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Financial Management Questions and Answers

Question 1

Question 1

a) ABC Bhd. is a fast growing drug company. The company forecasts that in the next three years, its growth rates will be 30 percent, 28 percent, and 24 percent, respectively. Last week the firm declared a dividend of RM1.67 per share. After three years, the company expects a more stable growth rate of 8 percent thereafter. If the required rate of return is 14 percent, compute the current value

of the firmâ€™s stock.

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b) Discuss the key differences between debt and equity.

- Define debt financing and equity financing.

- Discuss the differences based on different characteristics, namely voice in management, claims on income and assets, maturity, and tax treatment.

c) Discuss the general steps for private firms to go public via initial public offering.

- Define initial public offering.

- Describes the five general steps to go public (refer to Tutorial 6).

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Question 2

a) GM Corporation has 5.7 percent coupon bonds, making semi-annual payments and selling at 108.96 percent of par. The bond has a face value of RM2,000and mature in 16 years. What is the yield to maturity (YTM) of the bond? What is the current yield?

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Coupons = 0.057(RM2000) = 114/2 = RM57

Bond price = 1.0896(RM2000) = RM2179.20

57(1 â€“ 1/(1 + X)^32)/X + 2000/(1+X)^32 â€“ 2179.20 Shift solve sum

X = 0.024431858

YTM = 0. 024431858 Ã— 2 = 0.04886 = 4.89%

Current yield = RM114/2179.20 = 0.0523 = 5.23%Â

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b) Discuss the relationship between the current yield and YTM for a bond.

- Define current yield.

- Define yield to maturity.

- Discuss the relationship based on bond pricing, such as par, discount, and premium.

c) Discuss the factors which determine the required return on bonds.

- Briefly explain what is required return of a bond, the yield to maturity.

- Discuss the factors such as interest rate risk, future inflation and real rate of interest which might affect the required return on bonds.

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Question 3

a) GREEN Bhd. is considering a four-year project to improve its production efficiency. Buying a new machine press for RM560,000 is estimated to result in RM210,000 in annual pre-tax cost savings. The press will be depreciated straight-line over its 4 years life span, and it will have a salvage value of RM80,000 at the end of the project. The press also requires an initial investment in working capital of RM20,000, along with an additional RM3,000 for each succeeding year of the project. The corporate tax rate is 25 percent, and the

cost of capital is 9 percent. Should the firm invest in this project?

Annual depreciation = RM560,000/4 = RM140,000

After-tax salvage value = RM80,000 (1 â€“ 0.25) = RM60,000

OCF = RM210,000 (1 â€“ 0.25) + 140,000 (0.25) = RM192,500Â

NPV = -580,000 + 189,500(1 â€“ 1/1.09^3)/0.09 + 281,500/1.09^4

NPV = -580,000 + 479,680.34 + 199,421.70 = RM99,102.04

The firm should invest in this project because of the positive NPV which indicate this project will add value to the firm.

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b) BLUE Bhd. has a target debt â€“ equity ratio of 0.60. The debt consists of 7.5 percent semi-annual coupon bonds with a maturity of 15 years and are currently selling for 95.65 percent of par. The companyâ€™s share is currently priced at RM34 per share and has a beta of 1.05. The market risk premium is 8 percent, treasury bills are yielding at 5 percent. The relevant tax rate is 21 percent. Calculate the firmâ€™s weighted average cost of capital.

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Market Value:

Debt/equity = 0.60

D = 0.60

E = 1.00

V = 1.60

WD = 0.60/1.6

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c) Discuss the two conditions in which the weighted average cost of capital (WACC) is an appropriate discount rate for a project.

- Define WACC.

- Discuss the two conditions - same level of systematic risk, and same financing mix (same proportions of debt, equity and preferred stock).Â

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Question 4

a) ABC Bhd. is a fast growing drug company. The company forecasts that in the next three years, its growth rates will be 30 percent, 28 percent, and 24 percent, respectively. Last week the firm declared a dividend of RM1.67 per share. After three years, the company expects a more stable growth rate of 8 percent thereafter. If the required rate of return is 14 percent, compute the current value

of the firmâ€™s stock.

b) Discuss the key differences between debt and equity.

c) Discuss the general steps for private firms to go public via initial public offering.

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Question 5Â

a) GM Corporation has 5.7 percent coupon bonds, making semi-annual payments and selling at 108.96 percent of par. The bond has a face value of RM2,000 and mature in 16 years. What is the yield to maturity (YTM) of the bond? What

is the current yield?

b) Discuss the relationship between the current yield and YTM for a bond.

c) Discuss the factors which determine the required return on bonds.

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Question 6

a) GREEN Bhd. is considering a four-year project to improve its production efficiency. Buying a new machine press for RM560,000 is estimated to result in RM210,000 in annual pre-tax cost savings. The press will be depreciated straight-line over its 4 years life span, and it will have a salvage value of RM80,000 at the end of the project. The press also requires an initial investment in working capital of RM20,000, along with an additional RM3,000 for each succeeding year of the project. The corporate tax rate is 25 percent, and the

cost of capital is 9 percent. Should the firm invest in this project?

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b) BLUE Bhd. has a target debt â€“ equity ratio of 0.60. The debt consists of 7.5 percent semi-annual coupon bonds with a maturity of 15 years and are currently selling for 95.65 percent of par. The companyâ€™s share is currently priced at RM34 per share and has a beta of 1.05. The market risk premium is 8 percent, treasury bills are yielding at 5 percent. The relevant tax rate is 21 percent. Calculate the firmâ€™s weighted average cost of capital.

c) Discuss the two conditions in which the weighted average cost of capital (WACC) is an appropriate discount rate for a project.