Questions and Answers of Corporate Finance Principles And Practice

Kopperud Electronics has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is $125 million.The firm will depreciate the investment to zero using the
Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1.4 million; the new one will cost $1.7 million. The new machine will be depreciated straight-line to zero
After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products.The first is a medication for headache pain.
It is 15 December, and a company wants to borrow £2m, for a period of three months, in three months’ time. The three-month LIBOR rate stands at 6 per cent and the company wants to guard against an
Yell plc wants to find the relative importance of the determinants of its cost of equity, namely the risk-free rate of return, business risk and financial risk. You have the following information:1.
Arclight plc, a company producing high-quality household lighting products, is considering diversifying into the furniture business. The project has an expected return of 15 per cent. Arclight plc
PXP plc is a listed company that has made an offer of £3.20 per share for the ordinary share capital of VVM plc. Details of the two companies are as follows:PXP is not sure whether to finance the
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 will be considered by the company in reaching a decision on when
Three investment projects, A, B and C, have the following net cash flows. Decide which of them should be accepted using the NPV decision rule if the discount rate is 12 per cent.
Why is payback commonly used as a way of dealing with risk in investment projects?
Discuss the use of risk-adjusted discount rates in evaluating investment projects.
Explain the meaning of ‘simulation’ in the context of investment appraisal.
How do foreign direct investment decisions differ from domestic investment decisions?
The shares 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
Discuss whether all companies use the same investment appraisal methods.
The global financial crisis of 2008, followed by the Covid-19 pandemic, has made fundamental changes to the way financial markets work. Interventions by central banks, designed to save economies from
Explain why risk continues to exist even in a well-diversified portfolio.
Nobel-prize winning economist Harry Markowitz wrote that ‘diversification is the only free lunch in finance’. A free lunch sounds good, but the reality is often bland sandwiches, a plate of
Discuss whether diversification at company level has any value to a company’s ordinary shareholders.
You are looking to invest in two shares, X and Y, and have the following information:(a) Calculate the expected return for each share and for a portfolio of 60 per cent X and 40 per cent Y. (b)
Distinguish between an efficient portfolio and an optimal portfolio.
The US equity risk premium, the extra return investors can expect for buying US stocks instead of riskfree government bonds, has fallen to its lowest levels of the past decade by some measures, as
Rosenior plc has been investing surplus funds in a small portfolio of shares over the past few years. Details of the portfolio are as follows:The current market return is 12 per cent and the yield on
Value investing, defined as buying or selling securities at prices different than their true value, is alive and well. You might not know that by reading headlines in the financial press or
Explain the importance of risk-free assets to portfolio theory.
How do we approximate the risk-free rate in practice? In reality, will the capital market line be a straight line?
List the limitations of portfolio theory as an aid to investment decisions.
Explain whether you consider the assumptions upon which the capital asset pricing model is based to be unrealistic.
Explain what is measured by beta.
Identify the problems associated with determining the equity risk premium.
The market return is 10 per cent and UK Treasury bills yield 4 per cent. Lime Spider plc shares have a covariance of 7.5 with the market whereas the market has a variance of 4.5. What is the required
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

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