Faculy of Social Sciences School of Business Corporae Finance Examinaion December 03 English Dae: Monday 09 December, 03 Time: 4 hours/ 9:00-3:00 Toal number of pages including he cover page: 5 Toal number of quesions:5 Maximum marks: 00 The candidae mus answer all quesions and heir pars. Be precise. Answers are only acceped in English. Reference aids allowed: Financial calculaor BUT The calculaor memory mus be empy. The calculaor mus no be able o communicae wih oher compuing devices. The calculaor is no allowed o be conneced o he elecriciy. The calculaor mus no produce any sound. One dicionary: Naive language - English/English - naive language or English - English Noe: The candidae mus ensure ha he answer se is complee. The candidae s name mus no be wrien on he answer shees. Please wrie wih a blue or black ballpoin pen. ØABED4000 (ORD)
Quesion (Marks 8+7+5) You are CFO of a muliproduc company. Each produc is considered as a sand-alone business. One of he producs, produc X, is produced in a manufacuring plan locaed in Bergen. One fine morning your CEO calls you in her office and ells you ha a mulinaional firm has recenly approached her and has shown keen ineres in buying he Bergen plan. Even hough X has been a reasonable venure bu i does no compleely fi ino our company s produc porfolio, she observes. Your CEO s exciemen is hence quie undersandable. owever, before she eners ino he negoiaion process she wans o know he worh of his plan. You are he mos suiable person for such a valuaion she remarks and quickly adds bu hurry up provide me he minimum accepable price for his plan a your earlies. The informaion you colleced suggess ha he plan is expeced o generae free cash flows of NOK 9 million per year, growing a a rae of 3% per year. Bu here is one foonoe which says growh rae may go up o 4%. The equiy cos of capial of 5% and a deb cos of capial of 7% is repored in he company accouns. Your company is subjec o a corporae ax rae of 8%, and your deb-equiy raio is 3. Your finance manager is quie confused abou an invesmen decision and seeks your help. I undersand NPV and IRR rules bu..you know in his case.. he exclaims. e coninues, Wih an invesmen budge of NOK 30 million a hand and our company s cos of capial of 8%, I am evaluaing he following wo invesmen projecs each of which requires an iniial invesmen of NOK 30 million. Will you please guide me which projec is beer for our firm? c. Invesmen Projec Fuure Cash Flows (NOK) 5 000 000 9 00 000 4 000 000 3 000 000 The policy guidelines for developing he cash budge of your company is o hold NOK 5 million in excess cash reserves, invesed in risk-free Treasury securiies earning 3% per year. Wih a deb equiy raio of and cos of deb @ 0% and cos of equiy @ 0%, your WACC is 3.6% (corporae ax rae is 8%). Wha is he cos of permanenly mainaining his cash reserve? Quesion (Marks 5+7+8) Wih a face value of NOK 000, a zero-coupon corporae bond having five-year mauriy is jus issued a a price of NOK 700. Wha is he yield o mauriy of he bond? Green Bies has NOK l,000-par-value bonds ousanding currenly selling a par having 5 years unil final mauriy and 9% coupon rae. Ineresingly, anoher firm Mango Mania has a very similar bond issue ousanding. In fac, every bond feaure is he same as for he Green Bies bonds, excep ha Mango Mania s bonds maure in exacly 0 years. Now, assume ha he marke s annual required rae of reurn for boh bond issues suddenly fell o 8%. Which bond would show he greaes price change? Why?
c. You own some shares in a company. This year he company paid a dividend of NOK 5 and dividends were expeced o grow a a 5% rae. The curren share price is NOK 55. owever, you have jus received an email from he CEO of he company addressed o all shareholders of he company ha he company will cu is dividend from NOK 5 o NOK 3 per share and use he exra funds o expand. Wih he new expansion, is dividends are expeced o grow a an 8% rae. Wha share price would you expec afer he announcemen? Wha assumpion you migh ake for his valuaion? Is he expansion a posiive NPV invesmen? Quesion 3 (Marks 8+) Your friend has invesed in an all-equiy firm ABC Corp. Is asses are currenly valued a NOK 50 million and currenly million shares are ousanding. She was quie happy wih her invesmen bu now ABC has announced ha i plans o borrow NOK 50 million and use hese funds o repurchase shares (The corporae ax rae is 8%). ABC furher announces ha i will permanenly keep is ousanding deb equal o NOK 50 million. ABC offers NOK 60 per share o repurchase is shares. Your friend seeks your advice if she should accep or rejec his offer. The CFO of Wizards ASA has asked you o advise him abou he capial srucure decision of Wizards. As you know we are an all-equiy firm. We can raise deb @ 0% per year. Deb being cheaper source we should raise as much as we can, he observes. Being quie mehodical and cauious, you ariculae Deb may be a cheaper source bu i has is own risks.you beer know ha. We should be quie careful abou he amoun of deb we may raise. I agree, he says and ha s why I seek your advice. For his purpose you have jus compleed financial modeling of Wizards which shows ha his coming year Wizards will have an EBIT (ne of depreciaion expenses of NOK 5 million) of NOK 90 million. Moreover, i will spend NOK 0 million on capial expendiures and NOK million on increases in ne working capial. Your model suggess ha Wizards is expeced o grow by 5% per year. The corporae ax rae is 8% and is exising cos of capial of 5%. In your opinion how much can Wizards borrow now? Idenify he parameers ha migh affec your decision. Quesion 4 (Marks 9+6) The in-house research has enabled your firm o acquire paens o produce and sell U-G, an innovaive chemical o be used in oil refineries. Your paen will las for hree years only. The manufacuring plan o produce U-G will need an iniial invesmen of NOK 00 million and will have a life of only seven years. Moreover, by hen U-G is also likely o be replaced wih some innovaion. This plan has a capaciy o produce million liers of U-G which is he esimaed demand over seven years period. The plan will be operaional immediaely. The curren cos of producion and sale of U-G is NOK 00 per lier and considering your monopoly you propose o sell i a NOK 3000 per lier. As he news breaks, he indusry shows a keen ineres. Considering his ineres, i is observed in prin media ha once he paen period is over he echnological developmen will bring down he cos of manufacuring plan o NOK 90 million
and cos o produce a lier of U-G o NOK 000 per lier. All exciemen aside, your CEO asks you o work ou he NPV of his invesmen. You know cos of capial of your firm is 5%. Ignore inflaion and axes. You are holding 000 shares each of he wo firms A and B ha have idenical asses ha generae idenical cash flows. A is an all-equiy firm wih million shares ousanding ha is rading for a price of NOK 55 per share. B oo has million shares ousanding bu also has deb valued a NOK 30 million. The curren marke price of B is NOK 7. Which of he wo socks is a good buy or sell a he curren prices? Quesion 5 (Marks 5+6+9+5) Wha are plausible explanaions of he following exrac from Graham and arvey s aricle? Oher han NPV and IRR, he payback period is he mos frequenly used capial budgeing echnique (raing of.53). This is surprising because financial exbooks have lamened he shorcomings of he payback crierion for decades. Please commen briefly on he following exrac from Brav e al. aricle. Wih respec o dividend policy, one of Linner s key findings sill holds: idend policy is conservaive. From managemen s perspecive, dividend conservaism emanaes primarily from he marke s asymmeric reacion o dividend increases and decreases. c. Please lis a leas hree deerminans of corporae leverage decision along wih idenifying he direcion of heir relaionship (+ve or ve or?) and some plausible explanaion for such a relaionship. d. In sock marke wo erms are commonly used: cum-dividend and ex-dividend. Wha do hey mean?
FORMULAE SEET Fuure Value => Presen Value => Fuure Value of Annuiy => Presen Value of Annuiy => Value of a Bond => FV PV ( r) FCF PV ( r) C PV ( r) r FV of annuiy C r PV of annuiy C r r r C ( r),000 C... ( r) N N Bond Duraion => C Bond Duraion PV ( V ) Value of a Common Sock => PV ( r) Consan Growh Model => P0 r g Growh Rae => Reurn on Equiy x Plowback Raio FCF Model Valuaion => FCF PV ( r) FCF ( r) ( r) FCF... ( r) P... ( r) PV ( r) Profiabiliy Index => CAPM => r r i f PI i ( rm rf NPV Invesmen ) idendyield Marke Price D Weighed Average Cos of Capial => WACC rd ( Tc) V re E V