600543 Current Issues in Financial Management

Q1.

Market efficiency is an important assumption for both financial investors and non-financial firms which rely on market price as a signal for investment and/or financing decisions. The following diagram shows the reaction of a stock market index to a positive news. Based on this piece of evidence alone, can we conclude that this market is efficient in incorporating all available information? Explain your answer with reference to the relevant theory. (Hint: explain the concept of market efficiency; list the characteristics of market efficiency; conclude)

(Total 34 Marks)

Q2.

Hull Port (HP) plc has paid a dividend of £1.5 per share at the end of 2017. The dividend reflects a 100 per cent payout ratio. Market efficiency is assumed unless otherwise stated.

a. Suppose investors expect this level of dividend to prevail forever, and they require a 15 per cent of annual return for this type of asset. What will be the price of HP’s shares at the beginning of 2018? (12 Marks)

b. Suppose investors expect that the earning per share on HP’s equity will be £3 in 2018, but only 40 per cent of that will be distributed as dividend. This dividend policy is expected to prevail forever from 2018 onwards. What price are they willing to pay for HP’s shares at the beginning of 2019? (16 Marks)

c. Suppose the required rate of return increased from 15 per cent to 20 per cent at the beginning of 2019, as a result of risky growth. Recalculate the fair price of the equity at the beginning of 2019. (12 Marks)

d. Compare parts b and c, what is the value of growth and the cost of growth? (16 Marks)

e. Suppose the price of the equity stands at £8.50 per share at the beginning of 2018. Would you buy the CP’s shares based on your calculation in part a? Explain your answer. (10 Marks)

(Total 66 Marks)