Surname______________ First Name____________ ID No.

_____________
MASSEY UNIVERSITY
ALBANY CAMPUS
125.230 BUSINESS FINANCE
MID-TERM TEST
SEMESTER 1 2009
Time Allowed: 90 MINUTES

_______________________________________________________
Instructions
1.
2.
3.
4.
6.
7.
8.

Answer all questions.

The total term test carries 70 marks and counts towards 20% of your final grade.
Compounding/discounting tables have been provided and may be used.
A formula sheet is attached at the end of the examination paper.
Record your name, student ID number on pages 1 and 4 to 8 of this test paper in the
space indicated.
All workings must be clearly shown for Questions 21 to 23.
No one may leave the room during the test.

Section A: Answer questions 1 - 10 on the multiple choice answer sheet provided

on page 4. (select the one best answer)
(2 Marks each)
Q1.

The purpose of the dividend imputation system in New Zealand is to:

A)
solve the agency problem.
B)
make dividend income subject to one levy of tax. *
C)
reconcile the economic and accounting views of the firm.
D)
increase the tax rate on company profits.
E)
none of the above.

Q2.

Which of the following statements about trading on the stock exchange is

FALSE?
A)
the goal of trading is to buy low and sell high for maximum profit
B)
only individuals can legally buy and sell shares; firms are prohibited*
C)
once placed, orders can be processed in minutes
D)
to make transactions on the floor of the ASX, a player must have
access through a brokerage firm
E)
answers A and C

Q3.

When the amount earned on a deposit has become part of the principal at the
end of a specified time period, the concept is called:
A)
primary interest.
B)
compound interest. *
C)
future value.
D)
discount interest.
E)
nominal interest.

Q4.

The rate of interest agreed upon contractually, charged by a lender or

promised by a borrower, is the ________ interest rate.
A)
continuous
B)
effective
C)
nominal *
D)
discounted
E)
compounding

Q5.

If the nominal interest rate is 6 per cent per annum, compounded monthly, the
effective interest rate is:
A)
6.09%.
B)
6.17%. *
C)
6.20%.
D)
6.14%.
E)
6.00%

Q6.

To find the equal monthly payments necessary to pay off a mortgage at a

specified rate over a given period we would use:
A)
a loan amortisation schedule. *
B)
the periodic table.
C)
our bank manager.
D)
the New Zealand Business Review.
E)
none of the above.

Q7.

If a person requires greater return when risk increases, that person is said to
be:
A)
risk-averse. *
B)
risk-aware.
C)
risk-seeking.
D)
risk-indifferent.
E)
risk-neutral.

Q8.

A common approach of estimating the variability of returns involving

forecasting the pessimistic, most likely, and optimistic returns associated with
the asset is called:
A)
financial statement analysis.
B)
sensitivity analysis. *
C)
marginal analysis.
D)
break-even analysis.
E)
none of the above.

Use the information below to answer questions 9-11.

Asset
X
Y
Z
Q9.

Proportion
0.50
0.25
0.25

Annual Return
10%
8%
16%

Beta
1.2
1.6
2.0

Refer to the information above. What is the expected annual return of this
portfolio containing assets X, Y and Z?
A)
10.0%
B)
11.4%
C)
11.0%*
D)
11.7%
E)
12.0%

Q10. Refer to the information above. The beta of the portfolio containing assets X,
Y and Z is:
A)
2.4.
B)
1.6.
C)
2.0.
D)
1.5. *
E)
4.8
Q11. Refer to the information above. The beta of the portfolio indicates this
portfolio:
A)
has an undetermined amount of risk compared to the market.
B)
has less risk than the market.
C)
has more risk than the market. *
D)
has the same risk as the market.
E)
cannot be determined.

Q12. The key determinants of the real rate of interest are:

A)
the Reserve Bank and Treasury.
B)
cash flows and discount rate.
C)
inflation.
D)
supply and demand for funds. *
E)
risk free rate.
Q13. The relationship between the yield to maturity and the length to maturity is
known as the:
A)
repayment structure of interest rates.
B)
term structure of interest rates. *
C)
risk structure of interest rates.
D)
tax structure of interest rates.
E)
loan amortisation.
Q14. Foxam Company has issued a bond which has a $100 par value and a 15 per
cent annual coupon interest rate. The bond will mature in ten years and
currently sells for $125. Using the approximation formula to calculate the yield
to maturity (YTM) of this bond results in a YTM of:
A)
11.11 per cent. *
B)
42.22 per cent.
C)
15.00 per cent.
D)
27.78 per cent.
E)
20.00 per cent.
Q15. If expected return is less than the required return on an asset, rational
investors will:
A)
buy the asset, since price is expected to increase.
B)
sell the asset, which will drive the price down and cause the expected
return to reach the level of the required return. *
C)
buy the asset, which will drive the price up and cause expected return
to reach the level of the required return.
D)
sell the asset, which will drive the price up and cause the expected
return to reach the level of the required return.
E)
none of the above are correct.
Q16. In regard to the differences between debt and equity capital, which of the
following is TRUE?
A)
Debt capital is long term funds provided by the firm's shareholders.
B)
Interest received by holders of bonds is taxable, while dividends
received on shares are not taxable.
C)
Equity capital has no stated maturity *
D)
Shares are traded on financial markets, while bonds are not traded.
E)
Debt capital is short term funds provided by the firms shareholders.

Q17. The four basic sources of long-term funds for the firm are:
A)
current liabilities, long-term debt, ordinary shares and retained
earnings.
B)
long-term debt, accounts payable, ordinary shares and retained
earnings.
C)
current liabilities, long-term debt, ordinary shares and preference
shares.
D)
long-term debt, ordinary shares, preference shares and retained
earnings. *
E)
long-term debt, ordinary shares, account receivable and retained
earnings.
Q18. The cost of each type of capital depends on:
A)
the risk-free cost of that type of funds.
B)
the financial risk of the firm.
C)
the business risk of the firm.
D)
all of the above. *
E)
None of the above.
Q19. Debt is generally the least expensive source of capital. This is due primarily
to:
A)
the tax deductibility of interest payments. *
B)
fixed interest payments.
C)
its position in the priority of claims on assets and earnings in the event
of liquidation.
D)
the secured nature of a debt obligation.
E)
debt has maturity date.
Q20. The cost of new ordinary equity financing is higher than the cost of retained
earnings due to:
A)
flotation costs and underpricing. *
B)
flotation costs and overpricing.
C)
commission costs and overpricing.
D)
flotation costs and commission costs.
E)
None of the above.

Student ID________________ Name___________________________

125.230 Business Finance
MULTIPLE CHOICE ANSWER SHEET

Place an X in the appropriate box.

1.

11.
A

2.

12.
A

3.

13.
A

4.

14.
A

5.

15.
A

6.

16.
A

7.

17.
A

8.

18.
A

9.

19.
A

10.

E
20.

Student ID________________

Name______________________________

Section B: Please answer the following questions in the spaces provided after
each question.
Q21. Mr and Mrs Pribel wish to purchase a boat in 8 years when they retire.
They are planning to purchase the boat using proceeds from the sale of their
property, which is currently worth $90 000 and its value is growing at 7 per
cent a year. The boat is currently worth $200 000, increasing in value at 5 per
cent per year. In addition to the value of their property, how much additional
money should they deposit at the end of each year in an account paying 9 per
cent annual interest in order to be able to buy the boat upon retirement?
[7
marks]

Value of the property upon retirement:

FV = PV (FVIF(k, n))
FV (8) = $90 000 (FVIF (7%, 8))
= $90 000 1.718
= $154 620
Value of the boat upon retirement:
FV with (8) = $200 000 (FVIF(5%, 8))
= $200 00 1.477
= $295 400
Additional money needed upon retirement:
$295 400 - $154 620 = $140 780
Amount of money needed to deposit at the end of each year:
PMT = (FVA/FVIFA (k, n))
= ($140 780/FVIFA (9%,8))
= ($140 780/11.028)
= $12 765.69

Student ID________________

Name______________________________

Q23. Two years ago Walcart Limited issued 110,000 ten year bonds to the public
that have a par value of $1,000 each and pay a coupon rate of 10%. The
bonds traded at a yield-to-maturity of 7%. Walcart also owes $27,320,000 on
a long term banking facility that has an interest rate of 8.2%.
The current risk free rate is 6%, investors view Walcart as a relatively low risk
company. The company has a beta of 0.8 and the market risk premium is
7.5%. Walcart has 32,000,000 ordinary shares on issue. The current dividend
payment is $0.38 per share and it is expected the dividend to grow at 4% in
the future. The corporate tax rate is 30%.
A.

Using the information provided, estimate Walcarts current WACC.

[13 marks]

Cost of Capital
New Zealand Corporate Tax Rate
Company Beta Estimate
Market Risk Premium
Risk Free rate
Bank Loan
current dividend D0
dividend growth rate g
Coupon Rate
YTM
No. Bonds
Years to Maturity
Current Bond Value
Return on Equity
Share Price
Share on Issue

30%
0.8
7.50%
6.00%
8.20%
0.38
4%
10.00%
7.00%
110,000
8
1,179.14

Market Value of Equity

Bank Term Loan
Bonds

12.00%
$4.94
32,000,000
Value
158,080,000
27,320,000
129,705,285

Weight
50.17%
8.67%
41.16%

Value of Firm

315,105,285

100.00%

B.

Cost
12.00%
8.20%
7.00%

AT Cost
12.00%
5.74%
4.90%

Weighted Cost
6.02%
0.50%
2.02%

If the risk free rate increase what impact, if any, is there likely to be on
the yield to maturity of Walcarts bonds and on the market risk
premium?
[2 marks]

8.53%

The Marking for this question should be based on the following:

Part A
2 Marks
for determining current bond value
2 Marks
for determining required return on equity
2 Marks
for deternining current share price
3 Marks
for using market values of both debt and equity
2 Marks
for using after-tax cost of for both bank loan and bonds
2 Marks
for calculating WACC correct based on the students values
Part B
1 Mark

for saying that an increase in Rf will increase YTM on bonds

1 Mark

for saying that there will be no change in market risk premium given an increase in Rf

Q23.
To expand its operations, International Tools Ltd has applied to the
International Bank for a 3-year, $3,500 loan. Prepare a loan amortisation
table, assuming a 10 per cent rate of interest.
[8 marks]
PMT = (PVA /PVIFA(k,n))
= ($3,500 /PVIFA(10%,3))
= ($3,500/2.487)
= $1,407.40
Year
1
2
3

Beg. Bal.
$3,500
$2442.60
$1,279.46

Payment
$1,407.40
$1,407.40
$1,407.40

Interest
$350
$244.26
$127.95

Principal
$1 057. 40
$1,163.14
$1,279.46

End. Balance
$2 442.60
$1 279.46
0