ECONM1007MScFAExam.docx
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ECONM1007MScFAExam.docx
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ECONM1007MScFAExam
UNIVERSITYOFBRISTOL
ExaminationfortheDegreeofM.Sc.inAccounting,FinanceandManagement,
andinEconomics,FinanceandManagement
MAY/JUNE2008
EXAMPAPERNUMBERECONM1007
FINANCEANDACCOUNTING
(ModuleNo.ECONM1007)
Timeallowed:
THREEhours
AnswerTHREEquestionsfromthefollowingFIVE,
TWOfromSectionAandONEfromSectionB.
QuestionsinSectionAcarry35markseachand
questionsinSectionBcarry30markseach
Approvedelectroniccalculatorsmaybeused,butcandidates
mustshowthebasisofallcalculations.
Interesttablesareprovided.
Youmayfindthefollowingformulaehelpfulintheexamination:
MVg=MVu+DTc
Keg=Keu+[(Keu-rd)(1-Tc)(D/E)]
g=u+u(1-Tc)(D/E)
TURNOVER
SECTIONA
AnswerTWOquestionsfromthissection.Answerallpartsofthequestionyouchoose.
Question1
TheDirectorsofBlenheimplcaretryingtofindanappropriatecostofcapitaltouseinappraisingnewprojects.AsastartingpointtheywanttofindtheexistingWeightedAverageCostofCapital(WACC)ofthecompany.
Blenheimplchasanauthorisedsharecapitalof10million50pordinaryshares,ofwhich7millionhavebeenissued.Thecurrentexdivmarketpriceperordinaryshareis120pandadividendof15ppersharehasrecentlybeenpaid.Thecompanymaintainsapolicyofpaying40%ofitsprofitsaftertaxasadividendeachyear.Earningsretainedproduceareturnof10%whenreinvested.Extractsfromthelatestbalancesheetaregivenbelow:
£’000
Issuedsharecapital
3,500
Sharepremium
500
Retainedearnings
3,500
Shareholders’funds
7,500
NonCurrentLiabilities
2.6%irredeemabledebentures
1,000
3%redeemabledebentures
1,800
Bankloans
2,600
Alldebtinterestispayableannuallyandinterestpaymentshavejustbeenmadeonallthedebentures.Thecurrentex-interestmarketpricesfor£100nominalvalueare£80.40forthe2.6%debenturesand£105.70forthe3%debentures.The3%debenturesareredeemableatparin20years’time.
Thebankloansbearinterestat2%abovebaserate,whichiscurrently6%,andaredueforrepaymentin6years.Theeffectiverateofcorporationtaxis30%.
Required:
(a)CalculatetheeffectiveaftertaxWACC.
[12marks]
(b)WhatfactorswouldBlenheimplcneedtoconsiderbeforeusingtheWACCcalculatedin1(a)toappraiseanewproject?
[8marks]
(c)Ithasbeenarguedthatthepatternofdividendspaidtoshareholdersisirrelevantwhenvaluingthesharesofacompany.Explainthisargumentanddiscuss3factorsrelatingtothefinancialaspectsofacompanywhichmay,inpractice,influencethelevelofdividendsacompanydistributestoitsshareholders.
[15marks]
TURNOVER
Question2
GreymouthplcisaUnitedKingdom(UK)basedmanufacturerofnavigationequipmentforaircraft.Thecompanyiscurrentlyconsideringwhetherornottoestablishanewmanufacturingdivision,whichwillproducepassengersafetyequipmentforcars.TheBoardofDirectorshasaskedtheFinanceDepartmenttoconductafinancialappraisaloftheproposal.Thecompanyemploysnetpresentvalueanalysisfortheappraisalofallitslong-termprojects.
Thefollowinginformationhasbeentakenfromthebalancesheetofthecompanyfortheyearjustended:
£’m
Shareholdersequity
£1ordinaryshares
200
Retainedprofits
800
1,000
NonCurrentLiabilities
6%loanstock
300
Bankloan
200
500
Theordinaryshareshaveacurrentmarketvalueof£5.35pershareandthegearedbetaofthecompanyis1.2.Thereturnfromthemarketis10.4%andtheriskfreerateis5.1%.Theloanstockisirredeemableandcurrentlytradingat£110per£100nominalvalue.Itcanbeassumedthatallofthecompany’sloancapitalisriskfree.Thecompanywillnotneedtoraisenewfinancefortheexpansion.
TheFinanceDepartmenthasidentifiedacompanywhichmanufacturespassengersafetyequipmentforcars.Thecompanyisfinanced50%byequityand50%bydebt,basedonmarketvalues,andhasagearedbetaof1.6.
Theeffectiverateofcompanytaxforbothcompaniesis25%.
Required:
(a)ExplainwhytheexistingWeightedAverageCostofCapital(WACC)ofGreymouthshouldbeadjustedwhenevaluatingthenewinvestmentproposalandwhatproblemsmaybeencounteredinmakinganyadjustment.
[8marks]
(b)UsingtheModiglianiandMillerequations,calculatetheWACCthatshouldbeusedasthediscountratewhenevaluatingthenewproposal.
[12marks]
(c)Ithasbeensuggestedthatthelevelofgearingemployedbyacompanywillhavenoeffectonitsoverallcostofcapital.Discusstheargumentsforandagainstthisviewpoint.
[15marks]
Question3
MethvenplcisamanufacturerofelectronicdevicesintheUnitedKingdom(UK).IthasbeenapproachedbyanAmericancompanywhoownthepatentrightstoanewdevicewhichisquicklybecomingverypopularintheUnitedStatesofAmerica.MethvenplchavebeenofferedexclusiverightstomakeanddistributethedeviceintheUKforanimmediatepaymentof£3.2millionandaroyaltyof£1foreachdevicesold.Researchwascarriedout,atacostof£0.4million,whichshowedthatifMethvenplccharged£9perdevicetheywouldbeabletosell400,000devicesineachofthenext4years.After4yearsmoreadvancedtechnologywouldrenderthedevicesobsolete.
Productionwouldrequireequipmentcosting£1milliontobeboughtimmediately.Thisequipmentwouldhavearesidualvalueattheendof4yearsof£0.5million.Thevariablecostsofproduction(excludingtheroyaltypayment)areestimatedtobe£3.25perunitandthefixedcostsareexpectedtobe£1.325perannumincludingstraightlinedepreciationofthenewproductionequipment.Halfofthefixedcosts,excludingdepreciation,area‘fairshare’ofthecentraloverheadcostsofthecompany,whiletheremainderrelatedirectlytotheproductionofthenewdevice.
Methvenplcisfinanced100%byequityandthecompany’sshareshaveabetavalueof1.2.Themarketrateofreturnis9%andtheriskfreerateis4%.
Required:
(a)Basedonanetpresentvalueanalysis,adviseMethvenplconwhethertheyshouldproduceandsellthisnewdevice.
[13marks]
(b)Carryoutsensitivityanalysistoshowbyhowmucheachofthefollowingwouldhavetochangebeforeyourdecisionin3(a)changes:
i.Theresidualvalueoftheequipment
ii.Thenumberofdevicessoldperannum
iii.Thesellingprice
iv.Thediscountrate
Commentontheresultsofthesensitivityanalysis.
[16marks]
(c)Discusstheassumptionsyouhavemadeinestimatingthecostofcapitalandcommentonwhetheryouthinkthesearereasonableinthecurrentsituation.
[6marks]
TURNOVER
SECTIONB
AnswerONEquestionfromthissection.Answerallpartsofthequestionyouchoose.
Question4
(a)Acompanypurchasedacaron1April2006for£15,000,whichisbeingdepreciatedover5years.Plantandmachineryof£20,000waspurchasedonthesamedate.Itisbeingdepreciatedby25%onareducingbalancebasis.On31January2008thecarissoldfor£8000.Whatentrieswilltherebe,inthefinancialstatements,inrespectoftheseassetsfortheyearended31March2008?
Youmayassumethatthereisnodepreciationintheyearofdisposal,butafullyear’sdepreciationintheyearofpurchase.
[6marks]
(b)Acompanyistoissue300,000£1ordinarysharesatanissuepriceof£3.
(i)Whatentrieswilltherebeinthefinancialstatementstoreflectthis
transaction?
[3marks]
(ii)Discussthedifferencesbetweenanofferforsaleshareissueandarightsissue.
[3marks]
(c)PictonLtdwasrecentlyformedtoimportphotocopiersfromAsia.Thebalancesheetofthecompanyat31May2008isasfollows:
Balancesheet
PictonLtd
£
Non-currentassets
Freeholdpremises
116,000
Equipment
54,000
170,000
Currentassets
Inventories
125,000
Tradereceivables
228,000
Cash,shorttermdepositsetc
22,000
375,000
CurrentLiabilities
Tradepayables
(125,000)
Accruedoverheads
(12,000)
Dividends
(22,000)
(159,000)
NetCurrentassets
216,000
TotalAssetslesscurrentliabilities
386,000
Equity
£1Ordinaryshares
350,000
Retainedprofit
36,000
386,000
ThelevelofsaleshasremainedconstantoverthepastthreemonthsandtheSalesDirectorhasestimatedthatsalesofphotocopiersoverthenext6monthswillbeasfollows:
Month
SalesUnits
June
50
July
40
August
60
September
80
October
80
November
100
TheSalesDirectorisnotveryconfidentabouttheaccuracyoftheseforecastsasthebusinessisstillrelativelynewandthemarketforphotocopiershasbecomeverycompetitiveinrecentmonths.
Thephotocopiersaresoldfor£2,850eachandcost£2,500tobuy.Allsalesaremadeon2monthscredit.Theoperatingexpensesofthecompanyareexpectedtobe£15,000inJune2008,risingto£18,000foreachofthenext4monthsandthenrisingagainto£22,000inNovember2008.Theseoperatingexpensesarepaid1monthaftertheyareincurredandincludeadepreciationchargeof£1,500permonth.
Thecompanyisgiven1monthscreditfromitssuppliersandbuysthephotocopiersthemonthbeforetheyaresold.Newequipmentandvehiclescosting£55,000willbepurchasedandpaidforinNovember2008.Thesewillbeneededtocopewiththeforecastincreaseinsales.
ThecompanyannouncesadividendinMayandNovembereachyearandthepolicyofthecompanyistopaydividends2monthsaftertheyareannounced.ThedividendforNovember2008isplannedtobe£15,000.
Required:
(i)Prepareacashflowforecastforeachofthe6monthsto30November
2008.
[12marks]
(ii)Prepar
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