Corporate Finance Examination Overview

The Corporate Finance module at the University of Hertfordshire for the academic year 2023/24 includes a comprehensive examination that spans three hours. The exam consists of six questions, each with multiple parts, and students are required to answer all questions. The examination allows the use of university-approved calculators, and students may request continuation answer sheets from invigilators. It is important for candidates to write their exam number on any sheets submitted.

Question 1: Valuation of Elevate Ltd

Elevate Ltd is preparing for a listing on the London Stock Exchange (AIM) and requires a valuation based on its financial statements. Key financial data includes:

Fixed Assets: £168,000,000
Current Assets: £12,500,000
Current Liabilities: £8,500,000
Ordinary Shares (£2): £80,000,000
Reserves: £32,000,000
7% Loan: £60,000,000
Total Earnings after tax: £44,000,000
Total Dividends paid: £2,400,000
Growth in dividends: 5%
Industry PE ratio: 3
Industry β (beta): 0.85
Return on market: 9%
Risk-free rate of return: 3%

Valuation Methods

To calculate the value of an Elevate Ltd share, two methods are applied:

Book Value Method:
- Book value per share = Total Equity / Number of Shares
- Calculation: Total Equity = Ordinary Shares + Reserves = £80,000,000 + £32,000,000 = £112,000,000
- Book Value per Share = £112,000,000 / 40,000,000 = £2.80
Net Realisable Value Method:
- Net realisable value = Disposal value of fixed assets + Realisable value of current assets
- Calculation: £130,000,000 (fixed assets) + £8,500,000 (current assets) = £138,500,000
- Value per Share = £138,500,000 / 40,000,000 = £3.46

Earnings Method and Dividend Growth Model

Using the earnings method and the dividend growth model, the value per share is calculated as follows:

Earnings Method:
- Value per Share = Earnings per Share (EPS) * PE Ratio
- EPS = Total Earnings / Number of Shares = £44,000,000 / 40,000,000 = £1.10
- Value per Share = £1.10 * 3 = £3.30
Dividend Growth Model:
- Value per Share = D1 / (Ke - g)
- D1 = Dividend per Share = Total Dividends / Number of Shares = £2,400,000 / 40,000,000 = £0.06
- g = growth rate = 5% = 0.05
- Ke = Required return = Risk-free rate + β * (Market return - Risk-free rate) = 3% + 0.85 * (9% - 3%) = 6.4%
- Value per Share = £0.06 / (0.064 - 0.05) = £4.00

Benefits and Drawbacks of Stock Exchange Listing

Two benefits and two drawbacks of a stock exchange listing for Elevate Ltd include:

Benefits:
- Access to Capital: A listing allows the company to raise funds through equity financing.
- Increased Visibility: Being publicly listed enhances the company's profile and credibility.
Drawbacks:
- Regulatory Scrutiny: Public companies face stringent regulations and reporting requirements.
- Cost of Listing: The process of going public can be expensive and time-consuming.

Question 2: Financing Options for Rapido plc

Rapido plc seeks to raise £330 million for a long-term project and an additional £8 million for operational cash flow. The company is considering issuing long-term corporate bonds or additional shares for the £330 million and using commercial paper for the £8 million. Key financial data includes:

Current Share Price: £4
Ordinary Shares (£2 nominal value): £880 million
Reserves: £600 million
6% Loan Notes: £60 million

Roles of Financial Intermediaries

Three roles played by financial intermediaries in assisting firms like Rapido plc in raising finance include:

Advisory Services: They provide expert advice on the best financing options available.
Risk Assessment: They evaluate the risks associated with different financing methods.
Market Access: They facilitate access to capital markets, connecting issuers with investors.

Calculation of Market Price of Redeemable Debenture

To calculate the market price of the redeemable debenture:

Coupon Payment: £1,000 * 7% = £70
Market Price: Using the present value formula, the price can be calculated considering the required return of 6%.

Number of New Shares for Rights Issue

To calculate the number of new shares required to raise £330 million at a 25% discount:

Discounted Share Price: £4 * (1 - 0.25) = £3
Number of Shares Issued: £330 million / £3 = 110 million shares

Theoretical Ex-Rights Share Price

The theoretical ex-rights share price can be calculated using the formula:

Ex-Rights Price: (Current Market Value + New Capital) / Total Shares

Differences Between Capital Markets and Money Markets

The capital markets and money markets differ primarily in terms of the duration of the instruments traded:

Capital Markets: Deal with long-term securities such as stocks and bonds.
Money Markets: Deal with short-term debt instruments like treasury bills and commercial paper.

Question 3: Portfolio Management and Risk

Effective portfolio management requires an understanding of the risk-return trade-off. The following portfolios are being considered:

Metalogix: Return: 13.15%, Beta: 1.25
Carbonix: Return: 12.45%, Beta: 1.40
Gaslogix: Return: 9.35%, Beta: 0.92
Minerolix: Return: 9.43%, Beta: 0.65
Organix: Return: 11.00%, Beta: 1.00

Expected Returns Using CAPM

Using the Capital Asset Pricing Model (CAPM), the expected returns for each portfolio can be calculated:

CAPM Formula: Expected Return = Risk-free Rate + Beta * (Market Return - Risk-free Rate)

Unsystematic vs Systematic Risk

Unsystematic risk is specific to a company or industry, while systematic risk affects the entire market. The significance of beta (β) lies in its measurement of systematic risk:

Unsystematic Risk: Can be reduced through diversification.
Systematic Risk: Cannot be diversified away and is inherent to the market.

Question 4: Credit Sales and Inventory Management

Stack Then High Ltd, a UK retailer, has annual credit sales of £20 million and a collection period of 45 days. The company is considering a 2% discount for early payment:

Discount Impact: 65% of customers are expected to take the discount.
Current Finance Cost: £162,740 at an annual interest rate of 6%.

Advising on Discount Proposal

To advise on the discount proposal, a financial analysis must be conducted:

Cost of Discount: Calculate the impact of offering a 2% discount on cash flow and finance costs.

Importance of Credit Management

Effective credit management is crucial for maintaining cash flow and minimizing bad debts, which is vital for the financial health of Stack Then High Ltd.

Inventory Cost Calculation Using EOQ

To compute the total inventory cost and assess the benefits of implementing the Economic Order Quantity (EOQ) model:

EOQ Formula: EOQ = √(2 * Demand * Order Cost)
Current Total Inventory Costs: £20,190 per annum for product TP3.

Financial Analysis of Shona plc and Geminal plc

Question 5: Shona plc Capital Structure and WACC Calculation

The financing decision for long-term corporate projects is crucial for finance managers due to its implications on the firm's cost of capital and bankruptcy risk. The finance manager of Shona plc, a UK-based manufacturing company, is tasked with evaluating the capital structure to minimize the Weighted Average Cost of Capital (WACC). Below are the financial details extracted from the company's annual accounts for the year ending March 31, 2024:

Ordinary Share Capital:
- 185 million shares issued
- Current share price: £1.58 (ex-dividend)
- Dividend just paid: £0.18 per share
- Dividend growth rate: 4% per year
Preference Share Capital:
- Issued preference capital: £36 million
- Type: 9% £0.90 shares
- Current share price: 60p per share
Debt Capital:
- 8% redeemable debentures due in 5 years at par
- Current market value per debenture: £102
- Total book value: £160 million
- Irredeemable bonds: £8 million issued at 6% on a £100 nominal value
- Market value per bond: £85
Tax Rate: 20%

To calculate the current WACC for Shona plc, the following assumptions are made:

Market values are used for equity and debt calculations.
Tax implications are considered for debt financing.

Advantages of Raising Long-Term Finance through Debt Instruments

Tax Benefits: Interest payments on debt are tax-deductible, reducing the overall tax burden on the company.
Retaining Control: Raising funds through debt does not dilute ownership, allowing existing shareholders to maintain control over the company.

Factors Impacting Cost of Capital for Shona plc

Market Conditions: Fluctuations in interest rates can affect the cost of debt and equity.
Company Risk Profile: Changes in the firm's perceived risk can influence the required return by investors.

Question 6: Geminal plc Project Evaluation

Geminal plc is a manufacturer focused on engine noise-cancelling devices. The company has successfully trialed its new product, the DB50. Below are the relevant financial details:

Research and Development Costs: £1,600,000
Market Research Costs: £800,000
Equipment Cost: £14,500,000
Equipment Resale Value: £1,550,000 after 5 years
Production and Sales Forecast:
- Year 1: 50,000 units
- Year 2: 80,000 units
- Year 3: 95,000 units
- Year 4: 60,000 units
- Year 5: 20,000 units
Selling Price per Unit: £350 (with 4% inflation per year)
Variable Material Cost per Unit: £150 (with 5% inflation per year)
Labour Cost: £40 per hour, requiring 30 minutes of labour per unit
Marketing Fees: £1,430,000 per annum plus an immediate one-off fee of £1,000,000
Additional Overheads: £1,300,000 per annum
Patent Rights Sale Value: £15 million if the project does not proceed
Cost of Capital: 12%

Net Present Value (NPV) Calculation

To determine the NPV of the DB50 project, the following cash flows must be considered:

Initial Investment: £14,500,000 (Year 0)
Annual Cash Flows: Calculated from sales revenue, variable costs, labour costs, marketing fees, and overheads.
Final Cash Flow: Equipment resale value of £1,550,000 at Year 5.

Using the provided discount factors at a 12% discount rate, the NPV can be calculated by discounting future cash flows back to present value and subtracting the initial investment.

Recommendation on Product Launch

Based on the NPV calculation, a recommendation will be made on whether Geminal plc should launch the DB50 product.

Strengths and Weaknesses of NPV as an Investment Appraisal Technique

Strengths:
- Considers the time value of money, providing a more accurate assessment of profitability.
- Helps in comparing different investment opportunities on a consistent basis.
Weaknesses:
- Relies heavily on estimates of future cash flows, which can be uncertain.
- May overlook qualitative factors that could influence investment decisions.

In conclusion, both Shona plc and Geminal plc face critical financial decisions that require careful analysis of their respective capital structures and investment opportunities.

Corporate Finance Exam Guide: Valuation & Financing Strategies

Corporate Finance Exam Guide: Valuation & Financing Strategies