MGT6097 Corporate Finance Autumn Semester 2017-2018
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MGT6097
MANAGEMENT SCHOOL
Autumn Semester 2017-2018
Corporate Finance
Section A
Question 1
(a) Assume that you are 30 years old today, and that you are planning on retirement at age of 65. Your current salary is $45,000 and you expect your salary to increase at a rate of 5% per year as long as you work. To save for your retirement, you plan on making annual contributions to a retirement account. Your first contribution will be made on your 31st birthday and will be 8% of this year's salary. Likewise, you
expect to deposit 8% of your salary each year until you reach age 65. Assume that the annual rate of interest is 7%.
1) Calculate the present value (at age 30) of your retirement savings .
(10 marks)
2) Calculate the future value at retirement (age 65) of your savings.
(10 marks)
(b) Show that the relationship between the value of an ordinary annuity and the value
of an otherwise equivalent annuity due is: Annuity due value = Ordinary annuity value × (1 + r). You can use mathematic derivation or a numerical example to illustrate.
(10 marks)
Question 2
(a) Growing Real Fast Company (GRF) is expected to have a 25% growth rate for
the next four years (effecting D1, D2, D3, and D4). Beginning in year five, the
growth rate is expected to drop to 7% per year and last indefinitely. If GRF just paid a $2.00 dividend and the appropriate discount rate is 15%, what is the current value of a share of GRE?
(15 marks)
(b) Compare and contrast the following three methods of share valuations: Gordon growth model, two-stage dividend discount model and net present value of growth opportunities (NPVGO) model.
(15 marks)
Question 3
(a) Use the following information to answer the question(s) below.
|
Firm |
Portfolio Weight |
Volatility |
Correlation with the Market Portfolio |
|
Taggart Transcontinental |
0.25 |
14% |
0.7 |
|
Wyatt Oil |
0.35 |
18% |
0.6 |
|
Rearden Metal |
0.40 |
15% |
0.5 |
The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the risk-free rate is 4%.
1) Calculate the betas of Taggart Transcontinental, Wyatt Oil and Rearden Metal. (6 marks)
2) Calculate the expected returns of Taggart Transcontinental, Wyatt Oil and Rearden Metal.
(6 marks)
3) Calculate the beta and expected return of the portfolio consisting of the three stocks in the table above.
(6 marks)
(b) Evaluate, using graphical illustration, the nature and importance of the concept of ‘the market portfolio’ in modern investment theory and practice. Also explain the link between the market portfolio and the efficient frontier in portfolio theory.
(12 marks)
Question 4
Sapphire is an all equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15%. The company has decided to modify its capital structure. The plan is to have a target debt/equity ratio of 25%.
The company has been told that any borrowings made by them will be at a rate of 7%. Assume this is in a perfect capital market.
1) Calculate the return on equity of Sapphire before and after the restructuring.
(20 marks)
2) Explain why the return on equity has changed as a result of restructuring.
(10 marks)
Section B
Question 5
Market efficiency is a myth but no other competing models are sufficient to replace the theory of stock market efficiency proposed by Fama (1970).
(a) Discuss the different forms of the efficient market hypothesis (EMH).
(20 marks)
(b) Critically assess the implications of market efficiency to corporate financial
managers and shareholders.
(20 marks)
Question 6
“Since investors are able to create homemade dividends, managers should not be rewarded for adopting high dividend payout policy.” Critically evaluate this statement in the light of both the theories of dividend policy and practical considerations.
(40 marks)
2022-01-25