Question

1 a)

What are the three important financial decision-making areas that a financial manager in a firm is responsible for? Illustrate each of the areas identified using examples from an organisation that you are familiar with.

b)

What is the goal towards which the above financial decision-making should be directed in a firm? In what ways can the pursuit of such a firm-specific goal come in conflict with the personal goals of the financial manager? Question 2 a)

Explain what is a portfolio and discuss how an investor can reduce investment risk by constructing an investment portfolio. Why would an investor not be able to reduce investment risk by constructing an investment portfolio comprising perfectly positively correlated assets.

b)

Corporations Ltd operates in the manufacturing industry. The company plans to invest in advanced manufacturing technologies. For the purpose of this, the company buys 10 000 modern gadgets each year and demand is constant over time. The carrying cost per gadget for one year is $4.00 and the cost of placing and handling the order is $32.00. The company uses the Economic Order Quantity (EOQ) model to determine the appropriate order quantity. Calculate the EOQ and the total annual inventory cost for the company.

Question

3 a)

Carnation Ltd has a 5-year bond that is currently trading at a yield to maturity of 9% per annum compounded semi-annually. The bond’s coupon rate is 7% per annum, with semi-annual interest payments. Rumours have started circulating that Moody’s will soon downgrade the credit rating of Carnation’s bonds, which will result in a 3% p.a. increase in the yield to maturity, from 9% to 12% per annum. Determine the price of Carnation’s bond before and after the rumour, and explain the expected change in the price of Carnation’s bonds. Assume the face value of each bond is $1 000. b) Beta Ltd has current earnings of 90 cents per share. These earnings are expected to continue growing at the rate of 6% per annum in the foreseeable future. Assume 30% of the earnings are paid out as dividends. Determine the expected share price of the company using the dividend growth model. Assume that a cost of equity of 10% is applicable. a) Pottery Store sells various pottery items at local markets. The fixed expenses of the business (e.g. depreciation on the kiln, utilities, tools and portable selling booth) are $5 000 per year. The average price of a piece of pottery is $5.50, and the average total variable cost (e.g. clay, paints, glazes and price tags) is $3.50 per item. i) How many pieces of pottery must Pottery Store sell to cover fixed expenses? What is the Break Even Sales in this case for the store? ii) If Pottery Store wants to earn $7 000 profit, how many pieces of pottery must be sold? b) Pottery Store has spare capacity in that its pottery makers have some spare time. An overseas retail chain has offered the firm an order for 3000 pottery items at a price of $4.50 per item. (Assume that the firm does not incur any extra fixed cost for this). Without considering non-cost issues, should the store accept the order? What other non-cost factors should the store consider before reaching a final decision? Question 4 Carnation Ltd has a 5-year bond that is currently trading at a yield to maturity of 9% per annum compounded semi-annually. The bond’s coupon rate is 7% per annum, with semi-annual interest payments. Rumors have started circulating that Moody’s will soon downgrade the credit rating of Carnation’s bonds, which will result in a 3% p.a. increase in the yield to maturity, from 9% to 12% per annum. Determine the price of Carnation’s bond before and after the rumor, and explain the expected change in the price of Carnation’s bonds. Assume the face value of each bond is $1 000. b) Beta Ltd has current earnings of 90 cents per share. These earnings are expected to continue growing at the rate of 6% per annum in the foreseeable future. Assume 30% of the earnings are paid out as dividends. Determine the expected share price of the company using the dividend growth model. Assume that a cost of equity of 10% is applicable.