Final Examination, BUS312,Spring 2013

NAME: ______Student #______

Instructions: For qualitative questions, point form is not an acceptable answer. For quantitative questions, show your work. There are a total of 126 marks on this examination with 12 questions and 12 pages. Answer all questions on the examination. No other sheets of paper will be marked. The examination period is three hours. There will be no extensions. No cell phones, computers, or other communications devices may be used during the examination period. Remove baseball caps or wear them backwards. No washroom breaks.

Caution — In accordance with the Academic Honesty Policy (T10.02), academic dishonesty in any form will not be tolerated. Prohibited acts include, but are not limited to, the following:

  • making use of any books, papers, electronic devices or memoranda, other than those authorized by the examiners.
  • speaking or communicating with other students who are writing examinations.
  • copying from the work of other candidates or purposely exposing written papers to the view of other candidates.

1. (10 Marks) Consider a bond that offers a fixed per annum coupon rate of 6.6% compounded and paid semi-annually with a par value of $1,000,000. When you buy the bond, the yield to maturity is 6.6% per annum compounded semi-annually.The invoice price is $1,010,881.17. You sell the bond four years and nine months from today.When you sell the bond, the yield to maturity is 6.6% per annum compounded semi-annually.

Required: What is the quoted price of the bond when you sell it?

2. (10 Marks). You believe that the constant growth version of the discounted dividend model is a reasonable representation of value for ABC Company common shares. They pay dividends once per year and they have just made a dividend payment (the ex-dividend date is today). ABC’ price to forward earnings ratio is 10, their per annum market capitalization rate is 10%, and their per annum forward ROE is 8%.

Required:Find ABC’s expected per annum corporate growth rate.

3. (10 Marks)You believe that the constant growth version of the discounted dividend model is a reasonable representation of common share value for ABC Company Ltd. They pay dividends once per year and they have just made a dividend payment (the ex-dividend date is today). They retain a constant fraction of earnings each year for reinvestment and growth. ABC’s market/book ratio is 3.0, their forward dividend yield is 4% per annum, and their price to forward earnings ratio is 10.0. You expect the ex-dividend share-price in one year to be $60.18.

Required: What is ABC’s book equity per share today?

4. (10 Marks)Explain the difference between the rate of return on equity and the market capitalization rate. Use no numerical examples in your answer.

5. (10 Marks)You buy a financial asset today for $300 that pays $100 in three months, $100 in seven months, and $300 in eighteen months.

(i)Find the per annum IRR on this investment.

(ii)Find the per annum IRR compounded quarterly on this investment.

6. (10 Marks) ABC Company Limited pays dividends once per year and it has just made a dividend payment (i.e., the ex-dividend date is today). The next and upcoming dividend is in one year. ABC’s price to book ratio (market to book) is 1.8, their forward dividend yield is 5% per annum, and their price to forward earnings ratio is 12. You expect share price in one year, the trading day prior to the ex-dividend date at that time, to be $44.4. ABC has one million shares outstanding. You own one hundred thousandABC Company common shares. Today, ABC is completing a general cash offer of new common shares. You do not buy additional shares for your portfolio from this new issue. As the result of the general cash offer, your fractional ownership of ABC Company shares falls to 8%.

Required:

How many new shares does ABC sell in the offer?

7. (10 Marks) Today, ABC Company is planning a business investment. ABC is a start-up firm and, therefore, it has no investments or assets (for example, ABC has no cash balance). Also, ABC has no other business investments planned or contemplated other than the one described in this problem. For an investment (expenditure) of $1,000,000 today, the expected cash flow (free cash flow) to ABC at the end of the current year is $C which then grows at the rate g% per annum indefinitely. That is, each cash flow after the first is 1+g greater than the previous. Currently, ABC has no debt in its financial structure and its book equity is zero. Book equity is the sum of share-capital and retained earnings. In order to undertake its investment, ABC needs to do some financing. They plan to sell new shares to new shareholders in the amount of $1,000,000 to finance their business investment. The financial market opportunity cost (expressed as a rate of return) facing the shareholders of ABC for this business investment is 15% per annum. The fractional ownership of ABC’s original shareholders falls from 100% to 80% as the result of the equity issue. The IRR on the business investment is 18% per annum.

Required: Jointly determine g, the percentage growth in per annum cash flows and C, expected free cash-flow at the end of the current year.

8. (10 Marks) You have made nineteen semi-annual deposits into a savings plan. The last deposit was six months ago. Each deposit was 2% greater than the previous. The plan has paid 4% per annum compounded semi-annually. Beginning today, the savings plan will pay interest at the rate of 4.4% per annum compounded quarterly. You plan to make seventy five quarterly withdrawals from your account with the first in one quarter. Each withdrawal is 1.1% greater than the previous. At the time of the last withdrawal, you expect your account balance to be zero. Your account balance four years and eight months from today will be $4,300,000.

Required: What was your account balance five years and two months ago?

9. (10 Marks)Comment on the following assertion: “When forward ROIC (after tax and after depreciation exceeds the after corporate tax interest rate that a business pays on its debt, then the business creates wealth for financial asset-holders and shareholders in particular.” Use no numerical examples in your discussion.

10. (10 Marks)ABC Company Ltd. has a share price of $P. They are planning a rights issue of new common shares. ABC gives shareholders one right per outstanding share.NRrights plus the subscription price of $22 buys a new share in the offering. If you sell your rights (you as an existing shareholder), your fractional ownership of ABC common shares falls from 10% to 7.5% and your dollar investment in ABC common shares falls by $1 per share.

Required: Find ABC’s share price prior to the rights offering, $P.

11. (10 Marks) Today is Dec 31, 2012. You borrow $X from the Royal Bank of Canada (RBC) in a mortgage agreement. Since your mortgage requires monthly payments, your first payment is at the end of January 2013. The interest portion of your 60th payment is $1,001.65, principal repayment is $1,766.69, and the outstanding balance after the payment is $401,389.93.

Required: How much did you originally borrow?

12. (16Marks) ABC is a public company. Their share-price is $18 and they have 1,200,000 outstanding shares. In addition, they have financed their business investment with long-term bonds that have par-value (in total) of $10,000,000 and common equity. Both the coupon rate and the yield for ABC’s bond is y% per annum (paid annually with the next coupon in a year). ABC’s tax rate is 40%. ABC’s price to forward earnings ratio is 12.0 and their price to book ratio (for equity) is 1.8. ABC’s forward dividend yield is 4% per annum. ABC’s forward rate of return on invested capital after tax and after depreciation (ROIC) is 9% per annum. ABC is considering a new business investment that has a payback period of 8 years.

Required: Would you recommend that ABC undertake this business investment or not? Explain why or why not.

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