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Semester One Final Examinations, 2019

FINM7402 Corporate Finance

Question 1

(20 marks)

Brisbane Sun and Surf Inc. has outstanding 1 million shares with a total market value of $20 million. The firm is expected to pay $1 million of dividends next year, and thereafter the amount paid out is expected to grow by 5% a year in perpetuity. However, the         company has heard that the value of a share depends on the flow of dividends, and      therefore it announces that next year’s dividend will be increased to $2 million, and that the extra cash will be raised immediately by an issue of shares. After that, the total        amount paid out each year will be as previously forecasted, that is, $1.05 million in year 2, and increasing by 5% in each subsequent year.

a.  At what price will the new share be issued in year 1?

b.   How many shares will the firm need to issue?

c.   What will be the expected dividend payments on these new shares? What, therefore, will be paid out to the old shareholders after year 1?

d.   Did the company successfully change the value of their shares? Explain why or why not.

 

Question 2

(20 marks)

The following information relates to two companies with the same business risk.

Item

Brisbane Bakeries

Bakers Warehouse

Earnings before interest ($)

10,000

10,000

Market value of debt ($)

50,000

-

kd (%)

4%

-

ke (%)

2%

10%

Market value of equity ($)

66,666

100,000

Total market value ($)

116,666

100,000

According to Modigliani and Miller, the total market value of the two companies should be the same, regardless of the methods used to finance their investments. Suppose you       hold 1% of the shares in Brisbane Bakeries.

Show the process and the amount by which you could increase your income without increasing your risk.

 

Question 3

(10 marks)

Suppose a stock price can go up by 15% or down by 13% over the next year. You     won a one-year put on the stock. The interest rate is 10%, and the current stock price is $60.

a.  Which exercise price leaves you indifferent between holding the put or exercising it now?

b.   How does this break-even exercise price change if the interest rate is increased?

 

Question 4

(20 marks)

Salties Ltd is considering the acquisition of Northern Queensland Beaches Inc.         (NQB). The values of the two companies as separate entities are $10 million and $5 million, respectively. Salties estimates that by combining the two companies it will     reduce selling and administrative costs by $200,000 per annum in perpetuity. Salties can either pay $7 million cash for NQB, or offer NQB a 50% holding in Salties. If the opportunity cost of capital is 10% per annum:

a.  What is the gain, in present value terms, from the merger?

b.  What is the net cost of the cash offer?

c.   What is the net cost of the share alternative?

d.  What is the NPV of the acquisition under:

a.  The cash offer?

b.  The share offer?

 

Question 5

(5 marks)

Most IPOs earn significant returns on the day the shares go public and are traded in   financial markets. Ken, the CEO of Fair Value Trading Inc. (FVT), is about to issue his company’s shares in an IPO.

a.   Should Ken be upset if his shares earn big returns on the first day of trading? Why, or why not?

b.  What is book-building?