maf620_fmc570

CONFIDENTIAL AC/JAN 2013/MAF620/FMC570

UNIVERSITI TEKNOLOGI MARA FINAL EXAMINATION

COURSE

COURSE CODE

EXAMINATION

TIME

CORPORATE FINANCE

MAF620/FMC570

JANUARY 2013

3 HOURS

INSTRUCTIONS TO CANDIDATES

1. This question paper consists of five (5) questions.

Answer ALL questions in the Answer Booklet. Start each answer on a new page. 2.

3. Do not bring any material into the examination room unless permission is given by the invigilator.

Please check to make sure that this examination pack consists of:

i) the Question Paper ii) a two-page Appendix 1 (Present Value Table) iii) an Answer Booklet - provided by the Faculty

DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

This examination paper consists of 6 printed pages

© Hak Cipta Universiti Teknologi MARA CONFIDENTIAL

CONFIDENTIAL 2 AC/JAN 2013/MAF620/FMC570

QUESTION 1

Sun World Bhd is considering investing its excess funds in one of the following two companies. The following table shows the estimated returns of the two securities for next year and the related probabilities.

State of economy

Recession Normal Boom

Probability

0.30 0.50 0.20

Estimated return (%) May Bhd

-11 12 17

June Bhd 10 9 7

The expected returns and standard deviation of the market are 5.9% and 8.23% respectively. The covariance between May and the market is 92.21 while the covariance between June and the market is -7.61.

Required:

a) Calculate the expected return and standard deviation of May Bhd and June Bhd. Which security should the company choose? Why?

(9 marks)

b) Calculate and comment on the beta of each security. (4 marks)

c) Assume the capital asset pricing model (CAPM) holds true. If the Treasury Bill rate is 3%, calculate the required return of each security. In which security should the company invest in?

(3 marks)

d) Management may make decisions which are often in conflict with their shareholders' interest. Explain two (2) control mechanisms that shareholders can use to cause management to act in the shareholders' best interest.

(4 marks) (Total: 20 marks)



QUESTION 2

A. Chendana Berhad and Dupa Berhad are identical in all respects except that Chendana Berhad is more levered than Dupa Berhad. Chendana Berhad's debt obligation requires the firm to make RM8 million in payments. Dupa Berhad's debt obligations are RM4.9 million.

Both companies expect that the probability next year of an expansion is 70 percent and of a recession is 30 percent. If an expansion occurs, each firm will have earnings before interest and taxes (EBIT) of RM15 million. On the other hand, if a recession occurs, each firm will have EBIT of RM7 million.

Required:

a) Assume a one-period model and no taxes. The shareholders and bondholders in these firms are risk-neutral and they discount the firm's cash flows at 12 percent.

i) Calculate the value of Chendana Berhad and Dupa Berhad. (Show calculations of each firm's equity and debt values).

(10 marks)

ii) Is it true that Dupa Berhad should have a higher value than Chendana Berhad as Dupa Berhad has less debt, and therefore less bankruptcy risk? Comment.

(3 marks)

B. In the real world, financial distress can lead to conflict of interest between stockholders and bondholders. Discuss the three (3) kinds of selfish investment strategies that stockholders use to gain benefits and hurt the bondholders. Why are these strategies costly?




QUESTION 3

A. Indicate whether the following statements are true or false. Provide a brief explanation for your answer.

i) "The desire for current income is not a valid explanation for adopting a high dividend payout because investors can always create homemade dividends by selling a portion of their stocks".

ii) "Empirical research has found that there are significant increases in stock price on the day an initial dividend is announced".

iii) "A firm with weak cash flows can boost its share price by raising its dividend in the longer term".

(9 marks)

B. In the context of the efficient market hypothesis (EMH), explain what it means for a stock market to be efficient. Describe two (2) examples when the stock market price reaction may be called inefficient.

(5 marks)

C. Explain Research on Mutual Funds and the evidence this research provides. Which form(s) of EMH does it support or prove?

(3 marks)

D. Do empirical studies support or reject the notion that corporate insiders earn abnormal returns on their trades? What forms of market efficiency are supported or rejected?


QUESTION 4

Kejora Bhd is considering a RM10 million project that will last five years. The straight line depreciation method is used. The cash inflows for the project are RM3.5 million per year for the first two years and RM4.5 million per year for the remaining years. This project is expected to have a salvage value of RM0.5 million at the end of the project's life.

Kejora Bhd can obtain a five-year commercial bank loan at 8% interest per year but the company will only borrow 40% of the project's value. The bank will charge a processing fee of 1 % of the loan amount. The fee is payable upfront, and is to be amortized over the term of the loan. The terms of agreement require the company to settle principal payments of RM800,000 at the end the second year and the balance in the fifth year.

The corporate tax rate is 25 percent. The risk-free rate is 6 percent and the applicable unlevered cost of capital is 20 percent.



Required:

a) Determine whether or not Kejora Bhd should undertake the project if it is 100-percent equity financed.

(6 marks)

b) Calculate the Adjusted Present Value (APV) of the project. Advise the firm whether or not Kejora Bhd should undertake the project with debt financing from the commercial bank.

(10 marks)

c) Assume that the Melaka State Government is willing to offer 40% of the project's value through a non-amortized government loan at 5% interest rate for 3 years with no processing cost. The repayment of the principal is a lump sum at the end of the loan term. Advise Kejora Bhd on which financing option is the best for the company.


QUESTION 5

The shareholders of Apple Bhd have voted in favour of a buyout offer from Maddox Bhd. Information about each firm is given below:

Price-earnings ratio Number of Shares outstanding Earnings Dividends

Maddox Bhd 15

1,200,000 RM2,400,000 RM720,000

Apple Bhd 10.8

660,000 RM696,000 RM348.000

Securities analysts expect that the earnings and dividends of Apple Bhd will grow at a constant rate of 5 percent each year. It is estimated that the acquisition will create economies of scale for Apple that will increase its growth rate to 7 percent per year.

Required:

a) Determine the value of Apple Bhd to Maddox Bhd. (6 marks)

b) Calculate the present value of the synergy from the merger. (2 marks)

c) If Maddox were to offer RM20 in cash for each share of Apple, what would the NPV of the acquisition be?

(2 marks)

d) Determine the maximum price Maddox should be willing to pay for each share of Apple Bhd.

(2 marks)



e) If Maddox Bhd were to offer 300,000 of its shares in exchange for the outstanding stock of Apple Bhd, what would the NPV be?

(4 marks)

f) Calculate the after-acquisition stock price of Maddox if the stock offer had been used.

(2 marks)

g) Should the acquisition be attempted? If so, should it be a cash offer or stock offer?


END OF QUESTION PAPER


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Table A-2: Present Value of an Annuity of RM1 per period for n Period

Period 4% 5% 6% 7% 8% 9% 10%

(D 3 O

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1 2 3 4 5

0.9615 1.8861 2.7751 3.6299 4.4518

0.9524 1.8594 2.7232 3.5460 4.3295

6 7 8 9 10

5.2421 6.0021 6.7327 7.4353 8.1109

5.0757 5.7864 6.4632 7.1078 7.7217

0.9434 1.8334 2.6730 3.4651 4.2124

4.9173 5.5824 6.2098 6.8017 7.3601

0.9346 1.8080 2.6243 3.3872 4.1002

4.7665 5.3893 5.9713 6.5152 7.0236

0.9259 1.7833 2.5771 3.3121 3.9927

4.6229 5.2064 5.7466 6.2469 6.7101

0.9174 0.9091 1.7591 1.7355 2.5313 2.4869 3.2397 3.1699 3.8897 3.7908

4.4859 5.0330 5.5348 5.9952 6.4177

4.3553 4.8684 5.3349 5.7590 6.1446

11 12 13 14 15

8.7605 9.3851 9.9856 10.563 11.1184

8.3064 8.8633 9.3936 9.8986 10.38

7.8869 8.3838 8.8527 9.2950 9.7122

7.4987 7.9427 8.3577 8.7455 9.1079

7.1390 7.5361 7.9038 8.2442 8.5595

6.8052 7.1607 7.4869 7.7862 8.0607

6.4951 6.8137 7.1034 7.3667 7.6061

O O

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16 11.652 10.838 10.106 9.4466 8.8514 17 12.166 11.274 10.477 9.7632 9.1216 18 12.659 11.69 10.828 10.059 9.3719 19 13.134 12.085 11.158 10.336 9.6036 20 13.59 12.462 11.47 10.5940 9.8181

21 22 23 24 25

14.029 14.451 14.857 15.2470 15.622

12.821 13.1630 13.489 13.799 14.094

11.764 12.042 12.303 12.55 12.783

10.836 11.061 11.272 11.469 11.654

10.017 10.201 10.371 10.529 10.675

8.3126 7.8237 8.5436 8.0216 8.7556 8.2014 8.9501 8.3649 9.1285 8.5136

9.2922 9.4424 9.5802 9.7066 9.8226

8.6487 8.7715 8.8832 8.9847 90770

12% 0.8929 1.6901 2.4018 3.0373 3.6048

4.1114 4.5638 4.9676 5.3282 5.6502

5.9377 6.1944 6.4235 6.6282 6.8109

6.9740 7.1196 7.2497 7.3658 7.4694

7.5620 7.6446 7.7184 7.7843 7.8431

14% 0.8772 1.6467 2.3216 2.9137 3.4331

3.8887 4.2883 4.6389 4.9464 5.2161

5.4527 5.6603 5.8424 6.0021 6.1422

6.2651 6.3729 6.4674 6.5504 6.6231

6.6870 6.7429 6.7921 6.8351 6.8729

15% 0.8696 1.6257 2.2832 2.8550 3.3522

3.7845 4.1604 4.4873 4.7716 5.0188

5.2337 5.4206 5.5831 5.7245 5.8474

5.9542 6.0472 6.1280 6.1982 6.2593

6.3125 6.3587 6.3988 6.4338 6.3641

16% 0.8621 1.6052 2.2459 2.7982 3.2743

3.6847 4.0386 4.3436 4.6065 4.8332

5.0286 5.1971 5.3423 5.4675 5.5755

5.6685 5.7487 5.8178 5.8775 5.9288

5.9731 6.0113 6.0442 6.0726 6.0971

18% 0.8475 1.5656 2.1743 2.6901 3.1272

3.4976 3.8115 4.0776 4.3030 4.4941

4.6560 4.7932 4.9095 5.0081 5.0916

5.1624 5.2223 5.2732 5.3162 5.3527

5.3837 5.4099 5.4321 5.4509 5.4669

20% 0.8333 1.5278 2.1065 2.5887 2.9906

3.3255 3.6046 3.8372 4.0310 4.1925

4.3271 4.4392 4.5327 4.6106 4.6755

4.7296 4.7746 4.8122 4.8435 4.8696

4.8913 4.9094 4.9245 4.9371 4.9476

24% 0.8065 1.4568 1.9613 2.4043 2.7454

3.0205 3.2423 3.4212 3.5655 3.6819

3.7757 3.8514 3.9124 3.9616 4.0013

4.0333 4.0591 4.0799 4.0967 4.1103

4.1212 4.1300 4.1371 4.1428 4.1474

28% 0.7813 1.3916 1.8684 2.2410 2.5320

2.7594 2.9370 3.0758 3.1842 3.2689

3.3351 3.3868 3.4272 3.4587 3.4834

3.5026 3.5177 3.5294 3.5386 3.5458

3.5514 3.5558 3.5592 3.5619 3.5640

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