ASSIGNMENT – BMMF5103

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MAY SEMESTER 2013

MANAGERIAL FINANCE – BMMF5103 ASSIGNMENT

INSTRUCTION: There are SIX questions. Answer ALL questions. Question 1 a) What does it mean to say that maximizing shareholder wealth is a “moral imperative” for

financial managers? [4 marks]

b) Briefly discuss “principal - agent problems” and “agency costs” as related to a

corporation. [4 marks]

c) What is the meaning of business ethics? By giving an example, explain why business

ethics is important to corporations? [4 marks]

d) Discuss the advantages and disadvantages of issuing common stock versus long-term

debt. [4 marks]

e) Name THREE main users of ratio analysis. For each group of user, discuss the type of

ratios that would be meaningful to them. [4 marks]

[TOTAL: 20 MARKS]

Question 2

a) Briefly explain the different categories of financial ratios. Discuss some of the limitations

of using the financial ratios to evaluate a company. [4 marks]

b) Assuming that everything else remains the same, briefly discuss the effect of an

increase in a company’s debt ratio to its return on equity. [4 marks]

c) A firm has notes payable of RM1,546,000, long-term debt of RM13,000,000, and total

interest expense of RM1,300,000. If the firm pays 8 percent interest on its long-term debt, what rate of interest does it pay on its notes payable?

[4 marks]

ASSIGNMENT – BMMF5103

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d) Stockholders’ equity was RM537 million at the beginning of the year. During the year,

the company generated RM128 million of net income and paid dividends of RM57 million. If the ending Stockholders’ Equity balance is RM485 million, what dollar amount of shares were repurchased throughout the year?

[4 marks] e) A corporation has a current ratio of 5.65 when the industry average is 1.42. What could

be the reason for this disparity? [4 marks]

[TOTAL: 20 MARKS]

Question 3 a) Why is the preferred stock also known as a hybrid security?

[4 marks]

b) MoonlightCorp has an outstanding preferred issue of stock with a par value of RM100 and an annual dividend of 10 percent (of par). Similar risk preferred stocks are yielding 11.5 percent annual rate of return.

(i) What is the current value of the outstanding preferred stock?

(ii) What will happen to the price of the preferred stock as the risk-free rate increases? Explain.

[4 marks]

c) The CenturyMotel Ltd. has been very successful in the past four years. Over these years, it has paid common stock dividend of RM4 in the first year, RM4.20 in the second year, RM4.41 in the third year, and its most recent dividend was RM4.63. The company is expected to continue this dividend growth indefinitely. What is the value of the company’s stock if the required rate of return is 12 percent?

[4 marks]

d) You are given the following data:

• The risk-free rate is 5 percent. • The required return on the market is 8 percent. • The expected growth rate for the firm is 4 percent. • The last dividend paid was RM0.80 per share. • Beta is 1.3.

Now assume the following changes occur: � The inflation premium drops by 1 percent. � An increased degree of risk aversion causes the required return on the market to

go to 10 percent after adjusting for the changed inflation premium. � The expected growth rate increases to 6 percent. � Beta rises to 1.5.

ASSIGNMENT – BMMF5103

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What will be the change in price per share, assuming the stock was in equilibrium before the changes?

[4 marks]

e) Barney Garden Bhd currently (2013) does not pay any dividend. However, the company is expected to pay a RM1.00 dividend two years from today (2015). The dividend is then expected to grow at a rate of 20 percent a year for the following three years. After the dividend is paid in 2018, it is expected to grow forever at a constant rate of 7 percent. Currently, the risk-free rate is 6 percent, market risk premium (rM – rRF) is 5 percent, and the stock’s beta is 1.4. What should be the price of the stock today?

[4 marks]

[TOTAL: 20 MARKS]

Question 4 a) In their meeting with their advisor, the Marians concluded that they would need

RM40,000 per year during their retirement years in order to live comfortably. They will retire 10 years from now and expect a 20-year retirement period. How much should they deposit now in a bank account paying 9 percent to reach financial happiness during retirement?

[4 marks] b) You are considering the purchase of new equipment for your company and you have

narrowed down the possibilities to two models which perform equally well. However, the method of paying for the two models is different. Model A requires $5,000 per year payment for the next five years and Model B requires the payment following the schedule as shown below:

[

Based on the above information, which model should you buy if your opportunity cost is 8 percent?

[4 marks]

Year

Payment (RM)

Model A Model B

1 5,000 7,000

2 5,000 6,000

3 5,000 5,000

4 5,000 4,000

5 5,000 3,000

ASSIGNMENT – BMMF5103

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c) To expand its operation, the Tyson Inc. (TI) has applied for a RM3,500,000 loan from the International Bank. According to TI’s financial manager, the company can only afford a maximum yearly loan payment of RM1,000,000. The bank has offered TI,

1) a 3-year loan with a 10 percent interest rate,

2) a 4-year loan with a 11 percent interest rate, or

3) a 5-year loan with a 12 percent interest rate.

Which option should the company choose? Justify your answer.

[4 marks]

d) How are present value and future value calculations related?

[4 marks]

e) In general, with an amortized loan, why does the principal portion of each payment grow over the life of the loan, while the interest portion of each payment decreases over the life of the loan?

[4 marks]

[TOTAL: 20 MARKS]

Question 5

a) Briefly explain the types of cash flows an investor will receive if he invests in bonds.

[4 marks] b) What is the relationship between interest rates and bond prices? When is a bond sold at

(i) a premium, and (ii) at a discount? [4 marks]

c) Param has recently inherited RM10,000 and is considering purchasing 10 bonds of the

Sunshine Corporation. The bond has a par value of RM1,000 with 10 percent coupon rate and will mature in 10 years. Does Param have enough money to buy 10 bonds if the required rate of return is 9 percent?

[4 marks] d) Molleque Industries has issued a bond which has a RM1,000 par value and a 15 percent

annual coupon interest rate. The bond will mature in ten years and currently sells for RM1,250. Using this information, what is the yield to maturity on Molleque’s bond?

[4 marks]

e) Differentiate between interest rate risk and reinvestment rate risk. To which type of risk are holders of long term bonds more exposed?

[4 marks]

[TOTAL: 20 MARKS]

ASSIGNMENT – BMMF5103

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Question 6

a) Billie Jean bought 100 shares of Dresidon Corp at RM24.00 per share on 1 January, 2009. He received a dividend of RM2.00 per share at the end of 2009 and RM3.00 per share at the end of 2010. At the end of 2011, he collected a dividend of RM4.00 per share and sold his stock for RM18.00 per share. What was Billie Jean’s realized rate of return during the three years holding period?

[4 marks] b) Given that the market expected return is 12 percent and standard deviation of 20

percent. The risk-free rate is 8 percent. Information related to three stocks are as follows: Stock Beta Ri(%) 1 0.8 12 2 1.2 13

3 0.6 11 i) Calculate the required rate of return for each stock using the SML.

[2 marks] ii) Assume that an analyst, using fundamental analysis, develops the estimates

labeled Ri for these stocks. Which stock would be recommended for purchase? Why?

[2 marks] c) Why is market risk sometimes said to be the “relevant” risk for a portfolio manager?

What is the measure of market risk? [4 marks]

d) Suppose the Security Market Line (SML) has a risk-free rate (kRF) of 5 percent and an

expected market return ( kM ) of 15 percent. Now suppose that the SML shifts, changing slope, so that kRF is still 5 percent but kM is now 16 percent. What does this shift suggest about investors’ risk aversion? If the slope were to change downward, what would that suggest?

[4 marks] e) You are an investor in common stock, and you currently hold a well-diversified portfolio

which has an expected return of 12 percent, a beta of 1.2, and a total value of RM9,000. You plan to increase your portfolio by buying 100 shares of Techno Bhd at RM10 a share. Techno has an expected return of 20 percent with a beta of 2.0. What will be the expected return and the beta of your portfolio after you have purchased the new stock?

[4 marks]

[TOTAL: 20 MARKS]