UNIVERSITY OF KWAZULU-NATAL SCHOOL OF ECONOMICS AND FINANCE EXAMINATION: JUNE 2007 SUBJECT, COURSE AND CODE: FINANCE 201 (FINA201)

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1 UNIVERSITY OF KWAZULU-NATAL SCHOOL OF ECONOMICS AND FINANCE EXAMINATION: JUNE 2007 SUBJECT, COURSE AND CODE: FINANCE 201 (FINA201) EXAMINERS (INTERNAL): MRS S DONNELLY EXAMINER (EXTERNAL): MR G OLDHAM TOTAL: 200 MARKS DURATION: 3 HOURS INSTRUCTIONS TO CANDIDATES: 1. This question paper consists of THIRTEEN numbered pages, including this page. Present and Future Value tables are attached. 2. There are four questions in this paper ANSWER ALL FOUR QUESTIONS All questions carry equal marks. 3. Answer Question 1 on the MCQ data sheet provided, and each of Questions 2, 3 and 4 in a different booklet, ensuring that you complete the required information on the cover of the MCQ data sheet and each answer booklet. 4. Submit the MCQ data sheet and all three booklets, even if you have not used all of them. 5. Show all workings. 6. Appendix A on page 11 contains formulae you may find useful. 7. Appendix B on page 12 must be returned inside your Question 2 booklet, and must be clearly marked with your name and student number. 8. Appendix C on page 13 must be returned inside your Question 3 booklet, and must be clearly marked with your name and student number. 1

2 QUESTION 1 (50 marks: 45 minutes) This is a Multiple Choice question. Answer each question by clearly indicating your choice on the data sheet provided. Your name and student number must appear on the data sheet. Each question carries 2 marks. There will be no negative marking. 1. Select from the following list the most appropriate form of finance for purchasing a new office building. (a) A loan repayable in six month s time. (b) An arrangement with a factoring company. (c) A ten-year mortgage loan. (d) A lease. 2. The Alt X is a market for: (a) Companies that promote alternative lifestyles. (b) Overseas companies without a trading history. (c) Companies who do not wish to list on the JSE. (d) Companies that do not satisfy the criteria for a Main Board listing on the JSE. 3. Financial management has strong academic links with: (a) economics and IT (b) accountancy, statistics and algebra (c) geography and sociology (d) (a) and (b) (e) all of the above 4. Which of the following statements is correct? (a) One of the advantages of the company form of organization is that it is fairly easy to set up. (b) The partnership form of organization has easy transferability of ownership. (c) One of the disadvantages of the sole proprietorship form of organization is that there is unlimited liability. (d) Statements b and c are correct. (e) None of the above statements are correct. 5. The Agency Problem arises when: (a) Shareholders have their own agenda at the expense of how management wish to run the business. (b) Management are not the owners of the company. (c) Shareholders and management do not share the same goals and objectives. (d) All of the above. (e) (b) and (c) 2

3 6. The role of a financial manager would include: (a) Identifying wealth-creating investment opportunities. (b) Financing assets at the highest possible risk and cost. (c) Efficient financial analysis, reporting, planning and control. (d) All of the above. (e) (a) and (c) only. 7. The financial goal of the firm is to. (a) maximise profits (b) optimise solvency and liquidity (c) maximise shareholder s wealth (d) limit bad debts (e) (a) and (c) 8. How many of the following statements are correct? 1. Financial management and accounting are not synonymous. 2. Accounting uses a cash flow basis. 3. Financial management emphasises cash flows and market values. 4. The receipt of funds sooner as opposed to later is preferred. (a) None of them (b) One statement (c) Two statements (d) Three statements (e) Four statements Answer questions 9 and 10 based upon the following numbered entities: (i) Sole proprietorship (ii) Partnership (iii) Close corporation (iv) Private company (v) Public company 9. Which of the above enterprise forms are permitted to have only one owner / partner / member / shareholder? (a) (i), (ii) and (iii) (b) all of the enterprise forms (c) (i), (ii), (iii) and (v) (d) (i), (iii), and (iv) 10. The following enterprise forms are a separate legal and tax entity: (a) (i), (iii), (iv) and (v) (b) (iii), (iv) and (v) (c) (iv) and (v) (d) (i), (iv) and (v) 3

4 11. Which of the following statements is true of a secondary market: (a) The Johannesburg Securities Exchange acts as a secondary market. (b) New shares can be issued on a secondary market. (c) It is the market for trading in short-term securities only. (d) None of the above are true. 12. Which of the following statements is true of listings on the JSE: (a) A main board listing has the least stringent criteria. (b) An AltX listing is only for companies involved in high-risk, speculative projects. (c) A Main Board listing requirement is that the company must have more than 25 million issued shares. (d) All of the above are true. 13. Which of the following is a secondary market transaction? (a) You sell 200 Investec shares in the open market. (b) You buy 200 Investec shares from your brother (c) Investec issues 2 million shares of new shares to the public (d) Statements a and b are correct (e) All of the statements above are correct 14. Until this year, Cheers Inc. was organized as a partnership. This year, the partners have decided to organize the business as a company. As a result of this change in organizational form, which of the following statements is correct? (a) Cheers' shareholders (the ex-partners) will now have limited liability. (b) Cheers will now be subject to fewer regulations. (c) Cheers will now pay less in taxes (d) Cheers' investors will now find it more difficult to transfer ownership. (e) Cheers will now find it more difficult to raise additional capital. 15. How many of the following three statements are true? 1. In a public company, management elects a board of directors and a chairman to run the company. 2. The financial manager in a company usually sits on the Board of Directors. 3. An organization chart of a company would show that the Financial Director oversees the Marketing, Human Resources, Operations and Financial functions. (a) One statement is true (b) Two statements are true (c) Three statements are true (d) None of the statements are true. 4

5 16. An example of a direct agency cost is: (a) The purchase of a company limousine by the financial manager. (b) The cost of hiring auditors to represent shareholders interests. (c) The cost of lost profits due to a business opportunity ignored by management. (d) (a) and (b) only (e) All of the above are examples of direct agency costs. 17. The agency problem can be addressed by: (a) Linking management compensation to the inflation rate. (b) Threatening to remove the directors from office if they do not support management decisions. (c) Allowing all shareholders the opportunity to decide on their annual dividend. (d) None of the above. 18. The Efficient Market Hypothesis asserts that: (a) The JSE is a semi-strong form efficient market (b) You can consistently earn abnormal returns in an efficient market (c) Well-organised capital markets, such as the NYSE are efficient markets (d) All of the above 19. The following statement is true: (a) Several of the world s stock markets are strong-form efficient. (b) You can use inside information to beat a semi-strong form efficient market such as the JSE, as it is perfectly legal. (c) You can never make money investing in a strong-form efficient market. (d) An investment in an efficient market is a zero-npv investment at the time of purchase. 20. One of the functions of the financial markets and financial system as a whole is: (a) To transfer funds from surplus units to the principal markets and back again. (b) To mobilise savings in the economy and turn these savings into more risky assets for the investor. (c) To enable surplus units to invest in the JSE. (d) None of the above are a valid choice. 21. An example of a contractual intermediary is: (a) A stokvel (b) The Standard Bank of SA Ltd (c) Business Partners (d) Sanlam Insurance Company (e) all of the above 5

6 22. Indirect securities: (a) are issued by financial intermediaries (b) would appear as assets on the financial intermediary s Balance Sheet (c) play a role in direct financing between lenders and borrowers (d) an example is a Bankers Acceptance 23. The JSE: (a) currently uses the JET system of electronic trading. (b) Issues a paper-driven certificate to all purchasers of shares. (c) Is more of a formal financial market, than an over-the-counter (OTC) market. (d) None of the above are true of the JSE. 24. The following are functions of the SA Reserve Bank (SARB): (a) The SARB is responsible for printing all bank notes and mining all gold. (b) It is the banker to the man in the street as well as the government. (c) It acts as an agent in the foreign exchange market. (d) It ensures that the commercial banks have sufficient cash reserves to preserve their liquidity. (e) All of the above 25. Which of the following statements are untrue? (a) Short-term insurance is mainly concerned with the problem of living beyond a person s retirement age. (b) Long-term insurance protects from natural disasters and accidents. (c) In first-world countries, the focus of life insurance is more on the problem of premature death than living beyond your productive life. (d) All of the above are untrue. 6

7 QUESTION 2 (50 marks: 45 minutes) Airborne (Pty) Ltd was founded a decade ago by brothers Todd and Chase Wright. The company manufactures and sells light aircraft to order. The financial statements of Airborne (Pty) Ltd for the year ended 28 February 2007 are as follows: Airborne (Pty) Ltd Income Statement for the year ended 28 February 2007 (R) Sales revenue Less Cost of goods sold Other expenses Depreciation Profit before interest and tax Less Interest Profit before tax Less taxes (40%) Net Profit, after tax Dividends Addition to Retained Profit Airborne (Pty) Ltd Balance Sheet as at 28 February 2007 (R) Equity Ordinary Share Capital Retained earnings Liabilities Long-term debt Overdraft Accounts payable Total equity & Liabilities Assets Net Plant and Equipment Current assets Inventory Accounts receivable Cash and marketable securities Total Assets The brothers anticipate a realistic growth in sales for the 2008 financial year of 20%. Costs, interest, all assets and accounts payable should increase spontaneously with sales. The tax rate will change to 35% and they will maintain the same dividend payout ratio. Assume that the firm is operating at full capacity. The brothers cannot raise further share capital at this time, and their bankers will not allow them to exceed the firms overdraft limit of R as a measure to preserve liquidity. 7

8 Required: (a) Use the 2007 financials to calculate the internal growth rate and sustainable growth rate for Airborne (Pty) Ltd and interpret your answers. (12 marks: 11 minutes) (b) Use the information provided and the percentage of sales approach to complete a pro forma income statement and balance sheet for 2008, and to determine the extra financing needed (EFN) to achieve the targeted level of growth in Use Appendix B provided on page 12 of your exam paper to complete the pro forma income statement and balance sheet. Detach this from the test paper and include the sheet in your question 2 answer book. Write your student number in the space provided. (38 marks: 34 minutes) Round off final answers to two decimal places in the case of % rates e.g %, and in the case of Rand values to the nearest Rand. 8

9 QUESTION 3 (50 marks: 45 minutes) Boxco cc is a small firm that produces cardboard boxes in a variety of sizes. The owner, Gary Carton, works primarily in production and sales. He puts all receivables in one box, and all payables in another. You have been hired to improve on this disorganised system, and your first task was to gather all relevant information in order to undertake a budgeting exercise. The information gathered is as follows: All sales and all purchases are made on credit, and are evenly spread out across each quarter. The following sales have been projected for each of the next four quarters: Quarter 1 Quarter 2 Quarter 3 Quarter 4 Sales (Rands) Sales for the first quarter of next year are projected at R Boxco s accounts receivable period is 63 days, and they will open the first quarter with accounts receivable of R Boxco raw material orders each quarter amount to 50% of the next quarter s projected sales, and they pay their suppliers in 54 days. Wages, taxes and other costs each quarter will run at about 25% of that quarters projected sales. The firm needs to purchase new box folding machinery in the fourth quarter at a cost of R This purchase will be made in cash to take advantage of a discount. The firm needs to make a quarterly interest payment of R on its long-term debt. The business currently has a cash balance of R , and their policy is to maintain a minimum cash balance of R Boxco uses a local bank for their short-term financial needs. They pay 1.5% per quarter on any short-term borrowing, and maintain a money market account that pays 1% per quarter on all short-term investments. At present they do not have any short-term borrowings or investments. Required: (a) Calculate the Net Cash Inflow figures for Boxco cc for the next year. Show all workings. (28 marks: 25 minutes) (b) Ignore your answer to (a) above and assume the following forecasted net cash inflow figures for Boxco cc for the next year: Quarter 1 Quarter 2 Quarter 3 Quarter 4 Net Cash Inflow (R) (16 950) ( ) Now complete the Short term Financial Plan for Boxco cc for the next year. Use the outline provided on Appendix C on page 13. Do not forget to write your student number at the top of Appendix C, nor to detach it and place it inside your Question 3 booklet. (19 marks: 17 minutes) (c) Describe Boxco s short-term financial needs for the next year from their local bank. (3 marks: 3 minutes) Instructions: Assume 90 days in a quarter. Round off all values to the nearest Rand. 9

10 QUESTION 4 (50 marks: 45 minutes) Answer both unrelated parts of this question. Rand values must be rounded off to the nearest cent, factors to four decimal places, time periods to the nearest year, and percentage rates (%) to two decimal places. Part A (18 marks: 16 minutes) Today is Severus Snipe s birthday, and his father is starting to save for his tertiary education. Severus will enter university when he turns 18, and will need R4 000 then, and at the end of each of the following three years. His father will make an annual deposit of R1 400 to reach this goal, commencing a year from today, and ending on Severus s 17 th birthday. The investment will earn 6% per annum. Required: Calculate which birthday Severus is celebrating today. (18 marks: 16 minutes) Part B (32 marks: 29 minutes) The following information has been extracted from the latest Balance Sheet of Asian Exports Ltd (AEL): The company has bonds in issue, with a face value of R1 000 and a coupon rate of 9% per annum. The bonds make semi-annual coupon payments and mature in 12 years time. The current market rate for similar bonds is 8% per annum. The company has ordinary shares in issue. Shareholders have just received a R2.50 dividend, and the dividend is expected to grow at a constant 7% per annum for the foreseeable future. The required return on such shares is 15% per annum. The company has preference shares in issue which promise a fixed annual dividend of R10 per share. The required return on these shares is 12% per annum. Required: (i) Calculate the current market value of an AEL bond, an AEL ordinary share and an AEL preference share. (14 marks: 13 minutes) (ii) Calculate the current value of an AEL ordinary share if the company decides to put a hold on dividends to its ordinary shareholders for the next 3 years. They will pay a R10 dividend in 4 years time, and settle down to a constant 5% annual growth in dividends thereafter. The required return will remain unchanged at 15% per annum. (10 marks: 9 minutes) (iii) State any three Bond Pricing Theorems. (8 marks: 7 minutes) 10

11 APPENDIX A SELECTED RATIOS AND FORMULAE ROA = Net profit after tax / Total Assets ROE = Net profit after tax / Total equity IGR SGR ROA x b = 1 ( ROA x b) ROE x b = 1 (ROE x b) FV of a lump sum = PV x (1 + r) t PV of a lump sum = FV / (1 + r) t t (1+ r) 1 FV of annuity = C x r 1 1 t (1+ r) PV of annuity = C x r Bond Value = C x [1 1 / (1 + r) t ] / r + F / (1 + r) t P o = D 1 / (1 + r) + D 2 /(1 + r) 2 +..D t / (1 + r) t + P t / (1 + r) t P 0 = D 1 / (R g) P t = D t+1 / (R g) R = D 1 / P 0 + g 11

12 APPENDIX B Question 2 (b) STUDENT NUMBER AIRBORNE (PTY) LTD PRO FORMA INCOME STATEMENT (2008) (R) Sales revenue Less Cost of goods sold Other expenses Depreciation Profit before interest and tax Less Interest Profit before tax Less taxes Net Profit, after tax Dividends Addition to Retained Profit Airborne (Pty) Ltd Pro Forma Balance Sheet as at 28 February 2007 Equity Ordinary Share Capital Retained earnings Liabilities Long-term debt Overdraft Accounts payable Total equity & Liabilities Assets Net Plant and Equipment Current assets Inventory Accounts receivable Cash and marketable securities Total Assets DO NOT FORGET TO DETACH AND INCLUDE IN YOUR QUESTION 2 ANSWER BOOK 12

13 APPENDIX C Student number: Question 3 (b): Short-Term Financial Plan of Boxco cc Opening balance Quarter 1 Quarter 2 Quarter 3 Quarter 4 Net cash in / out flow (16 950) ( ) New ST investments Interest earned on ST investments ST investments sold New ST borrowing Interest paid on ST borrowing ST borrowing repaid Closing cash balance Minimum cash balance Cumulative surplus (deficit) Opening ST investments Closing ST investments Opening ST debt Closing ST debt DO NOT FORGET TO FILL IN YOUR STUDENT NUMBER AT THE TOP OF THIS PAGE, TO DETACH THIS PAGE FROM YOUR QUESTION PAPER, AND TO PLACE IT INSIDE YOUR QUESTION 3 ANSWER BOOK!!! 13

Who of the following make a broader use of accounting information?

Who of the following make a broader use of accounting information? Accountants Financial Analysts Auditors Marketers Which of the following is NOT an internal use of financial statements information? Planning