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Looking over this past paper, I have a few points I would like to seek clarification:
(Ref. p. 19 Answer) (b)(ii) The answer given uses the annual coupon rate in arriving at the answer. I used the coupon rate calculated in Appendix 1 instead i.e. 3.57% to calculate the Macaulay duration and arrived at the same answer, but is this acceptable in exam?
Secondly, for the fixed annual repayment of interest and capital, I calculate as, Macaulay duration = [$23.57/1.0357 + $23.57/1.0357^2 + $23.57/1.0357^3 + $23.57/1.0357^4 + $23.57/1.0357^5] / $100 = 3.1 years. Is this acceptable?
(Ref. p. 20 Answer) (b)(iii) Re Appendix 3: Forecast Financial Position. The answer deducts the interest payable from current assets; can I add it to current liabilities instead? Are the figures for reserves balancing figures?
Also would like to confirm if gearing is always calculated using total equity (incl. reserves), not just share capital.
Thank you Tutor.
With regard to your first two questions – yes, what you are doing is acceptable (although strictly, the calculation in the second part should be done as per the answer).
The interest has been treated as having been paid (therefore subtracted from assets). The examiners answer does say that this was just as assumption.
Adding to liabilities instead is OK.No – the reserves are not balancing figures. For proposal 1, for the share repurchase $1 x 120M is subtracted from share capital and the remaining $10 x 120M is subtracted from reserves. This makes the reserves 1,700 – 1,200 = 500M. The adjusted profit falls from 350.00 to 309.56 (see appendix 3), so a fall of 40.44M
So reserves become 500 – 40.44 = 459.56MYes – if gearing is calculated on book values then it is equity including reserves. (If calculated on market values then you just use the market value of the shares, because the market value effectively includes reserves.)
I have some questions to ask from the examiner’s answer:
1. I understand the 3.57% is the coupon rate but how can we use it as an annuity factor in calculating Macaulay duration based on fixed annual repayment?
2. From the share repurchase for proposal 1, how can we derived the 120 M shares from?
Thank you in advance Sir.
1. The PV of interest and capital repayments when discounted at 3.57% will always be equal to the amount borrowed – this is always true.
So if there are equal annual payments, to get the PV you would multiply by the annuity factor to get the PV.
So to get the equal annual payment we divide the PV by the annuity factor.2. They are raising $1320M. The shares have a market value of $11. So the number they will purchase = 1320M/11 = 120M
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