Section A
There is one and only one correct answer for each question. Please write down the
question number and your answer (either A, B, C or D) in your answers file (workings
are not required).
Question 1
Which of the following is not the main factor to be considered when a firm chooses between
flexible strategy and restrictive strategy to manage current liabilities?
A Term structure
B Pay-out policies
C Maturity hedging
D Cash reserves [3 marks]
Question 2
A bond is quoted at £950 and sold at £975 in the bond market. How much is the accrued
interest in the dirty price of this bond?
A £25
B £975
C £950
D £0.97 [3 marks]
Question 3
How many years until the final payment are there for a 5-year annuity due just issued?
A 7 years
B 6 years
C 5 years
D 4 years [3 marks]
Question 4
Which of the following is not a main drawback of internal rate of return (IRR) approach?
A Confusion over investing type cash flows and financing type cash flows
B Ranking issues
C Multiple solutions
D Lack of consideration on time value of money [3 marks]
Question 5
Which of the following is not a reason for popularity of payback methods?
A They are easy to understand, especially when communicating with non-specialists.
B They can be used at early stage of investment appraisal.
C They are precise methods.
D They are commonly used as secondary methods. [3 marks]
MN-2004 (January 2021) Page 3
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Question 6
Assuming the risk-free rate is 2%, and return of the market portfolio is 7.5%, how much is
the market risk premium?
A 9.5%
B 3.75%
C 5.5%
D None of the above [3 marks]
Question 7
Which of the following statements best describes total asset turnover?
A It measures how much more investors are willing to pay per unit of current earnings.
B It measures the profit for every unit of sales generates.
C It measures the sales for every unit of assets generates.
D None of the above [3 marks]
Question 8
Which of the following is not a common reason for firms to prefer share repurchases over
paying dividends?
A Share repurchases appeal to investors who seek stable cash flows.
B Share repurchases offer more flexibility.
C Share repurchases have tax advantage.
D Share repurchases can offset dilution on shares. [3 marks]
Question 9
Which of the following is not a commonly used type of dividend?
A Stock dividends
B Semi-annual coupons
C Stock split
D Cash dividends [3 marks]
Question 10
Which of the following theories concludes that required rate of return to shareholders rises
with leverage?
A The pie theory
B Portfolio theory
C Modigliani and Miller proposition I
D Modigliani and Miller proposition II [3 marks]
[Total 30 marks]
Page 4 MN-2004 (January 2021)
Section B
Please write down the question number, necessary workings and answers in your
answers file (rounding to two decimal places if necessary).
Question 1
(a) Chelseao plc. pays dividends that are expected to grow at 5% each year. Dividends will
stop growing at the end of year 5, at which point the firm will pay out all its earnings as
dividends. The next dividend will be paid one year from now at £10 and its earning per
share (EPS) at the time will be £15. If the appropriate discount rate on Chelseao plc. is
8%, what is its fair market price of the share today?
[15 marks]
(b) Arsenalo plc. has just issued level coupon bonds on the market with 7.5 years to maturity
and a yield to maturity (YTM) of 12%, and at a current fair market price of £950. The
bonds make quarterly payments. What must be the coupon rate on these bonds? Face
value of these bonds is £1,000.
[10 marks]
[Total 25 marks]
MN-2004 (January 2021) Page 5
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Question 2
(a) Villao plc. is an asset management company. It manages a two-asset portfolio which
consists of two risky assets, A and B. The proportions of A and B held in the portfolio
are 40% and 60%, respectively. The expected return of A and B are 12% and 8%,
respectively. Standard deviations of A and B are 70% and 40%, respectively. The
correlation coefficient between A and B is -0.6.
i) Calculate the expected return and standard deviation of the two-asset portfolio.
[6 marks]
ii) In light of the concept of portfolio diversification, make comments on the
results from i).
[7 marks]
(b) ManUnito plc. is a UK based pharmaceutical company, and the following information
regarding the financial position of the company is provided by their financial director
Ms. Jones:
Number of shares outstanding 15,000,000
Market value of debt (AA rating) £30,000,000
Expected yield of the debt 8%
Corporate tax rate 30%
Risk-free rate 3%
Market risk premium 5%
Current share price £2.00
Beta value of the share 1.60
In addition, Ms. Jones is considering two mutually exclusive projects by taking extra
finance, and cash flows of each project are shown below:
Points in time (yearly intervals) Project A (£) Project B (£)
0 -12,000 -10,000
1 5,000 4,000
2 5,000 4,000
3 5,000 4,000
i) Calculate the weighted average cost of capital of ManUnito plc.
[8 marks]
ii) Advise Ms. Jones which project to undertake by applying net present value
(NPV) approach. Assuming weighted average cost of capital is the appropriate
discount rate.
[4 marks]
[Total 25 marks]
Page 6 MN-2004 (January 2021)
Question 3
Evertono plc. is a fashion retail company and the following financial information about this
company is available:
Current assets £5,000,000
Current liabilities £4,000,000
Total revenue £12,000,000
Net income £3,000,000
Days in inventory 30 days
Days in receivables 42 days
Days in payables 45 days
Total cash demand for next year £800,000
Fixed transaction cost £20 per trade
Opportunity cost 10% per annum
Assuming Baumol Model is considered to be the appropriate cash management model.
i) Calculate the number of transactions Evertono plc. will need to make to replenish
the cash balance to optimal level next year, and in light of the assumptions of
Baumol Model and your calculation, briefly explain how the Baumol Model works
on cash management for Evertono plc.
[12 marks]
ii) Using the available information, calculate the current ratio, profit margin,
operating cycle and cash cycle of Evertono plc.
[8 marks]
[Total 20 marks]
End of Paper – An appendix of 2 pages follows
MN-2004 (January 2021) Page 7
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Appendix
1. Present value of an ordinary perpetuity
PV = A/R
2. Present value of a growing perpetuity
PV = A/(R-g)
3. Present value of an ordinary annuity
PV=???? ∙ [
1−1/(1+????)
????
????
]
4. Present value of a growing annuity
PV = ???? ∙ [
1−(
1+????
1+????
)
????
????−????
]
5. Pre-tax weighted average cost of capital
Pre − tax weighted average cost of capital =
????
???? + ????
???????? +
????
???? + ????
????????
6. Unlevered beta
Unlevered beta =
????
???? + ????
???????? +
????
???? + ????
????????
7. Weighted average cost of capital
???????????????????? =
????
????+????
???????? +
????
????+????
????????(1 − ????????)
8. Variance of a two-assets portfolio
Var(p)=(w11)
2 + (w22)
2 + 2w1w2 1 2 1,2
9. Expected return of a two-assets portfolio
E(Rp)=w1E(R1) + w2E(R2)
10.Present value of a share with zero growth dividends
PV = D1/R
11.Present value of a share with constant growth dividends
PV = D1/(R-g)
12.Present value of a consol
PV = C/R
Page 8 MN-2004 (January 2021)
13.Present value of a level coupon bond
???????? = ???? ∙ ????????
???? +
????
(1 + ????)
????
14.Formulae for Beta
???????? =
????????????(????????,????????)
(????????????)
2
15.Capital asset pricing model
E(????????
) = ???????? + ????????
∙ (????(????????) − ????????)
16.Baumol Model
2( )( ) F T C
k
17.
Average cash balance of Baumol Model
???? = ????/2
18.Miller-Orr Model
1/3 2
3( )( )
4
F
Z L
k
19.Upper control limit of Miller-Orr Model
???? = 3???? − 2????
20.Average cash balance of Miller-Orr Model
???? = (4???? − ????)/3
21.Debt yield and default equation (Cost of debt for low rating bonds)
???????? = ???? − ???? ∙ ????
22.Current ratio = Current assets / Current liabilities
23.Profit margin = Net income / Total revenue
24.Total asset turnover = Sales / Total assets
MN-2004 Jan 2021 online exam
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