PAPER ID - 00044

THE UNIVERSITY OF NEW SOUTH WALES

MONTH OF EXAMINATION JUNE 2011
FINAL EXAMINATION
ACTL5108
FINANCE & FINANCIAL REPORTING FOR ACTUARIES

1) TIME ALLOWED - 2 HOURS.

2) TOTAL NUMBER OF QUESTIONS 6.
3) QUESTIONS ARE NOT OF EQUAL VALUE. TOTAL MARKS - 100.
4) ANSWER ALL QUESTIONS.
5) THE PAPER MAY BE RETAINED BY THE CANDIDATE.
6) CANDIDATES MAY BRING THE FORMUALE AND TABLES FOR ACTUARIAL
EXAMINATIONS BOOK (ANY EDITION) INTO THE EXAMINATION. IT MUST
BE WHOLLY UNANNOTATED.
7) CANDIDATES MAY BRING THEIR OWN UNSW APPROVED CALCULATOR .
8) CANDIDATES SHOULD ANSWER EACH QUESTION ON A NEW PAGE.

ALL ANSWERS MUST BE WRITTEN IN INK. EXCEPT WHERE THEY ARE

EXPRESSLY REQUIRED, PENCILS MAY BE USED ONLY FOR DRAWING,
SKETCHING OR GRAPHICAL WORK.

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PAPER ID - 00044
Question 1 (10 marks)
You are a remuneration adviser for a large ASX-listed food, cooking oils and snacks
producer. The CEO of this corporation has recently resigned after prolonged poor
performance. Your task is to provide advice on structuring the remuneration package for
the replacement CEO.
a.) What are the advantages and disadvantages of running a business under a limited
liability corporate structure? (4 marks)
b.) Give two reasons for using a mix of cash and stocks in the remuneration package for
senior executives of a company. (3 marks)
c.) You are considering including performance hurdles in the remuneration package.
These hurdles mean the number of stocks awarded to the CEO each year depends on
whether they exceed a pre-agreed performance target. Give four possible performance
measures which can be used as suitable performance targets for this corporation.
(3 marks)

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PAPER ID - 00044
Question 2 (10 marks)
Goodman Fielder is a food, cooking oils and snacks producer listed on the Australian Stock
Exchange. The current market capitalisation of the company, as at 11th March 2011, is $1.574
billion.
You are analysing the financial results released by Goodman Fielder on 28th February 2011
for the period ending 31st December 2010. The tables below provide the information you
are focusing on :

The interim results above provide you with a comparison of key performance figures for
Goodman Fielder for the 2010 and 2011 First Half Year.
a.) Compute the net profit margin for the two half years. Compare the results and discuss.
(4 mark)
b.) Calculate the number of shares outstanding. (2 marks)
c.) What further information is required to assess the companys comparative performance
over the two half years? Describe two items. (4 marks)

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PAPER ID - 00044
Question 3 (17 marks)
You are the Chief Financial Officer of a leading Australian construction company which is
listed on the ASX with market capitalisation of $1.3 billion. The company is involved in
public infrastructure, property construction and facilities maintenance. Recently, following
much media speculation of the company facing financial problems due to a subsidiary
potentially facing bankruptcy, you have decided to consider issuing up to $279 million of
additional equity capital through a rights issue.
a.) Explain what is a rights issue. What does it mean for a rights issue to be renounceable?
(5 marks)
b.) The rights issue will be used to first pay down debt associated with the subsidiary,
which is recorded on your balance sheet as an investment. This investment is disclosed
by market value, rather than historical cost. Suppose $50 million remains after the
transaction cost and debt repayment. What factors would you consider in allocating this
remaining $50 million in the companys operations or investments? Where would you
seek information to assist you in making these decisions? (12 marks)

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PAPER ID - 00044
Question 4 (28 marks)
Robertson Holdings is a medium-sized operations and maintenance contractor company
listed on a stock exchange. The company has recently won a 5 year contract to provide
cleaning and properties maintenance for government schools. This contract was
successfully tendered for $95 million.
You are a financial modelling expert performing some scenario analysis using discounted
cash flow analysis to determine the likely profitability of this project under three current
possible scenarios Base market, bull market and bear market. Furthermore, you have
computed the IRR for the project under the three possible scenarios. The output and
assumptions are given below :
School Property Cleaning and Maintenance Project - Pro-forma Cash Flow Forecast Model
End of Year Figures (in $'mil)
Forecasted Net Profit (Base Case)
Forecasted Net Profit (Bull Market Case)
Forecasted Net Profit (Bear Market Case)
Assumptions
Probability
Risk-adjusted discount rate (%)
Annual Depreciation/Amortisation Expenses ($'mil)

Year 0

Year 1

Year 2

Year 3

Year 4

-95
-95
-95

25
29
16

28
34
23

32
39
22

34
42
27

Year 5 NPV @ IRR

35
44
28

($0.00)
($0.00)
($0.00)

Base Case Bull Market Bear Market

0.5
13%

0.2
16%

0.3
11%

Profitability Analysis - Internal Rate of Return

Base Case
Bull Market
Bear Market

26.704%
34.443%
16.481%

a.) Compute the NPV for the projects under the base, bull market and bear market cases.
Show your working and reasoning. (14 marks)
b.) Explain the meaning of internal rate of return, with respect to the figures calculated in
the above table. (4 marks)
c.) Compute the probability-weighted cash flows. Explain the meaning of these figures.
(5 marks)
d.) Explain why scenario analysis is superior to a single NPV estimate for evaluating
investment projects for capital budgeting purposes. (5 marks)

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PAPER ID - 00044
Question 5 (16 marks)
Equity research analysts typically value company stocks using the CAPM framework in
their discounted cash flow models. This is conducted by taking the companys financial
statements and forecasting future revenues, expenses and other profit/loss items. The
analysts then compute the free cash flows and discount these to the present value. The
present value of the free cash flows gives an estimate of the companys market value of
equity.
a.) List the parameters in the security market line. What are the typical market variables
used in the parameter estimates? (5 marks)
b.) What are the key limitations to using the market variables you describe in a.) for
valuing company stocks under this framework? (5 marks)
c.) The current government short-term borrowing rate is 4.75% p.a. and the listed equity
markets expected returns is 8% p.a. The market has a volatility of 14% pa. Suppose a
stock has an expected return of 8.3%, volatility of 19% and the non-diversifiable
volatility is 6%. Determine the stocks beta, stating any assumptions you make.
(6 marks)

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PAPER ID - 00044
Question 6 (19 marks)
Suppose a company has 100 million shares on issue, worth $13 each. This company is
currently unlevered. The market expects this company to report an EBIT of $150 million in
the coming year. The corporate tax rate is 30% and interest payments are tax deductible.
a.) Calculate the unlevered net profit after tax for this company, and the earnings per share.
(4 marks)
b.) Suppose the company issues $100 million in debt and this result in EBIT expecting to
increase to $165m. The debt incurs interest rate of 7% p.a. Calculate the net profit after
tax for this company, and the earnings per share, after the company changes its capital
structure to holding debt and equity capital. (5 marks)
c.) Compare your answers in a.) and b.). Comment on the effect of debt on company
profitability. (5 marks)
d.) Discuss how the companys dividend policy may change if they include debt in their
capital. Give reasons for your answer. (5 marks)

--END OF EXAMINATION PAPER--

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