Financial Management Past Papers PDF

Financial Management 必做选择题宝典 Part A Financial management function 22 Part B Financial Management Environment 19 Part C Working capital management 35 Part D Investment appraisal 24 Part E Business...

Financial Management 必做选择题宝典 Part A Financial management function 22 Part B Financial Management Environment 19 Part C Working capital management 35 Part D Investment appraisal 24 Part E Business Finance 61 Part F Business valuation 42 Part G Risk Management 42 2021/12 真题 9 2020/12 真题 30 2021/12 官方 mock 30 314 2022/03/07 第二次修订 Part A Financial management function The nature and purpose of financial management 1.[2016/09 Q10] Which of the following would you expect to be the responsibility of financial management? A. Producing annual accounts B. Producing monthly management accounts C. Advising on investment in non-current assets D. Deciding pay rates for staff 2.[ 2016/12 Q9] Green Co, a listed company, had the following share prices during the year ended 31 December 20X5: At start of 20X5 $2.5 Highest price in the year $3.15 Lowest price in the year $2.4 At the end of 20X5 $3.00 During the year, Green Co paid a total dividend of $0.15 per share What is the total shareholder return for 20X5? A.26% B.22% C.32% D.36% 3.[2014/12 Q1] TKQ Co has just paid a dividend of 21 cents per share and its share price one year ago was $3·10 per share. The total shareholder return for the year was 19·7%. What is the current share price? A. $3·50 B. $3·71 C. $3·31 D. $3·35 4.[2014/12 Q12] Which of the following statements concerning profit are correct? 1 Accounting profit is not the same as economic profit 2 Profit takes account of risk 3 Accounting profit can be manipulated by managers A. 1 and 3 only B. 1 and 2 only C. 2 and 3 only D. 1, 2 and 3 5.[2018/12] Last year ABC Co made profits before tax of $2,628,000. Tax amounted to $788,000. ABC Co's share capital was $2,000,000 (2,000,000 shares of $1) and $4,000,000 6% preference shares. What was the earnings per share (EPS) for the year? A. 31c B. 80c C. 92c D. 119c 6.[2019/06 Q2] Increasing which TWO of the following would be associated with the financial objective of shareholder wealth maximisation? A. Share price B. Dividend payment C. Reported profit D. Earnings per share E. Weighted average cost of capital Encouraging shareholder wealth maximization 7.[2014/12 Q11] Which of the following is LEAST likely to fall within financial management? A. The dividend payment to shareholders is increased B. Funds are raised to finance an investment project C. Surplus assets are sold off D. Non-executive directors are appointed to the remuneration committee 8.[ 2015/06 Q8] Which of the following statements are correct? 1. Share option schemes always reward good performance by managers 2. Performance-related pay can encourage dysfunctional behaviour 3. Value for money as an objective in not-for-profit organisations requires the pursuit of economy, efficiency and effectiveness A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 Measuring the achievement of financial objectives 9.[ 2016/09 Q14] Peach Co’s latest results are as follows: $000 Profit before interest and taxation 2,500 Profit before taxation 2,250 Profit after tax 1,400 In addition, extracts from its latest statement of financial position are as follows: $000 Equity 10,000 Non-current liabilities 2,500 What is Peach Co’s return on capital employed (ROCE)? A. 14% B. 18% C. 20% D. 25% 10.[2016/09 Q30] Which of the following statements about Fence Co directors' remuneration package is/are correct? 1. Directors' remuneration should be determined by senior executive directors 2. Introducing a share option scheme would help bring directors' objectives in line with shareholders' objectives 3. Linking financial rewards to a target return on capital employed will encourage short-term profitability and discourage capital investment A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 11.[ 2015/06 Q4] Which of the following statements is correct? A. One of the problems with maximising accounting profit as a financial objective is that accounting profit can be manipulated B. A target for a minimum level of dividend cover is a target for a minimum dividend payout ratio C. The welfare of employees is a financial objective D. One reason shareholders are interested in earnings per share is that accounting profit takes account of risk 12.[ 2014/12 Q3] Which of the following statements are correct? 1. Maximising market share is an example of a financial objective 2. Shareholder wealth maximisation is the primary financial objective for a company listed on a stock exchange 3. Financial objectives should be quantitative so that their achievement can be measured A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 Not for profit organisations 13. [2016/12 Q14] Which of the following statements is true? A. Value for money is usually taken to mean economy, efficiency and engagement B. Cum dividend means the buyer of the share is not entitled to receive the dividend shortly to be paid C. The dividend payout ratio compares the dividend per share with the market price  per share D. The agency problem means that shareholder wealth is not being maximised 额外补充 14. In relation to the financial management of a company, which of the following provides the best definition of a firm’s primary financial objective? A. To achieve long-term growth in earnings B. To maximise the level of annual dividends C. To maximise the wealth of its ordinary shareholder D. To maximise the level of annual profits 15. Which of the following are the THREE key areas covered by financial management decisions? A. Investment B. Cash flow C. Finance D. Dividend 16. Which of the following is an example of an internal stakeholder in a firm? A. Company directors B. Customers C. Suppliers D. Finance providers E. Local communities 17. Which of the following is not characteristics of a carefully designed remuneration package? A. Balance short-term and long-term performance related pay B. Matching of managers' time horizons to shareholders’ time horizons C. Possibility of manipulation by managers D. Encouragement for managers to adopt the same attitudes to risk as shareholders 18. Which of the following are typical criticisms of executive share option schemes (ESOPs)? 1. When directors exercise their options, they tend to sell the shares almost immediately to cash in on their profits 2. A general increase in share prices can lead to directors being rewarded for poor performance 3. If the share price falls when options have been awarded, and the options have no value, they cannot act as an incentive 4. Directors may distort reported profits to protect the share price and the value of their share options A. 1 only B. 1 and 3 only C. 2 and 3 only D. 1, 2, 3 and 4 19.[2015/06 Q3]The following information relates to a company: Year 0 1 2 3 Earnings per share (cents) 30·0 31·8 33·9 35·7 Dividends per share (cents) 13·0 13·2 13·3 15·0 Share price at start of year ($) 1·95 1·98 2·01 2·25 Which of the following statements is correct? A. The dividend payout ratio is greater than 40% in every year in the period B. Mean growth in dividends per share over the period is 4% C. Total shareholder return for the third year is 26% D. Mean growth in earnings per share over the period is 6% per year 20.[2017/09] Geeh Co paid an interim dividend of $0.06 per ordinary share on 31 October 20X6 and declared a final dividend of $0.08 on 31 December 20X6. The ordinary shares in Geeh Co are trading at a cum-div price of $1.83. What is the dividend yield (to one decimal place)? _______% 21.[ 2015/06 Q5] Which of the following statements is NOT correct? A. Return on capital employed can be defined as profit before interest and tax divided by the sum of shareholders’ funds and prior charge capital B. Return on capital employed is the product of net profit margin and net asset turnover C. Dividend yield can be defined as dividend per share divided by the ex dividend share price D. Return on equity can be defined as profit before interest and tax divided by shareholders’ funds 22.[ 2018/12 Q2] ARP is a charity providing transport for people visiting hospitals. Which of the following performance measures would BEST fit with efficiency in a value for money review? A. Percentage of members who re-use the service B. Cost per journey to hospital C. A comparison of actual operating expenses against the budget D. Number of communities served Part B Financial Management Environment Economic environment for business 1.[Pilot paper Q15] Governments have a number of economic targets as part of their monetary policy. Which of the following targets relate predominantly to monetary policy? 1. Increasing tax revenue 2. Controlling the growth in the size of the money supply 3. Reducing public expenditure 4. Keeping interest rates low A. 1 only B. 1 and 3 C. 2 and 4 only D. 2, 3 and 4 2.[ 2016/09 Q16] Which of the following government actions would lead to an increase in aggregate demand? (1) Increasing taxation and keeping government expenditure the same (2) Decreasing taxation and increasing government expenditure (3) Decreasing money supply (4) Decreasing interest rates A. 1 only B. 1 and 3 C. 2 and 4 only D. 2, 3 and 4 3.[2014/12] Governments have a number of economic targets as part of their fiscal policy. Which of the following government actions relate predominantly to fiscal policy? 1. Decreasing interest rates in order to stimulate consumer spending 2. Reducing taxation while maintaining public spending 3. Using official foreign currency reserves to buy the domestic currency 4. Borrowing money from the capital markets and spending it on public works A. 1 only B. 1 and 3 C. 2 and 4 only D. 2, 3 and 4 4.[ 2015/06] Which of the following statements is/are correct? 1. Monetary policy seeks to influence aggregate demand by increasing or decreasing the money raised through taxation 2. When governments adopt a floating exchange rate system, the exchange rate is an equilibrium between demand and supply in the foreign exchange market 3. Fiscal policy seeks to influence the economy and economic growth by increasing or decreasing interest rates A. 2 only B. 1 and 2 only C. 1 and 3 only D. 1, 2 and 3 5.[ 2014/12] Which of the following is/are usually seen as forms of market failure where regulation may be a solution? 1 Imperfect competition 2 Social costs or externalities 3 Imperfect information A. 1 only B. 1 and 2 only C. 2 and 3 only D. 1, 2 and 3 6.[2016/12] Which of the following statements relating to competition policy is/are correct? 1. Scale economies are an advantage of monopoly and oligopoly 2. Social costs or externalities are an example of economic inefficiency arising from market failure 3. Monopoly is discouraged because it can lead to inefficiency and excessive profits A. 1 and 2 only B. 3 only C. 2 and 3 only D. 1, 2 and 3 7.[2016/12 Q12] Indicate, by clicking on the relevant boxes, whether the following statements are true or false? A prospective merger would need to result in a company having a market share greater than 80% before it can be TRUE FALSE described as a monopoly A government may intervene to weaken its country's exchange rate in order to eliminate a balance of payments TRUE FALSE deficit A relatively high rate of domestic inflation will lead to a strengthening currency TRUE FALSE Government fiscal policy involves the management of interest rates TRUE FALSE Financial markets and institutions 8.[ 2015/06] Which of the following are financial intermediaries? (1) Venture capital organisation (2) Pension fund (3) Merchant bank A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 9.[2016/12] Which TWO of the following activities are carried out by a financial intermediary? A. Transforming interest rates B. Transforming foreign exchange C. Transforming maturity D. Transforming risk 10.[Pilot Q13] Which of the following is/are usually seen as benefits of financial intermediation? 1. Interest rate fixing 2. Risk pooling 3. Maturity transformation A. 1 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 11.[ 2014/12 Q2] Which of the following statements is/are correct? 1. Securitisation is the conversion of illiquid assets into marketable securities 2. The reverse yield gap refers to equity yields being higher than debt yields 3. Disintermediation arises where borrowers deal directly with lending individuals A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 12.[2016/09 Q2] Which of the following financial instruments will NOT be traded on a money market? A. Commercial paper B. Convertible loan notes C. Treasury bills D. Certificates of deposit 13.[2017/06] Which of the following statements relating to money markets is/are true? 1.Lending is for periods greater than one year. 2.Lending is securitised. 3.Borrowers are mainly small companies. A. 1 and 2 B. 2 and 3 C. 1 and 3 D. 2 only 14.[ 2019/06 Q1] A listed company is to enter into a sale and repurchase agreement on the money market. The company has agreed to sell $10m of treasury bills for $9.6m and will buy them back in 50 days' time for $9.65m. Assume a 365-day year. What is the implicit annual interest rate in this transaction (to the nearest 0.01%)? 15.[2021/06 Q2] Which of the following statements relating to money market instruments is/are correct? (1) Discounted instruments do not pay coupon interest (2) Commercial paper is secured on assets of the issuing company A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 16.[2015/06] Which of the following statements are correct? 1. A certificate of deposit is an example of a money market instrument 2. Money market deposits are short-term loans between organisations such as banks 3. Treasury bills are bought and sold on a discount basis A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 17.[Pilot Q6] Which of the following statements are features of money market instruments? 1. A negotiable security can be sold before maturity 2. The yield on commercial paper is usually lower than that on treasury bills 3. Discount instruments trade at less than face value A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 18.[2016/12] Max Co is a large multinational company which expects to have a $10m cash deficit in one month's time. The deficit is expected to last no more than two months. Max Co wishes to resolve its short-term liquidity problem by issuing an appropriate instrument on the money market. Which of the following instruments should Max Co issue? A. Commercial paper B. Interest rate futures C. Corporate loan notes D. Treasury bills 19.[2017/09] What role would the money market have in a letter of credit arrangement? A. Initial arrangement of the letter of credit B. Acceptance of the letter of credit C. Issuing of a banker's acceptance D. Discounting the banker's acceptance Part C Working capital management Working capital 1. A Co sells some inventory on credit for a profit. How will this transaction affect the current ratio and the quick ratio immediately after the transaction? Ratio Increase Decrease Current ratio Quick ratio 2. A company sells inventory for cash to a customer, at a selling price which is below the cost of the inventory items. How will this transaction affect the current ratio and the quick ratio immediately after the transaction? Ratio Increase Decrease Current ratio Quick ratio 3. [2014/06] The current assets and current liabilities of CSZ Co at the end of March 2014 are as follows: $000 $000 Inventory 5,700 Trade receivables 6,575 12,275 Trade payables 2,137 Overdraft 4,682 6,819 Net current assets 5,456 For the year to end of March 2014, CSZ Co had sales of $40 million, all on credit, while cost of sales was $26 million. Required: Calculate the working capital cycle (cash collection cycle) of CSZ Co at the end of March 2014. 4. The following information has been calculated for A Co: Trade receivables collection period 10 weeks Raw material inventory turnover period 6 weeks Work in progress inventory turnover period 2 weeks Finished goods inventory turnover period 6 weeks Trade payables payment period 7 weeks What is the length of the working capital cycle? weeks 5.The following has been calculated for BB Co: Receivables days: 50 Inventory turnover: 10 times per annum Payables days: 45 Assuming a 360-day year What is the length of the cash operating cycle? 6. [2014/12 Q13] A company has annual credit sales of $27 million and related cost of sales of $15 million. The company has the following targets for the next year: Trade receivables days 50 days Inventory days 60 days Trade payables 45 days Assume there are 360 days in the year. What is the net investment in working capital required for the next year? A. $8,125,000 B. $4,375,000 C. $2,875,000 D. $6,375,000 7. [2016/12] Mile Co is looking to change its working capital policy to match the rest of the industry. The following results are expected for the coming year: $’000 Revenue 20,500 Cost of sales (12,800) Gross profit 7,700 The working capital ratios of Mile Co, compared with the industry, are as follows: Mile Co Industry Receivable days 50 42 Inventory days 45 35 Payable days 40 35 Assume there are 365 days in each year. If Mile Co matches its working capital cycle with the industry, what will be the decrease in its net working capital? A. $624,600 B. $730,100 C. $835,600 D. $975,300 8.[ 2019/12 Q1] For the coming year, a company has budgeted sales of $2m per month, 80% of which will be on credit. It expects its accounts receivable payment period to be three months. Forecast average inventory and average accounts payable for the coming year are $10m and $4m respectively. What is the company's working capital requirement for the coming year (to one decimal place)? 9. A business has a current ratio of 2. Current assets consist of inventory of $10m and current liabilities of $15m. The company gives on average 36.5 days credit to its customers. Assuming a 365-day year Required Calculate the annual credit sales. 10.[ 2017/03] A company's typical inventory holding period at any time is: Raw materials : 15 days Work in progress: 35 days Finished goods: 40 days Annual cost of goods sold as per the financial statements is $100m of which the raw materials purchases account for 50% of the total. The company has implemented plans to reduce the level of inventory held, the effects of which are expected to be as follows: 1. Raw material holding time to be reduced by 5 days 2. Production time to be reduced by 4 days 3. Finished goods holding time to be reduced by 5 days. Assuming a 365-day year, what will be the reduction in inventory held? 11.[2018/06] Which TWO of the following statements about overcapitalisation and Overtrading are correct? 1. Overtrading often arises from a rapid increase in sales revenue 2. Overcapitalisation results in a relatively low current ratio 3. Overtrading may results in a relatively high accounts payable turnover period 4. Overcapitalisation is the result of too much short-term capital Managing inventory 12.[ 2020/03] The inventory ordering policy of ZAR Co is to order 100,000 units when the inventory level falls to 20,000 units. The cost of placing and processing an order is $200, while the cost of holding inventory is $0.50 per unit per year. Orders are received one week after being placed with the supplier. The production requirement for the next year (50 weeks) is 600,000 units. What is the cost of ZAR Co's inventory ordering policy? 13.[ 2016/12 Q1] Which of the following is an advantage of implementing just-in-time inventory management? A. Quality control costs will be eliminated B. Monthly finance costs incurred in holding inventory will be kept constant C. The frequency of raw materials deliveries is reduced D. The amount of obsolete inventory will be minimised 14.Which of the following is an aim of a Just in Time system of inventory control? A. Increase in capital tied up in inventory B. Creation of an inflexible production process C. Elimination of all activities performed that do not add value D. Lowering of inventory ordering costs 15. Which of the following would be LEAST likely to arise from the introduction of a just-in-time inventory ordering system? A. Lower inventory holding costs B. Less risk of inventory shortages C. More frequent deliveries D. Increased dependence on suppliers Managing receivables 16.[ 2015/06 Q16] Which of the following statements is/are correct? 1. Factoring with recourse provides insurance against bad debts 2. The expertise of a factor can increase the efficiency of trade receivables management for a company A. 2 only B. 1 only C. Neither 1 nor 2 D. 1 and 2 17. Which of the following services may be provided by a debt factor? 1. Bad debt insurance 2. Advancement of credit 3. Receivables ledger management 4. Management of debt collection processes A. 1, 2 and 4 only B. 1 and 4 only C. 1, 2 and 3 only D. 1, 2, 3 and 4 18. Which of the following is LEAST likely to be used in the management of foreign accounts receivable? A. Letters of credit B. Bills of exchange C. Invoice discounting D. Commercial paper 19. D Co decides to offer a 2% early settlement discount that half of all customers take up. They pay in 1 month instead of the usual 2. D Co pays 10% per annum for its overdraft facility. What impact will this have? Cash operating cycle Reported profits A. Reduce Increase B. Unaffected Increase C. Reduce Reduce D. Unaffected Reduce Managing trade payables 20.[2016/12 Q15] Swap Co is due to receive goods costing $2,500. The terms of trade state that payment must be received within three months. However, a discount of 1.5% will be given for payment within one month. Which of the following is the annual percentage cost of ignoring the discount and paying within three months? A. 6.23% B. 9.34% C. 6.14% D. 9.49% 21. Generally, increasing payables days suggests advantage is being taken of available credit but there are risks involved. Which of the following is unlikely to be one of the risks involved in increasing payables days? A. Customer bargaining power increasing B. Losing supplier goodwill C. Losing prompt payment discounts D. Suppliers increasing the price to compensate 22. Which of the following is NOT a potential hidden cost of increasing credit taken from suppliers? A. Damage to goodwill B. Early settlement discounts lost C. Business disruption D. Increased risk of bad debts The management of cash 23. Although cash needs to be invested to earn returns, businesses need to keep a certain amount readily available. Which THREE of the following are reasons for holding cash? A. Movement motive B. Transactions motive C. Precautionary motive D. Investment motive 24. Thrifty Pic's cash budget highlights a short-term surplus in the near future. Which of the following actions would be appropriate to make use of the surplus? A. Pay suppliers earlier to take advantage of any prompt payment discounts B. Buy back the company’s shares C. Increase payables by delaying payment to suppliers D. Invest in a long-term deposit bank account 25.[2015/06 Q15] A company needs $150,000 each year for regular payments. Converting the company’s short-term investments into cash to meet these regular payments incurs a fixed cost of $400 per transaction. These short-term investments pay interest of 5% per year, while the company earns interest of only 1% per year on cash deposits. According to the Baumol Model, what is the optimum amount of short-term investments to convert into cash in each transaction? A. $38,730 B. $48,990 C. $54,772 D. $63,246 26.[2017 单选题] 甲公司采用存货模式确定最佳现金持有量，在现金需求量保 持不变的情况下，当有价证券转换为现金的交易费用从每次 100 元下降至 50 元、 有价证券投资报酬率从 4%上涨至 8%时，甲公司现金管理应采取的措施是（ ）。 A.最佳现金持有量保持不变 B.将最佳现金持有量降低 50% C.将最佳现金持有量提高 50% D.将最佳现金持有量提高 100% 27. The treasury department in TB Co has calculated, using the Miller-Orr model, that the lowest cash balance they should have is $1m, and the highest is $10m. If the cash balance goes above $10m they transfer the cash into money market securities. Are the following true or false? True False When the balance reaches $10m they would buy $6m of securities When the cash balance falls to $1m they will sell $3m of securities If the variance of daily cash flows increases the spread between upper and lower limit will be increased. 28. JP Co has budgeted that sales will be $300,100 in January 20X2, $501,500 in February, $150,000 in March and $320,500 in April. Half of sales will be credit sales. 80% of receivables are expected to pay in the month after sale, 15% in the second month after sale, while the remaining 5% are expected to be bad debts. Receivables who pay in the month after sale can claim a 4% early settlement discount. What level of sales receipts should be shown in the cash budget for March 20X2 (to the nearest $)? 29. A company is preparing its cash flow forecast for the next financial period. Which THREE of the following items should be included in the calculations? A. A corporation tax payment B. A dividend receipt from a short term investment C. The receipt of funding for the purchase of a new vehicle D. A bad debt written off Working capital finance strategies 30.[2019/03 Q2] Which TWO of the following are correct descriptions of net working capital? A. Current assets – current liabilities B. Inventory days + accounts receivable days – accounts payable days C. Current assets / current liabilities D. The long term capital invested in net current assets 31.[2016/09 Q5]Crag Co has sales of $200m per year and the gross profit margin is 40%. Finished goods inventory days vary throughout the year within the following range: Maximum Minimum Inventory (days) 120 90 All purchases and sales are made on a cash basis and no inventory of raw materials or work in progress is carried. Crag Co intends to finance permanent current assets with equity and fluctuating current assets with its overdraft. In relation to finished goods inventory and assuming a 360-day year, how much finance will be needed from the overdraft? A $10m B $17m C $30m D $40m 32.[ 2016/09 Q7] Pop Co is switching from using mainly long-term fixed rate finance to fund its working capital to using mainly short-term variable rate finance. Which of the following statements about the change in Pop Co’s working capital financing policy is true? A. Finance costs will increase B. Re-financing risk will increase C. Interest rate risk will decrease D. Overcapitalisation risk will decrease 33.[2020/12 Q2]Which of the following is/are true? (1) A conservative working capital investment policy implies a higher proportion of permanent current assets to fluctuating current assets (2) Long-term finance is generally cheaper than short-term finance A. 1 only is correct B. 2 only is correct C. 1 and 2 are correct D. 1 and 2 are incorrect 34.[2021/06 Q3]Two companies, Acacia and Birch, have the following average levels of working capital: Working capital level ($m) Acacia Birch Maximum 10 12 Minimum 6 9 Acacia's working capital is financed with $4m of long-term debt and Birch's working capital is financed with $9m of long-term debt. The balance of finance is from short-term sources. Identify, by clicking on the relevant boxes in the table, which type of working capital funding strategy each company is employing. Acacia’s working capital funding Aggressive Matching Conservative strategy Birch’s working capital funding Aggressive Matching Conservative strategy 35. Which statement best reflects an aggressive working capital finance policy? A. More short-term finance is used because it is cheaper although it is risky. B. Investors are forced to accept lower rates of return. C. More long-term finance is used as it is less risky. D. Inventory levels are reduced. Part D investment Appraisal Investment decision 1. Which stage is missing or in the wrong order from the investment decision making process below? 1. Origination of ideas 2. Financial analysis 3. Implementation A. Project screening should follow after stage 1 B. Project screening should follow after stage 2 C. Raising finance should be before stage 1 D. Implementation should follow stage 1 2.[2019/03] Q1A project has average estimated cash flows of $3,000 per year with an initial investment of $9,000. Depreciation is straight-line with no residual value and the project has a five-year life span. The company has a target return on capital employed (ROCE) of 15% and a target payback period of 2.5 years. ROCE is based on initial investment. Under which investment appraisal method(s), using the company's targets, will the project be accepted? (1) ROCE (2) Payback basis A 1 only B 2 only C Both 1 and 2 D Neither 1 nor 2 3. EE Co is considering investing in a new 40-year project which will require an initial investment of $50,000 (with zero scrap value) and has a payback period of 20 years. The 40 year project has consistent cash flows each year. What is the return on capital employed (using the average investment method)? A. 2.5% B. 10% C. 7.5% D. 5% [2016/09 Q26-Q30] The following information relates to an investment project which being evaluated by the directors of Fence Co, a listed company. The initial investment, payable at the start of the first year of operation ,is $3.9 million. Year 1 2 3 4 Net operating cash flow ($000) 1,200 1,500 1,600 1,580 Scrap value($000) 100 The directors believe that the investment project will increase shareholder wealth if it achieves a return on capital employed greater than 15%. As a matter of policy, the directors require all investment projects to be evaluated using both the payback and return on capital employed methods. Shareholders have recently criticized the directors for using these investment appraisal methods, claiming that Fence CO ought to be using the academically-preferred net present value method. The directors have a remuneration package which includes a financial reward for achieving an annual return on capital employed greater than 15%. The remuneration package does not include a share option scheme. 4.What is the payback period of the investment project? A. 2·75 years B. 1·50 years C. 2·65 years D. 1·55 years 5.Based on the average investment method, what is the return on capital employed of the investment project? A. 13·3% B. 26·0% C. 52·0% D. 73·5% 6.Which of the following statements about investment appraisal methods is correct? A. The return on capital employed method considers the time value of money B. Return on capital employed must be greater than the cost of equity if a project is to be accepted C. Riskier projects should be evaluated with longer payback periods D. Payback period ignores the timing of cash flows within the payback period 7.Which of the following statements about Fence Co is/are correct? 1. Managerial reward schemes of listed companies should encourage the achievement of stakeholder objectives 2. Requiring investment projects to be evaluated with return on capital employed is an example of dysfunctional behaviour encouraged by performance-related pay 3. Fence Co has an agency problem as the directors are not acting to maximise the wealth of shareholders A. 1 and 2 only B. 1 only C. 2 and 3 only D. 1, 2 and 3 8.Which of the following statements about Fence Co directors' remuneration package is/are correct? 1. Directors' remuneration should be determined by senior executive directors 2. Introducing a share option scheme would help bring directors' objectives in line  with shareholders' objectives 3. Linking financial rewards to a target return on capital employed will encourage short-term profitability and discourage capital investment A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 9. An accountant is paid $30,000 per annum and spends two weeks one month working on appraising project Alpha. Why should the accountant NOT charge half of his month’s salary to the project? A. Because his salary cannot be apportioned B. Because his salary is not incremental C. Because his salary is not a cash flow D. Because his salary is an opportunity cost 10. SW Co has a barrel of chemicals in its warehouse that it purchased for a project a while ago at a cost of $1,000. It would cost $400 for a professional disposal company to collect the barrel and dispose of it safely. However, the chemicals could be used in a potential project which is currently being assessed. What is the relevant cost of using the chemicals in a new project proposal? A. $1,000 cost B. $400 benefit C. $400 cost D. Zero 11.A new project being considered by BLW Co would require 1,000 hours of skilled labour. The current workforce is already fully employed but more workers can be hired in at a cost of $20 per hour. The current workers are paid $15 per hour on a project that earns a contribution of $10 per hour. What is the relevant cost of labour to be included in the project appraisal? A. $10,000 B. $15,000 C. $20,000 D. $25,000 12. LW Co has a half empty factory on which it pays $5,000 pa rent. If it takes on a new project, it will have to move to a new bigger factory costing $17,000 pa and it could rent the old factory out for $3,000 pa until the end of the current lease. What is the rental cost to be included in the project appraisal? A. $14,000 B. $17,000 C. $9,000 D. $19,000 D2 DCF methods 13.[2015/06 Q13] A company is evaluating an investment project with the following forecast cash flows: Year 0 1 2 3 4 Cash flow($m) (6.5) 2.4 3.1 2.1 1.8 Using discount rates of 15% and 20%, what is the internal rate of return of the investment project? A. 15·8% B. 17·2% C. 17·8% D. 19·4% 14.[ 2020/12 Q1] A company is appraising a three-year project which requires an initial outlay on 1 January 20X4 of $30,000. The project is expected to give the following cash inflows on 31 December of each year: 20X4 $10,000 20X5 $20,000 20X6 $25,000 All of the above cash flows are before taking account of specific annual inflation of 5% per year. The real cost of capital is 4% and the nominal cost of capital is 14%. Using a nominal approach and the discount tables provided, what is the NPV of the project on 1 January 20X4 (to the nearest dollar)? Project appraisal and risk [Ex - 2014/12 Q7] An investment project has a cost of $12,000, payable at the start of the first year of operation. The possible future cash flows arising from the investment project have the following present values and associated probabilities: PV of PV of Year 1 cash flow ($) Probability Year 2 cash flow ($) Probability 16,000 0·15 20,000 0·75 12,000 0·60 (2,000) 0·25 (4,000) 0·25 15.What is the expected value of the net present value of the investment project? A. $11,850 B. $28,700 C. $11,100 D. $76,300 16.[Ex - 2015/06 Q6]Which of the following statements are correct? 1. The sensitivity of a project variable can be calculated by dividing the project net present value by the present value of the cash flows relating to that project  variable 2. The expected net present value is the value expected to occur if an investment project with several possible outcomes is undertaken once 3. The discounted payback period is the time taken for the cumulative net present value to change from negative to positive A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 [2016/12 Q26-30] Link Co has been prevented by the competition authorities from buying a competitor, Twist Co, on the basis that this prevents a monopoly position arising. Link Co has therefore decided to expand existing business operations instead and as a result the finance director has prepared the following evaluation of a proposed investment project for the company:(in $000) Present value of sales revenue 6,657 Present value of variable costs (2,777) Present value of contribution 3,880 Present value of fixed costs (1,569) Present value of operating cash flow 2,311 Initial capital investment (1,800) Net present value 511 The project life is expected to be four years and the finance director has used a discount rate of 10% in the evaluation. The investment project has no scrap value. The finance director is considering financing the investment project by a new issue of debt. 17.What is the change in sales volume which will make the NPV zero? A. 7·7% B. 13·2% C. 18·4% D. 22·1% 18.Which of the following statements relating to sensitivity analysis is/are correct? 1. Although critical factors may be identified, the management of Link Co may have no control over them 2. A weakness of sensitivity analysis is that it ignores interdependency between project variables 3. Sensitivity analysis can be used by Link Co to assess the risk of an investment project A. 1 and 2 only B. 1 only C. 2 and 3 only D. 1, 2 and 3 19. Using the average investment method and assuming operating cash flows of $729,000 per year, what is the return on capital employed of the investment project? A. 16% B. 28% C. 31% D. 64% 20.Which of the following statements relating to debt finance is correct? A. Link Co can issue long-term debt in the euro currency markets B. The interest rate which Link Co pays on its new issue of debt will depend on its weighted average cost of capital C. A new issue of loan notes by Link Co will take place in the primary market D. Link Co will not be able to issue new debt without offering non-current assets as security 21. Which of the following statements relating to competition policy is/are correct? 1. Scale economies are an advantage of monopoly and oligopoly 2. Social costs or externalities are an example of economic inefficiency arising from market failure 3. Monopoly is discouraged because it can lead to inefficiency and excessive profits A. 1 and 2 only B. 3 only C. 2 and 3 only D. 1, 2 and 3 Specific investment decisions 22.Which TWO of the following are typically benefits of a shorter replacement cycle? A. Higher scrap value B. Better company image and efficiency C. Lower annual depreciation D. Less time to benefit from owning the asset 23. Which of the following are potential ways of attempting to deal with a capital constraint? 1. Lease 2. Joint venture 3. Delay one or more of the projects A. 1 and 3 only B. 2 and 3 only C. 1 and 2 only D. 1, 2 and 3 24.[ Ex 2014/12 Q6] Which of the following statements is correct? A. Tax allowable depreciation is a relevant cash flow when evaluating borrowing to buy compared to leasing as a financing choice B. Asset replacement decisions require relevant cash flows to be discounted by the after-tax cost of debt C. If capital is rationed, divisible investment projects can be ranked by the profitability index when determining the optimum investment schedule D. Government restrictions on bank lending are associated with soft capital rationing Part E Business Finance Sources of finance 1. Businesses often use short-term loans or overdrafts or both as a source of finance. Which of the following is a benefit, to the borrower, of a short-term loan as opposed to an overdraft? A. Flexible repayment schedule B. Only charged for the amount drawn down C. Easy to arrange D. Lower interest rates 2. Compared to ordinary secured loan notes, which of the following statements is true when considering convertible secured loan notes? A. Likely to be more expensive to service because of their equity component B. Likely to be less expensive to service because of their equity component C. Likely to be more expensive to service because converting to equity requires the holders to make additional payments D. Likely to be less expensive to service because they must rank after ordinary secured loan stock 3. In relation to preference shares as a source of capital for a company, fill in the gaps below to complete the sentence. Preference shares are a form of......capital which carry......risk than ordinary shares. Choose from the following: equity loan lower higher 4. [Ex 2016/12 Q3] Frost Co is planning a 1 for 4 rights issue with an issue price at a 10% discount to the current share price. The EPS is currently $0.50 and the shares of Frost Co are trading on a price/earnings ratio of 20 times. The market capitalisation of the company is $50m. What is the theoretical ex rights price per share (to two decimal places)? 5.[Ex 2016/09 Q15] Drumlin Co has $5m of $0·50 nominal value ordinary shares in issue. It recently announced a 1 for 4 rights issue at $6 per share. Its share price on the announcement of the rights issue was $8 per share. What is the theoretical value of a right per existing share? A $1·60 B $0·40 C $0·50 D $1·50 6.[ Ex - 2020/12 Q3] Simon Co is planning a 1 for 4 rights issue. The value of rights has been calculated as $0.40 per existing share. Simon Co's market price is currently $7.00 per share. What is the theoretical ex rights price (TERP) per share and the rights issue price per share? Islamic finance 7.[2019/06 Q20] The company plans to expand existing business by acquiring a new factory at a cost of $20m. Tulip Co is seeking additional finance and is considering using Islamic finance and, in particular, would require a form which would be similar to equity financing. Regarding Tulip Co’s interest in Islamic finance, which of the following statements is/are correct? 1. Murabaha could be used to meet Tulip Co’s financing needs 2. Mudaraba involves an investing partner and a managing or working partner A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 8. Which of the following describes a sukuk? A. A bond in Islamic finance where the lender owns the underlying asset and shares in the risks and rewards of ownership. B. Equity in Islamic finance where profits are shared according to a pre agreed contract – dividends are not paid as such. C. Trade credit in Islamic finance where a pre agreed mark up is agreed in advance for the convenience of paying later. D. A lease in Islamic finance where the lessor retains ownership and the risk and rewards of ownership of the underlying asset. Finance for SME 9. Which of the following are handicaps that young SMEs face in accessing funds? 1. Uncertainty and risk for lenders 2. Financial statements are not sufficiently detailed 3. Shares cannot be placed privately 10. The following statements relate to small and medium sized enterprises (SMEs). 1. SMEs are restricted in sources of new equity 2. A potential source of financing for SMEs is venture capital. 11. Private individuals or groups of individuals can invest directly into a small business. What is this known as? A. Reverse factoring B. Supply chain finance C. Venture capital D. Business angel financing 12.[2016/12 Q5] Select the correct term to complete the below sentence. Small and medium-sized entities (SME) have restricted access to capital markets. The difference between the finance required to operate an SME and the amount obtained is known as the: A. Forecasted gap B. Maturity gap C. Funding gap D. Asset gap 13.[ Ex - 2020/07 Q2]Small and medium sized entities (SMEs) often face a funding gap problem. Indicate, whether the following statements about SMEs are TRUE or FALSE, by selecting the correct answer next to the relevant statement. SMEs will often experience a funding gap, due to them being seen as a higher risk investment than a TRUE FALSE larger company Founding shareholders of an SME will often have to sacrifice limited liability in order to obtain bank TRUE FALSE finance A lack of suitable, sufficient, non-current assets TRUE FALSE increases the funding gap problem for an SME 14. The following statements relate to small and medium sized enterprises (SMEs). 1. Medium term loans are harder to obtain than longer term loans for SMEs. 2. SMEs are prone to funding gaps. Are the statements true or false? A. Statement 1 is true and statement 2 is false B. Statement 2 is true and statement 1 is false C. Both statements are true D. Both statements are false 15. The following statements relate to supply chain finance (SCF). 1. SCF is considered to be financial debt. 2. SCF allows an SME to raise finance at a lower interest rate than would normally be available to it. Are the statements true or false? A. Statement 1 is true and statement 2 is false B. Statement 2 is true and statement 1 is false C. Both statements are true D. Both statements are false Dividend policy 16. Which of the below best describes the signalling effect of dividend policy/announcements? A. It indicates future dividend patterns. B. A dividend that is different from investor expectations highlights information about the business to the investors. C. It flags reported financial results to follow. D. It indicates poor cash flow health. 17. Three companies (Sun Co, Moon Co and Nite Co) have the following dividend payments history: Company 20X1 20X2 20X3 Sun Co – Dividend 100 110 121 Sun Co – Earnings 200 200 201 Moon Co – Dividend 50 150 25 Moon Co – Earnings 100 300 50 Nite Co – Dividend nil 300 nil Nite Co – Earnings 400 350 500 Which best describes their apparent dividend policies? Sun Co Moon Co Nite Co A. Constant growth Constant pay-out Residual B. Constant pay-out Constant growth Residual C. High pay-out Residual Constant pay-out D. Constant growth Residual Constant pay-out 18. Which of the following are assumptions for Modigliani and Miller's dividend irrelevance theory? 1. Perfect capital markets 2. No taxes or tax preferences 3. No transaction costs 4. No inflation A. 1,2,3 only B. 1,2,4 only C. 2,3,4 only D. 1,2,3,4 19. In Modigliani & Miller's dividend irrelevance theory, the process of 'manufacturing dividends' refers to which of the following? A. Dividends from manufacturing businesses. B. Investors selling some shares to realise some capital gain. C. Creative accounting to allow dividends to be paid. D. Investing plans designed to create regular returns to shareholders 20. Which of the following is the best statement of the conclusion of Modigliani and Miller on the relevance of dividend policy? A. All shareholders are indifferent between receiving dividend income and capital gains B. Increase in retentions results in a higher growth rate C. Discounting the dividends is not an appropriate way to value the firm's equity D. The value of the shareholders' equity is determined solely by the firm's investment selection criteria 21. Which of the following statments is true of a scrip issue with perfect information? A. Decreases earinings per share B. Decreases the debt/equity ratio of the company C. Increasses individual shareholder wealth D. Increases the market price of the share 22. What does an enhanced scrip dividend mean? A. In addition to the scrip dividend cash is also paid B. Bonus shares are paid in return for accepting a delay C. More than $1 worth of shares is offered as an alternative to every $1 cash dividend to be paid D. A higher scrip dividend is offered to a limited shareholder group. 23.[Ex 2014/12 Q5] Which of the following statements is correct? A. A bonus issue can be used to raise new equity finance B. A share repurchase scheme can increase both earnings per share and gearing C. Miller and Modigliani argued that the financing decision is more important than the dividend decision D. Shareholders usually have the power to increase dividends at annual general meetings of a company 24.[2019/06 Q19] Which of the following statements about equity finance is correct? A. Equity finance reserves represent cash which is available to a company to invest B. Additional equity finance can be raised by rights issues and bonus issues C. Retained earnings are a source of equity finance D. Equity finance includes both ordinary shares and preference shares Gearing and capital structure 25. A summary of HM Co's recent statement of profit or loss is given below: $'000 Revenue 10,123 Cost of sales (7,222) Gross profit 2,901 Expenses (999) Profit before interest and tax 1,902 Interest (1,000) Tax (271) Profit after interest and tax 631 70% of cost of sales and 10% of expenses are variable costs. What is HM Co's operational gearing? 26. If a company that currently pays its workforce on a piece rate system were to automate its production line, which of the following responses would it expect of operating gearing? A. Decrease B. Increase C. Remain the same D. Increase or decrease depending on the nature of the production process [ 2021/06 Section B] Nolciln Co needs to raise more capital and wants to identify the most appropriate capital structure to maximise its shareholders wealth. The company has approached you for advice on aspects of its financial and operational gearing. The following has been extracted from Nolciln Co's 20X9 financial statements $'000 Revenue 9,540 Profit before interest and tax (PBIT) 1,590 Profit after tax 1,072 Dividends paid 500 Ordinary shares (nominal value$1) 7,800 8% loan notes 3,125 Detailed analysis has shown that variable costs are equal to 60% of Nolciln Co's revenue. You have been informed that it is company policy to calculate operational gearing as Operational gearing Contribution /PBIT The directors of NolciIn Co are also seeking advice on the optimal capital structure. They are aware of the Modigliani and Miller models but seek further information, in particular in respect of what is meant by market imperfections 27. What was Nolciln Co's operational gearing in 20X9 (to one decimal place)? ____________ times 28. What was Nolciln Co's interest cover in 20X9 (to one decimal place)? ____________ times 29. Who suffers financial risk as financial gearing increases, and why? A. Lenders because they are less likely to be repaid. B. Lenders because there are fewer assets to offer as security. C. Shareholders as their returns are lower. D. Shareholders as their dividends become more variable. [2014/12 Q17]The following are extracts from the statement of financial position of a company: $000 $000 Equity Ordinary shares 8,000 Reserves 20,000 28,000 Non-current liabilities Bonds 4,000 Bank loans 6,200 Preference shares 2,000 12,200 Current liabilities Overdraft 1,000 Trade payables 1,500 2,500 Total equity and liabilities 42,700 The ordinary shares have a nominal value of 50 cents per share and are trading at $5·00 per share. The preference shares have a nominal value of $1·00 per share and are trading at 80 cents per share. The bonds have a nominal value of $100 and are trading at $105 per bond. 30.What is the market value based gearing of the company, defined as prior charge capital/equity? A. 15·0% B. 13·0% C. 11·8% D. 7·3% 31. Which of the following is most likely to result in a company's financial gearing being high? A. Low taxable profits B. Low tax rates C. Inexpensive share issue costs D. Intangible assets being a low proportion of total assets The cost of capital 32. According to the creditor hierarchy, list the following from high risk to low risk: 1. Ordinary share capital 2. Preference share capital 3. Trade payables 4. Bank loan with fixed and floating charges A. 1,2,3,4 B. 2,1,4,3 C. 1,2,4,3 D. 4,1,2,3 33.[2014/12 Q19] A company has just paid an ordinary share dividend of 32·0 cents and is expected to pay a dividend of 33·6 cents in one year’s time. The company has a cost of equity of 13%. What is the market price of the company’s shares to the nearest cent on an ex dividend basis? A. $3·20 B. $4·41 C. $2·59 D. $4·20 34.[2014/12 Q15] Which of the following statements is/are correct? 1. An increase in the cost of equity leads to a fall in share price 2. Investors faced with increased risk will expect increased return as compensation 3. The cost of debt is usually lower than the cost of preference shares A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 35.[2016/12 Q24] Indicate, by clicking on the relevant boxes, whether the following are assumptions that are made by the dividend growth model? Investors make rational decisions YES NO Dividends show either constant YES NO growth or zero growth The dividend growth rate is less YES NO than the cost of equity 36. GG Co has a cost of equity of 25%. It has 4 million shares in issue, and has done for many years. Its dividend payments in the years 20X9 to 20Y3 were as follows. End of year Dividends $'000 20X9 220 20Y0 257 20Y1 310 20Y2 356 20Y3 423 Dividends are expected to continue to grow at the same average rate into the future. According to the dividend valuation model, what should be the share price at the start of 20Y4? 37.[2016/12 Q10] Carp Co has announced that it will pay an annual dividend equal to 55% of earnings. Its earnings per share is $0.80, and it has ten million shares in issue. The return on equity of Carp Co is 20% and its current cum dividend share price is $4.60 What is the cost of equity of Carp Co? A. 19.4% B. 20.5% C. 28.0% D. 22.7% 38. [2016/3] Cant Co has a cost of equity of 10% and has forecast its future dividends as follows: Current year: No dividend Year 1: No dividend Year 2: $0.25 per share Year 3: $0.50 per share and increasing by 3% per year in subsequent years What is the current share price of Cant Co using the dividend valuation model? A.7.35 B.5.57 C.6.11 D.6.28 39. Which of the following best describes systematic risk? 1. The risk associated with investing in equity 2. The diversifiable risk associated with investing in equity 3. The residual risk associated with investing in a well-diversified portfolio. 4. Unsystematic risk can be diversified away 40. Which of the following assumptions is not required when using the capital asset pricing model to estimate the cost of equity for project appraisal? 1. Efficient capital markets 2. Well diversified investors 3. Future periods are consistent with the present 4. Companies are well diversified 41. A security's required return can be predicted using the CAPM using the formula: rj = rf+βj(rm-rf) Security X has a beta value of 1.6 and provides a return of 12.0% Security Y has a beta value of 0.9 and provides a return of 13.0% Security Z has a beta value of 1.2 and provides a return of 13.2% Security Z is correctly priced. The risk free return is 6%. What does this information indicate about the pricing of securities X, Y? Fill in the gaps in the statements below. Security X is...... Security Y is...... Choose from the following: Underpriced / overpriced 42. The equity beta of Par Co is 1.2. Which of the following statements relating to the capital asset pricing model is correct? A. The equity beta of Par Co considers only business risk B. The capital asset pricing model considers systematic risk and unsystematic risk C. The equity beta of Par Co indicates that the company is more risky than the market as a whole D. The debt beta of Par Co is zero 43.[2015/06 Q7] Which of the following statements is/are correct? 1. The asset beta reflects both business risk and financial risk 2. Total risk is the sum of systematic risk and unsystematic risk 3. Assuming that the beta of debt is zero will understate financial risk when ungearing an equity beta A. 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 Bond price and yield 44.[2015/06 Q10] A company has in issue loan notes with a nominal value of $100 each. Interest on the loan notes is 6% per year, payable annually. The loan notes will be redeemed in eight years’ time at a 5% premium to nominal value. The before-tax cost of debt of the company is 7% per year. What is the ex interest market value of each loan note? A. $96·94 45.[2014/12 Q9] A company has 7% loan notes in issue which are redeemable in seven years’ time at a 5% premium to their nominal value of $100 per loan note. The before-tax cost of debt of the company is 9% and the after-tax cost of debt of the company is 6%. What is the current market value of each loan note? A. $92·67 46.[2016/09 Q11] Lane Co has in issue 3% convertible loan notes which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note can be converted in five years’ time into 25 Lane Co ordinary shares. The current share price of Lane Co is $3·60 per share and future share price growth is expected to be 5% per year. The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%. What is the current market value of a Lane Co convertible loan note? A $82·71 B $73·47 C $67·26 D $94·20 [2019/06 Q17&16 – convertible] The following scenario relates to questions 16–20 Tulip Co is a large company with an equity beta of 1·05. The company plans to expand existing business by acquiring a new factory at a cost of $20m. The finance for the expansion will be raised from an issue of 3% loan notes, issued at nominal value of $100 per loan note. These loan notes will be redeemable after five years at nominal value or convertible at that time into ordinary shares in Tulip Co with a value expected to be $115 per loan note. The risk-free rate of return is 2·5% and the equity risk premium is 7·8%. Tulip Co is seeking additional finance and is considering using Islamic finance and, in particular, would require a form which would be similar to equity financing. 47. Using estimates of 5% and 6%, what is the cost of debt of the convertible loan notes? A. 3·0% B. 5·2% C. 6·9% D. 5·7% 48.What is the cost of equity of Tulip Co using the capital asset pricing model? A. 13·3% B. 10·7% C. 8·1% D. 10·3% 49.[2018/12&2017/06] Black Co has in issue 5% irredeemable loan notes, nominal value of $ 100 per loan note, on which interest is shortly to be paid. Black Co has a before-tax cost of debt of 10% and corporation tax is 30% What is the current market value of one loan note? A. $ 55 50.[2019/06 改] The 6% preference shares of Corfe Co have a nominal value of $0·75 per share and an ex-dividend market price of $0·64 per share. Kpref = (0·06 x 0·75)/0·64 = 7·03% WACC 51.[ 2015/06 Q19] On a market value basis, GFV Co is financed 70% by equity and 30% by debt. The company has an after-tax cost of debt of 6% and an equity beta of 1·2. The risk-free rate of return is 4% and the equity risk premium is 5%. What is the after-tax weighted average cost of capital of GFV Co? A. 5·4% B. 7·2% C. 8·3% D. 8·8% Theories of capital structure 52.Director A believes there is an optimal balance of debt:equity whereas director B does not believe that the gearing decision affects the value of the business. Which theories are the directors subscribing to? Director A Director B 1. MM (with tax) MM (no tax) 2. Traditional view MM (no tax) 3. Traditional view MM (with tax) 4. MM (no tax) Traditional view 53. Alf Co's gearing is 1:1 debt : equity. The industry average is 1:5. Alf Co is looking to raise finance for investment in a new project and it is wondering whether to raise debt or equity. Applying the traditional view, which of the following is true? 1. It should take on debt finance, as to do so will save tax. 2. It should take on equity finance, as their gearing is probably beyond optimal. 3. It doesn't matter, as it won't affect the returns the projects generate. 4. More information is needed before a decision can be made. 54. What does tax exhaustion mean? 1. All avenues have been explored to minimise corporation tax. 2. As deductions have reduced tax payable to zero, further deductions won't save tax. 3. Non current assets have a zero tax written down value. 4. Tax liabilities have been completely discharged. 55.[2021/06 Q3] Which TWO of the following are consistent with traditional capital structure theory? A There is no optimal capital structure B The value of the company remains unchanged with increased gearing C The cost of equity is higher when there is a high proportion of debt capital D There is a point at which the weighted average cost of capital is minimised 56.[2021/06 Q4] Responding to the directors' request for advice, which of the following is consistent with Modigliani and Miller’s with-tax model? A The value of Nolciln Co decreases with increased gearing B The weighted average cost of capital remains constant with increased gearing C The optimal capital structure is made up almost entirely of debt D The cost of equity remains constant with increased gearing 57. [2021/06 Q5] In relation to capital structure, which TWO of the following are valid statements about market imperfections? A Tax exhaustion occurs when there is a very high proportion of equity capital B Debt-holders may impose restrictive covenants in loan agreements C Agency costs, tax exhaustion and bankruptcy risk encourage very high gearing levels D When a company’s gearing creates a high risk of bankruptcy the weighted verage cost of capital will be higher Project specific costs of capital 58.Which of the following are assumed if a company's current weighted average cost of capital (WACC) is to be used to appraise a potential project? 1. Capital structure will remain unchanged for the duration of the project 2. The business risk of the project is the same as the current business operations 3. The project is relatively small in size A. 1 and 2 only B. 2 and 3 only C. 1 and 3 only D. 1, 2 and 3 The following information relates to questions 1 and 2. TR Co has a gearing level of 1:3 debt : equity. TR is considering diversifying into a new market. B Co is already operating in the new market. B Co has an equity beta of 1.05 and a gearing level of 1:4 debt : equity. Both companies pay 30% corporation tax. 59.What is the asset beta relevant to TR for the new market (to 2 dp)? 60.The risk free rate is 4% and the market premium is 4%. What is TR Co's cost of equity for assessing the decision to diversify into the new market? A. 4% B. 7.6% C. 8.4% D. 6.3% 61. [2017/12] Shyma Co is a company that manufactures ships and has an equity beta of 1.6 and a debt: equity ratio of 1: 3. It is considering a new project to manufacture farm vehicles. Trant Co is a manufacturer of farm vehicles and has an asset beta of 1.1 and a debt : equity ratio of 2: 3. The risk free rate of return is 5%, the market risk premium is 3% and the corporation tax rate is 40%. Using CAPM, What would be the suitable cost of equity for Shyma to use in its appraisal of the farm machinery project(to one decimal place)? % 62.[2018/3] Leah Co is an all equity financed company which wishes to appraise a project in a new area of activity. Its existing equity beta is 1. 2. The industry average equity beta for the new business area is 2.0, with an average debt/debt +equity ratio of 25%. The risk-free rate of return is 5% and the market risk premium is 4% Ignoring tax and using the capital asset pricing model, calculate a suitable risk-adjusted cost of equity for the new project(to one decimal place) Part F Business valuations 1.[2015/06 Q20]The following financial information relates to QK Co, whose ordinary shares have a nominal value of $0·50 per share: $m $m Non-current assets 120 Current assets Inventory 8 Trade receivables 12 20 Total assets 140 Equity Ordinary shares 25 Reserves 80 105 Non-current liabilities 20 Current liabilities 15 Total equity and liabilities 140 On an historic basis, what is the net asset value per share of QK Co? 2.[ 2016/09 Q1] The owners of a private company wish to dispose of their entire investment in the company. The company has an issued share capital of $1m of $0·50 nominal value ordinary shares. The owners have made the following valuations of the company’s assets and liabilities. Non-current assets (book value) $30m Current assets $18m Non-current liabilities $12m Current liabilities $10m The net realisable value of the non-current assets exceeds their book value by $4m. The current assets include $2m of accounts receivable which are thought to be irrecoverable. What is the minimum price per share which the owners should accept for the company? 3. Asset-based business valuations using net realisable values are useful in which of the following situations? A. When the company is being bought for the earnings/cash flow that all of its assets can produce in the future. B. For asset stripping C. To identify a maximum price in a takeover D. When the company has a highly-skilled workforce 4. Which of the following best describes the replacement value of a business? A. Value if sold off piece-meal B. Value to replace assets with new C. Cost of setting up an equivalent venture D. Net present value of current operations 5. Statement of Financial Position Note $000s Non-current assets 1 400 Current assets 2 50 Total assets 450 Share capital (50 cent ords.) 100 Reserves 170 Bank Loans - repayable 20X8 140 Current liabilities 40 Total equity and liabilities 450 Note 1: Included in non-current assets is specialist machinery that has a NBV of $100,000, would cost $500,000 to replace but would only be able to be sold for scrap of $25,000 if disposed of. Note 2: Current assets have a net realisable value of $40,000 6.[ 2014/12 Q2 改 ]Recent information on the earnings per share of Par Co is as follows: Year 2011 2012 2013 2014 Earnings per share (cents) 64 68 70 62 Listed companies similar to Par Co have been recently reported to have an average price /earnings ratio of 12 times. Required: Calculate the share price of Par Co using the price/earnings ratio method 7. The shares of Fencer pic are currently valued on a P/E ratio of 8. The company is considering a takeover bid for Seed Limited, but the shareholders of Seed have indicated that they would not accept an offer unless it values their shares on a P/E multiple of at least 10. Which three of the following are reasons which might justify an offer by Fencer pic for the shares of Seed on a higher P/E multiple? A. Seed has better growth prospects than Fortunate B. Seed has better-quality assets than Fortunate C. Seed has a higher gearing ratio than Fortunate D. Seed is in a different country from Fortunate, where average P/E ratios are higher 8.[2016/12 Q4] Indicate, by clicking on the relevant boxes, whether the following statements are true or false in relation to business valuation. The earnings yield method and the dividend growth model should give similar values for a TRUE FALSE company Market capitalisation represents the TRUE FALSE maximum value for a company The price/earnings ratio is the reciprocal of TRUE FALSE the earnings yield The price/earnings ratio should be increased if the company being valued is riskier than TRUE FALSE the valuing company 9. Pike Co, a listed conglomerate, is looking to buy Minnow Co, an advertising company owned and run by Fred Minnow. Minnow Co made a profit after tax of $7m last year. This expected to grow by 3% per annum. Despite owning and running the company, Fred Minnow does not take a salary, preferring to take money out of the business via high dividends. Pike pic estimates that it will need to offer a salary of $100,000 to replace Fred when he leaves. Trout and Co, a quoted advertising agency with similar gearing and growth prospects to Minnow Co, has a P/E ratio of 7 Minnow Co pays corporation tax at 30%. What is the MV of equity of Minnow Co? 10.[ 2016/12 Q10] Carp Co has announced that it will pay an annual dividend equal to 55% of earnings. Its earnings per share is $0.80, and it has ten million shares in issue. The return on equity of Carp Co is 20% and its current cum dividend share price is $4.60 What is the cost of equity of Carp Co? A. 19.4% B. 20.5% C. 28.0% D. 22.7% 11. Which of the following need to be assumed when using the dividend valuation formula to estimate a share value? 1) The recent dividend, 'D0', is typical ie doesn't vary significantly from historical trends 2) Growth will be constant 3) The cost of equity will remain constant 4) A majority shareholding is being purchased A. 1, 2 and 3 only B. 3 and 4 only C. 1 and 2 only D. 1, 2, 3 and 4 12.[ 2016/3] Cant Co has a cost of equity of 10% and has forecast its future dividends as follows: Current year: No dividend Year 1: No dividend Year 2: $0.25 per share Year 3: $0.50 per share and increasing by 3% per year in subsequent years What is the current share price of Cant Co using the dividend valuation model? A.7.35 B.5.57 C.6.11 D.6.28 13.[ 2016/09 Q 9] A company has annual after-tax cash flows of $2 million per year which are expected to continue in perpetuity. The company has a cost of equity of 10%, a before-tax cost of debt of 5% and an after-tax weighted average cost of capital of 8% per year. Corporation tax is 20%. What is the theoretical value of the company? A $20m B $40m C $50m D $25m 14.[2018/03] Alpha Co and Beta Co are two companies in different industries who are both evaluating the acquisition of the same target company called Gamma Co, Gamma Co is in the same industry as Alpha Co. Alpha Co has valued Gamma Co at $100m but Beta Co has only valued Gamma Co at $90m. Which of following statements would explain why Alpha Co's value of Gamma Co is higher? A. Alpha Co has used more prudent growth estimates B. Beta Co could achieve more synergy C. Beta Co is a better negotiator than Alpha Co D. Gamma Co is a direct competitor of Alpha Co 15. Pike Co, a listed conglomerate, is looking to buy Minnow Co Statement of financial position for Minnow Co Bank loan $2.5m Pike Co anticipates that, after making a number of changes, Minnow Co will generate free cash flow of $6m next year. This is expected to grow by 4% per annum thereafter. Trout and Co, a quoted advertising agency with similar gearing and growth prospects to Minnow Co, has a WACC of 12% and a cost of equity of 15%. Minnow Co pays corporation tax at 30%. Calculate the market value of the equity of Minnow Co using discounted cash flows. 16. The following information relates to two companies, Alpha pic and Beta pic. Alpha pic Beta pic Earnings after tax $210,000 $900,000 P/E ratio 16 21 Beta pic's management estimate that if they were to acquire Alpha pic they could save $100,000 annually after tax on administrative costs in running the new joint company. Additionally, they estimate that the P/E ratio of the new company would be 20. On the basis of these estimates, what is the maximum that the shareholders of Beta pic should pay for the entire share capital of Alpha pic? Market efficiency 17.[2014/12 Q14] An investor believes that they can make abnormal returns by studying past share price movements. In terms of capital market efficiency, to which of the following does the investor’s belief relate? A. Fundamental analysis B. Operational efficiency C. Technical analysis D. Semi-strong form efficiency 18.[ 2019/12 Q2] The efficient markets hypothesis refers to the way in which the prices of traded financial securities reflect relevant information. Which TWO of the following are true for a weak-form efficient market? A. Share prices fully and fairly represent past information B. Share prices fully and fairly represent private information C. Share prices appear to follow a 'random walk' D. The market does not provide enough information to make good buying and selling decisions 19.[ 2015/06 Q18] Which of the following statements are correct? 1. If a capital market is weak form efficient, an investor cannot make abnormal returns by using technical analysis 2. Operational efficiency means that efficient capital markets direct funds to their most productive use 3. Tests for semi-strong form efficiency focus on the speed and accuracy of share price responses to the arrival of new information A. 1 and 2 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 20.[2018/12] Which TWO of the following would be evidence of strong form market efficiency? A. The lack of regulation on use of private information (insider dealing B. Inability to consistently outperform the market and make abnormal gains C. Immediate share price reaction to company announcements to the market D. Regulation to ensure quick and timely public announcement of information 21. Mr Mays plans to invest on the Stock Exchange. A friend of his who works in the City of London has told him that the London Stock Exchange shows strong form market efficiency. If this is the case, which of the following investment strategies should Mr Mays follow? A. Study the company reports in the press and try to spot under-valued shares in which to invest B. Invest in two or three blue chip companies and hold the shares for as long as possible C. Build up a good spread of shares in different industry sectors D. Study the company reports in the press and try to spot strongly growing companies in which to invest 22.[ 2016/12 Q7] In relation to capital markets, which of the following statements is true? A. The return from investing in larger companies has been shown to be greater than the average return from all companies B. Weak form efficiency arises when investors tend not to make rational investment decisions C. Allocative efficiency means that transaction costs are kept to a minimum D. Research has shown that, overtime, share prices appear to follow a random walk [2016/09 B-2] The following scenario relates to questions 21 to 25. Ring Co has in issue ordinary shares with a nominal value of $0·25 per share. These shares are traded on an efficient capital market. It is now 20X6 and the company has just paid a dividend of $0·450 per share. Recent dividends of the company are as follows: Year 20X6 20X5 20X4 20X3 20X2 Dividend per share $0·450 $0·428 $0·408 $0·389 $0·370 Ring Co also has in issue loan notes which are redeemable in seven years’ time at their nominal value of $100 per loan note and which pay interest of 6% per year. The finance director of Ring Co wishes to determine the value of the company. Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The company pays corporation tax of 25% per year. 23.Using the dividend growth model, what is the market value of each ordinary share? A $8·59 B $9·00 C $9·45 D $7·77 24. What is the market value of each loan note? A $109·34 B $112·01 C $116·57 D $118·68 25. The finance director of Ring Co has been advised to calculate the net asset value (NAV) of the company. Which of the following formulae calculates correctly the NAV of Ring Co? A. Total assets less current liabilities B. Non-current assets plus net current assets C. Non-current assets plus current assets less total liabilities D. Non-current assets less net current assets less non-current liabilities 26. Which of the following statements about valuation methods is true? A. The earnings yield method multiplies earnings by the earnings yield B. The equity market value is number of shares multiplied by share price, plus the market value of debt C. The dividend valuation model makes the unreasonable assumption that average dividend growth is constant D. The price/earnings ratio method divides earnings by the price/earnings ratio 27. Which of the following statements about capital market efficiency is/are correct? (1) Insider information cannot be used to make abnormal gains in a strong form efficient capital market (2) In a weak form efficient capital market, Ring Co’s share price reacts to new information the day after it is announced (3) Ring Co’s share price reacts quickly and accurately to newly-released information in a semi-strong form efficient capital market A 1 and 2 only B 1 and 3 only C 3 only D 1, 2 and 3 [2016/12 B-2] The finance director of Coral Co has been asked to provide values for the company’s equity and loan notes. Coral Co is a listed company and has the following long-term finance: $m Ordinary shares 7.8 7% Convertible loan notes 8.0 15.8 The ordinary shares of Coral Co have a nominal value of $0·25 per share and are currently trading on an ex dividend basis at $7·10 per share. An economic recovery has been forecast and so share process are expected to grow by 8% per year for the foreseeable future. The loan notes are redeemable after six years at their nominal value of $100 per loan note, or can be converted after six years into 10 ordinary shares of Coral Co per loan note. The loan notes are traded on the capital market. The before-tax cost of debt of Coral Co is 5% and the company pays corporation tax of 20% per year 28. What is the equity market value of Coral Co (to two decimal places)? 29. Assuming conversion, what is the market value of each loan note of Coral Co? A. $110·13 B. $112·67 C. $119·58 D. $125·70 30. Which of the following statements about the equity market value of Coral Co is/are true? (1)The equity market value will change frequently due to capital market forces (2)If the capital market is semi-strong form efficient, the equity market value will not be affected by the release to the public of insider information (3)Over time, the equity market value of Coral Co will follow a random walk A. 1 only B. 1 and 3 only C. 2 and 3 only D. 1, 2 and 3 31. Indicate, by clicking on the relevant boxes, whether the following are assumptions that are made by the dividend growth model? Investors make rational Yes No decisions Dividends show either Yes No constant growth or zero growth The dividend growth rate is Yes No less than the cost of equity 32. Why might valuations of the equity and loan notes of Coral Co be necessary? (1) The company is planning to go to the market for additional finance (2) The securities need to be valued for corporate taxation purposes (3) The company has received a takeover bid from a rival company A. 1 and 2 only B. 1 and 3 only C. 3 only D. 1, 2 and 3 [ Pilot paper 16-20]Par Co currently has the following long-term capital structure: $m $m Equity finance Ordinary shares 30.0 Reserves 38.4  68.4 Non-current liabilities Bank loans 15.0 8% convertible loan notes 40.0 5% redeemable preference shares 15.0 70.0 Total equity and liabilities 138.4 The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time. If not converted, the loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9% per year. The ordinary shares of Par Co have a nominal value of $1 per share. The current ex dividend share price of the company is $10.90 per share and share prices are expected to grow by 6% per year for the foreseeable future. The equity beta of Par Co is 1.2. 33. The loan notes are secured on non-current assets of Par Co and the bank loan is secured by a floating charge on the current assets of the company. In terms of risk to the investor, what are the riskiest and least risky sources of finance for Par Co? Riskiest Least risky A. Redeemable preference shares Bank loan B. Ordinary shares Bank loan C. Bank loan Loan notes D. Ordinary shares Loan notes 34. What is the conversion value of the 8% loan notes of Par Co after seven years? A. $16.39 B. $111.98 C. $131.12 D. $71.72 35. Assuming the conversion value after seven years is $126·15, what is the current market value of the 8% loan notes of Par Co? A $115.20 B $109.26 C $94.93 D $69.00 36. The equity beta of Par Co is 1.2. Which of the following statements relating to the capital asset pricing model is correct? A. The equity beta of Par Co considers only business risk B. The capital asset pricing model considers systematic risk and unsystematic risk C. The equity beta of Par Co indicates that the company is more risky than the market as a whole D. The debt beta of Par Co is zero 37. Which of the following statements are problems in using the price/earnings ratio method to value a company? 1. It is the reciprocal of the earnings yield 2. It combines stock market information and corporate information 3. It is difficult to select a suitable price/earnings ratio 4. The ratio is more suited to valuing the shares of listed companies A. 1 and 2 only B. 3 and 4 only C. 1, 3 and 4 only D. 1, 2, 3 and 4 [2019/06 Q21-25] The following scenario relates to questions 21–25 Extracts from the financial statements of Bluebell Co, a listed company, are as follows: $m Profit before interest and tax 238 Finance costs (24) Profit before tax 214 Corporation tax (64) Profit after tax 150 The following scenario relates to questions 21–25 Extracts from the financial statements of Bluebell Co, a listed company, are as follows: $m Assets Non-current assets Property, plant and equipment 768 Goodwill(internally generated) 105 873 Current assets Inventories 285 Trade receivables 192 477 Total assets 1,350 The following scenario relates to questions 21–25 Extracts from the financial statements of Bluebell Co, a listed company, are as follows: $m Equity and liabilities Total equity 688 Non-current liabilities Long-term borrowings 250 Current liabilities Trade payables 312 Short-term borrowings 100 Total current liabilities 412 Total liabilities 662 Total equity and liabilities 1,350 A similar size competitor company has a price/earnings ratio of 12·5 times. This competitor believes that if Bluebell Co were liquidated, property, plant and equipment would only realise $600m, while 10% of trade receivables would be irrecoverable and inventory would be sold at $30m less than its book value. Separately, Bluebell Co is considering the acquisition of Dandelion Co, an unlisted company which is a supplier of Bluebell Co. 38. What is the value of Bluebell Co on a net realisable value basis? A. $140·8m B. $470·8m C. $365·8m D. $1,027·8m 39. What is the value of Bluebell Co using the earnings yield method? A. $2,675m B. $1,200m C. $1,875m D. $2,975m 40. When valuing Bluebell Co using asset-based valuations, which of the following statements is correct? A. An asset-based valuation would be useful for an asset-stripping acquisition B. Bluebell Co’s workforce can be valued as an intangible asset C. Asset-based valuations consider the present value of Bluebell Co’s future income D. Replacement cost basis provides a deprival value for Bluebell Co 41. Which of the following is/are indicators of market imperfections? 1. Low volume of trading in shares of smaller companies 2. Overreaction to unexpected news A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 42. Which of the following statements is correct? A. Dandelion Co is easier to value than Bluebell Co because a small number of  shareholders own all the shares B. Bluebell Co will have to pay a higher price per share to take control of Dandelion Co than if it were buying a minority holding C. Scrip dividends decrease the liquidity of shares by retaining cash in a company D. Dandelion Co’s shares will trade at a premium to similar listed shares because it will have a lower cost of equity Part G Risk Management The Marigoid Co is based in a country which uses the dollar(s)as home currency. Marigold Co has a wholly-owned subsidiary based in a country Which uses the M shiling(MS)as its currency.The subsidiary's financial statements are prepared in MS Due to economic uncertainty in both countries, an exchange loss of 5100 000 is expected to occur after consolidating the results of the subsidiary into Marigold Cos group accounts Manigoid Co is expecting a receipt of MS300, 000 from the subsidiary in three months which it wishes to protect against exchange rate movement. The following information is available. Exchange rates MS per$ 1 Spot rate 1.0950-1.1250 Three-month forward rate 1.0850-1.1125 Money Market Rates Annual Deposit Annual Borrow % % MS 3.6 4.0 $ 6.0 7.0 1. What type of exchange rate risk would Marigold Co experience with the $100,000 loss in its consolidated financial statements? A. Economic B. Translation C. Transaction D. Political 2. If Marigold Co uses the forward market to hedge the MS receipt, what amount will be received (to the nearest $)? 3.Match the appropriate value to the relevant target in order to reflect what amount Marigold Co will borrow and deposit if it uses the money market to hedge the MS receipt. Value Target MS288，461 $256,410 Amount to borrow MS289，575 $263,435 Amount to deposit MS297，030 $264,027 MS297，324 $271,260 4. Marigold Co is now considering the use of an option to hedge the currency risk on the MS receipt. Its bank has offered an over-the-counter option with an exercise price of MS1.1250 per $. Which TWO of the following statements concerning the option are TRUE? A. The option will be more expensive to set up compared with either the forward contract or money market hedge B. An imperfect hedge will result as the option will be for a standard amount of currency and only a whole number of contracts may be used C. If the $ was to strengthen against the MS, Marigold Co is likely to be worse off by using the option compared to either the forward contract or money market hedge D. Using an option hedge will mean that Marigold Co is obligated to exercise the option in three months irrespective of the spot rate on the day 5. Marigold Co is unsure whether to use a forward contract or a money market hedge and is comparing the relative advantages and disadvantages of the two. Which of the following statements is true? A. The forward contract has the advantage of being tailored precisely to Marigold Co's requirements but the money market hedge will be a standardised instrument resulting in an imperfect hedge B. The forward contract will result in Marigold Co receiving the dollar equivalent of the MS receipt in three months' time, whereas the money market hedge will provide Marigold Co with dollar receipts today C. The forward contract will result in the effective rate of exchange being fixed whereas the money market hedge will allow Marigold Co to benefit from favorable movement in the exchange rate D. Marigold Co will be obligated to fulfil the forward contract in three months' time whereas the money market hedge could be traded on an exchange to another party before settlement [2019/06] Peony Co’s finance director is concerned about the effect of future interest rates on the company and has been looking at the yield curve. Peony Co, whose domestic currency is the dollar ($), plans to take out a $100m loan in three months’ time for a period of nine months. The company is concerned that interest rates might rise before the loan is taken out and its bank has offered a 3 v 12 forward rate agreement at 7·10–6·85. The loan will be converted into pesos and invested in a nine-month project which is expected to generate income of 580m pesos, with 200m pesos being paid in six months’ time (from today) and 380m pesos being paid in 12 months’ time (from today). The current spot exchange rate is 5 pesos per $1. The following information on current short-term interest rates is available: Dollars 6·5% per year Pesos 10·0% per year As a result of the general uncertainty over interest rates, Peony Co is considering a variety of ways in which to manage its interest rate risk, including the use of derivatives. 6. In relation to the yield curve, which of the following statements is correct? A. Expectations theory suggests that deferred consumption requires increased compensation as maturity increases B. An inverted yield curve can be caused by government action to increase its long-term borrowing C. A kink (discontinuity) in the normal yield curve can be due to differing yields in different market segments D. Basis risk can cause the corporate yield curve to rise more steeply than the government yield curve 7. If the interest rate on the loan is 6·5% when it is taken out, what is the nature of the compensatory payment under the forward rate agreement? A. Peony Co pays bank $600,000 B. Peony Co pays bank $250,000 C. Peony Co pays bank $450,000 D. Bank pays Peony Co $600,000 8. Using exchange rates based on interest rate parity, what is the dollar income received from the project? A. $112·3m B. $114·1m C. $116·0m D. $112·9m 9. In respect of Peony Co managing its interest rate risk, which of the following statements is/are correct? (1) Smoothing is an interest rate risk hedging technique which involves maintaining a balance between fixed-rate and floating-rate debt (2) Asset and liability management can hedge interest rate risk by matching the maturity of assets and liabilities A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 10. In relation to the use of derivatives by Peony Co, which of the following statements is correct? A. Interest rate options must be exercised on their expiry date, if they have not been exercised before then B. Peony Co can hedge interest rate risk on borrowing by selling interest rate futures now and buying them back in the future C. An interest rate swap is an agreement to exchange both principal and interest rate payments D. Peony Co can hedge interest rate risk on borrowing by buying a floor and selling a cap [2016/09] The following scenario relates to questions 16 to 20. Herd Co is based in a country whose currency is the dollar ($). The company expects to receive €1,500,000 in six months’ time from Find Co, a foreign customer. The finance director of Herd Co is concerned that the euro (€) may depreciate against the dollar before the foreign customer makes payment and she is looking at hedging the receipt. Herd Co has in issue loan notes with a total nominal value of $4 million which can be redeemed in 10 years’ time. The interest paid on the loan notes is at a variable rate linked to LIBOR. The finance director of Herd Co believes that interest rates may increase in the near future. The spot exchange rate is €1·543 per $1. The domestic short-term interest rate is 2% per year, while the foreign short-term interest rate is 5% per year. 11. What is the six-month forward exchange rate predicted by interest rate parity? A. €1·499 per $1 B. €1·520 per $1 C. €1·566 per $1 D. €1·588 per $1 12. As regards the euro receipt, what is the primary nature of the risk faced by Herd Co? A. Transaction risk B. Economic risk C. Translation risk D. Business risk 13. Which of the following hedging methods will NOT be suitable for hedging the euro receipt? A. Forward exchange contract B. Money market hedge C. Currency futures D. Currency swap 14. Which of the following statements support the finance director’s belief that the euro will depreciate against the dollar? (1) The dollar inflation rate is greater than the euro inflation rate (2) The dollar nominal interest rate is less than the euro nominal interest rate A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 15. As regards the interest rate risk faced by Herd Co, which of the following statements is correct? A. In exchange for a premium, Herd Co could hedge its interest rate risk by buying interest rate options B. Buying a floor will give Herd Co a hedge against interest rate increases C. Herd Co can hedge its interest rate risk by buying interest rate futures now in order to sell them at a future date D. Taking out a variable rate overdraft will allow Herd Co to hedge the interest rate risk through matching [2016/12] Park Co is based in a country whose currency is the dollar ($). The company regularly imports goods denominated in euro (€) and regularly sells goods denominated in dinars. Two of the future transactions of the company are as follows: Three months: Paying €650,000 for imported goods Six months: Receiving 12 million dinars for exported capital goods Park Co has the following exchange rates and interest rates available to it: Bid Offer Spot exchange rate (dinars per $1): 57·31 57·52 Six-month forward rate (dinars per $1): 58·41 58·64 Spot exchange rate (€ per $1): 1·544 1·552 Three-month forward rate (€ per $1): 1·532 1·540 Six-month interest rates: Borrow Deposit Dinars 4.0% 2.0% Dollars 2.0% 0.5% The finance director of Park Co believes that the upward-sloping yield curve reported in the financial media means that the general level of interest rates will increase in the future, and therefore expects the reported six-month interest rates to increase. 16. What is the future dollar value of the dinar receipt using a money market hedge? A. $197,752 B. $201,602 C. $208,623 D. $210,629 17. Indicate, by clicking on the relevant boxes, whether Park Co will find each of the following hedges to be effective or not effective in hedging the foreign currency risk of the two transactions. Leading the euro payment on its EFFECTIVE NOT EFFECTIVE imported goods Taking out a forward exchange EFFECTIVE NOT EFFECTIVE contract on its future dinar receipt Buying a tailor-made currency option EFFECTIVE NOT EFFECTIVE for its future euro payment 18. Which hedging methods will assist Park Co in reducing its overall foreign currency risk? (1)Taking out a long-term euro -denominated loan (2)Taking out a dinar-denominated overdraft A. 1 only B. 2 only C. Both 1 and 2 D. Neither 1 nor 2 19. Indicate, by clicking on the relevant boxes, whether the following statements are correct or incorrect? Purchasing power parity can be used CORRECT INCORRECT to predict the forward exchange rate The international Fisher effect can CORRECT INCORRECT be used to predict the real interest rate 20. Which of the following statements is consistent with an upward-sloping yield curve? A. The risk of borrowers defaulting on their loans increases with the duration of the lending B. Liquidity preference theory implies that short-term interest rates contain a premium over long-term interest rates to compensate for lost liquidity C. Banks are reluctant to lend short-term, while government debt repayments have significantly increased the amount of long-term funds available D. The government has increased short-term interest rate