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Department of Accounting and Finance
M.Sc. Finance
And
M.Sc. International Accounting and Financial Studies
Finance III and IV
Tuesday 6 th^ May 2008 10.00am – 1.00pm (3 hours)
Instructions for Candidates
Answer ALL Questions from Section A (in the spaces provided),
ONE Question from Section B (in the GREY answer book)
and ONE Question from Section C (in the PURPLE answer book)
[Failure to comply will result in papers not being marked]
Calculators must not be used to store text and/or formulae nor be capable of communication. Invigilators may require calculators to be reset. All answers are to be written in the spaces provided in ink. Please write clearly as illegible writing cannot be marked. If more space is required the answer can be continued on the back of the page where the question appears. Failure to follow these requirements will lead to a deduction of marks.
To Be Completed (please write clearly)
Family Name:
Other Name:
Course (please indicate by ticking appropriate box)
M.Sc. Finance M.Sc. IAFS
For Examiners Use Only SECTION A TOTAL MARKS
.Sc. Finance (D1) 1
Section A Answer ALL Questions
Q1. The finance director of Pollock plc has established that it would be possible to borrow £100 million at an interest rate of 8 per cent to fund a proposed capital expenditure programme. Alternatively the company could issue 50 million shares at the prevailing market price of £2.00 to raise the funds. The company currently has 160 million shares outstanding and has not previously employed any debt in its financing. The company's expected earnings before interest and tax for next year, after taking the expansion of the company's assets into account, has been estimated to be £90 million and it is anticipated that this level of earnings can be maintained indefinitely into the future..
a) Assuming a corporate tax rate of 30 per cent determine the expected earnings per share of the company under both forms of financing. (2 marks)
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b) At what level of earnings before interest and tax will both financing plans produce the same level of earnings per share?
.Sc. Finance (D1) 2
b) Using the Modigliani-Miller model with tax, determine the value of the company if it employs the debt financing. Explain briefly the basis of the difference in the value for Pollock plc, with and without the use of debt. (2 marks)
c) Determine the cost of equity capital and the weighted average cost of capital with the geared capital structure. (3 marks)
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Q3. Demonstrate using a diagram the equilibrium position in Miller’s Debt and Taxes analysis if the risk adjusted cost of equity is 10 per cent and the corporate tax rate is 30 per cent. (2 marks)
.Sc. Finance (D1) 4
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Q4. Webman plc is planning a rights issue for £420m so as to be able to reduce its level of debt. The board of directors approved the issue even though considerable concern was expressed over the possible reaction of the shareholders as the company’s recent financial performance has been poor. The company’s profitability has fallen significantly over the last three years, and the share price is now well below the peak recorded in 2005. Its cash flows are also well below the level anticipated when its level of debt was initially increased. The finance director is holding discussions with the company’s investment bank and is considering the terms to be set for the rights issue, and whether or not to have the issue underwritten. The current share
.Sc. Finance (D1) 5
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Q6. The board of directors Johnson plc has decided in taking dividend decisions that its long term target payout ratio is 60 per cent and that it will only increase dividends if the increase appears to be sustainable. The directors tend to adjust the dividend payment by 50 per cent of the difference between the target dividend and the previous period’s dividend. The company's last dividend per share was 80p, and its earnings per share for the next three years are expected to be 140p, 160p, and 150p.
What dividends can the company be expected to pay over the next three years if earnings are in line with expectations? Comment on the expected dividend in year 3. (3 marks)
.Sc. Finance (D1) 7
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Q7. A company needs to hold a stock of item X for sale to customers. Although the item is of relatively small value per unit, the customers’ quality control requirements and the need to obtain competitive supply tenders at frequent intervals result in high procurement costs. Basic data about item X are as follows:
Annual sales demand (D) over 52 weeks = 4,095 units Cost of placing and processing a purchase order (procurement costs – C (^) o) = £48. Cost of holding one unit for one year (C (^) h) = £4. Normal delay between placing purchase order and receiving goods = 3 weeks
a) Calculate
i. The economic order quantity for item X. (1 mark)
.Sc. Finance (D1) 8
b) Are there any other factors which the company might take account of before making a final decision? (2 marks)
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Q9. X is a bank that has weathered the recent liquidity crises well. Bank X knows that bank Y is in some financial difficulty and has decided to make an offer for this bank. Bank X has 100 million shares outstanding which are currently trading at £4.80 per share. In contrast, Bank Y’ shares are currently trading at £0.80, down from a high of £3.50 only six months ago. The bid will be in the form of shares. Bank Y has 500 million authorised shares but only 200 million of these are outstanding at the present time. It is believed that cost savings with a present value of £80 million can be achieved if the takeover goes ahead.
a) Assuming no premium is paid on the current market price, and Bank X’s share price does not change on the announcement day of the offer, how many shares should Bank X offer per Bank Y share? (2 marks)
.Sc. Finance
b) What is the net cost of the takeover? (3 marks)
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c) What is the likely impact of a take over on the price of Bank Y’s shares. (3 marks)
.Sc. Finance
(TOTAL 50 MARKS)
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.Sc. Finance
Section B Answer ONE Question
Q1. Discuss some of the hypotheses put forward to explain what appears to be a tendency to under-price initial public offers. (25 MARKS)
Q2. Explain and discuss Lintner’s model for the determination of dividend payments and comment on the possible determinants of the target payout ratio and adjustment factor. (25 MARKS)
Q3. a) Explain what is meant by a rights issue and discuss the advantages and disadvantages of such issues for companies and their shareholders. (12 marks)
b) Explain and discuss some of the theories developed to explain the tendency of the market to react adversely to the announcement of an equity issue. (13 marks) (TOTAL 25 MARKS)
Q4. Explain what is meant by bankruptcy costs and critically evaluate the role of these costs in the trade-off model’s explanation of the determination of the optimal capital structure. (25 MARKS)
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.Sc. Finance
