affect the probability distribution of future cash flows of a project. e) None of the others. Question 10 Which of the following is true a) In calculating a firm’s cash flow from operation, we need to subtract taxes from the earnings before interest and tax (EBIT) and then add depreciation because depreciation is a cash item. b) In calculating a firm’s free cash flow, we need to add depreciation to the firm’s cash flow from operation because depreciation is one of investment expenditures. c) Mezzanine debt provides its investors with a high return despite a low risk d) A semi-strong form efficiency of stock market says that all relevant information, including privately held information, is reflected in the share price such that even insiders are unable to make abnormal profits. e) None of the others. Paper Code: ACFI213 Page 5 of 10 Question 11 Which of the following is false a) Payback is the length of the first time when cumulated cash flows, including an initial outflow, either equal or exceed zero. b) Discounted payback does not take into account cash flows after the cut-off date. c) Discounted payback ignores the time value of money. d) Payback selects a cut-off date in an arbitrary way. e) None of the others. Question 12 Which of the following is false a) If an investor enters a forward contract, then the investor has a legal obligation to trade the underlying asset at the agreed price at the agreed future date. b) The ability to abandon, expand or defer a project can add considerable value compared with a project without one of these flexibilities. c) Real option analysis enables investors to calculate the true NPV of a project with flexibilities. d) Put-call parity holds true if put and call options have the same underlying asset. e) None of the others. Question 13 Which of the following is false a) An interest rate cap is a contract that gives the purchaser the right to receive cash flow if interest rates rise above an agreed fixed rate. b) If a company purchases a forward rate agreement, then this company has the right, but not an obligation, to pay interests at the future spot rate and to receive interests at the agreed fixed rate. c) Consider a floor contract. If an interest rate falls below an agreed level, then the seller (i.e., the floor writer) makes payment to the floor buyer. d) Speculators take a position in financial instruments and other assets with a view to obtaining a profit on changes in price rather than for the purpose of protecting a business or assets against changes in the price of underlying assets. e) None of the others. Question 14 Consider foreign exchange risk. Which of the following is false a) Transaction risk is the risk related to actual payments denominated in foreign currencies. b) Translation risk arises because financial data denominated in one currency is then expressed in terms of another currency. Paper Code: ACFI213 Page 6 of 10 c) Economic risk is the risk of a company’s competitive position that is affected by long-term changes in the exchange rate. d) Economic risk can be managed well by using the forward contracts that cover a short
period. Question 15 Assume that the CAPM is true. Stock A is priced at ￡8 per share and its beta is 0.80. Stock B is priced at ￡4 per share and its beta is 1.20. The expected (annual) return to the market portfolio is 8%. The (annual) risk free rate is 3%. Suppose that Mr. Goodheart holds a portfolio that consists of 200 shares of stock A and 200 shares of stock B. What is the expected (annual) return to Mr. Goodheart’s portfolio a) 7.67% b) 8.53% c) 9.45% d) 11.24% Question 16 Suppose a company, Fidelity plc, has an outstanding bond: its annual coupon rate is 8%, the market value of the bond is ￡300,000, and its annual yield-to-maturity is 12%. The company has 40,000 outstanding ordinary shares of which per-share price is ￡15. The required annual return to Fidelity plc’s ordinary shares is 18%. Assume that the corporate tax rate is 25%. What is the (annual) weighted average cost of capital of Fidelity plc a) 14.6% b) 15.0% c) 15.8% d) 14.1% Question 17 Which of the following is false a) In CAPM, the market risk is the only risk factor that affects the risk premium for any asset, given the risk-free rate. b) Multi-factor models specify multiple variables that systematically affect the share returns. c) In CAPM, it is assumed that all investors hold the market portfolio. d) One of the problems of CAPM is that very few government securities are close to being risk free. e) None of the others. Question 18 Paper Code: ACFI213 Page 7 of 10 Which of the following is true a) Internal rate of return (IRR) fails to take account of the time value of money. b) Internal rate of return (IRR) measures well absolute amounts of wealth changes. c) Net present value (NPV) ignores cash flows after a cutoff period. d) Discounted cash flow (DCF) analysis takes account of the time value of money and opportunity cost of capital in project appraisal. e) None of the others. Question 19 Which of the following is false a) The most secured type of corporate bonds is called a debenture. b) Mezzanine debt is a loan offering a high return with a low risk. c) Convertible bonds give the holder the right to exchange the bonds at some stage in the future into ordinary shares according to some prearranged formula. d) Mezzanine debt has a lower priority than a straight bond. e) None of the others. Question 20 Which of the following is true a) Default risk of futures is higher than that of forwards contracts. b) If an Internal rate of return (IRR) is lower than the required return, then the net present value (NPV) of the project is negative. c) A major problem with the arbitrage pricing theory (APT) is that APT does not tell investors in advance what the risk factors are. d) Zero correlation implies that the return to one asset is independent of the return to the other asset. e) None of the others. Question 21 Consider an American put option. This option expires in two periods later; its underlying asset is one share of StableGrowth plc stock, where the per-share stock price can either increase by 25% (with probability of 50%) or decrease by 20% (with probability of 50%), in every period; the per-share stock price is now ￡60; assume that no dividend is paid. And the exercise price of the put option is ￡61. Risk-free rate is 4% per period. Assume that there is no arbitrage opportunity. What is the present value of this American put option a) ￡6.063 b) ￡4.724 c) ￡5.637 d) ￡6.561 Question 22 Suppose that you consider to invest in a copper mine that can produce 20 million kilograms (kg) of copper in one year later. To purchase this copper mine, you need to pay ￡28 million now. The per-kilogram copper price is ￡4 and will be either ￡6 (with prob. of Paper Code: ACFI213 Page 8 of 10 50%) or ￡2 (with prob. of 50%) in one year later, where the extraction cost of one kilogram of copper will be ￡3 in the next year. Note that in the next year, you can sell the copper mine at ￡22 million without production of copper, if you purchase the copper mine now. The risk-free rate is 4% per year. What is the net present value (NPV) of purchasing the copper mine a) ￡3.885 million b) ￡31.385 million c) ￡12.885 million d) ￡40.385 million Question 23 Consider a quarterly coupon bond as follows: Par value is ￡40,000. Annual coupon rate is 12%, and coupons are paid at the end of 3 months, 6 months, 9 months and 12 months, respectively, for a given year. The first coupon will be paid in 3 months later from now, and the last coupon will be paid at the maturity date when is 20 years later from now. The required return, in an effective annual return, to this bond is 8%. What is the market price of this bond a) ￡48,518 b) ￡47,693 c) ￡56,275 d) ￡57,100 Question 24 Consider a project that costs ￡60,000 now, at the end of year 0. This project will deliver cash flows in the future as follows: ￡25,350 at the end of year 2 (labeled year-2 CF); ￡40,630 at the end of year 3 (labeled year-3 CF); ￡7,330 at the end of year 4 (labeled year-4 CF); and ￡5,460 at the end of year 5 (labeled year-5 CF). The required returns, in terms of effective annual returns, for future cash flows are as follows: 6% for year-2 CF, 8% for year-3 CF, 9% for year-4 CF, and 11% for year-5 CF. What is this project’s net present value (NPV) a) ￡3,077 b) ￡3,248 c) ￡3,604 d) ￡3,812 Question 25 Refer to the earlier Question 24. What is the (annual) internal rate of return (IRR) of this project a) 6.884% b) 7.193% c) 9.917% d) 7.882% Paper Code: ACFI213 Page 9 of 10 Question 26 Refer to the Modigliani and Miller’s conclusion that the total market value of any company is independent of its capital structure. Choose the false statement about the assumptions upon which the aforementioned Modigliani and Miller’s conclusion is reached. a) There is no taxation. b) Capital markets are perfect, perfect information is available to all economic agents, and there is no transaction cost. c) Costs of financial distress are substantially large. d) Individuals can borrow at the same rate as corporations do. e) None of the others. Question 27 Suppose that the expected per-share dividend of a company, GrowthStock plc, is ￡4.8 at the end of year 1, ￡5.5 at the end of year 2, ￡6.0 at the end of year 3, and thereafter growing at 5% per year forever and paid at the end of every year since the end of year 3. Assume that the required return to the stock of GrowthStock plc is 18% per year. What is the per-share stock price of GrowthStock plc now (i.e., at the end of year 0) a) ￡60.13 b) ￡48.46 c) ￡44.34 d) ￡41.16 Question 28 – 29 Suppose a company, IdioRisk plc, has 500 (ordinary) shares and a debt, labeled existing bond, that promises to pay the interest of ￡600 and face value of ￡6,000 at the end of the next period. The company’s next-period earnings before interest and tax (EBIT) is stochastic: either ￡26,000 (w/ prob. 50%) or ￡11,000 (w/ prob. 50%), where such a risk is idiosyncratic, i.e., a non-systemic risk. This company’s depreciation in the next period will be ￡1,000 for sure. In the next period and thereafter, the company will make no investment other than depreciation in the next period. At the end of the next period, the company will have zero asset (full depreciation). After the next period, the company stops to run its business. Assume that in the next period, depreciation will be the only investment expenditure. The risk-free rate is 4% per period. The corporate tax rate is 30%. If the company can not pay fully to any debtholder, then the company goes to bankruptcy; in the event of bankruptcy, the company can not use interest of a defaulted debt as an interest expense to reduce its taxable income and the company is taken over by holders of the defaulted debt. Paper Code: ACFI213 Page 10 of 10 Question 28 What is the per-share stock price now a) ￡12.56 b) ￡11.98 c) ￡12.35 d) ￡12.96 Question 29 Assume that the company’s managers now determine to issue a new bond that promises to pay the interest of ￡400 and face value of ￡4,000 at the end of the next period. Assume that this new bondholder has the lower priority than the existing bondholder does: in case of bankruptcy, existing bondholders should be paid first, and then the remaining cash, if any, is paid to the new bondholders. If the existing bondholders are fully paid as promised and only new bond is defaulted (i.e., partial default), then the company can still use the interest payment to the existing bondholders as an interest expense to reduce its taxable income. What would be the per-share stock price immediately after issuing the new bond a) ￡14.40 b) ￡12.56 c) ￡12.35 d) ￡12.67 Question 30 Fill the blank. An interest rate gives the purchaser the right to, at the agreed time in the future, receive interests at the spot rate and to pay interests at the fixed rate. a) floor b) cap c) futures d) swap e) none of the others