FINC1302 (FIN3010) – Fundamental Financial Management (Financial Management I)

Exercises & Assignments

Time Value of Money

(Where applicable, show the mathematical approach and use financial calculator to solve these
questions. Draw the time line and label the time, known variable and unknown variable, where
applicable)

1. If you were to make a deposit of $5,000 today in an investment account expected to pay 5% p.a.
compounded annually, what is the future value at the end of year 5?

2. You plan to invest $20,000.00 today in an equity unit trust fund expected to pay a return of 10% p.a.,
calculated annually. How much will you have in your account at the end of year 10?

3. What is the minimum nominal rate of return should you accept, if you require a 4% real rate of return
and the rate of inflation is expected to average 3% during the investment period?

4. You invest $10,000 in a one year time-deposit account paying you 2.5% per annum. If inflation
averages 3% during this time period, what is your real rate of return?

5. In 1990 you bought a house for $155,000. Property value in your neighbourhood appreciates at an
average annual rate of 4%. What would be the estimated value of your house today if this rate holds?

6. In 1990, a bank clerk earned $6,000 a year. How much does he earns today (2020) if his yearly salary
increases at the rate of 4% per annum? If inflation averages 4% annually during this time period, what is
the rate of increase in his salary in real terms?

7. Your annual sales this year (t = 0) were $500,000. You estimate that sales will grow at the compounded
annual growth rate of 5% next year three years (t = 1; t = 2 and t = 3). What is your annualized projected
sales (in $) for the next three years?

8. Your annual sales this year (t = 0) were $500,000. You estimate that sales will grow at the compounded
annual growth rate of 5% in year 1(t = 1), 6% in year 2(t = 2) and 7% in year 3(t = 3). What is your
annualized projected sales (in $) for next three years?

9. How much must you invest today to have $6,381.41 at the end of year 5 if the investment account pays
you 5% p.a. compounded annually?

10. You need $51,874.85 ten years from now. An investment-linked fund has been paying an average
return of 10% p.a. for last 5 years. Assume that this investment fund will continue to pay this annual rate
of return for some foreseeable future, how much money you need to invest today to achieve your
investment objective?

11. You will receive $100,000 in 5 years from a trust fund. If you can have the money now, you can
invest them to earn 10% per year.
a) How much is this future payment worth today?
b) Suppose today your Trustee offers you one lump sum payment of $72,000 for the right to take over the
trust fund when it is due. Will you take up the offer? Explain. (Assume the opportunity cost of 10% holds)

1
12. Suppose you are to invest the following cash flows in an account that is expected to earn a return of
11% per annum:
End of Year 1: $100
End of Year 2: $200
End of Year 3: $300
End of Year 4: $400
a) How much would you accumulate at the end of year 4?
b) How much would you accumulate at the end of year 5?

13. Suppose you are to receive the following cash flows over the next 4 years:
End of Year 1: $100
End of Year 2: $200
End of Year 3: $300
End of Year 4: $400
If you were to receive the monies today, you could have invested them to earn an annual rate of return of
11%. How much would these future cash flows worth today?

14.What is the annual compounded rate of return on an investment of $1,000 (t = 0) that will reward you
with a lump sum payment of $2,000 at the end of year 4(t = 4).

15. How long must you wait (to the nearest year) for an initial investment to triple in value if the
investment earns 8% p.a. compounded annually?

16. Suppose you deposit $1,000 at the end of every year for the next 10 years in an account paying you
7% p.a., with annual compounding. How much money would you have at the end of year 10?

17. How much will be in your retirement account if you invest $2,500 per year starting one year from
today for 35 years and it earns 9% p.a compounded annually?

18. How much will be in your retirement account if you deposit $2,500 per year beginning today for 35
years and it earns 9% p.a compounded annually?

19. Suppose you expect to receive $1,000 every year for the next 10 years. If your opportunity cost of
capital is 7% p.a., how much money would these cash flows worth today?

20. You will be receiving an annual fixed payment of $1,000 for the next 6 years, with the first payment
to commence next year. If you can invest to earn 8% p.a., how much is this stream of fixed payments
worth today? If you were to receive the fixed payment of $1,000 for the next 6 years, with the first
payment commencing today, what is the present value of this annuity?

21. Suppose you are to receive the $100 (t=3), $100 (t=4) and $100 (t=5). If you were to receive the
monies today, you could have invested them to earn a return of 9%. How much would these future cash
flows worth today?

22. The present value of the all the cash inflows stream discounted at 10% is $771.25. Find the missing
cash flow, $X.
0 1 2 3 4 5
l --------------- l --------------- l --------------- l --------------- l --------------- l
$771.25 $150 $150 $X $250 $330

2
23. What is the future value of a $2,000 investment at the end year 10 (t=10) if it earns a return of 12%
p.a. with:
a) annually compounded?
b) semi-annually compounded?
c) quarterly compounded?
d) monthly compounded?
e) weekly compounded?
f) daily compounded?

24. What is the effective rate of return on your investment based on the compounding periods in question
number 23 above?

25. Suppose you deposit $100 every month for the next 3 years in an account paying you 6% p.a., with
monthly compounding. How much money would you have at the end of year 3?

26. What is the annual instalment payment on a 5 year $10,000 loan if interest rate charged on this loan is
10% per annum, interest calculated on a yearly reducing balance? What if interest charged on this loan is
10% per annum, but interest is calculated on a monthly reducing balance?

27. You took a $100,000 mortgage from Cut-Throat Bank. The loan is for 20 years to be repaid by equal
monthly instalments. If the bank is charging you at 12% per annum, with interest calculated on a monthly
rest,
a) What is your monthly instalment?
b) What is the total interest amount you would have paid over the life of the loan?
c) What is the total principal amount you would have paid over the life of the loan?
d) What is the loan outstanding balance after you have paid the 24th instalment payment?

28. You want to borrow $10,000 for a period of five years. The lenders offer you a choice of three
payment structures with interest at 10% per annum:
a) Pay all of the interest and principal in one lump sum at the end of five years.
b) Pay only the interest every year for four years and then a final payment of interest and principal at the
end of the 5th year.
c) Pay five equal payments at the end of each year inclusive of interest and part of the principal.
d) Under which of the three options will you pay the least interest and why? [Calculate the total amount
of the payments and the amount of interest paid under each alternative].

29. You bought YHS Berhad shares for $6.92 per share 5 years ago. It is currently selling for $9.26 per
share. What is the rate of return on your investment?

30. What is the value of a company, expected to generate net cash flows of $10,000 per year forever,
assuming you require
a) 15% return?
b) 10% return?
c) 20% return?

31. Exactly one year from now, you want to retire with an annual income of $60,000. Assume also that an
investment account pays an average annual dividend of 5%. How much must you have in your account
today in order to withdraw $60,000 every year, without using a single cent of your initial investment?

3
32. Monica has decided that she wants to build enough retirement wealth that, if invested at 6% p.a.,with
monthly compounding, will provide her with $2,000 monthly income for 30 years. To date, she has saved
nothing, but she still has 25 years until she retires. How much money does she need to contribute per
month to reach her goal?

33. Your rich uncle gave you $10,000 today on your 20th birthday. You want to invest the money and then
start making monthly deposits, beginning one month from today, so that you will accumulate $500,000 by
the time you are 60 years old. You believe that you can earn 8% p.a. on your investment. How much will
you have to deposit each month to reach your goal of $500,000.00 by your 60th birthday? (Assume
monthly compounding)

34. Aisya plans to save money to buy a new car that costs $60,000. Assume that the price of the car does
not change regardless of when the car is purchased. If Aisya’s investment account earns an annual rate of
return of 10% and assuming monthly compounding:
a) How long before Aisya will be able to purchase the car is she saves $3,000 a month (assume she
deposit the amount at the beginning of each month)?
b) How much must Aisya save a month (at the beginning of the month) if she wants to purchase the car in
12 months’ time?

35. Gina have just contracted to sell a small parcel of land that she inherited a few days ago. The buyer is
willing to pay $22,589 at the closing of the transaction or will pay the amounts shown in the table below,
at the beginning of each of the next five years. Because Gina does not really need the money today, she
plans to let it accumulate in an account that earns 5% annual return. Given her desire to buy a house at the
end of five years after closing on the sale of the lot, she decides to choose the payment alternative that
provides the higher future value at the end of 5 years. The payment alternatives are:
(I) $22,589 single amount or
(II) the mixed stream of payments in the table below.
Beginning of year Cash Flow $
1 5,000
2 5,000
3 2,000
4 8,000
5 8,000
Which alternative will she choose? Explain.

4
Bond Valuation

Assume bonds par value (a.k.a face value, maturity value, future value) =$1,000.
Annual interest payment in dollars = Coupon rate multiply by par value.
Interest rate (a.k.a market rate, YTM) is used as discount rate to determine the bond’s value.

1. What is the value of a 10-year, 10% annual coupon bond, if kd = 10%?

2. Suppose inflation rises by 3%, causing kd = 13%. When kd rises above the coupon rate, what is the
bond’s value?

3. Suppose inflation falls by 3%, causing kd = 7%. When kd falls below the coupon rate, what is the
bond’s value?

4. What would happen to the value of this bond if its required rate of return remained at 10%, or at 13%,
or at 7% until maturity? (Determine the bond’s values with 9 years, 7 years, 5 years, 3 years and 1 year to
maturities under each situation)

5. What is the yield to maturity (YTM) on a 10-year, 9% annual coupon, $1,000 par value bond, selling
for $1,134.20?

6. What is the yield to maturity (YTM) on a 10-year, 9% annual coupon, $1,000 par value bond, selling
for $887.00?

7. Find the current yield for a 10-year, 9% annual coupon bond that sells for $887, and has a face value of
$1,000.

8. Continuation using information on Q6 & Q7. Find the expected price one year from now if market rates
remain unchanged.

9. Continuation from Q8. Calculate the capital gains yield.

10. What is the value of a 10-year, 10% semi-annual coupon bond, if kd = 13%?

11. If the proper price for this 10-year, 10% semi-annual coupon bond is $1,000, what would be the
proper price for the 10-year, 10% annual coupon bond?

12. Would you prefer to buy a 10-year, 10% annual coupon bond or a 10-year, 10% semi-annual coupon
bond, all else equal?

13. A 10-year, 10% semi-annual coupon bond selling for $1,135.90 can be called in 4 years for $1,050,
what is its yield to call (YTC)?

14. Last year, Malayawata Waterworks Berhad (MWW) issued a 15-year bond with $1000 par value and
carrying a coupon rate of 9% per annum. Interest is paid semi-annually. As an analyst with an Asset
Management company, you are evaluating your investment portfolio and are considering adding MWW
bonds into your portfolio. The bond is currently being traded at $853.20. What is the rate you would earn
if you bought and held the bond to maturity? If your required rate of return for bonds of similar risk-class
is 10%, would you invest in the bond?

5
15. Consider the following details for a bond issued by West Coast Expressway Ltd:
Issue Date 1/7/2000
Maturity Date 1/7/2030
Coupon Rate (semi-annual coupons) 9%
Face Value $1,000
Suppose that today’s date is 1st July 2019, what should the value of this bond if investors require a 10%
annual return?

16. A corporate bond with a 6% coupon has 10 years left to maturity. It has had a credit rating of BBB
and a yield to maturity of 6.25%. The firm has recently gotten into some trouble and the rating agency is
downgrading the bonds to BB. The new appropriate discount rate will be 7%. What will be the change in
the bond's price in dollars and percent? [Assume that interest payments are paid semi-annually. Use 3-
decimal places for all calculation]

17. Serangoon Industries Limited has a bond outstanding with 15 years to maturity, an 8.25% nominal
coupon, semi-annual payments, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity,
but it can be called in 6 years at a price of $1,150. What is the bond’s nominal yield to call?

18. Consider the following four bonds.

Bond Par Coupon Time to Discount Bond
Value Rate Maturity (years) Rate Price
A 1,000 10% 10 ? 1,000
B 1,000 10% 20 10% ?
C 1,000 ? 15 8% 1,342.38
D 1,000 6% ? 8% 828.81
Assume that all bonds pay coupons annually.
a) Determine or calculate the unknown bond parameters in the table above. That is, what is:
1) The discount rate for Bond A?
2) The bond price of Bond B?
3) The coupon rate for Bond C?
4) The time to maturity for Bond D?
b) Comparing bonds A and B, the price of which bond is more sensitive to changes in the discount
rate. That is, if the discount rate were to increase by 1%, which bond price is expected to change
more in percentage terms? Why? [No computations are needed, only an explanation in words].
c) Similarly to the previous question, comparing bonds C and D, the price of which bond is more
sensitive to changes in the discount rate, and why?

19. The bond shown in the following table pays interest annually.
Par value Coupon interest rate Years to maturity Current value
RM1,000.00 13% 7 $1,200.00
a) Calculate the yield to maturity (YTM) for the bond.
b) As the bond approaches maturity (time to maturity declines), what relationship exists between
(1) coupon interest rate and yield to maturity
(2) par value and market value of a bond.

6
20. The SRD Company has bonds outstanding with a par value of $10,000,000 that reaches maturity in 15
years. The bond certificate indicates that the stated coupon rate for this bond is 8% and that the coupon
payments are to be made semi-annually.
a) How much will each semi-annual coupon payment in dollars ($) be?
b) Assuming the appropriate Yield to Maturity (YTM or market rate) on the SRD bond is 7.5%,
what should be the value of these bonds?
c) Assuming that this bond trades for $918.556 per unit, then what is its YTM?
d) Continuing from part (c) above. Assume that the market interest rate remains the same (i.e. does
not change through the year), at that price should this bond be traded for (per unit) one year from
today? (Use 3-decimal places for your answer)

7
Stock Valuation

For DDM, use investor’s required rate of return as the discount rate to find the intrinsic value.
Investor’s required rate of return is determined by using the Capital Asset Pricing Model (CAPM):
Ks = Krf + (Km – Krf)*β
For FCF Model, use WACC [Weighted Average Cost of Capital] as the discount rate to find Vc.

1. If kRF = 7%, kM = 12%, and β = 1.2, what is the required rate of return on the firm’s stock (use CAPM)?

2. If D0 = $2 and dividend does not grow for some foreseeable future, i.e. g = 0, find intrinsic value of the
stock.

3. If D0 = $2 and g is a constant 6%, what is the stock’s intrinsic value?

4. What is the expected price of the stock, one year from now if the required return remains constant?

5. What are the expected dividend yield, capital gains yield, and total return during the first year?

6. If the stock is expected to have a negative growth, g = -6%, would anyone buy the stock? What would
the expected price today?

7. What is the expected price if D0 = $2 and g = 30% for 3 years before achieving long-run growth of 6%?

8. Find expected dividend yield and capital gains yield during the first and fourth years.

9. What if D0 = $2 and g = 0% for 3 years before long-run growth of 6%?

10. Find expected dividend and capital gains yields during the first and fourth years.

11. What if D0 = $2 and g shrink at 10% (g = -10%) for 3 years before long-run growth of 6%?

12. Suppose FCF0 = $2m and FCFs are not expected to grow for some foreseeable future, i.e. g = 0, find
the firm’s value if WACC = 13%?

13. Suppose FCF0 = $2m and FCFs are expected to grow at a constant rate of 6% for some foreseeable
future, i.e. g = 6%, what is the value of the corporation if WACC = 13%?

14. The expected FCFs of the firm are as follows: FCF1= -$5m; FCF2=$10m; FCF3=$20m. From year
three onwards, the long-run the long-run gFCF = 6%. Given the firm’s WACC of 10%, use the corporate
value model to find the firm’s intrinsic value.

15. Extension to Q14. If the firm has $40 million in debt and has 10 million shares of stock, what is the
firm’s intrinsic value per share?

8
16. If there are 1 million shares of $0.50 par value, what are the book value per share and the revised net
asset value (RNAV) per share?
Book value Market value
Borrowings $0 $0
Current Liabilities $1.0m $1.0m
Current Assets $1.5m $1.4m
Fixed Assets – Land $1.0m $2.0m
Eqpt $0.5m $0.3m
Bldg $1.0m $3.0m

17. Continuation from Q16. Determine the RNAV if:

a) the book value of common stock is $500,000 with a par value of $0.25 each?
b) the book value of common stock is $500,000 with a par value of $1.00 each?

18. The book value per share is $2.00 and its market price is $2.40 per share. What is P/BVR?

19. Net book value of company is $300m. Share outstanding is 100m with $1.00 par value. Market price
is $4.30 per share. What is P/BVR?

20. If profits earned for ordinary shareholders is $40m and the company has 100m outstanding shares,
market price of share is $4.00,what is the firm PER?

21. Current EPS $0.40 and expected to grow at 5% per year; with a PER of 10x, at what price should the
stock be traded in the market?

22. Current EPS = $3.00. Next year’s earnings are expected to grow at 3% of current EPS. If the share has
traded, historically at PER of 16 times, and the industry average P/E ratio is also 16, what should be the
price of the stock?

23. The average PE ratio for the construction industry is 11x. Bagus Builders Bhd posted an after-tax
profit of $235,000.00. There are 1,000,000 shares issued and outstanding. Assuming earnings is expected
to grow at a rate of 2% for the coming year. Based on market approach, at what price should Bagus shares
be traded?

24. A $100 par value preferred stock carries an annual dividend of 10%. If its required return were 10.3%,
then what is the preferred stock’s intrinsic value?

25. If preferred stock with an annual dividend of $5 sells for $50, what is the preferred stock’s expected
return?

26. Pahang Consolidated Gold Mining Corporation 4% preferred stock has a par value of $50. If your
required return is 15%, what is the intrinsic value per share? If the preferred stock is trading at $15.00 per
share, should you buy the stock?

27. Consider a firm those stock had been priced using a 5% growth rate and a 10% required rate. The firm
recently paid a $0.50 dividend. The firm has just announced that because of a new joint venture, it will
likely grow at a 7% rate. How much should the stock price change (in dollars and percentage)?

28. Yesterday you bought UMW shares at $5.00. Forthcoming dividend is expected to be $0.50 per share.
If expected growth rate of dividend is 5%, what is your expected rate of return?

9
29. Is the following common stock priced correctly? If not, what is the correct price?
Current market price = $26.25
Required rate of return = 13%
Dividend paid = $2.00
Expected dividend year 1 = $2.10

30. Tandop Hotels, Inc. is entering into a three year remodelling and expansion project. The construction
will have a limiting effect on earnings during that time but when it is complete, it should allow the
company to enjoy much improved growth in earnings and dividends. Last year, the company paid a
dividend of $3.40. It expects zero growth in the next year. In the second and third year, 5% growth is
expected and in the fourth year, 15% growth. In year 5 and thereafter, growth should be a constant 10%
per year. What is the maximum price per share that an investor should pay for Tandop Hotels common
stock if the required rate of return is 14%?

31. Acme Corporation is considering a cash purchase of the stock of BoxPak Corporation. During the
year just completed, BoxPak earned $3.64 per share and paid cash dividends of $1.94 per share. (D0
equals=$1.94). BoxPak’s earnings and dividends are expected to grow at 30% per year for the next 3
years, after which they are expected to grow 7% per year to infinity. What is the maximum price per share
that Acme should pay for BoxPak if it has a required return of 11% on investments with risk
characteristics similar to those of BoxPak?

32. Ryan Enterprise Inc. forecasts the free cash flows (in millions) shown below. The weighted average
cost of capital is 13.0%, and the FCFs are expected to continue growing at a 5.0% rate after Year 3. What
is the Year 0 value of operations, in millions?
Year 1 2 3
FCF -$15.0 $10.0 $40.0

33. Based on the corporate valuation model, Wang Inc.’s value of operations is $750m. Its balance sheet
shows $100m notes payable, $200m of long-term debt, $40m of common stock (par plus paid-in-capital)
and $160 million of retained earnings. What is the best estimate for the firm’s value of equity?

34. Sandakan Oil Palm Estates Sdn Bhd (SOP) is one of the oldest and largest privately-owned plantation
companies in Sabah. This family-owned company has another 175,000 hectares in Kalimantan, Indonesia
with trees averaging about 4 years old and has been earmarked for harvest in about 3 to 4 years’ time.
SOP is considering going public but needs to determine a fair offering price. Before hiring an investment
banker in making the public offering exercise, managers at SOP have decided to make their own estimate
of the company share value. The company CFO has gathered data for performing the valuation using the
free cash flow valuation model.
 Weighted average cost of capital (WACC) is 12%
 Long Term Debt at market value is $14.5m and market value of preference shares is $5m.
 Estimated free cash flows over the next 5 years are as follows:
2021= $10.25m; 2022= $10.60m; 2023= $11.2m; 2024= $12.10m; 2025= $13.40m
 Beyond 2025 to infinity, SSOP expects its FCF to grow by 3% annually
If SOP plans to issue 30million ordinary shares, what is its estimated value per share?

10
Return & Risk:

1. One year ago, you bought 3,000 Scomimr stocks at $0.40 per share. Yesterday, you sold them at
$0.475 per share. The stock does not pay any dividend. How much money do you make? What was your
rate of return from this investment? (Ignore transaction cost)

2. Two years ago, you bought 10,000 Scomimr stocks at $0.40 per share. Yesterday, you sold them at
$0.675 per share. The stock does not pay any dividend. How much money do you make? What was your
rate of return from this investment? (Ignore transaction cost)

3. You bought 100,000 shares of Wah Seong 3 months ago at $1.98 per share. This morning you sold
them for $2.07 per share. You remembered receiving dividend of $0.06 per share. What is your dollar
return? What is your holding period return? What is your annualized rate of return from this investment?
(Ignore transaction cost)

4. Suppose you bought 1,000 NSOP shares at $5.05 per share 7 months ago. Now you want to evaluate
your investment position. Current market price is $6.00. You received $0.05 a share in dividends. What is
your holding period return? What is your annualized rate of return from this investment? (Ignore
transaction cost)

5. You invested in an Equity Unit Trust Fund and the return for the past 4 years is provided below:
Year 2016 10%
Year 2017 9%
Year 2018 7%
Year 2019 -3%
a) What is the arithmetic average return?
b) What is your geometric average return?

6. YTL Power Berhad dividend payments for the last 5 years are given below:
2015 $0.30
2016 $0.31
2017 $0.34
2018 $0.33
2019 $0.35
a) What is the compounded annual growth rate of dividends over this period?
b) What is the expected dividend for 2020 if the growth rate of dividend holds?

7. Assume BFM stock currently trades for $100 per share. In one year, there is a 25% chance the share
price will be $140, a 50% chance it will be $110, and a 25% chance it will be $80. What is the expected
rate of return?

8. The historical return of the XDL is given below.

Year k
2017 15%
2018 - 5%
2019 20%
What were the average return and the standard deviation of average return of this financial asset?

11
9. You are evaluating Metronic Corp stock and believe the following probability distribution exists for the
stock. What is the expected return and the standard deviation of expected return of the stock?
State of Probability of Stock's
the Economy State Occurring Projected Return
Boom 0.35 25%
Normal 0.50 15%
Recession 0.15 5%

10. Suppose a financial manager is considering two mutually exclusive one-year investments. The
outcomes are uncertain but three different states of nature about the economic strength have been
ascertained. The relevant data are as follows:-
Investment Outcome
State of Economy Probability A B
$ $
Recession 20% 4,000 0
Normal 60% 5,000 5,000
Boom 20% 6,000 10,000
a. Calculate the expected return of each investment.
b. Which investment is more risky?

11. Suppose you are considering two alternative investment proposals, the relevant data are as follows:
Asset X Asset Y
Expected return $2,000 $6,000
Standard deviation $600 $1,200
Which investment should be chosen?

12. A financial manager faces conditions of risk in terms of the economic strength in the coming year.
Three different states may occur as given below. Three alternative one-year investments are under
consideration offering returns as follows:
Investment Outcome
State of Economy Probability A B C
$ $ $
Strong 0.3 2,700 2,400 3,000
Average 0.5 2,250 1,800 2,400
Weak 0.2 1,200 1,500 1,350
Evaluate the investment alternatives in relation to risk and return and decide which one should be chosen.

13. An investor has $100,000 cash in hand and is considering investing in the shares of two companies,
Harta Berhad and Barta Berhad. The relevant information is as follows:-
Rate of Return
Probability Harta Barta
0.25 40% -20%
0.25 -10 50
0.25 35 -9
0.25 -5 39
a) What are the expected return of each security and its standard deviation of expected return?
b) If a portfolio consisting of 50% Harta shares and 50% Barta shares is held by the investor, what would
the expected return from the portfolio and its standard deviation be?

12
14. Suppose an investor wishes to establish a portfolio of two counters, IJM Berhad and KL City Berhad,
in the proportion of 60% and 40% respectively. The expected return and standard deviation of the two
counters are as follows:
Counter E(k) Std Dev.
IJM Berhad 15% 12%
KL City Berhad 20% 14%
A) Calculate the expected return of the portfolio.
B) Calculate its standard deviation of the portfolio, if the correlation coefficient is
a) perfectly positive correlated, where r = 1.00
b) positively correlated, r = 0.5
c) Not correlated at all, r = 0.0
d) Negatively correlated, r = - 0.6
e) perfectly negative, where r = -1.00

15. What is the expected return for the following portfolio? What is the beta of the portfolio?
Number of shares Share price Expected return Beta
IGB 100 $9.50 15% 1.25
SCO 200 $5.00 20% 1.60

16. Tom Cheung has a 2-stock portfolio with a total value of $100,000. $75,000 is invested in Stock A
with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's
beta?

17. Wolff Enterprises must consider one investment project using the capital asset pricing model(CAPM).
Relevant information is presented in the following table.
Item Rate of return Beta, β
Risk-free asset 8% 0.00
Market portfolio 13% 1.00
Project 1.27
a) Calculate the required rate of return for the project given its level of non-diversifiable risk.
b) Calculate the risk premium of the project, given its level of non-diversifiable risk.

18. Computers ‘R Us, a growing technology company, has a beta of 1.5. The return on the market
portfolio of assets has been determined to be 13% while the risk free rate is 3%.
a) What does a beta of 1.5 imply or mean?
b) On the basis of the Capital Asset Pricing Model (CAPM), calculate the required return on the
company.

19. You are going to invest $60,000 in a portfolio consisting of assets X, Y, and Z, as follows:
Expected
Asset Annual Probability Beta Proportion
Return
X 10% 0.50 0.90 0.333
Y 13% 0.25 1.08 0.333
Z 16% 0.25 1.60 0.333
a. Given the information above, what is the expected annual return of this portfolio?
b. What is the beta of the portfolio containing assets X, Y, and Z?
c. Would you make the investment if the 10-year MGS is expected to yield 4% and the expected return of
the FBM-KLCI is 12%?

13
20. You plan to create a portfolio with the following securities below. Is the portfolio providing you with
the return that you want? Show your findings and explain.
Stock Number of Market Estimated Beta
Code shares held price ($) return %
AMWY 10,000 5.00 12.0 1.05
STM 15,000 4.00 11.0 1.30
MIEG 40,000 1.00 13.0 1.45
MOONREIT 20,000 1.50 9.0 0.95
Other information:
FBM-KLCI = 11.0%
Risk-free rate = 3.25%

14
Cost of Capital

1. 3H Corp issues a $1,000 par, 20 year bond paying the market rate of 10%. Coupon payments are made
annually. The bond will sell for par since it pays the market rate, but flotation costs amount to $50 per
bond. Company tax rate bracket is 40%.
a. What is the pre-tax cost of debt? What is the after-tax cost of debt?
b. What are the before and after-tax costs if the bond pays interest semi-annually?

2. Xerox preferred pays an 8.25% dividend on a $50 par value. Suppose the current market price of
Xerox preferred is $43.42. What is the cost of the preferred stock?

3. If 3H Corp. issues preferred stock; it will pay a dividend of $8 per year and the price of its preferred
stock should be valued at $75 per share. Cost of issuing new preferred stock (flotation cost) amount to $1
per share.
a. What is the cost of preferred stock?
b. What is the cost of new preferred stock?

4. The common stock of Maju Steel has a beta of 1.25. The risk-free rate is 4% and the market risk
premium (km - krf) is 8%. Assume the firm will be able to use retained earnings to fund the equity portion
of its capital budget. What is the cost of retained earnings, ks?

5. 3H Corp common stock has a beta of 0.95. The 10-year MGS yields 5 % and the expected market
return is 12%. What is the company’s cost of retained earnings, ks?

6. Tonypak Company common stock is selling for $28 per share; its last dividend (D0) was $2.00 and its
expected dividend growth rate is 6 percent. If Tomypak Company were to issue new equity, a flotation
cost of 2.5% of issue price will be incurred.
a. What is the cost of retained earnings?
b. What will the cost of issuing new common stock be?

7. Several years ago the Scanlon Inc. sold a $1,000 par value, non-callable bond that now has 20 years to
maturity and a 7.00% annual coupon that is paid semi-annually. The bond currently sells for $950 and the
company’s tax rate is 40%. The firm provides the following data to determine its cost of equity from
retained earnings: KRF = 4.10%; RPM = 5.25%; and β = 1.15.Scanlon’s target capital structure is 60%
equity and 40% debt. What is Scanlon’s WACC estimates to evaluate its potential investment whose risk
is similar with the company?

8. You are evaluating the following investment opportunities for your firm’s expansion:
Project Return% Initial Investment $
A 12 200,000
B 14 250,000
C 15 230,000
D 13 220,000
E 16 280,000
Suppose the cost of equity is 20% and the before tax cost of debt is 12%. Your company is in the 40% tax
bracket. Your targeted capital structure is 40% debt and 60% equity. Assume the following:
1. Your expansion is limited to the currently available funds you are having.
2. The investment alternatives are all having the same average risk as the company
Subject to the above constraints, which project/s, if any, should be accepted? Explain.

15
9. Trio-Pharma target capital structure is 40% debt, 50% common stock, and 10% preferred stock.
Information regarding the company’s cost of capital can be summarized as follows:
Bond: Current bond price is $1,060.47 with 8 years to maturity. Annual coupon rate is 8%, with semi-
annual coupon payment. The company’s tax rate is 35%.
Preferred stock: Preferred stock sells for $8.90 a share and pays an annual dividend of $0.90 a share.
Common equity: Common stock sells for $28 a share, and is expected to pay a dividend of $2 a share at
the end of the year. Dividends are expected to grow at a constant rate of 7% a year.
To issue new common equity, a flotation cost of 2.5% of issue price will have to be incurred.
a. If the firm will be able to use its retained earnings to fund the equity portion of its capital budget, what
is the firm’s WACC?
b. What is the new WACC if the firm has exhausted all its retained earnings?

10. ABC Berhad has the following target capital structure: 30% debt, 10% preferred stock, 60% equity.
The firm as a before-tax cost of debt of 8% and a tax rate of 25%. The company has preferred stock,
which pays a fixed dividend of $1.20 per share that is currently selling for $8.00. The firm’s ordinary
shares are also listed on the stock exchange and the current price is $2.00. The firm recently issued
dividends on ordinary shares in the amount of $0.50 per share. For the purpose of computations, assume
that dividends for ABC Berhad will grow at a constant rate of 6% indefinitely. Issuing new preferred
stock and new ordinary shares will involve floatation costs of 2%. Based on the information above,
calculate the Weighted Average Cost of Capital (WACC) for ABC Berhad, assuming that new preferred
stock and ordinary shares will be issued.

16
CAPITAL BUDGETING
Capital Budgeting Techniques

1. The net cash flows of Projects S and L are given below, assume WACC is 10%.
Expected after-tax net cash flows ($)
Year Project S Project L
0 -3,000 -3,000
1 1,500 400
2 1,200 900
3 800 1,300
4 300 1,500
a) Determine the following:
(i) Payback Period (PP); (ii) Discounted Payback Period (DPP); (iii) Profitability Index (PI);
(iv) Net Present Value (NPV) and Internal Rate of Return (IRR).
b) Using each criterion, if they are independent projects, which one would you choose?
c) Using each criterion, if they are mutually exclusive projects, which one should be selected?

2. Consider the following projects. Assume that all cash inflows (in $) occurs at year-end and WACC is
14%.
Project A Project B Project C
Initial Investment Initial Investment Initial Investment
100,000 75,000 120,000

Year Cash Inflow Year Cash Inflow Year Cash Inflow

1 50,000 1 12,000 1 5,000
2 30,000 2 20,000 2 25,000
3 40,000 3 28,000 3 35,000
4 100,000 4 25,000 4 50,000
5 50,000 5 15,000 5 30,000
6 10,000 6 20,000
7 5,000 7 10,000
8 8,000

a) What is the Payback Period for Project C?

b) Calculate the Net Present Value (NPV) of Project B. Should you accept this project?
c) What is the Profitability Index of Project B?
d) Calculate the Internal Rate of Return (IRR) of Project A. Under what circumstances would you
accept this project?

3. The following projects are all characterized by a single initial cash outflow (the initial investment)
followed by a series of cash inflows. Rank them based on profitability index.
Investment ($) NPV ($)
Project A 160,000.00 30,000.00
Project B 120,000.00 15,000.00
Project C 110,000.00 25,000.00
Project D 200,000.00 40,000.00

17
4. Frazier Fudge, Inc. is considering two independent projects with the following cash flows. Using the
NPV criteria, which project should be accepted? Assume a cost of capital of 12%.
(Figures in $)
Year 0 1 2 3 4
Project A (350,000.00) 130,000.00 150,000.00 180,000.00 100,000.00
Project B (350,000.00) 180,000.00 120,000.00 120,000.00 100,000.00

5. Rieger International is attempting to evaluate the feasibility of investing $88,000 in a piece of

equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as
shown in the table below and the firm has a 11% cost of capital.
Year (t) A-tax CFs
1 $20,000
2 $25,000
3 $25,000
4 $30,000
5 $35,000

a. Calculate the payback period (PP).

b. Determine the profitibility index (PI).
c. Calculate the net present value (NPV).
d. Calculate the internal rate of return (IRR).
e. Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation
would you make relative to implementation of the project?

18
 Financial Management
Formula Sheet

TVOM

PV0 = FVn FVn = PV (1 + k)n

(1 + k)n

FVn x m = PV (1 + k ) n x m Effective Rate = (1 + k )m - 1

m m

 (1  k ) n  1   (1  k ) n  1 
FV  Pmt  FVan.due  Pmt (1  k )
 k   k 

 1   1 
1  1 
(1  k ) n (1  k ) n
PVannuity  Pmt  PVan.due  Pmt (1  k )
 k   k 
   
   

PVperpetuity = PMT
k

Periodic rate = knom / m

knom = APR = (Period rate) x (m)

(1 + nominal rate) = (1 + real rate) (1+ Inflation rate)

Internal Rate of Return (IRR) calculation by Interpolation

IRR = kL+ ( kH – kL) (NPVL)

(NPVL-NPVH)
where:
kL = Lower discount rate
kH = Higher discount rate
NPVL = Net Present Value at the lower rate
NPVH = Net Present Value at the higher rate

Alternative Equation:-

IRR = A + a x (B – A)
(a – b)
where:
A = Lower discount rate
B = Higher discount rate
a = NPV at the lower rate
b = NPV at the higher rate

19
Bond Valuation

N
INT M
VB =  (1  k
t 1 ) t

(1  k d ) N
d

N
INT Call Pr ice
VCallable B =  (1  k
t 1 ) t

(1  k d ) N
d

Approx. YTM = Int. + [(M – Vd) ÷ N]

[2 (Vd) + M] ÷ 3

CY=Annual Coupon Pmt / P0

CGY = (P1 – P0) / P0

Stock Valuation

DY=DPS1/ P0

^ DPS
P0 
k

^ DPS0 (1  g) DPS1
P0  
ks - g ks - g

P0 = DPS1 + DPS2 +….…+ DPSn + Pn

(1+ks) (1+ks)2 (1+ks)n (1+ks)n

where: Pn = DPSn (1+gLT)

(ks–gLT)

VC = FCF1 / ka
where: FCF is in perpetuity

VC = FCF1 / (ka - g)
where: growth rate of FCF, g, is constant

20
VC = FCF1 + FCF2 +…..+… FCFn + HVn
(1+ka) (1+ka)2 (1+ka)n (1+ka)n

where: HVn = FCFn (1+gLT)

(ka – gLT)

FCF = OCF –IOC

where: OCF = EBIT – Taxes + Depreciation
IOC = Δ Gross fixed assets + Δ Net operating working capital

VC = VS + VP +VD

P/BVR = Market price per share

BV per share

PER = Market price per share

Earnings per share

Market capitalization = market price of shares x no. of common shares outstanding

g = (Retention rate) (ROE) = (1 – Payout rate) (ROE)

Risk & Return

(1 + nom) = (1 + real) (1 + inflation premium)

Ending price  Beginning price  Dividend received

HPR =
Beginning price

Rg = [𝜋(𝑅𝑒𝑡𝑢𝑟𝑛 𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒)] 1⁄𝑛 - 1

Ra = Σ HPR
n

21
σ2= ∑ (ki – kavg) 2
n–1

kˆ  Pr1 k 1  Pr2 k 2    Prn k n

n
  Pri k i
i1

CV = σ
k

COV a,i = ∑ (a-ā) (i-ī)

n-1

n
COV a,i = ∑ (a - ā) (i – ī ) Pr
i=1

Correlation, ai = COVai

σa σi

β = COV (ri, rm) = rim σi σm = rim (σi / σm)

σm2 σm2

 p   A2 A2   B2 B2  2 A B Cov AB OR  p   A2 A2   B2 B2  2 A B rAB A B

ki = krf + ßi (km – krf)

kport = krf + ßport (km – krf)

βport = w1β1 + w2β2 + w3β3 …+…wn βn

kport = w1k1 + w2k2 + w3k3 …+…wn kn

22
Cost of Capital

INT INT INT M

V    
d 
1 k
d
1  
1 k
d
2 
1 k
d
N  
1 k N
d
 
N INT M
  

t 1 d

  1 k t 1 k N
d

Approx. KdBT = Cpn pyt + [(M – Vd) ÷ N]

[2 (Vd) + M] ÷ 3

kdAT = kd - (kd x T) = kd(1-T)

D ps D ps D ps D ps
k ps   
k ps  NP P0  Flotation costs P0 (1  F )
P

D̂ D̂ D̂
k  k RF  RP  1  g  k̂ k  1 g  1 g
s P0 s e NP P 1  F
0

k s = krf + ßs (km – krf)

k s = Bond yield + Risk premium

BPj = AFj / Wj

WACC =Wd (kdAT) + Wp (kp) + Ws (ks or ke)

Retained earnings = NI – Dividend

23
Capital Budgeting

OCF = NOPAT + Depreciation,

where: NOPAT = EBIT (1 – Tax rate)

Book value = TDA – Accumulated depreciation

 Unre cov ered cos t at s tart 

 Number of years before  of full - recovery year 
Payback  PB   full recovery of   
   Total cas h flow during 
 original inves tment   
 full - recovery year 

N
CFt
NPV  
t 0 ( 1  k )
t

N
CFt
0
t 0 (1  IRR) t

Approx. IRR = A + a x (B-A)

(a –b)

where: A = Lower discount rate

B = Higher discount rate
a = NPV at the lower rate
b = NPV at the higher rate

PV costs = TV inflows
(1 + MIRR)n

24