Questions and Answers of Corporate Finance Principles And Practice

Ofwat has turned the screw on water industry operators across England and Wales by demanding they accept lower rates of return on equity and capital in the next five-year regulatory period that runs
Gorky has in issue 500,000 £1 ordinary shares whose current ex dividend market price is £1.50 per share. The company has just paid a dividend of 27p per share and dividends are expected to continue
Calet plc pays corporation tax at 19 per cent and has the following capital structure: – Ordinary shares: 1,000,000 ordinary shares of nominal value 25p per share and market value of 79p per share.
You are given the following financial position statement information about Jordan plc: Non-current assets Current assets Total assets Equity finance Ordinary shares (50p nominal
Strummer plc is calculating its current weighted average cost of capital on both a book value and a market value basis. You have the following information:1. The current dividend, shortly to be paid,
At one point in February 2020, a single cruise ship – the Diamond Princess – accounted for more than half of the world’s confirmed cases of Covid-19 outside China. The 3,700 passengers and crew
The following information has been taken from the accounts of Merlin plc: (i) The current ex div ordinary share price of Merlin plc is £3.14. Both dividends and share price are expected to increase
The 8 per cent irredeemable bonds of Eranio plc are currently trading at £92 per £100 bond. If the company pays corporation tax of 19 per cent, what is the current after-tax cost of debt of the
Two companies, A and B, have similar net operating incomes (i.e. gross income less operating expenses) and similar levels of business risk. The only difference is that Company A is not geared,
Pollock has in issue 1 million ordinary shares, nominal 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 current weighted average cost of capital as the discount rate when assessing the acceptability of new projects?
Explain why the asset beta of a company will always be lower than its equity beta, unless the company is all-equity financed.
A company has an equity beta of 1.30 and is financed by 25 per cent debt and 75 per cent equity. What will be the company’s new equity beta if it changes its financing to 33 per cent debt and 67
What difficulties may be faced by analysts seeking to use the capital asset pricing model to determine a discount rate for foreign direct investment?
Describe the main factors influencing the choice and mix of financing used in foreign direct investment.
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 it is financed by equity alone. York’s
Briefly explain the traditional view of capital structure.
Shareholders require a 15 per cent return on their shares and a company has just paid a dividend of 80p per share. Over the past four years, the company has paid dividends of 68p, 73p, 74p and 77p
Shares in the AA fell almost 30 per cent after the breakdown cover provider slashed its dividend and warned of lower profits as it embarks on a technology drive. The company laid out a three-year
Discuss the practical issues to be considered by a company when deciding on the size of its dividend payment.
Global growth in dividends is forecast to slow sharply this year with the prospects for big increases dimming even before Russia’s invasion of Ukraine further clouded the outlook. After a bumper
Which of the following statements lends support to dividend irrelevance rather than to dividend relevance? (a) Investors prefer the certainty of dividends to the uncertainty of capital gains.(b)
BMT is a company that has been listed on the London Stock Exchange for many years. Institutional investors own approximately 45 per cent of the ordinary shares of the company. The recent financial
UK share buybacks are close to matching the amount of new equity issued for the first time in five years, but investors cautioned they are not yet at a level to help a stock market that has been a
XYZ’s has just announced a dividend of 20p per share and the cum dividend share price is £3.45 per share. If the current share price is fair and if shareholders require a rate of return of 15 per
It has become increasingly common for companies to offer shareholders a choice between a cash dividend and a scrip dividend. Briefly consider the advantages of scrip dividends from the points of view
UK investors can expect a drop in dividend payouts in 2022, according to an industry forecast, dashing hopes of a steady return to pre-pandemic levels. While many listed companies will raise
(a) Critically discuss the extent to which the following factors affect dividend policy: – The industry in which a company operates; – The level of inflation; – A company’s past dividend
The ordinary share price of Chock-stock plc is £2.00 per share and the company has been paying a dividend of 30p per share for 10 years. The company plans to retain the next three years’ dividends
Twenty years ago, shareholder perks played a major part in persuading investors to buy shares. Discounts of thousands of pounds on new-build properties were commonplace for shareholders in
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
Given the assumptions made by Miller and Modigliani’s dividend irrelevance theory, do you consider their conclusions to be logical?
It used to be all so simple. Corporates, wanting to borrow at a floating rate, could take out loans or issue bonds safe in the knowledge that it could be underpinned by LIBOR, a benchmark that, for
Twitter has launched a poison pill takeover defense to fend off a $43bn hostile bid from billionaire Tesla chief executive Elon Musk. In the first sign that the social media company plans to fight
Global dealmaking has reached $2.5tn in the first half of 2018, breaking the all-time high for the period and underscoring the intense nature of mergers and acquisition activity in spite of
Big plc is to take over Little plc and plans to offer its shares in payment for Little’s shares. If we assume that Big has to pay £25m (market value) to take over Little, Big must issue 10
Discuss whether the assumptions made by Miller and Modigliani’s dividend irrelevance theory fail to mirror the real world. If you agree that they fail to mirror the real world, does that invalidate
How do you consider the increased ownership of shares by institutional shareholders has affected the dividend policies of UK public limited companies?
Explain the following terms: (a) The residual theory of dividends; (b) The clientele effect; (c) The signalling properties of dividends;(d) The ‘bird in the hand’ argument.
Commons plc has distributable earnings of £120m, a weighted average cost of capital of 7 per cent and a price/earnings ratio of 18.2 times. It is in the process of taking over Hulse plc, whose
Outline briefly the economic reasons used to justify acquisitions.
Beer and cigarettes are not the healthiest combination, but for Altria, the maker of Marlboro, owning 27 per cent of brewer SABMiller has proven lucrative. Why is Altria, which has a substantial
Outline briefly the financial reasons used to justify acquisitions.
To the victor the spoils, the saying goes. Unfortunately, the culmination of a long-running competition wrangle over sportswear recalls another piece of fighting-related talk: there are no winners
Why might growth by acquisition not be in the best interests of a company?
Explain why acquisitions occur in waves.
Who knows what temptations a golden parachute can open up? Reports suggest that senior executives at Mead Johnson, the US baby formula maker talking to Reckitt Benckiser about a $17bn takeover, could
Discuss the use of the price/earnings ratio and dividend growth methods of determining the value of a target company.
Melrose Industries plans to spin off the GKN automotive division as a new UK-listed company in a move that will crystallize the break-up of one of Britain’s oldest engineering businesses. The FTSE
Explain why the DCF valuation method is preferred by academics and identify the practical difficulties in using this method.
The private equity groups Blackstone, Carlyle and Hellman & Friedman raised almost $15bn of debt on Thursday across bond and loan markets as they close in on financing the largest leveraged buyout
Briefly discuss the advantages and disadvantages of financing a takeover by an issue of convertible bonds.
Describe briefly four defenses that a company can use after it has received a takeover bid.
Explain why a company may wish to divest part of its operations.
Briefly describe some of the important contributing factors which explain why shareholders of acquiring companies rarely benefit from takeovers.
In the following cases, state which type of exchange rate risk the company is facing and whether this risk is beneficial or harmful in nature. (a) A power-generating company imports coal from
A UK company sells a car to a German customer for €22,000 and gives three months’ credit, with payment to be received in euros. At the current spot rate of €1.124/£ the company expects to
China’s renminbi fell to the lowest level since 2008 as the country’s central bank holds back from intervening to prop up the currency in response to the rallying dollar. The renminbi is the
Recommend internal hedging methods that a company can use to reduce translation risk and transaction risk.
Clearing houses are experiencing record activity as banks and investors comply with new derivative rules and push their over-the-counter fixed income and foreign exchange swaps towards centralized
Translation risk can be illustrated by considering a UK company that buys a hotel in the USA for $1.5m and finances the purchase with sterling debt. At the prevailing exchange rate of $1.737/£, the
What are the major differences between OTC options and traded options?
Consider a company, based solely in the UK, which buys its raw material and sells its finished goods in the domestic market. While not facing any transaction risk or translation risk, it faces
As JPMorgan reels from a complicated hedging strategy, one that misfired to the tune of at least $2.3bn in losses, derivatives-market participants worried about new rules on trading fear it will be
Identify the factors that influence a company’s decision to hedge interest rate risk.
In recent financial crises, derivatives have amplified and propagated losses in markets. They are now posing risks again but there has been a shift in the underlying nature of them. Vulnerabilities
A company wants to borrow £5.6m in three months’ time for a period of six months. The current interest rate is 6 per cent and the company, fearing that in three months’ time the interest rate
The monthly cash budget of HYK Communications plc shows that the company will need £18 million in two months’ time for a period of four months. Financial markets have been volatile recently and
A company is going to borrow £6m in three months’ time for a period of six months. It is afraid that interest rates will rise between now and the time that the loan is taken out. It intends to
A company expects to receive $180,000 in three months’ time and wants to lock into the current exchange rate of $1.65/£. It fears that the pound will appreciate against the dollar. To set up a
MetLife posted its biggest quarterly loss in at least a decade after shifts in financial markets fuelled by Donald Trump’s election victory triggered a $3.2bn hit to its derivatives portfolio.
A company plans to borrow £500,000 in three months’ time for a period of three months but expects the future interest rate to be higher than the current interest rate of 10 per cent. To hedge its
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 use external instruments, what
It is 1 January, and a UK company expects to receive $300,000 in three months’ time. Being concerned about the pound strengthening against the dollar, it decides to use CME-traded currency futures
Which of the following will not help a company to hedge successfully against an increase in interest rates? (a) Selling interest rate futures contracts.(b) Swapping floating rate interest for fixed
What are the drawbacks of hedging exchange rate risk by using a swap agreement?
It is 19 December, and a UK company is expecting to receive $1m in three months’ time in payment for exports. The company wants to guard against the pound appreciating against the dollar, which
Given the following list of US sterling currency options (all with three months to run) and the fact that the current spot rate is $1.55/£, which option do you expect to have the highest market
Consider two companies, A and B. The interest rates at which they can borrow are shown in the first part of Figure 12.4. Company A, with a better credit rating, can borrow at a lower fixed and a
A UK airline is buying a new aeroplane. Payment will be in US dollars, so the airline will finance its purchase with a fixed interest dollar loan from a US bank (stage 1 in Figure 12.5). As the
Explain how political risk may be assessed by a company considering foreign direct investment and identify the policies and strategies that it could use to mitigate the risk.
AT&T’s credit rating was downgraded to two notches above junk by two rating agencies on Friday, after the US telecommunication giant completed its $80bn acquisition of Time Warner. 1. Explain why
Consider an 8 per cent irredeemable bond where debt investors require a return of 11 per cent. The theoretical market value of the bond will be: Po = Kd = £8/0.11 £72.73 =
Petrobras is a Brazilian state oil company engulfed last year by a multibillion-dollar bribery and kickback scandal. Would global investors really lend it money for 100 years? Well, yes, they would.
Consider a 12 per cent convertible bond, redeemable at nominal value of £100 in six years’ time, which can be converted at any time in the next three years into 30 ordinary shares. The bond is
Explain what is meant by the following terms that refer to bonds:(a) Covenant; (b) Refinancing; (c) Redemption window.
Cold plc has decided to acquire equipment with a current market value of £700,000. A bank has offered a five-year loan at an interest rate of 13 per cent per year, provided it can reach agreement
Explain the following items 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) Warrants; (d)
Discuss the reasons for the popularity of leasing as a source of finance.
We follow on from the last example and repeat our earlier calculation with semiannual interest payments of £5 discounted at a six-monthly required rate of return of 6 per cent (half of the 12 per
Barclays and Pimco are planning a multibillion-pound securitization of the mortgages they recently agreed to acquire from the UK government’s ‘bad bank’, taking advantage of buoyant demand from
What are the advantages and disadvantages to a company of financing via Eurobonds?
Turner plc is considering whether to buy a machine costing £1,000 through a three-year loan with interest at 14 per cent per year. The machine would have zero scrap value at the end of its
There are plenty of signs the credit cycle is advancing into its later stages and one more can be added to the list – companies are issuing more convertible debt (which has features of both bonds
A 10 per cent convertible bond can be converted in four years’ time into 25 ordinary shares or redeemed at nominal value of £100 on the same date. The return required on the bond is 11 per cent.
Explain the difference between a conversion premium and a rights premium.
Calculate the return on capital employed (average investment basis) for projects A, B and C, and show which would be chosen if the target ROCE is 12 per cent. Scrap value is zero. Initial
UK consumer confidence hovered around a 50-year low last month as Britons struggled against a backdrop of soaring inflation, political turmoil and high borrowing costs, according to new data. The
Clement plc is evaluating three investment projects, whose expected cash flows are given in Table 6.4. Calculate the net present value for each project if Clement’s cost of capital is 10 per cent
Explain why the payback method cannot be recommended as the main method used by a company to assess potential investment projects.

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