Section 1

Multiple choice  (Each question carries 3 marks and 30 marks in total)

There  is one and only one  correct answer for each question.  Please write down the question number and your answer (either A, B, C or D) on the answer book (Workings are not required).

Question 1

Which of the following is the correct interpretation of the terms of sale “A customer is granted credit with terms of net 40.”?

A  The customer has 40 days from the invoice date to pay and 40% discount is offered for

early payment.

B  The customer has 60 days from the invoice date to pay and 40% discount is offered for

early payment.

C  The customer has 40 days from the invoice date to pay and no discount is offered for

early payment.

D  The customer has 60 days from the invoice date to pay and no discount is offered for

early payment.

Question 2

Which of the following is a main drawback of Gordon growth model?

A  It cannot be applied on firms who did not pay dividends.

B  It does not consider the time value of money.

C  It does not consider the discount rate.

D  It does not consider the pattern of future dividends.

Question 3

Which of following formulae correctly describes bond price?

A  Dirty price = Clean price – Accrued interest

B  Dirty price = Accrued interest

C  Dirty price = Clean price + Accrued interest

D  Dirty price = Coupon +Accrued interest

Question 4

Which of the following statements is correct?

A  An asset is said to be overpriced if the market price is above its present value.  B  An asset is said to be underpriced if the market price is above its present value. C  An asset is said to be priced fairly if the market price is above its present value. D  None of the above

Question 5

Which of the following is not a main drawback of the internal rate of return (IRR) approach?

A  No consideration on time value of money.

B  Ranking issues

C  Multiple solutions

D  Confusion over investing type and financing type cash flows

Question 6

Assuming the Capital Asset Pricing Model (CAPM) holds, what is the beta value of market portfolio assumed to be?

A  0

B  1

C  -1

D  It changes over time.

Question 7

Which of the following is not an element of statement of financial position? A  Assets

B  Liabilities

C  Shareholders’ equity

D  Current share price

Question 8

Which of the following statements about portfolio diversification is not correct? A  Total risk can be diversified if assets are perfectly positively correlated.       B  Total risk can be diversified if assets are perfectly negatively correlated.

C  Total risk can be diversified if assets are not correlated.

D  Diversification can diversify unique risk.

Question 9

Which of the following statements about cash dividends is not correct?

A  Firms may pay regular cash dividends.

B  Firms may pay extra cash dividends.

C  Paying cash dividends reduces the corporate cash and retained earnings . D  Cash dividends are not taxable.

Question 10

Which of the following is not a general assumption of Modigliani and Miller proposition I and II in a perfect market?

A  No taxation

B  No risk

C  No transaction costs

D  No bankruptcy costs

Section 2

Calculation and analysis (70 marks in total)

Please write down the question number, necessary workings and answers on the answer book. (Rounding to two decimal places if necessary)

Question 1 (20 marks in total)

(a) A five-year  annuity  due  offers  constant  annual  payments  of £1,200. Assuming  an alternative investment offers a rate of return at 15%, what is the present value of this annuity due? [5 marks]

(b) Stock A is expected to pay a dividend of £1 at the end of year 1, £2 at the end of year 2, with dividend growth expected to be 3% per annum thereafter. If the required return on similar equities is 10%, calculate the fair market price of stock A. [6 marks]

(c) Datasoft  plc.  has  bonds on the  market with  12.5 years to  maturity  and a yield to maturity of 10% per annum. The bonds make semi-annual payments with the next coupon payment £20 due in 6 months. The face value of these bonds is £1,000. What is the fair market price of the bond? [9 marks]

Question 2 (30 marks in total)

(a) Given the risk-free rate is 2% and market risk premium is 5% in the market, share B has a beta of 1.6 and an expected return of 12%, share C has a beta of 1.2 and an expected return of 6%. Assuming Capital Asset Pricing Model (CAPM) holds and share B and share C are in the same market. Briefly discuss what is likely to happen to the market prices and expected returns of share B and share C, and use calculations to support the discussion. [14 marks]

(b) Yuzhi plc. is equally financed (50% by debt and 50% by equity). Given the cost of equity and cost of debt of Yuzhi plc. are 10% and 8%, respectively, and corporate tax rate is 20%. Calculate the weighted average cost of capital (WACC) of Yuzhi plc. [6 marks]

(c) Mr. Davies invests in a two-asset portfolio which is consisted of two risky assets, x1 and  x2 .  The  proportions  of  x1   and  x2   held  in  the  portfolio  are  30%  and  70%, respectively. The expected return of x1 and x2 are 10%; and 8%, respectively. Standard deviations of x1 and x2 are 75% and 50%; respectively. The correlation between x1 and x2   is  -0.7.  Calculate  the  expected  return  and  standard  deviation  of this two-asset portfolio. [10 marks]

Question 3 (20 marks in total)

(a) Vineet  plc.  is considering two  investment  projects  (mutually exclusive) whose cash flows are shown below:

Points in time (yearly intervals)

0

1

2

3

4

Project A (£)

-240,000

120,000

90,000

84,000

36,000

Project B (£)

-240,000

30,000

90,000

110,000

120,000

Given the cost of capital of Vineet plc. is  15% and no threshold figure is set, use the discounted payback method to advise the company which project should be taken and briefly discuss the popularity of payback methods. [10 marks]

(b) Hark plc. is a pharmaceutical company and the following financial information about this company is available to investors:

Use the available information, calculate operating cycle, cash cycle, earnings per share (EPS), price earnings (PE) ratio and market to book ratio of Hark plc. [10 marks]