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Mei 507 Security Analysis Question Paper
Mei 507 Security Analysis
Course:Master Of Business Administration In Corporate Management
Institution: Kca University question papers
Exam Year:2014
UNIVERSITY EXAMINATIONS: 2013/2014
EXAMINATION FOR THE MASTERS OF BUSINESS ADMINISTRATION
(MBA) CORPORATE MANAGEMENT
MEI 507 SECURITY ANALYSIS
KITENGELA CAMPUS
DATE: AUGUST, 2014
TIME: 3 HOURS
INSTRUCTIONS: Answer Question One and Any Other Three Questions
QUESTION ONE (31 MARKS)
(i)
A security has been plotted on the security market line and fallen above it. What does this
imply? Suppose it fell below it what does that imply?
(ii)
(4 Marks)
Fundamental analysis consists of three stages namely economy analysis, industry analysis and
company analysis. Briefly explain each of the stages.
(6 Marks)
(iii) Differentiate between intrinsic and market value of a security.
(4 Marks)
(iv) A fund is split between two securities X and Y. The following data relate to these two
securities;
Variance of asset X=300
Covariance cov(X, Y) = - 55
Variance of asset X = 10
Required
The proportions that an extremely risk averse individual would place in a portfolio comprising
of assets X and Y to obtain a minimum standard deviation.
(v)
(6 Marks)
On the last trading day of 2013, an analyst is reviewing his valuation of ABC ordinary shares.
The analyst has the following information and assumptions:
1. The current price is sh 50.
2. The analyst estimate of the company’s intrinsic value is sh 55.00
1
3.
In addition to the full correction of the difference between the company’s current price
and its intrinsic value the analyst forecasts additional price appreciation of sh 3.20 and a
cash dividend of sh 0.60 over the next year.
4.
The required rate of return of the company is 9%
Required
i) What is the analyst’s expected holding period return of the company? (4 Marks)
ii) What is the company’s ex ante alpha? (3 Marks)
iii)Calculate ex post alpha given the following additional information;
- Over the next year (29th December 2013 through 31st December 2014) the company’s
actual rate of return is estimated to be 9.5%.
- 1n 2014, the realized rate of return for stocks of similar risk was 6%.
(4 Marks)
QUESTION TWO (23 MARKS)
(i) Explain the main assumptions of the H model of share valuation.
(6 Marks )
(ii) The equity share of a company offers a dividend of sh 6.00 at present. The present dividend
growth rate is 20%. Analysts predict that the dividend growth rate will decline linearly over a
period of 10 years after which it will stabilize at 10%. An investor requires a return of 15% for
his investment in the equity share of the company. What is the intrinsic value of the equity
share?
(iii)
(9 Marks)
Explain the theories of the term structure of interest rates. (8 Marks)
QUESTION THREE (23 MARKS)
(i) State and explain the assumptions of the Gordon’s model of stock valuation.
(ii) A financial analyst intends to estimate the sustainable growth rate of XYZ limited. The
(5 Marks)
following data was extracted from the financial statements of the company for the latest
financial period.
Net income 18,000,000
Sales 200,000,000
Total assets 120,000,000
Shareholders equity
60,000,000
Total earnings sh 5million
Total Dividends sh 3million
Required;
2
The sustainable growth rate for XYZ’s limited.
(iii)
(6 Marks)
Sololo Ltd is paying a dividend of sh =10.00 per share currently. The dividend that the
company can pay in the subsequent years is expected to decline at the rate of 4% every year in
perpetuity. The capitalization rate of the company is 15%. Calculate the intrinsic value of the
company’s ordinary share.
(iv)
(6 Marks)
ABC Ltd. has net tangible assets worth sh. 96million and the return of these net assets is 10%.
The company expects to receive sh.15 million as profits per year for the next 4 years. The
company has 2,000,000 ordinary shares outstanding.
Required:
Determine the theoretical value of the company’s ordinary share using the super profits method.
(6 Marks)
QUESTION FOUR (23 MARKS)
(i)
For a company having return on equity equal to the capitalization rate (cost of equity), the share
value is unaffected by the dividend policy. Comment on the validity of the above statement
(6 Marks)
(ii)
XYZ Ltd. paid sh.5 as dividends per share in the last accounting period. The dividends are
expected to increase by 10 % for the first 3 years, 8% for the next 2 years and at 5 % thereafter
in perpetuity. If the discounting rate is 10%, determine the intrinsic value of XYZ Ltd’s
ordinary share.
(iii)
(10 Marks)
Clearly explain the equity valuation process. (7 Marks)
QUESTION FIVE (23 MARKS)
General Motors Ltd. started operations on 1 September 2013. The company raised the
required equity capital of Sh.65 million and debt at an annual rate of interest of 18% before
commencing business. Given below are some statistics extracted from the books of the
company in respect of the financial statements prepared to 31 August 2014.
Sh.’000’
Total fixed assets (Net book value) 75,000
Operating costs (excluding debt interest) 39,150
Dividends declared and paid 4,220
Cash and bank balances 3,125
3
Eighty percent (80%) of the sales were on credit. The current assets on 31 August 2014
consisted of only stock, debtors and cash and bank balances as given above, while current
liabilities consisted of only creditors and tax provided for in respect of the year to 31 August
2014. Taxation was provided for at the rate of 30%.
You are also provided with the following ratios which have been determined from the
financial statements of General Motors Ltd.
Fixed assets turnover 1.8 times
Gross profit margin 45%
Stock turnover
4.4 times
Interest cover 4 times
Average debt collection period (based on 360 days of the year) 84 days
Current ratio 2.5:1
Required:
In respect of the year ended 31 August 2014, you are required to prepare the company’s:
a) Trading profit and loss account. (10 Marks)
b) Balance sheet. (10 Marks)
c) Explain the weakness of the percentage of sale method as a method of financial forecasting.
(3 Marks)
QUESTION SIX (23 MARKS)
i)
Combining a risk free security and a risky security makes it possible to derive the minimum
required return of a portfolio comprising of the two securities. This then makes it possible to
establish if a security is efficiently priced or not. Using this knowledge derive the capital
market line equation.
ii)
There are two different approaches to security analysis namely the fundamental analysis and
technical analysis. State and explain the meaning of each.
iii)
(8 Marks)
(6 Marks)
Benjamin Graham (1963) wrote that there is a double function of the financial analysts, related
in part to securities and in part to people. Explain the analysts function related to people and
explain how the analyst’s work contributes to the functioning of capital markets?
(9 Marks)
4
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