1
HERIOT-WATT UNIVERSITY

FINANCE – DECEMBER 2021

Section I

Case Studies

Question 1

Teakus Enterprises plc is a UK based green energy component supplier company. It has
operations in South Africa and is looking to expand there. It is evaluating an ambitious new
project in its normal line of business. The project has been given the go-ahead by the UK
board of directors and the South African government have welcomed the investment. The
project will last five years.

The capital investment in equipment will amount to 1,400 million South African rand (ZAR).
This will be depreciated straight line over five years to 200 million ZAR. It is expected that
the equipment would be sold for that amount at the end of the project.

Initial sales in year 1 are forecast to be ZAR 1,900m and will grow at 18% per annum over
the five-year period. There will be additional working capital requirements at the start of the
project of ZAR 150m and a further ZAR 90m in year 1 and then remaining at that level until
year 4 when a further ZAR 70m in working capital will be needed.

The cost of goods sold will run at 62% of the sales figure for each of the five years of the
project. Additional project operating expenses will be incurred and these will run at ZAR
140m in year 1 and will grow at a rate of 10% per annum for the five years.

Inflation in South Africa is currently at 5.25% annually compared to 2.5% in the UK. The risk-
free rate of interest in the UK is 3% and in South Africa it is 6.5%.

The market risk premium is 6%. Teakus is a UK stock market listed company and has an
ungeared beta of 1.25 and a debt beta of 0.2. The company has a target capital structure
with 30% debt funding. The company faces a tax rate of 25% in both UK and South Africa.
Teakus expects to make interest payments of ZAR 400m each year of the project.

The current spot exchange rate between the British pound (GBP) and the South African rand
(ZAR) is ZAR 17.31/GBP 1.00.

Required: Maximum Word Limit 1000 words

(a) Calculate the cost of capital that will be used to discount the South African cash
flows.
(8 marks)

(b) Calculate the NPV of the project in both South African rand and in British pounds.
(9 marks)

(c) Teakus’s board of directors are eager for the project to be a success and provide a
boost to the share price. Companies operating internationally will usually look to
hedge their transaction cash flows. Explain: (i) when it would be better to use futures
or forwards to hedge; and, (ii) when it would be better to use options to manage the
risk. Give examples to support your answer.
(8 marks)

2
(d) Using the information in the question calculate the six month and two year forward
rates between the South African rand and the British pound. Which currency is
appreciating in value?
(5 marks)

Total 30 marks


















































3
Question 2 Maximum Word Limit 1000 words

(a) Some multinational companies do not hedge. What arguments would you give for
this position and can you give examples of companies that do not hedge.
(6 marks)

(b) Companies face translations risk and transaction risk in international business.
Explain whether they should be hedged and how they might be hedged?
(6 marks)

(c) Take the example of Apple shares and assume that the share price is currently $150.
Draw and clearly label the payoff diagram for a seller of a call option with an exercise
price of $150 and call price of $9 with three months to expiry and explain where the
seller will profit and when they will lose on the transaction.
(6 marks)

(d) What will the profit or loss be for the seller of the Apple call option in part (c) above, if
the share price at option expiry is: (i) $170; (ii) $120? Give the call option value for
each and the profit or loss for each outcome.
(6 marks)

(e) (i) Galway Corp has agreed to repay a bank loan in five annual payments of
£110,000 each. The interest rate is 8%. What is the face (original) value of
the loan?

(ii) Skye Telecom has just paid a 36p a share annual dividend. The company has
a payout ratio of 0.60. The current share price is 1200p. What is Skye
Telecom’s price earnings ratio?
(6 marks)

Total 30 marks

























4
Section II

Short Questions

Maximum Word Limit 2000 words

1. (i) Moyes plc needs to redeem a £100m bond at the end of 10 years. If it can
earn 6% per annum on investments, and the risk-free rate of interest is 2%,
how much must it put away each year starting from the end of the first year to
be able to redeem the bond at the end of 10 years?

(ii) Cork Traction shares are currently trading at 480p on the stock market. The
firm’s earnings per share is 30p. Cork has just paid a 20p annual dividend.
The growth rate of dividends is 5%. The risk-free rate of interest is 2% and
company has an equity beta of 1.4. What is the expected rate of return on
Cork?
(8 marks)

2. Describe a project that you have been involved in (recently or in the past). Describe
whether it has been successful or a failure. What do you think was the reason for the
success or failure? How does the company measure success and how do you feel
that it has done from a finance point of view? (If you do not have personal experience
of a project, describe one by a firm that you are familiar with either a local firm or an
international firm).
(8 marks)

3. A company should use the NPV technique when considering ‘make or buy’ decisions.
What other factors would go into the decision apart from just the NPV figure? Give an
example of a make or buy decision (real or made up) and list the other factors the
company should consider (look at this from both sides, i.e. company will manufacture
rather than buy and also when they give up manufacturing and buy from outside)?
(8 marks)

4. How do agency problems differ in a private company compared to a public company?
Take the example of technology start-ups that are funded by venture capitalists and
technology companies that are listed on the stock market and discuss the agency
problems in each and how they are dealt with.
(8 marks)

5. EnviroCo is an auto component supplier. It has an expansion project in the hydrogen
power area. It feels there is great potential in this market, but at the moment the NPV
of the project is negative. The project director wants it to be considered as an
expansion option (in terms of real options) in which case it could have a large value.
What conditions would have to hold for the expansion option to have significant
value?
(8 marks)

Total 40 marks


END OF PAPER