Questions and Answers of Corporate Finance Principles And Practice

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.
Private pension funds across the world are finding it more difficult to meet their obligations to future retirees. In July 2012, the 100 largest US private pension funds faced a $533bn shortfall,
Outline the advantages and disadvantages to a company of issuing convertible bonds.
DDX plc is trying to decide whether to lease or to buy a machine with a useful life of six years. DDX could borrow £90,000 to buy the machine or lease it for annual lease rentals of £20,000 per
Clement plc is evaluating three investment projects, whose expected cash flows were given in Table 6.4. Calculate the internal rate of return for each project. If Clement’s cost of capital is 10
Explain the shortcomings of return on capital employed as an investment appraisal method and suggest reasons why it may be used by managers.
List the advantages of the net present value investment appraisal method.
How can a company’s optimum investment schedule be determined under the conditions of capital rationing?
UK ministers have launched a consultation into replacing the temporary capital spending allowance that runs out next year as concerns grow about the impact of fast rising inflation on companies’
Discuss which cash flows are relevant to investment appraisal calculations.
NML plc is considering buying a new machine costing £200,000 which would generate the following before-tax cash flows from the sale of goods produced. NML pays corporation tax of 19 per cent per
Explain the difference between the nominal-terms approach and the real-terms approach to dealing with inflation in investment appraisal.
Thorne plc is planning to sell a new electronic toy. Non-current assets costing £700,000 would be needed, with £500,000 payable at once and the balance payable after one year. Initial investment in
Explain whether general inflation or specific inflation should be included in investment appraisal.
Swift has a cost of capital of 12 per cent and plans to invest £7m in a machine with a life of four years. The units produced will have a selling price of £9.20 each and will cost £6 each to make.
Explain the difference between risk and uncertainty.
Star has a cost of capital of 12 per cent and is evaluating a project with an initial investment of £375,000. The estimated net cash flows of the project under different economic circumstances and
WK plc is a UK company which plans to set up a manufacturing subsidiary in the small country of Parland, whose currency is the dollar. An initial investment of $5m in plant and machinery is needed.
Discuss how sensitivity analysis helps managers to assess the risk of an investment project.
Carbon plc is planning to buy a new machine and has found two that meet its needs. Each machine has an expected life of five years. Machine 1 would generate annual net cash flows (receipts less
Explain the attractions of leasing as a source of finance.
A company has in issue some 9 per cent bonds which are redeemable at nominal value of £100 in three years’ time. Investors require a yield of 10 per cent. What will be the current ex-interest
What is the gearing effect of warrants?
Explain how NPV and IRR investment appraisal methods deal with non-conventional cash flows.
Discuss the problem of choosing between mutually exclusive projects with respect to their net present values and internal rates of return.
Explain with the aid of a numerical example how linear interpolation can be used to determine the internal rate of return of a project.
Explain the distinction between hard and soft capital rationing, and outline the reasons why these conditions might occur.
Explain how the concept of the time value of money can assist a financial manager in deciding between two investment opportunities.
Calculate the following values assuming a discount rate of 12 percent:(a) £500 compounded for five years; (b) The present value of £500 received in five years’ time; (c) The present value of
What are the functions and areas of responsibility under the control of the financial manager?
Give examples to illustrate the high level of interdependence between the decision areas of corporate finance.
Given the following corporate objectives, provide a reasoned argument explaining which of them should be the main goal of the financial manager:(a) Profit maximization;(b) Sales maximization; (c)
Explain how a financial manager can, in practice, maximize the wealth of shareholders.
What is meant by the ‘agency problem’ in the context of a public limited company? How is it possible for the agency problem to be reduced in a company?
Which of the following will not reduce the agency problem experienced by shareholders?(a) Increased monitoring by shareholders; (b) Salary bonuses for directors based on financial performance; (c)
What goals might be pursued by managers instead of maximizing shareholder wealth?
Do you consider the agency problem to be relevant to UK public limited companies?
Describe the factors influencing the relative proportions of internal and external finance used in capital investment.
Recent capital market efficiency research has explored anomalies in share price behaviour. Briefly describe some of these anomalies and suggest possible explanations.
What is the relevance of the efficient market hypothesis for the financial manager?
Which of the following statements about capital market efficiency is not correct? (a) If a stock market is weak form efficient, chartists cannot make abnormal returns.(b) If a stock market is strong
Discuss the following statement: ‘It is not possible to test whether a stock market is strong form efficient. In fact, the existence of insider trading proves otherwise’.
Explain the meaning of the following terms: allocational efficiency, pricing efficiency and operational efficiency.
Discuss the following statement: ‘Ratio analysis using financial statements is pointless. Only economic value added gives a true measure of the financial performance of a company’.
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 plc (financial statements
Why is it difficult to test for strong form efficiency?
Describe three anomalies in share price behaviour.
Describe benchmarks that can be used when assessing financial performance.
What are the potential problems associated with using ratio analysis to assess the financial health and performance of companies?
Explain the meaning of economic value added (EVA). How can EVA help financial managers create value for shareholders?
Explain the different working capital funding policies that a company may adopt.
Describe the cash conversion cycle and explain its significance in determining the working capital needed by a company.
Describe the main sources of short-term finance for a company.
Describe the strategies that could be followed by a company dealing with the problem of overtrading.
Discuss the possible reasons why a company might experience cash-flow problems and suggest ways in which such problems might be alleviated.
Explain why a company may choose to have reserves of cash.
Discuss ways in which a company might invest its short-term cash surpluses, explaining briefly the factors which it should consider in making its selection.
How might the creditworthiness of a new customer be checked?
Is it worth offering early settlement discounts to trade receivables to encourage prompt payment?
Explain the difference between factoring and invoice discounting.
Explain why the return required by ordinary shareholders is different from the return required by bondholders.
Briefly outline some of the important rights of ordinary shareholders.
Briefly explain the various ways in which a company may obtain a listing for its ordinary shares on the London Stock Exchange.
Companies often offer their shareholders a cash dividend and an equivalent scrip dividend. Briefly consider the advantages of scrip dividends from the point of view of: (a) The company; (b) The
Outline the advantages and disadvantages that should be considered by a currently unquoted company which is considering obtaining a listing on a stock exchange.
What are pre-emptive rights and why are they important to shareholders?
Discuss the advantages and disadvantages of a rights issue to a company.
A conversion of existing capital reserves into ordinary shares, which are then distributed pro rata to existing shareholders.’ This statement best defines: (a) Scrip dividends; (b) A rights
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
Explain why preference shares are not popular as a source of finance for companies.

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