Questions and Answers of Corporate Financial Management

5 Seddet International is considering four major projects which have either two- or three-year lives. The firm has raised all of its capital in the form of equity and has never borrowed money. This
4 Using a 13 per cent discount rate find the NPV of a project with the following cash flows: Why would this project be difficult to evaluate using IRR? Points in time (yearly intervals) Cash flow ()
3 Mr Baffled, the managing director of Confused plc, has heard that the internal rate of return (IRR) method of investment appraisal is the best modern approach. He is trying to apply the IRR method
2 Highflyer plc has two possible projects to consider. It cannot do both - they are mutually exclusive. The cash flows are:Highflyer's cost of capital is 12 per cent. Assume unlimited funds. These
1 Proast plc is considering two investment projects whose cash flows are:The company's required rate of return is 15 per cent. a Advise the company whether to undertake the two projects. b Indicate
Martac plc is a manufacturer of Martac-aphro. Two new automated process machines used in the produc- tion of Martac-aphro have been introduced to the market, the CAM and the ATR. Both will give cost
=+2 Analyse a company you know well in the light of the various ideas, theories and models regarding capital structure. Write up your findings in a report, and include implications and
=+9 Given the following facts about Company X, what would the equity cost of capital be if it was transformed from its current gearing to having no debt, if Modigliani and Miller's model with no tax
=+8 (Examination level) Within a given industry, wide variations in the degree of financial gearing of firms is observed. What might explain this?
=+You step forward and offer to write a report for the managing director both outlining the theoretical arguments and explaining the real-world influences on the gearing levels of firms.
=+"The consultants I spoke to yesterday explained that some academic theorists advance the idea that, if your objective is the maximisation of shareholder wealth, the debt to equity ratio does not
=+7 (Examination level) The managing director of your firm is thinking aloud about an appropriate gearing level for the company:
=+b Describe and explain the factors which might lead to a rise in the overall cost of capital for Hickling.
=+6 a (Examination level) Hickling plc has estimated the cost of debt and equity for various financial gearing levels:Proportion of debt Required rate of return Debt, ADAT Equity. KE(VD + VE)%0.80
=+what ways do the main MM economic models of gearing fail? Discuss some alterna-tive explanations for the actual gearing levels of companies.
=+5 (Examination level) In 1984 Stewart Myers wrote, 'our theories do not seem to explain actual financing behaviour', when referring to the capital structure debate. In
=+4 (Examination level) 'It is in management's interest to keep the financial gearing level as low as possible, while it is in shareholders' interests to keep it at a high level.'Discuss this
=+draw on Modigliani and Miller's theory, financial distress and agency theory.
=+Director B believes that shareholders will demand a rate of return of 23.7 per cent;Director C believes that shareholders will demand a rate of return of 17 per cent and Director D believes the
=+b The directors are considering the partial replacement of equity finance with bor-rowings so that the borrowings make up 60 per cent of the total capital. Director A believes that the cost of
=+3" a(Examination level) Hose ple presently has a capital structure which is 30 per cent debt and 70 per cent equity. The cost of debt (i.e borrowings) before taxes is 9 per cent and that for equity
=+d Some writers have advocated the high use of debt because of the positive effect on managerial actions. Describe these ideas and consider some counter-arguments.
=+Calculate business risk and the additional risk due to financial risk and explain what these terms mean,
=+b Calculate the standard deviation of the expected annual return under each of the capital structures.
=+13 per cent.There are three possible outcomes for the future annual cash flows before interest:Success of product Cash flow before interest Probability Poor€60,000 0.25 Good£160,000 0.50
=+2" (Examination level) Eastwell ple is to be established shortly. The founders are consid-ering their options with regard to capital structure. A total of Elm will be needed to establish the
=+1* Calculate and comment upon some gearing ratios for Vodafone plc.Extracts from Vodafone Group ple Balance sheet and profit and loss account, 2003 Em Fixed assets 154,689 Current assets:Stocks 365
=+9 Describe the following ideas which are advanced to explain the low levels of gearing in some companies:a Borrowing capacity.b Managerial preferences.€Pecking order.d Financial slack.e Control 10
=+8 What are agency costs and how do they affect the gearing decision?
=+7 What is financial distress and how does it affect the gearing decision?
=+6 Describe how MM analysis changes if taxes are allowed into the model.
=+5 Modigliani and Miller's original model resulted in three propositions. Describe them.Also, what are the major assumptions on which the model was built?
=+4 What are business risk and financial risk?
=+3 Explain the terms operating gearing, financial gearing, capital gearing, income gearing.
=+2 Explain how debt finance is 'cheaper and riskier' for the firm.
=+1 What was the traditional (pre-MM) view on optimal gearing levels?
=+vvdiscuss the effect of gearing, and differentiate business and financial risk;describe the underlying assumptions, rationale and conclusions of Modigliani and Miller's models, in worlds with and
=+2 If your company has recently acquired a business or is considering such a purchase obtain as much data as you can to calculate a possible bargain range. The upper boundary of this is fixed by the
=+In a report make clear your awareness of the sensitivity of the results to your assumptions.
=+1 Estimate the value of a share in your company (or one you know well) using the fol-lowing approaches:net asset value;dividend valuation model;crude price-earnings ratio - comparing with peer
=+Assume for the purpose of f that the shares are valued at your valuation in d and that Dela is taxed at a rate of 30 per cent.
=+Calculate a weighted average cost of capital given that the balance sheet entry"Creditors falling due after more than one year' consists entirely of the nominal value of a debenture issue and this
=+What is the prospective price to earnings ratio (P/E ratio) given the share price in d?e F
=+d Value one of Dela's shares using the dividend valuation model. (Assume the divi-dend of 10p has just been paid and the next dividend is due in one year.)
=+c Briefly describe two circumstances where balance sheet net asset values become very important for corporate valuation.
=+b Briefly explain why balance sheets generally have limited usefulness for estimating the value of a firm.
=+There have been no new issues of shares in the past eight years.-Dela has 1,000 million shares in issue.vvRequired Value Dela using the net asset value (NAV) method.a
=+You believe that Dela has overstated the value of stocks by £30m and one-quarter of its debtors are likely to be uncollectable.
=+You have obtained an independent valuation of Dela's fixed assets at £350m.
=+The impressive average annual growth in Dela's earnings and dividends over the last few years is likely to persist.Additional information
=+Datastream has calculated a beta for Dela of 1.2 and this may be used as the appro-priate adjustment to the risk premium on the average share. The risk-free rate of return on UK Treasury bills is
=+At the last year-end Dela's summarised balance sheet is as shown in Table 1.Year-end Earnings per share (pence)Dividend per share (pence)2005 20 10 2004 18 9.5 2003 17 9 2002 16 8 2001 13 7 2000 12
=+10* (Examination level) You have been asked to carry out a valuation of Dela ple, a listed company on the main London market.
=+vFor the purpose of calculating the weighted average cost of capital the tax rate may be assumed to be 30 per cent.
=+Calculate the weighted average cost of capital (WACC) for Green ple on the assumptions that the share price calculated in question c is the market share price and the entry 'Creditors (amounts
=+Use a dividend valuation model to calculate the value of one share in Green plc.Assume that future dividend growth will be the same as the average rate for recent years.d
=+b Comment on some of the problems associated with valuing a share or a corpora-tion using net asset value. For what type of company is net asset value particularly useful?
=+tangible assets are worth £50m more than shown in the balance sheet;one-half of the debtors figure will never be collected; and in your judgement Green's directors have overestimated the stock
=+Green ple has demonstrated an equity beta of 1.3 over the past five years (and this can be taken as an appropriate adjustment factor to the average risk premium for shares over risk-free
=+(Examination level) Green ple is a conglomerate quoted on the main London market. The latest set of accounts has just been published. The balance sheet is summarised below,vOther information
=+Lanes' management believe that the ten shops will be a perfect fit with their own.There are no towns in which they both trade, and economies of scale can be obtained. Suppliers will grant quantity
=+The rate of return required on a business of this risk class is 13 per cent per annum.Required Calculate the value of the shops to Roberts' shareholders.b
=+If the shops remain part of Roberts the earnings growth is expected to continue at the average historical rate to infinity.
=+8. Lanes ple, the retail butchers, is considering the purchase of ten shops from Roberts ple, the conglomerate. The information gathered on the ten shops trading as a sepa-rate subsidiary company
=+Other information The debenture pays a coupon of 9 per cent on par value.The coupons are payable annually - the next is due in 12 months.The debenture is currently trading at 105.50.The balance
=+h If you assumed for the sake of simplicity that all the long-term debt in the bal-ance sheet is a debenture issued six years ago which is due for redemption three years from now at par value of
=+g What would be the PER if, i k = 14, g = 12; ii k = 15, g = 11 and next year's divi-dend and earnings are the same as calculated in d and f?
=+f Given the answer in d for share price, what is the prospective price-earnings ratio(PER) if future earnings grow at the same rate as future dividends?
=+Give some potential explanatory reasons for the difference between the value given in d and the value placed on a share in the London Stock Market of 355p,
=+d If you assume that the dividend growth rate over the past 16 years is unsustain-able, and that in the future the rate of growth will average half the rate of the past, at what would you value one
=+c For what type of company and in what circumstances does NAV provide a good estimate of value?
=+vb The total market capitalisation of Tes at the present time is £8bn. Provide some possible reasons for the great difference between the value that the market placed on Tes and the NAV.
=+20 per cent of the debtors figure will never be collected;the stock figure includes £30m of unsaleable stock;'Current investments' now have a market value of £205m.
=+The average risk premium over risk-free securities is 5 per cent. The risk-free rate of return is 6.25 per cent and Tes's beta of 0.77 represents the appropriate adjustment to the average risk
=+7*v(Examination level) The following figures are extracted from Tes ple's Annual Report and Accounts.
=+What additional factors would you need to allow for when valuing an unquoted share rather than one listed on a stock exchange?
=+Describe and explain the problems of using the crude historic PER as an analyti-cal tool.
=+Use the more complete PER model to decide if the shares at 205p are over- or under-priced.e
=+Calculate the required rate of return on a share of this risk class.C d
=+b Calculate the future growth rate of dividends and earnings.
=+The risk-free rate of return is 6.5 per cent and the risk premium on the average share has been 5 per cent for decades, Blueberry is in a higher systematic risk class than the average share and
=+The rate of growth in earnings and dividends shown in the past is expected to con-tinue into the future.
=+6" (Examination level) The current share price of Blueberry ple is 205p. It recently reported earnings per share of 14p and has a policy of paying out 50 per cent of earn-ings in dividends each
=+The rate of return on risk-free securities is 7 per cent and the risk premium on the average share has been 5 per cent. Tented is in a systematic risk class which means that the average risk
=+5" Tented ple has developed a new tent which has had rave reviews in the camping press.The company paid a dividend of 11p per share recently and the next is due in one year. Dividends are expected
=+4 Elec Wat is a regulated supplier of electricity and water. It is expected to pay a divi-dend of 24p per share per year for ever. Calculate the value of one share if a company of this risk class
=+The rate of return required on a share of this risk class is 13 per cent. Assuming that this dividend growth rate is unsustainable and Shades will halve its historic rate in the future, what is the
=+3 Shades ple has the following dividend history:Year Dividend per share Recently paid 21p Last year 19 Two years ago 18p Three years ago I6p Four years ago 14p Five years ago 12p
=+2"Some companies do not pay dividends, in others the growth rate is higher than the required rate of return, therefore the dividend valuation models are useless.' Explain your reasons for agreeing
=+1 'Valuing shares is either a simple exercise of plugging numbers into mathematical for-mulae or making comparisons with shares in the same sector.' Explain the problems with this statement.
=+10 Why might a share have a different value to someone who was able to exercise con-trol over the organisation than to someone who had a small, almost powerless, stake?
=+9 What additional factors might you consider when valuing an unquoted share rather than one listed on a stock exchange?
=+8 Why do PERs vary over time, and between firms in the same industry?
=+What are the differences between the crude PER model and the more complete PER model?
=+range of future growth rates for a firm?7
=+6 What are the main investigatory routes you would pursue to try to establish the likely
=+Does this mean that we are only valuing next year's dividend? Explain your answer.
=+individual investors hold shares for a shorter period, making capital gains (and losses).The dividend growth model takes the form:P =kg-8
=+4 Explain why the dividend valuation model discounts all dividends to infinity and yet
=+3 Name the three types of future income flows which may be examined to value shares.

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