QQI / LJMU
BA (Hons) Accounting and Finance
Level 3
SUMMER 2015 EXAMINATIONS
Module Code B8AC020 / B8AF106
Module Description: Finance II/
Advanced Financial Management
Examiner: Mr. John Munnelly
Internal Moderator: Mr. Ian Browne
External Examiner: Dr Ciaran Mac An Bhaird
Date: Monday, 11th May 2015
Time: 2pm to 5pm
INSTRUCTIONS TO CANDIDATES
Time allowed is THREE hours.
Answer FOUR out of SIX questions.
Please show all workings clearly.
All questions carry equal marks.
Formulae and Mathematical Tables attached.
Question 1
Western Foods Ltd is evaluating an investment proposal to manufacture a new food product,
“The Chunky Bite”. Dave Evans, the managing director has asked you to evaluate the
following information relating to this investment proposal:
Initial investment €600,000
Selling price (current price terms) € 5 per unit
Expected selling price inflation 4% per year
Variable operating costs (current price terms) € 2 per unit
Fixed operating costs (current price terms) €41,000 per year
Expected operating cost inflation 3% per year
The investment in machinery €600,000 qualifies for tax allowances and can be written down
at 25% per year reducing balance basis.
Paul Hewson, Sales director of Western Foods has prepared the following demand forecast.
The forecast reflects expected demand from Retailers in the UK and Ireland for ‘The Chunky
Bite’.
Year 1 2 3 4
Demand (units) 75,000 84,000 108,000 67,000
It is expected that all units of ‘The Chunky Bite’ produced will be sold, in line with the
company’s policy of keeping no inventory of finished goods. The machinery scrap value is
expected at the end of four years to be €100,000. Mr Hewson expects sales to decline in year
4 as competitors will start to copy “The Chunky Bite”.
For investment appraisal purposes, Western Foods Ltd uses a nominal (money) discount rate
of 9% per year.
Taxation on profits are 30% and are payable 1 year in arrears.
Required:
Part A: Calculate the following relating to the investment appraisal above
(i) Net Present Value (N.P.V.) (15 marks)
(ii) Internal Rate of Return (I.R.R.) ( 6 marks)
Part B: Discuss the types of rationing that occurs in situations where
there is a restriction on the amount of investment capital available (4 marks)
(Total 25 marks)
Question 2
There is an argument going on between the Chairman and Chief Executive Officer of Brass
Monkeys International, over the latest trading results that have to be published to the stock
exchange. The Chairman believes that the company must issue the accounts honestly and let the
market see how the company has performed. However the Chief Executive strongly disagrees
and states that the company should not publish the bad results until after there is good news to
report.
You, the finance director have been called in to explain Market efficiency to both the Chairman
and Chief Executive.
Part A:
Distinguish between weak form, semi-strong form and strong form stock market efficiency
(12 Marks)
And discuss the significance to a listed company if the stock market on which its shares are
traded is shown to be semi-strong form efficient. (3 Marks)
Part B:
Since your meeting the Chief Executive Officer wishes to understand how share behaviour
works. Discuss the following
(i) Fundamental Analysis.
(ii) Technical Analysis.
(iii) Random Walk Theory. (10 Marks)
(Total 25 marks)
Question 3
Browne Equine Traders Ltd (B.E.T.L.) has recently appointed you as Financial Director.
Your first task in your new role is to calculate the weighted average cost of capital for the
company. The following information relates to the company at the current time:
Number of ordinary shares 15million
Book value of 10% convertible debt €28 million
Book value of 12% bank loan €7 million
Market price of ordinary shares €2.25 per share
Market value of convertible debt €103.15 per €100 bond
Equity beta of Browne
Equine Traders Ltd 0.8
Risk-free rate of return 2.7%
Average market return 4.5%
Rate of taxation 30.0%
Browne Equine Traders Ltd (B.E.T.L.) expects share prices to rise in the future at an average
rate of 7% per year. The convertible debt can be redeemed at par in six years’ time or
converted in four years’ time into 50 shares of Browne Equine Traders Ltd (B.E.T.L.) per
€100 bond.
Required:
(a) Calculate the market value weighted average cost of capital of Browne Equine
Traders Ltd
(12 marks)
(b) Discuss whether the dividend growth model or the capital asset pricing model offers
the better estimate of the cost of equity of a company.
(4 marks)
(c) The Managing director has heard something about risk but wants you to explain the
following to him.
(i) Business risk
(3 marks)
(ii) Operating risk
(3 marks)
(iii) Financial risk
(3 marks)
(Total: 25 marks)
Question 4
McDuck plc a duck sandwich fast food business that has undergone significant growth over
the past 5 years. To help its expansion plans, McDuck is considering a takeover of Fab Fries
plc. Who specialise in French Fries. Both companies are quoted, and are in the same business
sector. The Management of McDuck feel that this acquisition target will complement its
business.
Financial information for Fab Fries is as follows:
Number of ordinary shares 20 million
Ordinary share price €3.20
EPS 60 cent
Proposed payout ratio 50%
DPS one year ago 18.5 cent
DPS two years ago 16.5 cent
Equity beta 1.1
Other relevant information is as follows:
Average sector P/E 7
Risk-free rate of return 4.2%
Return on the market 11.6%
Required:
(a) Calculate the value of Fab Fries plc. using the following methods:
i. Market capitalisation (3 marks)
ii. Price/earnings ratio method (3 marks)
iii. Discuss any problems arising from using the P/E method (3 marks)
(b) Calculate the Dividend growth model (8 marks)
(c) Discuss what factors to consider when using asset-based methods to value a firm.
(8 marks)
(Total: 25 marks)
Question 5
Your company is considering an acquisition of a leading competitor but the CEO is unsure of
the synergies that may arise as a consequence of the acquisition.
Part A explain
Revenue Synergy
Cost Synergy
Financial Synergy (12 marks)
Part B
Advise the board of directors of your company of any corporate issues that might arise as a
consequence of the acquisition. (13 marks)
(Total 25 marks)
Question 6
As a newly appointed Finance Manager to Z Cars International a company based in Ireland
whose main currency is the Euro. Your manager has called you in to discuss the increasing
risks the business.
Part (a)
Explain the 4T’s approach to risk Management (6 Marks)
Part (b)
The company has the following Debtor Baz who will pay Z cars International £700,000
Sterling in 3 months time. At the same time Z Cars must pay a creditor £1,100,000.
(i) Show how netting might help minimise the currency exposure (2 Marks)
(ii) The following annual interest rates and exchange rates are currently available:
£ Sterling Euro
Deposit Rate Borrowing Rate Deposit Rate Borrowing Rate
8% 10% 9% 13%
Exchange Rate (£ per €) Bank Sells Bank Buys
Spot 0.8106 – 0.8138
3 months forward 0.8223 – 0.8257
Using the netted off amount, calculate the cost in three months’ time of hedging
using the following methods
The Forward Hedge (5 Marks)
The Money Market Hedge (8 Marks)
Part (c)
Explain what is meant by Caps and Floors (4 Marks)
(Total 25 marks)
FORMULAE
PRESENT VALUE OF A SHARE (Dividend Valuation Model)
Po = Div0 (1+g)
(Ke – g)
COST OF EQUITY CAPITAL
Ke = [Do (1+g)] +g
Po
CAPITAL ASSET PRICING MODEL
Ke = rf + β [E(rm) – rf]
WEIGHTED AVERAGE COST OF CAPITAL AFTER TAX (WACC)
WACC = Ke x E + Kd x (1-T) x D
E+D E+D
ASSET BETA
β asset = β equity x E .
E + D (1-T)
EQUITY BETA
β equity = β asset x E + D (1-T)
E
NOMINAL AND REAL RETURNS
(1 + i) = (1 + r) (1 + h)
INTERNAL RATE OF RETURN
IRR = L + {(NL/(NL - NH)) x (H-L)}
GROWTH ESTIMATION FORMULA
PURCHASING POWER PARITY AND INTEREST RATE PARITY
S1 = So x (1+hc)/(1+hb) F0 = So x (1+ic)/(1+ib)
GORDONS GROWTH APPROXIMATION
b = re
PRESENT VALUE TABLE
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
ANNUITY TABLE
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 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.893 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.37 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.26 10.58 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.13 11.35 10.63 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.00 12.11 11.30 10.56 9.899 9.295 8.745 8.244 7.786 7.367
15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606
(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 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.496 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.586 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675