Sample Examination

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Sample Examination

UNIT: ACCT6004 - Finance - Exam

TIME ALLOWED: 3hrs + 15 minutes including file download and submission upload

PERMITTED MATERIALS: This is an OPEN BOOK exam where the use of unit study resources such as textbooks and tutorial materials is permitted. Your completed Word document is submitted through Turnitin, hence academic standards of referencing and originality are mandatory.

SPECIAL INSTRUCTIONS: Only one attempt is permitted.

You must complete your exam on this document.

After downloading the paper, spend 5-10 minutes for composing yourself, reading the exam paper, and planning which questions to answer, and how. We advise you to read the instructions and questions carefully before you begin.

Upload your completed exam document by [exam completion time] using the link in the Exam folder of the Assessment Tasks and Submission section of the ACCT6004 MySCU learning site.

The exam has 5 main questions and all questions are compulsory.

Type your answers under each question. Expand the space under each as needed.

Workings for calculations must be shown for full marks. You can show workings by typing them or you can paste the relevant part of a spreadsheet you have used.

Action required if you have any submission problems:

Take photos of any error messages or other evidence of the problem and email these, along with your completed exam, to the UA (jennifer.harrison@scu.edu.au).

If you are unable to email the completed exam file, you must take clear photos of the document properties (click on File on the top menu), cover page and answers to each question. Email these to the UA, along with the photos (point above) evidencing the problem.

Your exam will not be marked until it has been successfully uploaded through Turnitin and evidence provided of its completion before [exam completion time].

QUESTION 1 (10 marks)

The table below includes information ABC Ltd, X Ltd and a portfolio of ABC and X. Calculate the missing figures (labelled A, B, C, D and E) in the table below. (5 marks)

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Explain the benefit of investing in the portfolio in (a), rather than one of the individual companies. (3 marks)

Write a brief interpretation of the beta for ABC and the beta for X. (2 marks)

QUESTION 2 (10 marks)

Chopper Manufacturing Ltd is considering whether the company should undertake Project X, which involves the production and distribution of an updated type of coffee grinder. The company has paid $100,000 for a feasibility analysis of the project, which has provided the following information.

Forecasts for Project X are sales of 100,000 units per year at a price of $80 each. Variable costs per grinder will be 70 per cent of revenue and the project will have a 4-year life.

Fixed costs for the project will be $0.6 million per year and Chopper will need to invest a total of $0.8 million in new manufacturing equipment to undertake the project. Annual depreciation of the equipment for tax purposes will be $0.2 million per year. At the end of the project life, the equipment is expected to be sold for $0.1 million. To support Project X, working capital will need to be increased up front by $0.4 million but this investment is expected to be fully recovered in the last year of the project.

Chopper pays company income tax at a rate of 30 per cent and has other taxable income, which it can reduce with any loses from Project X and hence reduce its tax. The company has a WACC of 8%.

(a)You have been given the following spreadsheet showing incremental cash flows of the project. Identify and correct the errors in this analysis. (8 marks)

To do this, you can edit the table below with the corrections. If you prefer, you can copy it into a spreadsheet, correct it and then paste it back into this document.

Figures in $millions Year 0 1 2 3 4

Revenue 80 80 80 80

Variable costs -5.6 -5.6 -5.6 -5.6

Feasibility analysis -0.1 Fixed costs -0.6 -0.6 -0.6 -0.6 Depreciation -0.2 -0.2 -0.2 -0.2

Profit before tax -0.7 73.6 73.6 73.6 74.2

Tax -0.21 22.08 22.08 22.08 22.26

Profit after tax -0.49 51.52 51.52 51.52 51.94

Equipment cash flows -0.8 0.1

Working capital cash flows -0.4

Net cash flows -1.69 51.52 51.52 51.52 52.04

Notes on equipment salvage: Market value at salvage 0.1 Book value at salvage 0 Taxable gain (loss) 0.1 Tax on salvage 0.03 (b)Assume the NPV of the project is $3.5 million. Should the company accept or reject the project? Briefly explain, including a comment on the expected impact on firm value (2 marks)

QUESTION 3(10 marks)

Answer the following questions based on the project outlined in Question 2 and any additional information provided below.

(a)The graph below shows the results of a sensitivity analysis of the project (assume it is based on the correct cash flows). Interpret these results, including managerial implications. (5 marks)

(b)What needs to be considered before using the companys WACC as the discount rate for the project and why? (5 marks)

QUESTION 4(10 marks)

You have the following information on Pound Industries Ltd:

Debt/Assets Ratio Bond Rating After-tax cost of debt WACC

0% n/a 4.8% 12.00%

10 Aa 4.8 11.64

20 Aa 5.0 11.32

30 A 5.4 11.10

40 Baa 6.0 11.04

50 Ba 7.2 11.40

60 Caa9.0 12.36

What is the companys optimal capital structure and why? (6 marks)

Use theories of capital structure to explain why Pound Industries WACC would at first decrease and then increase as more debt is used in the capital structure. (14 marks)

QUESTION 5(10 marks)

Assume a perfect market world except for the following: tax on dividends is greater than the tax on capital gains in the hands of shareholders, there are transaction costs (including issuance costs), and information asymmetry exists between managers and shareholders. Given these assumptions, firms are behaving irrationally if they continue to pay dividends while also issuing new shares to raise funds for investment opportunities. Explain and critique this statement, referring where relevant to distribution policy theories in your discussion.

END OF EXAM