Questions and Answers of Corporate Finance Principles And Practice

Identify the factors that influence a company’s decision to hedge interest rate risk.(S-4)
Which factors determine whether a company, having decided to hedge its interest rate exposure, uses internal hedging methods or external instruments? If it decides to hedge interest rate risk
What are the drawbacks of hedging exchange rate risk by using a swap agreement?(S-4)
Carrycan plc must make a payment of $364 897 in six months’ time. It is currently 1 January. The company plans to hedge its transaction exposure and has collected the following information.By
Discuss the factors which influence the price of traded options.
Two companies, A and B, are considering entering into a swap agreement. Their borrowing rates are as follows:Company A needs a floating rate loan of £5m and B needs a fixed rate loan of £5m.(a)
Explain the difference between the nominal (or money) terms approach and the real terms approach to dealing with inflation in the context of investment appraisal.
Explain whether general or specific inflation should be taken into account in investment appraisal.
Discuss how sensitivity analysis can help managers to assess the risk of an investment project.
Discuss the use of risk-adjusted discount rates in the evaluation of investment projects.
Explain the meaning of the term ‘simulation’.
List the ways in which foreign direct investment decisions are different from domestic investment decisions.
Logar is considering the purchase of a machine which will increase sales by £110 000 per year for a period of five years. At the end of the five-year period, the machine will be scrapped. Two
Buddington Ltd is evaluating the purchase of a new machine and has the following information:(a) Calculate the internal rate of return of the project.(b) Assess the sensitivity of the purchase
Scot plc is planning to invest in Glumrovia and, because of risky nature of investments in this part of the world, it will require an after-tax return of at least 20 per cent on the project.Market
Brinpool plc has been invited to build a factory in the small state of Gehell by the government of that country. The local currency is the Ked (K) and data on current and expected exchange rates are
DK plc is evaluating the purchase of a freeze dryer. Packets of frozen food will be sold in boxes of eight and the following information applies to each box:The selling price and cost of the frozen
R plc plans to invest £1 million in new machinery to produce Product GF. Advertising costs in the first two years of production would be £70 000 per year and quality control costs would be 3 per
Ring plc is evaluating the purchase of a machine to produce Product MP3, to which the following information applies:Incremental fixed costs will be c25 000 per year. The machine will cost c850 000
GZ plc plans to build a factory in the USA for $3.4m. Additional investment in working capital of $500 000 would be needed and this would be financed by a loan from a US bank of $500 000. Annual
Ice plc has decided to expand sales in Northland because of increasing pressure in its domestic market. It is evaluating two alternative expansion proposals.Proposal 1 Ice plc could increase
Explain why certain levels of risk cannot be avoided even in a well-diversified portfolio.
The market currently yields a return of 10 per cent whereas Treasury bills yield 4 per cent. Shares of Lime Spider plc have a covariance of 7.5 with the market whereas the market has a variance of
Brown plc has been investing surplus funds in a small portfolio of equity shares over the past few years. Details of the portfolio are as follows.The current market return is 12 per cent and the
You are given the following data which refers to the performance of the FTSE 100 and two companies over the last financial year.Required:(a) Using the data above, calculate whether or not a
Mr Magoo is planning to invest £18m in one of two short-term portfolios. Both portfolios consist of four short-term securities from diverse industries. The correlation between the returns of the
The securities of companies Z and Y have the following expected returns and standard deviations:If the correlation coefficient between the two securities is +0.25, calculate the expected return and
Mr. Moroley has just finished reading a textbook about portfolio theory and he is keen to put his new-found knowledge into action with respect to savings of £1000 he wishes to invest. He has
You have the following information about the returns for the securities of Super Lux plc and the returns for the market:Given that the rate of return on Treasury bills is 8 per cent and that the
Five years ago, Eranio plc issued 8 per cent irredeemable bonds at their par value of£100. The current market price of these bonds is £92. If the company pays corporate tax at a rate of 30 per
Pollock has in issue 1 million ordinary shares, par value 25p and £100 000 of 8 per cent irredeemable bonds. The current ex-dividend market price of the ordinary shares is 49p per share and the
Should companies use their weighted average cost of capital as the discount rate when assessing the acceptability of new projects?
A firm has an equity beta of 1.30 and is currently financed by 25 per cent debt and 75 per cent equity. What will be the company’s new equity beta if the company changes its financing to 33 per
One-third of the total market value of Johnson plc consists of bonds with a cost of 10 per cent. York plc is identical in every respect to Johnson except that its capital structure is all equity and
Calet plc, which pays corporate tax at 30 per cent, has the following capital structure:■ Ordinary shares: 1 000 000 ordinary shares of nominal value 25p per share. The market value of the shares
Icicle Works plc is a frozen food packaging company that intends to diversify into electronics.The project has a return of 12 per cent and Icicle Works is trying to decide whether it should be
Paisley Brothers plc, a company producing loud paisley shirts, has net operating income of £2000 and is faced with three options of how to structure its debt and equity:(a) to issue no debt and pay
The calculation of the WACC is straightforward in theory, but difficult in practice.Outline any possible difficulties that might be experienced when trying to calculate the WACC.
Discuss problems that may be encountered in applying the CAPM in investment appraisal.
You are given the following information about Jordan plc: Financial position statement at January 20X0 000 000 Non-current assets 1511 Current assets 672 Current liabilities 323 349 Total assets less
The following information has been extracted from the accounts of Merlin plc:(i) The 12 per cent bonds are redeemable in five years’ time at par. Annual interest has just been paid. The current
Critically discuss whether you consider that companies, by integrating a sensible level of gearing into their capital structure, can minimise their weighted average cost of capital.
The finance director of Kingsize plc is currently reviewing the capital structure of her company. She is convinced that the company is not financing itself in a way that minimises its cost of capital
Which of the following statements lends support to dividend irrelevance rather than to dividend relevance theory?(a) Investors prefer the certainty of dividends to the uncertainty of capital
XYZ’s current cum dividend share price is £3.45 and the company has just announced a dividend per share of 20p. At what rate do investors expect dividends to grow in the future if the current
The ordinary shares of Chock-stock plc are currently quoted at 200p per share and the company has been paying a dividend of 30p per share for 10 years. The company is planning to retain the next
Which of the following is the best course of action for a company that wants to retain funds while still rewarding its shareholders?(a) Paying a special dividend.(b) Announcing a share repurchase.(c)
Explain the different strategies a company may follow in order to finance its cumulative working capital requirements.
Describe the strategies that could be followed by a company seeking to deal with the problem of overtrading.
Is it worth offering discounts to trade receivables to encourage prompt payment?
MW has sales of c700 000 per year. Its costs as a percentage of sales are as follows:Raw materials are carried in inventory for two weeks and finished goods are held in inventory for three weeks.
MC has current sales of £1.5m per year. Cost of sales is 75 per cent of sales and bad debts are 1 per cent of sales. Cost of sales comprises 80 per cent variable costs and 20 per cent fixed costs.
A company is planning to offer a discount for payment within 10 days to its customers, who currently pay after 45 days. Only 40 per cent of credit customers would take the discount, although
The finance director of Stenigot is concerned about the lax management of the company’s trade receivables. The trade terms of Stenigot require settlement within 30 days, but its customers take an
The following information has been extracted from the financial statements of Rowett:Powell, a factoring company, has offered to take over the debt administration and credit control of Rowett on a
The finance director of Menendez is trying to improve the company’s slack working capital management. Although the trade terms of Menendez require settlement within 30 days, its customers take an
Briefly explain the various ways in which a company may obtain a quotation for its ordinary shares on the London Stock Exchange.
Outline the advantages and disadvantages which should be considered by a currently unquoted company which is considering obtaining a listing on a recognised stock exchange.
XTC is planning a 1 for 4 rights issue at a 20 per cent discount to the current market price of £2.50. If investors wish to sell their ‘rights per existing share’, how much should they sell them
Brand plc generates profit after tax of 15 per cent on shareholders’ funds. Its current capital structure is as follows:The board of Brand plc wishes to raise c160 000 from a rights issue in order
Maltby plc, a company quoted on the London Stock Exchange, has been making regular annual after-tax profits of £7 million for some years and has the following long-term capital structure.The bond
It has become common for companies to offer their shareholders a choice between a cash dividend and an equivalent scrip dividend. Briefly consider the advantages of scrip dividends from the point of
Hanging Valley plc has issued share capital of 2 million ordinary shares, par value c1.00. The board of the company has decided it needs to raise c1 million, net of issue costs, to finance a new
Mansun plc is a listed company with the following capital structure.The 13 per cent bonds give Mansun plc the right to redeem them at any time before maturity as long as full market value is paid to
Freeze plc is a service company that has been listed for six years. It has been advised that its proposed 1 for 4 rights issue should be at a 15 per cent discount to its current ordinary share price
Discuss briefly the key features of bonds such as debentures and ordinary loan stock.
Explain what is meant by the following terms that refer to fixed interest bonds:(a) restrictive covenant;(b) refinancing;(c) redemption window.
Explain the meaning of the following terms and state the circumstances under which their issue would be beneficial to (i) lenders and (ii) borrowers:(a) deep discount bonds;(b) zero coupon bonds;(c)
What are the advantages and disadvantages to a company of raising finance via Eurobonds?
A company has in issue a 10 per cent bond, redeemable at the option of the company between one and five years from now. What factors do you think will be considered by the company in reaching a
Briefly outline the advantages and disadvantages to a company of issuing convertible bonds.
A company has in issue some 9 per cent bonds which are redeemable at par in three years’ time. Investors now require a yield of 10 per cent. What will be the current ex-interest market value of
Explain the difference between a finance lease and an operating lease, and discuss the importance of the distinction for corporate finance.
Bugle plc has some surplus funds that it wishes to invest. It requires a return of 15 per cent on corporate bonds and you have been asked to advise on whether it should invest in either of the
Laursen plc has in issue 10 per cent convertible bonds which will be redeemed in 10 years’time and which are currently selling at £93. Interest on the bonds is paid annually and each £100 bond is
(a) Discuss the factors which determine the market price of convertible bonds.(b) Marlowe plc has in issue bonds which are convertible in three years’ time into 25 ordinary shares per bond. If not
Utterby is considering the purchase of a new machine which would enable the company to cut annual salaries by £130 000 per year.The machine would cost £480 000 if bought from the manufacturers,
Permafrost plc needs a new computer network but is uncertain whether to buy the system or to lease it from Slush plc. The system will cost £800 000 if bought and Permafrost plc would borrow to
Calculate the return on capital employed (average investment basis) for the following projects, and show which would be chosen if the target ROCE is 12 per cent. Assume straight-line depreciation
Three investment projects have the following net cash flows. Decide which of them should be accepted using the NPV decision rule if the discount rate to be applied is 12 per cent. Year Project A ()
Explain how NPV and IRR deal with non-conventional cash flows.
Show with the aid of a numerical example how linear interpolation can be used to determine the internal rate of return of a project.
What techniques can be used to determine the optimum investment schedule for a company under conditions of capital rationing?
The finance manager of Willow plc is evaluating two mutually exclusive projects with the following cash flows.Willow’s cost of capital is 10 per cent and both investment projects have zero scrap
The finance manager of Wide plc is evaluating two capital investment projects which may assist the company in achieving its business objectives. Both projects will require an initial investment of
Given the following corporate objectives, provide a reasoned argument explaining which of them should be the main goal of the financial manager:(a) profit maximisation;(b) sales maximisation;(c)
Explain how a financial manager can, in practice, maximise the wealth of shareholders.
Which of the following will not reduce the agency problem experienced by shareholders?(a) Increased monitoring by shareholders.(b) Salary bonuses for management based on financial performance.(c) The
What goals might be pursued by managers instead of maximisation of shareholder wealth?
Do you consider the agency problem to be of particular relevance to UK public limited companies?
The primary financial objective of a company is stated by corporate finance theory to be the maximisation of the wealth of its shareholders, but this objective is usually replaced by the surrogate
Explain why maximisation of a company’s share price is preferred as a financial objective to the maximisation of its sales.
Discuss the ways in which the concepts of agency theory can be used to explain the relationships that exist between the managers of a listed company and the providers of its equity finance. Your
You are given the following details about Facts of Life plc.Breakdown of activities by percentage of total annual company turnover:The directors of the company were given share options by its
Discuss ways in which the shareholders of a company can encourage its managers to act in a way which is consistent with the objective of maximisation of shareholder wealth.
Critically evaluate the differing approaches taken by the US and UK governments to solve the shortcomings of their corporate governance systems.
Describe the factors that influence the relative proportions of internal and external finance used in capital investment.
Which of the following statements about the efficient market hypothesis is not correct?(a) If a stock market is weak form efficient, chartists cannot make abnormal returns.(b) If a stock market is
Describe the five categories of ratios, list and define the ratios in each category and, without referring to the calculations in the text, calculate each ratio for Boater.
What are the potential problems associated with using ratio analysis to analyse the financial health and performance of companies?

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