MGT6097R Corporate Finance Summer Semester 2017-2018
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MGT6097R
Management School
Corporate Finance
Summer Semester 2017-2018
Section A
Question 1
(a) Wyatt oil currently pays no dividend. You anticipate Wyatt Oil will pay an annual dividend of
$0.56 per share two years from today and you expect dividends to grow by 4% per year thereafter. If Wyatt Oil's equity cost of capital is 12%, calculate the value of a share of Wyatt oil today.
(15 marks)
(b) Several years ago, Wrongmove Ltd. issued bonds at face value of £1,000 with the semi-annual
coupon of £40. Now, with 5 years left until the maturity of the bonds, the company has run into hard times and the yield to maturity on the bonds has increased to 12%. Calculate the price of the bond, assuming that the coupon is paid semi-annually?
(15 marks)
Question 2
Gleek Ltd. stock returns have a beta of 1.2. The historical rate of return on the market is 14%. Gleek intends to issue corporate bonds with a rate of 7.20% and the risk-free rate of return is currently at 6%. The market value of the bonds is £250 million. Gleek stock, of which 25 million shares are outstanding, sells for £30 per share. The corporate tax rate is 10%.
(a) Calculate Gleek’s cost of equity.
(3 marks)
(b) Calculate Gleek's after-tax weighted average cost of capital (WACC).
(3 marks)
(c) Gleek must decide whether or not to purchase additional capital equipment. The cost of the equipment is £7 million. The expected after-tax cash flows from the new equipment are £4 million a year for the first 2 years and £0.5 million a year for another year. The salvage value is zero. Demonstrate by calculation whether Gleek should purchase the equipment or not.
(10 marks)
(d) Demonstrate by calculation whether Gleek should purchase the equipment or not if corporate
tax rate increases from 10% to 25%? Assume that the corporate tax affects only the WACC. (14 marks)
Question 3
In the table below, you are given the expected returns and standard deviations of L’Oreal and Daimler AG, the Euro Stoxx 50 Index of largest Eurozone firms, and the risk free asset.
Asset Expected Return Standard Deviation
L’Oreal 16% 30%
Daimler 12% 25%
Euro Stoxx 50 13% 12%
Risk Free Asset 3% 0%
(a) Assuming that the returns are explained by the capital asset pricing model (CAPM), calculate
the betas of L’Oreal and Daimler.
(6 marks)
(b) Calculate the risk of a portfolio holding L’Oreal and Daimler with an expected return the
same as the Euro Stoxx 50 Index return.
(10 marks)
(c) Construct a portfolio consisting of the Euro Stoxx 50 Index and the risk-free asset that will produce an expected return of 12%. Contrast the risk of this portfolio with the risk of Daimler.
(10 marks)
(d) In general, is a diversified investment better than a stand-alone investment? Explain your answer.
(4 marks)
Question 4
The return on equity (ROE) on Daltrey Ltd is 14%, and it has a payout ratio of 0.5. Current book value per share is €50, and the book value will grow as the firm reinvests earnings. Assume that the
ROE and payout ratio stay constant for the next four years. After that, competition forces ROE down to 11.5%, and the payout ratio increase to 0.8. The appropriate discount rate is 11.5%.
(a) What are Daltrey’s EPS and dividends next year?
(5 marks)
(b) How will EPS and dividends grow in years 2, 3, 4, 5 and subsequent years?
(10 marks)
(c) What is the current share price?
(15 marks)
Question 5
(a) Briefly explain the following terms in the financial markets:
(i) operational efficiency
(ii) informational efficiency
(5 marks)
(b) Discuss the different forms ofthe efficient market hypothesis and their implications.
(10 marks)
(c) The efficient market hypothesis has some well-documented anomalies. Using examples and empirical studies, critically evaluate three anomalies.
(25 marks)
Question 6
After the groundbreaking work by Modigliani and Miller arguing that dividend policy is irrelevant, several theories were proposed to suggest that dividend policy does matter. Explain why dividend policy does matter to corporate financial managers? In particular, critically evaluate how these theories explain the implications of dividend policy upon the value ofthe firm.
(40 marks)
2022-01-25