FINM7409 Final Exam Semester 2, 2021
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Question 1
Mattala Corp. is an all-equity firm with 20 million shares outstanding and $150 million worth
of debt outstanding. Its current share price is $65. Mattala’s equity cost of capital is 7.5%.
Mattala has just announced that it will issue $250 million worth of debt. It will use the
proceeds from this debt to pay off its existing debt and use the remaining $100 million to pay
an immediate dividend. Assume perfect capital markets.
a) Estimate Mattala’s share price just after the recapitalization is announced, but before
the transaction occurs. (3 marks)
b) Estimate Mattala’s share price at the conclusion of the transaction. (Hint: use the
market value balance sheet) (4 marks)
c) Suppose Mattala’s existing debt was risk-free with a 4.50% expected return, and its
new debt is risky with a 5.80% expected return. Estimate Mattala’s equity cost of
capital after the transaction. (3 marks)
Show your workings and round your final answers to two decimal places.
Total marks: 3 + 4 + 3 = 10 marks
Question 2
Commonstealth Bank issued a bond that pays a 7.20% coupon quarterly and matures at the
end of September 2036. If the current market rate for similar bonds is 6.50%, what is the
bond price at the end of October 2021?
Show your workings and round your final answers to two decimal places.
Total marks: 10 marks
Question 3
You are given the following information about 4 stocks:
Variance-Covariance Matrix
Stock 1 2 3 4
1 0.0325 0.0125 0.0244 0.4525
2 0.0125 0.0759 0.0252 0.0155
3 0.0244 0.0252 0.0987 0.0832
4 0.4525 0.0155 0.0832 0.0288
What is the variance of the equally weighted portfolio consisting of these stocks? Round your
final answer to four decimal places.
Total marks: 10 marks
FINM7409 Final Exam Semester 2, 2021
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Question 4
Briefly answer the following questions:
1) Assume CAPM holds. Is the ratio of the risk premium on two risky assets equal to the
ratio of their betas? Explain. (5 marks)
2) Suppose a portfolio has a positive investment in every asset, that is, the weight of every
asset in the portfolio is greater than zero. Can the expected return on the portfolio be
greater than that on every asset in the portfolio? Can it be less than that on every asset
in the portfolio? Explain. (5 marks)
Total marks: 5 + 5 = 10 marks
Question 5
Alfalfa Ltd. will pay cash dividends of $5.25, $6.48, $6.15, and $3.36 for the next four years.
Thereafter, it expects its long-term growth rate to be at a constant rate of 5.75%. If the required
rate of return is 12.25%, what is its share worth today?
Show your workings and round your final answers to two decimal places.
Total marks: 10 marks
Question 6
The following information is from the accounts of Neway Ltd for the years 2018 and 2019
Neway Ltd
Summary of the statement of comprehensive income
2019 2018
$m $m
Sales revenue 650 615
COGS 305 295
Gross profit 345 320
Interest expense (15) (13)
Other expenses (including depreciation) (120) (100)
Profit 210 207
Depreciation expense 85 63
Accounts payable at the end of the period 30 25
Accounts receivable at the end of the period 34 46
Inventory held at the end of the period 65 57
Required:
a) Prepare a statement of cash flows from operations for Neway Ltd. (5 marks)
b) Prepare a statement that reconciles the profit with the cash flows from operations. (5
marks)
FINM7409 Final Exam Semester 2, 2021
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Show your workings.
Total marks: 5 + 5 = 10 marks
Question 7
Alpha Ltd. has just borrowed to finance one of its projects. The loan contract specifies that the
company will make a quarterly payment of $5,235 for five years. The lender quoted Alpha a
rate of 5.60% p.a. compounding monthly. What is the amount Alpha has borrowed?
Show your workings and round your final answers to two decimal places.
Total marks: 10 marks
Question 8
AC&DC Company will be worth $135 per share one year from now. This company has a beta
of 2.3. The risk-free rate is 5.5% and the market risk premium is 7.0%. Assuming CAPM holds
and AC&DC does not pay dividends, how much are you willing to pay for one share today?
Show your workings and round your final answer to two decimal places.
Total marks: 10 marks
Question 9
Antara Ltd. is considering the purchase of a new machine for the production of latex. The
machine costs $500,000. The machine will be usable for ten years, at which time it will become
worthless. Antara plans to update to a new model in five years when it will be sold for
$100,000. Annual revenues from the new machine are expected to be $130,000 per year for
the first four years of use and $95,000 in Year 5. The company uses the straight-line
depreciation method for its non-current assets. The company’s cost of capital is 10%.
Required:
a) Calculate the Accounting Rate of Return (ARR) for the new machine. (Round your
answer to two decimal places). (2.5 marks)
b) Calculate the Payback Period for the new machine (Round your answer to two decimal
places). (2.5 marks)
c) Calculate the Net Present Value (NPV) for the new machine. (5 marks)
Show your workings.
Total marks: 2.5 + 2.5 + 5 = 10 marks
Question 10
Briefly answer the following questions:
a) Explain the trade-off theory and the concept of optimal capital structure. (3 marks)
b) Explain the Modigliani and Miller (M&M) Capital Structure Theorem. (5 marks)
FINM7409 Final Exam Semester 2, 2021
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c) At the most basic level, if a firm’s WACC is 15%, what does this mean? (2 marks)
Total marks: 3 + 5 + 2 = 10 marks