##### Which of the following is not the main factor to be considered when a firm chooses between flexible strategy and restrictive strategy to manage current liabilities?

##### A Term structure B Pay-out policies C Maturity hedging D Cash reserves [3 marks]

Section A

There is one and only one correct answer for each question. Please write down the

question number and your answer (either A, B, C or D) in your answers file (workings

are not required).

Question 1

Which of the following is not the main factor to be considered when a firm chooses between

flexible strategy and restrictive strategy to manage current liabilities?

A Term structure

B Pay-out policies

C Maturity hedging

D Cash reserves [3 marks]

Question 2

A bond is quoted at £950 and sold at £975 in the bond market. How much is the accrued

interest in the dirty price of this bond?

A £25

B £975

C £950

D £0.97 [3 marks]

Question 3

How many years until the final payment are there for a 5-year annuity due just issued?

A 7 years

B 6 years

C 5 years

D 4 years [3 marks]

Question 4

Which of the following is not a main drawback of internal rate of return (IRR) approach?

A Confusion over investing type cash flows and financing type cash flows

B Ranking issues

C Multiple solutions

D Lack of consideration on time value of money [3 marks]

Question 5

Which of the following is not a reason for popularity of payback methods?

A They are easy to understand, especially when communicating with non-specialists.

B They can be used at early stage of investment appraisal.

C They are precise methods.

D They are commonly used as secondary methods. [3 marks]

MN-2004 (January 2021) Page 3

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Question 6

Assuming the risk-free rate is 2%, and return of the market portfolio is 7.5%, how much is

the market risk premium?

A 9.5%

B 3.75%

C 5.5%

D None of the above [3 marks]

Question 7

Which of the following statements best describes total asset turnover?

A It measures how much more investors are willing to pay per unit of current earnings.

B It measures the profit for every unit of sales generates.

C It measures the sales for every unit of assets generates.

D None of the above [3 marks]

Question 8

Which of the following is not a common reason for firms to prefer share repurchases over

paying dividends?

A Share repurchases appeal to investors who seek stable cash flows.

B Share repurchases offer more flexibility.

C Share repurchases have tax advantage.

D Share repurchases can offset dilution on shares. [3 marks]

Question 9

Which of the following is not a commonly used type of dividend?

A Stock dividends

B Semi-annual coupons

C Stock split

D Cash dividends [3 marks]

Question 10

Which of the following theories concludes that required rate of return to shareholders rises

with leverage?

A The pie theory

B Portfolio theory

C Modigliani and Miller proposition I

D Modigliani and Miller proposition II [3 marks]

[Total 30 marks]

Page 4 MN-2004 (January 2021)

Section B

Please write down the question number, necessary workings and answers in your

answers file (rounding to two decimal places if necessary).

Question 1

(a) Chelseao plc. pays dividends that are expected to grow at 5% each year. Dividends will

stop growing at the end of year 5, at which point the firm will pay out all its earnings as

dividends. The next dividend will be paid one year from now at £10 and its earning per

share (EPS) at the time will be £15. If the appropriate discount rate on Chelseao plc. is

8%, what is its fair market price of the share today?

[15 marks]

(b) Arsenalo plc. has just issued level coupon bonds on the market with 7.5 years to maturity

and a yield to maturity (YTM) of 12%, and at a current fair market price of £950. The

bonds make quarterly payments. What must be the coupon rate on these bonds? Face

value of these bonds is £1,000.

[10 marks]

[Total 25 marks]

MN-2004 (January 2021) Page 5

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Question 2

(a) Villao plc. is an asset management company. It manages a two-asset portfolio which

consists of two risky assets, A and B. The proportions of A and B held in the portfolio

are 40% and 60%, respectively. The expected return of A and B are 12% and 8%,

respectively. Standard deviations of A and B are 70% and 40%, respectively. The

correlation coefficient between A and B is -0.6.

i) Calculate the expected return and standard deviation of the two-asset portfolio.

[6 marks]

ii) In light of the concept of portfolio diversification, make comments on the

results from i).

[7 marks]

(b) ManUnito plc. is a UK based pharmaceutical company, and the following information

regarding the financial position of the company is provided by their financial director

Ms. Jones:

Number of shares outstanding 15,000,000

Market value of debt (AA rating) £30,000,000

Expected yield of the debt 8%

Corporate tax rate 30%

Risk-free rate 3%

Market risk premium 5%

Current share price £2.00

Beta value of the share 1.60

In addition, Ms. Jones is considering two mutually exclusive projects by taking extra

finance, and cash flows of each project are shown below:

Points in time (yearly intervals) Project A (£) Project B (£)

0 -12,000 -10,000

1 5,000 4,000

2 5,000 4,000

3 5,000 4,000

i) Calculate the weighted average cost of capital of ManUnito plc.

[8 marks]

ii) Advise Ms. Jones which project to undertake by applying net present value

(NPV) approach. Assuming weighted average cost of capital is the appropriate

discount rate.

[4 marks]

[Total 25 marks]

Page 6 MN-2004 (January 2021)

Question 3

Evertono plc. is a fashion retail company and the following financial information about this

company is available:

Current assets £5,000,000

Current liabilities £4,000,000

Total revenue £12,000,000

Net income £3,000,000

Days in inventory 30 days

Days in receivables 42 days

Days in payables 45 days

Total cash demand for next year £800,000

Fixed transaction cost £20 per trade

Opportunity cost 10% per annum

Assuming Baumol Model is considered to be the appropriate cash management model.

i) Calculate the number of transactions Evertono plc. will need to make to replenish

the cash balance to optimal level next year, and in light of the assumptions of

Baumol Model and your calculation, briefly explain how the Baumol Model works

on cash management for Evertono plc.

[12 marks]

ii) Using the available information, calculate the current ratio, profit margin,

operating cycle and cash cycle of Evertono plc.

[8 marks]

[Total 20 marks]

End of Paper – An appendix of 2 pages follows

MN-2004 (January 2021) Page 7

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Appendix

1. Present value of an ordinary perpetuity

PV = A/R

2. Present value of a growing perpetuity

PV = A/(R-g)

3. Present value of an ordinary annuity

PV=𝐴 ∙ [

1−1/(1+𝑅)

𝑇

𝑅

]

4. Present value of a growing annuity

PV = 𝐴 ∙ [

1−(

1+𝑔

1+𝑅

)

𝑇

𝑅−𝑔

]

5. Pre-tax weighted average cost of capital

Pre − tax weighted average cost of capital =

𝐸

𝐸 + 𝐷

𝑟𝐸 +

𝐷

𝐸 + 𝐷

𝑟𝐷

6. Unlevered beta

Unlevered beta =

𝐸

𝐸 + 𝐷

𝛽𝐸 +

𝐷

𝐸 + 𝐷

𝛽𝐷

7. Weighted average cost of capital

𝑟𝑊𝐴𝐶𝐶 =

𝐸

𝐸+𝐷

𝑟𝐸 +

𝐷

𝐸+𝐷

𝑟𝐷(1 − 𝜏𝐶)

8. Variance of a two-assets portfolio

Var(p)=(w11)

2 + (w22)

2 + 2w1w2 1 2 1,2

9. Expected return of a two-assets portfolio

E(Rp)=w1E(R1) + w2E(R2)

10.Present value of a share with zero growth dividends

PV = D1/R

11.Present value of a share with constant growth dividends

PV = D1/(R-g)

12.Present value of a consol

PV = C/R

Page 8 MN-2004 (January 2021)

13.Present value of a level coupon bond

𝑃𝑉 = 𝐶 ∙ 𝐴𝑅

𝑇 +

𝐹

(1 + 𝑅)

𝑇

14.Formulae for Beta

𝛽𝑖 =

𝑐𝑜𝑣(𝑅𝑚,𝑅𝑖)

(𝜎𝑅𝑚)

2

15.Capital asset pricing model

E(𝑅𝑖

) = 𝑅𝑓 + 𝛽𝑖

∙ (𝐸(𝑅𝑚) − 𝑅𝑓)

16.Baumol Model

2( )( ) F T C

k

17.

Average cash balance of Baumol Model

𝐴 = 𝐶/2

18.Miller-Orr Model

1/3 2

3( )( )

4

F

Z L

k

19.Upper control limit of Miller-Orr Model

𝑈 = 3𝑍 − 2𝐿

20.Average cash balance of Miller-Orr Model

𝐴 = (4𝑍 − 𝐿)/3

21.Debt yield and default equation (Cost of debt for low rating bonds)

𝑟𝐷 = 𝑦 − 𝑝 ∙ 𝐿

22.Current ratio = Current assets / Current liabilities

23.Profit margin = Net income / Total revenue

24.Total asset turnover = Sales / Total assets