Questions and Answers of Corporate Financial Management

=+Information not considered by the consultants for Proposal 2 The £9m investment includes £5m in buildings not subject to depreciation. It also includes £4m in equipment, 10 per cent of which has
=+This investment idea is not original; Mercia investigated a similar project two years ago and discovered that there are some costs which have been ignored by the consult-ants. First, the local
=+The annual income from ticket sales will be £600,000 to an infinite horizon.Operational costs (attendants, security, power, etc.) will be £100,000 per annum. The consultants have also apportioned
=+b Is this project to be accepted under the internal rate of return method?
=+It is expected that the car park will be fully operational as from the completion date(365 days after the earthmovers first begin).
=+Proposal 1 is to spend £150,000 levelling the site and then constructing a six-level car park at an additional cost of £1,600,000. The earthmoving firm will be paid £150,000 on the start date
=+6 a If the cost of capital is 14 per cent find the modified internal rate of return for the following investment and state if you would implement it.Points in time (yearly intervals)Cash flow-9,300
=+4" (Examination level) Mercia plc owns two acres of derelict land near to the centre of a major UK city. The firm has received an invoice for £50,000 from consultants who were given the task of
=+b Explain to a management team unfamiliar with discounted cash flow appraisal techniques the significance and value of the NPV method.
=+For the purposes of this appraisal you may regard all receipts and payments as occurring at the year end to which they relate, unless otherwise stated. The company's cost of capital is 12 per
=+The overhead figures in the budgeted accounts have two elements - 60 per cent is due to a reallocation of existing overheads, 40 per cent is directly incurred because of the take-up of the project.
=+You have calculated the modified internal rate of return (MIRR), now calculate the IRR for comparison.
=+Customers receive one year's credit from the firm.
=+b If £900 is the initial cash outflow at time 0 calculate the compounding rate that will equate the initial cash outflow with the terminal value as calculated in (a)above.
=+Both the additional stock and other working capital increases will be released at the end of the project.
=+It may be assumed that payment for materials, other variable costs and overheads are made at the end of each year.
=+When production is started it will be necessary to raise material stock levels by£30,000 and other working capital by £20,000.
=+5 a Find the total terminal value of the following cash flows when compounded at 15 per cent. Cash flows occur at annual intervals and the fourth year's cash flow is the last.Points in time (yearly
=+The accounts department has produced budgeted profit and loss statements for each of the next five years for the project. At the end of the fifth year the capital equip-ment will be sold and
=+3 (Examination level) Pine Ltd have spent £20,000 researching the prospects for a new range of products. If it were decided that production is to go ahead an investment of£240,000 in capital
=+Calculate the net operating cash flow for the years 20X2-20X4.
=+How many IRRs would you expect to find for this project?
=+These sales will be made on three months' credit and there will be no bad debts.There are only three cost elements. First, wages amounting to £6m p.a. Second, raw materials costing one-half of
=+Using a 13 per cent discount rate find the NPV of a project with the following cash flows:Points in time (yearly intervals)5 Cash flow (E)-300+260-200+600
=+2 A senior management team at Railcam, a supplier to the railway industry, is trying to prepare a cash flow forecast for the years 20X1-20X5. The estimated sales are:Year 20X1 20X2 20X3 20X4 20X5
=+b Assume an infinite life for the project and a cost of capital of 17 per cent. What is the net present value?
=+a Lay out the net annual cash flow calculations. Explain your reasoning.
=+Advise Confused whether to accept either or both projects. (Assume a discount rate of 25 per cent.)4
=+1 The Tenby-Saundersfoot Dock company is considering the reopening of one of its mothballed loading docks. Repairs and new equipment will cost £250,000 payable immediately. To operate the new dock
=+Explain why Mr Baffled is having difficulties with the IRR method.
=+8 A firm is considering the implementation of a new project to produce slippers. The equipment to be used has sufficient spare capacity to allow this new production with- out affecting existing
=+7 'Depreciation is a cost recognised by tax authorities so why don't you use it in project appraisal?' Help the person who made this statement.
=+3" Mr Baffled, the managing director of Confused ple, 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
=+6 In a 'make or buy' type of decision should we also consider factors not easily quanti-fied such as security of supply, convenience and the morale of the workforce? (This question is meant to
=+k The cost of the utility services installed last year.
=+h The tax saving due to the plant investment being offset against taxable income.The fim of additional raw material stock required at the start of production.The interest that will be charged on
=+Compare and explain the results in (a) and (b) and indicate which project the com-pany should undertake and why.
=+R A proportion of the US head office costs.
=+f Three senior managers will be drafted in from other divisions for a period of a year.
=+e Arcmat's other product lines are expected to be more popular due to the comple-mentary nature of the new doll range with these existing products - the net cash flow effect is anticipated at £1m.
=+Calculate the net present value (NPV) for each project.
=+d Depreciation on the machines.
=+The future cost of modernising the factory.b The £100,000 spent two months ago on a market survey investigating the demand for these plastic dolls.Machines to produce the dolls - cost £10m
=+Highflyer's cost of capital is 12 per cent. Assume unlimited funds. These are the only cash flows associated with the projects.a Calculate the internal rate of return (IRR) for each project.b
=+This will require complete modernisation. Mrs Hambicious is a little confused about project appraisal and has asked your advice about which of the following are relevant and incremental cash flows.
=+5 Arcmat ple owns a factory which at present is empty. Mrs Hambicious, a business strategist, has been working on a proposal for using the factory for doll manufacture,
=+4 What are the two main techniques available for evaluating mutually exclusive repeated projects with different lengths of life? Why is it not valid simply to use NPVs?
=+2 Highflyer ple has two possible projects to consider. It cannot do both - they are mutu-ally exclusive. The cash flows are:Points in time (yearly intervals)Project A Project B 0-420,000-100,000
=+3 What is an annual equivalent annuity?
=+there would be a big lump of costs not written off. All projects must bear some central overhead.' Discuss this statement,
=+Those business school graduates don't know what they are talking about. We have to allocate overheads to every department and activity. If we simply excluded this cost
=+1 Imagine the Ministry of Defence have spent £50m researching and developing a new guided weapon system. Explain why this fact may be irrelevant to the decision on whether to go ahead with
=+b Indicate the maximum outlay in year 0 for each project before it ceases to be viable.
=+a Advise the company whether to undertake the two projects.
=+1 Proast ple is considering two investment projects whose cash flows are:1973379)E Points in time (yearly intervals)Project A Project B 0-120,000-120,000 160,000 15,000 245,000 45,000 342,000
=+4 What is the reinvestment assumption for project cash flows under IRR? Why is this problematical? How can it be corrected?
=+11 Supersalesman offers you an annuity of £800 per annum for 10 years. The price he asks is £4,800. Assuming you could earn 11 per cent on alternative invest-ments would you buy the annuity?
=+ What is the effective annual rate?
=+10 How much must be invested now to provide an amount of £10,000 in six years'time assuming interest is compounded quarterly at a nominal annual rate of 8 per cent?
=+9 What sum must be invested now to provide an amount of £18,000 at the end of 15 years if interest is to accumulate at 8 per cent for the first 10 years and 12 per cent thereafter?
=+8 What is the present value of £100 to be received in 10 years' time when the inter-est rate (nominal annual) is 12 per cent and (a) annual discounting is used? (b)semi-annual discounting is used?
=+7 If the flat (nominal annual) rate of interest is 14 per cent and compounding takes place monthly, what is the effective annual rate of interest (the Annual Percentage Rate)?
=+How much would you have to put into an account which was to make these payments if the account guaranteed an interest rate of 8 per cent?
=+6 The Morbid Memorial Garden company will maintain a garden plot around your grave for a payment of £50 now, followed by annual payments, in perpetuity, of£50.
=+5 A bank lends a customer £5,000. At the end of 10 years he repays this amount plus interest. The amount he repays is £8,950. What is the rate of interest charged by the bank?
=+d £200,000 for each of the next 10 years, starting in one year.If the time value of money is 9 per cent, which is the most valuable prize?
=+4 As a winner of a lottery you can choose one of the following prizes:a £1,000,000 now.b £1,700,000 at the end of five years.c £135,000 a year for ever, starting in one year.
=+b. If the value of the shares increases by 15 per cent a year, what will be the value of the shares in 20 years?
=+a If the value of the shares increases by 5 per cent a year, what will be the value of the shares in 20 years?
=+2 You plan to invest £10,000 in the shares of a company.
=+vpercentage measure of investment performance and be able to use the modified internal rate of return.
=+demonstrate awareness of the propensity for management to favour a
=+describe and explain at least two potential problems that can arise with internal rate of return in specific circumstances;
=+show an appreciation of the relationship between net present value and internal rate of return;
=+calculate net present value and internal rate of return;
=+Visit www.pearsoned.co.uk/arnold for further questions, weblinks and an online glossary.
=+How might the efforts of all individuals be channelled more effectively?
=+1 have come into contact with. List as many objectives as you can, explicit or implicit, that have been revealed to, or suspected, by you. To what extent was goal congruence between different
=+Consider the organisations where you have worked in the past and the people you
=+How might you change matters to persuade the chief executive to focus on shareholder wealth in all decision making?
=+Will this encourage the adoption of decisions which are shareholder wealth enhancing?
=+7 The chief executive of Geight plc receives a salary of £80,000 plus 4 per cent of sales.
=+Provide reasons why, despite the same total profit over the last five years, shareholders regard firm A as being worth £5m more (extend your thoughts beyond the numbers in the table).
=+Firm A has a stock market value of £20m (number of shares in issue x share price), while firm B is valued at £15m. The firms have similar profit histories:Firm A Firm B2001 1.5 1.8 2002 1.6 1.0
=+Discuss the relationship between economic growth and the development of a financial In services sector.
=+12 Briefly explain the role of the following:a The money markets bThe bond markets The foreign exchange markets dThe share markets The derivatives market.
=+11 Briefly describe the following types of decisions (give examples):a Financing bInvestment eTreasury dRisk management eStrategic.
=+10 What difficulties might arise in state-owned industries in making financial decisions?
=+8 What is the principal-agent problem?
=+4 What are the economies of scale of intermediaries?
=+3 How does money assist the well-being of society?
=+1 Why is it important to specify a goal for the corporation?
explain the outstanding difficulties in this area of finance.
3 Triglass plc has three types of capital. The market capitalisation of its equity is 20m. These ordinary shares have a beta of 0.9, as measured over the past five years of monthly returns. The
2 The projected cash flows for a company to be established are 1m per year forever. The company will require 9m in capital to be viable and produce the 1m annual cash flows. The prospective directors
1 A company obtains 65% of its capital from equity and 35% from debt. This is the optimum capital structure. The equity holders require a return of 9% per year given their opportunity cost of
6 Explain two of the practical difficulties in calculating a firm's cost of capital.
5 Should the WACC be used in all circumstances?
4 Describe the weighted average cost of capital and explain why a project, SBU or product line should not be evaluated using the cost of finance associated with the latest portion of capital raised.
3 Why can we not always take the coupon rate on a bond issued years ago as the cost of bond capital?

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