Final Examination Semester 2 / Year 2010

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1 Southern College Kolej Selatan 南方学院 Final Examination Semester 2 / Year 2010 COURSE : COURSE CODE : FINE3003 TIME : 2 1/2 HOURS DEPARTMENT : ACCOUNTING & FINANCE, MANAGEMENT LECTURER : KAN YOKE YUE Students ID : Batch No : Notes to candidates: 1) The question paper consists of 2 sections and 7 pages. 2) Section A: Answer ALL questions. Section B: Answer ALL questions. 3) Write all your answers in the answer booklet. 4) Return the question paper with your answer booklet.

2 Section A: Multiple Choice Questions Answer ALL questions. (20 x 1 mark = 20 marks) 1. Prime grade commercial paper will most likely have a higher annual return than (a) a Treasury bill. (b) a preferred stock. (c) a common stock. (d) an investment grade bond. 2. The is a measure of relative dispersion used in comparing the risk of assets with differing expected returns. (a) coefficient of variation (b) chi square (c) mean (d) standard deviation 3. A collection of assets is called a(n) (a) grouping. (b) portfolio. (c) investment. (d) diversity. 4. Perfectly correlated series move exactly together and have a correlation coefficient of, while perfectly correlated series move exactly in opposite directions and have a correlation coefficient of. (a) negatively; 1; positively; 1 (b) negatively; 1; positively; 1 (c) positively; 1; negatively; 1 (d) positively; 1; negatively; 1 5. Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that (a) remains unchanged. (b) decreases to a level below that of either asset. (c) increases to a level above that of either asset. (d) stabilizes to a level between the asset with the higher risk and the asset with the lower risk. 6. A feature that gives the issuer the opportunity to repurchase bonds at a stated price prior to maturity is called (a) stock purchase warrants. (b) call feature. (c) conversion feature. (d) None of the above. 7. The significant portion of the return on a zero coupon bond is in the form of (a) interest and gain in value. (b) interest. (c) gain in value. (d) tax reduction. Page 1 of 7

3 8. The return expected from an asset is fully defined by its (a) risk and cash flow. (b) cash flow and timing. (c) discount rate. (d) beta. 9. As a form of financing, equity capital (a) has a maturity date. (b) is only liquidated in bankruptcy. (c) is temporary. (d) has priority over bonds. 10. A 6 percent preferred stock with a market price of $110 per share and a $100 par value pays a cash dividend of. (a) $6.00 (b) $6.60 (c) $ (d) $ Shares of stock currently owned by the firm s shareholders are called (a) authorized. (b) issued. (c) outstanding. (d) treasury shares. 12. The residual theory of dividends suggests that dividends are to the value of the firm. (a) residual (b) relevant (c) irrelevant (d) integral 13. The clientele effect refers to (a) the relevance of dividend policy on share value. (b) the firm s ability to attract stockholders whose dividend preferences are similar to the firm s dividend policy. (c) the informational content of dividends. (d) the bird in the hand argument. 14. The firm in a merger transaction that attempts to merge or takeover another company is called the (a) target company. (b) holding company. (c) acquiring company. (d) conglomerate. 15. involves the combination of firms in unrelated businesses. (a) Congeneric merger (b) Conglomerate merger (c) Horizontal merger (d) Vertical merger Page 2 of 7

4 16. A hostile merger is typically accomplished through (a) a cash purchase. (b) an exchange of the acquirer s stock. (c) a tender offer. (d) an exchange of the acquirer s stocks and bonds. 17. costs are a function of volume, not time. (a) Fixed operating (b) Semi variable (c) Variable (d) Fixed financial 18. At the operating breakeven point, equals zero. (a) sales revenue (b) fixed operating costs (c) variable operating costs (d) earnings before interest and taxes 19. is the potential use of fixed financial charges to magnify the effects of changes in earnings before interest and taxes on the firm s earnings per share. (a) Financial leverage (b) Operating leverage (c) Total leverage (d) Debt service 20. The cost of common stock equity is (a) the cost of the guaranteed stated dividend. (b) the rate at which investors discount the expected dividends of the firm. (c) the after tax cost of the interest obligations. (d) the historical cost of floating the stock issue. Page 3 of 7

5 Section B: Essay Questions Answer ALL questions. Question 1 (Total 20 marks) A company has issued bond with a par value of $1,000, coupon rate of 5.5 percent, and maturity of 10 years. The opportunity cost is 6.5%. (a) Do you think this bond will trade at premium, discount or par? Why? (b) Compute the price of the bond if interest is paid annually. (c) Compute the price of the bond if interest is paid semiannually. (d) Calculate the yield to maturity of a bond that is sold at market price of $990 and pays 5% semi annual coupon. The par value of the bond is $1,000 and will mature in 12 years. (e) Explain the differences between common stock and bond. Page 4 of 7

6 Question 2 (Total 20 marks) Allied Corporation is attempting to acquire Best Trading Company. Selected financial data is presented for both companies in the table below: Item Allied Corporation Best Trading Company Earnings available for common stock $400 million $20 million Number of shares of stock outstanding 200 million 5 million Market price per share $32 $72 (a) Calculate the EPS of Allied Corporation and Best Trading Company before the merger. (b) Calculate the P/E ratio of Allied Corporation and Best Trading Company before the merger. (c) If the ratio of exchange is 2.5, what will be the earnings per share of the merged firm? (3 marks) (d) The market favors the mergers and investors generally believe that the merged firm will trade at higher PE ratio of 17 times after the merger. Calculate the expected market price per share of the merged firm. (3 marks) (e) What is the P/E ratio paid to acquire Best Trading Company (3 marks) (f) Is this merger favorable to Allied Corporation or Best Trading Company? Why? (3 marks) Page 5 of 7

7 Question 3 (Total 20 marks) (a) Why is the cost of financing a project with retained earnings less than the cost of financing it with a new issue of common stock? (b) Time Corporation has determined its optimal capital structure, which is composed of the following sources and target market value proportions: Target Source of Capital Market Proportions Long term debt 30% Preferred stock 10 Common stock equity 60 Debt: Time can sell a 20 year, $1,000 par value, 8 percent annual coupon bond for $1120. A flotation cost of 2 percent of the face value would be required in addition to the discount of $20. Preferred Stock: Time has determined it can issue preferred stock at $84 per share. The par value is $100. The stock will pay an $8 annual dividend. The cost of issuing and selling the stock is $5 per share. Common Stock: Time s common stock is currently selling for $40 per share. The dividend expected to be paid at $5 next year. Its dividend payments have been growing at a constant rate of 3% for the last five years. Additionally, the firm s marginal tax rate is 40 percent. Calculate: (i) The after tax cost of debt. (ii) (iii) (iv) The cost of preferred stock. The cost of common stock. The weighted average cost of capital. Page 6 of 7

8 Question 4 (Total 20 marks) The management of a new company wishes to know the optimal capital structure that will balance the benefits and costs of debt financing. The common stock of the company is trading at $20 per share in the market. The company plans to have total assets of $10,000,000. The forecasted earnings before interest and tax is $1,000,000. The company is taxed at a rate of 28%. The company is considering of the following percentage of debt financing: 0%, 10%, 20%, 30%, 40%, 50%, 60% As the percentage of debt increases, the shareholders required rate of return and interest rate charged on borrowings are as follows: Percentage of Debt (%) Required rate of return (%) Interest rate for debt financing Advise the company which level of debt is optimal by calculating the following items: (a) Total debt (b) Total equity (c) Number of shares issued (d) Total interest expense (e) Profit before taxes (f) Taxes (g) Net Income (h) Earnings per share (i) Estimated price per share Present your answer in a table. Which level of debt financing is optimal for the company? (20 marks) 000 Page 7 of 7

Final Examination Semester 1 / Year 2008

Southern College Kolej Selatan 南方学院 Final Examination Semester 1 / Year 2008 COURSE : COURSE CODE : FINE3003 TIME : 2 1/2 HOURS DEPARTMENT : MANAGEMENT LECTURER : KAN YOKE YUE Student s ID : Batch No.