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Nottingham University Business School
MASTER OF BUSINESS ADMINISTRATION IN FINANCIAL STUDIES
Examinations JUNE 2001
CORPORATE FINANCE
Time allowed TWO hours
Candidates must NOT start writing their answers until told to do so
Answer THREE questions
Dictionaries are not allowed with one exception. Those whose first language is not English may use a dictionary
to translate between that language and English provided that neither language is the subject of this examination.
If more than three questions are answered, marks will be awarded for the first three answers only.
The Black Scholes option pricing formula may be used, if necessary, in this examination.
C  S .N (d1 )  PV ( X ).N (d 2 )
 S 
ln 
PV ( X ) 

d1 
 0.5 t
 t
d 2  d1   t
1.
Singleton Supplies sells small appliances to hardware stores throughout the United Kingdom. Joe
Singleton, the managing director of the company is considering changing the credit policy to attract new
customers. The current policy is 1/10, net 30 and the new policy would be 3/10, net 50. Currently 40
percent of Singleton’s customers take the discount and it is anticipated that this would go up to 50
percent with the new discount policy. It is expected that annual sales would increase from a level of
£200,000 to £250,000 as a result of the change in the credit policy.
The increased sales would also affect the level of inventory carried. Average inventory at Singleton
Supplies is based on the Economic Order Quantity. Unit sales of small appliances are expected to
increase from 20,000 units to 25,000 units. The ordering cost is £100 per order and the carrying cost is
£1 per unit (these values will not change with the discount). The average inventory is based on EOQ/2.
Each unit in inventory has an average cost of £6.50.
EOQ 
2 AC
H
Cost of goods sold is equal to 65 percent of net sales; general and administration expenses are 10 percent
of net sales; and interest payments of 12 percent will be necessary only for the increase in debtors and
inventory balances. Taxes are 25 percent of before-tax income.
REQUIRED
a) Calculate the average debtors balance before and after the change in credit policy. Use net sales (total sales
minus cash discounts).
(20%)
b) Determine the EOQ before and after the change in credit policy. Translate these into average inventory (in
units and monetary value).
(20%)
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c) Draft an income statement to determine the income after taxes under both policies.
(25%)
d) Critically discuss whether Singleton Supplies should go ahead with the new credit policy, including any other
factors which you consider relevant to the decision.
(35%)
2.
A friend of yours, who has just completed a Masters degree in electronic engineering, has an idea for a
new business venture. You decide to set up a small company and go into business together. Critically
discuss the various sources of finance available to you. What particular issues might you face in gaining
funding for a young high-tech start-up?
(100%)
3.
Outline and evaluate the behavioural critique of the efficient markets hypothesis.
4.
5.
(100%)
a)
RHB plc shares have a volatility of 0.3 and a current price of £10. No dividend will be paid by RHB
plc in the next six months. European call and put options with exercise price £8, expiring in three
months are both available. Given a risk free rate of 5% calculate a fair price for each of the options.
(60%)
b)
“It is possible to view equity as a call option on the assets of the firm and to view risky corporate
debt as riskless debt plus a short position in a put option on the assets of the firm.” Explain and
justify this statement.
(40%)
PJB plc is considering launching a new product. The required, immediate, investment is £150 million.
During the start up year production facilities will clearly not operate at full capacity but should generate a
year end cash flow of £20 million. The performance of the product will then depend on the state of the
economy. If the economy is buoyant, then year end cash flows of £20 million in perpetuity are anticipated.
However, if the economy is depressed then the product will not become as well established, and year end
cash flows will only be £5 million, again in perpetuity.
The risk free rate in the economy is 10%. Further, £100 invested in the market portfolio will be worth £150
in one year if the economy is buoyant, and £75 if the economy is depressed.
a)
b)
c)
6.
What is the NPV of the proposed project? (40%)
Suppose the building of the factory can be delayed for one year. Does this affect the analysis and
decision, and if so, how? (30%)
“Traditional DCF methods are likely to undervalue long term, high risk projects.” Is this statement
correct? If so, why? If not, why not? (30%)
Two all equity financed companies, A and B, have the same anticipated asset value of £100m one period
from now. In fact the two companies are identical in all respects other than dividend policy. Firm A will
pay a zero dividend one period from now, while firm B will pay out 10% of its asset value as dividends.
Because the firms are identical in every respect other than dividend policy, present values can be calculated
using a common discount rate of 10%.
a)
Suppose dividends are taxed at 20%, and capital gains are taxed at 10% when they accrue. Under a
classical tax system what are the current values of the two companies? Is high dividend payout good
or bad? (35%)
b)
Suppose the corporate tax rate is 40%, dividends are taxed at 20%, and capital gains are taxed at
10% when they accrue. Under an imputation tax system what are the current values of the two
companies? Is high dividend payout good or bad? (35%)
c)
What are the key features of the current UK taxation system that affect the choice of dividend
policy? What are the implications for dividend policy? (30%)
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END
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