FTX3044F

FINANCE IIA

TEST 1

TIME: 90 MINUTES + 24 MARCH 2022 MARKS: 75

5 MINUTES READING
PLEASE READ THE FOLLOWING INSTRUCTIONS VERY CAREFULLY

1. All cell phones must be switched off for the duration of the test and placed in your bags
out of sight underneath your chair.

2. Please fill in your personal details on the attendance slip and leave this on your desk
with your student card.

3. Complete your personal details on the cover of all answer books before the start of the
test.

4. Sections A and B should be answered in one answer book, and Section C in a

second answer book. You must hand in both books at the end of the test.

5. Do not open this test paper until instructed to do so. You may not write anything
on your test paper or in your answer books before the start of the test or once you have
been instructed to stop writing.

6. From the time the first test paper is distributed to the class and until the last test answer
book is collected you may not talk to any other student. This is a standard university
policy and anyone contravening this rule will be disqualified.

7. Written answers must be completed in blue or black ink only. The university allows
workings to be in pencil although we encourage you to do these in pen and clearly
mark them.

8. No questions will be answered by the invigilators during the test. Make whatever
assumptions you deem appropriate and clearly state these in your answer.

This test paper consists of 9 pages including the cover page and formula
sheet.

Page 1 of 9
SECTION A (24 marks, 29 minutes)

Required:
There are 8 questions in this section each worth 3 marks. There is no negative
marking. Select the most correct option. You do not need to explain your answer.

1. You have a list of assets. If some are real and some are financial which of the
following options is correct?
i. Patents
ii. Lease obligations
iii. Customer goodwill
iv. A college education
v. A $5 bill

a) Option i, ii and iii are financial assets.

b) Option v is the only financial asset.
c) Option i, iii and iv are real assets.
d) Option i, iii, iv and v are real assets.
e) They are all real assets.

2. Fiscal policy is difficult to implement quickly because

a) it requires political negotiations.
b) much of government spending is nondiscretionary and cannot be changed.
c) increases in tax rates affect consumer spending gradually.
d) it requires political negotiations, and much of government spending is
nondiscretionary and cannot be changed.
e) it requires political negotiations, and increases in tax rates affect consumer
spending gradually.

3. If the currency of your country is appreciating, the result should be to ______

exports and to _______ imports.
a) increase; increase
b) increase; decrease
c) decrease; increase
d) decrease; decrease
e) not affect; not affect

Page 2 of 9
4. Below are a list of asset classes and securities. Which of the following options is
correct?
i. Stock in Apple
ii. Property
iii. Currency
iv. Bitcoin
v. Derivatives
vi. 10-year US government bonds

a) All of the above are asset classes.

b) Option ii, iii, iv and v are asset classes.
c) Option i, iv, and v are securities.
d) Option ii, iii, and v are asset classes.
e) All of the above are securities.

5. The following list is a combination of fixed income asset classes. Choose the option
that best lists the asset classes from least risky to most risky. Each asset class in
the list has the same maturity (10 years) except for treasury bills which mature in 1
year.
i. Treasury bills
ii. Corporate bonds
iii. Municipal bonds
iv. Treasury bonds

a) i, ii, iii, iv
b) i, iv, iii, ii
c) i, iii, iv, ii
d) i, iv, iii, ii
e) i, iv, ii, iii

6. The Fan Company is expected to pay a dividend of R3.50 in the coming year.
Dividends are expected to grow at a rate of 10% per year. The risk-free rate of
return is 5%, and the expected return on the market portfolio is 13%. The stock is
trading in the market today at a price of R90.00. What is the market capitalisation
rate for the company?
a) 13.6%
b) 13.9%
c) 15.6%
d) 16.9%
e) 8%

Page 3 of 9
7. Stingy Corporation is expected to have EBIT of R1.5M this year. Stingy Corporation
is in the 28% tax bracket, will report R120 000 in depreciation, will make R90 000
in capital expenditures, and will have a R30 000 increase in net working capital this
year. What is Stingy's FCFF?
a) R1,080,000
b) R420,000
c) R1,500,000
d) R1,260,000
e) R1,110,000

8. You have a list of the following stocks with both their current prices and number of
shares in issue. We want to create a market capitalisation weighted index based on
the data. Choose the correct option below based on the information.

Stock Price No. of Shares in Issue

Molly Blackburn Inc. $20 1,000
Leslie Social Inc. $100 10,000
Snape Building LLC. $500 3,000
Jammie Stairs Ltd. $80 15,000
Kopano Residence Inc. $5 20,000

a) The largest stock in our index will be Snape Building LLC while the smallest
stock will be Molly Blackburn Inc.
b) The ranking of stocks from smallest to largest in our index will be: Kopano
Residence Inc, Molly Blackburn Inc, Leslie Social Inc, Jammie Stairs Ltd
and Snape Building LLC.
c) The stock in the middle of our index will be Jammie Stairs Ltd.
d) Leslie Social Inc. will have a larger weight than Jammie Stairs Ltd.
e) None of the above is true.

Page 4 of 9
SECTION B (26 marks, 31 minutes)

This section comprises 4 questions totalling 26 marks. Answer all questions.

QUESTION 1 (13 marks)

You are an analyst in an asset management firm that is trying to decide on a new
benchmark for your global equity fund. You have a choice between two benchmarks
one of which is price weighted and the other being market capitalisation weighted.
Your head of equities wants to understand the difference between the two benchmarks
so asks you to consider the data below.

Shares
Share Price
Ticker Name Outstanding
(USD)
(millions)
MSFT US Equity Microsoft 295.22 7519
CVX US Equity Chevron 160.44 1930
T US Equity AT&T 23.19 7141
MMM US Equity 3M 147.69 572
NKE US Equity Nike 127.41 1578
PG US Equity Proctor & Gamble 150.23 2430

Required:
a) Based on the data above construct the two indices, using the different
methodologies, showing the weight of each stock from largest to smallest.
(9 marks)
b) Based on the output in a), provide a reason for why you would choose the price
weighted index. Provide a reason why you would not choose this method as
well. (2 marks)
c) Based on the output in a), provide a reason for why you would choose the
market capitalisation weighted index. Provide a reason why you would not
choose this method as well. (2 marks)

QUESTION 2 (4 marks)

Required:
Two key features of common stock investing are residual claim and limited liability.
Explain these concepts. (2 * 2 marks each)

Page 5 of 9
QUESTION 3 (5 marks)

The US Federal Reserve (which is the US Central Bank) increased interest rates by
25 basis points. They did this because inflation is above their target of 2% (inflation is
currently 7.9%).

Required:
a) Why is inflation so high? (2 marks)
b) How will raising interest rates lower inflation? (1 mark)
c) The FED claims that raising interest rates will not increase the unemployment
rate, does this seem reasonable? Provide a reason for your answer. (2 marks)

QUESTION 4 (4 marks)

Required:
Discuss LIBOR in a paragraph. In your paragraph address the following questions:
• How was it calculated?
• What is it used for?
• What went wrong with it?
• What is the proposed way forward? (4 marks)

Answer the next section (Section C) in a new answer book.

Page 6 of 9
SECTION C (25 marks, 30 minutes)

This section comprises 4 questions totalling 25 marks. Answer all questions. Please
answer this section in a new answer book.

QUESTION 1 (2 marks)

Required:
List two ways in which economies of scale could be achieved in increasing the value
of a business. (2 marks)

QUESTION 2 (6 marks)

Consider the free cash flow approach to stock valuation. F&G Manufacturing Company
is expected to have before-tax cash flow from operations of $750,000 in the coming
year. The firm's corporate tax rate is 40%. It is expected that $250,000 of operating
cash flow will be invested in new fixed assets. Depreciation for the year will be
$125,000. After the coming year, cash flows are expected to grow at 7% per year. The
appropriate market capitalisation rate for unleveraged cash flow is 13% per year. The
firm has no outstanding debt.

Required:
a) Determine the after-tax income. (2 marks)
b) What will be the free cash flow? (1 mark)
c) What will be the total value of the equity of the firm? (3 marks)

QUESTION 3 (7 marks)

Tahlia PPE Ltd has just posted an EPS of R8 per share. The capitalisation rate is 10%
and ROE is 15%.

Required:
a) If Tahlia pays out all EPS as dividends, determine the current value of its share.
(2 marks)
b) Suppose Tahlia expects to pay out 60% of EPS as dividends, what will the value
of the share be, assuming the share price equals its intrinsic value?
(3 marks)
c) Determine the PVGO of the share. (2 marks)

Page 7 of 9
QUESTION 4 (10 marks)

Required:
Refer to the financial statements of Snapit Company and determine the following ratios
listed below, with workings:
a) The firm's current ratio for 2021. (2 marks)
b) The firm's leverage ratio for 2021. (2 marks)
c) The firm's times interest earned ratio for 2021. (2 marks)
d) The firm's average return on equity ratio for 2021. (2 marks)
e) The firm's average asset turnover ratio for 2021. (2 marks)

Income statement of SNAPIT 2021

BALANCE SHEET of SNAPIT

2021 2020

THE END

Page 8 of 9
 Useful Formulae

 Debt 
ROE = (1 − t )   ROA + ( ROA − r )  
 Equity 
𝐷𝑜 (1+𝑔) 𝐷1
𝑉0 = =
𝑘−𝑔 𝑘−𝑔

𝐹𝐶𝐹𝐹 = 𝐸𝐵𝐼𝑇 ∗ (1 − 𝑡) + 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 − 𝐶𝑎𝑝. 𝐸𝑥𝑝. −∆𝑁𝑊𝐶

𝐹𝐶𝐹𝐹𝑇+1
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 = 𝑊𝐴𝐶𝐶−𝑔

𝐹𝐶𝐹𝐸 = 𝐹𝐶𝐹𝐹 − 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 ∗ (1 − 𝑡) − ∆𝐷𝑒𝑏𝑡

𝐹𝐶𝐹𝐸𝑇+1
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 = 𝑘𝐸 −𝑔

𝐸1
𝑃0 = + 𝑃𝑉𝐺𝑂
𝑘

𝐾 = 𝑅𝑓 + 𝑏(𝐾𝑚 − 𝑅𝑓 )

𝐹𝐶
𝐷𝑂𝐿 = 1 + 𝑃𝑟𝑜𝑓𝑖𝑡

Page 9 of 9