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fundamentals corporate finance

Questions and Answers of Fundamentals Corporate Finance

What are the main motives for holding cash?
What do you understand by carrying costs and ordering costs? How do they fit into the economic order quantity formula?
What are the main elements in a firm’s credit policy?
A survey of large UK companies (Pike et al., 1998) found that the normal credit period granted was 30 days, but the average credit period taken by customers was 46 days. Only 20 per cent of firms
Financial signals: is there evidence of the customer running up losses or having liquidity problems?
Customer payment record: is the customer a prompt payer?
Define overtrading. How does it arise, and what are its consequences?
How should working capital be financed?
What should be the level of investment for each type of current asset?
What should be the firm’s total level of investment in current assets?
Explain why two firms in the same industry could have very different cash operating cycles. What are the financial implications?
ABC plc is a UK-based service company with a number of wholly-owned subsidiaries and interests in associated companies throughout the world. In response to the rapid growth in the company, the
What are the risks that a manufacturing company might encounter as a result of interest rate movements? Describe two financial instruments the company could use to reduce such risks.
Atlas Ltd is a newly formed digital media company with a number of locations in the United Kingdom, France and Germany. The board of directors is currently discussing whether the finance function
Companies are required to disclose their principal risks and uncertainties within the annual report. Download the latest annual report for BT (www.btplc.com). What are the major risks the company
What is the possible consequence if the identified risk event did occur?
How likely is it that the risk will occur?
Companies often state that reputational risk is one of the greatest threats that they face. Very high-profile cases that illustrate the hugely harmful effect that reputational events can have upon a
Define in your own words the main forms of derivatives – forwards, futures, swaps and options.
Take a look at the latest annual report of Ferguson plc (www.ferguson.com). What does the Directors’ Report say about its financial risk management?
What do you understand by the matching approach to financing fixed and current assets?
How would you define treasury management?
Risk management, hedging and the use of derivatives.
How to manage banking relationships.
Use of the yield curve by organisations.
Treasury funding issues.
The purpose and structure of the treasury function.
The managing director of Wemere, a medium-sized private company, wishes to improve the company’s investment decision-making process by using discounted cash flow techniques. He is disappointed to
You are given the following information about Electronics plc. It has a payout ratio of 0.6, a return on equity of 20 per cent, an equity Beta of 1.33 and is expected to pay a dividend next year of
The ordinary shares of Stanley plc are quoted on the London Stock Exchange. The directors, who are also major shareholders, have been evaluating some new investment opportunities. If they go ahead
(a) Berlan plc has annual earnings before interest and tax of £15 million. These earnings are expected to remain constant. The market price of the company’s ordinary shares is 86 pence per share
Kipling plc is a food manufacturer which has the following long-term capital structure:££1 ordinary shares (fully paid)Share premium account Retained profit 8% preference shares 10% debentures
Demonstrate how the process of home-made gearing-cum-arbitrage would operate in an MM world so as to equalise the values of the following two firms. The companies are identical in every respect
Diamonds plc estimates its costs of debt and equity for different capital structures as follows:% Debt % Equity kd ke WACC– 100 – 20% ?25 75 8% 24% ?50 50 8% 32% ?75 25 8% 56% ?Required(i) What
With the following information about Rushden plc, determine its cost of equity according to the MM no-tax model.keu = 20,; kd = 8,;VB VB + VS= 20,
How would you identify the point beyond which a firm would be unable to borrow?
What is the APV and how is it calculated?
Ungear a B of 1.45 if:Tax rate = 30, The debt/equity ratio = 1:2
Compare the overall required return in geared and ungeared firms if:keu = 15, Tax rate = 30, The geared firm has borrowed £200m at 7% interest, and has issued equity of £400m
Determine the respective values of geared and ungeared firms if:Earnings = £100m before tax Tax rate = 30, keu = 15,The geared firm borrows £200m.
What factors restrict the ability of investors to arbitrage in the way envisaged by MM?
Why does a geared company have the same value (allowing for size) as an ungeared company of equivalent risk in the ‘basic’ MM model?
Explain the use of the adjusted present value method in valuation and capital budgeting decisions
Apply the Modigliani-Miller theory to firms suffering financial distress.
Identify the extent to which a Beta coefficient incorporates financial risk.
Appreciate how the CAPM is integrated into capital structure analysis.
Appreciate the differences between the ‘traditional’ view of gearing and the Modigliani–Miller versions of optimal capital structure and gearing.
Understand the theoretical underpinnings of ‘modern’ capital structure theory.
The directors of Zeus plc are considering opening a new manufacturing facility. The finance director has provided the following information:Initial capital investment: £2,500,000.Dividends for the
Calculate the weighted average cost of capital for the following company, using both book value and market value weightings.Statement of financial position(Balance sheet) values Cost of finance
(a) Calculate the value of the tax shield in each of the following cases, all based on borrowing of £100 million at 10 per cent interest p.a., pre-tax.(i) Perpetual life debt, tax rate is 30 per
Darnol plc is currently ungeared and is considering a buy-back of ordinary shares via an open market purchase, borrowing in order to do so. You have been commissioned to report on the likely impact
Calculate the cost of debt facing a firm that issued £50 million in debentures in £100 units two years ago at a nominal interest rate of 8 per cent p.a., in each of the following cases:(i) market
Using the accounting information provided below, calculate the following measures of gearing:long-term debt (LTD) to equity LTD to LTD plus equity total debt to equity net debt in absolute terms net
Identify examples of distressed behaviour by highly geared firms from your reading of the financial press.
What is the value of the tax shield for £10 million debt, coupon rate 6 per cent, tax rate 30 per cent:(a) if the debt is perpetual?(b) if it is to be repaid in 20 years?
Verify that the solution rate in the above IRR equation is 9.9 per cent.
What is the market value of the 3.5 per cent War Loan when market rates are:(i) 11%?(ii) 3%?
What is this firm’s WACC? (Ignore taxation.)debt-to-equity ratio = 40, cost of equity = 18, cost of debt = 8,
What is the effect on share price in the Lindley example if shareholders require returns of 25 per cent under 25 per cent gearing, and of 35 per cent under 50 per cent gearing?
Calculate the expected value of Lindley’s ROE under each scenario.
Show the effect on the combined gearing multiplier in the Burley example if fixed costs are£530,000 and interest charges are £240,000.
Obtain the accounts of a firm of your choice and conduct a similar exercise to the D.S. Smith plc calculations.
Distinguish between capital gearing and income gearing. How is each measured?
Determine the following gearing ratios using the information supplied.(i) debt-to-equity ratio(ii) debt-to-debt plus equity ratio(iii) net debt Equity = £100m Long-term debt = £50m Short-term debt
What practical guidelines can we offer to financial managers?
What overall return should be achieved by a company using debt?
How does taxation affect the analysis?
What do the competing theories of capital structure tell us about optimal financing decisions?
What are the dangers of debt capital? How do shareholders react to ‘high’ levels of gearing?
How is the cost of debt capital measured?
Why do companies use debt capital?
How is gearing measured?
To enable you to understand the factors that a finance manager should consider when framing capital structure policy
To help you understand the issues involved in financing foreign operations.
To enable you to understand the likely limits on the use of debt, and the nature of ‘financial distress’costs.
To explain the meaning of, and how to calculate, the Weighted Average Cost of Capital (WACC).
To provide an in-depth understanding of the advantages of debt capital.
To explain ways of measuring gearing.
Pavlon plc has recently obtained a listing on the Stock Exchange. Ninety per cent of the company’s shares were previously owned by members of one family, but, since the listing, approximately 60
Galahad plc, a quoted manufacturer of textiles, has followed a policy in recent years of paying out a steadily increasing dividend per share as shown below:Year EPS Dividend (net) Cover 2013 11.8p
Tamas plc, which is ungeared, earned pre-tax accounting profits of £30 million in the financial year just ended.Replacement investment will match last year’s depreciation of £2 million. Both are
Harry plc prides itself on its consistent dividend policy. Past data suggest that its target dividend payout ratio is 50 per cent of earnings. However, when earnings increase, Harry invariably raises
Dick plc faces the following marginal efficiency of investment profile. All projects are indivisible.Project IRR (%) Required outlay (£m)A 15 3 B 24 5 C 40 2 D 12 4 E 21 7 Dick’s shareholders
Tom plc follows a residual dividend policy. It has just announced earnings of £10 million and is to pay a dividend of 20p per share. Its nominal issued share capital is £5 million with par value of
Rehearse the arguments in favour of a stable dividend policy.
Suggest some arguments against share repurchases.
How many shares would an investor receive in lieu of cash dividends of £1,000 if offered:(i) a pro rata scrip alternative?(ii) an ESD of 20%?Share price is £20.
What is meant by a shareholder clientèle? Which shareholders are most likely to prefer nearin-time dividends?
Why is Gordon’s ‘early resolution of uncertainty’ argument in favour of paying early dividends logically flawed?
What dividend, if any, should the firm pay in the following situation? Earnings are £1 million, ke = 12 per cent.Project Required outlay IRR A £300,000 18%B £400,000 16%C £700,000 14%D £200,000
How can dividend policy damage shareholder interests when no external financing is available?
Rework the Divicut example for the case where the returns on the new investment are £1,080 rather than £1,200 in year 2.
Understand why changes in dividend payments usually lag behind changes in company earnings.
Appreciate the impact of taxation on dividend decisions.
Know about alternatives to cash dividends that may be used to deliver value to owners.
Understand what is meant by signalling and the ‘information content’ of dividends.
Understand what factors a financial manager should consider when deciding to recommend a change in dividend payouts.
Understand the competing views about the role of dividend policy.
How can investors avoid making irrational decisions, and so achieve returns superior to other investors?

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