FINA2006 CLASS TEST: WEEK 6
Assignment PART A
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Each question has been allocated 2 marks.
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Multiple Choice: Select the most appropriate solution and record your choice under each question as ‘Your Answer’ on this class test paper. Note – no workings are required to be shown for this component of the class test.
1. What are the three main decisions corporate managers must make to realise the corporate objective?
- Investment decision, financing decision, and dividend decision
- Investment decision, wealth decision, and dividend decision
- Wealth decision, financing decision, and dividend decision
- Investment decision, financing decision, and wealth decision
2. The manner in which funds raised in capital markets are to be employed in productive activities is the subject of the—————–decision.
- Gearing
- Capital budgeting
- Financing
- Investment
3. An example of a cash flow stemming from bonds is:
- The principal repayment on maturity
- The discount to face value when issued
- The bond premium payable
- All of the above
4. Which of these is the most effective way to encourage directors to make decisions that maximise the wealth of shareholders?
- Make the directors shareholders in the
- Reduce the number of non-executive board
- Impose fines on directors who fail to meet predetermined earnings performance
- Pay bonuses to the directors on the basis of the company’s earnings performance.
5. Over a one-year period, the approximate difference between the future value of $500 invested at 15% p.a. simple interest and $500 invested at 15% p.a. annually compounded interest will be
- Nothing
- $150
- $1.50
- $15
6. What is the approximate present value of the following set of annual end-of-year cash flows when the discount rate is 12% p.a. compounded monthly? Round your answer to the nearest
Year 1: $150
Year 2: $300
Year 3: $500
Year 4: $950
- $1,840
- $1,330
- $1,310
- $1,470
7. Which of the following will yield the highest future value at the end of 5 years?
- $1,300 invested at 10.25% p.a. compounded monthly
- $1,250 invested at 9.95% p.a. compounded daily
- $1,200 invested at 11.5% p.a. compounded quarterly
- $1,400 invested at 12% p.a. simple interest
If you require an 11% rate of return, how much would you pay now for a bond with a face value of $3,000, pays $120 interest at the end of each year and matures in 11 years’ time? Round your answer to the nearest $10.
- $1,700
- $1,950
- $2,130
- $810
Assignment PART B
Each question has been allocated 1mark.
True / False : Select the most appropriate solution (either true [T] or false [F]) and record your choice under each question as ‘Your Answer’ on this class test paper.
Note – no workings are required to be shown for this component of the class test.
- A constant dividend paying share is an example of an ordinary annuity.
- Holding all other factors constant, increasing the frequency of the compounding period will increase the future value of an initial investment.
- The growth rate must be greater than the required rate of return in the constant dividend growth model for the outcome to be realistic.
- Weta Industries has a P/E ratio of 16.03 and Katipo Company has a P/E ratio of 13.25. As both companies are in the same industry, it is reasonable to assume that Katipo’s shares are underpriced.
- Corporate finance is concerned with making decisions about what investments a company should make, how these investments are financed and how company directors should be remunerated.
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Assignment PART C
Record your responses to the relevant questions in the space provided for each question.
Question C-1 (Total marks for this question = 9)
Mick Moody borrowed $110,000 from the Burnside Bank at an interest rate of 15% p.a. compounded monthly. The loan is required to be repaid by equal end of month instalments over a period of 20 years.
Required:
- Calculate the effective interest rate on the loan.
- Calculate the end of month instalment payable on the loan.
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- Calculate the approximate amount owing to the bank after 10 years of loan repayments (immediately after the 120th payment).
- If the loan was paid out after 10 years, how much interest had been paid on the loan to date and comment on whether this amount is equal to the amount of interest saved by not having to make the remaining 10 years of loan repayments (assume the interest rate remains constant over the loan term).
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Question C-2
- If both dividends and capital gains/losses form part of the return a shareholder will receive from investing in shares why are only the dividends taken into account when pricing the share using a constant dividend model or constant dividend growth model?
- Using a bond as an example, explain to a novice investor why there is an inverse relationship between price and yield.
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