Ethics of Finance Essay

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Corporate Finance: Theory & Practice (25557)
Final Exam Sample Questions (Spring 2012)
SECTION A: Core professional obligations, values and operations of organisations including sustainability. 1. You chair the compensation committee of the board of directors of MCC Ltd. Apart from a base salary, there are two packages suggested for the new CEO:
a. A conventional stock-option plan, with the exercise price fixed at today’s share price.
b. An alternative plan in which the compensation includes a bonus that depends on EVA.
Give one advantage and one disadvantage of the two plans. (4 marks)
Conventional Plan
Tying compensation to stock price so manager would work hard to maximise firm value
Advantage ____________________________________________________________________________
Stock price does not just depend on company performance, encourage excessive risktaking or tempt managers to manipulate earnings
Disadvantage __________________________________________________________________________
Alternative Plan
Makes the cost of capital visible to managers, invests only if the increase in earnings exceeds the cost of capital, underutilised assets tend to be disposed of
Advantage ____________________________________________________________________________ a low EVA may be a result of factors outside the manager’s control, does not measure PV, an accounting measure, biased to reward quick payback projects
Disadvantage __________________________________________________________________________

2. Briefly explain how a plant manager can improve Economic Value Added (EVA). (2 marks)


Increasing earnings
Reducing capital employed
__________________________________________________________________________



Page 1 of 4

SECTION B: Work-ready disciplinary knowledge.
1.

According to the pecking order theory of capital structure, ________ will last be used when external funds are required to finance new investment opportunities. (1 mark) equity ______________________________________________________________________________

2. Apart from increasing the debt ratio or a share repurchase, one way to solve the problem of too much free cash flow is: (1 mark) raising dividends
______________________________________________________________________________

3. The equity beta of a levered firm is 1.20. The beta of debt is 0.20. The firm's market value debt to equity ratio is 0.50. What is the asset beta if the tax rate is zero?
1.2 =  A + (0.5)( A - 0.2); A = 0.8667
________________________________________________________________________________

Page 2 of 4

SECTION C: Technical skills necessary for professional practice in business.
1.

A firm sells its desks for $50 apiece. Production cost is $30 per desk. There is a 10 percent chance that a customer, MCQ, will go bankrupt within the next year. MCQ orders 100 desks and asks for three months’ credit. Assume that the discount rate is 10 percent per year and MCQ will pay either in full or not at all. What is the NPV of the order? (1 mark)
NPV = 0.90 (5,000)/1.103/12 – 3,000 = $1,394
______________________________________________________________________________

2. A firm offers credit terms of 2/10, net 60 to its customers. If a customer pays on day 50, what is the effective annual interest rate for extending the use of trade credit? (1 mark)
= (1 + 2/98)365/40 – 1 = 20.24%
_______________________________________________________________________________
3. An Australian company is evaluating a proposal to build a new plant in
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