MODULE: PRINCIPLES OF FINANCE

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1 Programme: BSc (Hons) Financial Services with Law BSc (Hons) Accounting with Finance BSc (Hons) Banking and International Finance BSc (Hons) Management Cohort: BFSL/13/FT Aug BACF/13/PT Aug BACF/13/FT Aug BBIF/13/FT Aug BBIF/13/PT Aug BMAN/13/FT Aug Bth 1-Gen + BMAN/13/FT Aug Bth 2 Mktg BMAN/13/FT Aug Bth 3 - Law Examinations for Semester I/2013 Semester II MODULE: PRINCIPLES OF FINANCE MODULE CODE: ACCF1201 Duration: 2 Hours Reading time: 10 Minutes Instructions to Candidates: 1. This question paper consists of Section A and Section B. 2. Section A is compulsory. 3. Answer any two questions from Section B. 4. Always start a new question on a fresh page. 5. Total Marks: 100 This question paper contains 4 questions and 7 pages. Page 1 of 7

2 QUESTION 1: (40 MARKS) SECTION A: COMPULSORY (a) List four factors which explain why a Rupee in hand today will be worth more than a Rupee promised at a future date. (b) Explain what is meant by compounding. Illustrate your answer with an example. (c) Congratulations! You have just won Rs 10 million in the National Lottery. Unfortunately, the lottery officials inform you that you will be paid the Rs 10 million in Rs 250,000 annual installments over the next 40 years, starting at the end of the actual year. You estimate that your appropriate discount rate is 7% annually. Based on this, how much money did you really win in present value terms? (5 marks) (d) La Rudence Life Insurance Co. is trying to sell you an investment policy that will pay you Rs 700 annually forever. If the required return on investment is 12%, what is the maximum amount which you will be willing to pay for the policy? Show your workings. (e) Mr George has the following two investment options: 1. Buy preference shares issued by Company Y which pays Rs 20 annually forever 2. Buy ordinary shares issued by Company Z. Company just paid a dividend of Rs 5. Dividends are expected to grow at a constant rate forever. Mr George s required rate of return is 10% per annum. By how much should the dividend paid by Company Z grow annually such that Mr George will be indifferent between choosing Y and Z? (7 marks) Page 2 of 7

3 (f) You plan to buy a motor cycle. The dealer offers you 4 ways of paying as follows: 1. Cash of Rs 22,500 payable now 2. Deposit of Rs 8,000 today followed by 3 annual payments of Rs 5, No deposit. Make 4 annual payments of Rs 6,400 with first payment made one year from today. 4. Deposit of Rs 2,250 now and Rs 26,000 payable after 4 years. Assume that you can borrow at 9% interest rate per annum. Which option is the most attractive? Show all workings. (g) Peter Paul has just bought a 10% NTC bond which is redeemable in 4 years time at par value. Par Value is Rs 100/bond. Current market price is Rs 92/bond Calculate the Yield to Maturity (YTM). Page 3 of 7

4 SECTION B: ANSWER ANY TWO QUESTIONS QUESTION 2: (30 MARKS) (a) Briefly define the following fundamental features of a bond: (i) Face value (ii) Coupon payment (iii) Coupon rate (iv) Maturity date (b) Give one similarity and one difference between a preferred stock and a bond. (6 marks) (c) Explain how you would calculate the price of a zero-coupon bond? (3 marks) (d) Calculate the value (price) of a Rs 10,000-par-value bond paying semi-annual interest at an annual coupon interest rate of 10 percent and having 10 years until maturity. Assume the required return on similar risk bonds is 12 percent annual rate, paid semi annually. (e) A corporation has a 9 percent, Rs 1,000 par value preferred stock issue outstanding. If the required rate of return is 14 percent, calculate the value of the preferred stock. (5 marks) Page 4 of 7

5 QUESTION 3: (30 MARKS) Company ABC is considering four (4) projects. Because of past financial difficulties, the company has a high cost of capital of 15 percent. The investment costs and cash inflows of the projects are as follows: Project A Project B Project C Project D Initial 50, ,000 80, ,000 Investment (Rs) Year Cash Inflows (Rs) 1 20,000 35,000 20, , ,000 50,000 40,000 80, ,000 50,000 60,000 60,000 (a) Calculate the Net Present Values of each project, using the cost of capital of 15 percent. (16 marks) (b) Rank acceptable projects by Net Present Values. (c) Using the method of interpolation, determine the Internal Rate of Return for Project D with the help of 15 percent discounting factor and 20 percent discounting factor. (10 marks) Page 5 of 7

6 QUESTION 4:(30 MARKS) (a) Consider the stock return information provided below for two mutual funds. Fund A (%) Fund B(%) (i) Calculate the mean return for each of the funds across the five years. (ii) Calculate the standard deviation of returns for each of the funds across the five years. (b) You wish to invest equally in the following two stocks having risks and returns as provided in the table below : Assets Expected Return (%) Standard Deviation (%) Stock Weet Stock Abix 15 9 The Correlation coefficient between the returns of stocks Weet and Abix is (i) Calculate the expected rate of return of the portfolio. (3 marks) (ii) Calculate the risk as measured by the standard deviation of the portfolio. (5 marks) (c) Clearly explain the difference, with the use of graphical illustrations, between specific and non-diversifiable risks. (10 marks) ***END OF QUESTION PAPER*** Page 6 of 7

7 Formulae FUTURE VALUE Simple Interest Future Value at Simple Interest FV t = P 0 (1 + rt) Compound Interest Future Value (Single Period) FV t = P 0 (1 + r) t FV t = P 0. FVIF r,t Future Value (Annuity) FV = A/r [ (1+r) t 1 ] FV = A. FVIFA r,t Future Value (Annuity Due) FV = A/r [ (1+r) t 1 ]. (1+r) FV = A. FVIFA r,t. (1+r) PRESENT VALUE Simple Interest Present Value at Simple Interest P 0 = FV t / (1 + rt) Compound Interest Present Value (Single Period) P 0 = FV t / (1 + r) t P 0 = FV t. PVIF r,t Present Value (Annuity) P 0 = A/r [ 1 1/(1+r) t ] P 0 = A. PVIFA r,t Present Value (Annuity Due) P 0 = A/r [ 1 1/(1+r) t ]. (1+r) P 0 = A. PVIFA r,t. (1+r) PV of Perpetuity P 0 = A/r Net Present Value NPV = PV - C IRR Find r such that PV C = 0 Page 7 of 7

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