CORPORATE FINANCE TUTORIAL QUESTIONS Page 1 of 3

QUESTION

The efficiencies of capital markets have implications for the investment analysis and management of your portfolio. Capital markets should be efficient because numerous rational and profit maximizing investors react quickly to the new information. Assuming prices reflect new information, they are unbiased estimates of the securities’ true, intrinsic value and there should be a consistent relationship between the return on an investment and its risk.

Required:

Discuss the notion of efficient capital market, weak, semi-strong and strong form Efficient Market Hypotheses (EMH). Critically analyzed the test associated with each of the hypothesis.

(Total: 25 marks)

QUESTION

You are considering two independent projects, Project A and Project B. The initial cash outlay associated with the project A is $50,000 and initial cash outlay associated with project B is $70,000. The required rate of return on both projects is 12 percent. The expected annual free cash flows from each project are as follows:

Year Project A Project B0 -$50,000 -$70,0001 12,000 13,0002 12,000 13,0003 12,000 13,0004 12,000 13,0005 12,000 13,0006 12,000 13,0007 12,000 13,000

Required:

a. Calculate the NPV, PI and IRR for each project and indicate if the project should be accepted.

(10 marks)b. Critically examine the components of the statement of cash flows.

(15 marks) (Total: 25 marks)

APU Level 3 Asia Pacific University of Technology and Innovation 201301

CORPORATE FINANCE TUTORIAL QUESTIONS Page 2 of 3

QUESTION

When a firm’s investments generate free cash flow, the firm must decide how to use the cash. If the firm has new positive NPV investment opportunities, it can reinvest the cash and increase the value of the firm. Many young, rapidly growing firms reinvest 100% of their cash flows in this way. But mature, profitable firms such as Microsoft often find that they generate more cash than they need to fund.

Required:

a. When a firm repurchases its own shares, the price rises due to the decrease in the supply of the outstanding shares. Discuss the impact of this transaction for the company providing examples.

(5 marks)b. In a perfect capital market, how important is the firm’s decision to pay dividends

versus repurchases shares?(10 marks)

c. Explain common reasons a firm should consider acquisition part of its strategy. (10 marks)

(Total: 25 marks)QUESTION

Interest rate is quoted in variety of ways. While generally stated as an annual rate, the interest payments themselves may occur at different intervals, such as monthly or semiannually. Interest rates also affect a firm’s incentive to raise capital and invest. Therefore, it is primarily important for the central bank authority to manage the issues of interest to serve the benefit of the society.

a.Critically analyze the function of interest rate instruments used by the central banks to control the economy.

(10 marks)b.During the 2007 to 2009 financial crisis, the Fed became concerned about the risk of

deflation. Compare and contrast between inflation and deflation. What are the policies taken by Fed measures to control inflation and deflation?

(15 marks) (Total: 25 marks)

QUESTION

IBM Corporation bonds pay $70 in annual interest, with a $1000 par value. The bonds mature in 17 years. Your required rate of return is 8.5 percent.

a.Calculate the value of the bond. How does the value change if your required rate of return increases to 11 percent and decreases to 6 percent? Comment on your answers.

(15 marks)

APU Level 3 Asia Pacific University of Technology and Innovation 201301

CORPORATE FINANCE TUTORIAL QUESTIONS Page 3 of 3

b.Critically identify the key relationship that exists in bond valuation.(10 marks)

(Total: 25 marks)

QUESTION

a. The capital structure for the Bias Corporation is as follows. The company plans to maintain its debt structure in the future. If the firm has a 6 percent after tax cost of debt, a 1.35 percent cost of preferred stock, and a 19 percent cost of common stock, calculate the firm’s weighted cost of capital.

CAPITAL STRUCTURE ($000)Bonds $1,100Preferred stock 250Common stock 3700Total 5,050

(10 marks)b. Critically analyze the key factors in CAPM (Capital Asset Pricing Model) and

issues in implementing the CAPM.(15 marks)

(Total: 25 marks)

APU Level 3 Asia Pacific University of Technology and Innovation 201301