Questions and Answers of Corporate Financial Management

2 Explain how you might calculate the cost of equity capital.
1 Explain the term 'the cost of capital'.
7 Explain why it is possible to obtain an inaccurate result using the trial and error method of IRR when a wide difference of two discount rates is used for interpolation.
6 What is the 'yield' of a project?
5 Rearrange the compounding equation to solve for: (a) the annual interest rate, and (b) the number of years over which compounding takes place.
4 What is the reinvestment assumption for project cash flows under IRR? Why is this problematical?
3 Define the time value of money.
2 Explain what is meant by conventional and unconventional cash flows and what problems they might cause in investment appraisal.
1 What are the theoretical justifications for the NPV decision rules?
Using discount rates of 8 per cent, and then 16 per cent, calculate the NPVs and state which project is superior. Why do you get a different preference depending on the discount rate used?
Camrat plc requires a return on investment of at least 10 per cent per annum over the life of any proposed project with the same risk as its existing projects in order to meet the opportunity cost of
describe and explain at least three potential problems that can arise with internal rate of return in specific circumstances.
discuss the role of scrip dividends and share repurchases (buy-backs).
discuss the impact of agency theory on the dividend decision;
describe the influence of particular dividend policies attracting different 'clients' as shareholders, the effect of taxation and the importance of dividends as a signalling device;
explain the rationale and conclusion of the ideas of Miller and Modigliani's dividend irrelevancy hypothesis, as well as the concept of dividends as a residual;
7 "The flatter the line on the sensitivity graph, the less attention we have to pay to that variable." Is the executive who made this statement correct in all cases?
6 Suggest reasons why probability analysis is used so infrequently by major international corporations.
5 Why has the development of powerful computers helped the more widespread adoption of scenario analysis?
4 Explain the attraction of using more than one method to examine risk in project appraisal.
3 Discuss the consequences of the quantification of personal judgements about future eventualities. Are we right to undertake precise analysis on this sort of basis?
2 What do you understand by the following? (i) Risk-lover. (ii) Diminishing marginal utility. (ii) Standard deviation.
1 Explain, with reference to probability and sensitivity analysis, why the examination of the most likely outcome of an investment in isolation can both be limiting and give a false impression.
discuss the limitations, explain the appropriate use and make an accurate interpretation of the results of the risk techniques described in this chapter.
explain the nature of real options and the advantages in recognising value in them;
explain the rules to follow when investment appraisal is done in an environment of capital rationing, taxation and inflation.
describe the capital-allocation planning process in a corporation;
describe and explain the advantages and disadvantages of the traditional investment appraisal techniques of payback and accounting rate of return;
2 If possible, obtain data on a real project, historical or proposed, and analyse it using the techniques learned in this chapter. Visit www.pearsoned.co.uk/arnold to get access to Gradetracker
1 Try to discover the extent to which NPV and IRR are used in your organisation. Also try to gauge the degree of appreciation of the problems of using IRR.
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 recommendations
1 Obtain accounting and other information on a company of interest to you and calculate gearing ratios. Point out in a report the difficulties involved in this process.
explain the relevance of some important, but often non-quantifiable, influences on the optimal gearing level question.
describe the underlying assumptions, rationale and conclusions of Modigliani and Miller's models, in worlds with and without tax;
discuss the effect of gearing, and differentiate business and financial risk;
4 Review the long-term debt instruments used by a company familiar to you. Consider the merits and drawbacks of these and explain alternative long-term debt strategies. Visit
3 Obtain a representative sample of recently paid invoices. Examine the terms and conditions, calculat the benefit of paying early and recommend changes in policy if this seems appropriate.
2 If a firm familiar to you is at present heavily reliant on bank finance, consider the relative merits of shifting the current balance from overdraft to term loans. Also consider the greater use of
1 Consider some of the items of equipment that your firm uses and investigate the possibility of alterna tive methods of financing/obtaining the use of those assets. Write a report outlining the
12 (Examination level) A factoring company has offered a one-year agreement with Glub Ltd to both manage in debtors and advance 80 per cent of the value of all its invoices immediately a sale is
11 A small firm is considering the purchase of a photocopier. This will cost 2,000. An alternative to purchase to enter into a leasing agreement known as an operating lease, in which the agreement
10 The Cable Company sells its goods on six months' credit which until now it has financed through term loans and overdrafts. Recently factoring firms have been pestering the managing director,
describe the fundamental features of the Capital Asset Pricing Model (CAPM)
What is corporate finance?
1 What are the economies of scale of intermediaries?
7 Why is it important to specify a goal for the corporation?
9 What is the principal-agent problem?
10 How can 'goal congruence' for managers and shareholders be achieved?
11 What difficulties might arise in state-owned industries in making financial decisions?
2 Review all the financial services you or your firm purchase. Try to establish a rough estimate of the cost of using each financial intermediary and write a balanced report considering whether you
Blue plc is a relatively small company with only one SBU. It manufactures wire grilles for the consumer market for cooker manufacturers and for export. Following a thorough investigation by the
What are the economies of scale of intermediaries?
Distinguish between a primary market and a secondary market. How does the secondary market aid the effectiveness of the primary market?
Illustrate the flow of funds between primary investors and ultimate borrowers in a modern economy. Give examples of intermediary activity.
List as many financial intermediaries as you can.Describe the nature of their intermediation and explain the intermediate securities they create.
Briefly describe the main types of financial decisions a firm has to deal with.
Briefly explain the role of the following:a The money markets b The bond markets c The foreign exchange markets d The share markets e The derivatives market.
Why is it important to specify a goal for the corporation?
What is the ‘contractual theory’? Do you regard it as a strong argument?
What is the principal–agent problem?
How can ‘goal congruence’ for managers and shareholders be achieved?
What difficulties might arise in state-owned industries in making financial decisions?
Explain the rationale for selecting shareholder wealth maximisation as the objective of the firm. Include a consideration of profit maximisation as an alternative goal.
What benefits are derived from the financial services sector which have led to its growth over recent years in terms of employment and share of GDP?
What is managerialism and how might it be incompatible with shareholder interests?
Firm A has a stock market value of £20m (number of shares in issue × share price), while firm B is valued at £15m.The firms have similar profit histories:Provide reasons why, despite the same
The chief executive of Geight plc receives a salary of £80,000 plus 4 per cent of sales. Will this encourage the adoption of decisions that are shareholder wealth enhancing? How might you change
Consider the organisations where you have worked in the past and the people you have come into contact with. List as many objectives as you can, explicit or implicit, that have been revealed to, or
Review all the financial services you or your firm purchase. Try to establish a rough estimate of the cost of using each financial intermediary and write a balanced report considering whether you or
What are the theoretical justifications for the NPV decision rules?
Explain what is meant by conventional and unconventional cash flows and what problems they might cause in investment appraisal.
What is the reinvestment assumption for project cash flows under IRR? Why is this problematical?
Rearrange the compounding equation to solve for:(a) the annual interest rate, and (b) the number of years over which compounding takes place.
What is the ‘yield’ of a project?
Explain why it is possible to obtain an inaccurate result using the trial and error method of IRR when a wide difference of two discount rates is used for interpolation.
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 to
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) to t Cash flow
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 is
‘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 there would be a big lump
Arcmat plc 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. This will require complete
Payback is dismissed as unsound. Discuss.Describe discounted payback.
Define accounting rate of return and compare it with net present value.
Do you believe the arguments for using IRR are strong enough to justify relying on this technique alone?
Why is investment project generation, selection and implementation closer to an art form than a science?
How would you appraise a project with a high proportion of non-quantifiable benefits?
If you were chief executive of a large corporation, how would you encourage project idea generation, communication and sponsorship?
Why is project screening necessary?
When do capital expenditure controls and postcompletion audits become an excessive burden, and when are they very important?
Explain why hard and soft rationing occur. Why not simply rank projects on the basis of the highest NPV in conditions of capital rationing?
Explain the alternative methods of dealing with inflation in project appraisal.
Explain, with reference to probability and sensitivity analysis, why the examination of the most likely outcome of an investment in isolation can both be limiting and give a false impression.
What do you understand by the following?(i) Risk-lover.(ii) Diminishing marginal utility.(iii) Standard deviation.
Discuss the consequences of the quantification of personal judgements about future eventualities.Are we right to undertake precise analysis on this sort of basis?
Explain the attraction of using more than one method to examine risk in project appraisal.
Why has the development of powerful computers helped the more widespread adoption of scenario analysis?
Suggest reasons why probability analysis is used so infrequently by major international corporations.
‘The flatter the line on the sensitivity graph, the less attention we have to pay to that variable.’ Is the executive who made this statement correct in all cases?
How are holding-period returns calculated?
How do you calculate the risk on a two-asset portfolio?
Show how the covariance and correlation coefficient are related.

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