Assignment FINA 321

Business Finance
Last Date of Submission 4th November 2016
Section A: 5 marks
Section B: 5 marks
Section C: 10 marks
______________________________________________________________________________
Section A [5 marks]
Attempt ALL multiple choice questions (1 x 5 = 5)

1. Consider a corporate bond with a $1000 face value, 10% coupon with semiannual coupon
payments, 5 years until maturity, and currently is selling for (has a cash price of) $1,113.80. The next
coupon payment will be made in 63 days and there are 182 days in the current coupon period. The
clean price for this bond is closest to:
a. $1146.50
b. $1065.70
c. $1113.80
d. $1081.10
2. Which of the following costs would you consider when making a capital budgeting decision?
a. Sunk cost
b. Opportunity cost
c. Interest expense
d. Fixed overhead cost

3. Which is the best measure of risk for an asset held in a well-diversified portfolio?
a. Variance
b. Standard deviation
c. Beta

4.

d. Semi-variance
e. Expected value

In a portfolio of three different stocks, which of the following could not be true?
a.
b.
c.
d.

The riskiness of the portfolio is less than the riskiness of each stock held in isolation.
The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
The beta of the portfolio is less than the beta of each of the individual stocks.
The beta of the portfolio is greater than the beta of one or two of the individual
stocks.
e. The beta of the portfolio is equal to the beta of one of the individual stocks.

5.

Which of the following statements is most correct?

a. The expected future rate of return, r , is always above the past realized rate of return,
r , except for highly risk-averse investors.

b. The expected future rate of return, r , is always below the past realized rate of return,
r , except for highly risk-averse investors.

c. The expected future rate of return, r , is always below the required rate of return, r,
except for highly risk-averse investors.
d. There is no logical reason to think that any relationship exists between the expected

future rate of return, r , on a security and the securitys required rate of return, r.
e. Each of the above statements is false.
Section B [5marks]
Attempt ALL Questions
Question. 1 Describe the different mechanisms available to a firm to use to repurchase shares
(2.5 marks)

Question. 2 KMS Corporation has assets with a market value of $500 million, $50 million of which
are cash. It has debt of $200 million, and 10 million shares outstanding. Assume perfect capital
markets. (2.5 marks)
a. What is its current stock price?
b. If KMS distributes $50 million as a dividend, what will its share price be after the dividend
is paid?
c. If instead, KMS distributes $50 million as a share repurchase, what will its share price be
once the shares are repurchased?
d. What will its new market debt-equity ratio be after either transaction?

Section C [10 marks]

CASE STUDY ANALYSIS

Attempt ALL Questions

1.

Stock A has the following probability distribution of expected returns:[3 marks]

Probability
0.1
0.2
0.4
0.2
0.1

Rate of Return
-15%
0
5
10
25

What is Stock As expected rate of return and standard deviation?

a. 8.0%; 9.5%
b. 8.0%; 6.5%
c. 5.0%; 3.5%
SOLUTION

d. 5.0%; 6.5%
e. 5.0%; 9.5%

e. r A 0.1 (-15%) + 0.2(0%) + 0.4(5%) + 0.2(10%) + 0.1(25) = 5.0%.

Variance = 0.1(-0.15 0.05)2 + 0.2(0.0 0.05)2 + 0.4(0.05 0.05)2
+ 0.2(0.10 0.05)2 + 0.1(0.25 0.05)2
= 0.009.
Standard deviation =

2.

0.009 = 0.0949 = 9.5%.

What would rX be if investors expected the inflation rate to increase by 2 percentage

points? [2.5 marks]

a. 18.7%
b. 16.7%
c. 14.8%
d. 12.8%
Solution
.
c. rX = rRF + (rM rRF)bX = 7% + (13% 7%)1.3 = 14.8%.

e. 11.9%

A change in the inflation premium does not change the market risk premium
(rM rRF) since both rM and rRF are affected.

3.

Jan Middleton owns a 3-stock portfolio with a total investment value equal to $300,000.
Stock
A
B
C
Total

Investment
$100,000
100,000
100,000
$300,000

Beta
0.5
1.0
1.5

What is the weighted average beta of Jans 3-stock portfolio? [2.5 marks]
a. 0.9

b. 1.3

c. 1.0

d. 0.4

e. 1.2

Solution
c. The calculation of the portfolios beta is as follows:
bp = (1/3)(0.5) + (1/3)(1.0) + (1/3)(1.5) = 1.0.

4.

The Apple Investment Fund has a total investment of $450 million in five stocks.
Stock
1
2
3
4
5
Total

Investment (Millions)
$130
110
70
90
50
$450

Beta
0.4
1.5
3.0
2.0
1.0

What is the funds overall, or weighted average, beta? [2 marks]

a. 1.14

b. 1.22

c. 1.35

d. 1.46

e. 1.53

Solution
5

Answer d. b p = w i bi
i =1

$130
$110
$70
$90
$50
(0.4)
(1.5)
(3.0)
(2.0)
(1.0) 1.46.
$450
$450
$450
$450
$450