BUS704 Corporate Finance
Task 3 Questions
Answer all six (6) questions
Please be advised that your answers will be checked for plagiarism.
Penalties are severe where this is detected.
Please refer to the announcements page in the BUS704 Course in Blackboard for details on USC’s policy on academic misconduct.
Question 1 (20 marks)
“One of the most important aspects to project evaluation is to make a correct estimate of the discount rate.”
Explain how the “discount rate” is derived and assess its significance in relation to other factors that are also important to project evaluation.
Question 2 (20 marks)
Mustang Ltd. Is evaluating an i) extra dividend, and ii) a share repurchase.
In either case, $13,325 would be spent.
Current earnings are $4.25 per share, and the share sells for $116. There are 5125 shares outstanding.
Ignore taxes and other transaction fees and charges in answering the following questions.
a. Evaluate the two alternatives [i) and ii)] in terms of the effect on the price per share and on shareholder wealth.
b. What will be the effect on Mustang’s earnings per share EPS and the price-earnings ratio under the two different scenarios [i) and ii)]?
c. In the real world, which of these two actions [i) or ii)] would you not recommend? Why?
d. “A company’s dividend policy is not as important as its capital structure policy.” Discuss.
Question 3 (20 marks)
Helena’s Health Foods
Earnings before interest ($) 20,000
Market value of debt ($) 58,000
???? (%) 5.5%
???? (%) 13%
Market value of equity ($) 143,818
Actual Total market value ($) 201,818
Equilibrium value 181,818
A second company, La Salle Health Foods, has the same financial information as Helena’s Health Foods, except that La Salle Health Foods has no debt and has an equilibrium value of $166,667 and a Cost of equity of 12%.
According to Modigliani and Miller, the total market value of the two companies should be the same irrespective of the methods used to finance their investments.
a. Suppose you hold 2% of the shares Helena’s Health Foods. Show the process and the amount by which you could increase your income without increasing your risk.
b. What are the potential advantages and disadvantages to a company’s owners if the company increases the proportion of debt in its capital structure?
Question 4 (20 marks)
a. On 30 September 20XX, the quoted price on the December 20XX 90-day bank bill futures contract was 93.67. Connor believed that interest rates would rise over the next month. Suppose that he committed to five contracts on 30 September 20XX and closed out his position on 31 October 20XX at a price of 92.46.
Ignoring transaction costs, how much has Connor made or lost?
Assume a Face Value of $1 million Australian. (4 marks)
b. On 10 October 20XX, the December 20XX 10-year bond futures contract was priced at 94.685. Milly believed that interest rates would fall. Suppose she took possession of two contracts on 10 October and closed out her position on 12 October at a price of
Ignoring transaction costs, how much has Milly made or lost in total? Assume a Face Value of $100,000 (Australian) and $3,000 interest per half year.
c. On 30 September 20XX, the December 20XX SPI 200 futures contract was priced at 5350.0. Michelle believed the share market was likely to rise over the next month. Suppose she committed to five contracts on 30 September and closed out her position on 31 October at a price of 5480.0.
Ignoring transaction costs, how much has Michelle made or lost?
Please refer to the textbook for the pricing formula.
d. Explain the key determinants of futures prices and explain the factors that may cause the futures market price at maturity, to be different from the spot market price at that same date.
Question 5 (20 marks)
Norton Ltd. shares are trading at $24 each. Its directors have announced a 1-for-4 rights issue with a subscription price of $21.10 per share.
a. Calculate the theoretical value of a right to one new share
b. Calculate the ex-rights price and the amount of right per share.
c. In theory, what would happen if the subscription price were $26.00?
d. In theory, what is the minimum possible subscription price?
e. “If a company undertakes a rights issue it will always cause the value
of the investor’s shareholding in that company to reduce.” Discuss.
Question 6 (20 marks)
Describe and evaluate the range of agency relationships that exist for an incorporated entity. To what extent do these relationships add value to the incorporated entity? (Maximum 1000 words).
Please cite relevant references according to USC policy on referencing. (See the following link via the USC library.
End of Examination