SECTION A QUESTIONS
1. THE FINANCIAL MANAGEMENT FUNCTION
1. Which of the following is one of the 3E’s “value for money” concept?
A.
B.
C.
D.
Earnings
Equity
Evaluation
Effectiveness
2. Which of the following is most consistent with the maximising shareholder
wealth?
A.
B.
C.
D.
Profit maximisation
Market share growth
Maximising the firm‟s cost of capital
Maximising earnings per share
3. Which of the following statements is correct?
A.
B.
C.
D.
Profit maximization results in shareholder wealth maximisation
Divorce of ownership and control can lead to agency costs
Maximising earnings per share results in shareholder wealth maximisation
Increasing market share will lead to increased shareholder wealth
4. Which of the following is the best indicator of shareholder wealth?
A.
B.
C.
D.
Profit before interest and tax
Sales revenues
Market price of the share
Price/earnings ratio
5. Which of the following is not consequence or symptom of the agency problem?
A.
B.
C.
D.
Managers diverting funds into their own pet projects
Managers selecting quick payback projects
Managers engaging in empire building
Managers increasing the firm‟s level of financial gearing
6. Hathaway Co has just paid a dividend of $0.21 per share and its share price is $3.50 per
share. One year ago its share price was $3.60 per share
Working to one decimal place, what is the total shareholder return over the
period?
A. 8.9%
B. 8.6%
C. 3.1%
D. 0.9%
7. Which or the following actions is most likely to increase shareholder wealth?
A.
B.
C.
D.
The average cost of capital is increased by a recent financing decision
The firm‟s cash operating cycle becomes longer
The board of directors decides to invest in a project with a quick payback period
The annual report declares full compliance with the corporate governance code
8. Which of the following statements about non-for-profit organisations is correct?
A. Not-for-profit organisations often have multiple stakeholders with conflicting
objectives
B. The provision of value for money embodies economy, equality and effectiveness
C. Not-for-profit organisations usually have one dominant stakeholder
D. The key objective of not-for-profit organisations is to make profits
9. The following are extracts from the statement of profit or loss of IQ Co
Sales revenue
Cost of sales
$'000
60,000
50,000
Profit before interest and
tax
Interest
10,000
4,000
Profit before tax
Tax
6,000
4,500
Profit after tax
1,500
80% of the cost of sales is variable
costs.
What is the operational gearing of IQ Co?
A.
B.
C.
D.
2.0 times
2.5 times
0.5 times
3.0 times
10. Which of the following statements about financial management are correct?
1. it is concerned with investment decisions, financing decisions and dividend
decisions.
2. It may use information from management accounting
3. It must hedge all of the firm‟s currency risks
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
11. Which of the followig statements about a company with low operating gearing is
true?
A.
B.
C.
D.
A change in sales will have a relatively small impact on profits
The company has a relatively low proportion of debt finance
The company will have higher risk and increased potential return
The company will have low interest cover
12. The following information relates to a company:
Year
Earnings
per
share
Dividends
per
share
Share price at start of year
0
$
1
$
2
$
3
$
o.30
0.318
0.339
0.357
0.13
1.95
0.132
1.98
0.133
2.01
0.15
2.25
Which of the following statements is correct?
A.
B.
C.
D.
The dividend payout ratio is greater than 40% in every year in period
Mean growth in dividends per share over the period is 4%
Total shareholder return for the third year is 26%
Mean growth in earnings per share over the period is 6% per year
13. 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.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
14. Which of the following is LEAST likely to fall within financial management?
A.
B.
C.
D.
The dividend payment to shareholders is increased
Funds are raised to finance an investment project
Surplus assets are sold off
Non-executive directors are appointed to the remuneration committee
15. The following are extracts from the statement of financial position of a company:
Equity
Ordinary shares
Reserves
$'000
8,000
20,000
$'000
28,000
Non-current liabilities
Loan notes
Bank loans
Preference shares
4,000
6,200
2,000
12,200
Current liabilities
Overdraft
Trade payables
Total equity and liabilities
1,000
1,500
2,500
42,700
The ordinary shares have a nominal value of $0.50 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 $0.80 per share. The loan notes have a nominal value of $100 and
are trading at $105 per loan note.
What is the market value weighted gearing of the company, defined as prior
charge capital/equity?
A.
B.
C.
D.
15.0%
13.0%
11.8%
7.3%
16. Kent Co had sales growth of 10% over the past year. EBIT grew by 15% and earnings
per share (EPS) grew by 25% over the same period
Which of the following statements about Kent Co’s gearing is correct?
A.
B.
C.
D.
Total gearing is equal to 0.9
Total gearing is equal to 2.1
Financial gearing is equal to 0.6
Operating gearing is equal to 1.5
17. TKQ Co has just paid a dividend of 21 c per share and its share price is $3.50 per share.
One year ago its share price was $3.10 per share.
What is the total shareholder return over the period, to one decimal place?
A.
B.
C.
D.
17.4
18.2
18.9
19.7
18. Value for money is an important objective for not-for - profit organizations
Which action is Least consistent with increasing value for money?
A. Using a cheaper source of goods without decreasing the quality of not-for-profit
organisation services
B. Searching for ways to diversify the finances of the not-for-profit organisation
C. Decreasing waste in the provision of a service by the not-for-profit organisation
D. Focusing on meeting the objectives of the not-for-profit organization
2. THE FINANCIAL MANAGEMENT ENVIRONMENT
1. Which of the following is least likely to act as a financial intermediary?
A.
B.
C.
D.
Insurance company
Pension fund
Credit rating agency
Islamic bank
2. Which of the following lists of securities is ranked in order of increasing risk of
the investor?
A.
B.
C.
D.
Ordinary share, unsecured loan, preference share
Unsecured loan, preference share, ordinary share
Preference share, unsecured loan, ordinary share
Ordinary share, preference share, unsecured loan
3. Which if the following best describes commercial paper?
A.
B.
C.
D.
Secured long-term loan notes issued by companies
Secured short-term loan notes issued by companies
Unsecured long-term loan notes issued by companies
Unsecured short-term loan notes issued by companies
4. Which of the following would be least likely to be a function of a treasury
department?
A.
B.
C.
D.
Managing relationships with banks
Liquidity management including investment of surplus funds
Currency management
Investment appraisal
5. Which of the following is likely to have the lowest expected rate of return?
A.
B.
C.
D.
Unsecured bank loan
Preference shares
Secured loan notes
Ordinary shares
6. Which of the following statements are features of money market instruments?
1. Interest bearing instruments usually trade below their nominal value
2. The yield on commercial paper is usually higher than that on treasury bills
3. Negotiable instruments cam be sold before their maturity date
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
7. Governments have a number of economic targets as part of their fiscal policy.
Which of the following targets relate predominantly to fiscal policy?
1.
2.
3.
4.
A.
B.
C.
D.
Increasing tax revenues
Controlling the growth in the size of the money supply
Reducing public expenditure
Keeping interest rates low
1 only
1 and 3 only
2 and 4 only
2,3 and 4
8. Freely fluctuating exchange rates perform which of the following functions?
A.
B.
C.
D.
They tend to correct a trade surplus or deficit
They make imports cheaper and exports more expensive
They eliminate the opportunity for currency speculation
They eliminate business‟ exposure to currency risk
9. Supply side economic policy is designed for what purpose?
A.
B.
C.
D.
To raise the level of demand in the company
To increase the provision of state services
To improve the ability of the economy to produce goods and services
To reduce interest rates by increasing the money supply
10. Which of the following government policies would not lend to raise national
income over time?
A.
B.
C.
D.
Increased expenditure on infrastructure
Tex cuts to encourage higher spending by consumers
Supply side policies to increase labour flexibility
Incentives to encourage personal saving
11. Which of the following statements is/are correct?
1. Securitization is the conversion of illiquid assets into marketable securities
2. The reverse yield gap refers to equity yield being higher than debt yield
3. Disintermediation arises where borrowers deal directly with lending individuals
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
3. INVESTMENT DECISIONS
1. Harvey Co is evaluating a capital investment proposal with the following information:
Initial cost
Life
Annual operating cash flow
Scrap value
$500,000
10 years
$200,000
$100,000
The investment will be depreciated using the straight-line method
What is the payback period for this investment ?
A.
B.
C.
D.
3.25 years
2.67 years
2.5 years
2 years
2. A project requires an initial outlay of $1,000. The forecast cash inflows are:
Year 1
Year 2
Year 3
Year 4
$200
$200
$400
$400
What is the investment’s payback period?
A.
B.
C.
D.
4.0 years
3.5 years
3.4 years
3.0 years
3. Which of the following statements about investment decision making methods is
true?
A. The discounted payback method takes into account cash flows for all periods
B. The payback method ignores all cash flows after the end of the payback period
C. The net present value rule is to accept investment opportunities when their rates
of return exceed the company‟s weighted average cost of capital
D. The internal rate of return is to accept the investment of the weighted average
cost of capital is greater than the internal rate of return
4. Which of the following statements about investment decision making is correct?
A.
B.
C.
D.
Opportunity costs are not relevant
The accounting rate of return considers the time value of money
A strength of the payback method is that it is based on profitability
Capital budgeting is based on predictions of an uncertain future
5. A company with an 8% cost of capital purchases a machine for $ 43,000. The forecast
operating cash flows generated by the machine are as follows:
Year 1
Year 2
Year 3
Year 4
$10,000
$15,000
$20,000
$27,000
What is the discounted payback period in years?
A.
B.
C.
D.
3.10
3.25
2.90
3.14
6. Kunchman Kookies will invest $100,000 in new equipment. The firm‟s discount rate is
8% and the operating cash flows from the investment are expected to be as follows;
Year 1
Year 2
Year 3
Year 4
$35,000
$38,000
$20,000
$10,000
What is the investments payback period in years?
A.
B.
C.
D.
2.3
3.1
4.0
4.7
4. DISCOUNTED CASH FLOWS TECHNIQUES
1. Gunning Industries is considering investment in a new machine. The following informal is
provided:




The new machine will cost $ 190,000 and has a five year life with zero scrap
value
The investment in the new machine will also require an increase in working
capital of $35,000
Tax-allowable depreciation is available on a straight-line basis
Gunning is subject to a 40% tax rate and has a 10% cost of capital
What is the present value of the tax saving on the first year’s tax- allowable
depreciation?
A.
B.
C.
D.
$13,817
$15,200
$16,762
$20,725
2. Wendy‟s Sandwich Shop acquires an asset for $100,000 that has no residual value and
a 10-year life. Wendy‟s tax rate is 40% tax allowable depreciation is available on a
straight-line basis
What is Wendy’s annual tax saving from the asset?
A.
B.
C.
D.
$10,000
$6,000
$4,000
$2,000
3. Which of the following events would decrease the internal rate of return of a
potential investment?
A.
B.
C.
D.
Decreased tax-allowable depreciation available on the investment
Decreased working capital requirements
Decreased cost of capital
Using reducing balance, instead of straight-line depreciation
4. Which of the following changes would result in the highest present value for a
series of cash flows?
A.
B.
C.
D.
A $100 decrease in taxes each year for four years
A $100 decrease in the cash outflow each year for three years
A $100 increase in disposal value at the end of four years
A $100 increase in cash inflow each year for three years
5. Which of the following is an advantage of the net present value method?
A.
B.
C.
D.
It is measured in time, not dollars
It uses accrual basis, not cash basis accounting for a project
It uses the accounting rate of return
It accounts for compounding of returns
6. ABC Co plans to buy a new machine. The cost of the machine is $ 100,000 and it has a
five- year life with no disposal value. The machine will be depreciated on a straight line
basis which matches the policy for tax allowable depreciation. The machine will increase
annual operating cash flows by $50,000 ABC‟s profit tax rate is 35%
What is annual after-tax cash flow generated by the machine?
A.
B.
C.
D.
$19,500
$30,000
$32,500
$39,500
7. A company has identified two mutually-exclusive projects which have an equivalent
effect on the risk profile of the company:
Project I
Project II
Discounted payback period 2.8 years
3.2 years
Net
present
value
$17,200
$15,700
Internal rate of return
18%
22%
Accounting rate of return
19%
21%
The company‟s cost of capital is 15%
Assuming that the directors wish to maximise shareholder wealth and no
shortage of capital is expected, which of project should the company choose?
A.
B.
C.
D.
Project I because it has the shorter payback period
Project I because it has higher net present value
Project II because it has the higher internal rate of return
Project II because it has the higher accounting rate of return
8. A project has an initial cash outflow followed by several years of cash inflows.
What would be the effects on the internal rate of return (IRR) of the project and its
discounted payback period (PPP) of a decrease in the company’s cost of capital?
A
B
C
D
IRR
Decrease
Decrease
No change
No change
DPP
Decrease
Increase
Decrease
Increase
9. A company has a “money” cost of capital of 21% per year. The general inflation rate is
9% per year
What is the “real” cost of capital?
A.
B.
C.
D.
9%
11%
12%
21%
10. The following data is relevant to the evaluation of a particular project:
10%
per
Cost of capital in real terms
year
General inflation rate
5% per year
Specific inflation rate of project's annual cash
inflow
6% per year
Specific inflation rate of project's annual cash
outflow
4% per year
Which of the following sets of adjustments will lead to the correct calculation of
net present value?
Discount
Cash inflow
Cash outflow
rate
5%
annual 5%
annual
A
increase
increase
15.5%
6%
annual 4%
annual
B
increase
increase
15.0%
6%
annual 4%
annual
C
increase
increase
15.5%
D
Unadjusted
Unadjusted
10.0%
5. APPLICATIONS OF DISCOUNTED CASH FLOW TECHNIQUES
1. Which of the following is a limitation of the profitability index?
A.
B.
C.
D.
It uses accounting profits rather than cash flows
It ignores the time value of money
It is inconsistent with the goal of shareholder wealth maximization
It cannot deal with multi-period capital rationing
2. ABC Co is trying to decide between keeping an existing machine or replacing it with a
new machine. The old machine was purchased just two years ago for $50,000 and
had an expected life of 10 years. It now costs $1,000 a month for maintenance and
repairs due to a mechanical problem. A new machine is being considered to replace if
at a cost of $60,000. The new machine is more efficient and it will only cost $200 a
month for maintenance and repairs. The new machine has an expected life of 10
years
In deciding to replace the old machine, which of the following factors should
ABC not consider?
A.
B.
C.
D.
Any estimated scrap value on the old machine
The original cost of the old machine
The estimated useful life of the new machine
The lower maintenance cost on the new machine
3. A company is considering whether to buy or lease two assets:
Asset 1 has a 10-year economic life with a zero residual value. It can be purchased
for $80,000 payable immediately. Alternatively, it can be leased with 10 lease rentals
of $12,000 per year payable annually in advance.
Asset 2 has a five- year economic life. It can be purchased for $81,000 payable
immediately and will have a residual value of $40,000 after five years. Alternatively, it
can be leased with five lease rentals of $14,000 per year payable annually in arrears
The appropriate discount rate is 10% per year.
How should the company finance each asset?
Asset 1
Asset 2
A
Lease
Lease
B
Lease
Buy
C
Buy
Lease
D
Buy
Buy
4. The cost of purchasing a machine is $100,000 payable immediately. Its disposal
value is expected to be $10,000 in five year‟s time.
The same asset can be leased for a period of five years with rentals of $25,000
payable annually in advance.
What is the net present value (to the nearest $10) to the lessor if it purchases
the machine then leases it to the user on the above terms if it applies an annual
discount rate of 10%?
A.
B.
C.
D.
$990 positive
$10,460 positive
$1,960 negative
$11,440 negative
5. A machine costing $150,000 has a useful life of eight years, after which time its
estimated resale value will be $25,000. Annual running costs will be $5,000 for the
first three years of use and then $8,000 for each of the next five years. All running
costs are payable on the last day of the year of which they relate
Using a discount rate of 20%, what is the equivalent annual cost of the machine
(to the nearest $100)?
A.
B.
C.
D.
46,600
43,900
43,400
21,100
6. PROJECT APPRAISAL UNDER RISK
1. During a typical year, Deet Co experience the following power cuts:
Number
of
months
3
2
4
3
12
Number of power
cuts per months
0
1
2
3
Each power cut results in additional costs of $400. For $500 per month, Deet can
lease a generator to provide electricity during power cuts
If Deet leases the generator what is the estimated annual savings/(additional
cost)?
A.
B.
C.
D.
($3,600)
($1,200)
$1,600
$1,900
2. Excalibur Co has developed a model to predict sales levels for its beachwear based on
long-range weather forecasts. The probability of various temperatures and related
sales units are as follows:
Units sales
10,000
30,000
500,000
40,000
250,000
Temperature
below 20
20-24
24-28
28-32
over 32
Probability
5%
25%
50%
15%
5%
What sales volume, in units, would Excalibur Co anticipate using the expected
value approach?
A.
B.
C.
D.
31,000
40,250
50,000
155,000
3. A shopkeeper has determined the following probability distribution of weekly demand
for one of his most popular products
The shopkeeper must order each week‟s sales in advance and any items left in
inventory at the end of the week are scrapped. The items cost the shopkeeper $2.50
and he sells them for $3 each
What is the optimal quantity to be ordered each week?
A.
B.
C.
D.
300
400
450
500
4. A company has constructed a model for predicting profits. Net profit or loss depends
on two variables: gross profit and overheads. The following are independent probability
distribution of the two variables :
Gross profit
$
12,000
6,000
4,000
3,000
Probability Overheads
$
0.1
6,000
0.4
4,000
0.4
3,000
0.1
2,000
Probability
0.3
0.3
0.3
0.1
What is the probability that the company will make a positive net profit?
A.
B.
C.
D.
0.27
0.55
0.73
0.83
5. Adrian is contemplating purchasing for $60,000 a machine which he will use to
produce 10,000 disks per year for five years. These disks will be sold for $9 each and
unit variable costs are expected to be $5. Incremental fixed costs will be $14,000 per
year for production costs and $5,000 per year for selling and administration costs.
Adrian has a discount rate of 10% per year
By how many units must the estimate of production and sales volume fall for
the project to be regarded as not worthwhile?
A.
B.
C.
D.
575
1,293
1,623
2,463
6. The following financial information relates to an investment project:
Present value of sales revenue
Present value of variable cost
$'0000
50,025
25,475
Present value of contribution
Present value of fixed
costs
24,550
Present value of operating income
Initial investment
6,300
5,000
18,250
What is the sensitivity of the net present value of the investment project to a
change in fixed costs?
A.
B.
C.
D.
7.1%
5.3%
5.1%
2.6%
7. An investment project has a cost of $12,000, payable at the start of the first year of
operation. The possible future cash flows arising from the investment project have the
following present values and associated probabilities :
PV of
Year 1
flow($)
16,000
12,000
-4,000
PV of
cash
Year 2
Probability flow($)
0.15
20,000
0.6
-20,000
0.25
cash
Probability
0.75
0.25
What is the expected net present value of the investment project?
A.
B.
C.
D.
$11,850
$28,700
$11,100
$76,300
7. EQUITY FINANCE AND DEBT FINANCE
1. What is a major advantage of issuing long-term debt?
A.
B.
C.
D.
Increased financial flexibility
The reduction in profit before tax
Decreased financial risk
The reduction of shareholders‟ control over the company
2. When issuing new loan notes what would be the primary reason for a debt
covenant limiting the firm’s future level of debt?
To cause the firm‟s share price to rise
To lower the company‟s credit rating
To reduce issue costs
To reduce the coupon rate
A.
B.
C.
D.
3. Bander Co is determining how to finance some long-term projects . Bander has decided
that it prefers the flexibility of no fixed servicing cost, no fixed maturity date and an
increase in the credit rating of the company.
Which of the following would best meet Bander’s financing requirements?
A.
B.
C.
D.
Irredeemable loan notes
Ordinary shares
Long-term bank loans
Preference shares
4. Which of the following statements about corporate debt and equity securities
is/are true?
1. Both debt and equity holders have an ownership interest in the company
2. Both debt and equity securities have an obligation to pay income
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
5. Which of the following types of loan note is most likely to maintain a constant
market value?
A.
B.
C.
D.
Zero-coupon
Floating-rate
Irredeemable
Convertible
6. A company currently has 1,000 ordinary shares in issue and no debt. It has the choice
of raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 ordinary
shares
The company has 40% tax rate
What level of earnings before interest and taxes (EBIT) would result in the same
earnings per share (EPS) for the two financing options?
A.
B.
C.
D.
$27,000
$21,000
$18,000
$10,800
7. A company currently has 10 million $1 shares in issue with a market value of $3 per
share
The company wishes to raise new funds using a 1 for 4 rights issue. The resulting
theoretical ex-rights price per share has been calculated as $2.80
How much new finance was raised?
A.
B.
C.
D.
$2,500,000
$4,000,000
$5,000,000
$7,000,000
8. Which of the following may be regarded as an advantage to existing shareholders
of listing the firm on a major stock market?
A.
B.
C.
D.
Reduced disclosure requirements
Larger dividends can be paid
Shares become more marketable
Reduced risk of takeover
9. Which of the following defines dividend cover?
A.
B.
C.
D.
Dividend per share divided by earnings per share
Earnings per share divided by dividend per share
Share price divided by dividend per share
Retained profit per share divided by dividend per share
10. The stock exchange may provide a quotation for a company‟s existing shares without
that company making any new shares available to the market
What is this method of obtaining a quotation called?
A. An offer for sale
B. An introduction
C. A placing
D. A scrip issue
11. Which of the following is prohibited under islamic financing principles?
1. The use of debt
2. The financing of immoral activities
3. The use of derivatives
A.
B.
C.
D.
2 only
1 and 3
1,2 and 3
2 and 3
12. Which of the following statements about a rights issue are correct?
1.
2.
3.
4.
The new shares are normally issued at a discount to the existing price
There will be no change in shareholder wealth
The main purpose of a right issue is to raise finance
The new shares must be issued to the existing shareholders
A.
B.
C.
D.
1,2 and 3 only
2,3 and 4 only
1,3 and 4 only
1,2 and 4 only
13. Which of the following statements about a bonus(scrip) issue is correct?
A.
B.
C.
D.
The new shares are issued at nominal value
Earnings per share would be expected to rise
The main purpose of bonus issue is to raise finance
The bonus shares do not carry voting rights
14. Which of the following is the correct definition of a warrant?
A.
B.
C.
D.
Security or collateral provided for debt
Shares issued in lieu of a cash dividend
Restrictive covenants written into debt contacts
Share options attracted to a debt issue
15. Which of the following is an example of supply chain finance?
A.
B.
C.
D.
Finance raised to invest in supply chain infrastructure
Taking loans from suppliers
Selling a sales invoice to a customer‟s bank for immediate payment
Issuing shares to a supplier
16. Which of the following is NOT true of peer-to-peer (P2P) lending?
A. It can also be referred to as “debt-based crowdfunding”
B. It involves individuals lending money to other individuals or to small
businesses
C. It requires a financial institution to act to as an intermediary
D. It is an example of “Microfinance”
17. Which of the following statements about crowdfunding is correct?
A.
B.
C.
D.
It involves either issuing shares or loans to large group of investors
It is only available to unlisted companies
“Reward-based” crowdfunding does not raise any cash for the business
It is particularly appropriate for early stage “seed” finance
8. COST OF CAPITAL
1. Which of the following usually determines the optimal capital structure for an
organisation?
A.
B.
C.
D.
Maximum degree of financial gearing
Maximum degree of operating gearing
Lowest weighted average cost of capital
Capital structure used by competitors
2. Which of the following rates is most commonly compared to a project’s internal
rate of return to evaluate whether to make an investment?
A.
B.
C.
D.
Risk-free rate
Accounting rate of return
Weighted average cost of capital
Cost of equity
3. A company with a tax rate of 30% has the following capital structure:
Weight
40%
50%
10%
Instrument
Loan notes
Ordinary shares
Prreference
shares
Pre-tax
capital
6%
12%
cost
of
8%
What is the company’s weighted average cost of capital?
A.
B.
C.
D.
9.2%
7.7%
8.2%
8.5%
4. A company has in issue 9% $20 nominal value preference shares. Their current
market price is $40 and the company‟s tax rate is 30%.
What is the company’s cost of preference shares?
A.
B.
C.
D.
4.5%
3.15%
9.0%
6.3%
5. Which three elements are needed to estimate the cost of equity using the
dividend growth model?
A. Current dividends per share, expected growth rate in earnings per share and
current market price per share
B. Current earnings per share, expected growth rate in dividends per share and
current market price per share
C. Current earnings per share, expected growth rate in earnings per share and
current book value per share
D. Current dividends per share, expected growth rate in dividends per share and
current market price per share
6. A firm has a share price of $30, a forecast dividend per share after one year of $3 and
thereafter an expected growth rate of 10%
What is the firm’s cost of equity?
A.
B.
C.
D.
21.1%
12.2%
11.0%
20.0%
7. A firm has a bank loan with a 10% interest rate. The firm also has in issue 8%
preference shares trading at nominal value and has estimated that its cost of ordinary
shares is 18%. The firm has a 30% tax rate
What is the weighted average cost of capital if the firm uses a capital
structure comprising 50% debt and an even split between preference and
ordinary shares?
A.
B.
C.
D.
11.50%
10.00%
9.40%
8.05%
8. A firm‟s weighted average cost of capital is minimised when its debt to equity ratio is
4:1
Which of the following statements is most accurate?
A. The value of the firm is maximised when it uses more equity that debt
B. A higher ratio than 4:1 means dents holders will require a lower return
C. A higher ratio than 4:1 means an equity holders will require a higher
return
D. The value of the firm will be maximised if it is 75% debt financed
9. Recent statistics relating to the ordinary shares of Calc Co , a quoted, are as follows:
Dividend (just paid)
Average annual
growth rate of dividends
Dividend cover
$0.05
10%
2.4
Price/earnings ratio
8
What is Calc Co’s cost of equity?
A.
B.
C.
D.
13.8
15.2
15.7
23.8
10. A firm has achieved an average growth in dividends over the last five years of 10.5%
per year. It is now widely believed that the long-run average annual dividend growth
rate will be 9.16% per year. The firm‟s current dividend yield is 4.8%
What is the firm’s cost of equity?
A.
B.
C.
D.
13.96%
14.40%
15.30%
15.80%
11. Which of the following statements about capital structure theory is correct?
A. In the traditional view, there is a linear relationship between the cost of equity
and financial risk
B. Modigliani and Miller said that, in the absence of tax, the cost of equity would
remain constant
C. Pecking order theory does not suggest an optimal debt to equity ratio
D. Modigliani and Miller said that, in the presence of tax, the weighted average
cost of capital would remain constant
9. CAPITAL ASSET PRICING MODEL
1. Colt Co has an equity beta factor of 1.15 and an asset beta factor of 0.85. The riskfree rate of return is 8.5% and the market return is estimated at 12.4%. The corporate
tax rate is 25%
What is Colt’s cost of equity geared?
A.
B.
C.
D.
11.82%
12.99%
9.74%
14.26%
2. The risk-free rate of return is 3% and the market premium is 6.5%. A firm‟s equity
beta is 1.15 and asset beta 0.85
What will the firm’s cost of equity be if it redeems all outstanding debt?
A.
B.
C.
D.
7.0%
10.5%
8.5%
6.0%
3. A firm‟s equity beta is 1.10 and its asset beta is 0.85. The market premium is 4.5%
and the risk-free rate 3%
What is the firm’s cost of equity geared?
A.
B.
C.
D.
7.95%
4.65%
6.83%
4.28%
4. What type of risk cannot be eliminated through diversification?
A.
B.
C.
D.
Business risk
Unsystematic risk
Financial risk
Systematic risk
5. The risk-free rate of return is 6% and the required return on a security with a beta
factor of 1.2 is 15.6%
What is the required annual rate of return on the market portfolio?
A. 11.52%
B. 13.00%
C. 14.00%
D. 17.52%
6. The beta of company X‟s shares is 1.6, the risk free rate is 5% and the required return
on company X‟s shares is 16.2% company Y is quoted in the same stock market, but
its shares have a beta of 1.4
What is the required rate of return on company Y’s shares?
A.
B.
C.
D.
12.0%
13.0%
13.2%
14.8%
7. Which of the following measures business risk?
A.
B.
C.
D.
Equity beta
Debt beta
Volatility of net income
Asset beta
8. Which of the following are assumptions of the capital asset pricing model?
1. Linear relationship between risk and required return
2. Constant dividend growth rate
3. Perfect capital markets
A.
B.
C.
D.
2 only
1 and 3
1,2 and 3
2 and 3
10. WORKING CAPITAL MANAGEMENT
1. Which of the following would increase the net working capital of a firm?
A.
B.
C.
D.
Cash collection of accounts receivables
Refinancing of accounts payable with a two-year bank loan
Payment to suppliers
Payment of a dividend
2. During the year, Mason Co‟s current assets increased by $120,000 and current
liabilities decreased by $50,000
What was the effect on net working capital?
A.
B.
C.
D.
Increased by $70,000
Decreased by $170,000
Increased by $170,000
Decreased by $70,000
3. Which of the following indicates that a company is becoming more
conservative in its working capital funding policy?
A.
B.
C.
D.
Increase in the ratio of current liabilities to non-current liabilities
Decrease in the operating cycle
Decrease in the current ratio
Increase in the ratio of long-term finance to current liabilities
4. Which of the following may indicate overtrading?
A.
B.
C.
D.
Significant new issues of long-term finance
Rising profits but falling margins
Rising receivables turnover
Falling revenues
5. Which working capital financing policy exposes the firm to the greatest risk of
being unable to meet its obligations as they fall due?
A.
B.
C.
D.
Financing fluctuating current assets with long-term debt
Financing permanent current assets with long-term debt
Financing permanent current assets with short term debt
Financing fluctuating current assets with short term debt
6. A company has a current ratio of 2.3 and a quick ratio of 0.8. It increases its
overdraft in order to buy more inventory as a cash purchase.
What will happen to the company’s ratios as a result of this transaction?
A
Current ratio
Increase
Quick ratio
Increase
B
C
D
Increase
Decrease
Decrease
Decrease
Increase
Decrease
7. Which of the following is LEAST likely to characterise overtrading?
A.
B.
C.
D.
Increased short term borrowing
Increased cash balances
Increased revenue
Reduced working capital
8. The following information has been calculated for AAA Co:
Trade receivables collection
period
Raw material holding period
Length of the production cycle
Credit taken from suppliers
Finished goods holding period
25 days
24 days
30 days
56 days
34 days
What is the length of the working capital cycle?
A.
B.
C.
D.
3 days
27 days
57 days
169 days
9. Which of the following statements about working capital management are
correct?
1. The twin objectives of working capital management are profitability and
liquidity
2. An aggressive approach to working capital financing can increase profitability
3. Poor working capital management is a signal of overtrading
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
10. 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
Trade payables
60 days
45 days
Assume there are 360 days in the year
What is the net investment in working capital required for the next year?
A.
B.
C.
D.
$8,125,000
$4,375,000
$2,875,000
$6,375,000
11. INVENTORY MANAGEMENT
1. Which of the following would affect the optimal level of inventory?
1.
2.
3.
4.
A.
B.
C.
D.
Holding cost per unit of inventory
Current level of inventory
Cost of placing an order for inventory
Demand
1,2 and 3 only
2,3 and 4 only
1,3 and 4 only
1,2 and 4 only
2. In inventory management, which of the following will tend to increase the level
of safety stock?
A.
B.
C.
D.
Holding cost increases
Cost of running out of inventory decreases
Variability of lead-time increases
Reliability of demand forecasting increases
3. Which of the following assumptions is associated with the economic order
quantity model?
A.
B.
C.
D.
The holding cost per unit will vary quantity ordered
The cost of placing an order will vary with quantity ordered
Holding costs depend on the average level of inventory
The purchase cost per unit will vary based on quantity discounts
4. To measure inventory management performance, a company monitors its inventory
turnover ratio. Selected data from company‟s accounting records show the following:
Annual sales
Gross profit
Current year
2,525,000
40%
Prior year
2.125,000
35%
Opening finished goods inventory for the current year was 15% of the prior year‟s
annual sales volume at cost and closing finished goods inventory was 22% of the
current- year‟s annual sales volume at cost
What was the company’s inventory turnover for the current year?
A.
B.
C.
D.
E.
4.55 times
5.61 times
6.51 times
6.81 times
5. Which of the following statements about the economic order quantity (EOQ)
and the reorder level (ROL) are true?
A.
B.
C.
D.
The EOQ determines ROL
The ROL determines the EOQ
both are influenced by demand
Both are influenced by lead time
6. Which of the following is LEAST relevant to the economic order quantity model
for inventory?
A.
B.
C.
D.
Safety stock
Annual demand
Holding costs
Order costs
7. Which of the following is/are usually seen as benefits of the just-in-time
approach to inventory management?
1. Reduced risk of stock outs
2. Reduced holding holds
3. Reduced dependence on suppliers
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
12. CASH MANAGEMENT
1. The CFO of Lang Co wants to earn a higher return on the company‟s cash holdings.
Which of the following comparable maturity investment will earn Lang the
highest expected return?
A.
B.
C.
D.
Certificates of deposit
Treasury bills
Commercial paper
Bank deposits
2. Which of the following securities has the least amount of default risk?
A.
B.
C.
D.
Corporate loan notes
Treasury bills
Commercial paper
Bills of exchange
3. Which of the following best describes the risk associated with the ability to sell
a short- term investment quickly without significant impact on price?
A.
B.
C.
D.
Interest rate risk
Purchasing power risk
Financial risk
Liquidity risk
4. Which of the following statements about the Miller-Orr cash management
model is/are true?
1. The greater the variability in cash flows, the greater is the spread between the
upper and lower cash balance limits
2. When short-term investments are liquidated the firm‟s cash balances should
return to the lower limit
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
5. A company uses the Baumol cash management model. Cash disbursements are
constant at 20,000 each month. Short-term investment yield 5% per year, while cash
held in the company‟s bank account earns zero interest. Switching costs (that is, for
each purchase or sale of short-term investments) are $30 for each transaction
What is the optimal amount (to the nearest $100) to be transferred in each
transaction?
A.
B.
C.
D.
$500
$1,700
$4,900
$17,000
6. Which of the following is an assumption of the Baumol model not the MillerOrr model?
A.
B.
C.
D.
Constant usage of cash
Holding cash incurs an opportunity cost
Fixed commission for switching between cash and cash equivalents
Variability of cash flows
7. A company needs $150,000 each year for regular payments. Converting the
company‟s short- term investment 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.
B.
C.
D.
38,730
48,990
54,772
63,246
13. MANAGEMENT OF ACCOUNTS RECEIVABLES AND PAYABLE
1. A supplier offers a 3% discount for payment within 10 days or full payment within 45
days.
Assuming a 360-day year what is the annualized cost of not taking the discount?
A.
B.
C.
D.
37.11
36.00
24.74
31.81
2. A company has daily sales of 150,000. A debt factor has guaranteed to reduce the
company‟s receivables collection time by four days for a monthly fee of 2,500. Cash
surpluses can be invested in money market deposits yielding 4% per annum
What is the additional annual income/(loss) for using the cash management
service?
A.
B.
C.
D.
$6,000
$(6,000)
$12,000
$(12,000)
3. Amicable Wireless Co offers customers credit terms of 2% discount for payment within
10 days or full payment within 25 days. 60% of Amicable‟s customers take the 2%
discount and pay on day 10. The remainder of Amicable‟s customers pay on day 30.
What is Amicable’s receivables days?
A.
B.
C.
D.
16
12
18
20
4. The CFO of a company is concerned about the company‟s accounts receivables turnover
ratio. The company currently offers customers terms of 3 discount for settlement within 10
days or full payment within 30 days.
Which of the following strategies would most likely improve the company’s
accounts receivable turnover ratio?
A.
B.
C.
D.
Using invoice discounting
Changing customer terms to a 1 discount for settlement within 10 days
Entering into a factoring agreement with a finance company
Changing customer terms to a 3 discount for settlement within 20 days
5. Scrimpy Co buys materials from Frugal Enterprises. Frugal offers discount terms of 2%
discount for payment within 10 days or full payment within 30 days.
Assuming a 360-day year, what is the annual percentage cost associated with
Scrimpy’s failure to take advantage of the discount offered by Frugal?
A.
B.
C.
D.
2.0%
33.3%
36.0%
36.7%
6. Which of the following statements about debt factoring and invoice discounting is
true?
A.
B.
C.
D.
Factoring is with recourse whereas discounting is without recourse
Invoice discounting is usually performed on the entire receivables ledger
Both are relatively cheap sources of finance
Only factoring involves outsourcing the administration of the receivables ledger
7. The management of XYZ Co has annual credit sales of $20 million and accounts
receivable of $4 million. Working capital is financed by an overdraft at 12% interest per
year. Assume 365 days in a year
What is the annual finance cost saving if the management reduces the collection
period by 60 days?
A.
B.
C.
D.
$85,479
$394,521
$78,904
$68,384
14. RISK MANAGEMENT
1. Hedgehog international is a UK based firm which must pay $500,000 to its foreign
supplier in 90 days the current spot rate is $1.60 per £1 Hedgehog purchases an option
to buy the dollar in 90 days at $1.64 per £1, paying a premium of $0.07 per $1. The
spot rate after 90 days is $1.58 per £1
What will Hedgehog do on the payables’ settlement date?
A.
B.
C.
D.
Hedgehog will exercise the option
Hedgehog will not exercise the option
Hedgehog will be indifferent as to whether it exercises the option or not
Hedgehog will allow the option to lapse
2. Hedgehog international is a UK based firm which must pay $500,000 to its foreign
supplier in 90 days the current spot rate is $1.60 per £1. Hedgehog purchases an
option to buy the dollar in 90 days at $1.64 per £1, paying a premium of $0.03 per £1.
The spot rate after 90 days is $1.58 per £1.
What will Hedgehog do after 90 days?
A.
B.
C.
D.
Hedgehog will exercise its option
Hedgehog will lapse the option
Hedgehog will be indifferent as to whether it exercises the option or not
Hedgehog will receive a refund of the premium
3. A US importer expects to pay a European supplier $500,000 in three months.
Which of the following hedges could be appropriate for the US importer?
A.
B.
C.
D.
Buying call options on the euro
Buying put options on the euro
Selling put options on the euro
Selling call options on the euro
4. Platinum Co us US-based and expects to receive 30,000 euros in 30 days. The
treasurer is concerned that the euro may depreciate against the dollar before the
payment is received
What should platinum do to reduce this risk?
A.
B.
C.
D.
Deposit 30,000 euros today
Enter into an interest rate swap contract for 30 days
Enter into a forward contract to sell 30,000 euros in 30 days
Plantinum cannot effectively reduce this risk
5. In evaluating the impact of relative inflation rates on the demand for a foreign
currency, which of the following is true?
A. Inflation is irrelavant to currency demand
B. As inflation associated with a foreign economy increases in relation to a
domestic economy, demand for the foreign currency falls
C. As inflation associated with a foreign economy increases in relation to a
domestic economy, demand for the foreign currency increases
D. As inflation associated with a foreign economy decreases in relation to a
domestic economy, demand for the foreign currency falls
6. A company has several long-term floating rate loan notes outstanding and is
considering hedging interest rate risk
Which of the following derivative instruments is recommended for this purpose?
A.
B.
C.
D.
Money market hedge
Forward currency contract
Fixed rate bank loans
Interest rate swap
7. Which of the following statements about the terms structure of interest rates
is/are true?
1. An “inverted” yield curve is where long-term interest rates are higher than shortterm interest rates
2. A rising yield curve is caused when investors prefer to buy for long-dated loan
notes
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
8. In relations to hedging currency risk, which of the following statements is
correct?
A. The flexible nature of currency futures means that they can always be
matched with a specific currency exposure
B. Currency options carry an obligation to the holder to exercise the option at
maturity
C. Forward contracts require the payment of a premium
D. A money market hedge should give approximately the same result as a
forward contract
9. The home currency of GB Co is sterling (£) and it trades with a company in a foreign
country whose home currency is the rupee. The following information is available:
Spot
Home Country
Foreign country
80.00 rupees per
rate
£
Interest rate
Inflation rate
2% per year
1% per year
9% per year
5% per year
What is the two-year forward exchange rate?
A.
B.
C.
D.
91.36 rupees per £
86.46 rupees per £
70.05 rupees per £
76.96 rupees per £
10. What is the impact of an appreciation in the value of country’s currency?
1. Exports will be given a stimulus
2. The rate of domestic inflation will rise
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
11. “There is a risk that the value of out export earnings will fall over the next few years due
to appreciating domestic currency”
To which risk does the above statements refer?
A.
B.
C.
D.
Translation risk
Economic risk
Transaction risk
Financial risk
12. In relation to the term structure of interest rates what is a “normal” yield curve?
A.
B.
C.
D.
Upward sloping
Downward sloping
U-shaped
Horizontal
13. Burger Queen Co conducts business in a number of different countries and is trying to
evaluate its economic exposure to long-term exchange rate trends
Which of the following statements is correct?
A. Burger queen will suffer an economic loss if it has to make payments in a
foreign currency and its domestic currency appreciates
B. Burger queen will enjoy an economic gain if it has to make payments in a
foreign currency and the foreign currency appreciates
C. Burger queen will suffer an economic loss if it has net receipts of a foreign
currency and its domestic currency depreciates
D. Burger queen will suffer an economic loss if it has net receipts of a foreign
currency and its foreign currency depreciates
14. Universal exports co limits its operations to exporting overseas
Which of the following statements about universal’s exposures to exchange rate
risk is correct?
A.
B.
C.
D.
Universal is subject to transaction, economic and translation exposure
Universal is subject to transaction and economic exposure
Universal is only subject to transaction exposure
Universal is not subject to exchange rate risk as currency fluctuations would
balance out over time
15. What is the effect on a UK-based company when a foreign competitor’s currency
becomes weaker compared to sterling?
A.
B.
C.
D.
The foreign company will have an advantage in the UK market
The foreign company will be disadvantaged in the UK market
No effect
It is advantageous for the UK company when sterling strengthens
16. An investor plans to exchange $1,000 into euros now, invest the resulting euros for 12
months, and then exchange the euros back into dollars at the of the 12-month period.
The spot exchange rate is €1.415 per $1 and the euro interest rate is 2% per year. The
dollar interest rate is 1.8% per year
Compared to making a dollar investment for 12 months , at what 12-month
forward exchange rate will the investor make neither a loss nor a gain?
A.
B.
C.
D.
€1.223 per $1
€1.412 per $1
€1.418 per $1
€1.439 per $1
17. A company whose home currency is the dollar ($) expects to receive 500,000 pesos in
six months‟ time from a customer in a foreign country. The following interest rates and
exchange rates are available to the company:
Spot
rate
Six-month forward rate
Borrowing interest rate
Deposit interest rate
Dollar ($)
4% per year
3% per year
15.00 pesos per
$
15.30 pesos per
$
Peso
8% per year
6% per year
Working to the nearest $100, what is the six-month dollar value of the expected
receipt using a money-market hedge?
A.
B.
C.
D.
$32,500
$33,700
$31,800
%31,900
18. Which of the following interest rate derivatives are characterised by a standard
contract size?
1.
2.
3.
4.
Interest rate futures
Over-The-Counter cap
Forward rate agreement
Interest rate swap
A.
B.
C.
D.
1 only
1 and 4
2 and 3
3 and 4
19. Which of the following statements about the causes of interest rate fluctuations
are true?
1. Liquidity preference theory suggests that investors want more compensation for
long-term lending than for short-term lending
2. According to expectations theory, the shape of tje yield curve gives information
on how inflation rates are expected to influence interest rates in the future
3. An inverted yield curve can occur if government policy is to keep short-term
interest rates high in order to control inflation
4. Market segmentation theory suggests long-term interest rates depend on how
easily investors can switch between market segments of different maturity
A.
B.
C.
D.
1 only
1 and 3 only
2 and 4
1,3 and 4
20. Which of the following derivatives would protect a firm from falling income on
short-term investments but allow it to benefit if yields rise?
A.
B.
C.
D.
Interest rate futures
Forward rate agreement
Interest rate swap
Interest rate floor
15. BUSINESS VALUATION
1. Assuming an increase in price levels over time, which of the following asset
valuation will produce the highest return on assets.
A.
B.
C.
D.
Net book value
Gross book value
Replacement cots
Depreciated replacement cost
2. A company has just paid an dividend per share of $0.32 and is expected to pay a
dividend of $0.336 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 exdividend basis?
A.
B.
C.
D.
3.20
4.41
2.59
4.20
3. Jack co owns a $1,000 nominal value of the loan note purchased at nominal value with
an annual coupon of 5%
What would happen to the market value of the loan note if market interest rates
later decreased to 4% and why?
A. Increase because the loan note pays a higher coupon than the current market
rate
B. Stay the same since the loan note pays a fixed coupon
C. Stay the same since the firm‟s credit rating has not changed
D. Decrease since market interest rates have declined
4. Fernwell wants to buy shares of Gurst Co in two years. Fernwell uses the dividend
valuations model with an assumed dividend growth rate of 5%
If Fernwell’s discount rate is 10% and Gurst’s current year dividend is $20, what
is the approximate price Fernwell will pay?
A.
B.
C.
D.
$400
$420
$441
$463
5. Harken co‟s price earnings ratio is 10, its earnings in the current year is $5 per share
but the earnings forecast for the next year is $8 per share.
What is the current share price of Harken co?
A.
B.
C.
D.
$0.50
$0.80
$50
$80
6. Which of the following is a basic premise of behavioral corporate finance?
A.
B.
C.
D.
Cost behavior determines valuation
Behavioral characteristics of financial managers can distort judgment
Corporate behavior will impact financial decisions
Corporate finance is inherently quantitative and objective
7. A financial manager believes that his actions will cause earnings to increase and the
firm‟s share price to rise in direct proportion to earnings
What does the manager’s behavior illustrate?
A.
B.
C.
D.
Overconfidence
Excessive optimism
Illusion of control
Confirmation bias
8. A loan note has a fixed annual coupon of 7% and it will be repaid at its nominal value of
$100 in one year‟s time. Similar loan notes have a gross redemption yield (i.e. yield to
maturity) of 8%.
What is the current market value of the loan note?
A.
B.
C.
D.
$99.07
$100.00
$100.93
$106.07
9. Which of the following statements about the efficient market hypothesis is/are
true?
1. In a strongly efficient market, the price/earnings ratio of all companies would be
the same
2. In a semi-strong efficient market, the share price for a particular company should
not change when its financial statements are made public
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
10. A firm maintains a 30% pay-out ratio. Future projects are expected to generate an
annual post-tax return on investment of 15 % and pre-tax return of 20%.
What is the firm’s expected annual rate of growth?
A.
B.
C.
D.
4.5%
6.0%
10.5%
14.0%
11. Warren analyses publicly available information about firms and uses this to try and
predict their share price movements
To what extend does Warren believe capital markets to be efficient?
A.
B.
C.
D.
Not efficient at all
Weak form efficient
Semi-strong form efficient
Strong form efficient
12. Korma Co has paid the following dividends per share in recent years:
Year
Dividend per share
20X6
$0.35
20X5
$0.34
20X4
$0.33
20X3
$0.31
The dividend for 20X6 has just been paid and korma co has a cost of equity of 12%.
What is the market price of Korma Co shares to the nearest cent?
A.
B.
C.
D.
$4.01
$4.66
$4.07
$4.55
13. Donald co has 8% convertible loan notes in issue which are redeemable in five year‟s
time at their nominal value of $100 per loan note. Alternatively, each loan note could be
converted after five years into 60 equity shares with a nominal value of $1 each
The equity shares of Donald Co are currently trading at $1.25 per share and this share
price is expected to grow by 4% per year. The yield to maturity ( gross redemption
yield) of the loan notes is 10%
What is the current market value of each loan note to the nearest dollar?
A.
B.
C.
D.
$91
$92
$100
$103
14. Stern Bear is using dividend valuation model with a constant growth rate to estimate the
value of an ordinary share.
Which of the following assumptions is Stern Bear making?
A.
B.
C.
D.
The cost of equity will grow at a constant rate
Earnings will grow at a constant rate
The share price will grow at the same rate as dividend
The share price will grow at the same amount as the dividend
15. What does a low price/earnings (P/E) ratio indicate to investors?
A.
B.
C.
D.
Earnings have limited growth potential
Earnings are expected to rise quickly
There are problems with the company‟s management
The company is overvalued
16. The following financial information relates to QK Co, whose ordinary shares have a
nominal value of $0.50 per share:
$m
Non-current assets
Current assets
Inventory
Trade receivables
Total assets
8
12
$m
120
20
140
Equity
Ordinary shares
Reserves
Non current liabilities
Current liabilities
Total equity and liabilities
25
80
105
20
15
140
On a historic basis, what is the net asset value per share of QK Co?
A.
B.
C.
D.
$2.10 per share
$2.50 per share
$2.80 per share
$4.20 per share
17. TQK Co has just paid a dividend of $0.21 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
18. A company has 7% loan notes in issue which are redeemable in seven year‟s 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.
B.
C.
D.
$92.67
$108.90
$89.93
$103.14
19. Luke co has 8% convertible loan notes issue which are redeemable in five year‟s time
at their nominal value of $100 per loan note. Alternatively each loan note could be
converted after five years into 70 equity shares with a nominal value of $1 each.
The equity shares of Luke Co are currently trading at $1.25 per share and this share
price is expected to grow by 4% per year. The before-tax cost of debt of Luke Co is
10% and the after-tax cost of debt of Luke Co is 7%
What is the current market value of each loan note to the nearest dollar?
A.
B.
C.
D.
$92
$96
$104
$109
20. Which of the following are possible reasons for estimating the market value of a
private firm’s shares?
A.
B.
C.
D.
To comply with international financial reporting standards
To set a guide price in an initial public offering
To allow the firm‟s return on equity to be calculated
To set a guide price for a scrip issue of shares
21. Which of the following are limitations of valuing a firm’s equity based on the net
assets as reported in its statement of financial position prepared in accordance
with international financial reporting standards?
1.
2.
3.
4.
A.
B.
C.
D.
The information may be out of date
The value of internally-generated brands will not be reported
Some long-term lease liabilities may not be reported
The effect of rising property prices cannot be reported
1 only
1 and 2 only
1,2 and 4
2,3 and 4
SECTION B QUESTIONS
THE FINANCIAL MANAGEMENT FUCTION
1. QSX CO
The following scenario relates to question 1-5
A shareholder of QSX Co is concerned about the recent performance of the company and
has collected the following information:
Year to 31 May
Earnings
per
share
Dividend
per
share
Closing ex-dividend share price
20X6
$
20X5
$
20X4
$
0.589
0.642
0.607
0.400
6.48
0.385
8.35
0.37
7.4
1. What is the capital gain for the year to 31 May 20X5?
A.
B.
C.
D.
12.8%
-22.4%
11.4%
-12.4%
2. What was the total shareholder return for the year to 31 May 20X6?
A.
B.
C.
D.
-22.7%
27.2%
-17.6%
-22.4%
3. What was the average earnings yield for the period 20X4 to 20X6?
A.
B.
C.
D.
9.1%
5.2%
6.3%
8.3%
4. 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.
5. Which of the following is NOT correct?
A. Return on capital employed can be defined as profit before interest and tax
divided by the sum of shareholder‟s funds and prior charge capital
B. Return on equity 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
shareholder‟s funds
INVESTMENT DECISIONS
1. BACKPAY CO
The following scenario relates to question 1-5
Backpay Co is considering investing $50,000 in a new machine. The machine will have scrap
value of $10,000 at the end of its five year life. It is expected that 20,000 units will be sold each
year at a selling price of $3.00 per unit. Variable production costs are expected to be $1.65 per
unit, while incremental fixed costs are expected to be $10,000 per year.
1. What is the project’s payback period?
A.
B.
C.
D.
1.9 years
2.9 years
1.0 years
2.5 years
2. What is the project’s return on capital employed based on average investment?
A.
B.
C.
D.
34%
45%
57%
30%
3. Backpay Co is also evaluating an investment project with the following forecast cash flow:
Year
0
1
2
3
4
Cash flow ($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.
B.
C.
D.
15.8%
17.2%
17.8%
19.4%
4. The chairman of Backpay Co is concerned about how government economic policy may
affect the success of the firm‟s future projects.
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
5. Which of the following government actions relate predominantly to fiscal policy?
1.
2.
3.
4.
A.
B.
C.
D.
Decreasing interest rates in order to stimulate consumer spending
Reducing taxation while maintaining public spending
Using official foreign currency reserves to buy the domestic currency
Borrowing money from the capital markets and spending it on public works
1 only
1 and 3
2 and 4 only
2,3 and 4
DISCOUNTED CASH FLOW TECHNIQUES
1. RUNRAG CO
The following scenario relates to question 1-5
Runrag Co is an unlisted firm evaluating a project which it proposes to finance with a bank loan.
The cost of the machinery, which is payable immediately, is $1.5 million, and the scrap value of
the machinery at the end of four year is expected to be $100,000. Tax-allowable depreciation
can be claimed on this investment on a 25% reducing balance basis. Information on future
returns from the investment has been forecast to be as follows:
Year
Sales volume (units/year)
Selling price ($/unit)
Variable cost ($/unit)
Fixed
costs
($/year)
1
50,000
25.00
10.00
2
95,000
24.00
11.00
3
140,000
23.00
12.00
4
75,000
23.00
12.50
105,000 115,000 125,000 125,000
This information must be adjusted to allow for selling price inflation of 4% per year and variable
cost inflation of 2.5% per year. Fixed costs, which are wholly attributable to the project, have
already been adjusted for inflation. Runrag Co pays profit tax 30% per year.
1. What is the tax effect of the disposal of the machinery?
A.
B.
C.
D.
$30,000 tax payable
$532,812 tax saving
$159,844 tax saving
%82,500 tax payable
2. What is the 3 nominal total contribution (to the nearest $000)?
A.
B.
C.
D.
$3,622,000
$1,540,000
$1,688,000
$1,813,000
3. Which of the following would be the appropriate rate to estimate the project’s net
present value?
A.
B.
C.
D.
Real post-tax weighted average cost of capital
Nominal post-tax weighted average cost of capital
Pre-tax cost of debt
Post-tax cost of debt
4. Which of the following methods can deal adequately with project risk?
1. Sensitivity analysis
2. Simulation
3. Probability analysis
A.
B.
C.
D.
1 only
1 and 2 only
2 and 3 only
1,2 and 3
5. Which of the following may be appropriate alternative sources of finance for the
project?
1.
2.
3.
4.
A.
B.
C.
D.
Peer-to-peer lending
Rights issue on the stock market
Crowdfunding
Internal equity
1 and 3 only
1,2 and 4
2 and 4 only
2,3 and 4
APPLICATIONS OF DISCOUNTED CASH FLOW TECHNIQUES
1. REPLACEMENT CYCLES
The following scenario relates to question 1-5
A company is trying to determine the optimal replacement cycle for the computers used by its
sales team. The following information is relevant to the decision:
The cost of each computer is $2,400. Maintenance costs are payable at the end of each full
year at ownership, but not in the year of replacement (e.g. if the notebook is owned for three
years, then the maintenance cost is payable at the end of year 1 and at the end of year 2).
Interval
between
replacement
(year)
1
2
3
Trade in value
$
1,200
800
To be determined
Maintenance cost
$
Nil
75 (payable at the end of Year 1)
150 ( payable at the end of Year2)
The company uses a relatively high discount rate of 14% as it faces capital rationing.
1. What is the annual equivalent cost of replacing the computer every year?
A.
B.
C.
D.
$1,348
$1,537
$1,413
$1,611
2. What is the year 3 trade-in value given that the annual equivalent cost of a 3-year
replacement cycle is $1,024?
A.
B.
C.
D.
$268
$727
$412
$301
3. Which of the following are potential tax implications of the asset replacement
decision?
1. Tax savings on tax-allowable depreciation
2. Tax payment on a balancing charge
3. Tax savings on maintenance costs
A. 1 only
B. 1 and 2 only
C. 2 and 3 only
D. 1,2 and 3
4. Which of the following factors may encourage the company to replace the computers
relatively often?
1. Changing technology
2. Supplier discounts
3. Environmental impacts
A.
B.
C.
D.
1 only
1 and 2 only
2 and 3 only
1,2 and 3
5. Which of the following would NOT explain why the company faces capital rationing?
A.
B.
C.
D.
Asymmetry of information
Poor credit rating
Strict government monetary policy
Large proportion of tangible assets
EQUITY FINANCE AND DEBT FINANCE
1. STARDUST CO
The following scenario relates to question 1-5
Stardust Co is a medium-sized manufacturing company which owns its own factory. It is
considering a 1 for 5 rights issue at a 15% discount to the current market price of $4.00 per
share. It is proposed that the fund raised will be used to redeem some of the existing loan notes
at their nominal value. Stardust co currently has the following long-term capital structure:
Ordinary shares ($0.50 per share)
Reserves
Non-current liabilities : 12% loan notes
Total equity and liabilities
$'000
2,000
1,500
3,500
4,500
8,000
Profit before interest and tax been forecasted to be $2 million.
Stardust Co pays corporation tax at a rate of 30%
1. What is the value of rights per existing Stardust Co share, ignoring the proposed use
of the funds raised in the rights issue?
A.
B.
C.
D.
$0.12
$0.10
$0.50
$0.68
2. What is Stardust Co’s expected earnings per share, if the rights issue funds are used
for redeem some of the existing loan notes?
A.
B.
C.
D.
$0.42
$0.29
$0.47
$0.26
3. Which of the following could be alternatively methods for Stardust Co to raise funds
for redeeming some of the existing loan notes?
1. Scrip issue
2. Placement
3. Sale and leaseback
A.
B.
C.
D.
2 and 3 only
3 only
1 only
1,2 and 3
4. Stardust Co will also need finance in future in order to expand its business.
Which of the following correctly ranks management’s preference for finance
according to Pecking Order Theory?
A.
B.
C.
D.
Debt, share issues, retained earnings
Debt, retained earnings, share issues
Retained earnings, debt, share issues
Retained earnings, share issues, debt
5. Which of the following are examples of financial disintermediation?
1.
2.
3.
4.
Bank overdraft
Peer-to-peer lending
Securitisation
Loan notes
A.
B.
C.
D.
1 only
2 and 3 only
2,3 and 4
1,2 and 3
COST OF CAPITAL AND GEARING
1. DDD CO
The following scenario relates to question 1-5
DDD Co has two loan notes in issue, each with a nominal value of $100:
Loan note A will be redeemed at nominal value in 10 years‟ time and pays annual interest of
9%. The current ex-interest market price of this loan note is $95.08.
Loan note B will be redeemed at a premium of 5% in four years‟ time and pays annual interest
of 8%. The pre-tax cost of debt of this loan note is 7%
1. Which of the following is closest to the pre-tax cost of dent of loan note A?
A.
B.
C.
D.
9%
10%
8%
14%
2. What is the ex-interest market price of loan note B?
A.
B.
C.
D.
$105.00
$80.12
$103.40
$107.21
3. Which of the following are possible reasons why loan note A and loan note B have
different pre-tax costs of debt?
1. Different levels of security
2. Different periods to redemption
3. Different redemption prices
A.
B.
C.
D.
1 and 2 only
1 only
1 and 3 only
3 only
4. Which of the following statements are correct?
1. Loan notes are assets for the issuer but liabilities for the buyer
2. Loan note markets can be classified into exchange and over-the-counter
markets
3. A secondary market is where securities are bought and sold by investors
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
5. What happens to the market price of a loan note if the general level of interest rates in
the economy rises?
A.
B.
C.
D.
The market price of the loan note rises
The market price of the lone note falls
The market price of loan note may rise or fall
The market price of loan note is unaffected as the loan note pay fixed interest
2. BKB CO
The following scenario relates to question 1-5
The statement of financial position of BKB Co provides the following information:
Equity finance
Ordinary shares ($0.5 nominal value)
Reserves
$m
25
15
$m
40
Non-current liabilities
7% Convertible loan notes ($100 nominal value)
5% Preference shares ($1 nominal value)
20
10
30
Current liabilities
Trade payables
Overdraft
Total equity and libailities
10
15
25
95
BKB Co has an equity beta of 1.2 and an asset beta of 0.9. The ex-dividend market value of the
company‟s equity is $250 million. The ex-dividend market value of the preference shares is
$6.25 million.
The convertible loan notes of BKB Co have a conversion ratio of 19 ordinary shares per $100
nominal value loan note. The conversion date and redemption date are both on the same date
in seven years‟ time. The current ordinary share price of BKB Co is expected to increase by 4%
per year for the foreseeable future.
The equity risk premium is 5% per year and the risk-free rate of return is 3% per year. BKB Co
pays profit tax at an annual rate of 30% per year.
1. What is BKB Co’s ungeared cost of equity?
A.
B.
C.
D.
9%
5.4%
7.5%
4.8%
2. What is the forecast conversion value of the loan note?
A.
B.
C.
D.
$125
$122
$100
$107
3. What is BKB Co’s cost of preference shares?
A.
B.
C.
D.
5%
3.5%
5.6%
8%
4. Which of the following correctly ranks BKB Co’s securities in terms of risk to the
investor ( highest risk first)?
A.
B.
C.
D.
Ordinary shares, preference shares, convertible loan notes
Convertible loan notes, preference shares, ordinary shares
Ordinary shares, convertible loan notes, preference shares
Preference shares, ordinary shares, convertible loan notes
5. 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.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
INVENTORY MANAGEMENT
1. PLOT CO
The following scenario relates to question 1-5
Plot Co sells both Product P and Product Q, with sales of both products occurring evenly
throughout the year.
Product P
Plot Co currently places one order per month for 25,000 units of Product P. Each order costs
$267 to place. The cost of holding Products P in inventory is $0.10 per unit per year.
Product Q
The annual demand for Product Q is 456,000 units per year and Plot Co buys in this product at
$1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for
settlement of invoices within 20 days
Other information
Plot Co finances working capital with short-term finance costing 5% per year. Assume that
there are 365 days in each year
1. What is the total annual ordering and holding cost (to the nearest $100) if Plot Co
uses the economic order quantity for Product P?
A.
B.
C.
D.
$6,000
$4,454
$2,300
$4,000
2. What is the increase in Plot Co’s annual finance costs ( to the nearest $100) if it
accepts the early settlement discount for Product Q?
A.
B.
C.
D.
$2,500
$1,300
$1,700
$2,300
3. Which of the following are potential advantages for Plot Co of accepting the early
payment discount for Product Q?
1. A shortening in the operating cycle
2. An increase in profit margins
3. Improved business reputation
A.
B.
C.
D.
1, 2 and 3
2 and 3 only
1 only
2 only
4. Which of the following would definitely occur if Plot Co changes to a “conservative”
working capital financing policy?
A.
B.
C.
D.
Finance costs will rise
Financial gearing will fall
Current ratio will rise
Operating gearing will fall
5. Which of the following statements about working capital management are correct?
1. Working capital usually increases as sales increase
2. An increase in the cash operating cycle will decrease profitability
3. Overtrading is also known as under-capitalisation
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
2. CAT CO
The following scenario relates to question 1-5
CAT Co currently places one order per month for 10,000 components which are used in its
manufacturing processes. The cost per component is $7.50, the cost of ordering is $200 per
order and the cost of holding components in inventory is $1.00 per component per year.
Warehouse space is rented on a daily basis.
The supplier has offered a bulk purchase discount of 3.6% on orders of 30,000 or more
components. If the bulk purchase discount is taken, the cost of holding components in inventory
would increase to $2.20 per component per year
The supplier has also offered a 2% settlement discount for payment within 20 days. CAT Co
currently takes 60 day‟s credit from the supplier and has an overdraft rate of 15% per annum.
Assume there are 360 days in one year.
1. What is the total annual cost of ordering, purchasing and holding inventory if the bulk
purchase discount is taken?
A.
B.
C.
D.
$901,400
$883,400
$934,400
$936,160
2. Which of the following is most likely if CAT Co changes from renting warehouse
space on a daily basis to signing a long-term lease?
A.
B.
C.
D.
Financial flexibility will increase
Financial gearing will decrease
Insurance costs will decrease
The space required will increase
3. What is the annual value of the settlement discount (in percentage terms) and should
the discount be accepted or rejected?
Value of discount
18.40%
18.00%
18.40%
18.00%
A
B
C
D
Decision
Reject
Accept
Accept
Reject
4. Which of the following are potential benefits to CAT Co of implementing just-in-time
inventory management?
1. Less dependence on suppliers
2. Shorter operating cycle
3. Reduced risk of stock outs
A.
B.
C.
D.
2 only
1,2 and 3
2 and 3 only
1 only
5. Which of the following are characteristics of an “aggressive” policy relating to the
level of investment in current assets?
1. Allowing extended credit to customers
2. Taking extended credit from suppliers
3. Holding no buffer stock
A.
B.
C.
D.
1 only
1,2 and 3
2 and 3 only
3 only
MANAGEMENT OF ACCOUNTS RECEIVABLE AND PAYABLE
1. KXP CO
The following scenario relates to question 1-5
In the last year KXP Co had sales of $15million and cost of sales of $12 million. All sales were
on 30 days credit.
Extracts from the company‟s most recent statement of financial position are as follows:
Inventory
Trade receivables
Trade payables
Overdraft
$'000
1,151
2,466
1,808
3,000
KXP Co proposes introducing an early settlement discount of 1% for payment within 25 days,
while increasing its normal credit period to 45 days. It is expected that, on average, 50% of
customers will take the discount and pay within 30 days, 30% of customers will pay after 46
days, and 20% of customers will not change their current paying behavior.
KXP Co currently uses the economic order quantity (EOQ) model for purchases of Product Z,
annual demand for which is 180,000 units. The supplier has offered a 2% bulk purchase
discount for orders of Product Z of 35,000 units or more. Each order costs KXP Co $150 to
place and the holding cost is $0.24 per unit per year.
Assume there are 365 days a year.
1. Which of the following statements best describes KXP Co’s policy for financing
current assets?
A.
B.
C.
D.
A “matching” policy
An “aggressive policy”
A “conservative policy”
No conclusion can be made without knowing the proportion of ”permanent” and
“fluctuating” current assets
2. What will KXP Co’s receivables days be following the introduction of the early
settlement discount?
A.
B.
C.
D.
32 days
38 days
26 days
30 days
3. KXP Co is considering debt factoring as an alternative to offering early settlement discounts.
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.
B.
C.
D.
2 only
1 only
Neither 1 nor 2
1 and 2
4. Which of the following are assumptions of the economic order quantity (EOQ) model?
1.
2.
3.
4.
A.
B.
C.
D.
Constant demand
Holding costs depend on the maximum level of inventory
No risk of stock outs
Cost per order is independent of order quantity
1,2, 3 and 4
1,3 and 4
3 and 4 only
1 only
5. What is the increase in annual holding costs if KXP Co accepts the bulk purchase
discount for product Z?
A.
B.
C.
D.
$2,400
$4,200
$4,800
$8,400
2. WIDNOR CO
The following scenario relates to question 1-5
Widnor Co has credit sales of $26,750,000 per year an 1% of these turn into bad debts.
Customers are offered 50 days credit but on average take an additional 10 days. Widnor Co has
a cost of short-term finance of 5% per year.
The finance director is considering a proposal from a factoring company which would manage
Widnor Co‟s sales ledger on a with-recourse basis. The factor believes it can reduce average
trade receivables days to 35 days, while cutting bad debts by 70%
The factor would also advance Widnor Co 80% of the value of invoices raised at an interest rate
of 7% per year.
Assume that there are 360 days in each year.
1. What is the level of Widnor Co’s bad debts expense if it accepts the factor’s offer?
A.
B.
C.
D.
$80,250
$187,250
$nil
$267,500
2. What is Widnor Co’s overall cost of financing receivables (to the nearest $000) if it
accepts the factor’s offer?
A.
B.
C.
D.
$1,766,000
$1,498,000
$123,000
$172,000
3. Which of the following methods could Widnor Co use to assess the creditworthiness
of potential customers?
1.
2.
3.
4.
Trade references
Credit rating agencies
Financial statements analysis
Analysis of the yield curve
A.
B.
C.
D.
1,2, 3 and 4
1,2 and 3 only
3 and 4 only
1 and 2 only
4. As the proposed factoring arrangement would improve the firm‟s cash provision Widnor‟s
finance director is evaluating alternative short-term investments.
Which of the following statements are correct?
1. A certificate of deposit is an example of a money market instrument
2. Commercial paper is high risk debt issued by a company
3. Treasury bills are bought and sold on a discount basis
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
5. Widnor‟s chairman is concerned that the firm‟s share price has been falling by more than its
competitors. The chairman believes this may be due to market inefficiency rather than poor
company performance.
Which of the following statements about the efficient markets hypothesis are correct?
1. It tests the allocational efficiency of the stock market
2. It assumes rational investors
3. Technical analysis can predict share price movements in a weak form market
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
RISK MANAGEMENT
1. PKA CO
The following scenario relates to question 1-5 PKA Co is a European company that has used a
foreign supplier for the first time and must pay $250,000 to the supplier in six months‟ time. The
following information has been provided by the company‟s bank:
Spot rate ($ per
£)
1.9962.000
1.9751.983
Six months forward rate ($ per £)
Money market rates availabke to
PKA:
Borrowing Deposit
One year euro interest
rates:
One year dollar interest
rates:
6.1%
5.4%
4.0%
3.5%
Assume that it is now 1 December and that PKA has no surplus cash at the present time. PKA‟s
home currency is the euro.
1. What are the appropriate six-month interest rates for PKA Co to use if the company
hedges the dollar payment using money market hedge?
A
B
C
D
Borrowing
rate
6.10%
4.00%
2.00%
3.05%
Deposit rate
3.50%
5.40%
2.70%
1.75%
2. What is the euro cost of a forward market hedge?
A.
B.
C.
D.
£126,582
£126,326
£493,750
£126,072
3. Which of the following statements relating to interest rate parity theory are correct?
1. The currency with a higher interest rate would be expected to strengthen against the
other currency
2. The theory operates using real interest rates rather than nominal interest rates
3. The forward rate cam be found by multiplying the spot rate by the ratio of the interest
rates on each currency
A.
B.
C.
D.
1,2 and 3
3 only
1 and 3 only
2 and 3 only
4. Which of the following are possible methods for PKA Co to hedge foreign
currency risk?
1.
2.
3.
4.
A.
B.
C.
D.
Invoice in euros
Forward rate agreements (FRAs)
Leading and laggings
Currency futures
1,2,3 and 4
1 and 3 only
1,3 and 4
2 and 3 only
5. PKA Co also expects to receive export earnings of $500,000 in three months‟ time.
Which of the following is the correct procedure for hedging this receipt using a
money market hedge?
A. Step 1 Borrow an appropriate amount in dollars now
Step 2 Convert the dollar amount into euros now
Step 3 Place the euros on deposit
Step 4 Use the export earnings to repay loan
B. Step 1 Borrow an appropriate amount in dollars now
Step 2 Place the dollar on deposit
Step 3 Convert the dollars amount into euros in three months‟ time
Step 4 Use the export earnings to repay loan
C. Step 1 Borrow an appropriate amount in euros now
Step 2 Convert the euros amount into dollars now
Step 3 Place the dollars on deposit
Step 4 Use the export earnings to repay loan
D. Step 1 Borrow an appropriate amount in euros now
Step 2 Place the euros on deposit
Step 3 Convert the euros amount into dollars in three months‟ time
Step 4 Use the export earnings to repay loan
2. GN CO
The following scenario relates to question 1-5
GN Co, whose home currency is the dollar, has exported products to Europe for several years
and all European customers pay on a credit basis in euros.
It now plans to invest in a European storage, packing and distribution network. The investment
will cost €13 million and is to be financed by equal amounts of equity and debt.
The debt finance will be provided by an immediate €6.5 million loan note issue. The interest rate
on the loan note issue is 8% per year, with interest being payable in euros on a six-monthly
basis.
The equity finance will be an immediate rights issue in GN‟s home country to raise $5 million
after issue costs of $300,000. GN‟s current share price is $2.50 per share and the rights issue
would be made at a 20% discount.
The spot exchange rate is $1=€1.30. The sic month forward rate is $1=€1.2876 and the 12month forward rate is $1=€1.2752.
1. To which of the following currency risks is GN Co potentially exposed?
1. Transaction risk
2. Translation risk
3. Economic risk
A.
B.
C.
D.
1 only
1,2 and 3
3 only
1 and 3 only
2. How many shares will GN Co need to sell in the rights issue?
A.
B.
C.
D.
2.65 million
2 million
2.5 million
2.12 million
3. What is the dollar cost in the forward market hedging the first interest payment of the
loan note?
A.
B.
C.
D.
$403,852
$407,779
$203,890
$201,926
4. Which of the following is correct procedure for hedging the first interest payment on
the loan note?
A. Step 1 Borrow an appropriate amount in euros now
Step 2 Convert the euros amount into dollars now
Step 3 Place the dollars on deposit
B. Step 1 Borrow an appropriate amount in dollars now
Step 2 Place the dollar on deposit now
Step 3 Convert the dollars amount into euros in six months‟ time
C. Step 1 Borrow an appropriate amount in dollars now
Step 2 Convert the dollars amount into dollars now
Step 3 Place the euros on deposit
D. Step 1 Borrow an appropriate amount in euros now
Step 2 Place the euros on deposit
Step 3 Convert the euros amount into dollars in six months‟ time
5. Which of the following methods could GN Co use to hedge the currency risk on the
loan note?
1. Currency swap
2. Netting
3. Interest rate futures
A.
B.
C.
D.
1 only
1,2 and 3
3 only
1 and 2 only
3. ZIGZAG CO
The following scenario relates to question 1-5
ZigZag Co, whose home currency is the dollar, has recently begun exporting to a European
country and expects to receive €500,000 in six months‟ time. ZigZag Co can deposit euros at an
annual interest rate of 3% and can borrow euros at 5% per year. The company can deposit
dollars at an annual interest rate of 4% and borrow dollars at 6% per year. Inflation in the
European country is 3% per year, while inflation in the home country of ZigZag Co is 4.5% per
year.
The following exchange rates are currently available to ZigZag Co:
Current spot exchange
rate
Six-month forward excahnge rate
One-year forward exchange rate
2.000 euro per $
1.990 euro per $
1.981 euro per $
1. What is the future dollar value if the €500,000 receipt is hedged using a forward
contract?
A. $995,00
B. $252,398
C. $990,500
D. $251,256
2. What sum should ZigZag Co borrow today to establish a money market hedge on
€500,000 receipt?
A.
B.
C.
D.
$476,150
$235,849
$487,805
$242,718
3. What is the one-year expected spot rate predicted by purchasing power parity
theory?
A.
B.
C.
D.
€1.971 per $
€1.995 per $
€1.981 per $
€1.990 per $
4. Which of the following statements is correct?
A. Currency futures have a wide range of delivery dates
B. Currency swaps can be used to hedge exchange rate risk over longer periods
than the forward market
C. Banks will allow forward exchange contracts to lapse if they are not exercised by
the counterparty
D. Currency options are paid for when they are exercised
5. Which of the following may result from a depreciation in the value of a country’s
currency?
1. Exports are boosted
2. The inflation rate will rise
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
4. PZK CO
The following scenario relates to question 1-5
PZK Co, whose home currency is the dollar, trades regularly with customers in a number of
different countries. The company expects to receive €1,200,000 in six months‟ time from a
foreign customer. Current exchange rates in the home country of PZK Co are as follows:
Spot exchange
rate:
Six month forward exchange rate:
4.1780-4.2080 euros per $
4.2302-4.2606 euros per $
12 month forward exchange rate:
4.2825-4.3132 euros per $
1. What is the loss or gain compared to its current dollar value which PZK Co will incur
by taking out a forward exchange contract on the future euro receipt?
A.
B.
C.
D.
$3,520 loss
$3,544 gain
$6,955 loss
$7,009 gain
2. Which of the following derivatives could be used to hedge the future euro receipt?
A.
B.
C.
D.
Interest rate futures
Forward rate agreement
Currency swap
Call options on the dollar
3. What is the annual euro interest rate implied by the 12 month forward exchange rate if
the dollar interest rate is 4% per year?
A.
B.
C.
D.
3.3%
5.3%
6.6%
1.5%
The chairman of PZK Co has been reading about macroeconomics and asks you the
following questions:
4. 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
in 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.
B.
C.
D.
2 only
1 and 2 only
1 and 3 only
1,2 and 3
5. Which of the following statements are correct?
1. The general level of interest rates is affected by investors „ desire for a real
return
2. Market segmentation theory can explain kinks (discontinuities) in the yield curve
3. When interest rates are expected to fall, the yield curve could be sloping
downwards.
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
5. ROSE CO
The following scenario relates to question 1-5
Rose Co, whose home currency is the dollar, expects to receive €750,000 from a credit
customer in the European Union in six months‟ time and to pay €500,000 to a supplier in 12
months‟ time. The spot exchange rate is €2.349 per $1 and the following interest rates are
available to Rose Co :
Deposit
rate
4.00%
2.00%
Euros
Dollars
Borrowing rate
8.00%
3.50%
The risk-free interest rate on the euro is 5.0% per year and on the dollar is 2.2% per year. The
inflation rate in Rose Co‟s home country is 1.5% per year and the European Union is 3.0% per
year.
1. Which of the following would correctly set up a money market hedge on the €750,000
receipt expected in six months’ time?
A.
B.
C.
D.
Today borrow €694,444
Today borrow €721,154
Today borrow $319,285
Today deposit €735,294
2. Which of the following would correctly hedge on the €500,000 payment expected in 12
months’ time?
A.
B.
C.
D.
Today borrow euros
Forward rate agreement
Buy euro futures contracts
Put options on the euro
3. If Rose Co continues to trade with the European Union for many years which of the
following currency risks will it potentially be exposed to?
1. Transaction risk
2. Translation risk
3. Economic risk
A. 1 only
B. 1,2 and 3
C. 3 only
D. 1 and 3 only
4. Which of the following would be the 12-month forward exchange rate?
A.
B.
C.
D.
€2.413 per $1
€2.286 per $1
€2.172 per $1
€2.315 per $1
5. Rise Co is planning to issue debt and is considering the use of interest rate derivatives
to protect against a rise in interest rates.
Which of the following statements are correct?
1. Interest rate options allow the buyer to take advantage of favorable interest rate
movements
2. A forward rate agreement does not allow a borrower to benefit from a decrease
in interest rates
3. Borrowers hedging against an interest rate increase will buy interest rate futures
now and sell them at a later date
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
BUSINESS VALUATION
1. PHOBIA CO
The following scenario relates to question 1-5
Phobia Co has in issue 9% loan notes which are redeemable at their nominal value of $100 in
five years‟ time. Alternatively, each loan note may be converted on that date into 20 ordinary
shares of the company. The current ordinary share price of Phobia is $4.45 and this is expected
to grow at a rate of 6.5% per year for the foreseeable future.
Investors currently require a return of 7% per annum on Phobia Co‟s loan notes.
1. What is the forecast conversion value of each $100 loan note?
A.
B.
C.
D.
$118
$89
$122
$131
2. What is the floor value (to the nearest $1) of each $100 loan note?
A.
B.
C.
D.
$108
$121
$100
$93
3. Which of the following is an advantage to a company of issuing convertible loan
notes?
A.
B.
C.
D.
Dilution of earnings per share upon conversion
Lower annual interest expense compared to non-convertible loan notes
The company can choose whether to redeem or convert the loan notes
New equity finance raised upon conversion
4. Which of the following statements is correct?
A. Governments can keep interest rates low by selling short-dated governments
bills in money market
B. The normal yield curve slopes upward to reflect increasing compensation to
investors for being unable to use their cash now
C. The yield on long-term loan notes is lower than the yield on short-term loan notes
because long-term debt is less risky for an investor than short-term debt
D. Expectations theory states that future interest rates reflect expectations of future
inflation rate movements
5. In relation to hedging interest rate risk, which of the following statements is correct?
A. The flexible nature of interest rate futures mean that they can always be matched
with a specific interest rate exposure
B. Interest rate options carry an obligation to the holder to complete the contract at
maturity
C. Forward rate agreements are the interest rate equivalent of forward exchange
contracts
D. Matching is where a balance is maintained between fixed rate and floating rate
debt
2. NSX
The following scenario relates to question 1-5
NSX Co has the following data:
Year to 31 May
Dividend
per
share
Closing ex-dividend share price
20X6
$0.40
20X5
$0.385
20X4
$0.3698
$6.48
$8.35
$7.40
The finance director has proposed that, in order to conserve cash within the company, no
dividend would be paid in the next three years. It would then possible to pay a dividend of $0.70
per share in the fourth year and an annual dividend increase of 3% per year in subsequent
years.
NSX Co‟s chairman is considering methods of aligning management‟s objectives with those of
shareholders and of raising new capital from financial intermediaries.
The current cost of equity of NSX Co is 10% per year.
1. What is the share price of NSX Co, using the dividend growth model, based on the
existing dividend policy?
A.
B.
C.
D.
$6.48
$6.93
$6.67
$5.89
2. What is the share price of NSX Co, using the dividend growth model, if the proposed
change in dividend policy is implemented?
A.
B.
C.
D.
$10.30
$7.74
$10.00
$7.51
3. What was the average total shareholder return for the period 20X4-20X6?
A.
B.
C.
D.
0.2%
-6.0%
6.0%
-0.2%
4. Which of the following statements are correct?
1. Share option schemes always reward good performance by managers
2. Performance-related pay can encourage dysfunctional behavior
3. Maximising earnings per share will maximise shareholder wealth
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 only
1,2 and 3
5. Which of the following are financial intermediaries?
1. Venture capital organisation
2. Pension fund
3. Merchant bank
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
3. NN CO
The following scenario relates to question 1-5
The following financial information refers to NN Co:
$m
Assets
Non-current
assets
Current assets
Inventory
Trade
receivables
Cash
101
11
21
10
42
143
Total assets
Equity and liabilities
Ordinary shares
Retained
earnings
Non-current liabilities
Irredeemable preference shares
$m
50
19
69
25
20
Long-term borrowings
Current liabilities
Trade payables
Other payables
Total equity and liabilities
45
22
7
29
143
NN Co has just paid an ordinary dividend of $0.66 per share and has a cost of equity of 12%.
The ordinary dividends of the company have grown in recent years by an average rate of 3%
per year. The ordinary shares of the company have a nominal value of $0.50 per share.
The irredeemable preference shares have a nominal value of $0.50 per share and pay an
annual dividend of 8%. The ex-dividend market value of the preference shares is $0.67 per
share.
NN Co pays profit tax at an annual rate of 20% per year.
1. What is the total equity value of NN Co using the dividend growth model?
A.
B.
C.
D.
$378 million
$367 million
$733 million
$755 million
2. What is the total equity value of NN Co using an asset-based valuation?
A.
B.
C.
D.
$143 million
$69 million
$94 million
$50 million
3. What is the cost of NN Co’s preference share capital?
A.
B.
C.
D.
8.0%
6.4%
6.0%
5.4%
4. Which of the following is correct statement about preference shares?
1. Preference dividends reduce the firm‟s taxable profits
2. Preference shares are secured on company assets
3. Preference dividends are a fixed percentage of profits
A. None of the above
B. 1 only
C. 2 and 3
D. 3 only
5. A shareholder in NN Co 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.
B.
C.
D.
Fundamental analysis
Operational efficiency
Technical analysis
Semi-strong from efficiency
4. CLOSER CO
The following scenario relates to question 1-5
Recent financial information relating to Closer Co is as follows:
Profit after tax (earnings)
Ordinary dividends
$m
66.6
40.0
Statement of financial position information
$m
Non-current assets
Current assets
Total assets
Equity
Ordinary shares ($1 nominal)
Reserves
$m
595
125
720
80
410
490
Non-current liabilities
6% Preference shares
8% Loan notes ($100
nominal)
Current liabilities
40
120
160
70
720
Total equity and liabilities
The non-current assets include a property with a market value 20% above its book value of
$200m. Current assets include receivables of $100m but 10% of these are considered
irrecoverable.
The dividends of Closer Co will grow in the future at a rate of 4% per year. The finance director
of Closer Co thinks that an earnings yield of 11% per year can be used for valuation purposes.
Closer Co has a cost of equity of 10% per year.
1. What is the total equity value of Closer Co’s using an asset-based valuation?
A.
B.
C.
D.
$490m
$720m
$750m
$520m
2. What is the total equity value of Closer Co using the dividend growth model?
A.
B.
C.
D.
$693m
$667m
$1110m
$594m
3. What is the total equity value of Closer Co using the earnings yield method?
A.
B.
C.
D.
$666m
$605m
$989m
$951m
4. Which of the following are weakness of the dividend growth model as a way of
valuing a company?
1. It is only relevant for valuing a minority stake
2. There is no method of justifying the growth forecast
3. It is affected by accounting policies
A.
B.
C.
D.
1 only
1 and 3 only
2 and 3 only
1,2 and 3
5. 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.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
5. WWW CO
The following scenario relates to question 1-5
WWW Co is a listed company and the following financial information is available:
Year
Profit after tax (earnings)
Ordinary dividends
20X2
8.5
5.0
20X3
8.9
5.2
$m
$m
91.0
20X4
9.7
5.6
20X3
10.1
6.0
Statement of financial position information
Non-current assets
Current assets
Inventory
Trade
receivables
Total assets
Equity
Oridnary shares
Reserves
3.8
4.5
8.3
99.3
20.0
47.2
67.2
Non-current liabilities
8% Loan notes
Current liabilities
Total equity and liabilities
25.0
7.1
99.3
The shares of WWW Co have a nominal value of $0.50 per share and a market value of $4.00
per share. The 8% loan notes are redeemable at a nominal value of $100 per loan note in seven
years‟ time and the before-tax cost of debt of WWW Co is 6% per year.
1. Which of the following statements about profit are correct?
1. Profit maximisation ensures shareholder wealth maximisation
2. Profit takes no account of risk
3. Profit is stated after deducting debt and equity financing costs
A.
B.
C.
D.
2 and 3 only
2 only
3 only
1,2 and 3
2. What is WWW Co’s market capitalisation?
A. $67.2 million
B. $207.2 million
C. $185 million
D. $160 million
3. What is the market value (to the nearest $1) of each of WWW Co’s loan notes?
A.
B.
C.
D.
$111
$100
$108
$98
4. What is WWW Co’s debt/equity ratio (book value basis)?
A.
B.
C.
D.
27%
37%
48%
32%
5. 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 dividend decision is more important than the
investment decision
D. Shareholders usually have the power to increase dividends at annual general
meetings of a company
6. GXG CO
The following scenario relates to question 1-5
GXG Co is considering an issue of $3,200,000 of loan notes paying annual interest of 6%.
Investment of the funds raised would increase operating profit by $576,000 per year.
Recent financial information relating to GXG Co is as follows:
Operating profit
Interest
$'000
3,450
200
Profit before taxation
Taxation
3250
650
Profit
taxation
Dividends
2600
1600
after
GXG Co has a cost of equity of 9% per year. Dividends are expected to grow by 3% per year.
1. What is the total value of GXG Co’s equity using the dividend growth model?
A.
B.
C.
D.
$27.5 million
$26.7 million
$44.6 million
$33.3 million
2. Which of the following would occur following the loan note issue?
1. Earnings per share would fall
2. The cost of equity would rise
3. Tax shield would rise
A.
B.
C.
D.
1,2 and 3
2 and 3 only
2 only
3 only
3. What is GXG Co’s interest cover following the loan note issue and investment of the
fund raised?
A.
B.
C.
D.
17 times
9 times
20 times
10 times
4. GXG Co‟s chairman has been reading about project appraisal techniques.
Which of the following statements are correct?
1. The sensitivity of a project variable can be calculated by dividing the project net
present value by the present value of the cash flows relating to that project
variable
2. The expected net present value is the value expected to occur if an investment
project with several possible outcomes is undertaken once
3. The discounted payback period is the time taken for the cumulative net present
value to change from negative to positive
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1,2 and 3
5. Which of the following statements is correct?
A. Tax-allowable depreciation is a relevant cash flow when evaluating borrowing to buy
compared to leasing as a financing choice
B. Asset replacement decisions require relevant cash flows to be discounted by the
after-tax cost of debt
C. If capital is rationed, divisible investment projects can be ranked by the profitability
index when determining the optimum investment schedule
D. Government restrictions on bank lending are associated with soft capital rationing
SPECIMEN EXAM (applicable from September 2016)
1. The home currency of ACB Co is the dollar ($) and it trades with a company in a foreign
country whose home currency is the Dinar. The following information is available:
Spot rate
Interest rate
Inflation rate.
Home country
20·00 Dinar per $
3% per year
2% per year
Foreign country
7% per year
5% per year
What is the six-month forward exchange rate?
A.
B.
C.
D.
A 20·39 Dinar per $
B 20·30 Dinar per $
C 20·59 Dinar per $
D 20·78 Dinar per $
2. The following financial information relates to an investment project
Present value of sales revenue
Present value of variable costs
Present value of contribution
Present value of fixed costs
Present value of operating
income
Initial investment
Net present value
$‟000
50,025
25,475
24,550
18,250
6,300
5,000
1,300
What is the sensitivity of the net present value of the investment project to a change
in sales volume?
A.
B.
C.
D.
A 7·1%
B 2·6%
C 5·1%
D 5·3%
3. Gurdip plots the historic movements of share prices and uses this analysis to make her
investment decisions.
To what extent does Gurdip believe capital markets to be efficient?
A. A Not efficient at all
B. B Weak form efficient
C. C Semi-strong form efficient
D. D Strong form efficient
4. Which of the following statements concerning capital structure theory is correct?
A. A In the traditional view, there is a linear relationship between the cost of equity and
financial risk
B. B Modigliani and Miller said that, in the absence of tax, the cost of equity would
remain constant
C. C Pecking order theory indicates that preference shares are preferred to convertible
debt as a source of finance
D. D Business risk is assumed to be constant as the capital structure changes
5. Which of the following actions is LEAST likely to increase shareholder wealth?
A.
B.
C.
D.
The weighted average cost of capital is decreased by a recent financing decision
The financial rewards of directors are linked to increasing earnings per share
The board of directors decides to invest in a project with a positive NPV
The annual report declares full compliance with the corporate governance code
6. 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.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1, 2 and 3
7. The following are extracts from the statement of profit or loss of CQB Co:
Sales revenue
Cost of sales
Profit before interest and
tax
Interest
Profit before tax
Tax
Profit after tax
60% of the cost of sales is variables costs.
$‟000
60,000
50,000
10,000
4,000
6,000
4,500
1,500
What is the operational gearing of CQB Co?
A.
B.
C.
D.
5·0 times
2·0 times
0·5 times
3·0 times
8. The management of XYZ Co has annual credit sales of $20 million and accounts receivable
of $4 million. Working capital is financed by an overdraft at 12% interest per year. Assume
365 days in a year.
What is the annual finance cost saving if the management reduces the collection
period to 60 days?
A.
B.
C.
D.
$85,479
$394,521
$78,904
$68,384
9. Which of the following statements concerning financial management are correct?
1) It is concerned with investment decisions, financing decisions and dividend decisions
2) It is concerned with financial planning and financial control
3) It considers the management of risk
A.
B.
C.
D.
1 and 2 only
1 and 3 only
2 and 3 only
1, 2 and 3
10. SKV Co has paid the following dividends per share in recent years:
Year 20X4 20X3 20X2 20X1 Dividend ($ per share) 0·360 0·338 0·328 0·311 The dividend
for 20X4 has just been paid and SKV Co has a cost of equity of 12%.
Using the geometric average historical dividend growth rate and the dividend growth
model, what is the market price of SKV Co shares on an ex dividend basis?
A.
B.
C.
D.
A $4·67
B $5·14
C $5·40
D $6·97
11. „There is a risk that the value of our foreign currency-denominated assets and liabilities will
change when we prepare our accounts‟
To which risk does the above statement refer?
A.
B.
C.
D.
A Translation risk
B Economic risk
C Transaction risk
D Interest rate risk
12. The following information has been calculated for A Co:
Trade receivables collection period: 52 days
Raw material inventory turnover period: 42 days
Work in progress inventory turnover period: 30 days
Trade payables payment period: 66 days
Finished goods inventory turnover period: 45 days
What is the length of the working capital cycle?
A.
B.
C.
D.
103 days
131 days
235 days
31 days
13. Which of the following is/are usually seen as benefits of financial intermediation?
1) Interest rate fixing
2) Risk pooling
3) Maturity transformation
A.
B.
C.
D.
1 only
1 and 3 only
2 and 3 only
1, 2 and 3
14. Which of the following statements concerning working capital management are
correct?
1) The twin objectives of working capital management are profitability and liquidity
2) A conservative approach to working capital investment will increase profitability
3) Working capital management is a key factor in a company‟s long-term success
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
15. Governments have a number of economic targets as part of their monetary policy.
Which of the following targets relate predominantly to monetary policy?
1)
2)
3)
4)
A.
B.
C.
D.
Increasing tax revenue
Controlling the growth in the size of the money supply
Reducing public expenditure
Keeping interest rates low
1 only
1 and 3
2 and 4 only
2, 3 and 4
Section B
The following scenario relates to questions 16–20.
Par Co currently has the following long-term capital structure:
$m
Equity finance
Ordinary shares
Reserves
$m
30·0
38·4
68·4
Non-current liabilities
Bank loans
8% convertible loan notes
5% redeemable preference shares
Total equity and liabilities
15·0
40·0
15.0
70·0
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.
16. 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
A.
B.
C.
D.
Least risky
Redeemable preference shares
Ordinary shares
Bank loan
Ordinary shares
Bank loan
Bank loan
Loan notes
Loan notes
17. What is the conversion value of the 8% loan notes of Par Co after seven years?
A.
B.
C.
D.
$16·39
$111·98
$131·12
$71·72
18. 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.
B.
C.
D.
$115·20
$109·26
$94·93
$69·00
19. 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
20. Which of the following statements are problems in using the price/earnings ratio
method to value a company?
1)
2)
3)
4)
It is the reciprocal of the earnings yield
It combines stock market information and corporate information
It is difficult to select a suitable price/earnings ratio
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
The following scenario relates to questions 21–25
ZPS Co, whose home currency is the dollar, took out a fixed-interest peso bank loan several
years ago when peso interest rates were relatively cheap compared to dollar interest rates. ZPS
Co does not have any income in pesos. Economic difficulties have now increased peso interest
rates while dollar interest rates have remained relatively stable.
ZPS Co must pay interest on the dates set by the bank. A payment of 5,000,000 pesos is due in
six months‟ time. The following information is available:
Spot rate
Six-month forward rate
12·500–12·582 pesos per $
12·805–12·889 pesos per $
Interest rates which can be used by ZPS Co:
Borrow
Deposit
Peso interest rates
10·0% per year
7·5% per year
Dollar interest rates
4·5% per year
3·5% per year
21. What is the dollar cost of a forward market hedge?
A.
B.
C.
D.
A $390,472
B $387,928
C $400,000
D $397,393
22. Which of the following statements relate to purchasing power parity theory?
1) The theory holds in the long term rather than the short term
2) The exchange rate reflects the different cost of living in two countries
3) The forward rate can be found by multiplying the spot rate by the ratio of the interest
rates of the two countries
A.
B.
C.
D.
1, 2 and 3
1 and 2 only
1 and 3 only
2 only
23. What are the appropriate six-month interest rates for ZPS Co to use if the company
hedges the peso payment using a money market hedge?
Deposit rate
A.
B.
C.
D.
7·5%
1·75%
3·75%
3·5%
Borrowing rate
4·5%
5·0%
2·25%
10·0%
24. Which of the following methods are possible ways for ZPS Co to hedge its existing
foreign currency risk?
1)
2)
3)
4)
A.
B.
C.
D.
Matching receipts and payments
Currency swaps
Leading or lagging
Currency futures
1, 2, 3 and 4
1 and 3 only
2 and 4 only
2, 3 and 4 only
25. ZPS Co also trades with companies in Europe which use the Euro as their home currency.
In three months‟ time ZPS Co will receive €300,000 from a customer.
Which of the following is the correct procedure for hedging this receipt using a
money market hedge?
A. Step 1 Borrow an appropriate amount in Euro now
Step 2 Convert the Euro amount into dollars
Step 3 Place the dollars on deposit
Step 4 Use the customer payment to repay the loan
B. Step 1 Borrow an appropriate amount in dollars now
Step 2 Place the dollars on deposit now
Step 3 Convert the dollars into Euro in three months‟ time
Step 4 Use the customer payment to repay the loan
C. Step 1 Borrow an appropriate amount in dollars now
Step 2 Convert the dollar amount into Euro
Step 3 Place the Euro on deposit
Step 4 Use the customer payment to repay the loan
D. Step 1 Borrow an appropriate amount in Euro now
Step 2 Place the Euro on deposit now
Step 3 Convert the Euro into dollars in three months‟ time
Step 4 Use the customer payment to repay the loan
The following scenario relates to questions 26–30
Ridag Co operates in an industry which has recently been deregulated as the government
seeks to increase competition in the industry.
Ridag Co plans to replace an existing machine and must choose between two machines.
Machine 1 has an initial cost of $200,000 and will have a scrap value of $25,000 after four
years. Machine 2 has an initial cost of $225,000 and will have a scrap value of $50,000 after
three years. Annual maintenance costs of the two machines are as follows:
Year
1
2
3
Machine 1 ($ per year)
25,000
29,000
32,000
Machine 2 ($ per year)
15,000
20,000
25,000
4
35,000
Where relevant, all information relating to this project has already been adjusted to include
expected future inflation. Taxation and tax allowable depreciation must be ignored in relation to
Machine 1 and Machine 2.
Ridag Co has a nominal before-tax weighted average cost of capital of 12% and a nominal
after-tax weighted average cost of capital of 7%.
26. In relation to Ridag Co, which of the following statements about competition and
deregulation are true?
1)
2)
3)
4)
Increased competition should encourage Ridag Co to reduce costs
Deregulation will lead to an increase in administrative and compliance costs for Ridag Co
Deregulation should mean an increase in economies of scale for Ridag Co
Deregulation could lead to a decrease in the quality of Ridag Co‟s products
A.
B.
C.
D.
A 1 and 4
B 2 and 3
C 1 and 3
D 2 and 4
27. What is the equivalent annual cost of Machine 1?
A.
B.
C.
D.
A $90,412
B $68,646
C $83,388
D $70,609
28 Which of the following statements about Ridag Co using the equivalent annual cost
method are true?
1) Ridag Co cannot use the equivalent annual cost method to compare Machine 1 and
Machine 2 because they have different useful lives
2) The machine which has the lowest total present value of costs should be selected by
Ridag Co
A.
B.
C.
D.
1 only
Both 1 and 2
2 only
Neither 1 nor 2
29 Doubt has been cast over the accuracy of the year 2 and year 3 maintenance costs for
Machine 2. On further investigation it was found that the following potential cash flows are now
predicted:
Year
Cash flow
Probability ($)
2
18,000
0·3
2
25,000
0·7
3
23,000
0·2
3
24,000
0·35
3
30,000
0·45
What is the expected present value of the maintenance costs for year 3?
A.
B.
C.
D.
$26,500
$18,868
$21,624
$35,173
30. Ridag Co is appraising a different project, with a positive NPV. It is concerned about the risk
and uncertainty associated with this other project.
Which of the following statements about risk, uncertainty and the project is true?
A. Sensitivity analysis takes into account the interrelationship between project variables
B. Probability analysis can be used to assess the uncertainty associated with the project
C. Uncertainty can be said to increase with project life, while risk increases with the
variability of returns
D. A discount rate of 5% could be used to lessen the effect of later cash flows on the
decision
SEPTEMBER 2016 EXAM
1. 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)
Current assets
Non-current liabilities
Current liabilities
$30m
$18m
$12m
$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?
A.
B.
C.
D.
$14
$25
$28
$13
2. 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
3. Andrew Co is a large listed company financed by both equity and debt.
In which of the following areas of financial management will the impact of working
capital management be smallest?
A Liquidity management
B Interest rate management
C Management of relationship with the bank
D Dividend policy
4.
Which of the following are descriptions of basis risk?
(1) It is the difference between the spot exchange rate and currency futures exchange rate
(2) It is the possibility that the movements in the currency futures price and spot price will be
different
(3) It is the difference between fixed and floating interest rates
(4) It is one of the reasons for an imperfect currency futures hedge
A 1 only
B 1 and 3
C 2 and 4 only
D 2, 3 and 4
5. 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:
Inventory (days)
Maximum
120
Minimum
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
6. In relation to an irredeemable security paying a fixed rate of interest, which of the
following statements is correct?
A. As risk rises, the market value of the security will fall to ensure that investors receive an
increased yield
B. As risk rises, the market value of the security will fall to ensure that investors receive a
reduced yield
C. As risk rises, the market value of the security will rise to ensure that investors receive an
increased yield
D. As risk rises, the market value of the security will rise to ensure that investors receive a
reduced yield
7. 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.
B.
C.
D.
Finance costs will increase
Re-financing risk will increase
Interest rate risk will decrease
Overcapitalisation risk will decrease
8. In relation to an operating lease, which of the following statements is correct?
A.
B.
C.
D.
All the risks and rewards of ownership transfer to the lessee
The asset and lease obligation will be recorded in the statement of financial position
The lease period will cover almost all of the leased asset‟s useful economic life
The lessor will be responsible for repairs and maintenance of the leased asset
9. A company has annual after-tax operating 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.
B.
C.
D.
$20m
$40m
$50m
$25m
10. Which of the following would you expect to be the responsibility of financial
management?
A.
B.
C.
D.
Producing annual accounts
Producing monthly management accounts
Advising on investment in non-current assets
Deciding pay rates for staff
11. 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
12. Country X uses the dollar as its currency and country Y uses the dinar. Country X‟s
expected inflation rate is 5% per year, compared to 2% per year in country Y. Country Y‟s
nominal interest rate is 4% per year and the current spot exchange rate between the two
countries is 1·5000 dinar per $1.
According to the four-way equivalence model, which of the following statements
is/are true?
1) Country X‟s nominal interest rate should be 7·06% per year
2) The future (expected) spot rate after one year should be 1·4571 dinar per $1
3) Country X‟s real interest rate should be higher than that of country Y
A.
B.
C.
D.
A 1 only
B 1 and 2 only
C 2 and 3 only
D 1, 2 and 3
13. Which of the following government actions would lead to an increase in aggregate
demand?
1)
2)
3)
4)
Increasing taxation and keeping government expenditure the same
Decreasing taxation and increasing government expenditure
Decreasing money supply
Decreasing interest rates
A.
B.
C.
D.
A 1 only
B 1 and 3
C 2 and 4 only
D 2, 3 and 4
14. 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.
B.
C.
D.
14%
18%
20%
25%
15. 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.
B.
C.
D.
$1·60
$0·40
$0·50
$1·50
Section B
The following scenario relates to questions 16 to 20.
Herd Co is based in a country whose currency is the dollar ($). 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.
16. What is the six-month forward exchange rate predicted by interest rate parity?
A.
B.
C.
D.
€1·499 per $1
€1·520 per $1
€1·566 per $1
€1·588 per $1
17. 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
18. Which of the following hedging methods will NOT be suitable for hedging the euro
receipt?
A.
B.
C.
D.
Forward exchange contract
Money market hedge
Currency futures
Currency swap
19. 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.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
20. 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
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
Dividend per share
20X6
20X5
20X4
20X3
20X2
$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.
21. Using the dividend growth model, what is the market value of each ordinary share?
A.
B.
C.
D.
$8·59
$9·00
$9·45
$7·77
22. What is the market value of each loan note?
A.
B.
C.
D.
$109·34
$112·01
$116·57
$118·68
23. 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.
B.
C.
D.
Total assets less current liabilities
Non-current assets plus net current assets
Non-current assets plus current assets less total liabilities
Non-current assets less net current assets less non-current liabilities
24. 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
25. 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.
B.
C.
D.
1 and 2 only
1 and 3 only
3 only
1, 2 and 3
The following scenario relates to questions 26 to 30.
The following information relates to an investment project which is 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
Net operating cash flow ($000)
Scrap value ($000)
1
2
1,200
1,500
3
4
1,600 1,580
100
The directors believe that this 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 criticised 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.
26. What is the payback period of the investment project?
A.
B.
C.
D.
2·75 years
1·50 years
2·65 years
1·55 years
27. 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%
28. 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
29. 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.
B.
C.
D.
1 and 2 only
1 only
2 and 3 only
1, 2 and 3
30. 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 shortterm profitability and discourage capital investment
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1, 2 and 3
DECEMBER 2016 EXAM
Section A
1. Which of the following is an advantage of implementing just-in-time inventory
management?
A.
B.
C.
D.
Quality control costs will be eliminated
Monthly finance costs incurred in holding inventory will be kept constant
The frequency of raw materials deliveries is reduced
The amount of obsolete inventory will be minimized
2. Which of the following activities are carried out by a financial intermediary?
1.
2.
3.
4.
Transforming interest rates
Transforming foreign exchange
Transforming maturity
Transforming risk
A.
B.
C.
D.
2 and 4
1 and 3
3 and 4
1 and 2
3. Frost Co is planning 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.
Which of the following is the theoretical ex rights price per share?
A.
B.
C.
D.
$9.80
$9.75
$10.20
$9.20
4. In relation to business valuation, which of the following is true?
A. The earnings yield method and the dividend growth model should give similar values for
a company
B. Market capitalisation represents the maximum value for a company
C. The price/earnings ratio is the reciprocal of the earnings yield
D. The price/earnings ratio should be increased if the company being valued is riskier than
the valuing company
5. Small and medium-sized entities (SME) have restricted access to capital markets.
What is the term given to the difference between the finance required to operate an SME
and the amount obtained?
A.
B.
C.
D.
Forecast gap
Maturity gap
Funding gap
Asset gap
6. Max Co is a large multinational company which experts 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.
B.
C.
D.
Commercial paper
Interest rate futures
Corporate loan notes
Treasury bills
7. 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 from efficiency arises when investors tend not to make rational investment
decisions
C. Allocation efficiency means that transaction costs are kept to a minimum
D. Research has shown that, over time, share prices appear to follow a random walk
The following data is available:
Country Y currency
Country X currency
Country Y interest rate
Country X interest rate
Country X expected inflation rate
Dollar
Peso
1 % per year
3% per year
2% per year
Spot exchange rate in country Y 1.60 peso per $1
8. What is the current six-month forward exchange rate in country Y?
A.
B.
C.
D.
1.63 peso per $1
1.62 peso per $1
1.57 peso per $1
1.58 peso per $1
Green Co, a listed company, had the following share prices during the year ended 31 December
20X5:
At start of 20X5
Highest price in the year
Lowest price in the year
At the end of 20X5
$2.50
$3.15
$2.40
$3.00
During the year, Green Co paid a total dividend of $0.15 per share
9. What is the total shareholder return for 20X5?
A.
B.
C.
D.
26%
22%
32%
36%
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.
10. What is the cost of equity of Carp Co?
A.
B.
C.
D.
19.4%
20.5%
28.0%
22.7%
Mile Co is looking to change its working policy to match the rest of the industry. The following
results are expected for the coming year :
$000
Revenue
Cost of sales
Gross profit
20,500
(12,800)
7,700
Revenue and cost of sales can be assumed to be spread evenly throughout the year. The
working capital ratios of Mile Co, compared with the industry, are as follows:
Mile Co
Industry
Receivables days
Inventory days
Payable days
50
45
40
42
35
35
Assume there are 365 days in each year
11. If Mile Co matches its working capital cycle with the industry, what will be the
decrease in its net working capital?
A.
B.
C.
D.
$624,600
$730,100
$835,600
$975,300
12. Which of the following statements is true?
A. A prospective merger would need to result in a company having a market share greater
than 80% before it can be described as a monopoly
B. A government may intervene to weaken its country‟s exchange rate in order to eliminate
a balance of payments deficit
C. A relatively high rate of domestic inflation will lead to a strengthening currency
D. Government fiscal policy involves the management of interest rates
13. Which of the following statements about interest rate risk hedging is correct?
A.
B.
C.
D.
An interest rate floor can be used to hedge an expected increase in interest rates
The cost of an interest rate floor is higher than the cost of an interest rate collar
The premium on an interest rate option is payable when it is exercised
The standardised nature of interest rate futures means that over- an under-hedging can
be avoided
14. 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 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
Swap Co is due to receive goods costing $2,500. The terms of trade state that payment must be
received within three months. However, a discount of 1.5% will be given for payment within one
month.
15. Which of the following is the annual percentage cost of ignoring the discount and
paying in three months?
A. 6.23%
B. 9.34%
C. 6.14%
D. 9.49%
Section B
The following scenario relates to questions 16 to 20.
Park Co is based in a country whose currency is the dollar ($). 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:
Paying €650,000 for imported goods
Receiving 12 million dinars for exported capital goods
Three months:
Six months:
Park Co has the following exchange rates and interest rates available to it:
Bid
Offer
Spot exchange rate (dinars per $1):
Six month forward rate (dinars per $1):
57.31
58.41
57.52
58.64
Spot exchange rate (€ per $ 1)
Three-month forward rate (€ per $1):
1.544
1.532
1.552
1.540
Six-month interest rates:
Dinars
Dollars
Borrow
Deposit
4.0%
2.0%
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. In hedging the foreign currency risk of the two transactions, which of the following
hedges will Park Co find to be effective?
1. Leading the euro payment on its imported goods
2. Taking out a forward exchange contract on its future dinar receipt
3. Buying a tailor-made currency option for its future euro payment
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1, 2 and 3
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.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
19. Which of the following statements is/are correct?
1. Purchasing power parity can be used to predict the forward exchange rate
2. The international Fisher effect can be used to predict the real interest rate.
A.
B.
C.
D.
1 only
2 only
Both 1 and 2
Neither 1 nor 2
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 long 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 rates in order to combat rising
inflation in the economy
The following scenario relates to questions 21 to 25.
The finance director of Coral Co has been asked to provide values for the company‟s equity and
loan notes. Coral Co us a listed company and has the following long term finance
$m
Ordinary share
7% Convertible loan notes
7.8
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 prices are expected to grow by 9% 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.
21. What is the equity market value of Coral Co?
A.
B.
C.
D.
$221.52m
$55.38m
$31.2m
$229.52m
22. Assuming conversion, what is the market value of each loan note of Coral Co?
A.
B.
C.
D.
$110.13
$112.67
$119.58
$125.70
23. 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. The capital market is semi-strong from 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.
B.
C.
D.
1 only
1 and 3 only
2 and 3 only
1,2 and 3
24. Which of the following assumptions is/are made by dividend growth model?
1. Investors make rational decisions
2. Dividends show either constant growth or zero growth
3. The dividend growth rate is less than the cost of equity
A.
B.
C.
D.
2 only
1 and 3 only
2 and 3 only
1,2 and 3
25. Why might valuations of the equity and loan notes of Coral Co be necessary?
1. The company is planning to go to market for additional finance
2. The securities need to be valued for corporate taxation purposes
3. The company has received a takeover bid form a rival company
A.
B.
C.
D.
1 and 2 only
1 and 3 only
3 only
1, 2 and 3
Link Co has been prevented by the competition authorities from buying a competitor, Twist Co,
on the basis that this prevents a company 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:
$000
Present value of sales revenue
Present value of variable costs
Present value of contribution
Present value of fixed costs
Present value of operating cash flow
Initial capital investment
Net present value
6,657
2,777
3,889
1,569
2,311
1,800
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 new issue of debt.
26. What is the change in sales volume which will make the NPV zero?
A.
B.
C.
D.
7.7%
13.2%
18.4%
22.1%
27. Which of the following statements relating to sensitivity analysis is/are correct?
Although critical factors may be identified, the management of Link Co may have no control over
them
A weakness of sensitivity analysis is that it ignores interdependency between project variables
Sensitivity analysis can be used by Link Co to assess the risk of an investment project
A.
B.
C.
D.
1 and 2 only
1 only
2 and 3 only
1,2 and 3
28. 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.
B.
C.
D.
16%
28%
31%
64%
29. Which of the following 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 asset as security
30. 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.
B.
C.
D.
1 and 2 only
3 only
2 and 3 only
1,2 and 3