Corporate finance Questions
Answer BOTH groups of questions in Section B. Marks for each question are stated in the text (40 marks)
Answer the question in Section C (40 marks)
MAX WORDS: 3000
SECTION B
OPTION I – CAPITAL STRUCTURE
Use the following information to answer the question(s) below
Consider that you are the CEO of Bubbles Star Ltd. You have decided to change the composition of your firm’s capital structure, and are evaluating how much your company can afford to borrow.
There are currently 7.5 million shares outstanding in your firm and the market price is £100 per share. The market value of the firm’s outstanding debt is currently £200 million. You are rated presently as BBB.
The stock of the firm has a beta of 1.45. The risk-free rate is 5%. The firm faces a marginal tax-rate of 35%. The market premium is equal to 6%.
You estimate that if you borrow £100 million more, the rating of your company will change to B. The current BBB rate is 10% while the B rate is 12%.
What would be the firm’s weighted average cost of capital after the additional borrowing?
(10 marks)
Would you decide to proceed with the additional borrowing? Explain your answer.
(10 marks)
OPTION II : PORTFOLIO THEORY& CAPM
Use the following information to answer the question(s) below.
Assume that you have the following information about the returns of three stocks: Corinet, Kieft and Bill’s.
Company Expected
Return Standard
Deviation Correlation with
Corinet Inc. Correlation with
Kieft Inc. Correlation with
Bill’s Inc.
Corinet Inc. 12% 7% 1.0 -1.0 0.2
Kieft Inc. 25% 18% -1.0 1.0 0.8
Bill’s Inc. 18% 12% 0.2 0.8 1.0
Discuss the criteria for portfolio choice of investors.
(5 marks)
If you were to combine two of the three stocks together, which would be most preferable and why? If you invest 50% into each stock, calculate the expected return and standard deviation for this portfolio and comment upon your results. Using this example, explain the process of portfolio diversification.
(5 marks)
What is the expected return and the standard deviation of a portfolio that is equally invested in Corinet Inc. and Bill’s Inc.?
(5 marks)
Discuss the assumptions of the Capital Asset Pricing Model (CAPM). Explain the concept of a Security Market Line. Explain how the conclusions of the CAPM would change in a financial market in which investors face different interest rates for borrowing and for lending.
(5 marks)
SECTION C. ESSAY QUESTION
Discuss the process of going public and current challenges for firms looking to go public. Use tools from the course and your reading to provide relevant examples. How do you think IPOs in 2020/2021 will perform in the short and long run?