SECTION A: Multiple Choice 1. D 2. E 3. C 4. E 5. C 6. B 7. E 8. B 9. A 10. C 11. E 12. D 13. B 14. C 15. A

SECTION B: Short Answer (8 Questions)
(Answer all questions in this section, each question is worth 5 marks)

1. How is it possible that dividends are so important but, at the same time, dividend policy is irrelevant ?

Answer : Signalling theory shows that dividends are important since they convey inside information to investors hence affect shares price. Under the MM assumptions, dividend policy is irrelevant because it only defines the form in which shareholders’ returns are received. Funds paid out as dividends can be replaced at zero cost by issuing more shares. From the shareholders’ viewpoint, returns can be received in the form of dividends (explicit cash flows) and capital gains (implicit cash flows). Changing dividend policy changes the form in which returns are received in a particular period, but cannot change the present value of the cash flows.

2. Suppose Growth Unlimited has just paid a $1 dividend. Over the next 3 years, you estimate the dividends will increase 50%, 25% and 20% respectively. After that, dividends should grow at 10% per year. An appropriate discount rate for this firm is 15%. What is the stock price for Growth Unlimited? Answer :

P3=1*1.5*1.25*1.2*1.1/(0.15-0.1)=49.5

Current price P0=1*1.5/1.15 + 1*1.5*1.25/1.15^2 + 1*1.5*1.25*1.2/1.15^3 + P3/1.15^3=36.75

3. A share market analyst is able to identify the mispricing of share prices by comparing the average price for the last 5 days with those for the last 20 days. If the analyst is able to develop a successful investment strategy on the basis of observation, what can you say about the market?

Answer : If knowledge of the