Answering Questions

  • Read each question carefully.
  • When you answer a question, your answer will automatically be saved.
  • You can revisit questions and change your answers at any time during the exam.
  • The only permitted characters for numerical answers are:
    • Numbers
    • One full stop as a decimal point if required
    • One minus symbol at the front of the figure if the answer is negative.

              For example: -10234.35

No other characters, including commas, are accepted.

Navigating between questions

  • Click Next Button to move to the next question.
  • Click Previous Button to move back to the previous question.
  • Click on a question number from the Exam Progress Details panel (see next page) to move directly to that question.
  • A message will be displayed when you click to move away from a question which has been partially attempted. You can choose to stay on the question and review your answer(s) or continue.
  • When reviewing your answer(s) for partially attempted questions ensure you read any message displayed in red text below the question in Section A or below the question
    part(s) in Section B
    .

Plam Co (March 2016 – Amended)

The directors of Plam Co expect that interest rates will fall over the next year and they are looking forward to paying less interest on the company’s debt finance. The dollar is the domestic currency of Plam Co. The company has a number of different kinds of debt finance, as follows:

 

Loan notes

Loan notes

Bank loan

Overdraft

Denomination

Dollar

Peso

Dollar

Dollar

Nominal value

$20m

300m pesos

$4m

$3m

Interest rate

7% per year

10% per year

8% per year

10% per year

Interest type

Fixed rate

Fixed rate

Variable rate

Variable rate

Interest due

6 months’ time

6 months’ time

6 months’ time

monthly

Redemption

8 years’ time at nominal value

8 years’ time at nominal value

Instalments

Continuing at current level

The 7% loan notes were issued domestically while the 10% loan notes were issued in a foreign country.

The interest rate on the long-term bank loan is reset to bank base rate plus a fixed percentage at the end of each year. The annual payment on the bank loan consists of interest on the year-end balance plus a capital repayment.

Relevant exchange rates are as follows:

 

Offer

Bid

Spot rate (pesos/$)

58.335

58.345

Six-month forward rate (pesos/$)

56.585

56.597

Plam Co can place pesos on deposit at 3% per year and borrow dollars at 10% per year. The company has no cash available for hedging purposes.

Required:

A. Evaluate the risk faced by Plam Co on its peso-denominated interest payment in six months’ time and advise how this risk might be hedged.
B. Identify and discuss the different kinds of interest rate risk faced by Plam Co.

C. The dollar denominated loan notes each have a nominal value of $1,000 and are convertible. As an alternative to redemption in eight years the loan note holders could after seven years convert each loan note into 110 ordinary shares of Plam Co. The ordinary shares of Plam Co are currently trading at $6.50 per share on an exdividend basis. The current cost of debt of the convertible loan notes is 8%.

Required:

Justifying any assumptions which you make, calculate the current market value of the loan notes of Plam Co, using future share price increases of:

  • 4% per year
  • 6% per year.

D. Discuss the limitations of the dividend growth model as a way of valuing the ordinary shares of a company.

Leave a Reply

Your email address will not be published. Required fields are marked *