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Subject Number: FNCE10002
Subject Name: Principles of Finance
Writing Time: 120 minutes
Reading Time: 15 minutes
Total Marks: 100
Question 1 (10 marks)
The annual report of WTC Ltd provides the following information about the firm. It has 20 million
ordinary shares outstanding with a current market price of $1.50 per share. The beta of ordinary shares is
1.5, the market risk premium is 8% p.a. and the riskfree rate is 6% p.a. The firm’s debt consists of
100,000 bonds paying an annual coupon rate of 10% at the end of each year and maturing in 4 years’
time. Each bond has a face value of $100 and the current yield to maturity on these bonds is 8.0% p.a.
The company tax rate is 30%. Calculate WTC’s after-tax weighted average cost of capital. Show all
workings.
Question 2 (10 marks)
KLC Ltd is evaluating an investment project with the following information:
Project life 2 years
Initial project cost $400,000
Real before-tax net operating cash flows $350,000 per annum
Real after-tax salvage value in year 2 $14,000
Corporate tax rate 30 percent
Nominal project discount rate 10.24% per annum
Expected inflation rat 4.00% per annum
Assuming end-of-year cash flows, calculate the NPV of this project. What decision should the firm
make? Show all workings.
Question 3 (10 marks)
You are given the following information on two stocks and the market portfolio. Note that the diagonal
terms are variances of returns and the off-diagonal terms are covariances of returns.
Security/Portfolio Variances and Covariances
Delta Ltd Omega Ltd Market Portfolio
Delta Ltd 0.250
Omega Ltd 0.060 0.090
Market Portfolio 0.030 0.050 0.040
(a) You have $50,000 available to invest and you form a portfolio by short selling $30,000 worth
of Delta Ltd and investing all the available funds in Omega Ltd. Calculate the beta of this
portfolio. Show all workings.
(b) If the market portfolio’s return unexpectedly falls by 2 percent what, if anything, will happen
to the portfolio’s return? Explain.
Question 4 (10 marks)
The CFO of the CSC Ltd is considering a recapitalization plan that would convert CSC from its current
all-equity capital structure to one including substantial financial leverage. At present, CSC has 250,000
ordinary shares outstanding, which are selling for $60.00 each, and the recapitalization proposal is to
issue $7,500,000 worth of long-term debt at an interest rate of 6.0 per cent and use the proceeds to
repurchase 125,000 ordinary shares worth $7,500,000. CSC’s expected EBIT next year will be
$2,000,000. Assume there are no market frictions such as corporate or personal income taxes.
(a) Calculate the number of shares outstanding, the share price and the debt-to-equity ratio for CSC
if the proposed recapitalization is adopted. Show all workings.
(b) Calculate the expected earnings per share and return on equity for CSC’s shareholders under
the expected EBIT for both the current all-equity capitalization and the proposed mixed
debt/equity capital structure. Show all workings.
Question 5 (10 marks)
You are an investor keen to invest in the shares of Asjeet Ltd and Pinder Ltd. Your plan is to construct a
portfolio consisting of a 30% investment in Asjeet Ltd shares and 70% in Pinder Ltd shares. You estimate
that the current yield on a 10-year Government bond is 3% p.a. and plan to use this security as a proxy for
the risk-free asset. You also estimate that the market risk premium is 6% p.a. You go on to compile the
following information with a view to treating the ASX 200 index as a proxy for the market portfolio.
Asset Standard
deviation of
returns (p.a.)
Correlation coefficient
Asjeet Ltd
shares
Pinder Ltd
shares
ASX 200 10-year
Government
bond
Asjeet Ltd
shares
20% 1.0
Pinder Ltd
shares
30% 0.6 1.0
ASX 200
index
25% 0.8 0.7 1.0
10-year
Government
bond
0 0 0 0 1.0
(a) What is the standard deviation of returns for your portfolio? Show all workings and round to the
nearest two decimal places.
(b) What is the beta of Asjeet Ltd and Pinder Ltd shares? Show all workings and round to the nearest two
decimal places.
Question 6 (10 marks)
Debra is a jeweler that regularly purchases ingots of gold so as to manufacture jewelry. She is concerned
that adverse price movements will increase the cost of manufacturing her products and so purchases a call
option written on gold. The option she purchases is a European-style option with an exercise price of
$2,600 for an ounce of gold. Debra pays $350 for the option and the current price of gold is $2,400 per
ounce.
(a) Draw the profit diagram of the option described above. Make sure you label all axes, turning points
and intercepts.
(b) What is the time value and intrinsic value of the option described in the text accompanying the
question above?
Question 7 (10 marks)
You have been awarded a Pinder Foundation scholarship to help cover your living costs while studying at
the University of Melbourne. The scholarship offers a regular payment of $1,000 per month for three
years with the first payment occurring in one and a half months’ time. If the relevant discount rate is 6%
p.a. compounding monthly, what is the present value of the scholarship today? Show all workings and
round to the nearest two decimal places.
Question 8 (10 marks)
You arrange a mortgage from the Pinder Bank of Australia. The amount you borrow is $760,000 with
payments required on a monthly basis over the next 25 years with the first payment required one month
from today. The interest rate quoted by the bank is 10% p.a. compounding monthly. What is the monthly
payment required by the bank? Show all workings and round to the nearest two decimal places.
Question 9 (10 marks)
You are employed by an investment bank to estimate the value of a coupon-paying bond with the
following features. It has a face value of $100,000, pays quarterly coupons at a rate of 8% p.a. and the
market required yield to maturity is 10% p.a. compounding quarterly. There is one full quarter until the
next payment will be received and the bond matures in 4 years. What is the market value of the bond?
Show all workings and round to the nearest two decimal places.