MG3077: Strategic Financial Management Online Exam - Brunel University

This document presents a comprehensive solution to an online exam in Strategic Financial Management (MG3077) from Brunel University. The solution covers several key areas of financial management, including capital budgeting using Net Present Value (NPV) and payback period analysis, foreign exchange rate calculations involving spot and forward rates, and interest rate arbitrage. It also delves into the Weighted Average Cost of Capital (WACC) calculation, the impact of capital structure on valuation, and the Capital Asset Pricing Model (CAPM), along with its assumptions, advantages, and limitations. The exam solution demonstrates the application of these financial concepts through detailed calculations and explanations, providing a valuable resource for students studying strategic financial management.

Online exam strategic financial
management ONLINE EXAM

TABLE OF CONTENTS
SECTION B...............................................................................................................................3
Question 2..............................................................................................................................3
Question 4..............................................................................................................................4
Question 5..............................................................................................................................5
Question 6..............................................................................................................................5
REFERENCES...........................................................................................................................8

SECTION B
Question 2
a)
Year
Cash
inflows
Discounting factor
@10%
Present
value
0 -10000 1 -10000
1 1500 0.909090909 1364
2 3000 0.826446281 2479
3 3500 0.751314801 2630
4 4500 0.683013455 3074
5 5500 0.620921323 3415
Net present
value 2961
The net present value derived from the above is positive, which indicates that the
company should investment into building a new factor. The net present value is the difference
between the present value of the cash inflow and present value of cash outflow. If it is
positive project is feasible and acceptable.
b)
Year
Cash
inflows Cumulative cash inflow
0 -10000 -10000
1 1500 -8500
2 3000 -5500
3 3500 -2000
4 4500 2500
5 5500 8000
3 + 2000/4500
Payback period 3.44
The payback period of the project is approximately 3 years ad 4 months which is not very
less in comparison to the 5 years of life of the project. But on an overall basis, it is good and
company can make an investment.
c)
The net present value presents the present value of the future cash flow which is reduced by
the cash outflow. It helps in determining the profitability of the proposal. On the other hand,
payback period helps in determining the time within which the company would be able to
recover the amount of capital which was initially invested. Under NPV, it requires the
discounting rate for determining the present value which is very difficult to estimate while the

payback period does not require any discount rate. The NPV considers the time value of
money while the payback period ignores it. The major issue under NPV method is that if the
discounting rate is estimated wrong than it will lead to wrong decisions which might incur
losses and in case of payback period, it does not consider the cash which is generated after
the expected life of the project.
Question 4
a)
Spot rate = $1.67
Forward rate = £1.98
Difference in the rates = $1.65
Amount to be paid by importer = £100,000 / 1.65 = $60606
b)
Using the relative power parity, the forward exchange rate come out to be 27.01 pesos per $.
F= 27.50 * [(1 + 3%)/(1 + 6.7%)]^0.5 = 27.01
Using the interest rate parity, forward exchange rate is 26.95 pesos per $.
F= 27.50 * [(1 + 4.5%)/(1 + 8.8%)]^0.5 = 26.95
c)
Interest arbitrage is an approach of making a profit through the way of buying currency in
one place and then selling it in another place through making use of the difference between
the interest rates in both the places. Other types if interest rate arbitrage are given below:
Covered Interest Arbitrage: It occurs when the exchange rate risk is hedged with the forward
contract. A sharp movement in the forex market can erase the gain made through the
difference in the exchange rates and thus, in order to erase this risk, investors set the currency
exchange rate in the future.
Carry Trade & Other Forms of Arbitrage: It is another form of interest rate arbitrage which
involves borrowing capital from one nation at lower interest rate and lending it in a nation
having higher interest rates.
d)
Stabilising speculation occurs when there is a change in the price are modified by the
speculator and the limit or the level of magnitude of price change is limited. For example, if
price falls, the firm will cut back the supply (Speculation – Stabilising and destabilising.
2020).

Destabilizing speculation refers to the sale of the foreign currency under the situation when
the exchange rate is low with the expectation that it will fall more in the future or the buying
the foreign currency when it is rising.
Question 5
a)
Cost of equity = Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-Free Rate
of Return)
Cost of equity = 4% +(9.5%) *1.235 = 15.7%
b)
Computing weighted average cost of capital of Peralta Plc for the new venture
Cost of equity = 4% +(9.5%) *1.235 = 15.7%
Cost of debt = 7.65 + (100 – 90.65 / 6) / (100 + 90.65 / 2)
= 7.65 + 9.35 / 95.325 = 7.75%
WACC
Securitie
s Weights Cost
WACC (Cost
* Weights0
Equity 65% 15.70% 10.21%
Bonds 35% 7.75% 2.71%
Total 100% 12.92%
Therefore, the weighted average cost of capital of Peralta Plc is 12.92%.
c)
The organization’s capital structure is basically the mixture of debt and equity source of
financing which is an important factor in the valuation of the business. The levels of the debt
and equity is having the potential to affect the risk and cash flow and consequently the
amount investor is willing to invest into the business (Hirdinis, 2019). The capital structure
matters because it has the potential to influence the cost of capital of the company. Valuators
mostly uses income-based valuation method, like the DCF in which the future economic
benefits is converted into the present value through the use of discounting rate or WACC.
Therefore, this rate is having the potential to affect the affect the cost of capital thus, leading
to impact the valuation of the company as well.
Question 6
a)

The mean return of the shares of Santiago Ltd = 0.15*(12%) + 0.35*26% + 0.05*5% +
0.25*17% + 0.20*10%
= 17.4%
The mean return of the shares of Boyle Ltd = 0.15*(12%) + 0.35*25% + 0.05*43% +
0.25*13% + 0.20*8%
= 17.55%
Risks of the shares of Santiago Ltd and Boyle Ltd
Expected variance of Santiago Ltd
= 0.15*(12 - 17.4) ^2 + 0.35*(26 - 17.4) ^2 + 0.05*(5 -17.4) ^2 + 0.25*(17 -17.4) ^2 +
0.20*(10 -17.4) ^2
= 48.94
Expected standard deviation of Santiago Ltd = Sqrt of 48.94 = 6.9
Expected variance of Boyle Ltd
= 0.15*(12- -17.55) + 0.35*(25 - 17.55) + 0.05*(43 - 17.55) + 0.25*(13 -17.55) + 0.20*(8 -
17.55)
= 5.265
Expected standard deviation of Boyle Ltd = Sqrt of 5.265 = 2.29
It can be stated that the mean return under both the shares is approximately 17.4% with no
much difference but the risk under Santiago Ltd is higher in comparison to the Boyle Ltd
because it is having higher standard deviation of 6.9 in contrast to 2.29.
b)
Assumptions of Capital Asset Pricing Model
 Investors are risk averse and all the shareholders are having the same beliefs from the
market and are well informed about it.
 No shareholder is having the potential to affect the security price.
 The market is perfect with no taxes, no transaction costs, and competitive market.
 Unlimited amounts can be borrowed at a risk-free rate (Andrei, Cujean and Wilson,
2020).
Advantages of CAPM
 It is very easy to use as it is having basic calculations.

 Shareholders hold diversified securities parallel to the market portfolio which
eradicates the unsystematic risk.
 It can be used in investment appraisal in comparison to other rates as it offers better
discount rates.
Limitations of CAPM
 It is based on too many assumptions which makes it unrealistic in practical life.
 It might result into wrong outcome of the investment as the CAPM is used as the
discounting rate which is very volatile a sit involves beta.

REFERENCES
Books and Journals
Andrei, D., Cujean, J. and Wilson, M. I., 2020. The lost capital asset pricing
model. Available at SSRN 2922598.
Hirdinis, M., 2019. Capital structure and firm size on firm value moderated by profitability.
Online
Speculation – Stabilising and destabilising. 2020. [Online]. Available Through:<
https://www.economicshelp.org/microessays/speculation-stabilising-and-
destabilising/#:~:text=Stabilising%20speculation%20occurs%20when
%20changes,hopes%20that%20prices%20will%20rise.)>.