CIS March 2011 Exam Diet
Examination Paper 1.2:
Corporate Finance
Equity Valuation and Analysis
Fixed Income Valuation and Analysis
Corporate Finance (1 - 20)
1.
The following are benefits of using net present value as project evaluation technique
except:
A. It recognizes the time value of money.
B. Its variant, profitability index, is useful in ranking projects in a situation of
capital rationing.
C. It discounts cash flows with market determined cost of capital.
D. It considers the risk attached to the project and management attitude to risk.
2.
Which of the following are assumptions of Modigliani & Miller theory of capital
structure?
I. Assumption of perfect market.
II. Assumption of homogeneity of risk class for individuals and firms.
III. Assumption of non existence of taxation.
IV. Assumption of no institutional factors against the arbitrage process.
A.
B.
C.
D.
I, II and IV only
II, III and IV only
I, II, III, and IV
I, II and III only
3.
Identify which of the following statements is incorrect:
A. If stock is too low; there is a risk of interruption in production.
B. If stock is too low; there could be frequent ordering cost.
C. If stock is too low; there could be high stock out cost.
D. If stock is too low; there could be high carrying cost.
4.
Which of the following instruments is not currently traded on the Nigerian Stock
Exchange?
A.
B.
C.
D.
Ordinary shares.
Bonds.
Rights.
Warrants.
5.
If you buy a stock of a company at a market price of N5.20k and expect the price to
increase to N7.00k next year, what is the expected return on the stock, assuming
that no dividend is paid during the period?
A. 34.62%
B. 36.41%
C. 32.41%
D. 3.46%
6.
The Capital Asset Pricing Model is developed on the following assumptions except:
A. Investors are risk-averse individuals who maximize the expected utility of their
end of period wealth
B. There exists a risk-free security such that investors may borrow or lend
unlimited amount at the risk-free rate.
C. There are no market imperfections such as taxes, regulations or transaction
costs.
D. The quantities of securities (or assets) are variable.
7.
Identify which of the following statements is untrue:
A. Systematic risk is due to overall market risk such as tax reform and interest rate
fluctuations.
B. Total risk is the summation of systematic risk and unsystematic risk.
C. Efficient diversification reduces the systematic risk of the portfolio
D. Unsystematic risk is caused by factors which are unique to a particular company.
8.
Which one of the following procedures would properly account for inflation in capital
budgeting analysis?
A. Use nominal cash flow figures and discount them using real discount rates.
B. Use real cash flow figures and discount them using nominal discount rates.
C. Adjust the capital cost components for inflation, before calculating the weighted
average cost for the firm.
D. If inflation is built in into the cash flow projections and the discount rate, we do
not need to make any further adjustments.
9.
Which of the following is/are useful techniques for evaluating project risks?
I. Applying a maximum payback period for the project.
II. Including an allowance for business risk in the company’s cost of capital.
III. Applying sensitivity analysis to the project.
IV. Measuring the standard deviation of the NPV of the project.
A.
B.
C.
D.
I, II and III only
I, II, III and IV
I, III and IV only
II and III only
10. A N1,000 par value irredeemable bond selling for N500 in the market has a coupon
rate of 10%. What is the required rate of return?
A. 2%
B. 5%
C. 10%
D. 20%
11. Which of the following is the most likely source of financing a small business?
A. Bank loan.
B. Leasing.
C. Bonds.
D. Proprietor’s personal savings.
12. Which of the
company?
A. Increase
B. Increase
C. Increase
D. Increase
following would not lead to an increase in the rate of growth of a
in
in
in
in
operating margin.
asset turnover ratio.
times interest earned.
leverage ratio.
13. If a company does not have any part of its capital in form of preference shares or
loan stock, it is said to be:
A. Geared.
B. Ungeared.
C. Relatively ungeared.
D. Highly geared.
14. Which of the following cannot be an objective of a firm?
A. To maximize profit.
B. To maximize sales.
C. To maximize shareholder’s wealth.
D. None of the above.
15. Which of the following steps is not appropriate for improving the cash flow of a
company?
A. Reduce the period of credit granted to debtors.
B. Reduce production cycle.
C. Reduce the amount of credit taken from creditors.
D. Reduce stock turnover periods.
16. 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 value of any asset is the sum of the discounted benefits expected to accrue
from owning it.
C. Valuation of unquoted companies is highly subjective.
D. All of the above.
17. The following statements are true about equity capital, except:
A. There are no fixed amounts of dividends payable.
B. Perpetual debentures constitute an integral part of equity capital.
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.
18. Effective credit control policy requires careful consideration of which of the following?
I.
II.
III.
IV.
Credit period.
Cost of cash discounts.
Collection policy.
Assessment of credit worthiness.
A.
B.
C.
D.
II, III and IV only
I, III and IV only
I, II and III only
I, II, III and IV
19. Which of the following is likely to occur as a company's debt/total capital ratio
increases?
I.
II.
III.
IV.
Both the cost of debt and the cost of equity will increase.
The weighted average cost of capital will first decline, and then begin to rise.
The beta of the company's stock will begin to increase.
The price of the common shares will tend to peak before earnings per share
reaches its peak.
A.
B.
C.
D.
III and IV only
I and III only
I, III and IV only
I, II, III and IV
20. Which of the following statements is least accurate with respect to the impact
changes in working capital will have on the capital budgeting process?
A. An increase in inventory will translate into a cash flow that is actually lower than
reported net income.
B. An increase in accounts receivable will translate into a cash flow that is actually
higher than reported net income.
C. An increase in accounts payable will translate into a cash flow that is actually
higher than reported net income.
D. Within this context, the working capital measure would exclude cash.
Equity Valuation and Analysis (21 - 40)
21. Which of the following statements is true with respect to the P/E ratios?
A. It is not commonly used as a valuation metric.
B. It gives an estimate of how long it would take (in years) before a share earns its
current market value.
C. As the growth prospects of a company's earnings are reduced, the P/E ratio will
rise as a result of a decrease in the denominator.
D. The greater the liquidity of reported earnings, the lower will be the P/E multiple.
22. In a highly efficient market, what do you expect the impact to be on the stock price
of a company which announces an unexpected large increase in its dividend
payments?
A. An abnormal price decrease at the time of the announcement.
B. The stock price should not change because nothing has really changed within the
company.
C. Actually, the stock price will decrease because it will indicate that the company
no longer has any profitable opportunities to finance with its earned income.
D. An abnormal price increase at the time of the announcement.
23. Which of the following statements best characterizes defensive stocks?
A. Defensive stocks are conservative with respect to how much dividends they pay
out to shareholders.
B. Defensive stocks makes reference to how conservative a company is within an
industry, therefore, there is a conservative stock from every industry.
C. Defensive stocks generally consist of companies that supply goods and services
to the military.
D. Defensive stocks exhibit a low correlation with respect to movements in the
market.
24. 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.
25. A stock is expected to pay a dividend of N0.52 per share at the end of the current
fiscal year. The risk-free rate is 4.5% and the risk premium for such a stock is 2.3%.
You expect the long-run growth rate in dividends to be 3.1%. What should this stock
be trading at?
A. N14.05
B. N3.92
C. N12.84
D. N8.97
26. The rights of equity shareholders include which of the following?
I.
II.
III.
IV.
Right to exercise control through voting.
Residual right to earnings.
Pre-emptive right to maintain proportion of ownership through rights issue.
Right of residual claim on the assets of the company.
A.
B.
C.
D.
I and III only
II and III only
I, II and III only
I, II, III and IV
27. What is the required rate of return for a stock with a beta of 1.2, when the risk- free
rate is 6% and the market is offering 12%?
A. 6.0%
B. 7.2%
C. 13.2%
D. 13.8%
28. Which of the following is/are fundamental assumptions of the dividend growth model
of equity valuation?
E.
F.
Dividend grows at a known, fixed rate into the nearest future.
Rate of growth of dividend should always be higher than the required rate of
return.
G. No restrictive relationship needs to exist between the growth rate of dividend
and the required rate of return.
H. None of the above.
29. The rate of return of stock X moves faster than that of the stock market when the
market is trending upward. Stock X is most likely to have:
A. Beta of zero.
B. Beta of 1.
C. Beta greater than 1.
D. Negative beta.
30. You are given the following estimates of future cash flows for ABC Ltd:
Cash flow (N'm)
Year 1
Year 2
Year 3
Year 4
-20
35
40
40
If the company’s WACC is 15%, compute the present value of the future cash flows
for the next 4 years.
A. N58.24 million.
B. N82.61 million.
C. N93.02 million.
D. N117.39 million.
31. When you observe relatively very high price to book ratio, the market is most likely:
A. Bullish.
B. Bearish.
C. Recovering.
D. Uncertain.
32. Which of the following organisations has the ultimate regulatory oversight over the
Nigerian Stock market?
A. Chartered Institute of Stockbrokers.
B. Nigerian Stock Exchange.
C. Central Securities Clearing System.
D. None of the above.
33. DEF Limited is a start-up company with future growth prospects. Given the
information below from the most recent financials, estimate the share price of the
company using price to sales ratio:
DEF Limited
Turnover – N50 million
Number of shares outstanding – N10 million
Profit after tax – N25 million (loss)
Peer company comparable to DEF Limited
Price-earnings ratio - 3 times
Price to sale ratio – 2 times
A.
B.
C.
D.
N5 per share
N7.5 per share
N7.5 per share
N10 per share
34. The preference shares of Brant Limited are valued in the market at N6 per share.
Assuming constant dividend of 50k per share in perpetuity, what is the best estimate
of the required rate of return of investors?
A. 8.33%
B. 10%
C. 12%
D. Insufficient Information for computation.
35. Which of the following has not been an advantage of equities as an investment
vehicle over bonds in the Nigerian capital market over the years?
A. Greater liquidity
B. Higher returns
C. Wider variety of instruments
D. Lower risk
36. Which of the following investments expose the holders to the lowest degree of risk?
A. Bonds.
B. Preference shares.
C. Ordinary shares.
D. Hybrid securities.
37. In company analysis, which of the following considerations are important?
I. Corporate strategy.
II. Calibre, motivation, integrity, dynamism, and commitment of the top
management personnel.
III. Competitive advantage of the company.
IV. Stability of the firm’s industry and/or products.
A.
B.
C.
D.
I and II only
II and III only
I, II and III only
I, II,III and IV
38. Which of the following ratios will be least helpful when analysing equity investments
aimed at generating dividend income in the next few years?
A. Return on equity.
B. Dividend payout ratio.
C. Earnings yield.
D. Stock turnover.
39. Compute the free cash flow from operations of Warlords Limited from the financial
forecasts below:
N
Sales
Cost of goods sold
General expenses
Depreciation
Interest expenses
Net Investments in fixed assets
Changes in net working capital
Corporate tax rate
A.
B.
C.
D.
N74
N94
N104
N114
600
300
180
40
10
-6
-4
20%
40. Stock market indexes are used for the following purposes except:
A. To measure the general performance of the market.
B. To perform fundamental analysis.
C. To predict future price movement.
D. To analyse factors underlying stock price market.
Fixed Income Valuation and Analysis (41 - 60)
41. Which of the following is/are false in relation to the yield curve?
I. Yield curve cannot have a negative slope.
II. Yield spreads between high and low grade corporate bonds tend to widen during
a boom period in the economy.
III. Riding the yield curve is a strategy that requires purchase of longer term bonds
when the yield curve is sloped upwards and expected to maintain the same level
and slope.
A.
B.
C.
D.
I only
II only
I and II only
II and III only
42. Which of the following theories advocates that investors are not indifferent to risk
and they charge higher rates than the expected future rates, if the maturity of the
instrument increases?
A. Naïve expectation theory.
B. Pure expectations theory.
C. Liquidity premium theory.
D. Preferred habitat theory.
43. Which of the following statements is/are false for the duration of a bond?
I. For all bonds which pay periodic coupons, duration is more than the term to
maturity.
II. A bond‘s duration will be equal to its term to maturity if it is a zero-coupon bond.
III. As the maturity of the coupon-bearing bond is lengthened, duration also
increases albeit at a faster rate.
A.
B.
C.
D.
I only
I and III only
II and III only
I, II and III
44. Consider the following data of a bond of BYY Ltd:
Par value: N3,000
Coupon rate: 12%
Years to maturity: 2
If the required rate of return is 14%, then the value of the bond is:
A. N2,684.24
B. N2,721.80
C. N2,861.45
D. N2,901.20
45. Assume that 3-year bonds are yielding 12% and 5-year bonds are yielding 13%. The
implied yield of 2-year bond after 3 years from now is:
A. 10.52%
B. 14.52%
C. 15.13%
D. 15.57%
46. Which of the following types of investments experience the least interest rate risk?
A. Zero coupon bonds.
B. Long term government bonds.
C. Preferred stock.
D. Long term corporate bonds.
47. Which of the following equations is correct in respect of bond pricing?
A. Full bond price = Quoted price + Accrued interest
B. Full bond price = Quoted price - Accrued interest
C. Full bond price = Quoted price
D. Full bond price = Clean price
48. Which of the following statement about warrants is not correct?
A. A warrant could be used as sweetner to a bond issue.
B. When warrants are exercised the balance sheet of the issuer is affected.
C. Warrants are similar to call options in some respects.
D. The number of warrant needed to purchase one ordinary share is determined by
the exercise price of the warrant.
49. Which of the following statements is true?
A. A callable bond is one that can be retired early at the instance of the holder.
B. The minimum value of a convertible bond is the lower of its conversion value or
its straight bond value.
C. A floating rate noteholder is usually less exposed to interest rate risk than a
straight bondholder.
D. Stripped bonds are zero-coupon bonds artificially created from corporate bonds
with low credit risk.
50. Which of the following statements is least accurate with respect to the price volatility
characteristics of putable bonds?
A. The price of a putable bond can never become lower than the price of an
equivalent non-putable bond.
B. The yield on a non-putable bond can never become higher than the yield of an
equivalent putable bond.
C. At yield levels above that of the coupon rate, putable bonds become extremely
sensitive to small changes in yield.
D. For low levels of yield, the price volatility characteristics of a putable bond will
mirror those of an equivalent non-putable bond.
51. Which of the following least accurately describes the various forms of event risk that
may impair an issuer's ability to meet its bond obligations?
A. An increasing number of new regulations could very well reduce an issuer's
financial ability to meet its bond obligations.
B. A foreign government may very well refuse its obligations to meet the terms of
any bonds that it has issued.
C. Municipal bonds may be subject to political risk and, therefore, default.
D. Corporate restructuring often improves the issuer's ability to meet its bond
obligations.
52. The term structure of interest rate could take which of these shapes?
I. Upward sloping.
II. Inverted.
III. Humped.
A.
B.
C.
D.
I and II only
I and III only
II and III only
I, II and III
53. The nominal interest rate could be decomposed into which of the following
component?
I. Real interest rate.
II. Inflation premium.
III. Risk premium.
A.
B.
C.
D.
I and II only
I and III only
II and III only
I, II and III
54. Which of the following statements is (are) true with respect to the types of extra
features that may be incorporated into a bond?
I.
Special redemption prices allow the issuer to call its bonds at just par, if certain
circumstances prevail.
II. Exchangeable bonds allow the holder to exchange the bonds for the common
shares of the underlying issuer.
III. Put provisions allow the holder of the bonds to deliver the underlying bond to the
issuer in exchange for some predetermined price.
A.
B.
C.
D.
I and II only
I and III only
II and III only
I, II and III
55. Commercial papers are:
A. Secured promissory note.
B. Unsecured promissory notes.
C. Sold at a risk premium.
D. Issued for over one year.
56. The price of a fixed income security moves:
A. In the opposite direction of a change in interest rate.
B. Along the direction of a change in interest rate.
C. Based on other factors apart from change in interest rate.
D. Only based on changes in the credit rating of the issuer.
57. In
A.
B.
C.
D.
the fixed income market, price risk and re-investment risk:
Act in opposite direction.
Act in the same direction.
Act independently.
Act in direction that cannot be predicted.
58. Which of the following statements is (are) true?
I.
A bond with a sinking fund provision is less volatile than a similar maturity bullet
bond.
II. Callable bonds exhibit less price volatility than their similar maturity non-callable
counterpart.
III. Price volatility is a symmetric phenomenon.
IV. For a given maturity, low coupon bonds are more volatile than high coupon
bonds.
A.
B.
C.
D.
I, II and III
I, II and IV
II, III and IV
III and IV only
59. You are given the following details about a bond:
Current price – 99.7%
Market yield – 7%
Bond duration – 3.67 years
Using duration to approximate price changes, what happens if the yield rises by 50
basis points (that is: 0.5%)?
A. Bond price decreases by 1.71%
B. Bond price increases by 1.71%
C. Bond price decreases by 3.42%
D. Bond price increases by 3.42%
60. With respect to credit risk and bond rating, which of these statements is correct?
A. Ability to repay debt is ultimately linked to the borrower’s “ability to generate
high profit”.
B. A “high yield” bond is one whose issuer has extremely strong capacity to pay
interest and repay principal.
C. Bonds with rating Aaa – Baa (using Moody rating) are considered investment
quality bonds.
D. Bonds ratings have no influence on the borrowing cost of the issuer.
Total = 60 marks
Question 2 - Corporate Finance
2(a) What is profitability index in capital budgeting?
(2 marks)
2(b) List two situations where the Weighted Average Cost of Capital (WACC) is
inappropriate as a discount rate for project appraisal.
(1 mark)
Question 3 – Equity Valuation and Analysis
3(a) Give two possible reasons why a company would reduce its dividend payout ratio.
(2 marks)
3(b) What do you understand by a ‘defensive stock’?
(2 marks)
Question 4 – Fixed Income Valuation and Analysis
4(a) The current price of a bond is 93 and rises to 96 at the end of a single period. If the
interest received is 5%, compute the holding period yield.
(1 mark)
4(b) What is a floating rate note? Does it have any special attraction as a fixed income
instrument?
(2 marks)
Question 5 - Corporate Finance
5(a) A financial analyst had done some preliminary analysis on three projects, A, B and C.
Detailed below is the result of the analysis.
PROJECT
NPV at 20%
discount rate (N)
NPV at 12%
discount rate (N)
A
(3,580)
12,250
B
(20,500)
30,825
C
(45,620)
102,300
Required:
Using the IRR appraisal technique, rank projects A, B and C in order of attractiveness
(5 marks)
5(b) Briefly explain how you would treat the following items when using the DCF valuation
techniques for capital budgeting:
5(b1) Sunk cost.
(1 mark)
5(b2) Working capital.
(2 marks)
5(b3) Inflation.
(2 marks)
Question 6 - Equity Valuation and Analysis
The shares of Global Market Bank Plc are quoted on the Nigerian Stock Exchange, and
are currently trading at N80. You would like to consider investing in the shares of the
company, but intend to carry out some research before taking the final decision.
The research department of your stockbroking firm was able to provide you with some
relevant information:
Projected EPS (for next year)
Dividend payout ratio
Return on equity
Required rate of return
- N15
- 60%
- 10%
- 12%
6(a) What is your opinion on the intrinsic value of the shares, using the dividend growth
model? Based on this, what action would you take?
(5 marks)
6(b)
You discovered that the correct estimate of the required rate of return was actually
20%. Will this change your decision in 6(a) above?
(5 marks)
Question 7 - Fixed Income Valuation and Analysis
7(a) Briefly explain the following concepts in the fixed income market:
7(a1)
Putable bond.
(1 mark)
7(a2)
Interest rate risk.
(1 mark)
7(a3)
Immunisation strategy.
(1 mark)
7(a4)
Sinking fund provision.
(1 mark)
7(b) A bond will pay N1, 000 in exactly 5 years. Assuming a 5-year spot rate of 5%, what
is the maximum price you would pay for the bond today? Explain.
(2 marks)
7(c) This is January 1, 2011. GMT Ltd just issued a convertible bond with a coupon rate of
5% p.a, payable annually. The bond has a face value of N1,000 and matures on 31st
December 2015.
Assuming straight bonds comparable with the GMT convertible bonds are yielding 7%
p.a, compute the straight bond value of the GMT bonds.
(4 marks)
FORMULAE
1)
2)
3)
Levered/unlevered beta:
Annuities:
Yield to maturity of a bond:
4)
Valuation of perpetual bonds:
5)
Price change approximated with duration:
6)
Portfolio duration: