Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: zz-x2580
PAPER CODE: FIN202/20-21/S2/Final exam paper Page 2 of 4
Question 1 (25 marks)
ABC plc, an all-equity firm, has the following earnings per share and dividend history (paid
annually).
Year Earnings per share Dividend per share
This year 21p 8p
Last year 18p 7.5p
2 years ago 16p 7p
3 years ago 13p 6.5p
4 years ago 14p 6p
This year’s dividend has just been paid and the next is due in one year. ABC has an
opportunity to invest in a new product, X, during the next two years. The directors are
considering cutting the dividend to 4p for each of the next two years. However, the dividend
in three years can be raised to 10p and will grow by 9 per cent per annual thereafter due to
the benefit from the investment. The company is focused on shareholder wealth
maximization and requires a rate of return of 13 per cent for its owners.
1) If the directors choose to ignore the investment opportunity and dividends continued to
grow at the historical rate what would be the value of one share using the dividend
valuation model? (7 marks)
2) If the investment is accepted, and therefore dividends are cut for the next two years,
what will be the value of one share? (8 marks)
3) The firm purely relies on the internally generated funds to finance its new projects.
Discuss the Pecking Order theory of capital structure decision and the logic behind. (10
marks)
Question 2 (25 marks)
1) Black plc has a £100m ten-year floating-rate loan from Bank A at Libor + 150 basis
points. The treasurer is worrying that interest rates. Red plc is willing to swap its
fixed-interest commitment for the next ten years. Red currently pays 9 per cent to Bank
B. Libor is currently 8 per cent. Show the interest-rate payment flows in a diagram under
a swap arrangement in which each firm pays the other’s interest payments. (9 marks)
2) What are the drawbacks of this swap arrangement for Black? (8 marks)
3) Black can buy a ten-year interest-rate cap set at a Libor of 8.5 per cent. This will cost 4
per cent of the amount covered. Show the annual payment flows if in the fourth year
Libor rises to 10 per cent. (8 marks)
PAPER CODE: FIN202/20-21/S2/Final exam paper Page 3 of 4
Question 3 (15 marks)
1) What is a factoring company? (5 marks)
2) XYZ plc is considering using a factor company to help with the administration of trade
receivables. A factor has offered such service on a non-recourse basis for an annual fee of 2%
of the credit sales. The factor will maintain a trade receivables collection period of 30 days.
As a condition of this factoring agreement, the factor would advance 80% of the face value
of receivables at an annual interest rate of 6%.
The following is the most recent financial status of XYZ plc. Its total sales are £40 million per
year and all sales are made on credit. Its current trade receivable is £5,000,500. On average,
the company will spend £100,000 administration costs on managing the trade receivables
per year, and the bad debt on customer nonpayment is £400,000 per year.
Assuming that the average cost of short-term finance is 4% each year, please evaluate
whether the proposal to factor the trade receivables is financially acceptable. (10 marks)
Question 4 (15 marks)
1) What is trade credit? (3 marks)
2) Company XYZ has taken delivery of £15,000 of goods from its supplier. The company
usually pays for the goods delivery 50 days after the invoice/delivery date. Recently, the
supplier has introduced an early settlement discount of 1% if the invoice is paid within 10
days. The interest rate on company XYZ’s overdraft facility is 10% per year. Assume no
tax. As the manager of company XYZ, please decide whether the company should pay
on the 10th day or the 50th day following the invoice date. (4 marks)
3) In addition to trade credit, are there any other forms of short-term to medium-term
finance that company XYZ can use? Please nominate and discuss TWO of them. ( 8
marks)
Question 5 (20 marks)
1) Please explain the concept of business risk and financial risk. (8 marks)
2) Discuss the following statement: issuing bonds will decrease the weighted average cost
of capital of a company and thereby increase the market value of the company. (12
marks)
