MGT6174  MGT6174  1  MANAGEMENT SCHOOL MOCK EXAM PAPER 2020-2021 FINANCIAL MANAGEMENT 1.5 HOURS The exam paper consists of TWO sections. Answer ANY 1 question from Section A (total of 40 Marks) Answer ANY 2 questions from Section B (total of 60 Marks) 100 MARKS IN TOTAL Candidates may use university authorised calculators. MGT6174 MGT6174  MGT6174  2  SECTION A – ANSWER ANY 1 QUESTION Question 1 Explain the Discounted Cash Flows (DCF) and Relative Valuation (RV) approaches to investment valuation. Include in your answer a discussion of the main advantages and disadvantages of these two approaches, as well as a brief discussion of when each approach works the best. [40 marks] [800 words] Question 2 Critically discuss the main functions of financial markets and intermediaries in the context of the current financial system. Please note that merely providing a list is not sufficient for a good answer. Instead, your answer should focus on discussing why you think these functions are important. [40 marks] [800 words] END OF SECTION A [TOTAL SECTION A MARKS 40] MGT6174  MGT6174  3  SECTION B – ANSWER ANY 2 QUESTIONS Question 3 Medics plc., a UK firm of medical equipment, reported earnings per share (EPS) in 2005 of £3.95 and paid dividends per share (DPS) of £0.68. Its earnings are expected to grow by 16% from 2006 to 2010, but the growth rate is expected to decline each year after that to a stable growth rate of 6% in 2015. The payout ratio is expected to remain unchanged from 2006 to 2010, after which it is expected to increase each year to reach 60% in steady state. Medics’s stock is expected to have a beta of 1.25 from 2006 to 2010, after which the beta would decline each year to reach 1.00 by the time the firm becomes stable. Further, the risk-free rate is 6.25% p.a. and the market risk premium 5.5% p.a. REQUIRED: A. Assuming that the growth rate declines linearly and that the payout ratio increases linearly, from 2011 to 2015, estimate the dividends per share each year from 2006 to 2015. [15 marks] [300 words] B. Estimate the expected price of Medics at the end of 2015. [5 marks] [100 words] C. Estimate the value per share of Medics, using the three-stage dividend discount model. [10 marks] [200 words] [Total: 30 marks] [Total: 600 words]         MGT6174  MGT6174  4  Question 4 Holly Ltd is faced with a choice between two mutually exclusive one-year projects, details of which are as follows: Project A Year 0 Year 1 Cash flow Probability Cash flow £000s £000s (1,000) 0.30 0 0.45 2,200 0.25 3,600 Project B Year 0 Year 1 Cash flow Probability Cash flow £000s £000s (1,350) 0.20 0 0.60 2,050 0.20 2,960 Figures in brackets represent cash outflows. Year 0 is now. The company’s cost of capital is 18%. REQUIRED: A. Calculate the expected NPV, variance and coefficient of variation of each of the projects, and state, with reasons, which project you would advise the company to select. Include any limitations of your advice and show all workings and formulae. [20 marks] [400 words] B. Critically discuss the advantages and disadvantages of the Net Present Value (NPV) and the Internal Rate of Return (IRR) approaches in assessing investment projects. (please note that merely listing the advantages and disadvantages of each approach will not be enough for a good answer). [10 marks] [200 words] [Total: 30 marks] [Total: 600 words] MGT6174  MGT6174  5  Question 5 Fountain Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of Fountain must choose between two mutually exclusive projects. Assume that the project Fountain chooses will be the firm’s only activity and that the firm will close one year from today. Fountain is obligated to make a £12,000 payment to bondholders at the end of the year. The projects have the same systematic risk but different volatilities. Consider the following information pertaining to the two projects: State of economy Probability (%) Low-risk project payoff (£) High-risk project payoff (£) Bad 50 12,000 11,400 Good 50 12,800 13,300 REQUIRED: A. What is the expected value of the firm if the low-volatility project is undertaken? What if the high-volatility project is undertaken? Which of the two strategies maximises the expected value of the firm? [5 marks] [100 words] B. What is the expected value of the firm’s equity if the low-volatility project is undertaken? What is it if the high-volatility project is undertaken? [5 marks] [100 words] C. Which project would Fountain’s stockholders prefer? Explain. [5 marks] [100 words] D. Suppose bondholders are fully aware that stockholders might choose to maximise equity value rather than total firm value and opt for the high-volatility project. To minimise this agency cost, the firm’s bondholders decide to use a bond covenant to stipulate that the bondholders can demand a higher payment if Fountain chooses to take on the high-volatility project. What MGT6174  MGT6174  6  payment to bondholders would make stockholders indifferent between the two projects? [15 marks] [300 words] [Total: 30 marks] [Total: 600 words] END OF SECTION B [TOTAL SECTION B MARKS 60] END OF EXAM PAPER












































































































































































































































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