FIMN7409 Final Exam Semester 2, 2022
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There are 10 (ten) questions in this exam worth a total of 100 marks.
Answer them all.
Question 1
Greedie Bank issued a 5.60% quarterly coupon bond that matures at the end of March 2044. If the
current market rate for similar bonds is 7.50%, what is the bond price at the end of November 2022?
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
Question 2
Alpha Ltd. plans to increase its dividend by 22% in one year, 18% in two years, 14% in three years,
and 10% in four years. Its most recent dividend paid was $2.5. The management believes that after
all these years, dividend growth will settle down to a constant, sustainable rate of 4.5% forever. The
required rate of return for Alpha Ltd. is 15%. What is the value of its share today?
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 3
You have bought 50 bonds issued by Delta Ltd. These bonds have seven years remaining to maturity.
It pays an annual coupon of $60. Unfortunately, the company is on the brink of bankruptcy, so the
creditors, including yourself, have allowed Delta Ltd. to postpone the payment of the next three
coupon interest (otherwise, the next coupon payment would have been due in 1 year). However, these
postponed payments will accrue interest at an annual rate of 5% and will be paid as a lump sum at
maturity in Year 7. The remaining coupon payments, for Years 4 through 7, will be made as
scheduled. Given the company’s substantial risk, the required rate of return on these bonds is
currently 30%. What is the value of each bond today?
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 4
Zeta Corp. is an all-equity firm with 30 million shares outstanding and $200 million worth of debt
outstanding. Its current share price is $50. Zeta’s cost of equity capital is 8.5%. Zeta has just
announced that it will issue $300 million worth of debt. Part of the proceeds from this new debt issue
is used to pay off its existing debt, while the remaining will be used to pay an immediate dividend.
Assume perfect capital markets.
a) Estimate Zeta’s share price just after the recapitalization is announced, but before the
transaction occurs. (2 marks)
b) Estimate Zeta’s share price at the conclusion of the transaction. (Hint: use the market value
balance sheet.) (4 marks)
c) Suppose Zeta’s existing debt was risk-free with a 4.50% expected return, and its new debt is
risky with a 5.50% expected return. Estimate Zeta’s cost of equity capital after the transaction.
(4 marks)
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 5
Eta Ltd. has no debt. Its management estimates there is a 70% probability that the company’s assets
will be worth $520 million in one year if the economy is booming, and if it does not happen, its assets
will be worth only $350 million. The current market value of Eta’s assets is $400 million.
a) What is the expected return of Eta stock without leverage? (3 marks)
b) Suppose the risk-free rate is 6.5%. If Eta borrows $200 million today at this rate and uses the
proceeds to pay an immediate cash dividend, what will be the market value of its equity just
after the dividend is paid, according to MM? (3 marks)
c) What is the expected return of Eta stock after the dividend is paid in Part b) above? (4 marks)
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
Question 6
Iota Ltd. has 35 million shares outstanding trading for $15 per share. In addition, Iota has $150
million in outstanding debt. Suppose Iota’s cost of equity capital is 12%, its cost of debt capital is 7.5%,
and the corporate tax rate is 35%.
a) What is Iota’s unlevered cost of capital? (4 marks)
b) What is Iota’s after-tax debt cost of capital? (2 marks)
c) What is Iota’s weighted average cost of capital? (4 marks)
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 7
Your boss gives you the following information about 4 assets:
Asset Return Beta
A 15% 1.0
B ? 0.8
C 18% ?
Riskless 5% ?
a) Fill in the missing values in the table (3 marks)
b) Suppose you form a portfolio of these assets, with 20% in A, 30% in B, 40% in C, and the rest
in the risk-free asset. What is the beta of this portfolio? (3 marks)
c) Using CAPM and the weighted-average return method, calculate the return on the above
portfolio. (4 marks)
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
Question 8
Suppose you form a portfolio that combines the risk-free asset and the market portfolio. It has an
expected return of 10% and a standard deviation of 15%. The expected return on the market portfolio
is 18%. The risk-free rate is 5%. You believe that CAPM holds. What is the expected rate of return on
a security if it has a 0.65 correlation with the market portfolio and a standard deviation of 72%?
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 9
Kappa Ltd. is considering the purchase of a new machine for the production of latex. The machine
costs $350,000. The machine will be usable for 10 years, at which time it will become worthless. Kappa
plans to update to a new model in 5 years when the machine will be sold for $150,000. Annual
revenues from the new machine are expected to be $100,000 per year for the first four years of use
and $50,000 in Year 5. The company uses the straight-line depreciation method for its non-current
assets. The company’s cost of capital is 10%.
a) Calculate the Accounting Rate of Return for the new machine. (2 marks)
b) Calculate the Payback Period for the new machine. (2 marks)
c) Calculate the Net Present Value for the new machine. (4 marks)
d) Is IRR higher or lower than Kappa’s cost of capital? Why? (2 marks)
Show your workings and round your final answers to 2 decimal places.
Total marks: 10 marks
FIMN7409 Final Exam Semester 2, 2022
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Question 10
Briefly answer the following questions.
a) Ordinary shareholders are at greater risk than the holders of other types of securities. Do you
agree or disagree with this statement, and why? (2 marks)
b) If a company issues risk-free debt, the risk of its equity does not change because there is no
default risk. As a result, risk-free debt allows a company to get the benefit of a low cost of debt
capital without raising its cost of equity capital. Explain. (2 marks)
c) The risk premium of a stock does not depend on its firm-specific risk. Do you agree or disagree
with this statement, and why? (2 marks)
d) What are the factors that determine bond yields? (2 marks)
e) Suppose you can borrow all the money you need for a project at 10%. Is this rate your cost of
capital for your project? Explain. (2 marks)
Total marks: 10 marks