BMMF5103/MAY2012-F/AA-HUTECH

PART A INSTRUCTIONS: 1. THERE ARE TWO (2) QUESTIONS IN THIS PART. 2. ANSWER BOTH QUESTIONS.

Question 1 a. For each case listed below, explain whether it should (or should not) be included in the calculation of the relevant cash flows for a project. i) The disposal value of a previously purchased machine which may be replaced by a proposed project. ii) Money that a firm has committed to spend regardless of whether a project is accepted or rejected. iii) Costs incurred as a result of past decisions. [6 marks] b. You are currently evaluating a new project for your company. The project requires an initial investment in equipment of RM90,000 and an investment in working capital of RM10,000 at the beginning (t = 0). The project is expected to produce sales revenues of RM120,000 for three years. Manufacturing costs are estimated to be 60% of the revenues. The asset is depreciated over the projects life using straight-line depreciation method. At the end of the project (t = 3), you can sell the equipment for RM10,000. The corporate tax rate is 30% and the cost of capital is 15%. Should you accept the project? Why? [10 marks] c. The market value of Chakrawala Corporation' s common stock is RM20 million and the market value of its risk-free debt is RM5 million. The beta of the company' s common stock is 1.25 and the market risk premium is 8%. If the Treasury bill rate is 5%, what is the company' s cost of capital? (Assume no taxes.) [4 marks] [TOTAL: 20 MARKS]

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Question 2 a. Your firm has a current ratio of 1.0x. What would you do in order to improve the liquidity of your firm? [4 marks] b. Assuming that everything else remains the same, briefly discuss the effect of an increase in a companys debt ratio to its return on equity. [4 marks] c. The financial ratios and financial statements of BintangTerang Bhd. are given below: BintangTerang Bhd. Key Ratios Industry Actual Average 2010 Current Ratio 1.3 1.0 Quick Ratio 0.8 0.75 Days Sales Outstanding 23 days 30 days Inventory Turnover 21.7 19 Debt Ratio 64.7% 50% Times Interest Earned 4.8 5.5 Gross Profit Margin 13.6% 12.0% Net Profit Margin 1.0% 0.5% Return on total assets 2.9% 2.0% Return on Equity 8.2% 4.0%

Actual 2011 (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x)

Income Statement BintangTerang Bhd. For the Year Ended December 31, 2011 Sales Revenue RM100,000 Less: Cost of Goods 87,000 Sold Gross Profits RM13,000 Less: Operating 11,000 Expenses Operating Profits RM2,000 Less: Interest Expense 500 Net Profits Before Taxes RM1,500 Less: Taxes (40%) 600 Net Profits After Taxes RM900

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Balance Sheet BintangTerang Bhd. As at December 31, 2011 Assets Cash Accounts Receivable Inventories Total Current Assets Gross Fixed Assets Less: Accumulated Depreciation Net Fixed Assets Total Assets Accounts Payable Accruals Total Current Liabilities Long-term Debt Total Liabilities Common Stock Retained Earnings Total Stockholders Equity Total Liabilities & Stockholders Equity RM 1,000 8,900 4,350 RM14,250 RM35,000 13,250 21,750 RM36,000 RM 9,000 6,675 RM15,675 4,125 RM19,800 1,000 15,200 RM16,200 RM36,000

Liabilities & Stockholders Equity

You are required: i) Calculate the key ratios of the company in 2011.

ii) Compare the companys financial ratios in 2011 to that of 2010, the industry average and briefly discuss the findings. [12 marks] [TOTAL: 20 MARKS]

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PART B INSTRUCTIONS: 1. THERE ARE FIVE (5) QUESTIONS IN THIS PART. 2. ANSWER THREE (3) QUESTIONS ONLY.

Question 1 a. A wealthy art collector has decided to endow her favorite art museum by establishing funds for an endowment which would provide the museum with RM1,000,000 per year for acquisitions into perpetuity. The art collector will give the endowment upon her fiftieth birthday, 10 years from today. She plans to accumulate the endowment by making annual end-of-year deposits into an account. The rate of interest is expected to be 6 percent in all future periods. How much must the art collector deposit each year to accumulate to the required amount? [6 marks] b. Latifah has just received (i.e. t = 0) an annual bonus of RM1,500. Her annual bonuses are expected to grow at 5 percent for the next 5 years. How much will Latifah have at the end of the fifth year if she invests her bonuses (including the most recent bonus, i.e. in Year 5) in a project paying 8 percent per year? [6 marks] c. Assume you have a choice between two deposit accounts. Account I has an annual percentage rate of 7.50 percent but the interest is compounded monthly. Account II has an annual percentage rate of 7.30 percent and the interest is compounded weekly. Which account will you choose? Why? [4 marks] d. In an amortized loan, why does the principal portion of each payment grow over the life of the loan, while the interest portion of each payment decreases over the life of the loan? [4 marks] [TOTAL: 20 MARKS]

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Question 2 a. Given the following expected returns and standard deviations of assets I, II, III, and IV, which asset should a risk-averse investor select? Why? Asset I II III IV Expected Return 10% 16% 14% 12% Standard Deviation 5% 10% 9% 8% [5 marks] b. Calculate the expected value, standard deviation of returns, and coefficient of variation for Asset A based on the information given below: Asset A Probability 0.25 0.55 0.20

Possible Outcomes Pessimistic Most likely Optimistic

Returns (%) 5 10 13 [6 marks]

c.

Briefly explain how diversification reduces risk. [4 marks]

d.

Given the following data for a stock: beta = 1.5; risk-free rate = 4%; market rate of return = 12%; and the expected rate of return of the stock = 15%. Is the stock overpriced or underpriced? Explain. [5 marks] [TOTAL: 20 MARKS]

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Question 3 a. Compute the current value of a share of common stock of a company whose most recent dividend was RM2.50 and is expected to grow at 3 percent per year for the next 5 years, after which the dividend growth rate will increase to 6 percent per year indefinitely. Assume 10 percent required rate of return. [6 marks] b. You are considering to purchase the stock of Tambunan Tea Bhd. You expect it to pay a dividend of RM3 in 1 year, RM4.25 in 2 years, and RM6.00 in 3 years. You expect to sell the stock for RM100 in 3 years. If your required rate of return for the stock is 12 percent, how much would you pay for the stock today? [4 marks] c. Discuss THREE key differences between common stocks and bonds. [5 marks] d. As a rational investor, what would you do if you find that the expected return of a stock is above its required rate of return? Explain. [5 marks] [TOTAL: 20 MARKS]

Question 4 a. What are some of the advantages and disadvantages of using the internal rate of return (IRR) method in evaluating a project? [6 marks] b. A firm owns a building with a book value of RM150,000 and a market value of RM250,000. If the building is utilized for a project, what would be the opportunity cost (ignore the taxes). Explain your answer. [4 marks] c. The cost of a new machine is RM250,000. The machine has a 3-year life and zero salvage value. If the cash flow each year is equal to 40% of the cost of the machine, calculate the payback period for the project. [4 marks]

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d.

Luanti Corp. is considering investing in a new project. The project will need an initial investment of RM2,400,000 and will generate RM1,500,000 (before-tax) cash flows for three years. If the tax rate is 20 percent, calculate the internal rate of return (IRR) for the project. [6 marks] [TOTAL: 20 MARKS]

Question 5 a. Moralee Inc.s bonds have an 8.25 percent coupon and pay interest annually. The face value is RM1,000 and the current market price is RM1,004.60 per bond. The bonds mature in 17.5 years. What is the yield to maturity of the bond? [6 marks] b. Tuaran Fruits Bhd. has a 7 percent coupon bond outstanding that matures in 13.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is RM1,000 and the yield to maturity is 14.78 percent? [6 marks] c. Miri' s Tools has a 9-year, 7 percent annual coupon bond outstanding with a RM1,000 par value. Bintulu' s Tools has a 10-year, 6 percent annual coupon bond with a RM1,000 par value. Both bonds currently have a yield to maturity of 6.5 percent. If the market yield increases to 6.75 percent, which bond will experience more price changes? No calculation is needed, simply justify your answer. [4 marks] d. Damais bonds have a face value of RM1,000 and a current market price of RM1,047.20. The bonds have a 6 percent coupon rate. What is the current yield on these bonds? [4 marks] [TOTAL: 20 MARKS]

QUESTIONS END HERE