BU7654

Faculty of Arts Humanities and Social Sciences

Trinity Business School

MSc Finance 2020/2021 Reassessment 2020

BU7XXX – Title of Paper

Day Date Year Online Blackboard 00.00 – 00.00

Examiners: Prof Ekaterini Panopoulou (External Examiner) &

Dr Louise Gorman (Internal Examiner)

Instructions to Candidates:

The examination is two hours in duration.

Answer all three questions in Section A. Each question in Section A carries 24 marks.

Answer any two questions in Section B. Each question in Section B carries 14 marks.

Materials permitted for this examination:

Non-programmable calculators are permitted for this examination – please indicate the
make and model of your calculator on each exam book used.
A formula sheet is provided in Appendix A. Present value tables are provided in Appendix B.
 BU7654
SECTION A: Answer ALL THREE questions in this section

Question 1

a. Below are the financial statements for Morrison’s plc at 2 February 2020. Morrisons is the UK’s
fourth largest supermarket chain.

Morrisons plc Consolidated Income Statement 2 February 2020

2019

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Morrisons plc Consolidated Statement of Financial Position 2 February 2020

2020 £m 2019 £m

a. Using the DuPont method, comment on three underlying contributors to Return on Equity for
Morrisons for 2020 and 2019. Comment on how the different aspects of the company’s
performance impacted its profitability in both years.

(8 Marks)

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b. Briefly discuss FOUR implications of IFRS 15 for the financial analyst

(4 Marks)

c. Buildco enters into a contract to construct an asset for a customer, at an agreed price of
€2,500,000 and specified delivery date of 31 March 2020. The contract stipulates a penalty of
€100,000 for each month over which delivery becomes overdue while a €50,000 bonus will be
paid if the asset is constructed before the deadline. Buildco estimates a 5% chance of early
delivery and an 85% chance of meeting the deadline. The likelihood of being one month late is 5%
and the likelihood of being 2 months late is 5%.

Determine the amount of consideration to which the company expects to be entitled to in

exchange for transferring promised goods/services using the expected value method.

(4 Marks)

d. According to Cascino et al. (2014), future development of the conceptual framework may need to
consider the accessibility of financial statements to users who are not financially literate. Discuss
this issue with reference to this article or similar literature.

(8 Marks)
[Total: 24 Marks]

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Question 2

a. Below are extracts from the annual financial statements of Vitro plc.
Extracts from Income Statement
€(000)s
Sales 420
Operating expenses 185
Net finance costs 17
Taxation 61

Extracts from SOPF

€(000s)
Total assets 1,700
Cash & equivalents 550
Accounts and tax payable 280
Non-current loans and borrowings 220
Current loans and borrowings 65
Equity 700

(i) Prepare an analytical income statement and balance sheet for Vitro plc
(ii) Determine ROIC and provide verification of ROIC by decomposing it into TWO of its
principle components.
(iii) If the market value of Vitro’s equity is €1.7 million, calculate the market’s implicit
expectations for ROIC assuming a WACC of 11% and a rate of growth in EVA of 6%
(iv) Based on your answer for parts (ii) and (iii), comment on the company’s performance

(12 Marks)
b. A financial analyst is decomposing ROIC for two different companies. One is located in the
pharmaceutical sector and the other is supermarket retailer. Briefly describe the differences you
would expect him to observe between the two companies.
(4 Marks)
c. Zig Inc. and Zag Inc. are industry peers. Based on the information regarding these two companies
provided in the table below, calculate and comment on the sustainable growth rate for the two
companies.

Zig Inc. Zag Inc.

ROIC after tax 7% 9%
Net financial expenses after tax 8% 5%
Financial leverage 6 2
Payout ratio 12.5% 7.5%

(2 Marks)

d. Strategic analysis is central to accurate forecasting; yet, the analytical tools employed by
management may not be appropriate to the contemporary corporate and financial environment.
Discuss this statement with reference to Tassabehji et al. (2014).
(6 Marks)
[Total: 24 Marks]

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Question 3

a. CD ltd is a company in a declining industry. Its owners have decided to sell the business and to
value it using the liquidation approach. The book value of equity is €1.05m. Advisors have
indicated that the liquidation value of the company’s assets is €150,000 below the book value, and
that the book value of liabilities is €90,000 higher than that recorded in the firm’s accounts. These
advisors have invoiced the company €25,000 for their services

Calculate liquidation value of CD ltd.

(3 Marks)

b. The market value of Nova Co.’s debt is €5.25m and that of its equity is €15.5m. The firm’s three
main competitors have unleveraged β values of 0.4, 0.6 and 0.9.

If the tax rate is 12.5%, calculate the levered β for Nova Co.
(3 Marks)
c. A credit analyst has been presented with the following information regarding a corporate loan
provided by an Irish banking syndicate:

 Exposure at default: €10,000,000

 Probability of default: 15%
 Probability of recovery: 70%

What is the expected loss on this loan?

(3 Marks)

d. On the 1st of July 2020, a company which prepares accounts to the 31 st of December enters into a
4 year lease of a building. Annual Lease payments are €50,000 payable on the 1 st of July each year.
The rate of interest implicit in the lease is 7% per annum.

Account for:
(i) The lease liability
(ii) The right of use asset
(iii) Depreciation of the asset
(6 Marks)

e. Research on mergers and acquisitions has evolved to consider the implications for range of
stakeholders. Discuss this evolution with reference to the work of Segal et al. (2020) or similar
literature.
(9 Marks)
[Total: 24 Marks].

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SECTION B: Answer ANY TWO questions in this section

Question 4

a. How would the following financial assets be classified under IFRS 9?

i. An ordinary share
ii. Loan stock to be held to maturity
iii. Loan stock held to trade

Explain the rationale for your answers.

(4 Marks)
b. Ryan plc purchases a 20% interest in Collins plc for €350,000 on 1 October 2018. Collins reports
income and dividends as follows:

Income (€) Dividends (€)

2018 750,000 150,000

2019 1,000,000 250,000

2020 1,200,000 400,000

Calculate the investment in Collins plc that appears on Ryan plc’s balance sheet as of the end of
2020.
(3 Marks)

c. Briefly discuss two problems with the equity method of accounting for intercorporate investments
(3 Marks)

d. On 1 April 2020, a company issues €100,000 of 6% loan stock at par. Interest on this loan stock is
payable on 30 April each year beginning in 2021. The stock is due for redemption at par on 30 April
2024, but may be converted into ordinary shares on that date instead.

Calculate the fair value of the liability component and the equity component of this loan stock,
assuming that the fair value of the liability component is to be determined by cash flow analysis
using a discount rate of 8% per annum.
(4 Marks)
[Total: 14 Marks]

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Question 5
a. Below are the financial statements for Bat plc a firm which manufactures personal hygiene and
cleaning products.

Finance Costs -13.5

Profit before tax 168.75
Income Tax -45
Profit after tax 123.75

Bat plc Statement of Profit or Loss

2020 2019
£m £m
Revenue 1680 1340.5
Cost of Sales -1308.75 -1136
Gross Profit 371.25 204.5
Operating Costs -189 -181
Operating profits 182.25 23.5
Finance Costs -13.5 -16
Profit before tax 168.75 7.5
Income Tax -45 -2
Profit after tax 123.75 5.5

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a.
(i) Use three ratios of your choice to analyse the profitability of Bat plc in 2020 relative to
2019.
(ii) Use three ratios of your choice to analyse the solvency or activity of Bat plc in 2020
relative to 2019.
(6 Marks)

b. Based on your analysis performed in part ‘a’, and any other analysis you may choose to
perform, prepare a summary report advising the management of Bat plc. as to the strengths
and weaknesses of the firm’s performance in the areas of profitability and solvency.
(6 Marks)

c. Explain the differences between free cash flow to the firm and free cash flow to equity.
(2 Marks)
[Total: 14 Marks]

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Question 6
a. Audio Co. acquired 100% of MP4 ltd. by issuing 1,500,000 shares of its €1 par common stock (€20
market value). Immediately before the transaction, the two companies had the following
information:

Non current liabilities

Interest bearing loans and borrowings 32,000 4,000

Current Liabilities
Trade Payables 16,000 1,200
Total Equity & Liabilities 98,000 9,000

Consolidated Statement of Financial Position

€'000
Non current assets
Property Plant and Equipment 63,000 Franklin book value + Jefferson fai
Goodwill 19,200 Note 1

Current assets
Inventory 30,000 Franklin book value + Jefferson fai
Cash & Receivables 20,600 Franklin book value + Jefferson fai
Total assets 132,800

Show the post-combination balance sheet using the acquisition method

(5 Marks)

b. Why might a company requiring debt financing be incentivised to create a special purpose entity?
How do accounting regulations ensure transparency in this regard?

(3 Marks)
c. EZ plc sells goods to a UK-based customer for £100,000, payment to be received in British Pounds
Sterling.

Credit terms allow 60 days for payment. EZ plc’s functional and presentation currency is Euro.

 Exchange rate on date of the transaction: £1 = €1.140

 Exchange rate on date of payment: £1 = €1.165

Calculate EZ plc’s foreign exchange gain or loss.

(3 Marks)

d. Briefly explain what is meant by the term ‘substance over form’?

(3 Marks)
[Total: 14 Marks]

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Appendix A: Formula sheet

g = [ ROIC + (ROIC – NBC) x NIBD ] x (1 – PO)

E

Where:

g = sustainable growth rate

ROIC = ROIC after tax (based on the beginning of year balance sheet)
NBC = Net borrowing cost after tax in % (based on beginning of year balance sheet)
NIBD = Net interest-bearing debt
E = Equity
PO = Payout ratio (dividend as a percentage of net profit)

ROIC = Net operating profit after tax (NOPAT) x 100

Invested capital

ROIC before tax is measured as:

ROIC = Earnings before interest & tax x 100

Invested capital

Value added (EVA) = (ROIC – WACC) * Invested capital

Where:
ROIC = Return on invested capital after tax
BVE = Book value of equity
NIBD = (Book value of) net interest bearing debt
NBC = Net borrowing cost after tax in percent

Betaunlevered = Beta levered

[1 + (1-tax) (D/E)]

Betalevered = Betaunlevered [1 + (1-tax)(D/E)]

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EV = Enterprise value
ROIC = Return on invested capital after tax
Inv capital = Invested capital
WACC = Weighted average cost of capital

re = rf + βe (rm –rf)

Where:
re = investors’ required rate of return
rf = risk-free interest rate
βe = systematic risk on equity (levered beta)
rm = return on market portfolio

rd = (rf + rs) x (1 – t)

Where:
rd = Required rate of return on net interest-bearing debt (NIBD)
rf = risk-free interest rate
rs = credit spread (risk premium on debt)
t = corporate tax rate

Dividend valuation model (with dividend growth): P0 = Div

re-g

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Appendix B: Present value tables

Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386
11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239

(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.206 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.933
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065

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