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F3 Questions and Answers

Question # 6

The following information relates to Company A's current capital structure:

  

Company A is considering a change in the capital structure that will increase gearing to 30:70 (Debt:Equity). 

 

The risk -free rate is 3% and the return on the market portfolio is expected to be 10%.

The rate of corporate tax is 25%

 

Using the Capital Asset Pricing Model, calculate the cost of equity resulting from the proposed change to the capital structure.

A.

11.4%

B.

12.3%

C.

9.3%

D.

10.1%

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Question # 7

A venture capitalist invests in a company by means of buying:

   • 9 million shares for $2 a share and

   • 8% bonds with a nominal value of $2 million, repayable at par in 3 years' time. 

The venture capitalist expects a return on the equity portion of the investment of at least 20% a year on a compound basis over the first 3 years of the investment.

 

The company has 10 million shares in issue.

 

What is the minimum total equity value for the company in 3 years' time required to satisify the venture capitalist's expected return?

 

Give your answer to the nearest $ million.

 

$   million.   

 

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Question # 8

An all equity financed company reported earnings for the year ending 31 December 20X1 of $8 million.

One of its financial objectives is to increase earnings by 5% each year.

In the year ending 31 December 20X2 it financed a project by issuing a bond with a $1 million nominal value and a coupon rate of 4%.

The company pays corporate income tax at 20%.

 

If the company is to achieve its earnings target for the year ending 31 December 20X2, what is the minimum operating profit (profit before interest and tax) that it must achieve?

A.

$6.69 million

B.

$10.50 million

C.

$8.40 million

D.

$10.54 million

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Question # 9

The long-term prospects for inflation in the UK and the USA are 1% and 4% per annum respectively.

The GBP/USD spot rate is currently GBP/USD1.40

Using purchasing power parity theory, what GBP/USD spot rate would you expect to see in six months’ time?

A.

GBP/USD1.38

B.

GBP/USD1.44

C.

GBP/USD1.42

D.

GBP/USD1.36

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Question # 10

A national airline has made an offer to acquire a smaller airline in the same country.

 

Which of the following would be of most concern to the competition authorities?

A.

After the acquisition the board propose to reduce the number of  flight destinations from the country.

B.

The board informed a major institutional shareholder about the proposed acquisition before informing other shareholders.

C.

After the acquisition the board propose to increase prices significantly on routes where no other airlines operate.

D.

The acquisition is likely to result in significant redundancies of staff currently working for the smaller airline. 

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Question # 11

A company is funded by:

   • $40 million of debt (market value)

   • $60 million of equity (market value)

The company plans to:

   • Issue a bond and use the funds raised to buy back shares at their current market value.

   • Structure the deal so that the market value of debt becomes equal to the market value of equity.

According to Modigliani and Miller's theory with tax and assuming a corporate income tax rate of 20%, this plan would: 

A.

increase the company's asset beta.

B.

decrease the company's equity beta.

C.

increase shareholder wealth.

D.

increase the market value of the company's equity.

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Question # 12

TTT pic is a listed company. The following information is relevant:

TTT pic's board is considering issuing new 6% irredeemable debt to re-purchase equity. This is expected to change TTT pic's debt to equity mix to 40: 60 by market value. The corporate tax rate is 20%.

What will be TTT pic's WACC following this change in capital structure?

A.

11.66%

B.

12.67%

C.

13.43%

D.

11.09%

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Question # 13

An unlisted company.

• Is owned by the original founders and members of their families

• Pays annual dividends each year depending on the cash requirements of the dominant shareholders.

• Has earnings that are highly sensitive to underlying economic conditions.

• Is a small business in a large Industry where there are listed companies with comparable capital structures

Which of the following methods is likely to give the most accurate equity value for this unlisted company?

A.

Dividend valuation model.

B.

Net asset valuation

C.

P/E based valuation using the P/E of a similar company.

D.

Discounted cash flow analysis at WACC (based on cash flows after tax but before financing) plus the market value of debt.

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Question # 14

Company ABC's management has noticed that Company BCD has quickly built up a 20% stake by buying shares in Company ABC and are concerned that this is the start of a hostile bid.

This build-up of shares triggers the poison pill provision which automatically converts the rights to buy future preference shares previously issued to existing shareholders in Company ABC to full ordinary shares

What is the most likely impact of the triggering of a poison pill strategy at this stage in the bidding process?

A.

It is too late for a poison pill strategy to have any impact on a hostile takeover because Company BCD has already built up a significant stake in Company ABC.

B.

Company BCD loses value on its shareholding and has to sell at a loss before losing more value

C.

Company ABC becomes less attractive due to a fall in value of the shares as a result of the discount.

D.

The threat of a hostile takeover is reduced because Company ABC becomes more expensive to buy.

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Question # 15

Company E is a listed company. Its directors are valuing a smaller listed company, Company F, as a possible acquisition.

The two companies operate in the same markets and have the same business risk.

Relevant data on the two companies is as follows:

  

Both companies are wholly equity financed and both pay corporate tax at 30%.

The directors of Company E believe they can "bootstrap" Company F's earnings to improve performance.

Calculate the maximum price that Company E should offer to Company F's shareholders to acquire the company.

 

Give your answer to the nearest $million.

 

A.

3,150

B.

1,890

C.

4,500

D.

2,700

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Question # 16

Company A plans to acquire Company B, an unlisted company which has been in business for 3 years.

It has incurred losses in its first 3 years but is expected to become highly profitable in the near future.

No listed companies in the country operate the same business field as Company B, a unique new high-risk business process.

The future success of the process and hence the future growth rate in earnings and dividends is difficult to determine.

Company A is assessing the validity of using the dividend growth method to value Company B.

 Which THREE of the following are weaknesses of using the dividend growth model to value an unlisted company such as Company HHG?

A.

The company has been unprofitable to date and hence, there is no established dividend payment pattern.

B.

The future projected dividend stream is used as the basis for the valuation.

C.

The future growth rate in earnings and dividends will be difficult to accurately determine. 

D.

The dividend growth model does not take the time value of money into consideration.

E.

The cost of capital will be difficult to estimate. 

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Question # 17

A company is planning a share repurchase programme with the following details:

   • Repurchased shares will be immediately cancelled.

   • The shares will be purchased at a premium to the market share price.

The current market share price is greater than the nominal value of the shares.

 

Which of the following statements about the impact of the share repurchase programme on the company's financial statements is correct? 

A.

The premium to the nominal value would be charged to retained earnings.

B.

The share capital figure would reduce by the nominal value of the shares purchased.

C.

The total value of the equity in its Statement of Financial Position would remain unchanged.

D.

The premium to the market value would be charged to the Income Statement.

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Question # 18

BBA is a wholly owned subsidiary of AAB BBA operates in country B where the currency is the B$.

The following is an extract from BBA's financial statements at 31 December 20X1:

The following Information is relevant:

" The bonds were trading at $110 per $100 on 31 December 20X1. "Operating profit of BBA for the year ended 31 December 20X1 was S15 million

• The P/E ratio is 8

* Corporate income tax rate is 20%.

The tax authorities m country B Implemented thin capitalisation rules based on the level of gearing of the subsidiary, calculated as book value o( debt lo book value of equity The cut-off point for gearing used by the tax authorities for a company to be thinly capitalised is 75%.

Which of the following statements is correct as at 31 December 20X1?

A.

Gearing Is 71.43%. thin capitalisation rules are not breached

B.

Gearing is 250%. thin capitalisation rules are breached

C.

Gearing is 83.33%. thin capitalisation rules are breached

D.

Gearing is 83.33%. thin capitalisation rules are not breached

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Question # 19

An unlisted company operates in a niche market, exploring the west coast of Africa for new oiI reservoirs.

The oil exploration program has been successful in recent years and t now has a substantial amount of oil reserves with a high level of certainty of being recoverable Under financial reporting regulations, oil still in the ground is not recognised as an asset unit is extracted.

The expense of the exploration program has used up all the company’s available cash resources.

The company has denied to list or a stock market and raise finds through an initial public offering to finance its drilling program.

Which of the following valuation methods in the appropriate to use in calculating an initial listing price for this company?

A.

Market capitalisation.

B.

Framings valuation using the ratio of a multinational oil exploration company

C.

Net asset valuation based on book values.

D.

Discounted cash flow valuation

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Question # 20

The directors of a multinational group have decided to sell off a loss-making subsidiary and are considering the following methods of divestment:

1. Trade sale to an external buyer

2. A management buyout (MBO)

The MBO team and the external buyer have both offered the same price to the parent company for the subsidiary.

Which of the following is an advantage to the parent company of opting for a MBO compared to a trade sale as the preferred method of divestment?

A.

Raise the cash more quickly.

B.

Avoid a hostile reaction from key management.

C.

Focus on the core competencies of the business

D.

Retain the know edge of key management.

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Question # 21

A geared and profitable company is evaluating the best method of financing the purchase of new machinery. It is considering either buying the machinery outright, financed by a secured bank borrowingand selling the machinery at the end of a fixed period of time or obtain the machinery under a lease for the same period of time.

Which is the correct discount rate to use when discounting the incremental cash flows of the lease against those of the buy and borrow alternative?

A.

The post-tax cost of the bank borrowing

B.

The company's cost of equity

C.

The company's WACC.

D.

The pre-tax cost of the bank borrowing

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Question # 22

A listed company is financed by debt and equity.

If it increases the proportion of debt in its capital structure it would be in danger of breaching a debt covenant imposed by one of its lenders.

 

The following data is relevant:

  

 

The company now requires $800 million additional funding for a major expansion programme. 

 

Which of the following is the most appropriate as a source of finance for this expansion programme?

A.

Retained earnings

B.

Private placement of a bond

C.

Rights issue

D.

Bank overdraft

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Question # 23

A large, listed company in the food and household goods industry needs to raise $50 million for a period of up to 6 months.

It has an excellent credit rating and there is almost no risk of the company defaulting on the borrowings. The company already has a commercial paper programme in place and has a good relationship with its bank.

 

Which of the following is likely to be the most cost effective method of borrowing the money?

A.

Bank overdraft

B.

6 month term loan

C.

Treasury Bills

D.

Commercial paper

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Question # 24

A listed company plans to raise $350 million to finance a major expansion programme.

The cash flow projections for the programme are subject to considerable variability.

Brief details of the programme have been public knowledge for a few weeks.

The directors are considering two financing options, either a rights issue at a 20% discount to current share price or a long term bond.

 

The following data is relevant:

  

The company's share price has fallen by 5% over the past 3 months compared with a fall in the market of 3% over the same period.

The directors favour the bond option.

However, the Chief Accountant has provided arguments for a rights issue.

 

Which TWO of the following arguments in favour of a right issue are correct?

A.

The issue of bonds might limit the availability of debt finance in the future.

B.

The recent fall in the share price makes a rights issue more attractive to the company.

C.

The rights issue will lead to less pressure on the operating cash flows of the programme.

D.

The WACC will decrease assuming Modigliani and Miller's Theory of Capital Structure without taxes applies.

E.

The administrative costs of a rights issue will be lower.

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Question # 25

Which TIIRCC of the following are most likely to reduce the long term credit rating co a company?

A.

The issue of new shares where the funds raised are invested in a project that has an NPV of nil.

B.

The issue of a new bond where the funds raised are invested in a project that has an NPV of nil.

C.

The issue of new shares where the funds raised are invested in expanding into a new nigh risk market.

D.

Loss of a major customer that contributed 30% of sales revenue.

E.

Disposal of a loss-making division where the funds raised will be used to pay a special dividend to shareholders.

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Question # 26

ZZZ wishes to borrow at a floating rate and has been told that it can use swaps to reduce the effective interest rate it pays. ZZZ can borrow floating at the risk-free rate + 1, and fixed at 10%.

Which of the following companies would be the most appropriate for ZZZ to enter into a swap with?

A.

Company DDA - it can borrow at risk-free rate + 1 Vz and fixed at 10.5%

B.

Company CCA - it can borrow at risk-free rate + Y% and fixed at 9%

C.

Company BBA - it can borrow floating at risk-free rate +VA and fixed at 12%

D.

Company AAB - it can borrow floating at risk-free rate + % and fixed at 9.5%

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Question # 27

The ex div share price of Company A’s shares is $.3.50

An investor in Company A currently holds 2,000 shares.

Company A plans to issue a script divided of 1 new shares for every 10 shares currently held.

After the scrip divided, what will be the total wealth of the shareholder?

Give your answer to the nearest whole $.

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Question # 28

A company proposes to value itself based on the net present value of estimated future cash flows.

 

Relevant data:

   • The cash flow for the next three years is expected to be £100 million each year

   • The cash flow after year 3 will grow at 2% to perpetuity

   • The cost of capital is 12%

The value of the company to the nearest $ million is:

A.

$966 million

B.

$1,260 million

C.

$889 million

D.

$834 million

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Question # 29

Company A plans to acquire Company B in a 1-for-1 share exchange.

Pre-acquisition information is as follows:

 

 

Post-acquisition information is as follows:

  • Annual earnings are expected to increase by $4 million.
  • The P/E multiple of the combined company is expected to be 12 times.

 

If the acquisition proceeds, what is the expected percentage increase in the post acquisition share price of Company A?  

A.

50%

B.

 8%

C.

6%

D.

0%

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Question # 30

A company's annual dividend has grown steadily at an annual rate of 3% for many years. It has a cost of equity of 11%. The share price is presently $64.38.

 

The company is about to announce its latest dividend, which is expected to be $5.00 per share.

 

The Board of Directors is considering an attractive investment opportunity that would have to be funded by reducing the dividend to $4.50 per share. The board expects the project to enable future dividends to grow by 5% every year and the cost of equity to remain unchanged.

 

Calculate the change in share price, assuming that the directors announce their intention to proceed with this investment opportunity.

 

Give your answer to 2 decimal places.

 

 $ ?   

 

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Question # 31

A company is in the process of issuing a 10 year $100 million bond and is considering using an interest rate swap to change the interest profile on some or all of the $100 million new finance.

 

The company has a target fixed versus floating rate debt profile of 1:1. Before issuing the bond its debt profile was as follows:

 

 

 

Which of the following is the most appropriate interest rate swap structure for the company? 

A.

Pay fixed receive floating interest rate swap for $100 million.

B.

Pay fixed receive floating interest rate swap for $50 million.

C.

Receive fixed pay floating interest rate swap for $100 million.

D.

Receive fixed pay floating interest rate swap for $50 million.

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Question # 32

A company currently has a 6.25% fixed rate loan but it wishes to change the interest style of the loan to variable by using an interest rate swap directly with the bank.

 

The bank has quoted the following swap rate:

   • 5.50% - 5.55% in exchange for LIBOR

LIBOR is currently 5%.

 

If the company enters into the swap and LIBOR remains at 5%, what will the company's interest cost be?

A.

5.00%

B.

5.75%

C.

5.70%

D.

6.25%

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Question # 33

The Board of Directors of a small listed company engaged in exploration are currently considering the future dividend policy of the company. Exploration is considered a high-risk business and consequently the company has a low level of debt finance.

 

Forecasts indicate a period of profit fluctuation in the next few years as the company is planning to embark on a major capital investment project. Debt finance is unlikely to be available due to the project's high business risk.

 

Which THREE of the following are practical considerations when determining the company's dividend/retention policy? 

A.

The timing and size of the cash flow requirements for the new investment.

B.

The fluctuating nature of the projected future profits.

C.

The legislation and regulation governing distributable profits.

D.

The dividend policies of mature listed multinational companies in the exploration industry. 

E.

The general level of interest rates and the tax savings on interest costs relating to debt finance.

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Question # 34

A company's gearing is well below its optimal level and therefore it is considering implementing a share re-purchase programme.

This programme will be funded from the proceeds of a planned new long-term bond issue.

Its financial projections show no change to next year's expected earnings.

As a result, the company plans to pay the same total dividend in future years.

 

If the share re-purchase is implemented, which THREE of the following measures are most likely to decrease?

A.

The Weighted Average Cost of Capital

B.

The cost of equity

C.

The interest cover

D.

Next year's dividend per share

E.

The gearing, based on book value (debt ÷ (debt + equity))

F.

The number of shares in issue

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Question # 35

X exports goods to customers in a number of small countries Asia. At present, X invoices customers in X's home currency.

The Sales Director has proposed that X should begin to invoice in the customers currency, and the Treasurers considering the implications of the proposal.

Which TWO of the following statement are correct?

A.

X may be able to sell the receipts forward.

B.

If the proposal is adopted, X will have a lower effective sales price per unit due to exchange rate fluctuations.

C.

X will know advance the amount of home currency it will receive for the export sales.

D.

The overseas customers may have difficulty obtaining X's name currency with which to make the purchases, so the Sales Director’s proposal may increase sales.

E.

The customer will tear the foreign exchange risk and will only buy from X if they are prepared to accept this.

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Question # 36

A company's current profit before interest and taxation is $1.1 million and it is expected to remain constant for the foreseeable future.

 

The company has 4 million shares in issue on which the earnings yield is currently 10%. It also has a $2 million bond in issue with a fixed interest rate of 5%.

 

The corporate income tax rate is 20% and is expected to remain unchanged.

 

Which of the following is the best estimate of the current share price?

A.

$2.75

B.

$2.50

C.

$2.00

D.

$1.10

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Question # 37

Company A is based in Country A where the functional currency is the A$. Currently all sales are to domestic customers in Country A. However, the company is planning to expand internationally by acquiring Company B, a distribution company in Country B, to enable it to sell goods worldwide The functional currency of Country B is the BS

Company A will invoice its international customers in their local currency.

Wage increases in Country B are forecast to be modest, due to high unemployment levels, but overall inflation in Country B is forecast to be significantly higher than in Country A

Which TWO of the following statements about the economic risk of the acquisition of Company B are true?

A.

Financing this acquisition with block denominated in B$ will reduce economic risk.

B.

Economic risk can be eliminated by using forward contracts to convert future cash flows into A$

C.

Higher inflation will increase the project's BS returns, so the economic risk can be ignored

D.

Exporting into a variety of international markets will reduce economic risk.

E.

Using purchasing power parity, AS is forecast to strengthen against B$, so the economic risk can be ignored

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Question # 38

Company M is a listed company in a highly technical service industry.

The directors are considering making a cash offer for the shares in Company Q, an unquoted company in the same industry.

 

Relevant data about Company Q:

   • The company has seen consistent growth in earnings each year since it was founded 10 years ago.

   • It has relatively few non-current assets.

   • Many of the employees are leading experts in their field. A recent exercise suggested that the value of the company's human capital exceeded the value of its tangible assets.

The directors and major shareholders of Company Q have indicated willingness to sell the company.

Before negotiations become too advanced, the directors of Company M are considering the benefits to their company that would follow the acquisition.

 

Which THREE of the following are the most likely benefits of the acquisition to Company M's shareholders?

A.

Access to technical expertise.

B.

Reduction of risk through diversification.

C.

Improved asset backing for borrowing due to the acquisition of intangible assets.

D.

Gain economies of scale.

E.

Improve earnings per share (EPS).

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Question # 39

Company A has made an offer to take over all the shares in Company B on the following terms:

   • For every 20 shares currently held, Company B's shareholders will receive $100 bond with a coupon rate of 3%

   • The bond will be repaid in 10 years' time at its par value of $100.

   • The current yield on 10 year bonds of similar risk is 6%.

What is the effective offer price per share being made to Company B's shareholders?

A.

$6.43

B.

$4.50

C.

$3.89

D.

$6.89

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Question # 40

Which THREE of the following non-financial objectives would be most appropriate for a listed company in the food retailing industry?

A.

Reduce customer complaints

B.

Increase customer service quality

C.

Reduce production time

D.

Improve staff morale

E.

Reduce raw material wastage

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Question # 41

Which THREE of the following long term changes are most likely to increase the credit rating of a company?

A.

An increase in the interest cover ratio.

B.

A decrease in the (Net debt) / (Earnings before interest, tax, depreciation and amortisation) ratio.

C.

An increase in the free cashflow generated from operations.

D.

A decrease in the (Book value of debt) / (Book value of equity) ratio.

E.

A decrease in the dividend cover ratio.

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Question # 42

Formed in 2010, the International Integrated Reporting Council

The primary purpose of the IIRC's framework is to help enable an organisation to communicate which of the following'?

A.

How it creates value in the short medium and long term.

B.

How it minimises the environmental impact of its business processes.

C.

How it contributes positively to the economic wellbeing of the environment in which it operates.

D.

How it ensures that the conflicting net sets of different stakeholder groups are met in an optimal manner.

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Question # 43

A company has just received a hostile bid.  Which of the following response strategies could be considered?

A.

Revalue non-current assets

B.

Poison pill strategy

C.

Change the Articles of Association to amend voting rights

D.

Approach a White Knight 

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Question # 44

Which THREE of the following would be most important if a hospital wishes to review the effectiveness of its services?

A.

The proportion of surgical procedures that are deemed to be successful.

B.

Average waiting times for treatment.

C.

Patient satisfaction ratings.

D.

Staff costs compared to previous years. 

E.

Revenue generated from car park charges. 

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Question # 45

A national rail operating company has made an offer to acquire a smaller competitor.

Which of the following pieces of information would be of most concern to the competition authorities?

A.

After the acquisition, the board proposes to increase prices on some routes not serviced by other rail operators.

B.

After the acquisition, the board proposes to withdraw some of the less profitable services.

C.

The board informed a major institutional shareholder about the proposed acquisition before informing other shareholders.

D.

The acquisition is likely to result in significant redundancies of staff currently working for the smaller rail operator.

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Question # 46

For which THREE of the following risk categories does IFRS 7 require sensitivity analysis? 

A.

Currency risk

B.

Liquidity risk

C.

Interest rate risk

D.

Commodity risk

E.

Credit risk

F.

Supply chain risk

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Question # 47

Company M is a listed company in a highly technical service industry.

The directors are considering making a cash offer for the shares in Company Q, an unquoted company in the same industry.

 

Relevant data about Company Q:

   • The company has seen consistent growth in earnings each year since it was founded 10 years ago.

   • It has relatively few non-current assets.

   • Many of the employees are leading experts in their field. A recent exercise suggested that the value of the company's human capital exceeded the value of its tangible assets.

The directors and major shareholders of Company Q have indicated willingness to sell the company.

Before negotiations become too advanced, the directors of Company M are considering the benefits to their company that would follow the acquisition.

 

Which THREE of the following are the most likely benefits of the acquisition to Company M's shareholders?

A.

Access to technical expertise.

B.

Reduction of risk through diversification.

C.

Improved asset backing for borrowing due to the acquisition of intangible assets.

D.

Gain economies of scale.

E.

Improve earnings per share (EPS).

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Question # 48

The primary objective of a public sector entity is to ensure value for money is generated.

Value for money is defined as performing an activity so as to simultaneously achieve economy, efficiency and effectiveness

Efficiency is defined as:

A.

spending funds so as to achieve the objectives of the entity.

B.

performing activities in the least amount of time possible

C.

obtaining maximum output from minimum inputs

D.

obtaining quality inputs at minimum cost.

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Question # 49

A company has recently announced a scrip issue of 1 new share for every 4 existing shares. The market value of each share price before the announcement was $20.00.

What is the best estimate of the share price after the scrip issue ignoring all other influences on the share price?

A.

$40 00

B.

$25 00

C.

$16 00

D.

$20 00

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Question # 50

ADC is planning to acquire DEF in order to benefit from the expertise of DEF's owner ‘managers Both are Listed companies. ADC is trying to decide whether to offer cash or shares in consideration for DEF's shares.

Which THREE of the following are advantages to ABC of offering shares to acquire CEF?

A.

It shares tie benefits of future growth with the DCT shareholder.

B.

It dilutes ownership in ABC.

C.

It incentivises DEF to continue creating value for the combined group

D.

It results in a tax saving for ABC.

E.

The risk of poor future performance of the acquisition is shared with the DEF company shareholder.

F.

It preserves liquidity

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Question # 51

A company plans to raise $12 million to finance an expansion project using a rights issue.

Relevant data:

• Shares will be offered at a 20% discount to the present market price of $15.00 per share.

• There are currently 2 million shares in issue.

• The project is forecast to yield a positive NPV of $6 million.

What is the yield-adjusted Theoretical Ex-Rights Price following the announcement of the rights issue?

A.

$16.00

B.

$14.00

C.

$9.00

D.

$11.00

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Question # 52

A company's directors plan to increase gearing to come in line with the industry average of 40%. They need to know what the effect will be on the company's WACC.

According to traditional theory of gearing the WACC is most likely to:

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Question # 53

A company's main objective is to achieve an average growth in dividends of 10% a year. 

In the most recent financial year:

  

Sales are expected to grow at 8% a year over the next 5 years. 

Costs are expected to grow at 5% a year over the next 5 years. 

 

What is the minimum dividend payout ratio in 5 years' time that would allow the company to achieve its objective?

A.

21.7%

B.

30.0%

C.

27.5%

D.

22.5%

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Question # 54

Company WWW is identical in all operating and risk characteristics to Company ZZZ. but their capital structures differ. Company WWW and Company ZZZ both pay corporate income tax at 20%

Company WWW has a gearing ratio (debt: equity) of 1:3 Its pre-tax cost of debt is 6%.

Company ZZZ Is all-equity financed. Its cost of equity is 15%

What is the cost of equity tor Company WWW?

A.

17.0%

B.

18.0%

C.

17.4%

D.

17.7%

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Question # 55

Company C is a listed company. It is currently considering the acquisition of Company D. The original founder of Company C currently owns 52% of the shares.

Alternative forms of consideration for Company D being considered are as follows:

• Cash payment, financed by new borrowing

• issue of new shares in Company C

Which of the following is an advantage of a cash offer over a share-for exchange from the viewpoint of the original founder of Company C?

A.

A share for share exchange would result in a significant change in control of Company C whereas a cash offer would not.

B.

A share-for-share exchange would require the approval shareholders in Company C but a cash offer would not.

C.

A share-for-share exchange would require the approval of the Competition Authorities but a cash offer would not.

D.

A cash offer would result in a lower gearing ratio therefore reduce the weighted overage cost of capital whereas a cash offer would not.

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Question # 56

Which of the following statements about IFRS 7 Financial Instruments: Disclosures is true?

A.

IFRS 7 only applies to entities that are designated as financial institutions by a regulatory authority.

B.

IFRS 7 requires disclosures to be given for each separate class of financial instruments.

C.

The main requirement of IFRS 7 is for qualitative disclosures relating to financial instruments and market risks.

D.

IFRS 7 requires sensitivity analysis in relation to credit risk.

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Question # 57

Which of the following statements about the tax impact on debt finance is correct?

A.

Debt instruments issued with fixed and floating charges do not attract tax relief on interest paid.

B.

Preference share dividends attract tax relief in the same way as debenture interest.

C.

Interest on debt is deducted from post-tax profits.

D.

Interest on debt is deducted from pre-tax profits.

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Question # 58

Company A plans to acquire a minority stake in Company B.

The last available share price for Company B was $0.60.  

 

Relevant data about Company B is as follows:

   • A dividend per share of $0.08 has just been paid

   • Dividend growth is expected to be 2% 

   • Earnings growth is expected to be 4%

   • The cost of equity is 15%

   • The weighted average cost of capital is 13%

Using the dividend growth model, what would be the expected change in share price?

A.

$0.03 increase

B.

$0.07 fall

C.

$0.16 increase

D.

$0.14 increase

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Question # 59

The ex div share price of a company's shares is $2.20.

 

An investor in the company currently holds 1,000 shares.

 

The company plans to issue a scrip dividend of 1 new share for every 10 shares currently held.

 

After the scrip dividend, what will be the total wealth of the shareholder?

 

Give your answer to the nearest whole $.

 

 $ ?  .

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Question # 60

A company wishes to raise new finance using a rights issue to invest in a new project offering an IRR of 10% 

 

The following data applies:

   • There are currently 1 million shares in issue at a current market value of $4 each.

   • The terms of the rights issue will be $3.50 for 1 new share for 5 existing shares.

   • The company's WACC is currently 8%.

 What is the yield-adjusted theoretical ex-rights price (TERP)?

 

Give your answer to 2 decimal places.

 

$  ?  

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Question # 61

Listed Company A has prepared a valuation of an unlisted company. Company B. to achieve vertical integration Company A is intending to acquire a controlling interest in the equity of Company B and therefore wants to value only the equity of Company B.

The assistant accountant of Company A has prepared the following valuation of Company B's equity using the dividend valuation model (DVM):

Where:

• S2 million is Company B's most recent dividend

• 5% is Company B's average dividend growth rate over the last 5 years

• 10% is a cost of equity calculated using the capital asset pricing model (CAPM), based on the industry average beta factor

Which THREE of the following are valid criticisms of the valuation of Company B's equity prepared by the assistant accountant?

A.

The DVM calculation should use Company A's cost of equity rather than Company B's cost of equity

B.

It is better to use the present value of earnings rather than present value of dividends to value a controlling interest

C.

The 5% growth rate may not reflect the future growth of Company B.

D.

The beta factor used may not reflect Company B's financial risk.

E.

An unlisted company cannot use the capital asset pricing model to calculate its cost of equity

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Question # 62

A government is currently considering the privatisation of the national airline. The shares are to be offered to the public via a fixed price Initial Public Offering (IPO).

Which THREE of the following statements are correct?

A.

An IPO is normally underwritten

B.

The government will receive significant financial resources from the sale of its shareholding in the national airline.

C.

The rational airline employees will no longer be public sector employees following the completion of the privatisation

D.

The use of a fixed price offer will ensure that the government raises the maximum amount of finance.

E.

The rational airline will receive significant financial resources as a direct result of the shares company shares in the IPO.

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Question # 63

Company C has received an unwelcome takeover bid from Company P.

Company P is approximately twice the size of Company C based on market capitalisation.

Although the two companies have some common business interests, the main aim of the bid is diversification for Company P.

The offer from Company P is a share exchange of 2 shares in Company P for 3 shares in Company C.

There is a cash alternative of $5.50 for each Company C share.

Company C has substantial cash balances which the directors were planning to use to fund an acquisition.

These plans have not been announced to the market.

 

The following share price information is relevant. All prices are in $.

  

 

Which of the following would be the most appropriate action by Company C's directors following receipt of this hostile bid?

A.

Write to shareholders explaining fully why the company's share price is under valued.

B.

Change the Articles of Association to increase the percentage of shareholder votes required to approve a takeover.

C.

Pay a one-off special dividend.

D.

Refer the bid to the country's competition authorities.

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Question # 64

At the last financial year end, 31 December 20X1, a company reported:

 

 

The corporate income tax rate is 30% and the bank borrowings are subject to an interest cover covenant of 4 times. 

The results are presently comfortably within the interest cover covenant as they show interest cover of 8.3 times. The company plans to invest in a new product line which is not expected to affect profit in the first year but will require additional borrowings of $20 million at an annual interest rate of 10%.

What is the likely impact on the existing interest cover covenant?

A.

Interest cover would reduce to 3 times and the covenant would be breached.

B.

Interest cover would reduce to 3 times and the covenant would NOT be breached.

C.

Interest cover would reduce to 5 times and the covenant would be breached.

D.

Interest cover would reduce to 5 times and the covenant would NOT be breached.

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Question # 65

When valuing an unlisted company, a P/E ratio for a similar listed company may be used but adjustments to the P/E ratio may be necessary.

 

Which THREE of the following factors would justify a reduction in the proxy p/e ratio before use? 

A.

The relative lack of marketability of unlisted company shares.

B.

A lower level of scrutiny and regulation for unlisted companies.

C.

Unlisted companies being generally smaller and less established.

D.

Control premium not being included within the proxy p/e ratio used.

E.

The forecast earnings growth being relatively higher in the unlisted company.

F.

A profit item within the unlisted company's latest earnings which will not reoccur.

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Question # 66

A company enters into a floating rate borrowing with interest due every 12 months over the five year life of the borrowing. 

At the same time, the company arranges an interest rate swap to swap the interest profile on the borrowing from floating to fixed rate. 

These transactions are designated as a hedge for hedge accounting purposes under IAS 39 Financial Instruments: Recognition and Measurement.

 

Assuming the hedge is considered to be effective, how would the swap be accounted for 12 months later? 

A.

The swap would be shown at nominal value in the statement of financial position and the change in value posted to other comprehensive income.

B.

The swap would be shown at nominal value in the statement of financial position and the change in value posted to profit or loss.

C.

The swap would be shown at fair value the statement of financial position and the change in value posted to other comprehensive income.

D.

The swap would be shown at fair value the statement of financial position and the change in value posted to profit or loss.

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Question # 67

A company based in Country A with the A$ as its functional currency requires A$500 million 20-year debt finance to finance a long-term investment The company has a high credit rating, but has not previously issued corporate bonds which are listed on the stock exchange Which THREE of the following are advantages of issuing 20 year bonds compared with simply borrowing for a 20 year period?

A.

Larger capital market

B.

Greater availability of debt of 20-year duration

C.

Lower arrangement costs

D.

Less administrative effort to arrange the new finance

E.

Lower interest rate

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Question # 68

The Senior Management Team of ABC, an owner-managed, capital intensive start-up engineering business, is considering the options for its dividend policy. It has so far been a successful business and is expanding quickly Once in place, the Senior Management Team anticipates that its current investment plans will yield returns for many years to come The first agenda item at every meeting currently concerns arranging and funding new equipment and premises.

Which of the following dividend policies is likely to be the most suitable?

A.

Constant growth

B.

Residual policy.

C.

Zero dividend

D.

A constant pay-out ratio

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Question # 69

A company has 6 million shares in issue. Each share has a market value of $4.00.

$9 million is to be raised using a rights issue.

Two directors disagree on the discount to be offered when the new shares are issued.

   • Director A proposes a discount of 25% 

   • Director B proposes a discount of 30%

 

Which THREE of the following statements are most likely to be correct?

A.

The theoretical ex-rights price will be higher under Director B's proposal than under Director A's proposal.

B.

More shares will be issued under Director B's proposal than under Director A's proposal.

C.

The rights issue price will be $3.00 under Director A's proposal.

D.

The terms of the rights issue will be one new share for every two existing shares under Director A's proposal.

E.

Shareholder wealth will be higher under Director A's proposal than under Director B's proposal.

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Question # 70

Which THREE of the following remain unchanged over the life of a 10 year fixed rate bond?

A.

The coupon rate

B.

The yield

C.

The market value

D.

The nominal value

E.

The amount payable on maturity

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Question # 71

Which THREE of the following are likely to be strategic reasons for a horizontal acquisition?

A.

Reduction of risk by building a larger portfolio

B.

Acquisition of an undervalued company

C.

To achieve economies of scale

D.

To secure key parts of the value chain

E.

Reduction of competition

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Question # 72

The Board of Directors of a listed company wish to estimate a reasonable valuation of the entire share capital of the company in the event of a takeover bid.

The company's current profit before taxation is $4.0 million.

The rate of corporate tax is 25%.

The average P/E multiple of listed companies in the same industry is 8 times current earnings.

The P/E multiple of recent takeovers in the same industry have ranged from 9 times to 10 times current earnings.

The average P/E multiple of the top 100 companies on the stock market is 15 times current earnings. 

 

Advise the Board of Directors which of the following is a reasonable estimate of a range of values of the entire share capital in the event of a bid being made for the whole company?

A.

Minimum = $36 million, and maximum = $40 million.

B.

Minimum = $27 million, and maximum = $30 million.

C.

Minimum = $32 million, and maximum = $60 million.

D.

Minimum = $24 million, and maximum = $45 million.

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Question # 73

Company A is planning to acquire Company B.

 

Company A's managers think they can improve the performance of Company B to the extent that its own P/E ratio should be applied to Company B's earnings.

 

Relevant Data:

  

 

What is the expected synergy if the acquisition goes ahead? 

 

Give your answer to the nearest $ million.

  

$ ?  million

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Question # 74

An unlisted software development business is to be sold by its founders to a private equity house following the initial development of the software. The business has not yet made a profit but significantprofits are expected for the next three years with only negligible profits thereafter. The business owns the freehold of the property from which it operates. However, it is the industry norm to lease property.

Which THREE of the following are limitations to the validity of using the Calculated Intangible Value (CIV) method for this business?

A.

The business owns the freehold property from which it operates.

B.

Significant profits are forecast for the next three years with only negligible profits thereafter.

C.

The business has not yet made a profit.

D.

The CIV method cannot be applied to an unlisted company.

E.

The intellectual property representing the software development has not been included in the accounts.

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Question # 75

Company A needs to raise AS500 mi lion to invest in a new project and is considering using a pub ic issue of bonds to finance the investment.

Which THREE of the following statements-relating to this bond issue are true?

A.

A company must be listed before it can issue bones.

B.

The largest issuer of bond i3 the government.

C.

Purchasing bonds in the capital markets enables entities to borrow large amounts of finance.

D.

The bond market is unregulated making it easier to raise finance

E.

Bonds issues in the corporate debt market are underwritten.

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Question # 76

KKL is a listed sports clothing company with three separate business units. KKL is seeking to sell TT’, one of these business units

TTP cwns a new. brand of trail running shoes that have Droved hugely popular with lone distance runners. The management team of TTP are frustrated by the constraints imposes b/ KKL in managing tie brand and developing. the bus ness and they believe that TTF has huge growth potential.

The management team of TTP have approached KKL with a proposal to purchase 1~P through a management layout (MDO). KKL has accepted this proposal as TTP has not proved to be a good fit' with the rest of the business and has agreed on the selling price.

Which THREE of the following factors a-e mast Likely to affect the success of the MBO?

A.

The motivation of the TTP management team to invest in future growth.

B.

Searing sufficient. funding for the MBO.

C.

The constraints imposed by KKL managing TTF's brand.

D.

The ability of the TTF management team to take over the head office functions successfully.

E.

The ability the TTP management team to develop the brand and achieve the expected growth.

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Question # 77

A company wishes to raise additional debt finance and is assessing the impact this will have on key ratios. 

The following data currently applies:

   • Profit before interest and tax for the current year is $500,000

   • Long term debt of $300,000 at a fixed interest rate of 5%

   • 250,000 shares in issue with a share price of $8

The company plans to borrow an additional $200,000 on the first day of the year to invest in new project which will improve annual profit before interest and tax by $24,000.

The additional debt would carry an interest rate of 3%.

Assume the number of shares in issue remain constant but the share price will increase to $8.50 after the investment.

The rate of corporate income tax is 30%.

 

After the investment, which of the following statements is correct?

A.

Interest cover will fall; P/E ratio will fall.

B.

Interest cover will fall; P/E ratio will rise.

C.

Interest cover will rise; P/E ratio will rise.

D.

Interest cover will rise; P/E ratio will fall.

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Question # 78

A company intends to sell one of its business units. Company W, by a management buyout (MBO). A selling price of S200 million has been agreed.

The managers are discussing with a bank and a venture capital company (VCC) the following financing proposal.

The VCC requires a minimum return on its equity investment In the MBO of 35% a year on a compound basis over 5 years. What is the minimum total equity value of Company W in 5 years time in order to meet the VCC's required return? Give your answer to one decimal place.

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Question # 79

H Company has a fixed rate load at 10.0%, but wishes to swap to variable. It can borrow at LIBOR 8%.

The bank is currently quoting swap rates of 3.1% (bid) and 3.5% (ask).

What net rate will HHH Company pay if it enters into the swap?

A.

Risk-free rate +6.5%

B.

Risk-free rate +8%

C.

Risk-free rate +6.9%

D.

Risk-free rate +3.1%

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Question # 80

A company is wholly equity funded. It has the following relevant data:

   • Dividend just paid $4 million

   • Dividend growth rate is constant at 5%

   • The risk free rate is 4%

   • The market premium is 7%

   • The company's equity beta factor is 1.2

Calculate the value of the company using the Dividend Growth Model.

Give your answer in $ million to 2 decimal places.

$ ?  million

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Question # 81

F Co. is a large private company, the founder holds 60% of the company's share capital and her 2 children each hold 20% of the share capital.

The company requires a large amount of long-term finance to pursue expansion opportunities, the finance is required within the next 3 months. The family has agreed that an Initial Public Offering (IPO) should not be pursued at this time, because it would take up to 12 months to arrange.

The existing shareholders are currently considering raising the required finance from an established Venture Capitalist in the form of debt and equity. The Venture Capitalist has agreed to provide the required finance provided it can earn a return on investment of 25% per year. In addition, the Venture Capitalist requires 60% of the equity capital, a directorship in the company and a veto on all expenditure of a capital or revenue nature above a specified limit.

From the perspective of the family, which of the following are advantages of raising the required finance from the Venture Capitalist?

Select all that apply.

A.

The cost of the finance under the Venture Capital investment.

B.

The changes in shareholding as a result of the Venture Capital investment.

C.

The veto on expenditure above a specified level of a revenue or capital nature.

D.

The speed with which the finance can be obtained.

E.

The experience of the Venture Capitalist with growing businesses.

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Question # 82

VVV has a floating rate loan that it wishes to replace with a fixed rate. The cost of the existing loan is the risk-free rate + 3%. VW would have to pay a fixed rate of 7% on a fixed rate loan VVVs bank has found a potential counterparty for a swap arrangement.

The counterparty wishes to raise a variable rate loan It would pay the risk-free rate +1 % on a variable rate loan and 8% on a fixed rate.

The bank will require 10% of the savings from the swap and WV and the counterparty will share the remaining saving equally.

Calculate VWs effective rate of interest from this swap arrangement.

A.

VVV would pay 5.2%

B.

VVV would pay 5.65%

C.

VVV would pay the risk-free rate + 1 %

D.

VVV would pay 5.5%

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Question # 83

Which THREE of the following statements are correct in respect of the issuance of debt securities.

A.

A bond issuer must appoint at least one market-maker to ensure that there is a liquid market in its traded bonds.

B.

The redemption yield on a corporate bond can be determined by calculating the internal rate of return based on the cash flows arising during the duration of the bond.

C.

Investors in traded bonds have an ownership (or equity stake) in the company which issued the bonds.

D.

A corporate entity coming to the bond market for the first time will find it easier to issue corporate bonds than to arrange a conventional term loan.

E.

Governments are the most frequent issuers of bonds and the proceeds are used to fund government expenditure or service the national debt.

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Question # 84

Company A is identical in all operating and risk characteristics to Company B, but their capital structures differ.

Company B is all-equity financed. Its cost of equity is 17%.

Company A has a gearing ratio (debt:equity) of 1:2. Its pre-tax cost of debt is 7%. 

Company A and Company B both pay corporate income tax at 30%.

What is the cost of equity for Company A?

A.

20.5%

B.

21.2%

C.

22.0%

D.

17.0%

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Question # 85

NNN is a company financed by both equity and debt. The directors of NNN wish to calculate a valuation of the company's equity and at a recent board meeting discussed various methods of business valuation.

Which THREE of the following are appropriate methods for the directors of NNN to use in this instance?

A.

Total earnings multiplied by a suitable price-earnings ratio.

B.

Cash flow to all investors discounted at WACC less the value of debt.

C.

Cash flow to all investors discounted at WACC.

D.

Cash flow to equity discounted at the cost of equity less the value of debt.

E.

Cash flow to equity discounted at the cost of equity.

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Question # 86

A financial services company reported the following results in its most recent accounting period:

The company has an objective to achieve 5% earnings growth each year. The directors are discussing how this objective might be achieved next year.

Revenues have been flat over the last couple of years as the company has faced difficult trading conditions. Revenue is expected to stay constant in the coming year and so the directors are focussing efforts on reducing costs in an attempt to achieve earnings growth next year.

Interest costs will not change because the company's borrowings are subject to a fixed rate of interest.

What operating profit margin will the company have to achieve next year in order to just achieve its 5% earnings growth objective'?

A.

55.8%

B.

60.0%

C.

58.0%

D.

58.5%

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Question # 87

Company A is planning to acquire Company B. Both companies are listed and are of similar size based on market capitalisation No approach has yet been made to Company B's shareholders as the directors of Company A are undecided about the most suitable method of financing the offer Two methods are under consideration a share exchange or a cash offer financed by debt.

Company A currently has a gearing ratio (debt to debt plus equity) of 30% based on market values. The average gearing ratio (debt to debt plus equity) for the industry is 50% Although no formal offer has been made there have been market rumours of the proposed bid. which is seen as favorable to Company A. As a consequence. Company As share price has risen over the past few weeks while Company B's share price has fallen.

Which THREE of the following statements are most likely to be correct?

A.

Based on current share price movements, a share exchange would mean Company A has to issue fewer shares to acquire Company B than it would have done a few weeks ago

B.

Company B's shareholders will be able to participate in the future growth of the combined business if it is a share exchange

C.

The method of finance chosen will not affect the post-acquisition earning per share of the combined business

D.

Company A's weighted average cost of capital will fall if financing is with debt

E.

Company A's gearing will increase following a share exchange.

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Question # 88

A company's Board of Directors is assessing the likely impact of financing future new projects using either equity or debt.

The directors are uncertain of the effects on key variables.

 

Which THREE of the following statements are true?

A.

The choice between using either equity or debt will have no impact on the amount of corporate income tax payable.

B.

Retained earnings has no cost, and is therefore the cheapest form of equity finance.

C.

Debt finance is always preferable to equity finance.

D.

Debt finance will increase the cost of equity.

E.

Equity finance will reduce the overall financial risk.

F.

Equity finance will increase pressure to pay a higher total future dividend.

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Question # 89

An unlisted company is attempting to value its equity using the dividend valuation model.

Relevant information is as follows:

   • A dividend of $500,000 has just been paid.

   • Dividend growth of 8% is expected for the foreseeable future.

   • Earnings growth of 6% is expected for the foreseeable future.

   • The cost of equity of a proxy listed company is 15%.

   • The risk premium required due to the company being unlisted is 3%.

The calculation that has been performed is as follows:

Equity value = $540,000 / (0.18 - 0.08) = $5,400,000

What is the fault with the calculation that has been performed?

A.

The cost of equity used in the calculation should have been 12% (15% subtract 3%).

B.

The dividend cashflow used should have been $500,000 rather than $540,000.

C.

The dividend growth rate is unsuitable given that earning growth is lower than dividend growth.

D.

The cost of equity used in the calculation should have been 15%; no adjustment was necessary.

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Question # 90

A company s about to announce a new project that has a positive NPV.

If the market is semi-strong form efficient, which of the following statements is most Likely to be true?

The value of the company will.

A.

only change to incorporate historical information.

B.

Increase by the NPV of the project once the information has been announced

C.

already include the value of the project.

D.

increase only on completion of the project.

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Question # 91

Company A is planning to acquire Company B by means of a cash offer. The directors of Company B are prepared to recommend acceptance if a bid price can be agreed. Estimates of the net present value (NPV) of future cash flows for the two companies and the combined group post acquisition have been prepared by Company A’s accountant. There are as follows:

What is the maximum price that Company A should offer for the shares in Company B?

Give your answer to the nearest $ million

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Question # 92

The directors of the following four entities have been discussing dividend policy:

Which of these four entities is most likely to have a residual dividend policy?

A.

A

B.

B

C.

C

D.

D

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Question # 93

A company based in Country D, whose currency is the D$, has an objective of maintaining an operating profit margin of at least 10% each year. 

 

Relevant data:

   • The company makes sales to Country E whose currency is the E$. It also makes sales to Country F whose currency is the F$. 

   • All purchases are from Country G whose currency is the G$.

   • The settlement of all transactions is in the currency of the customer or supplier.

 

Which of the following changes would be most likely to help the company achieve its objective?

A.

The D$ strengthens against the E$ over time. 

B.

The F$ weakens against the D$ over time.

C.

The D$ strengthens against the G$ over time.

D.

The D$ weakens against the G$ over time.

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Question # 94

On 1 January:

• Company ABB has a value of $55 million

• Company BBA has a value of $25 million

• Both companies are wholly equity financed

Company ABB plans to take over Company BBA by means of a share exchange Following the acquisition the post-tax cashflow of Company ABB for the foreseeable future is estimated to be $10 million each year The post-acquisition cost of equity is expected to be 10%

What is the best estimate of the value of the synergy that would arise from the acquisition?

A.

$125 million

B.

$30 million

C.

$75 million

D.

$20 million

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Question # 95

Company A is a large well-established listed entertainment company and Company B is a small unlisted company specializing in providing online media streaming.

Company A has a gearing ratio of 60% (using book values) and interest cover of 2.

Company A is considering making an offer for Company B, either a cash offer financial by raising additional debt finance or a share-for-share exchange.

Which of the following is most likely to occur if Company A offers a share-for exchange rather than offering cash finance by raising debt?

A.

Earnings per share would be higher.

B.

Divided per share would be higher.

C.

Gearing would be lower.

D.

There would be no dilution f of control.

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Question # 96

A company is financed by debt and equity and pays corporate income tax at 20%.  

Its main objective is the maximisation of shareholder wealth.

It needs to raise $200 million to undertake a project with a positive NPV of $10 million.

 

The company is considering three options:

   • A rights issue.

   • A bond issue.

   • A combination of both at the current debt to equity ratio.

Estimations of the market values of debt and equity both before and after the adoption of the project have been calculated, based upon Modigliani and Miller's capital theory with tax, and are shown below:

 

 

 

Under Modigliani and Miller's capital theory with tax, what is the increase in shareholder wealth?

A.

$210 million if financed by equity

B.

$50 million if financed by debt

C.

$160 million if financed by a mixture of debt and equity

D.

$10 million irrespective of finance

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Question # 97

A company’s statement of financial position includes non-current assets which are leased, the tax regime follows the accounting treatment.

Which cash flows should be discounted when evaluating the cost of lease finance?

A.

Lease payments, implied interested and straight-line accounting deprediation.

B.

Lease payments and straight-line accounting depreciation.

C.

Lease payments and implied interest.

D.

Lease payments, tax relief on implied interest and tax relief on straight-line account depreciation.

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Question # 98

A listed company in a high growth industry, where innovation is a key driver of success has always operated a residual dividend policy, resulting in volatility in dividends due to periodic significant investments in research and development.

 

The company has recently come under pressure from some investors to change its dividend policy so that shareholders receive a consistent growing dividend. In addition, they suggested that the company should use more debt finance. 

 If the suggested change is made to the financial policies, which THREE of the following statements are true?

A.

It may give a signal to the market that the company is entering a period of stable growth. 

B.

There may be a change to the shareholder profile due to 'the clientele effect'. 

C.

The directors will not have to take shareholder dividend preferences into consideration in future. 

D.

Retained earnings have a lower cost than debt finance.

E.

The company's financial risk will increase due to its increased use of debt finance.

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Question # 99

Company A is a listed company that produces pottery goods which it sells throughout Europe. The pottery is then delivered to a network of self employed artists who are contracted to paint the pottery in their own homes. Finished goods are distributed by network of sales agents.The directors of Company A are now considering acquiring one or more smaller companies by means of vertical integration to improve profit margins.

Advise the Board of Company A which of the following acquisitions is most likely to achieve the stated aim of vertical integration?

A.

A company in a similar market to Company A.

B.

A pottery factory in the Middle East.

C.

A company that produces accessories.

D.

A listed international logistics firm.

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Question # 100

A company has in a 5% corporate bond in issue on which there are two loan covenants.

   • Interest cover must not fall below 3 times

   • Retained earnings for the year must not fall below $3.5 million

The Company has 200 million shares in issue.

The most recent dividend per share was $0.04.

The Company intends increasing dividends by 10% next year.

 

Financial projections for next year are as follows:

 

Advise the Board of Directors which of the following will be the status of compliance with the loan covenants next year?

A.

The company will be in compliance with both covenants.

B.

The company will be in breach of both covenants.

C.

The company will breach the covenant in respect of retained earnings only.

D.

The company will be in breach of the covenant in respect of interest cover only.

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Question # 101

A project requires an initial outlay of $2 million which can be financed with either a bank loan or finance lease.

The company will be responsible for annual maintenance under either option.

 

The tax regime is:

   • Tax depreciation allowances can be claimed on purchased assets.

   • If leased using a finance lease, tax relief can be claimed on the interest element of the lease payments and also on the accounting depreciation charge.

The trainee management accountant has begun evaluating the lease versus buy decision and has produced the following data.  He is not confident that all this information is relevant to this decision.

  

 

Using only the relevant data, which of the following is correct?

A.

The bank loan is $30,000 MORE expensive than the finance lease.

B.

The bank loan is $20,000 LESS expensive than the finance lease.

C.

The bank loan is $70,000 LESS expensive than the finance lease.

D.

The bank loan is $120,000 LESS expensive than the finance lease.

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Question # 102

Providers of debt finance often insist on covenants being entered into when providing debt finance for companies.

Agreement and adherence to the specific covenants is often a condition of the loan provided by the lender.

 

Which THREE of the following statements are true in respect of covenants?

A.

Covenants are entered into to penalise the company.  

B.

Covenants are entered into to give the lender added protection on the loan extended to the company.

C.

Covenants are entered into to impose financial discipline on the company.

D.

Covenants enable the lender to demand immediate repayment or to renegotiate terms if it is breached. 

E.

Covenants are entered into to eliminate the tax liability of the company.

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Question # 103

Company A is proposing a rights issue to finance a new investment. Its current debt to equity ratio is 10%.

 

Which TWO of the following statements are true?

A.

The issue price has to be at least 20% below the pre-rights share price.

B.

The issue price of new shares should be set to guarantee the full take up of shares offered.

C.

The actual ex-rights price may be higher than the theoretical ex-rights price due to the value created from the project.

D.

Company A's current low gearing ratio may require a rights issue rather than a debt issue to finance the new project.

E.

According to Modigliani and Miller's Theory of Capital Structure with tax, the rights issue will result in a lower cost of equity for Company A.

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Question # 104

A company generates operating profit of $17.2 million, and incurs finance costs of $5.7 million.

 

It plans to increase interest cover to a multiple of 5-to-1 by raising funds from shareholders to repay some existing debt. The pre-tax cost of debt is fixed at 5%, and the refinancing will not affect this.

 

Assuming no change in operating profit, what amount must be raised from shareholders?

 

Give your answer in $ millions to the nearest one decimal place.

 

$ ?   

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Question # 105

The financial assistant of a geared company has prepared the following calculation of the company's equity value:

Useful information;

• Tax rate - 20%

• Cost of equity = 12%

• Weighted average cost of capital (WACC)« 10%

" Debt finance of the company comprises a $6 million 7% undated bond trading at par Valuation workings.

Which of the following errors has been made by the financial assistant?

A.

A two year discount factor is incorrect in the perpetuity calculation.

B.

Discounting at WACC is incorrect.

C.

The 20% tax charge is missing.

D.

A deduction for debt value is missing.

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Question # 106

Select the category of risk for each of the descriptions below:

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Question # 107

A company needs to raise $20 million to finance a project.

It has decided on a rights issue at a discount of 20% to its current market share price.

There are currently 20 million shares in issue with a nominal value of $1 and a market price of $5 per share.

 

Calculate the terms of the rights issue.

A.

1 new share for every 4 existing shares

B.

1 new share for every 20 existing shares

C.

1 new share for every 5 existing shares

D.

1 new share for every 25 existing shares

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Question # 108

A large, listed company in the food and household goods industry needs to raise $50 million for a period of up to 6 months.

It has an excellent credit rating and there is almost no risk of the company defaulting on the borrowings. The company already has a commercial paper programme in place and has a good relationship with its bank.

 

Which of the following is likely to be the most cost effective method of borrowing the money?

A.

Bank overdraft

B.

6 month term loan

C.

Treasury Bills

D.

Commercial paper

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Question # 109

A company based in the USA has a substantial fixed rate borrowing at an interest rate of 3.5% and wishes to swap a part of this to a floating rate to take advantage of reducing interest rates Its bank has quoted swap rates of 3 4%-3 5% against 12-month USD risk-free rate.

What is the overall interest rate achieved by the company under this borrowing plus swap combination?

A.

12-month USD risk-free rate minus 0 1 % (where 0 1 % = the fixed rate of 3.6% minus the swap rate of 3 4%)

B.

12-month USD risk-free rate

C.

12-month USD risk-free rate plus 0 1% (where 0.1 % = the fixed rate of 3.5% minus the swap rate of 3 4%) D. Unchanged at 3.60% as this is the same as the swap rate

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Question # 110

A company's current earnings before interest and taxation are $5 million.

These are expected to remain constant for the forseeable future.

The company has 10 million shares in issue which currently trade at $3.60.

It also has a $10 million long term floating rate loan.

The current interest rate on this loan is 5%.

The company pays tax at 20%.

The company expects interest rates to increase next year to 6% and it's Price/Earnings (P/E) ratio to move to 9.5 times by the end of next year.

 

What percentage reduction in the share price will occur by the end of next year if the interest rate increase and the P/E movement both occur?

A.

Reduction of 7%

B.

Reduction of 5%

C.

Reduction of 1%

D.

Reduction of 0%

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Question # 111

A company is based in Country Y whose functional currency is Y$. It has an investment in Country Z whose functional currency is Z$.

This year the company expects to generate Z$ 10 million profit after tax.

Tax Regime:

   • Corporate income tax rate in country Y is 50%

   • Corporate income tax rate in country Z is 20%

   • Full double tax relief is available

Assume an exchange rate of Y$ 1 = Z$ 5.

 

What is the expected profit after tax in Y$ if the Z$ profit is remitted to Country Y?

A.

Y$ 1.25 million

B.

Y$ 1.00 million

C.

Y$ 31.25 million

D.

Y$ 4.00 million

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Question # 112

Companies L. M N and O:

• are based in a country that uses the RS as its currency

• have an objective to grow operating profit year on year

• have the same total levels of revenue and cost

• trade with companies or individuals in the United States. All import and export trade with companies or individuals in the United States is priced in US$.

Typical import/export trade for each company in a year are as follows:

Which company's growth objective is most sensitive to a movement in the USS / RS exchange rate?

A.

Company L

B.

Company M

C.

Company N

D.

Company O

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Question # 113

A company has two divisions.

A is the manufacturing division and supplies only to B, the retail division.

The Board of Directors has been approached by another company to acquire Division B as part of their retail expansion programme.

Division A will continue to supply to Division B as a retail customer as well as source and supply to other retail customers.

Which is the main risk faced by the company based on the above proposal?

A.

Suppliers to Division A will be opposed to the divestment and stop the acquisition.

B.

The level of quality of the product will not be maintained by the acquired company.

C.

Division A's going concern is highly dependent on its relationship with Division B as a retail customer.

D.

Shareholders will be opposed to the divestment and stop the acquisition.

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Question # 114

A company's Board of Directors wishes to determine a range of values for its equity.

The following information is available:

Estimated net asset values (total asset less total liabilities including borrowings):

   • Net book value = $20 million

   • Net realisable value = $25 million

   • Free cash flows to equity = $3.5 million each year indefinitely, post-tax.

   • Cost of equity = 10%

   • Weighted Average Cost of Capital = 7%

Advise the Board on reasonable minimum and maximum values for the equity.

A.

Minimum value  = $25.0 million, and maximum value = $35.0 million

B.

Minimum value = $25.0 million, and maximum value = $50.0 million

C.

Minimum value = $20.0 million, and maximum value = $35.0 million

D.

Minimum value = $20.0 million, and maximum value = $50.0 million

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Question # 115

RST wishes to raise at least $40 million of new equity by issuing up to 10 million new equity shares at a minimum price of $3.00 under an offer for sale by tender. It receives the following tender offers:

What is the maximum amount that RST can raise by this share issue?

(Give your answer to the nearest $ million).

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Question # 116

G purchased a put option that grants the right to cap the interest on a loan at 10.0%. Simultaneously, G sold a call option that grants the holder the benefits of any decrease if interest rates fall below 8.5%.

Which THREE possible explanations would be consistent with G's behavior?

A.

G is willing to risk the loss of savings from a fall in interest rates if that offsets the cost of limiting the cost of rises.

B.

G's strategy is to ensure that its interest rates lie between 8.5% and 10.0%.

C.

G is concerned that interest rates may rise above 10.0%.

D.

G is concerned that interest rates may rise above 8.5%.

E.

G is concerned that interest rates may fall below 10%.

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Question # 117

A company needs to raise $40 million to finance a project. It has decided on a right issue at a discount of 20% to its current market share price.

There are currently 20 million shares in issue with a nominal value of $1 and a market price of $10.00 per share.

A.

1 new share for every 25 existing shares

B.

1 new share for every 4 existing shares

C.

1 new share for every 5 existing shares

D.

1 new share for every 20 existing shares

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Question # 118

A listed company is planning to raise $21.6 million to finance a new project with a positive net present value of $5 million.  The finance is to be raised via a rights issue at a 10% discount to the current share price.  There are currently 100 million shares in issue, trading at $2.00 each.

 

Taking the new project into account,  what would the theoretical ex-rights price be?

 

Give your answer to two decimal places.

 

$ ?  

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Question # 119

Which THREE of the following are benefits of integrated reporting?

A.

Improve the quality of information available to the providers of financial capital.

B.

Promote an understanding of the interdependencies of capitals. 

C.

Reduce the amount of work that is required to produce the report and accounts.

D.

Improve short term decision making.

E.

Support integrated decision-making. 

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Question # 120

An analyst has valued a company using the free cash flow valuation model.

 

The analyst used the following data in determining the value:

   • Estimated free cashflow in 1 year's time = $100,000

   • Estimated growth in free cashflow after the first year = 5% each year indefinitely

   • Appropriate cost of equity = 10% 

The result produced by the analyst was as follows:

Value of equity = $100,000 (1+0.05)/0.10 = $1,050,000

The analyst made a number of errors in determining the value. 

 

By how much has the analyst undervalued the company?

A.

$950,000

B.

$2,000,000

C.

$2,100,000

D.

$1,050,000

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Question # 121

DFG is a successful company and its shares are listed on a recognised stock exchange. The company's gearing ratio is currently in line with the industry average and the directors of DFG do not want to increase the company's financial risk. The company does not carry a large cash balance and its shareholders are not expected to be willing to support a rights issue at this time

LMB is a small services company owned and managed by a small board of directors who are going to retire within the next year

DFG wishes to purchase LMB and has approached LMB's owners, who are broadly open to the proposal, to discuss the bid and the consideration to be offered by DFG. LMB's owners explain to DFG that they are also keen to defer any tax liabilities they would be subject to on receipt of the consideration.

Based on the information provided, which of the following types of consideration would be most suitable to finance the acquisition?

A.

Loan stock in DFG for the current value of LMB

B.

DFG shares for the current value of LMB

C.

Cash for the current value of LMB

D.

DFG shares for a percentage of the current value of LMB plus a three year earn-out arrangement

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Question # 122

Company A is unlisted and all-equity financed. It is trying to estimate its cost of equity. 

 

The following information relates to another company, Company B, which operates in the same industry as Company A and has similar business risk:

 

Equity beta = 1.6      

Debt:equity ratio  40:60

The rate of corporate income tax is 20%.

The expected premium on the market portfolio is 7% and the risk-free rate is 5%.

What is the estimated cost of equity for Company A?

 

Give your answer to one decimal place.

 

 ? % 

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Question # 123

A company's Board of Directors is considering raising a long-term bank loan incorporating a number of covenants.

The Board members are unsure what loan covenants involve. 

 

Which THREE of the following statements regarding loan covenants are true?

A.

A positive loan covenant would require the company to undertake specific actions.

B.

A loan covenant has no contractually binding obligations.

C.

A restrictive covenant prohibits the company from conducting certain actions without the approval of the lending institution.

D.

A covenant gives the financial institution the right but not the obligation to convert debt into equity in a case of non-compliance. 

E.

A financial covenant usually requires the company to adhere to specific financial conditions or targets.

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Question # 124

A company generates and distributes electricity and gas to households and businesses.

Forecast results for the next financial year are as follows:

The Industry Regulator has announced a new price cap of $2.00 per Kilowatt.

The company expects this to cause consumption to rise by 15% but costs would remained unaltered.

The price cap is expected to cause the company's net profit to fall to:

A.

$8.75 million profit

B.

$164.00 million profit

C.

$43.00 million profit

D.

$126.50 million loss

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Question # 125

A company plans to raise $12 million to finance an expansion project using a rights issue.

Relevant data:

• Shares will be offered at a 20% discount to the present market price of $15.00 per share.

• There are currently 2 million shares in issue.

• The project is forecast to yield a positive NPV of $6 million.

What is the yield-adjusted Theoretical Ex-Rights Price following the announcement of the rights issue?

A.

$16.00

B.

$14.00

C.

$9.00

D.

$11.00

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Question # 126

A company has a loss-making division that it has decided to divest in order to raise cash for other parts of the business.

The losses stem from a combination of a lack of capital investment and poor divisional management.

The loss-making division would require new capital investment of at least $20 million in order to replace worn out and obsolete assets.

If this investment was carried out, the present value of the future cashflows, excluding the investment expenditure, is expected to be $15 million.

 

Which TWO of the following divestment methods are most likely to be suitable for the company?

A.

Management buy-out

B.

De-merger

C.

Trade sale

D.

Liquidation

E.

Spin-off

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Question # 127

A company has in a 5% corporate bond in issue on which there are two loan covenants.

   • Interest cover must not fall below 3 times

   • Retained earnings for the year must not fall below $3.5 million

The Company has 200 million shares in issue.

The most recent dividend per share was $0.04.

The Company intends increasing dividends by 10% next year.

 

Financial projections for next year are as follows:

 

Advise the Board of Directors which of the following will be the status of compliance with the loan covenants next year?

A.

The company will be in compliance with both covenants.

B.

The company will be in breach of both covenants.

C.

The company will breach the covenant in respect of retained earnings only.

D.

The company will be in breach of the covenant in respect of interest cover only.

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Question # 128

A company plans to raise S15 million to finance an expansion project using a rights issue Relevant data

• Shares will be offered at a 20% discount to the present market price of S12 50 per share

• There are currently 3 million shares in issue

• The project is forecast to yield a positive NPV of $9 million

What is the yield-adjusted Theoretical Ex-Rights Price following the announcement of the rights issue?

A.

$11.67

B.

$11 25

C.

$9.50

D.

$13.67

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Question # 129

Company Z has identified four potential acquisition targets: companies A, B, C and D.

Company Z has a current equity market value of $590 million.

The price it would have to pay for the equity of each company is as follows:

Only one of the target companies can be acquired and the consideration will be paid in cash.

The following estimations of the new combined value of Company Z have been prepared for each acquisition before deduction of the cash consideration:

Ignoring any premium paid on acquisition, which acquisition should the directors pursue?

A.

A

B.

B

C.

C

D.

D

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Question # 130

Which of the following statements best describes a residual dividend policy?

A.

Dividends are paid only after the on-going operational needs of the business have been met.

B.

Dividends are paid only if no further positive NPV projects are available.

C.

All surplus earnings are invested back into the business.

D.

Dividends are paid at a constant rate.

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