FNCE90060 Financial Management test

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THE UNIVERSITY OF MELBOURNE – DEPARTMENT OF FINANCE
PRACTISE FINAL EXAMINATION – SEMESTER 1, 2021

SUBJECT NUMBER: FNCE90060
SUBJECT NAME: Financial Management
EXAMINATION DURATION: 2 hours 15 minutes
EXAMINATION UPLOAD TIME: 30 minutes
TOTAL EXAMINATION TIME: 2 hours 45 minutes
TOTAL MARKS: 60% of Final Grade
NUMBER OF PAGES: 10 (including cover this page)

INSTRUCTIONS TO STUDENTS
1. This exam consists of two parts:

• Part A (ten multiple choice questions worth 2 marks each) is an LMS Quiz;
• Part B (eight questions worth 5 marks each) is a Gradescope assignment.
• Both parts must be completed and all questions must be answered.

2. Answers to Part B should be hand-written. Typed answers will not be accepted.
3. For full credit in Part B, show all your calculations. Not showing your work or not providing

an explanation means no marks.
4. Online examinations must be submitted on or before the specified time.

a. Late submissions will attract a 10% penalty of the total maximum mark for the exam
for each 30 minutes (or part thereof) after the submission deadline.

b. Submissions 1 hour after the submission deadline will not be marked.
c. Students who were prevented from submitting due to technical difficulties will need to

apply for technical consideration with supporting documentation.

NEED HELP DURING YOUR EXAM:

All exams will be moderated. Please log your concern via the Canvas chat board in the first
instance using the Big Blue Button. Alternatively, you can call the following numbers for
assistance during the exam if you are experiencing technical difficulties. Inside Australia:
13MELB (13 6352) (select Option 1 for current students then select Option 1 again for exam
enquiries). Outside Australia: +61 3 9035 5511 (select Option 1 for current students and then
select Option 1 again for exam enquiries). You will be able to contact your examiner during
the examination reading time. Do not contact your lecturer during the examination period.

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Part A 10 x 2 marks = 20 marks

Complete the Quiz on the Financial Management LMS

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Part B 8 x 5 = 40 marks

Question B1 [5 marks]

This year Woolcott Industries will produce 500,000 drones, and each drone requires wings. Woolcott buys
wings from an outside supplier at a price of $3.50 each, but the Woolcott plant manager believes that it
would be cheaper to make these wings in-house rather than buy them. Direct in-house production costs
are estimated to be only $3.00 per wing. The necessary machinery would cost $800,000 this year. This
investment would be depreciated to zero for tax purposes using straight line depreciation over the
machine’s 10-year productive life, beginning next year. After 10 years in production, the machine will be
obsolete and will have no salvage value. The plant manager estimates that the operation would require
additional working capital of $60,000 this year but argues that this sum can be ignored since it is
recoverable at the end of the ten years. Woolcott pays tax at a rate of 30% and has an opportunity cost of
capital of 12%.

What is the NPV of manufacturing the wings in house instead of purchasing them from the supplier?

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Question B2 [2+1+2=5 marks]

Suppose that FDU Financial Inc. issued a bond with 10 years until maturity, a face value of $1000, and a
coupon rate of 11% (annual payments). The yield to maturity on this bond when it was issued was 5%.

a. What was the price of this bond when it was issued?
b. Assuming the yield to maturity remains constant, what is the price of the bond immediately
before it makes its first coupon payment?
c. Assuming the yield to maturity remains constant, what is the price of the bond immediately
after it makes its first coupon payment?

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Question B3 [1+1+1+2=5 marks

We are now at the beginning of Year 1. At the end of Year 1 you expect that Harp Enterprises will have
earnings per share of $1.50. The firm retains 60% of its earnings to invest in projects with an expected
return of 15% per year, in perpetuity. Harp’s equity cost of capital is 12%.

a) Estimate the earnings growth rate.
b) Estimate the firm’s Year 2 earnings.
c) Estimate the Year 2 dividend payment.
d) What is the price of a share of Harp’s stock at the beginning of Year 1?

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Question B4 [1+1+1+2=5 marks]

Consider the following portfolios:

Portfolio
Expected
Return

Covariance
with A

Covariance
with B

Covariance
with C

A 3% 0.36 -1.44 0
B 11% -1.44 5.76 2.35
C 16% 0 2.35 1.96

a) Find the expected return and volatility of a portfolio that consists of a long position of $8,000 in

portfolio A and a long position of $2000 in portfolio B.
b) Given your answer from part a), what is the risk-free rate in this economy?
c) When combined with a risk-free investment, which of the three risky portfolios would suit a risk-

averse investor? Which portfolio would a risk-seeking investor choose?
d) Suppose an investor had a required return of 20%. Assume the investor can only invest in the

three portfolios (no risk-free bonds are available, but it is possible to short-sell portfolios). What
weights (percentages) of A, B and C would give the investor the required return for the lowest
risk?

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Question B5 [2+3=5 marks]
After market close yesterday, Cisco announced their quarterly results. As a result of the news, the
expected price of a share of Cisco stock in one year from now changed. The table below gives the last
price the stock traded for before the market closed yesterday, the new expected price after the results
were announced, and the CAPM beta for the stock.

Stock

Closing
Price

P0

New Expected
Price in 1 Year

E(P1)
CAPM
Beta

Cisco $45 $50 1.2

Markets have not yet opened today. The risk-free rate is 2% and the expected return of the market
portfolio is 7%. Assume Cisco does not pay dividends. Assume that the CAPM holds, and that the
expected return on the market and the stock’s beta do not change.

a) What should be today’s opening price for Cisco, according to the CAPM?
b) Before last night’s news, what was the expected price in one year of Cisco’s stock?

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Question B6 [1+1+2+1=5 marks]
Parkville Corp has just completed a recapitalization which raised its debt/equity ratio to 3, it’s equity beta
to 2.2, and it’s debt beta to 0.5. Before the recapitalization, the firm’s debt/equity ratio was 0.5 and it’s
debt was risk-free. The risk-free rate is 3% and the expected return on the market is 8%. Assume perfect
capital markets.

a) What is Parkville’s unlevered beta?
b) What was the beta of Parkville stock before the recapitalization?
c) What is Parkville’s cost of equity before and after the recapitalization?
d) Did Parkville’s cost of equity change after the recapitalization? Briefly explain why or why not.

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Question B7 [3+2=5 marks]

Alinda Technologies has $60 million in excess cash and no debt. The firm expects to generate
additional free cash flows of $50 million per year in perpetuity and will pay out these future free
cash flows as regular dividends. Alinda’s unlevered cost of capital is 8% and there are 20 million
shares outstanding. The firm’s board is meeting to decide whether to pay out its $60 million in
excess cash as a special dividend or to use it to repurchase shares of the firm’s stock.

Suppose that you own 5,000 shares of Alinda stock and that Alinda uses the entire $60 million to
pay a special dividend. You are unhappy with Alinda’s decision and would have preferred that
Alinda used the excess cash to repurchase shares. Show exactly how you could undo the dividend
in a way that will provide you with the same outcome that you would have obtained if Alinda had
instead repurchased shares. Assume perfect capital markets.

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Question B8 [1+2+2=5 marks]
Boyne Pty currently has permanent debt and the present value of its interest tax shield is $262.5 million.
The firm’s debt/equity ratio is 0.5. Boyne’s cost of debt is 8%, its current cost of equity is 15%, and its
marginal corporate tax rate is 35%.

a) What is the market value of Boyne’s debt?
b) What would be the firm’s cost of capital if the firm had no debt?
c) What would be the market value of the firm if the firm had no debt?

END OF EXAMINATION

INSTRUCTIONS TO STUDENTS
NEED HELP DURING YOUR EXAM:
Complete the Quiz on the Financial Management LMS
Question B1 [5 marks]
Question B2 [2+1+2=5 marks]
Question B3 [1+1+1+2=5 marks
Question B4 [1+1+1+2=5 marks]
Question B5 [2+3=5 marks]
After market close yesterday, Cisco announced their quarterly results. As a result of the news, the expected price of a share of Cisco stock in one year from now changed. The table below gives the last price the stock traded for before the market clos…
Markets have not yet opened today. The risk-free rate is 2% and the expected return of the market portfolio is 7%. Assume Cisco does not pay dividends. Assume that the CAPM holds, and that the expected return on the market and the stock’s beta do not …
a) What should be today’s opening price for Cisco, according to the CAPM?
b) Before last night’s news, what was the expected price in one year of Cisco’s stock?
Question B6 [1+1+2+1=5 marks]
Question B7 [3+2=5 marks]
Question B8 [1+2+2=5 marks]

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