Oak Plc has a cost of capital of 12%. It has considerable cash reserves and is reviewing the following possible investment projects

Question 1

Oak Plc has a cost of capital of 12%. It has considerable cash reserves and is reviewing the following possible investment projects which are not mutually exclusive.

Oak Plc

Oak Plc

a) Using the information above and your knowledge of project appraisal techniques, calculate the 4 missing values (as indicated by the ?s) from the table below.

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Oak Plc

Oak Plc

 

b) Assuming Oak Plc has limitless funds and the projects are not mutually exclusive, what is the maximum NPV Oak Plc can achieve from these investments?
c) Explain what is meant by the term “capital rationing”.
d) What is the maximum NPV Oak can achieve if it has a maximum of £900m to invest? You can assume the projects are fully divisible.
e) Outline the advantages and disadvantages of Discounted Payback and Internal Rate of Return (IRR) as project appraisal techniques.

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Question 2

a) Explain what is meant by the term “capital structure”?
b) A firm you are considering investing in has stated that they “have a gearing level of 65%”. Discuss the problems that investors face when trying to interpret such information and list any additional information that you would like the firm to provide in order for you to better judge their gearing position.
c) In 1963 Modigliani and Miller proposed a theory that argued the value of the firm was dependent on its capital structure. Outline the assumptions behind their theory and with the aid of a diagram, explain their conclusions in full.
d) Explain what is meant by the term “costs of financial distress”. Discuss how these relate to Modigliani and Miller theory and the implications such costs have for optimal capital structure theory.

Question 3

Consider the following three stocks:

Oak Plc

Oak Plc

a) What is the expected return for Stock B?
b) What is the standard deviation for Stock A?
c) Which of the three stocks is a rational investor most likely to purchase?
d) What is the expected return, standard deviation and beta of a portfolio of 50 shares of Stock A, 20 shares of Stock B and 30 shares of Stock C?
e) Explain what is meant by the term “correlation” and state the expected signs of the correlation coefficients between all the stocks (i.e. between A and B, between A and C, and between B and C).
f) With the aid of a diagram define the efficient frontier and identify the capital market line.

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Oak Plc has a cost of capital of 12%. It has considerable cash reserves and is reviewing the following possible investment projects