BAF5FOF Fundamentals of Finance

1. Candidates must complete the front cover sheet and include it in the final documents submitted.

2. Candidates must NOT communicate electronically or verbally with anyone about the content of the examination during completion of the examination.

3. Candidates must complete the answers either in clear handwriting, or in MS Word if typewritten.

4. Please use black / blue ink pen in handwritten documents to ensure that they can be scanned clearly.

5. Please begin each question on a new page.

6. Candidates are allowed to use any lined or graph paper in A4 size if possible for handwritten answers.

7. Questions answered must be noted on the left hand side of each page.

8. Each page must include a page number.

9. Candidates must scan handwritten answers using a mobile phone or scanning app.

10. Scanned and typewritten answer documents must be uploaded on Moodle before the stated deadline, FAILURE to do so will result in a zero mark.

11. Candidates should label documents “1 of x”, 2 of x” etc. to enable markers to ensure that all documents uploaded are located for marking.

Question 1

Athos, Porthos and Aramis each hold 6% of the ordinary shares in Dumas Limited, which has earned a cash profit of £4 million in the year just ended. At the annual general meeting the company’s directors have said that, as profit maximisation is the goal they have set for the firm, they want to reinvest this amount to produce a bigger cash profit of £4.5 million next year. Athos, Porthos and Aramis are discussing the company’s plan. Athos says he has no immediate use for the money so would rather receive a higher dividend next year - the company should therefore re-invest the amount.

Porthos says he would prefer to have the dividend payment now. Stock prices are currently depressed due to fears of a coronavirus epidemic, and this is a good time to buy. Instead of waiting for a higher amount of dividend next year, he could earn more by getting the dividend now and investing it in the stock market.

Aramis says he does not need the cash right away, but will require it in 6 months’ time to part-finance the expansion of his small business – since he cannot wait for a whole year, he would also prefer to get an immediate dividend.

Required

(a) Using the information in the first five paragraphs, recommend the course of action for Dumas Limited that would benefit all the company’s shareholders, regardless of their individual preferences – explain the reason for your recommendation, and illustrate your answer with appropriate calculations to show how Athos, Porthos and Aramis would all be better off.

(b) Identify and define the fundamental theorem of financial economics which formally sets out the principle which the above example illustrates, and explain the implications of this theorem for financial management.

(c) Discuss the potential problems that may arise from setting profit maximisation as the goal of a firm.

(a) Calculate the following in respect of each of the two projects:

(i) Net present value

(ii) Internal rate of return What would be the ranking of these two projects according to each of the above investment appraisal techniques?

(b) Explain the technical problems that may be faced in application of the IRR technique, particularly under conditions of mutual exclusivity. Where relevant, use your findings in part

(a) together with an appropriate diagram to illustrate your answer. Which project would you recommend that Ezra plc should select?

(c) Calculate the Modified Internal Rate of Return (MIRR) of the two projects, and explain how and to what extent this technique addresses the limitations of the IRR method of investment appraisal.

Required:

(a) Calculate the approximate issue price of the bonds (in nearest round pounds) and the number of bonds that would need to be issued at that price. What are the cash outflows that Bika plc would need to provide for in each of the 15 years in respect of the bond issue?

(b) Estimate the annual cash outflow that Bardot plc would have to provide for amortization of the bank term loan that has been proposed as an alternative to the issue of bonds.

(c) Discuss the advantages and disadvantages of raising finance through the issue of bonds rather than through term loans.

Required:

(a) Calculate the theoretical ex-rights price of an ordinary share of Novy plc following the rights issue of £56 million, and identify the price at which the rights are likely to be traded.

(b)Evaluate the two alternatives being considered by the owner of the 1,000 shares and explain whether, in theory, either of the alternatives would leave her worse off.

(c) Discuss the advantages and disadvantages of raising capital through a rights issue rather than a public issue.

(a) Explain the rationale and underlying principles of Islamic finance. Comment on why it is of increasing importance to accounting and finance professionals.

What would be the effective annual rate of return to Banco Brtianico plc, and in what way would this be different from the return earned under a loan transaction? Your answer should include comments on the tax implications of the transaction for Banco Britanico plc.

(b) Explain the key differences between Murabaha and Ijara, and the difference between Ijara and Ijara-wal-Iqtina.