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fundamentals corporate finance

Questions and Answers of Fundamentals Corporate Finance

Why is the Beta of the overall market equal to 1.0?
Suggest why Beta values tend to cluster in a range of roughly 0.60 to 1.30.
What is the significance of variations around the characteristics line? Relate this to a particular company, say, British Airways (now merged with Iberia to form International Airlines Group).
You read in the financial press that the ‘experts’ are predicting overall stock market returns of 25 per cent next year. What return would you expect from holding Walkley Wagons ordinary shares?
Give three examples of systematic and unique factors respectively that cause the returns on holding ordinary shares to vary over time.
How many shares would an investor have to hold in order to totally eliminate specific risk?
Determine the TSR for the year 201X in the following case:Share price, 1 January: £2.20 Share price, 31 December: £2.37 Interim dividend paid: £0.035 per share Final dividend paid: £0.065 per
To examine some criticisms of the CAPM.
To examine the case for corporate diversification.
To determine the appropriate risk premium to incorporate into a discount rate, whether for investment in securities or in capital projects.
To explain what a ‘Beta coefficient’ is.
To explain what type of risk is relevant for valuing capital assets.
The management of Gawain plc is evaluating two projects whose returns depend on the future state of the economy as shown in the following table:Probability IRRA(%) IRRB(%)0.3 0.4 0.3 27 18 535 15 20
Nissota, a Japanese-based car manufacturer, is evaluating two overseas locations for a proposed expansion of production facilities at a site in Ireland and another on Humberside. The likely future
Tomb-zapper plc manufactures computer video games. It is considering whether to expand production at its existing site in ‘Silicon Glen’ in Scotland, or to start production in a ‘greenfield
Determine the risk-minimising portfolios for the following two-asset portfolios:(i) ERA = 8,; ERB = 10%; sA = 3%; sB = 7%; rAB = -0.6(ii) ERA = 20%; ERB = 12%; sA = 12%; sB = 6%; rAB = -0.5(iii) ERA
The returns on investment in two projects, X and Y, have standard deviations of 30 per cent and 45 per cent, respectively. The correlation coefficient between the returns on the two investments is
Draw an envelope of portfolios for the case where four assets are available to invest in, either individually or as portfolios.
Using Figure 8.4, distinguish between risk-minimisation and risk-aversion.
Verify that the lowest achievable portfolio standard deviation is £3,496 and the expected NPV per house built from the minimum risk portfolio is £25,620.
What is meant by an efficient frontier in portfolio analysis?
Verify that the portfolio at B, involving 75 per cent of Z and 25 per cent of Y, is the minimum risk combination.
Verify that the standard deviation of this risk-minimising portfolio is 24 per cent.
With the figures in Table 8.1, check that the expected values for both A and B are 20 per cent, and that their respective standard deviations are 30 per cent and 40 per cent, using the formulae
What are the two required conditions for total elimination of portfolio risk?
To examine the drawbacks of portfolio analysis as an approach to project appraisal.
To explore why optimal portfolio selection is a matter of personal choice.
To explain the mechanics of portfolio construction with a user-friendly approach to the key statistics, using numerical examples.
To understand the rationale behind the diversification decisions of shareholders and companies.
The net present value approach and why it is consistent with shareholder goals.
The three discounted cash flow approaches – net present value, internal rate of return and profitability index.
The underlying strengths and limitations of the above methods.
How net present value and internal rate of return methods can be reconciled when they conflict.
Analysing investments when capital availability is an important constraint.
Why should managers seek to maximise net present value? Is business not about maximising profit?
Define the main elements in the capital investment decision.
Why should managers seek to maximise net present value? Is business not about maximising profit?
What are the three main DCF methods, and how do you know when to accept a capital project with each?
List four capital budgeting methods for evaluating project proposals. Identify the main strengths and drawbacks of each.
Why do problems arise in evaluating mutually exclusive projects? What approach would you recommend in such circumstances?
Take another look at the graphs in Figure 4.3. How would you explain to a manager that Project X, with the higher IRR, is actually less attractive than Project Y?
What do you understand by ‘soft’ and ‘hard’ forms of capital rationing? Give two approaches available to resolve capital rationing problems.
Calculate the terminal value of the project by compounding forward all interim cash flows at the cost of capital to the end of the project.
Find the rate of interest that equates the terminal value with the initial cost.
Describe how the modified IRR is calculated. What advantages does the MIRR have over the IRR in assessing capital investment decisions?
The directors of Yorkshire Autopoints are considering the acquisition of an automatic car-washing installation.The initial cost and setting-up expenses will amount to about £140,000. Its estimated
Microtic Ltd, a manufacturer of watches, is considering the selection of one from two mutually exclusive investment projects, each with an estimated five-year life. Project A costs £1,616,000 and is
Grace Ltd is planning its capital budget for 2018 and 2019. The company’s directors have reduced their initial list of projects to five, the expected cash flows of which are set out as
The directors of Bonzo Ltd are currently considering two mutually exclusive investment projects. Both projects are concerned with the purchase of new plant. The following data are available for each
The directors of XYZ plc wish to expand the company’s operations. However, they are not prepared to borrow at the present time to finance capital investment. The directors have therefore decided to
Raiders Ltd is a private limited company financed entirely by ordinary shares. Its effective cost of capital, net of tax, is 10 per cent p.a. The directors are considering the company’s capital
Identifying the relevant information in investment analysis.
Evaluating replacement and other investment decisions.
Handling inflation.
Assessing the effects of taxation on investment decisions.
Investment appraisal practices, strengths and limitations.
Identifying the appropriate discount rate.
What do you understand by the term ‘incremental cash flows’?
Waxo plc has developed a new wonder earache drug. The management is currently putting together an investment proposal to produce and sell the drug, but is not sure whether to include the following:1
Gregg – the marketing manager of a manufacturer of golf equipment – has recently submitted a proposal for the production of a range of clubs for beginners. He has just received the following
What is the impact of firms not adjusting their investment ‘hurdle’ rates for changing levels of inflation? How would you advise a company which employs a 20 per cent discount rate which was
Your boss says: ‘We only assess capital projects before tax. Every firm has to pay tax, so we can ignore it.’ Do you agree?
The following reasons for using payback were given by finance executives from three different companies:‘We use payback in support of other methods. It is not a sufficiently reliable tool to be
Major plc has 20 million £0.50 ordinary shares and irredeemable loan capital with a nominal value of £40 million in issue. The ordinary shares have a current market value of £2.40 per share and
Explain why most firms prefer IRR, although most capital budgeting textbooks strongly recommend NPV.
A project costing £20,000 offers an annual cash flow of £5,000 over its life.(a) Calculate the internal rate of return using the payback reciprocal assuming an infinite life.(b) Use tables to test
Your firm uses the IRR method and asks you to evaluate the following mutually exclusive projects:Year Cash flows (£) 0 1 2 3 4 Proposal L Proposal M-47,232-47,232 20,000 020,000 10,000 20,000 20,000
Explain two methods in which inflation can be handled in investment analysis. Which method would you recommend and why?
Heacham Manufacturing Co. Ltd has found that, after only two years of using a machine for a semi-automatic process, a more advanced model has arrived on the market. This advanced model will not only
Argon Mining plc is investigating the possibility of purchasing an open-cast coal mine in South Wales at a cost of £2.5 million which the British government is selling as part of its privatisation
Consolidated Oilfields plc is interested in exploring for oil near the west coast of Australia. The Australian government is prepared to grant an exploration licence to the company for a five-year
You are the chief accountant of Deighton plc, which manufactures a wide range of building and plumbing fittings.It has recently taken over a smaller unquoted competitor, Linton Ltd. Deighton is
(a) Explain how inflation affects the rate of return required on an investment project, and the distinction between a real and a nominal (or ‘money terms’) approach to the evaluation of an
How much of the information which he had gathered was really relevant to the decision?
What was the best approach to assessing the economic worth of the proposal? The company used payback and return on investment, but he felt that discounted cash flow techniques had some merit.
Cash was particularly limited this year and acceptance of this project could mean that other projects would have to be deferred.How should this be taken into consideration?
How should the strategic factors be assessed?
What about tax? Engineering Products plc pays Corporation Tax at 30 per cent, and annual writing-down allowances of 25 per cent on the reducing balance may be claimed. The existing machine has a nil
Examine the strategic issues in investment decisions.
Explain the investment process and related challenges.
Explore how strategy shapes investment decisions.
Explain issues and challenges in new technology and environmental projects.
Explore the investment decision and control process.
Evaluate the process of post-audit reviews.
How are project proposals initiated?
At what level are projects typically generated?
Is there a formal process for submitting ideas?
Is there an incentive scheme for identifying good project ideas?
Is the investment opportunity compatible with corporate strategy? Does it fall within a section of the business designated for growth?
Are the resources required by the project available (technical expertise, human resource, finance, etc.)?
Is the idea technically feasible?
Is the idea socially acceptable?
Is it an environment-friendly project?
What evidence is available to suggest that it is likely to provide an acceptable return?
Are the risks involved acceptable?
What are the main benefits from post-audits?
‘Capital budgeting is simply a matter of selecting the right decision rule.’ How true is this statement?
What are the objectives of carrying out post-audits?
AMT plc is increasing the level of automation of a production line dedicated to a single product. The options available are total automation or partial automation. The company works on a planning
To explain uncertainty and risk.

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