Professional Documents
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Maf620 FMC570
Maf620 FMC570
AC/JAN 2013/MAF620/FMC570
COURSE
CORPORATE FINANCE
COURSE CODE
MAF620/FMC570
EXAMINATION
JANUARY 2013
TIME
3 HOURS
INSTRUCTIONS TO CANDIDATES
1.
2.
Answer ALL questions in the Answer Booklet. Start each answer on a new page.
3.
Do not bring any material into the examination room unless permission is given by the
invigilator.
Please check to make sure that this examination pack consists of:
i)
ii)
iii)
CONFIDENTIAL
CONFIDENTIAL
AC/JAN 2013/MAF620/FMC570
QUESTION 1
Sun World Bhd is considering investing its excess funds in one of the following two
companies. The following table shows the estimated returns of the two securities for next
year and the related probabilities.
State of economy
Recession
Normal
Boom
Probability
0.30
0.50
0.20
The expected returns and standard deviation of the market are 5.9% and 8.23%
respectively. The covariance between May and the market is 92.21 while the covariance
between June and the market is -7.61.
Required:
a)
Calculate the expected return and standard deviation of May Bhd and June Bhd.
Which security should the company choose? Why?
(9 marks)
b)
c)
Assume the capital asset pricing model (CAPM) holds true. If the Treasury Bill rate is
3%, calculate the required return of each security. In which security should the
company invest in?
(3 marks)
d)
Management may make decisions which are often in conflict with their shareholders'
interest. Explain two (2) control mechanisms that shareholders can use to cause
management to act in the shareholders' best interest.
(4 marks)
(Total: 20 marks)
CONFIDENTIAL
CONFIDENTIAL
AC/JAN 2013/MAF620/FMC570
QUESTION 2
A.
Chendana Berhad and Dupa Berhad are identical in all respects except that Chendana
Berhad is more levered than Dupa Berhad. Chendana Berhad's debt obligation
requires the firm to make RM8 million in payments. Dupa Berhad's debt obligations
are RM4.9 million.
Both companies expect that the probability next year of an expansion is 70 percent
and of a recession is 30 percent. If an expansion occurs, each firm will have earnings
before interest and taxes (EBIT) of RM15 million. On the other hand, if a recession
occurs, each firm will have EBIT of RM7 million.
Required:
a)
B.
ii)
Is it true that Dupa Berhad should have a higher value than Chendana
Berhad as Dupa Berhad has less debt, and therefore less bankruptcy risk?
Comment.
(3 marks)
In the real world, financial distress can lead to conflict of interest between stockholders
and bondholders. Discuss the three (3) kinds of selfish investment strategies that
stockholders use to gain benefits and hurt the bondholders. Why are these strategies
costly?
(7 marks)
(Total: 20 marks)
CONFIDENTIAL
CONFIDENTIAL
AC/JAN 2013/MAF620/FMC570
QUESTION 3
A.
Indicate whether the following statements are true or false. Provide a brief explanation
for your answer.
i)
"The desire for current income is not a valid explanation for adopting a high
dividend payout because investors can always create homemade dividends by
selling a portion of their stocks".
ii)
"Empirical research has found that there are significant increases in stock price
on the day an initial dividend is announced".
iii)
"A firm with weak cash flows can boost its share price by raising its dividend in
the longer term".
(9 marks)
B.
In the context of the efficient market hypothesis (EMH), explain what it means for a
stock market to be efficient. Describe two (2) examples when the stock market price
reaction may be called inefficient.
(5 marks)
C.
Explain Research on Mutual Funds and the evidence this research provides. Which
form(s) of EMH does it support or prove?
(3 marks)
D.
Do empirical studies support or reject the notion that corporate insiders earn abnormal
returns on their trades? What forms of market efficiency are supported or rejected?
(3 marks)
(Total: 20 marks)
QUESTION 4
Kejora Bhd is considering a RM10 million project that will last five years. The straight line
depreciation method is used. The cash inflows for the project are RM3.5 million per year for
the first two years and RM4.5 million per year for the remaining years. This project is
expected to have a salvage value of RM0.5 million at the end of the project's life.
Kejora Bhd can obtain a five-year commercial bank loan at 8% interest per year but the
company will only borrow 40% of the project's value. The bank will charge a processing fee
of 1 % of the loan amount. The fee is payable upfront, and is to be amortized over the term of
the loan. The terms of agreement require the company to settle principal payments of
RM800,000 at the end the second year and the balance in the fifth year.
The corporate tax rate is 25 percent. The risk-free rate is 6 percent and the applicable
unlevered cost of capital is 20 percent.
CONFIDENTIAL
CONFIDENTIAL
AC/JAN 2013/MAF620/FMC570
Required:
a)
Determine whether or not Kejora Bhd should undertake the project if it is 100-percent
equity financed.
(6 marks)
b)
Calculate the Adjusted Present Value (APV) of the project. Advise the firm whether or
not Kejora Bhd should undertake the project with debt financing from the commercial
bank.
(10 marks)
c)
Assume that the Melaka State Government is willing to offer 40% of the project's value
through a non-amortized government loan at 5% interest rate for 3 years with no
processing cost. The repayment of the principal is a lump sum at the end of the loan
term. Advise Kejora Bhd on which financing option is the best for the company.
(4 marks)
(Total: 20 marks)
QUESTION 5
The shareholders of Apple Bhd have voted in favour of a buyout offer from Maddox Bhd.
Information about each firm is given below:
Price-earnings ratio
Number of Shares outstanding
Earnings
Dividends
Maddox Bhd
15
1,200,000
RM2,400,000
RM720,000
Apple Bhd
10.8
660,000
RM696,000
RM348.000
Securities analysts expect that the earnings and dividends of Apple Bhd will grow at a
constant rate of 5 percent each year. It is estimated that the acquisition will create
economies of scale for Apple that will increase its growth rate to 7 percent per year.
Required:
a)
b)
c)
If Maddox were to offer RM20 in cash for each share of Apple, what would the NPV of
the acquisition be?
(2 marks)
d)
Determine the maximum price Maddox should be willing to pay for each share of Apple
Bhd.
(2 marks)
CONFIDENTIAL
CONFIDENTIAL
AC/JAN 2013/MAF620/FMC570
e)
If Maddox Bhd were to offer 300,000 of its shares in exchange for the outstanding
stock of Apple Bhd, what would the NPV be?
(4 marks)
f)
Calculate the after-acquisition stock price of Maddox if the stock offer had been used.
(2 marks)
g)
Should the acquisition be attempted? If so, should it be a cash offer or stock offer?
(2 marks)
(Total: 20 marks)
CONFIDENTIAL
CONFIDENTIAL
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Table A-2: Present Value of an Annuity of RM1 per period for n Period
Period
4%
0.9615
1.8861
2.7751
3.6299
4.4518
5%
0.9524
1.8594
2.7232
3.5460
4.3295
6%
0.9434
1.8334
2.6730
3.4651
4.2124
7%
0.9346
1.8080
2.6243
3.3872
4.1002
8%
0.9259
1.7833
2.5771
3.3121
3.9927
9%
0.9174
1.7591
2.5313
3.2397
3.8897
10%
0.9091
1.7355
2.4869
3.1699
3.7908
12%
14%
15%
16%
18%
20%
24%
28%
1
2
3
4
5
0.8929
1.6901
2.4018
3.0373
3.6048
0.8772
1.6467
2.3216
2.9137
3.4331
0.8696
1.6257
2.2832
2.8550
3.3522
0.8621
1.6052
2.2459
2.7982
3.2743
0.8475
1.5656
2.1743
2.6901
3.1272
0.8333
1.5278
2.1065
2.5887
2.9906
0.8065
1.4568
1.9613
2.4043
2.7454
0.7813
1.3916
1.8684
2.2410
2.5320
6
7
8
9
10
5.2421
6.0021
6.7327
7.4353
8.1109
5.0757
5.7864
6.4632
7.1078
7.7217
4.9173
5.5824
6.2098
6.8017
7.3601
4.7665
5.3893
5.9713
6.5152
7.0236
4.6229
5.2064
5.7466
6.2469
6.7101
4.4859
5.0330
5.5348
5.9952
6.4177
4.3553
4.8684
5.3349
5.7590
6.1446
4.1114
4.5638
4.9676
5.3282
5.6502
3.8887
4.2883
4.6389
4.9464
5.2161
3.7845
4.1604
4.4873
4.7716
5.0188
3.6847
4.0386
4.3436
4.6065
4.8332
3.4976
3.8115
4.0776
4.3030
4.4941
3.3255
3.6046
3.8372
4.0310
4.1925
3.0205
3.2423
3.4212
3.5655
3.6819
2.7594
2.9370
3.0758
3.1842
3.2689
11
12
13
14
15
8.7605
9.3851
9.9856
10.563
11.1184
8.3064
8.8633
9.3936
9.8986
10.38
7.8869
8.3838
8.8527
9.2950
9.7122
7.4987
7.9427
8.3577
8.7455
9.1079
7.1390
7.5361
7.9038
8.2442
8.5595
6.8052
7.1607
7.4869
7.7862
8.0607
6.4951
6.8137
7.1034
7.3667
7.6061
5.9377
6.1944
6.4235
6.6282
6.8109
5.4527
5.6603
5.8424
6.0021
6.1422
5.2337
5.4206
5.5831
5.7245
5.8474
5.0286
5.1971
5.3423
5.4675
5.5755
4.6560
4.7932
4.9095
5.0081
5.0916
4.3271
4.4392
4.5327
4.6106
4.6755
3.7757
3.8514
3.9124
3.9616
4.0013
3.3351
3.3868
3.4272
3.4587
3.4834
16
17
18
19
20
11.652
12.166
12.659
13.134
13.59
10.838
11.274
11.69
12.085
12.462
10.106 9.4466
10.477 9.7632
10.828 10.059
11.158 10.336
11.47 10.5940
8.8514
9.1216
9.3719
9.6036
9.8181
8.3126
8.5436
8.7556
8.9501
9.1285
7.8237
8.0216
8.2014
8.3649
8.5136
6.9740
7.1196
7.2497
7.3658
7.4694
6.2651
6.3729
6.4674
6.5504
6.6231
5.9542
6.0472
6.1280
6.1982
6.2593
5.6685
5.7487
5.8178
5.8775
5.9288
5.1624
5.2223
5.2732
5.3162
5.3527
4.7296
4.7746
4.8122
4.8435
4.8696
4.0333
4.0591
4.0799
4.0967
4.1103
3.5026
3.5177
3.5294
3.5386
3.5458
21
22
23
24
25
14.029
14.451
14.857
15.2470
15.622
12.821
13.1630
13.489
13.799
14.094
11.764
12.042
12.303
12.55
12.783
10.017
10.201
10.371
10.529
10.675
9.2922
9.4424
9.5802
9.7066
9.8226
8.6487
8.7715
8.8832
8.9847
90770
7.5620
7.6446
7.7184
7.7843
7.8431
6.6870
6.7429
6.7921
6.8351
6.8729
6.3125
6.3587
6.3988
6.4338
6.3641
5.9731
6.0113
6.0442
6.0726
6.0971
5.3837
5.4099
5.4321
5.4509
5.4669
4.8913
4.9094
4.9245
4.9371
4.9476
4.1212
4.1300
4.1371
4.1428
4.1474
3.5514
3.5558
3.5592
3.5619
3.5640
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