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Department of Accounting and Finance
M.Sc. Finance
And
M.Sc. International Accounting and Financial Studies
Finance I
Class Test A & B
Tuesday 8 th November 2005 11.00am – 12.00pm (1 hour)
Instructions for Candidates
Answer ALL Questions (in the spaces provided) [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 Issued: Discount Tables
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
Comments
SOLUTIONS
TOTAL MARKS
AWARDED
NPV = I(i – r)/r 10,000 = 50,000 (i – r)/r (i – r)/r = 10,000/50,000 = 0. i = 1.20 x r = 1.20 x 0.10 = 0.
Q3. You have £30,000 invested in a pension fund that promises a minimum rate of
return on the assets it holds of 6 per cent. You have twenty years to go to retirement and you would like to receive an annual pension payment of £35,000 per annum for an anticipated retirement period of 15 years. You would also like to have £100,000 left in the fund at the end of this 15 year period. How much would you need to contribute to the fund on an annual basis until you retire to meet your objectives? (Assume all payments and receipts occur at the end of the year.)
(10 marks)
At the start of the retirement period you will require
W 15 = 35,000 PVAF15/0.06 + 100,000 PVF 15/0.
35,000 x 9.7122 + 100,000 x 0.
339,927 + 41,
381,
Deduct the futures value of the £30,000 you have already invested in the fund
This leaves a shortfall of 381,657 – 96,214 = 285,
The annual contribution to the fund
W**
Q4. The senior managers of the Scotia division of Global Services plc are negotiating a management buyout of the division. A price of £6 million has been agreed and the company has agreed that this can be paid on the basis of a down payment of £ million followed by four equal annual instalments. Determine the value of the annual instalment if the company intends charging an interest rate of 12 per cent on the outstanding balance of the amount owned by the buyout group.
(8 marks)
Loan = Instalment x PVAF4/0.
Loan = £4m = I x 3. I = £4m/3. = £1,316,
Q5. An investment of £100,000 is expected to produce a constant net cash flow of
£29,130 for each of the next 8 years and the required rate of return is 14 per cent.
a) Calculate the payback period and the approximate value of the discounted payback period for the investment.
(8 marks)
Payback period = Outlay/constant net cash flow = 100,000/29,130 = 3.43 years
Discounted payback period
Investment = C x PVAFn/0. 100,000 = 29,130 x PVAFn/0. 3.43 = PVAFn/0.
Use tables to identify n
Q6. a) If the real rate of interest is 4 per cent determine the rate of interest that
compensates fully for an expected rate of inflation of 8 per cent.
(4 marks)
r m = r 0 + f + r0f = 0.04 + 0.08 + 0.04 x 0. = 0.
b) If the rate of return offered on a deposit account last year was 14 per cent and the rate of inflation over the year was 9 per cent what real rate of return was earned on the deposit account?
(4 marks)
r 0 = (r m – f)/(1 + f) = (0.14 – 0.09)/1. = 0.
Q7. A proposed strip mining investment is expected to produce a constant annual net cash flow from year one to year seven, a higher next cash flow in year eight, when some of the machinery and vehicles used in the project are expected to be sold, and a negative cash flow in year nine when the work necessary to return the land to its former use will be undertaken. The investment will require an initial outlay of
£120,000 while the expenditure required in year nine is expected to be around
£40,000. The net cash flows are as follows and the company’s cost of capital (the required rate of return) is 12 per cent.
Time NCF
0 -120,
1 → 7 +27,
8 +63,
9 -40,
Evaluate the project using only a discounted rate of return measure (the modified rate of return) to identify whether or not the project can generate a positive net present value.
(10 marks)
Time NCF Adj. NCF
0 -120,000 -120,
1 → 7 +27,627 +27,
8 +63,341 -35,714 +25,
9 -40,
Calculate discounted rate of return
NPV = 0 = -120,000 + 27,627 PVAF8/i PVAF8/i = 120,000/27,627 = 4. i = 0.
Q8. Using the incremental rate of return choose between the following investments if the required rate of return is 11 per cent
Outlay Net Cash Flows (1 → 8) IRR A -40,000 9,210 16% B -70,000 15,676 15.15% (10 marks)
Outlay NCF DCF R of R A -40,000 9,210 16% B -70,000 15,676 15.15% Incremental -30,000 6,467 14%
(2 marks)
Q10. The management of Hendy Ltd is considering the introduction of a new product.
This would require an investment in some machinery required to manufacture the product and in a marketing programme. The development of the product has already cost £200,000 and it now meets all the regulatory requirements for a product of this nature. The marketing of the product will cost £50,000, an expenditure that can be recognised for tax purposes once it is undertaken. The product is expected to sell for £25.00 and annual sales of 300,000 units are anticipated. The expenditure required on new machinery will be £800,000 and the project will make use of some machines already owned by the company that are fully depreciated for tax purposes, but worth £150000 in the re-sale market. It is expected that the new and old machinery will be sold for scrap to realise
£120,000 at the end of the five year life anticipated for the product. The new machine will qualify for straight line depreciation over the five year period. The company will also have to invest in some working capital, made up of £80,000 of raw materials and 10 per cent of the expected sales of the final product. The variable cost per unit is expected to be £ 8.00 and the fixed costs per annum are expected to amount to £80,000. The fixed costs do not include the rent of
£30,000 on the premises required for the production process. The company allocates overhead charges to its various products on the basis of 10 per cent of annual revenues generated by a product. The tax rate is 30 per cent and the required rate of return is 14 per cent. Calculate the investment’s NPV and specify the key assumptions made in the analysis.
(12 marks)
Profit and Loss Account
Revenues 7,500,000 7,500,000 7,500,000 7,500,000 7, Variable costs -2,400,000 -2,400,000 -2,400,000 -2,400,000 -2, Fixed costs -80,000 -80,000 -80,000 -80,000 - Rent -30,000 -30,000 -30,000 -30,000 - Marketing costs -50, Capital allowances -160,000 -160,000 -160,000 -160,000 -
Capital adjustments -150,000 12 Profit -200,000 4,830,000 4,830,000 4,830,000 4,830,000 4, Tax 60,000 -1,449,000 -1,449,000 -1,449,000 -1,449,000 -1, Cash Flow Statement 0 1 2 3 4 Investment Outlay – new investment -800, Outlay – old investment -150, Recovery value Revenues 7,500,000 7,500,000 7,500,000 7,500,000 7, Variable costs -2,400,000 -2,400,000 -2,400,000 -2,400,000 -2, Fixed costs -80,000 -80,000 -80,000 -80,000 - Rent -30,000 -30,000 -30,000 -30,000 - Marketing costs -50, Working capital Materials -80,000 8 Final product -240,000 24 Tax 60,000 -1,449,000 -1,449,000 -1,449,000 -1,449,000 -1,
NCF -1,260,000 3,541,000 3,541,000 3,541,000 3,541,000 3,
PVF 1 0.87719298 0.76946753 0.67497152 0.59208028 0.
Present values -1,044,000 3,106,140 2,724,685 2,390,074 2,096,556 1, NPV 11,260, TOTAL 100 MARKS
M.Sc. Finance (A4) 6 of 6
