SEMESTER 1 EXAMINATIONS
ACADEMIC YEAR 2017/2018
Strategic Corporate Finance
Professor Andrew Stark
Professor Anthony Brabazon
Professor Eamonn Walsh
Dr Sean Power*
Time Allowed: 2 Hours
Instructions for Candidates
Answer QUESTION 1 (compulsory) AND two of the remaining three questions (2, 3 AND 4).
Instructions for Invigilators
Closed book examination
Use of non-programmable calculators permitted
Page 2 of 9
Question 1 – Firm Valuation
RaDrones Plc (RaDrones) is an Irish-listed company which manufactures and retails drones at
its stores throughout Ireland. RaDrones drones are popular with surveying companies, farmers
and hobbyists. The company has experienced high growth rates since it commenced trading in
2010. Since it commenced trading, the company has experienced average annual growth rates
of 10% per annum.
However, due to a number of well-publicised cases of drone operators flying recklessly, the
Irish airspace regulator introduced mandatory licences for drone operators in December 2017.
The process for obtaining a drone pilot licence is estimated to take 12-18 months to complete.
RaDrone expects the new regulations will have a significant negative impact on its business.
The company expects its growth rate will drop significantly in 2018 and will gradually recover
over a period of 5 years. However, it does not anticipate the growth rate will ever fully recover
to the high growth rates experienced during the pre-regulation period. The share price of
RaDrones had fallen to €32.50 per share by the end of December 2017.
Additional information for year ended / at the 31st December 2017:
Earnings before interest and taxes (EBIT) for 2017: €50 million
Capital expenditure for 2017: €20 million
Depreciation for 2017: €2 million
Revenues for 2017: €120 million
Working capital as a percentage of revenues: 10%.
Tax rate: 12.5%.
Current market value of RaDrones debt: €150 million
The risk free rate is 3% and the market risk premium is 5%.
The firm has 10 million outstanding shares in issue.
Expected financial information for next 5 year growth-recovery period:
Length of growth recovery period: 5 years
Expected growth rate for 2018: 1% (increasing by 1% per annum over the next 5
o Beta during recovery phase: 2.2
o Cost of Debt during recovery phase: 5% (pre-tax)
o Debt Ratio during recovery phase: 60%
Expected financial information after 5 recovery period:
Expected stable growth rate in FCFF: 6%.
Tax Rate: 15%
o Beta during stable growth phase: 2
o Cost of debt during stable growth phase: 7% (pre-tax)
o Debt ratio during stable growth phase: 40%
…Question 1 continues over the page.
Page 3 of 9
You may assume that the growth rate affects sales revenue, earnings before interest & taxes
(EBIT), capital expenditure and depreciation.
(a) Use a Free Cash Flow to Firm (FCFF) model, at the end of December 2017, to
estimate the value per share of RaDrones shares.
(b) Discuss other valuation methods that could be used to value RaDrones and outline
when they might be suitable.
(TOTAL: 40 MARKS)
Page 4 of 9
Question 2 – Bonds
Soze & Sons Shipping Plc (SSS) is a company listed on the Irish Stock Exchange. The company
was founded by William Soze in 1902. The company was run and owned entirely by the family
until 2015, when it became a listed company. The Soze family still own a combined 20% of
the share capital of the company. The Managing Director of SSS is Peter Soze, a descendant
of the founder. Peter’s business philosophy was heavily influenced by the opinions of his
grandfather; he believes the company should remain entirely equity financed. The company
has never, throughout its history, been financed with debt.
When the company was listed on the Irish Stock Exchange in 2015, the Soze family was forced
to make significant changes to the company’s board of directors. As a consequence, you were
appointed as the company’s Finance Director in late 2015.
In December 2017, Peter calls you into his office to discuss the financial affairs of the company.
During this meeting, Peter claims, “Our advisors keeping talking about bonds! They want me
to buy them and they want me to sell them. I need your advice.”
Firstly, SSS’s financial advisors have proposed that SSS consider investing any future excess
cash by purchasing other companies’ bonds. The advisors produced a report which contains
the yield curve below. Peter states during the meeting, “The longer the bond term, the higher
the yield. Of course I’m going to invest in the longer term bonds.”
Secondly, SSS needs to raise an additional €11 million in capital in order to finance its
operations in 2018. During the meeting, Peter states, “I don’t want the company to issue bonds;
debt is a very expensive way to finance a company. The 9% rate on the bonds exceeds our
current cost of capital.” SSS’s current cost of capital is 8%. You may ignore costs associated
with bond issues. The company’s financial advisors have proposed the company undertakes a
bond issue; the details of the proposed bonds are listed below:
Number of Bonds: 10,000
Bond Face Value: €1,000
Coupon Rate: 9%
Maturity Term: 3 years
Current Market Value: €1,100
Tax Rate: 12.5%
…Question 2 continues over the page.
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(a) Explain to Peter why investors may prefer to purchase bonds with shorter terms until
(b) Calculate and explain the financial implications of SSS undertaking the bond issue for
the company’s cost of capital. You are required to show all workings.
(c) Explain the benefits and disadvantages of financing a business with equity versus
(TOTAL: 30 MARKS)
Page 6 of 9
Question 3 – Financial Statement Analysis
You are a financial analyst working for a company called Five Worlds Chemicals Ltd (FWC).
FWC manufacture and export various chemical products.
The directors of FWC feel the company will grow rapidly over the next three years and are
focused on increasing the company’s manufacturing capacity to facilitate this future growth.
In the recent past, FWC completed a successful share issue and loan application which allowed
the company to raise much needed finance. The company now wishes to apply to their bank
for a further long-term loan facility. You have been tasked with analysing the business for the
purpose of making a loan application and identifying areas of the business which could be
improved in order to ensure the loan application is successful.
The following extracts from the financial statements of FWC for the year ended 31st December
have been made available to you:
Statement of Comprehensive Income / Income Statement
Revenue 1,200 810
Cost of Sales (496) (323)
Gross Profit 704 487
Administrative Expense (180) (200)
Depreciation Expense (50) (44)
Operating Expenses (158) (106)
Profit Before Tax 316 137
Finance Costs (100) (36)
Income Tax Expense (40) (19)
Profit from Continuing Operations 176 82
Dividends Declared (120) (100)
Cost of Capital 2% 2%
Tax Rate 12.5% 12.5%
…Question 3 continues over the page.
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Statement of Financial Position / Balance Sheet
ASSETS €'000 €'000
Property Plant and Equipment 6,100 5,220
Intangible Assets 1,225 950
Investment Property 1,455 500
Cash & Bank 300 310
Inventories 545 600
Receivables 480 390
Total Assets 10,105 7,970
EQUITY AND LIABILITIES
Share Capital (€1 Shares) 1,600 1,000
Share Premium 749 400
Retained Profit 4,906 4,850
Loan 2,500 1,300
Trade Payables 250 300
Taxation 100 120
Total Equity and Liabilities 10,105 7,970
(a) Using financial ratios and the available financial information, analyse the following
aspects of FWC’s performance:
(b) Explain the advantages and limitations of the Economic Valued Added (EVA)
(TOTAL: 30 MARKS)
Page 8 of 9
Question 4 – Dividend Policy & Acquisitions
Answer both parts of this question.
'Modigliani and Miller conclude that, in a perfect world, dividend policy should not matter to
the value of the firm. Given the world is imperfect relative to the one analysed by Modigliani
and Miller, which imperfections suggest that their conclusion might not hold in the world that
actually exists? How might these imperfections affect company dividend policy?'
Big Ten Four Ltd (BTF) is a listed company which owns and operates fuel stations around
Europe. The Managing Director of BTF is Daniel O’Leary. BTF is generates significant cash
from operations each year from its existing asset base. However, the company has experienced
a lack of available, profitable, investment opportunities over the last number of years. O’Leary
is considering using BTF’s excess cash reserves to purchase a large renewable energy company
which operates wind farms around Western Europe. O’Leary believes the acquisition will boost
BTF’s earnings per share and will diversify the company’s asset base, thereby reducing risk.
Discuss the potential benefits and drawbacks of O’Leary’s acquisition plan.
(TOTAL: 30 MARKS)
Page 9 of 9
GENERAL FINANCE FORMULAE
Cost of Equity (Ke) = Rf + β x [(Rm – Rf]
Stock Price P0 = Div1 / [Ke - g]
WACC = [Ke x (E / D+E)] + [KD x (D/ D+E)]
PRESENT VALUE DISCOUNT FACTORS
Time 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15%
0 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000 1.0000
1 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 0.9009 0.8929 0.8850 0.8772 0.8696
2 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 0.8116 0.7972 0.7831 0.7695 0.7561
3 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 0.7312 0.7118 0.6931 0.6750 0.6575
4 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 0.6587 0.6355 0.6133 0.5921 0.5718
5 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 0.5935 0.5674 0.5428 0.5194 0.4972
6 0.7462 0.7050 0.6663 0.6302 0.5963 0.5645 0.5346 0.5066 0.4803 0.4556 0.4323
7 0.7107 0.6651 0.6227 0.5835 0.5470 0.5132 0.4817 0.4523 0.4251 0.3996 0.3759
8 0.6768 0.6274 0.5820 0.5403 0.5019 0.4665 0.4339 0.4039 0.3762 0.3506 0.3269
9 0.6446 0.5919 0.5439 0.5002 0.4604 0.4241 0.3909 0.3606 0.3329 0.3075 0.2843
10 0.6139 0.5584 0.5083 0.4632 0.4224 0.3855 0.3522 0.3220 0.2946 0.2697 0.2472