Final 9

Final Examination, BUS312 Summer 2009

NAME: ___________________________________________Student #____________________

Instructions: For qualitative questions, point form is not an acceptable answer. For quantitative questions, show your work. There are a total of 120 marks on this examination composed of 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) Give four economically reasonable reasons why you might get a capital gain on a fixed rate bond over an investment holding period shorter than the bond’s maturity. Number your reasons from one to four and give a brief explanation of each.

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2. (10 marks) ABC Company Ltd., is considering a possible business investment that requires a $350,000 expenditure today. Immediately after the $350,000 expenditure, the new venture’s market to book ratio (value to expenditure) is 1.6.

Required: What is the new venture’s Net Present Value (NPV)?

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3. (10 marks) On Dec 31, 2002 you borrow from the Royal Bank of Canada (RBC) in a mortgage agreement. The mortgage calls for monthly payments starting at the end of January 2003. The mortgage rate is 3.75 percent per annum compounded semi-annually for a 5-year term. The amortization is 25 years (300 payments).

Today is Dec 31, 2007 and you have just made the 60’th mortgage payment. You renegotiate your mortgage with RBC for a second 5 year term with an amortization period of 20 years (240 payments). Your first monthly payment in this second term is one month from today. The mortgage rate over the second term is 4.5 percent per annum compounded semi-annually. The outstanding balance at the end of this second mortgage term (Dec 31, 2012) is $225,000.

Required: How much did you borrow on December 31, 2002?

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4. (10 marks) Complete the following sentence with one of the below choices. Identify your choice with a letter “a” to “j” and explain your answer.

“The cost of capital is the rate of return on ______________________________________”

a. the book value of equity.b. market cap. c. market value of assets.d. the coupon rate.e. the book value of assets.f. invested capital.g. par value.h. market value of equity.i. the current yield.j. capital gain.

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5. (10 marks) Consider a bond that offers a fixed per annum coupon rate, paid semi-annually, and has a par value of $10,000. The bond’s yield to maturity is 10% per annum compounded semi-annually. When you buy the bond, you pay accrued interest of $310. When you sell the bond, two months after a coupon payment, the invoice price is $9,720.63 and the quoted price is $9,565.63. Between when you buy the bond and when you sell the bond, the total amount that you receive in coupons (without interest) is $4,185. The yield to maturity does not change between your purchase and your sale of the bond.

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

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6. (10 marks) Today, ABC Company is planning a business investment. ABC is a start-up firm, and therefore, it has no previous investments. Also, ABC has no other investments planned or contemplated other than the one described in this problem. For an investment (expenditure) of $200,000 today, the expected cash flow to ABC in one year is $625,000. This cash flow occurs just once (that is, a one period investment) and not per annum. This cash flow is profit on the investment, plus salvage, net of taxes and commissions, etc. 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 $200,000 to finance their business investment. ABC has found a possible common equity investor who is willing to finance the new business venture in exchange for a fractional common equity ownership. That is, after financing, the investor will own X percent of outstanding common shares (new and old) and ABC will own 1-X percent of the common shares. Immediately after the share issue and the required capital expenditure of $200,000, ABC’s market to book ratio (value to expenditure) for the business investment is 2.50 (there remains, nonetheless, one year before the expected cash flow benefit of $625,000 is received).

Required: Find X, the fractional ownership of the new common equity investor immediately after the financing.

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7. (10 marks) You believe that the constant growth version of the discounted dividend model is a reasonable representation of ABC common share value. ABC 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. You belong to a dividend reinvestment plan that purchases additional ABC shares for you with your dividends (at the ex-dividend price at that time). Fractional shares are possible. ABC has a forward dividend yield of 5.55% per annum, a forward dividend of $1.65 per share for the upcoming year, and forward earnings per share of $2.75 for the upcoming year. Today, ABC’s book equity per share is $10.

Required: If you start with 10,000 shares today, how many shares will you have in 7 years immediately after the dividend and your reinvestment of that dividend at that time?

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8. (10 marks) Which one or more of the following economic factors (which are not necessarily mutually exclusive) best describes the determinants of the cost of capital for a business. Identify your proposed set of economic factors with letters “a” to “j” and explain your answer.

a. asset value b. dividend yield c. the coupon rated. riske. invested capitalf. par valueg. riskless interest rates in the economyh. market value of equity.i. expected inflation j. capital gain.

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9. (10 marks) ABC common shares trade on the Toronto Stock Exchange. ABC has 10 million shares outstanding. You own 25% of the outstanding shares of ABC Company. ABC is contemplating a general cash offer of $6,000,000 of new common shares (a primary new share offering). You do not plan to buy additional shares for your portfolio from the issue. Ignore transaction costs in this problem. Your fractional ownership in ABC falls to 15.625% as the result of the issue.

Required: Determine the new issue share price.

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10. (10 marks) You believe that the constant growth version of the discounted dividend model is a reasonable representation of ABC common share value. ABC pays dividends once per year and it has just made a dividend payment (i.e., the ex-dividend date is today). ABC retains a constant fraction of earnings each year for reinvestment and growth (i.e., constant retention ratio). ABC’s price to forward earnings ratio is 15, their market to book ratio is 5.0 and their forward dividend yield is 3.5% per annum.

Required: What is the expected return on the purchase of an ABC common share?

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11. (10 marks) You own 600 shares of ABC Limited, a publicly traded company. ABC has just announced that they are planning a rights issue of new common shares (ABC gives existing shareholders one right per outstanding share). Ignore commissions and other transactions costs. If you do not subscribe in the rights offering, that is, you sell your rights, your dollar investment in ABC shares falls by $750 (the proceeds of the rights sale). If you subscribe in the rights offering your dollar investment in ABC shares increases by $4,000. The ex-rights share price, that is ABC’s secondary market share price after the rights issue, is $23.75

Required: Find the price of a new share in the rights offering (the subscription price).

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12. (10 marks). George is buying a new car in the summer of 2009. The manufacturer’s suggested retail price (MSRP) of a new 2009 Volkswagen Jetta Sedan Clean Diesel base model with manual transmission is $23,334.84. Volkswagen offers special financing to encourage purchase equal to 0% APR for 36 monthly payments of $648.19 with the first payment one month after the vehicle purchase. The interest cost of borrowing from Volkswagen is $0 because 36 monthly payments of $648.19 to Volkswagen sum to the MSRP of $23,334.84 (freight and PDI of $1,360 included and ignore PST and GST). Alternatively, if George pays cash for the Jetta, Volkswagen will discount the MSRP by $1,500, so the cash-price to George will be $23,334.84-$1,500=$21,834.84. Because George is a poor university professor, he does not have this cash. However, George can borrow this amount from his bank at an interest rate of 2.25% per annum compounded monthly (the so-called prime rate).

Required: Given that George has decided to purchase the Jetta, should he pay cash to Volkswagen and borrow from his bank or should he take Volkswagen’s 0% financing? Explain.

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