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Department of Banking and Finance

Tutorial Questions
BFC 2140 Corporate Finance
Semester Two, 2016
Study tips:
To pass this unit, at the minimum you will have to read the textbook and practice tutorial
questions on a weekly basis. Start doing this from Week 1 and do not delay/accumulate the
required readings. Without attending the lecture, relying on lecture slides as the sole study
material is not enough to understand the topic. By nature, lecture slides are meant to be
complementary to, but cannot replace, the textbook. Past experience and historical evidence
show that students, who spend at least 6-9 hours/week as independent self-study for Corporate
Finance, have significantly higher chance of passing this unit.
Attempt the online quizzes on a weekly basis. They are designed to prepare you for the exam.
There are many tutorial questions in each week, partly because they are meant for you to
practice in your own time as well. Due to the time constraint of each tutorial, the tutor may
only focus on representative and more important questions.
We hold weekly consultation sessions. So please seek help from us. Dont wait until the SWOT
VAC.

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Tutorial 1 (Teaching Week 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
Investors, Firms and Markets
Questions from Prescribed Text (Questions and Problems section)
Ch. 1: 1.1, 1.4, 1.5, 1.16, 1.17, 1.19
Topic 2: Financial Mathematics
Ch. 5: 5.2, 5.6, 5.24, 5.32

Tutorial 3
Financial Mathematics
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 5: 5.16, 5.20, 5.33
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
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
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
Part 1:
1. Questions from Prescribed Text (Questions and Problems section)
Ch. 11: 11.1, 11.21, 11.13, 11.16
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 tax-paying 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
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
Solutions to Mid-Semester Test

Tutorial 9
Risk, Valuation and Investment
Warm-up questions
1.

Explain the relation between risk and return.

2.

Describe the two components of a total holding period return, and calculate this
return for an asset.

3.

Determining Portfolio Weights What are the portfolio weights for a portfolio
that has 135 shares of Stock A that sell for $47 per share and 105 shares of
Stock B that sell for $41 per share?

4.

Portfolio Expected Return


You own a portfolio that is 25 percent
invested in Stock A, 40 percent in Stock B, and 35 percent in Stock C. The
expected returns on these three stocks are 11 percent, 17 percent, and 14
percent, respectively. What is the expected return on this portfolio?

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 twoasset portfolio result in no reduction in portfolio risk? Explain.

Tutorial 10
Risk, Valuation and Investment
Warm-up questions:
1. What is the relation between the variance and the standard deviation?
2. What are the two components of total risk?
3. Diversification: Describe how investing in more than one asset can reduce risk
through diversification.

1. Questions from Prescribed Text (Questions and Problems section)


Ch. 7: 7.11, 7.12, 7.17, 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
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
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
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.

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