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business
fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

How are interest rates used to allocate capital among firms?AppendixLO1
What happens to market-clearing, or equilibrium, interest rates in a capital market when the demand for funds declines? What happens when inflation increases or decreases?AppendixLO1
Why does the price of capital change during booms and recessions?AppendixLO1
How does risk affect interest rates?AppendixLO1
Write out an equation for the nominal interest rate on any debt security.AppendixLO1
Distinguish between the real risk-free rate of interest, k*, and the nominal, or quoted, risk-free rate of interest, kRF .AppendixLO1
How is inflation dealt with when interest rates are determined by investors in the financial markets?AppendixLO1
Does the interest rate on a T-bond include a default risk premium? Explain.AppendixLO1
Distinguish between liquid and illiquid assets, and identify some assets that are liquid and some that are illiquid.AppendixLO1
If the rate of inflation is expected to increase, would this increase or decrease the slope of the yield curve?AppendixLO1
If the rate of inflation is expected to remain constant in the future, would the yield curve slope up, down, or be horizontal?AppendixLO1
Explain why corporate bonds' default and liquidity premiums are likely to increase with maturity.AppendixLO1
Explain why corporate bonds always trade at higher yields than Treasury bonds and why BBB-rated bonds always trade at higher yields than AA-rated bonds.\AppendixLO1
Assuming that the pure expectations theory is correct, how are long-term interest rates calculated?AppendixLO1
What is country risk?AppendixLO1
Other than inflationary expectations, name some additional factors that influence interest rates, and explain the effects of each.AppendixLO1
Does the Fed have complete control over U.S. interest rates; that is, can it set rates at any level it chooses?AppendixLO1
What are financial intermediaries, and what economic functions do they perform?AppendixLO1
Suppose interest rates on residential mortgages of equal risk were 7 percent in California and 9 percent in New York. Could this differential persist? What forces might tend to equalize rates? Would
What would happen to the standard of living in the United States if people lost faith in the safety of our financial institutions? Why?AppendixLO1
How does a cost-efficient capital market help to reduce the prices of goods and services?AppendixLO1
Which fluctuate more, long-term or short-term interest rates? Why?AppendixLO1
Suppose the population of Area Y is relatively young while that of Area O is relatively old, but everything else about the two areas is equal.a. Would interest rates likely be the same or different
Suppose a new process was developed that could be used to make oil out of seawater. The equipment required is quite expensive, but it would, in time, lead to very low prices for gasoline,
Suppose a new and much more liberal Congress and administration were elected, and their first order of business was to take away the independence of the Federal Reserve System, and to force the Fed
It is a fact that the federal government (1) encouraged the development of the savings and loan industry; (2) virtually forced the industry to make long-term, fixed-interest-rate mortgages;and (3)
Suppose interest rates on Treasury bonds rose from 7 to 14 percent as a result of higher interest rates in Europe. What effect would this have on the price of an average company's common
What are the two leading stock exchanges in the United States today?AppendixLO1
Explain briefly the ideas behind the dividend irrelevance theory.AppendixLO1
Why did MM refer to the Gordon-Lintner dividend argument as the bird-in-thehand fallacy?AppendixLO1
Why do some investors prefer high-dividend-paying stocks?AppendixLO1
Why might other investors prefer low-dividend-paying stocks?AppendixLO1
What is “catering theory,” and how does it impact a firm’s dividend policy?AppendixLO1
Explain the logic of the residual dividend model, the steps a firm would take to implement it, and the reason it is more likely to be used to establish a long-run payout target than to set the actual
How do firms use long-run planning models to help set dividend policy?AppendixLO1
What is the ex-dividend date, and why is it important to investors?AppendixLO1
A firm has a capital budget of $30 million, net income of $35 million, and a target capital structure of 45% debt and 55% equity. If the residual dividend policy is used, what is the firm’s
What are their advantages and disadvantages from both stockholders’ and firms’perspectives?AppendixLO1
l Discuss the role and nature of the Stock Exchange.
l Discuss the nature and implications of stock market efficiency.
l Outline the methods by which share capital may be issued.
l Identify the problems that smaller businesses experience in raising finance and describe the ways in which they may gain access to long-term finance.
‘Private equity’ is an important source of risk capital for smaller businesses.’Required:(a) Explain the term ‘private equity’ and discuss the main types of business that are likely to
(a) Explain what is meant by the term ‘efficient market hypothesis’ and discuss the three main forms of market efficiency.(b) Explain the implications of an efficient market for the managers of a
‘Smaller businesses experience greater problems in raising finance than larger businesses.’Required:(a) Discuss the problems that smaller businesses may confront when trying to obtain long-term
Pizza Shack plc operates a chain of pizza restaurants in the south of England. The business started operations five years ago and has enjoyed uninterrupted and rapid growth. The directors of the
The board of directors of Wicklow plc is considering an expansion of production capacity following an increase in sales over the past two years. The most recent financial statements for the business
Devonian plc has the following long-term capital structure as at 30 November Year 4:£m Ordinary shares 25p fully paid 50.0 General reserve 22.5 Retained earnings 25.5 98.0 The business has no
Carpets Direct plc wishes to increase the number of its retail outlets in the south of England. The board of directors has decided to finance this expansion programme by raising the funds from
l Describe the nature of dividends and the way in which they are paid.
l Explain why dividends should have no effect on shareholder wealth in a world of perfect and efficient markets.
l Discuss the factors that influence dividend policy in practice.
l Discuss other ways in which cash may be distributed to shareholders.
Why should a business wish to repurchase some of its shares?
The dividend policy of businesses has been the subject of much debate in the financial management literature.Required:Discuss the view that dividends can increase the wealth of shareholders.
Identify and discuss the factors that may influence the dividend policies of businesses.
The following listed businesses each have different policies concerning distributions to shareholders:l North plc pays all profits available for distribution to shareholders in the form of a cash
Fellingham plc has 20 million ordinary £1 shares in issue. No shares have been issued during the past four years. The business’s earnings and dividends record taken from the historic accounts
Mondrian plc is a new business that aims to maximise the wealth of its shareholders. The board of directors is currently trying to decide upon the most appropriate dividend policy to adopt for the
Traminer plc provides software solutions for the airline industry. At present, shares in the business are held by the senior managers and by a venture capital business. However, Traminer plc intends
Describe the shareholder value approach and explain its implications for the management of a business.
l Discuss the reasons why new ways of measuring shareholder value are necessary.
l Explain SVA and EVA® and describe their role in measuring and delivering shareholder value.
l Explain MVA and TSR and evaluate their usefulness for investors.
The shareholder value approach to managing businesses takes a different approach from the stakeholder approach to managing businesses. In the latter case, the different stakeholders of the business
Should managers take changes in the total market value of the shares (that is, share price × number of shares issued) over time as an indicator of shareholder value created (or lost)?
Aquarius plc has estimated the following free cash flows for its five-year planning period:Year Free cash flows£m 1 35.0 2 38.0 3 45.0 4 49.0 5 53.0 Required:How might it be possible to check the
Aries plc was recently formed and issued 80 million £0.50 shares at par and loan capital of£24m. The business used the proceeds from the capital issues to purchase the remaining lease on some
Virgo plc is considering introducing a system of EVA® and wants its managers to focus on the longer term rather than simply focus on the year-to-year EVA® results. The business is seeking your
Leo plc is considering entering a new market. A new product has been developed at a cost of£5 million and is now ready for production. The market is growing and estimates from the finance department
Pisces plc produced the following statement of financial position and income statement at the end of the third year of trading:Statement of financial position (balance sheet)as at the end of the
Identify and discuss the main reasons for mergers and takeovers.
l Discuss the advantages and disadvantages of each of the main forms of purchase consideration used in a takeover.
l Identify the likely winners and losers from takeover activity.
l Outline the tactics that may be used to defend against a hostile bid.
l Identify and discuss the main methods of valuing the shares of a business.
Identify four tactics the directors of a target business might employ to resist an unwelcome bid...When a business wishes to acquire another, it may make a bid in the form of cash, a share-forshare
Dawn Raider plc has just offered one of its shares for two shares in Sleepy Giant plc, a business in the same industry as itself. Extracts from the financial statements of each business for the year
An investment business is considering taking a minority stake in two businesses, Monaghan plc and Cavan plc. Both are in the same line of business and both are listed on the London Stock
Alpha plc, a dynamic, fast-growing business in microelectronics, has just made a bid of 17 of its own shares for every 20 shares of Beta plc, which manufactures a range of electric motors.Financial
Larkin Conglomerates plc owns a subsidiary, Hughes Ltd, which sells office equipment.Recently, Larkin Conglomerates plc has been reconsidering its future strategy and has decided that Hughes Ltd
The senior management of Galbraith Ltd is negotiating a management buy-out of the business from the existing shareholders. The most recent financial statements of Galbraith Ltd are as
l Explain how business plans are developed and the role that projected financial statements play in this process.
l Prepare projected financial statements for a business and interpret their significance for decision-making purposes.
l Discuss the strengths and weaknesses of the per-cent-of-sales method as an alternative method of preparing projected financial statements.
l Explain the ways in which projected financial statements may take into account the problems of risk and uncertainty.
Why would it normally be easier for an existing business than for a new one to prepare projected financial statements?
Why is the sales forecast normally of critical importance to the preparation of projected financial statements?
Choice Designs Ltd operates a small group of wholesale/retail carpet stores in the north of England.The statement of financial position (balance sheet) of the business as at 31 May 2008 is as
Prolog Ltd is a small wholesaler of powerful microcomputers. It has in recent months been selling 50 machines a month at a price of £2,000 each. These machines cost £1,600 each. A new model has
Davis Travel Ltd specialises in the provision of winter sports holidays but it also organises outdoor activity holidays in the summer. You are given the following information:Abbreviated statement of
Changes Ltd owns a chain of eight shops selling fashion goods. In the past the business maintained a healthy cash balance. However, this has fallen in recent months and at the end of September 2008
Kwaysar Ltd sells television satellite dishes both to retail outlets and direct to the public. Its most recent statement of financial position is as follows:Statement of financial position (balance
Newtake Records Ltd owns a chain of 14 shops selling CDs and DVDs. At the beginning of June, the business had an overdraft of £35,000 and the bank has asked for this to be eliminated by the end of
Goya Music Direct Ltd operates a mail order business offering classical music CDs to the general public. Its most recent statement of financial position is as follows:Statement of financial position
Some businesses operate on a low operating profit margin (for example, a supermarket chain).
Does this mean that the return on capital employed from the business will also be low?
What potential problems arise for the external analyst from the use of statement of financial position (balance sheet) figures in the calculation of financial ratios?
Is it responsible to publish Z-scores of businesses that are in financial difficulties? What are the potential problems of doing this?
Set out below are ratios relating to three different businesses. Each business operates within a different industrial sector.Ratio A plc B plc C plc Operating profit margin 3.6% 9.7% 6.8%Sales to

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