CIS March 2012 Exam Diet
Examination Paper 1.2:
Corporate Finance
Equity Valuation and Analysis
Fixed Income Valuation and Analysis
Corporate Finance (1 - 33)
1.
What does beta measure?
A. Systematic risk.
B. Unsystematic risk.
C. Total risk.
D. Unique risk.
2.
Which of the following is not a risk analysis technique?
A. Sensitivity analysis.
B. Scenario analysis.
C. Payback period.
D. Expected value.
3.
Which of the following statements with respect to Modigliani and Miller capital
structure proposition is true?
A. In the absence of taxes, the value of the firm is not affected by its capital
structure.
B. In the absence of taxes, a geared firm has higher value than an ungeared firm.
C. With taxes, a firm maximizes its value if it is 100% equity financed.
D. With taxes, the weighted average cost of capital (WACC) is minimised when the
capital structure is made up entirely of equity.
4.
XYZ is considering the following independent projects:
Project
Cost
A
B
N150,000
N570,000
Annual Cash flow
(5 years)
N45,900
N162,912
Required
Return
10%
13%
NPV
N23,997
N2,999
Which of the following represents the optimal choice?
A. Only project A should be accepted since it has a higher NPV.
B. Only project B should be chosen since it has a higher annual cash flow as well as
positive NPV.
C. Only project B should be chosen since it has a positive NPV despite having a
higher required rate of return then Project A.
D. Because project A has a NPV of N23,997 and project B has a NPV of N2,999
both should be chosen.
5.
In order to reduce the agency problem which of the following would most likely be
ineffective?
A. Ensuring managers’ compensation consists of a high proportion of stock options.
B. Shortening the terms in which managers may serve.
C. Instituting a strong corporate governance culture.
D. Having more sophisticated institutional investors who command greater influence
on managers in their decision making.
6.
Which of the following is likely to occur as a company’s leverage rises?
A. The beta of the company will begin to fall.
B. The weighted average cost of capital will remain flat.
C. The cost of equity will rise.
D. The cost of debt will fall.
7.
Which of the following statement concerning the principles underlying the capital
budgeting process is true?
A. Cash flows should be based on opportunity costs.
B. Financing cost should be added to the required rate of return of the project.
C. Cash flows relating to working capital should largely be ignored.
D. The net income of a project should be the primary basis of investment appraisal.
Use the following data to answer questions 8 to 10.
A company is considering the purchase of a metal fabricator that costs N500,000.
Assume a required rate of return of 10%, and the following cash flow schedule:
Year 1 : N300,000
Year 2 : N200,000
Year 3 : N200,000
8.
What is the project’s NPV?
A. (30,900)
B. +24,300
C. +88,300
D. +152,300
9.
The project’s IRR is closest to which of the following?
A. 5%
B. 10%
C. 15%
D. 21%
10. What is the projects’ profitability index?
A. 0.18
B. 0.72
C. 1.18
D. 1.72
11. Which of these is not likely to be an objective of a firm?
I. Value maximization for shareholders.
II. Minimization of cost.
III. Achievement, as far as possible, of the aim of all stakeholders.
A. I and II only.
B. I and III only.
C. II and III only.
D. None of the above.
12. A perpetual bond is currently priced at N105, and has an annual coupon of 9%. If
corporate tax rate is 30%, compute the cost of debt.
A. 6.00%
B. 6.30%
C. 8.57%
D. 9.00%
13. As a finance manager, your firm is faced with a single period capital rationing
situation, involving the following independent projects under consideration. The
maximum capital available now is N100,000.
Project
Initial Outlay
NPV
PI
A
100,000
45,000
0.45
B
50,000
25,000
0.50
C
25,000
20,000
0.8
D
25,000
15,000
0.60
What is the maximum NPV the firm could generate, given the capital constraint?
A. N40,000
B. N45,000
C. N60,000
D. N90,000
14. XZ is a constant growth firm that just paid a dividend of N2. The company’s share
sells for N27 and has a growth rate of 8%. What is the cost of equity using the
dividend discount model?
A. 13.6%
B. 16.0%
C. 16.6%
D. 16.9%
15. A company has a stock beta of 1.2; risk free rate is 10% and market risk premium is
5%. Compute the cost of equity using the capital assets pricing model (CAPM)
approach.
A. 13.6%
B. 16.0%
C. 16.6%
D. 16.9%
16. Which of the following would lead to an increase in the rate of growth of a
company?
A. Reduction in stock turnover.
B. Reduction in asset turnover ratio.
C. Increase in quick ratio.
D. Increase in leverage ratio.
17. Given the information below about a company, compute the weighted average cost
of capital.
Equity
Debt-equity ratio
Cost of equity
Cost of debt (before tax)
Corporate tax rate
A.
B.
C.
D.
N1 billion
1:1
12%
6%
30%
6.6%
8.1%
9.2%
10.2%
18. In relation to valuation of assets, shares and companies, identify which of the
following statements is correct?
A. Using published accounts is fraught with dangers e.g. under-valuation of fixed
assets.
B. The intrinsic value of an asset is not always the sum of the discounted benefits
expected to accrue from owning it.
C. It is easier to value unquoted companies since market sentiments do not affect
the valuation process.
D. If applied properly, all the valuation models would give the same result.
19. Which of the following statements about equity capital is least likely correct?
A. There are no fixed amounts of dividends payable.
B. Investing in equity capital gives assurance of reasonable returns, thereby
reducing the level of risk.
C. Issuing shares to new shareholders dilutes the degrees of control of existing
members.
D. It is truly permanent capital as no repayment is required.
20. Which of the following would not be a good reason for a company to buy back its
own shares?
A. Management wants to reduce the level of gearing in its capital structure.
B. Management wants to maintain a stable cash dividend policy in the interest of
shareholders.
C. Management believes the shares are undervalued.
D. Management wants to send a signal to investors that its outlook for the future is
positive.
21. A scrip dividend is:
A. A dividend paid at a fixed percentage rate on the nominal value of the shares.
B. A dividend paid at a fixed percentage rate on the market value of the share on
the date the dividend is declared.
C. A dividend payment that takes the form of new shares instead of cash.
D. An issue of new share to existing shareholders by converting reserves into issued
share capital.
22. The cost of equity capital is equal to the:
A. Expect market return.
B. A rate of return required by shareholders.
C. Cost of retained earnings plus dividends.
D. Risk the company incurs when financing.
23. Which of the following sources of finance is the most widely used by small
companies?
A. Debenture issue.
B. Bank borrowing.
C. Rights issues.
D. Retained earnings.
24. Which of the following is not a feature of the capital market?
A. Long term financial instruments.
B. Specialized operators.
C. Determination of prices by the forces of demand and supply.
D. Instruments having tenor of usually one year or less.
25. The popularity of the return on capital employed (ROCE) for project appraisal among
entrepreneurs is due to the following except:
A. Simplicity of usage.
B. Recognition of the time value of money.
C. Ease of understanding.
D. Use of subjective accounting profits for analysis.
26. Which of the following is not a feature of debenture stocks?
A. They pay fixed interest to investors.
B. They confer voting rights on holders.
C. The interest element is tax-deductible.
D. They are redeemable, irredeemable or convertible.
27. Profit maximization and risk minimization objectives of a company can be captured
by one of these objectives:
A. Short term solvency.
B. Profitability.
C. Shareholders’ wealth maximization.
D. Growth.
28. The following are the main components of working capital except:
A. Inventory.
B. Loan notes.
C. Creditors.
D. Bank overdraft.
29. Which of the following factors does not directly influence the level of investment in
working capital?
A. Nature of the business.
B. Sales and demand conditions.
C. Dividend policy.
D. Credit policy.
30. Which of the following is not a capital market instrument?
A. Treasury bills.
B. Redeemable preference shares.
C. Redeemable debentures.
D. State government bonds.
31. Which of the following is not an option available to a shareholder in the event that
the company issues a rights issue?
A. Take up the rights.
B. Renounce the rights.
C. Sell the rights.
D. Convert the rights to corporate bond.
32. A firm which desires to improve its cash flow would not take which of the following
steps?
A. Reduce working capital cycle.
B. Reduce creditors’ payment period.
C. Reduce stock turnover period.
D. Employ a factor for receivables management.
33. Which of the following is not correct about warrants?
A. They are a form of call option.
B. They give the holder the right to buy the equity of a firm at an agreed time in
future.
C. They are highly leveraged instruments.
D. They are basically risk-free instruments.
Equity Valuation and Analysis (34 - 67)
34. In
A.
B.
C.
D.
a bear market you are not likely to observe which of the following?
High dividend yields as against bond yields.
Low earnings multiple.
Low price-to-sale ratio.
High price–to–book ratio.
35. Which of the following is incorrect in respect of ordinary share capital payout ratio?
A. It has an impact on the rate of growth of the company.
B. It can be zero for a growth company.
C. It is always greater than the retention ratio.
D. The higher the payout ratio, the lower the retention ratio.
36. A stock whose rate of return is greater than the market rate of return is most likely
to have:
A. Beta of zero.
B. Beta of 1.
C. Beta less than 1.
D. Beta greater than 1.
37. An increase in which of the following variables will most likely result in a reduction of
the value of a company?
A. Long term sustainable growth rate.
B. Investors’ required rate of return.
C. Dividend payout.
D. Leverage.
38. Which of the following statements about company and stock analysis is false? A
growth:
A. stock always indicates a growth company.
B. stock earns a higher return than stock of equivalent risk.
C. company has above-average investment opportunities.
D. company can be overvalued.
39. Firms with abnormally high return on equity (ROE) will probably do which of the
following?
A. Go out of business.
B. Pay out all earnings in form of dividends.
C. Retain a large portion of their earnings.
D. Be indifferent between retention and payout.
40. If a company currently has a high and unsustainable growth rate (g) that exceeds
investors’ required rate of return (k), what is the most appropriate valuation model?
A. Book value model.
B. Infinite growth dividend discount model (DDM).
C. Price earnings multiple.
D. Differential growth dividend discount model (DDM).
41. Farland Company Limited has an expected ROE of 10%. The dividend growth rate
will be ________ if the firm follows a policy of paying 70% of earnings in the form of
dividends.
A. 3.0%
B. 4.8%
C. 6.0%
D. 7.0%
42. Each of two stocks, C and D, are expected to pay a dividend of N3 in the upcoming
year. The expected growth rate of dividends is 9% for both stocks. You require a
rate of return of 10% on stock C and a return of 13% on stock D. The intrinsic value
of stock C _________
A. Will be greater than the intrinsic value of stock D.
B. Will be the same as the intrinsic value of stock D.
C. Will be less than the intrinsic value of stock D.
D. Cannot be calculated without knowing the market rate of return.
43. The ______ is a common term for the market consensus value of the required return
on a stock.
A. Dividend payout ratio.
B. Intrinsic value.
C. Market capitalization rate.
D. Plowback rate.
44. High P/E ratios tend to indicate that a company will _______ ceteris paribus.
A. Grow quickly.
B. Grow at the same speed as the average company.
C. Grow slowly.
D. Not grow.
45. ________ are analysts who use information concerning current and prospective
profitability of a firm to assess the firm's fair market value.
A. Credit analysts.
B. Fundamental analysts.
C. Systems analysts.
D. Technical analysts.
46. The _______ is defined as the present value of all future cash proceeds to the
investor in the stock.
A. Dividend payout ratio.
B. Intrinsic value.
C. Market capitalization rate.
D. Plowback ratio.
47. If a
A.
B.
C.
firm has a required rate of return equal to the ROE:
The firm can increase market price and P/E by retaining more earnings.
The firm can increase market price and P/E by increasing the growth rate.
The amount of earnings retained by the firm does not affect market price or the
P/E.
D. (A) and (B) above.
48. Participating preference share is a type of instrument that embodies:
A. Rights to convert to the ordinary shares of the issuer.
B. All the rights of ordinary shareholders.
C. Rights to acquire ordinary shares of the issuer in future under agreed terms.
D. Rights to participate in further share of the profits after the ordinary
shareholders have received their distribution.
49. The dividend discount model (DDM):
A. Ignores capital gains.
B. Incorporates the after-tax value of capital gains.
C. Includes capital gains implicitly.
D. Restricts capital gains to a minimum.
50. Many stock analysts assume that a mispriced stock will:
A. Immediately return to its intrinsic value.
B. Return to its intrinsic value within a few days.
C. Never return to its intrinsic value.
D. Gradually approach its intrinsic value over several months.
51. Investors want high plowback ratios:
A. For all firms.
B. Whenever ROE > k.
C. Whenever k > ROE.
D. Only when they are in low tax brackets.
52. Because the DDM requires multiple estimates, investors should:
A. Carefully examine inputs to the model.
B. Not use this model.
C. Feel confident that DDM estimates are correct.
D. All of the above
53. For
A.
B.
C.
D.
most firms, P/E ratios and risk:
Will be directly related.
Will have an inverse relationship.
Will be unrelated.
Will both increase as inflation increases.
54. Which of the following is least subject to manipulation?
A. Sales.
B. Earnings.
C. Inventory.
D. Expenses.
Use the following data to answer Questions 55 to 60.
An analyst gathered the following information on Ajasco Limited.
Share price
N50.00
Shareholders’ Equity
N200 million
Retention rate
60%
Shares outstanding
20 million
Expected sales
N80 million
Total operating expenses
N34 million
Profit after tax
N10 million
Note: Operating expenses include N4.0 million in depreciation and amortization.
55. Ajasco’s book value per share is:
A. N2.00
B. N5.00
C. N10.00
D. N12.00
56. Ajasco’s earnings per share is:
A. N0.2
B. N0.5
C. N2.0
D. N10.0
57. Ajasco’s Price to book ratio is:
A. N2.0
B. N3.0
C. N4.0
D. N5.0
58. Ajasco’s Price/earnings ratio is:
A. 10 times.
B. 20 times.
C. 50 times.
D. 100 times.
59. Ajasco’s dividend payout ratio is:
A. 0.2
B. 0.4
C. 0.6
D. 0.8
60. Ajasco’s cash flow per share is:
A. N2.0
B. N2.5
C. N3.0
D. N4.0
61. An unlisted company cannot raise additional funds through which of the following
methods?
A. Prospectus issue.
B. Private placement.
C. Rights issue.
D. Retained earnings.
62. Which of the following factors can affect stock prices?
A. The national economy.
B. The political situation in the country.
C. Global macroeconomic factors.
D. All of the above.
63. What is the most appropriate discount rate to use when applying a Free Cash Flow to
the Firm (FCFF) valuation model?
A. Equity investors’ required rate of return.
B. Weighted Average Cost of Capital.
C. Risk-free rate.
D. General interest rate in the economy.
64. Limited liability is often discussed as a reason to own ordinary shares. This means:
A. Stock value is guaranteed.
B. Ordinary shares have less risk than a bond held to maturity.
C. Ordinary shares always pay dividend.
D. Loss is limited to the amount of stock purchase price.
65. Which of the following statements is not correct about bonus issue?
A. It amounts to capitalization of reserves.
B. It represents additional shares issued to an investor free in the proportion of
existing share holding.
C. With a bonus issue, the par value of each stock increases.
D. Bonus issue does not result in cash outflow from the company.
66. Which of these is not an advantage of rights offering?
A. It protects the preemptive right of shareholders.
B. It is normally a low-cost alternative.
C. Requirements for using margin facilities to purchase rights offerings are
generally less stringent.
D. It guarantees higher future returns to the shareholders.
67. Which of the following is not a right of equity shareholders?
A. Right to vote at the AGM of the company.
B. Right to share profit in the form of dividends.
C. Right to receive a copy of the statutory report.
D. Right to have first claim in case of winding up of the company.
Fixed Income Valuation and Analysis (68 - 100)
68. A bond's indenture:
A. Contains its covenants.
B. Is the same as a debenture.
C. Relates only to its interest and principal payments.
D. Is the bond’s marketing document.
69. A bond has a par value of N5,000 and a coupon rate of 8.5% payable semiannually.
What is the naira amount of the semiannual coupon payment?
A. N212.50
B. N238.33
C. N425.00
D. N535.12
70. From the perspective of the bondholder, which of the following pairs of options would
add value to a straight (option-free) bond?
A. Call option, conversion option.
B. Put option, conversion option.
C. Prepayment option, put option.
D. Call option, exchangeable option.
71. Debt securities offer all the following benefits except:
A. To the issuer, debt interest is tax deductible.
B. The issuer raises money without relinquishing any ownership.
C. The company can establish or enhance its credit history.
D. The issuer’s ordinary shares increase in value.
72. Which of the following most accurately describes the maximum price for a currently
callable bond?
A. Its par value.
B. The call price.
C. The present value of its par value,
D. The price of an equivalent non-callable bond.
73. Which of the following is least likely a provision for the early retirement of debt by
the issuer?
A. A conversion option.
B. A call option.
C. A sinking fund.
D. All of the above.
74. A non-callable, AA-rated, 5-year zero-coupon bond with a yield of 6% is least likely
to have:
A. Interest rate risk.
B. Reinvestment risk.
C. Default risk.
D. Event risk.
75. Under the pure expectations theory, an inverted yield curve is interpreted as
evidence that:
A. Demand for long-term bonds is falling.
B. Short-term rates are expected to fall in the future.
C. Investors have very little demand for liquidity.
D. None of the above.
76. Which of the following statements most accurately describes the relationship
between the economic health of a nation and credit spreads?
A. Credit spreads and economic well-being are not correlated.
B. Credit spreads decrease during an expanding economy because corporate cash
flows are expected to rise.
C. Credit spreads increase during an expanding economy because corporations
invest in more speculative projects.
D. None of the above.
Use the following data to answer Questions 77 to 79.
An analyst observes a 20-year, 8% option-free bond with semiannual coupons. The
required semiannual-pay yield to maturity on this bond was 8%, but suddenly it drops
to 7.25%.
77. As
A.
B.
C.
D.
a result of the drop, the price of this bond:
Will increase.
Will decrease.
Will stay the same.
Will neither increase now decrease.
78. Prior to the change in the required yield, what was the price of the bond?
A. 92.64
B. 100.00
C. 107.85
D. 150.76
79. The percentage change in the price of this bond when the rate decreased is closest
to:
A. 7.86%
B. 7.79%
C. 8.00%
D. 9.26%
80. Which of the following provisions would most likely decrease the yield to maturity on
a debt security?
A. Call option.
B. Conversion option.
C. Cap on a floating-rate security.
D. None of the above.
81. Nominal yield is known by all the following except:
A. Coupon rate.
B. Interest rate.
C. Issue rate.
D. Market price.
82.
Bond A
Bond B
Maturity
10 Years
7 Years
Coupon
8%
5.20%
Duration
6.70%
3.90%
Proportion in Portfolio
80%
20%
Which of the following is the best measure of portfolio duration?
A. 5.30
B. 5.58
C. 6.14
D. 10.6
83. Which of the following statements is true with respect to re-investment rate risk?
A. If held to maturity, zero coupon bonds have no reinvestment rate risk
whatsoever.
B. The shorter the maturity of the bond, the greater will be its reinvestment rate
risk.
C. The greater the frequency of coupon payments, the lower will be the
reinvestment rate risk.
D. All of the above.
84. A 10-year, 8% coupon bond has a price of 97.21 of 100 par. If its modified duration
is 4.9 and the yields increase by 0.35%, what is the approximate percentage price
change for this bond?
A. -1.72%
B. 1.72%
C. 4.90%
D. -4.90%
85. Which of the following statements is not true with respect to convertible bonds?
A. With a convertible bond, it is the investor, rather than the issuer, who is buying
the embedded option.
B. Convertible bonds are not generally secured by any of the assets of the
underlying issuer.
C. Convertible bonds are more likely to be converted when the underlying share
prices have had a considerable appreciation.
D. Convertible bonds generally pay a much higher yield than non-convertible bonds.
86. Which of the following credit ratings is considered to be speculative rating issued by
either Standard & Poor’s or Moody’s?
I.
II.
III.
IV.
Baa
BBB
Ba
BB
A.
B.
C.
D.
I and II only.
III and IV only.
I, II and III only.
I, II, III and IV
87. Which of the following variables would best gauge a bond's liquidity?
A. The yield to maturity on the specific bond.
B. The reputation of the underlying issuer.
C. The length of the bond's maturity.
D. The bid-ask spread on a bond.
88. Which of the following bonds will
A. 15-year maturity and a 12%
B. 20-year maturity and a 12%
C. 10-year maturity and a 15%
D. 20-year maturity and an 8%
have the longest duration?
coupon.
coupon.
coupon.
coupon.
89. An investor who expects increasing interest rates should purchase a bond that has a
_____ coupon and a _____ term to maturity.
A. Zero, long.
B. High, long.
C. High, short.
D. Low, long.
90. Revenue bonds issued by a state government are directly backed by which of the
following sources of income?
A. Sales taxes.
B. Project revenues.
C. Federal Allocation.
D. The totality of internally generated funds of the state.
91. What happens on a corporate bond’s maturity date?
A. Bond holders continue to earn interest until they redeem their bonds
B. The issuer pays bondholders the current market price of the bond
C. The issuer repays the par value to bondholders
D. The issuer calls in the bond.
92.
The term “structure of interest rate” does not normally exhibit which of the
following shapes?
A. Upward sloping.
B. Inverted.
C. Flat.
D. Vertical.
93.
Which of the following statement is correct about spot rate? It is:
A. The yield on a zero-coupon security.
B. The yield spread between any two bond issues.
C. Also called swap rate.
D. The yield on a par bond.
94.
Sinking funds are most likely to:
A. Reduce default risk.
B. Increase liquidity risk.
C. Negatively affect bond rating.
D. Increase prepayment risk.
95.
In
A.
B.
C.
D.
relation to bonds, prepayment risk means:
The risk of unexpected change in cash flow structure.
The risk that principal will not be repaid when due.
The total risk involved in bond investment.
The risk that a bond will not be allotted to an investors who has made payment
to the issuer.
Use the information below to answer questions 96 to 98.
An observer observes the
Issuer:
Coupon:
Maturity:
Par value
Yield to maturity (YTM):
following bond:
Stallion bank
10%
2 years
N100
9%
96.
The price of Stallion Bank’s bond is:
A. 92.59
B. 98.55
C. 101.75
D. 102.63
97.
The duration of Stallion Bank’s bond is:
A. 1.85 years.
B. 1.91 years.
C. 2 years.
D. 2.5 years.
98.
The current yield of Stallion Bank’s bond is:
A. 9%
B. 9.83%
C. 10%
D. 10.2%
99.
The price-yield relationship of a bond is basically:
A. Linear.
B. Convex.
C. Undefined.
D. Flat.
100. Which of the following statements is not correct about accrued interest on corporate
bonds?
A. The seller pays it.
B. It is paid on settlement date.
C. It is required to determine the dirty price.
D. It is really not relevant to the investor buying the bond.
Total = 100 marks
FORMULAE
Levered/unlevered beta:
Annuities:
Yield to maturity of a bond:
Valuation of perpetual bonds:
Price change approximated with duration:
Portfolio duration:
Macaulay duration: