CORPORATE FINANCE

OCTOBER 2018 EXAMINATION PAPER

INSTRUCTIONS TO CANDIDATES

1. The examination is for THREE (3) hours; in addition, candidates are given 20 minutes
reading time.
2. Candidates are not allowed to commence the examination until instructed of the Invigilator
3. Candidates WILL NOT leave the examination hall within the first hour of examination
commencement
4. Candidates will NOT be allowed to enter the examination hall to write this examination 30
minutes after the scheduled commencement times; and NO extra time will granted
candidates turning late for the examination.
5. Answer any four (4) out of the given seven (7) questions. Each question carrying 25
marks.
6. The Standard Normal Distribution Tables must be provided to candidates sitting for this
examination
7. Financial Tables will be provided for this examination; as such credit will not be given for
computing financial factors which should be extracted from the Financial Tables.
8. Credit will be given for correct solutions; calculations and as well as good presentation
9. Candidates may use non-programmable and non-financial calculators ONLY.
10. This is a closed book examination therefore use of reference materials is not allowable.
Cell phone, Use of iPads and other gadgets are allowed into the exam.
.

USER 1
QUESTION 1
Maple Ltd. currently has 10 million common shares outstanding. Maple has just paid a
dividend of $0.25 per share and investment analysts have informed you that the dividends are
expected to grow by 7% annually for the foreseeable future. The analysts have also informed
you that the shares are expected to be selling at a price of $4.50 exclusive of in 1 years’ time,
the beta on the Maple shares is 1.10, the market price of risk is 6%, and the risk-free rate of
return is 4%.

a) Calculate the following:

b) At the most recent Treasury bill auction, 182-day Treasury bills (T-bills) with a face value
of $100 were selling for $95.60. At this price, what is the yield offered by the T-bills (5
marks)
c) Your company currently purchases its inventory on credit with trade terms of 3/15, net 60.
What is the cost of the missed discount if the company decides to delay payment until day
60? (5 marks)
d) Discuss the arguments for and against a rights issue of shares rather than a public issue
of shares. (10 marks)

QUESTION 2
ZBRC, a Zimbabwe construction company, is planning to acquire new earthmoving equipment
at a cost of $10 million, and is considering the following alternative sources of finance:

Scenario 1 - A bank loan for the full cost of the equipment repayable over four years in equal
annual instalments which incorporate interest at a rate of 5% per annum, the first instalment to
be paid one year from the date of taking out the loan.

Scenario 2 - A finance lease with a monthly lease rental of $223,000 is under consideration.
The first rental is payable in advance, followed by further monthly rental payments for the next
four years. The equipment would have no residual value at the end of the period of four years.

The Company Secretary has a friend visiting from overseas, who has advised that it would be
preferable to lease the equipment rather than buy it. The friend’s argument is that leasing
would avoid ZBRC’s own capital being locked up, since it would be the lessor who would buy
and own the equipment. ZBRC is highly geared, and the friend has also suggested that
leasing the equipment instead of borrowing to buy it would make ZBRC’s balance sheet look
better. As an example of the convenience of leasing, the friend points to the rental car they
have been using while visiting the Victoria Falls.
Required:
a) Calculate the annual instalment that would be payable under the bank loan. Also calculate
how much would represent the principal repayment, and how much would represent
interest charges, in each of the four years and in total. (6 marks)
b) What is the before-tax rate of return to the lessor implied by the terms of the proposed
lease agreement, and how does it compare with the rate of interest on the bank loan? (6
marks)

USER 2
c) Discuss the soundness/relevance of the advice offered by the Company Secretary’s
friend. (6 marks)
d) Discuss the possible advantages to a company like Southee Limited of leasing the
equipment rather than acquiring it with a bank loan. (7 marks)

QUESTION 3
a) What the factors that influence the cost of capital. Discuss (3 marks)
b) The ZBRC Bank Ltd requires $100 million to finance its business activities. Potential
shareholders require an after-tax return of 12% per annum on their investment, while its
potential borrowers require 10% per annum before tax or 6.5% after tax. The rate of tax is
35%.
c) Using the information above, evaluate the following financing option and comment on the
results:
(i) The project is finance by 100% equity
(ii) Use 80% equity and 20% to finance the project
(iii) Use 60% equity and 40% debt to finance the project (12 marks)

d) You have purchased an old but beautiful Limousine for $10 000. The dealer has given you
a car loan at an interest rate of 7% per year, with interest compounded annually and
repayable in equal installments over 5 years.

Calculate:
(i) Annual installments (3 marks)
(ii) Quarterly compounding (3 marks)
(iii) Daily compounding using a 360 day year (4 marks)

QUESTION 4
a) Distinguish between systematic from unsystematic risk. (5 marks)
b) Identify and discuss the key assumptions that underpin the use of the weighted average
cost of capital as an appropriated discount rate for investment appraisal purposes. (8
marks)
c) A company is financed by a mixture of equity and debt capital, whose market values are in
the ratio 3:1. The debt capital, which is considered risk-free, yields 10% before tax. The
average stock market return on equity capital is 16%. The beta value of the company’s
equity capital is estimated at 0.95. The tax rate is 30%. What would be the appropriate
cost of capital to be used for investment appraisal of new projects with the same
systematic risk characteristics as the company’s current investment portfolio? (12 marks)

QUESTION 5
a) What is the importance of understanding the effects risks in business (5 mark)
b) Giving appropriate examples, discuss how the following risks impact on business
operating in Zimbabwe:
i) Financial risk (4 marks)
ii) Political risk (4 marks)
iii) Exchange rate risk (4 marks)
iv) Interest rate risk (4 marks)
v) Inflation risk (4 marks)

USER 3
QUESTION 6
a) List and explain financial factors that influence the value of a business. (6 marks)
b) ZBRC Books founded his own construction wholesale business many years ago. After
building a successful firm that supplies materials to real estate developers in his region,
he joined with a partner who provided the capital to expand throughout the state. They
changed the business to a privately owned corporation of which Titus owns 60 percent of
the shares. The partner owns 30 percent of the shares and 10 percent were set aside to
give to some employees in a stock ownership plan. The statewide expansion has been a
big success. Financial advisors have suggested to Titus that he take the company
public. What issues should he consider when thinking about it? (9 marks)
c) Define the term “opportunity cost of capital”. (5 marks)
d) List and discuss the components of the company’s capital structure. (5 marks)

QUESTION 7
Discuss how the following factors affect Dividend Policy:
(a) Legal constraints (5 marks)
(b) Growth prospects (5 marks)
(c) Market considerations (5 marks)
(d) Signaling (5 marks)
(e) Agency considerations (5 marks)

END OF PAPER

USER 4