Introduction to Corporate Finance

Question 1: Briefly explain the following elements of the required rate of return on investment (ROI) The time preference rate The adjustment for inflation The risk premium (6 marks) b.Explain the methods you would use to determine the appropriate levels for each of the three elements of the return on investment (ROI) listed in Part A. (12 marks) c.Read the following article and comment on what it contributes to the definition of the risk-free rate. What is the riskfree rate? A Search for the Basic Building Block [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip) ] . Stern School of Business, New York University (7 marks) Question 2: In this question you are required to estimate the weighted average cost of capital (WACC) for Pearson plc at their 2015 financial year-end (31 December 2015). Financial information on Pearson [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip) ] can be found in the Financial Statements section of the company’s annual report (pp. 124–228) and in the Assessment resources folder on the B858 website. In addition to Pearson’s 2015 group financial statements the notes to these statements will also be relevant, such as the following: Note 6: Net finance costs Note 7: Income tax Note 9: Dividends (and for previous years see the five-year summary on p. 223) Note 18: Financial liabilities – borrowings Note 27: Share capital and share premium (and the 5-year summary of issued shares on p. 223) In order to calculate Pearson’s WACC, you will need to use a range of corporate finance models. In order to calculate Pearson’s WACC, you will need to use a range of corporate finance models. You are required to: use two methods to calculate a cost of equity for Pearson use two methods to calculate a cost of debt for Pearson derive from these calculations the most appropriate estimate of Pearson’s WACC. Note: you may wish to refer to the WACC diagram (Figure 4.23) in Chapter 4, Section 4 of the module text. Before answering this question: Review the various methodologies which can be used to calculate the component parts of the WACC. List the individual data items which you will need to locate or estimate the WACC, such as Pearson’s debt capital (borrowings), its corporate tax rate and its share capital. Locate the sources of information to determine these data items. Provide details of the sources you use in addition to Pearson’s financial statements and your reasons for using them. Note the following data: risk-free rate: 1.5% p.a. equity risk premium: 6% p.a. beta for Pearson: 0.46. Assume the capital structure of Pearson will remain the same as at the 2015 financial year end. In addition to your numerical work you should provide an explanation of your methodology and justify your choice of inputs in the WACC formula. Remember to show all your calculations in detail. Note: this question is not just testing your ability to derive an appropriate percentage for Pearson’s WACC. It is also looking at your understanding of how to source relevant financial information and make considered decisions about whether and how to deploy it. This is reflected in the following allocation of marks for this question: The calculations of WACC: (15 marks). The accompanying explanation of, and justification for, your methodologies and the approach you have taken to the question: (15 marks). Question 2 total: 30 marks Question 3: Critically review the content of these two papers on the merits to companies of cross-listing their shares on stock exchanges: Fernandes, Nuno and Giannetti, Mariassunta (2013) On the fortunes of Stock Exchanges and their reversals: Evidence from foreign listings [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip) ] European Central Bank, Working Paper Series 1585, September 2013 Sarkissian, Sergei and Schill, Michael, J. (2009) Are there permanent valuation gains to overseas listing? Review of Financial Studies 22, 371–412. You are not expected to explain or evaluate the statistical methodologies in both papers. Rather, you are expected to identify and comment on the findings of both papers and on how these findings support, contradict or add to our understanding of the motivation for firms to cross-list. Question 3 total: 20 marks Question 4: a.What are the differences between commercial paper and medium-term notes? (5 marks) b.What actions must companies take prior to commencing the issuance of medium-term notes? (10 marks) c.What are the advantages and disadvantages of just using the international (multi-currency) money markets to provide an organisation with debt finance? (10 marks) Question 4 total: 25 marks