# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

 MODULE CODE: ACF312B ELEMENT: E1 MODULE TITLE: Financial Management MODULE LEADER: Ioannis Negkakis

This Coursework should be submitted on the DLE site for ACF312B.

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Suggested Word limit: 3000 words.

## Question 1 [30 Marks]

1. A pension fund manager expects those payments of \$1,500,000 per year will be paid to retirees starting at the beginning of Year 6. They will extend until Year 19. The discount rate is 8% compounded annually. What is the present value of the pension liability?

2. An asset pays 13% compounded quarterly. You have the right to reinvest the income at the same rate, and the maturity is 3 years. How much will the asset be worth at maturity if you invest \$400,000 today?

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

3. Texas Corp. is a calculator manufacturing firm that is expected to pay a dividend of \$2 next year that will grow 5% for two more years. If the stock is expected to sell for \$30 at the end of the third year and the required rate of return is 11%, then calculate the stock’s present value.

4. An analyst has gathered the following data for a company:

• Return on equity 15%

• Dividend payout ratio 30%

• Required rate of return on shares 20%

• Current year’s dividend per share \$2

Using the Gordon growth model, compute the intrinsic value per share.

5. A company has an issue of 5%, \$50 par value, perpetual, non-convertible, noncallable preferred shares outstanding. The required rate of return on similar issues is 4%. What is the intrinsic value of a preferred share?

6. A \$1,000 par value bond with 6% annual coupons matures in 2 years. If the required rate of return on the bond is 11%, then the current yield on the bond using simple compounding is closest to?

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

7. The following information is provided about three bonds that are currently trading at par.

 Bond Coupon Rate Maturity (years) A 4% 20 B 4% 10 C 6% 10

If the market discount rate for all three bonds increases by 100 basis points, which bond will most likely experience the greatest percentage change in price?

a. Bond A

b. Bond B

c. Bond C

8. Suppose a bond’s price is expected to decrease by 3% if its market discount rate increases by 100 basis points. If the bond’s market discount rate decreases by 100 basis points, the bond price is most likely to change by:

A. 3%.

B. less than 3%.

C. more than 3%.

9. Donald Hall is evaluating a project of a company that is expanding its operations in China. He has gathered the following information for this investment:

 Project beta 1.5 Risk-free interest rate 3% Market risk premium 8% Country risk premium for China 2.6%

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

What is the cost of equity? Please, present full calculations.

10. Which of the following is least likely accurate in regards to beta estimation?

a) Beta is estimated using data from historical returns.

b) Beta is believed to revert towards 0 over time.

c) The beta of small-cap firms may need to be adjusted upward.

11. Securitization, a process by which financial assets are purchased by an entity that then issues securities supported by the cash flows from those financial assets, has the following primary benefits except:

a) A reduction in funding costs for firms selling the financial assets to the securitizing entity.

b) An increase in credit rating from banks and other financial institutions.

c) An increase in the liquidity of the underlying financial assets.

12. In a semi-strong efficient market, investors must consider:

a) An enhanced indexing strategy that is dependent on trading patterns

b) Active portfolio management strategies

c) Passive portfolio management strategies

13. Which of the following is least accurate regarding efficient markets?

a) In an efficient market, securities may be mispriced, and trading these securities can offer positive risk-adjusted returns.

b) In an efficient market, it is difficult to find inaccurately priced securities.

c) In an efficient market, the time frame required for security prices to reflect any new information is very short.

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

14. A financial intermediary buys a stock and then resells it a few days later at a higher price. Which intermediary would this most likely describe?

a) A broker

b) A dealer

c) An arbitrageur

15. Which of the following would least likely be an objective of market regulations?

a) Reducing accounting standards

b) Making it easier for investors to compare the performance of different firms.

c) Preventing investors from using inside information in securities trading

## Question 2 [25 Marks]

Marriott International Inc. is planning to expand their operations in Barcelona by acquiring a resort with a capacity of 1500 rooms in order for the company to increase its market share in Spain. Marriott International Inc. is planning to operate the hotel, solely through a tour operator. It has currently secured a deal with a tour operator that, if the investment goes ahead, the tour operator will pre-book and manage all 1500 rooms. The resort will operate for 120 days, and the average price for each room will be 250€ per day. The acquisition cost of the resort will be €150 million. Moreover, Marriott International Inc. will invest €25 million for renovations. The Resort is expected to be operational at the beginning of 2022, and it will be salvaged at the end of 2026 (5 years) for €200 million. The variable costs are estimated at €120 per room per day. Also, €3 million per year will be required for maintenance. Assume a tax rate of 10%, a straight-line depreciation rate of 10% and an opportunity cost of capital of 9%. For simplicity, assume that there is no inflation. Use rounding (two decimals) for your calculations.

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

I. Calculate the estimated annual revenues and costs. [2 Marks]

II. Should Marriott International Inc buy the new resort? If yes, how much will Marriott International Inc earn from the investment? [Note: Ensure that you show all required derivations, as well as
the cash flows which you will use to come up with the investment decision.] [10 Marks]

III. Will Marriott International Inc. earn back the initial investment outlay and if yes, how long will it take? [3
Marks]

IV. The marketing team of Marriott International Inc concluded that, if they operate the resort without pre-booking it to the tour operator, the price charged per room per day will 30% higher. Variable costs per room per day will also be 30% higher. However, in this scenario, the resort is expected to operate with an overall occupancy rate of 70% for the 120 days of its operation (Hint: this will affect both costs and revenues). Moreover, because of the fact that occupancy rate is no longer 100%, maintenance costs will decrease by €1 million from year 2 onwards. Given the new data, how much is Marriott expected to earn from the investment and how long will it take to earn back the initial investment outlay? [8 Marks]

V. What is your recommendation for Marriott: should they choose to operate through the tour operator or not? Justify your opinion. [2 Marks]

[Note: Ensure that you provide adequate explanations throughout
Question 2 and that you present the cash flows which you will need to use for

## Question 3 [10 marks]

Consider the investment project in Question 2. What are (some of) the risk factors for this investment and how would you evaluate the risk for Marriott International Inc.?

Explain in detail and use appropriate data and examples where necessary [Hint: Marriott International
Inc. is a listed company].

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

## Question 4 [25 marks]

We now want to consider Marriott’s financing options, with respect to the investment project in Question 2. Marriott’s optimal capital structure is as follows:

Debt 55%

Preferred stock 15%

Common equity 30%

Total 100%

The expected retained earnings this year are \$30 million, while the dividend paid just before the beginning of the period (𝐷𝐷0) was \$3 per share, and its stock currently sells at a price of \$30 per share. Investors expect earnings and dividends to grow at a constant rate of 2% in the future. The tax rate is 10%. Marriott International Inc. can obtain new capital as follows:

Debt: Loans have an interest rate of 4% for debt up to \$44 million, 4.75% for up to \$88 million and 6% above \$88 million.

Common: New common stock has a flotation cost of 15%.

Preferred: New preferred stock with a dividend of \$6.3 can be sold to the public at a price of \$50 per share. Flotation costs will be 10%.

a. Find the break points in the MCC schedule. [8 marks]

b. Determine the cost of each capital structure component. [8 marks]

c. Calculate the weighted average cost of capital (WACC) in the interval between each break in the MCC schedule. [7
marks]

d. What discount rate should Marriott use for the investment project? Should it still accept it?(consider both scenarios) [2
mark]

## Question 5 [10 marks]

i.The Madoff company has 1 million shares outstanding with a current market value of £10 per share. The company recently sold a business unit of £2milion and wants to give this money to shareholders. Two strategies being evaluated:

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

1. Pay an extra (irregular) dividend.

2. Repurchase £2 million worth of shares.

What is the impact on the stock price and the shareholder wealth of using each method? [3 Marks]

ii. In 2019, the Madoff company earned a net income of £10 million. Cash not needed for business operations is £5 million. This money is invested, and the return is 4%, after tax. What would be the impact on EPS if the £5 million was used to buy back shares?

iii. ‘Dividends are conveyors of information’.

In a short paragraph discuss the above premise (200-300 words). [5 Marks]

End of Questions

## WORD LIMIT – REFERENCING – APPENDICES

The suggested word limit for the report is 3,000 words and the word count must be stated clearly on the cover page of the report.

Referencing should be done according to the Harvard referencing system. This guideto referencing should aid you. Please make sure that you reference your work appropriately and that you fully understand the consequences of plagiarism (see academic offences section in the last page of this document).

No important/assessed information in appendices: Appendices will not be marked and will not be looked at. That is, any information, tables, graphs that you put in the appendix will not be considered in the final marking, even if you make appropriate references to the appendix inside the text. Please note that even if you successfully address an assessment criterion in the appendices you may fail this marking criterion if this information is not included in the main text. All relevant information MUST be

# Deadline: Thursday 12th August 2021, 3:00 pm Submission procedure: Via the module page on the DLE

included in-text. Appendices may be only used to provide some additional information that is not core to the report per se and not feasible to include them in-text due to e.g., including unnecessarily large amount of data/detail. For example, if you have 4 pages of data you could include them in an appendix but you should provide a succinct summary of this data in-text if they are relevant in addressing an assessment criterion. So please be really careful with the use of appendices, and my personal advice is to avoid using them if you are not confident in using them efficiently.

## WRITING STYLE

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