CAUTION:

THE EXAM QUESTIONS ARE UNLIKELY TO BE THE SAME AS THOSE IN THE

PRACTICE MATERIALS. BUT THIS SET OF QUESTIONS SHOULD GIVE YOU AN
INDICATION OF THE TYPE AND DIFFICULTY LEVEL OF THE EXAM QUESTIONS
Question 1
a) The board directors of Swiss Chocolate Limited (SCL) - a large public company listed in the
London Stock Exchange - were appointed by Mr. Roger, the founder and Chief Executive
Officer of SCL, who owns 1 percent of the $100 million fully paid-up capital of SCL.
However, these directors possess the authority to decide the remuneration scheme for Mr.
Roger. What are the potential agency problems in the above situation?
b) What is the efficient market hypothesis? Define the three forms of market efficiency.
c) What are the implications of market efficiency for financial managers?
(5 + 5+5 = 15 marks)
Question 2
a. You have shopped around for deposit some money in a bank. You need make a choice between
the following two offers: Bank ANZ, 5.1% with quarterly compounding; Bank NAB, 5.03% with
monthly compounding. Which one should you choose and why?
(5 marks)
b. You took up a housing loan from Bank ABC. It charges a flat rate of 7% and the amount you
decided to borrow is $200,000.
1) What would the monthly payment be for 20 years?
2) If you make a monthly payment of $2000, how long does it take to pay off the loan?
(10 marks)
Question 3
a) A 2-year maturity bond with a face value of $1,000 makes annual coupon payments of $80
and selling at $1,080.
i) What is the current yield of the bond?
ii) What is the yield to maturity (YTM) of the bond?
iii) What is the price of the bond if inflation is expected to increase interest rate by 2
percent?
(7 marks)
b) Johnson Corporation currently pays $2.50 dividend per share on its ordinary shares. Due to its
impressive research and development facilities, the companys earning is expected to grow
rapidly during the next three years. The company directors projected that the dividend growth
rate will be 15 percent per year for the next three years and continue to grow at a rate of 6
percent thereafter.
i) What is the value of the ordinary share of John Cabin Corporation if the required rate of
return is 16%?
ii) What is the value of the ordinary share if the growth has been reduced to zero for the first
three and 6 percent thereafter?
(8 marks)
Question 4
a) Describe the main methods commonly used to evaluate investment proposals.
b) What are the strengths and weaknesses of each?
c) If the methods give conflicting results in a particular case, which method would you normally
recommend? Give reasons for your choice.
(4+4+2 = 10 marks)

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Question 5

The expected return and risk on shares in companies X and Y are as follows:
Expected return
Standard deviation

X
15%
9%

Y
27%
15%

a) The correlation coefficient of the return on X and Y is +0.8. Calculate the expected return and risk
of an equally weighted portfolio.
b) If the correlation coefficient of the returns on X and Y is zero, Calculate the expected return and
risk of an equally weighted portfolio.
c) Security A is expected to produce a rate of return of 22% and has a beta of 1.2. Security B is
expected to produce a rate of return of 15%, and has a beta of 0.5. What is the expected rate of
return on the market portfolio and the risk free rate of interest?
d) What is beta of a portfolio? Explain.
e) What are the factors that an investor would consider in choosing an optimal portfolio? Explain
what an optimal portfolio is.
(3 + 3 + 3+3+3 = 15 marks)

Question 6
Examine the following balance sheet of University Products Limited.
University Product Limited
Balance Sheet as at 31 December 2013
Assets ($m)
Liabilities and Net Worth ($m)
Cash and Short-term securities
$1
8% Coupon Bond (31/12/2023)
$10
Accounts receivable
3
10% Preferred Stock (Par = $10)
2
Inventories
7
Common stock (Par = $10)
$10
Plant and equipment
21
Retained Earnings
$10
Total
$32
Total
$32
Additional information:
i) The preferred stock currently sells for $15 per share. The common stock has a beta of 1.4 and
is currently trading at $20 per share.
ii) The market expects the yield to maturity of the companys bond to trade at 10 percent per
annum.
iii) The market risk premium is 10 percent and the risk-free rate of return is 6 percent.
The company pays a tax rate of 20%.
Required:
a)
b)

Calculate the firms Weighted Average Cost of Capital.

Critically evaluate the usefulness of using the WACC method to appraise the feasibility of
projects to be undertaken.
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(15 marks)

Question 7

a) Explain the various schools of thoughts on capital structure.

b) How would the Modgliani and Miller proposition II (MM II) be any difference to the first
proposition (MM I) ?
c) What dividend policies are commonly found in practice?
d) What practical steps can management take to determine a suitable dividend policy?
(4+4+4+3=15marks)

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FORMULAE
FV = PV(1 +r)t
PV = FV / (1 + r)t
PV = C / r
PV = C1 / (r g)
PVA = C({1 [1/(1 + r)t]} / r )
PVGA = C {[1/(r g)] [1/(r g)] [(1 + g)/(1 + r)]t}
EAR = [1 + (APR / m)]m 1
FV = PVeRt
PVAdue = (1 + r) PVA
FVA = C{[(1 + r)t 1] / r}
FVAdue = (1 + r) FVA
RP = XARA + XBRB
2P = (XA2 x 2A) + (2XA A AB XB B) + (XB2 x 2B)
RA = RF + A(RM RF)
Corr(RA,RB) = AB = AB/ A B
A = AM / 2M
WACC = {[S/(S+B)] x RS} + {[B/(S+B)] x RB x (1 tc)}

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