Reference no: EM133145576

ACFI3203 Business Finance - De Montfort University

Section A

Question 1

You have recently gained employment in a major consultancy firm in Leicester. The firm provides advisory services to business owners.
One of your clients wishes to expand their retail operation in Manchester and is concerned about financing this expansion through debt or equity.
Advise the client on the advantages and disadvantages of issuing debt over equity.

Section B
Choose ONE (1) question only from this section.

Question 2
AlphaBeta Systems is considering the following independent projects for the coming year:

Project	Required Investment £'million	Rate of Return %	Risk
A	4	14	High
B	5	11.5	High
C	3	9.5	Low
D	2	9	Average
E	6	12.5	High
F	5	12.5	Average
G	6	7	Low

AlphaBeta's weighted average cost of capital (WACC) is 10% but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2% for low-risk projects.

Required:

a) Which projects should AlphaBeta accept if it faces no capital constraints?

b) If AlphaBeta can only invest a total of £13 million, which projects should it accept and what would be the size of the capital budget?

c) Suppose AlphaBeta can raise additional funds beyond the £13 million, but each new increment (or partial increment) of £5 million of new capital will cause the WACC to increase by 1%. If AlphaBeta uses the same methods of risk adjustment, which projects should it now accept and what would be the size of its capital budget?

d) The Finance director of AlphaBeta Plc believes that it is insufficient to compare the internal rate of return with the WACC as a basis of selecting investment project. Write a report to the Finance Director outlining the pros and cons of using three other investment appraisal methods other than the IRR.

Question 3
IOM plc has conducted Market Research costing £15,000 which will allow the company to advertise their new product to the market more effectively.

To start producing the new product, further investment in machinery of £65,000 would be needed. The machinery would have an expected life of 5 years, and a residual value of £16,000.

Tax depreciation allowances will be claimed at 25% on a reducing balance basis, up until the year of disposal, when a balancing allowance will arise.

The revenue is forecast to be £60,000p.a. in real terms, and costs are forecast to be £25,000 p.a. in real terms.

Working capital will need to be £7,000 at the start of the project and will remain at current prices (in nominal terms) therefore the working capital requirement will increase in line with inflation each year.

At the end of the project, all working capital invested to date will be released. Inflation is forecast to be 3% p.a. over the next few years and the firm's real cost of capital is 7% p.a. The tax rate is 30%, and tax is payable the year after that profit is earned.

Required:
a) Calculate the Net Present Value of the product and determine whether the new product should be undertaken based on NPV alone.

b) Calculate the Modified Internal Rate of Return for the product and determine whether the new product should be undertaken based on the Modified Internal Rate of Return.

c) Write a report to the management of IOM Plc explaining the advantages and disadvantages of both methods and why the NPV approach is the preferred method.

Section C
Choose ONE (1) question only from this section.

Question 4
The current share price of Magma plc is 215p. It reported earnings per share of 24p and the financial history of the firm is as follows:

	Dividends	Magma plc's Return	Market Return
2021	24p	13%	12%
2020	23p	10%	9%
2019	22p	7%	5%
2018	21p	17%	5%
2017	20p	23%	11%
2016	19p	5%	5%

The rate of growth in earnings and dividends shown in the past is expected to continue. The risk-free rate of return is 7.5 per cent and the risk premium on the average share has been 6 per cent for decades.
Required:
a) Calculate the historical price-earnings ratio.

b) Calculate the growth rate of dividends.

c) Using the Magma's return calculate the beta β of the shares.

d) Calculate the expected return on a share of this risk class.

e) Determine whether the shares at 215p are over- or under-priced.

f) Explain the limitations of the CAPM model.

Question 5
a) State and describe the three forms of market hypothesis.

b) An investor achieves a return of 30% in a single year by investing in the shares of new internet companies. She carefully picks shares using only publicly available information. In the same year the market achieves a return of only 10%. Does this evidence imply that the semi-strong form of the Efficient Market Hypothesis is false? Give reasons for your answer.

c) Give and explain three (3) examples of inside information which would encourage an insider to buy a stock. Who would the insiders be in each case?

d) Describe two (2) tests and evidence for the semi-strong form market efficiency.

Attachment:- Business and Law.rar