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Question 1 (Total 20 marks) a

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Question 1 (Total 20 marks)
a. Companies adopt conservative working capital investment and financing policies at an expense of reduced profitability. Do you agree? Explain. (7 marks)
b. Aapnex Inc. has annual sales of $12 million, its cost of goods sold is 75% of annual sales, it carries an average inventory of $800,000 and its average collection period is as long as its inventory conversion period. The firm buys on terms of net 45 days, and it pays on time. Its new CFO wants to decrease the cash conversion cycle (CCC) by 5 days, based on a 365-day year. He believes that he can reduce the average collection period to 30 days with no effect on sales. Considering that payable period remains same, to achieve the goal, the firm must also reduce its levels of inventory and inventory conversion period. By how much the firm must reduce its inventory to meet its goal of reducing the cash conversion cycle? (9 marks)
c. Restwell Inc (a retail company) sells 5000 units of a product per month. Restwell incurs a fixed order placement, transportation, and receiving cost of £25,000 each time an order is placed. Each unit costs £150 and the company has a holding cost of 20 percent. Evaluate the number of units of product that the manager should order in each replenishment lot? (4 marks)
2020/21 FINAL YEAR SUMMER EXAMINATION PAPER
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This examination is subject to Examination Regulations for Candidates.
Question 2 (Total 20 marks)
a. How poison pills can be used as an anti-takeover defence strategy by a target company and why regulatory authorities seek to outlaw the use of poison pills?
(10 marks)
b. An acquiring company agrees to purchase a target company, where under the terms of agreement, the target company’s shareholders will receive one share of the Acquiring company’s stock for every four shares of the Target company’s stock they hold. Acquiring company’s share price prior to the announcement was $80.00. Target company has 30 million shares outstanding. What type of M&A transaction is this? Calculate the value to the target per share and the equity value of the target company. (8 marks)
c. How does an increase in price of share of acquiring company affect the value to the target in stock-on-stock transaction with fixed exchange ratio structure?
(2 marks)
Question 3 (Total 20 marks)
a. Explain systematic risk and unsystematic risk and their relevance in portfolio risk and return. (8 marks)
b. You have a portfolio that consists of 15% investment in stock A, 30% in stock B, 40% in stock C, 10% in stock D and 5% in stock E, these stocks have following further information available:
Stock
Standard deviation
Correlation with the market
A
0.05
0.35
B
0.10
0.8
C
0.07
0.15
D
0.12
0.67
2020/21 FINAL YEAR SUMMER EXAMINATION PAPER
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This examination is subject to Examination Regulations for Candidates.
E
0.08
0.24
Treasury bills currently offer a return of 5%, the expected market premium is 8% and variance of market portfolio is 0.0036. Calculate the expected return on your portfolio according to the CAPM. (12 marks)
Question 4 (Total 20 marks)
a. Why according to dividend irrelevance argument, the firm value depends on only optimal investment policy and not on the dividend pay-out? What are the shortcomings of the dividend irrelevance theory? (10 marks)
b. Carsley Plc currently paid $2.50 dividend per share. Next year’s dividend is expected to be $3 per share. After next year, dividends are expected to increase at a 9 percent annual rate for three years and a 6 percent annual rate thereafter. Calculate the current value of a share of Carsley’s stock to an investor who requires a 15 percent return on his or her investment. (10 marks)
Question 5 (Total 20 marks)
a. What is a breakeven EBIT and why it is an important consideration for a levered firm? (4 marks)
b. Logar plc is considering leasing a machinery from Brinpool Ltd, the leasing subsidiary of Scot Bank. The machinery would otherwise cost £250 million to purchase via a bank loan at a 12 per cent interest rate. Brinpool has quoted an annual rental of £60 million over five years, with the first instalment payable immediately, and the rest annually thereafter. The machinery has a life of 5 years and will be depreciated using straight-line method. Ignoring the tax implications, should Logar Plc lease or borrow-to-buy? (6 marks)
c. Granite plc maintains a debt to equity ratio of 82% and has a tax rate of 38%. Company’s coupon rate on its current outstanding issue of bond is 7% and yield
2020/21 FINAL YEAR SUMMER EXAMINATION PAPER
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This examination is subject to Examination Regulations for Candidates.
to maturity is 9%. Company’s beta is 1.2, risk free rate is 5% and the market risk premium is 8%. Calculate company’s weighted average cost of capital and explain why WACC is an important consideration for a company’s management?
(10 marks)