Department of Banking and Finance

Tutorial Questions
BFC 2140 Corporate Finance
Semester One, 2015

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Tutorial 1
Introduction
Note: these cases are designed for open discussions to introduce the basic concepts
in Finance; there are no formal solutions.

1. If you had a choice of receiving $100 today and $100 in one years time, which do
you prefer and why? Would your decision change if the amount in one years time is
changed to $110? and why?

2. Dave has just inherited $100,000 each from his Great-Aunt. Aunt Sophie's will
required that the money be invested in ordinary shares for 20 years before Dave
could access the money. However, Dave was allowed to specify which companies
their inheritance would be invested in.
Dave is considering 3 choices:
[A] to stake his whole inheritance on one stock (any stock).
[B] to choose 2 companies in the same industry.
[C] to invest roughly equal amounts in each of the top 10 largest companies.

i. If you were Daves financial advisor, which choice would you recommend and why?
ii. From Daves perspective, after the money is invested, what would be his greatest
concern?
iii. If you were to invest in stocks, how would you work out which stocks to buy?

3. Other than stocks, what other assets would you consider investing in? and why?

4. If you were to purchase an investment property, how will you fund the purchase?
How do you think this decision will affect your investment return?

Tutorial 2
Topic 1: Investors, Firms and Markets
Questions from Prescribed Text (Questions and Problems section)
Ch. 1: 1.1, 1.4, 1.5, 1.6, 1.13, 1.16, 1.17, 1.19, 1.22

Tutorial 3
Topic 2: Financial Mathematics
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 5: 5.2, 5.6, 5.24, 5.32
Ch. 6: 6.10, 6.14, 6.25, 6.31
2.

Additional Question

Shining Metal Mining Ltd. has just commenced a mining operation that will last for
exactly 10 years. At the end of the mining operation, the firm has agreed to restore the
land affected to its original condition. The cost of the restoration, beginning at the start of
the eleventh year, will be $268,000 each year for 3 years.
To make provision for the restoration cost at the end of the agreed term, Shining Metal
Mining has decided to invest a constant annual sum every year for 10 years in a growth
fund starting today. Assume that the return on funds invested is 12.5%.
Required:
What is the annual amount that the mining company should invest to meet the cost of
restoring the land when the mining operation has ended?

Tutorial 4
Topic 3: Valuation of Bonds and Equities
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 8: 8.2, 8.5, 8.14, 8.26
Ch. 9: 9.3, 9.10, 9.21, 9.26

3.

Additional Question

Cocoon Ltds current dividend per share is 80 cents. In recent years, the dividend of
Cocoon has been growing at 10% per annum and it is expected that this growth rate
can be maintained for a further 3 years. It is then projected that the growth rate will
decline to 6% per annum and remains at that level indefinitely. Estimate the current
value of the share if the required rate of return is 12% per annum.

Tutorial 5
Topic 4: Project Evaluation (1)
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 10: 10.6, 10.13, 10.18, 10.19, 10.31

2.

Additional Question

A company has four mutually exclusive projects for which the cash flows are:
Year

A($)

B($)

C($)

D($)

-2000

-2000

-2000

-2000

200

100

1400

400

1800

100

600

600

200

1500

1000

1000

-200

600

1000

-800

400

1200

Rank the projects using:

a.
payback period
b.
accounting rate of return (assuming the figures represent accounting profit)
c.
internal rate of return
d.
NPV using a discount rate of 10 per cent
Compare the results and explain any differences in the rankings.

Tutorial 6
Topic 4: Project Evaluation (2)
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 11: 11.1, 11.21

2.

Additional Question

Unicorn Airlines owns and operates a large workshop in which it services its aircraft.
The management of Unicorn has recently investigated the possibility of closing its
workshop and instead paying an unrelated company, Plane Repairers Ltd, to
undertake the regular servicing of Unicorn's aircraft. As part of this investigation
Unicorn has recently had three of its aircraft serviced by Plane Repairers to test the
quality and timeliness of the service offered by Plane Repairers. Unicorn's
accountant has estimated that Plane Repairers delivered the service at a cost that
was about $20 000 less than it would have cost Unicorn to undertake the servicing in
its own workshop. If the workshop is closed, Unicorn intends to remove and sell the
machinery currently in the workshop and use the space as a storage area. At
present Unicorn is very short of storage space and is currently leasing storage space
from Big Box Enterprises Ltd. If the workshop is closed there will be approximately
50 staff redundancies and Unicorn has an enterprise agreement that requires
Unicorn to pay all workers who are made redundant a sum equal to the wages they
would otherwise have been paid in the coming year. Unicorn is an Australian taxpaying company.
You have been asked to complete the investigation, using the net present value
method of investment evaluation. For each of the following, state whether the item
would be needed for your analysis and give brief reasons for each answer.

(a)

Next year's depreciation charge on the machinery currently in the workshop.

(b)

The written-down value of the machinery.

(c)

The amount payable in staff redundancy payments.

(d)

The $20 000 savings made by having had the three aircraft serviced by Plane
Repairers.

Tutorial 7
Topic 4: Project Evaluation (2)
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 11: 11.13, 11.16

Topic 5: Project Evaluation with Risks

1. Questions from Prescribed Text (Questions and Problems section)
Ch. 12: 12.5, 12.8, 12.15, 12.16, 12.20, 12.22

2.

Additional Question

R. Branson & Assoc. provides tourists with hot-air balloon flights over the city. As
their current balloon is due to be retired, they must decide whether to replace it with
a large or small model. The balloons have an expected life of 2 years, after which
salvage value is zero. Market research has estimated that there is a 60% probability
that demand will be high in both years, a 15% probability that demand will be high in
the first year and low in the second year, and a 20% probability that demand will be
low in both years. Mr. Branson has summarised the costs and cash flows below.
Initial Costs: Large Balloon
Small Balloon

$135,000
$90,000

Annual Cash Flows

Large Balloon

Small Balloon

High Demand

$100,000

$70,000

Low Demand

$55,000

$45,000

In the event of low demand, the balloons can be sold for 45% of their initial cost at
the end of the first year.
Required:
a.
Compute the net present value of purchasing the large balloon. Ignore the
effect of taxes, and use 10% as the required rate of return.
b.
Mr. Branson has computed that the net present value of purchasing the small
balloon is $18,574.38. Which balloon should R. Branson & Assoc. purchase?

Tutorial 8
Topic 8: Working Capital Management
Questions from Prescribed Text (Questions and Problems section)
Ch. 14: 14.1, 14.4, 14.6, 14.8, 14.11, 14.17, 14.20, 14.27, 14.29

Tutorial 9
Topic 6: Risk, Valuation and Investment
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 7: 7.1, 7.2, 7.4, 7.6, 7.14, 7.15, 7.16

2. Additional Question

"If I invest in more than one security, then I will be reducing my risk because I am
diversifying my portfolio. As I invest in more and more securities, I will eventually
reach the point where my portfolio becomes riskless."
a.
Comment on the validity of the above quotation. Your answer should include a
discussion of relevant underlying theory.
b.
Under what circumstances will diversification of a one-asset portfolio into a
two-asset portfolio result in no reduction in portfolio risk? Explain.

Tutorial 10
Topic 6: Risk, Valuation and Investment
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 7: 7.11, 7.12, 7.20, 7.24, 7.27, 7.32

2. Additional Question

Given that asset A has an expected return of 9.40% with a beta of 0.80 and asset B
has an expected return of 13.40% with a beta of 1.30. If the two assets are correctly
priced on the security market line, what is the return of the market portfolio? What is
the risk-free rate of return?

Tutorial 11
Topic 7: Cost of Capital
Questions from Prescribed Text (Questions and Problems section)
Ch. 13: 13.5, 13.7, 13.13, 13.18, 13.20, 13.24, 13.29

Tutorial 12
Topic 9: Capital Structure
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 16: 16.2, 16.10, 16.12, 16.14, 16.17, 16.25, 16.28, 16.31

2.

Additional Question

What are the benefits and costs of using debt financing? Discuss.

Tutorial 13
Topic 10: Dividend Policy
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 17: 17.1, 17.3, 17.10 (1st Ed 17.11), 17.21 (1st Ed 17.22), 17.22 (1st Ed 17.23)

2.

Additional Question

In the mid-1990s Chartwell Leasing Ltd ran into severe financial difficulties due to
mistakes its management had made in the computer leasing business in which it
operated. Between 1996 and 2000, it made large operating losses and had to stop
paying dividends. However, late in 2000, a new management team was installed in
the company at the instigation of the institutional shareholders and non-executive
directors. This new management turned the company around by restructuring its
business and focusing on the international leasing of construction equipment and the
company is once again profitable.
As a result, at the board meeting held recently at the end of the companys financial
year which had seen a further increase in profits the directors discussed whether
or not the company should re-start paying dividends. However, opinions were
divided. The chairman thought that a stable dividend policy should be introduced as
quickly as possible.
The finance director thought that dividend policy was
unimportant as he remembered quite clearly from his corporate finance courses that
dividends are irrelevant. Finally, the treasurer (who also acted as the chief
accountant) was of the opinion that the company should only pay an annual dividend
if there were not sufficient profitable projects available to absorb all the companys
earnings. Thus the amount paid out in dividends should purely be this residual.
Required:
Discuss dividend policy with special reference to the comments made by the board
members of Chartwell Leasing.

10