• THE UMVERSITY OF THE WEST INDIES

DISTANCE

c--F,J 14 2-- EXAMINATIONS OF APRIL/MAY 2006.

CODE AND NAME OF COURSE: MGMT2023 - FINANCIAL MANAGEMENT

DATE AND TIME: DURAT IO N: al ou rs

INSTRUCTIONS TO CANDIDATES: This paper has '7 pigs xnd 23 questions.

THIS PAPER HAS TWO SECTIONS — SECTION A AND SECTION B.

SECTION A
BOTH QUESTIONS ARE COMPULSORY AND MUST BE ATTEMPTED.

Question 1

Selwyn Ltd. is a large engineering business that was established three years ago. The company
is entirely financed by equity capital and has not issued any further shares since it was .

established. The company is listed on the Jamaica Stock Exchange and the current market price
of each share in the company is $5.50.

To date, the directors of the company have been using the payback method of investment
appraisal to evaluate project proposals but, at a recent meeting it was decided to use the net
present value method in the future. As a result of this decision, the directors are now trying to
determine the cost of capital of the company.

The directors are trying to derive the cost of equity using the Dividend Valuation Model and the
Cvital-A-sset Pricing Model (CAPIVI). The following information has been extracted from the
fithnual rePortiX4 accounts of the company:
..., .
41.-
:1.-ie beta value of Selwyn Ltd is 1.18, the expected market return is S.0% and the risk-free rate of
return is 4.0%. The rate of corporation tax is 25%.

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The L.Tniversity of the West Indies N

TURNOVER

----._ _
4,
.., coi( Dividends
'. M1 Year Per Share
-:- .c- d 30 April (cents) ik
/ 2006 22.05
2005 21.00
2004 20.00
Question 1 (cont'd)
•

a) Explain the term 'cost of capital' and state, why it is important for a company to
calculate
carefully its cost of capital, (5 marks)

b) Calculate the cost of equity for Selwyn Ltd. Using:

i. The Dividend Valuation Model; and

ii, The Capital Asset Pricing Model (CAW). (10 marks)

c) Suppose Selwyn Ltd. is considering changing its capital structure to 20% debt and 80%
equity. The company can borrow at 9.5%, Assume its cost of equity is 13.5% and
corporation tax remains the same. Calculate Selwyn Ltd's weighted average cost of
capital. (5 marks)

(Total 20 marks)

Ouestion 2

Heighway Ltd is a railway company. Heighway Ltd operates a passenger railway service and is
responsible for the operation of services and the maintenance of track, signaling equipment and
other facilities such as stations. In recent years it has been criticised for providing a poor service
to the traveling public in terms of punctuality, safety and the standard facilities offered to
passengers. In the last, year Heighway Ltd has invested over $20 million in new carriages,
station facilities and track maintenance programmes in an attempt to counter these criticisms.
Summarised financial results for Heighway Ltd for the last two years are given below.

Summarised 'Income Statement for the year ended 31 December

2003 2004
S Million S

Earnings before interest and tax 18.0 16.5

Interest (3.2) (4.7)
Tax (4.4) (3.5)
Earnings available to shareholders 10.4 8_3

TURNOVER

The University of the West Indies Course Code; MGMT2023 2006/05/03

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 • .1.• ..••• WI.. • ••••,••• .1. OS • • •••
 Page 3

• Question 2 (cont'd)
Required:
a) Summarised Calculate
Balanceany four
Sheet (4)31ofDecember
as at the following ratios for Heighwa.y Ltd for both 2003 an
2004: 2003
i)Return on capital employed (also known as return SonMillioninvestment) 2004
based upon closing
employed rren t Assets S
ii)Net profit margin
e Cash iii) Asset turnover 6.2 3.6
Accounts Reccivab Los
Av) Current ratio 11 2,4
Stock 5,9
Capital gearing ratio (8 mark
13+6 11.9
-
S. cNet Fixed Assets 100.4 120.5..
b) Total Assets 113nefly comment on the financial 114_11 performance
132.4 of Heighway Ltd in 2003 a
2004 as
revealed by the above ratios and suggest causes for any changes. (You are not required
Current
to calculate Liabilities
any other ratios.) (12 mar
Short term Creditors 8..4 9.2

Lung-term Debt g (Total: 20 marks)

% Debenture 20O 1.5_0 15.0
Bank Loan 210 35.0
35,1) 50.1) TURNOVER
S ha reholders Equity
Ordinary share capital ($1 shares) 25.0 25.0 .
The University of the West Indies
Retained Earnings. Course Code:
45.6 MGMT2023
+:182 2006105
70.6 73.2
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Total Lfabilltits arid shareholder's equity 114.0 132.4
 4
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SECTION B

Answer Al] Questions In This

Section On The Answer Sheet
Provided.
Each Question 1 Worth I
Mark.

1. The goal of financial management is:

a) Maximization of profit as measured by Earnin

Share..
b) Maximization of sales of the firm.
c) Minimization of the total costs of the firm.
Maximization of shareholder wealth as measured by
the price of the firm's shares.

0a.kthile Furniture has a beta coefficient of 0,7. If the

current risk-free rate is 4% and the market risk
premium is 11%, what is the required rate of return
for Oakdale? When is value created for a
corporation?
a) 9_6%.
b) 11.7%
c) 13,1%
d) 15,2%

3. You depos
pays 8% interest, compounded quarterly,
planning to use it to finish your last
year at university. Eighteen (18)
months later, you decide to go to
Carnival in Trinidad, so you close out
your account. How much money will
you receive?
a) $1,171
b) $1,126
e) S1,082
.d) $1,163

4. What is the
Company A should produce given: RF
%, 13 = 1,40 , = 13%
a) 13%
b) 2 L4%
c) 15_8%
d) 10.92%

5. What is t
annuity with annual payments of S200,
evaluated at a 15% interest rate?
 a) 5670.44
b) 5842.91
e) $1,522,64
d) $1,348.48
TURNOVER
The University of the West Indic& Course Code:
MGMT2.023 2CHR6.105/63

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 I6.A firm would accept a project with a net present value of zero because:

•
t
•
a)The project would maintain the wealth of the firm's owners.
b)The project would enhance the wealth of the firm's owners.
c)The return of the project would be positive.
d)The return on the project would be zero.

17. All of the following are criticisms of the payback period criteria EXCEPT:
a)Time value of money is not accounted for
b)Returns occurring after payback are ignored
c) It deals with accounting profits as opposed to cash flows
d)The AcceptiReject decision rule is subjective

IS. You are evaluating a project that has an initial outlay of $150,000 and yearly cash inflows
of $19,000 per year for 12 years. What is the payback period for this project?

a) 2.5 years
b) 3 years
c) 5.55 years
d) 7.89 years

19. True or False: The before-tax cost of debt, which is lower than the after-tax cost of debt,
is used as the component cost of debt for purposes of developing the firm's Weighted
Average cost of Capital,

a) True
b) False

20, The of a business is measured by its ability to satisfy its short-term

obligations as they come due.

a) activity
b) liquidity
c) d e b t
d) profitability

(Total: 20 marks)

: END OF QUESTION PAPER

vc \
•
4,1 I
ICO

Course Code: IT2023

The Univcrsi of the West Indies 2006105/03
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