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fundamentals of financial management

Questions and Answers of Fundamentals Of Financial Management

ST-3. For an investment to grow eightfold in nine years, at what rate would it have to grow?
ST-2. You purchase a boat for $35,000 and pay $5,000 down and agree to pay the rest over the next 10 years in 10 equal annual payments that include principal payments plus 13 percent of compound
ST-l. You place $25,000 in a savings account paying annual compound interest of 8 percent for three years and then move it into a savings account that pays 10 percent interest compounded annually.
5-6. What is an annuity? Give some examples of annuities. Distinguish between an annuity and aperpetuity.
5-5. What is the relationship between the PVIFi,n (Table 5-4) and the PVIFAi,n (Table 5-8)?What is the PVIFA 1O%.lOyr/ Add up the values of the PVIF10%,1I for n = 1, ... , 10. What is this value? Why
5-4. Suppose you were considering depositing your savings in one of three .banks, all of which pay 5 percent interest; bank A compounds annually, bank B compounds semiannually, and bank C compounds
5-3. How would an increase in the interest rate (I) or a decrease in the holding period (n) affect the future value (FVn) of a sum of money? Explain why.
5-2. The processes of discounting and compounding are related. Explain this relationship.
5-1. 'What is the time value of money? 'Why is it so important?
million units per year. Its life is expected to be five years and its scrap value at that time £100,000.The accountant has prepared the following cost estimates based on the expected output of 1
million units per year but typically it has been run at only 80 per cent of capacity because of the lack of demand for its output. The new line has a capacity of
Haverhill Engineers Ltd manufactures components for the car industry. It is considering automating its line for producing crankshaft bearings. The automated equipment will cost£700,000. It will
Chesterfield Wanderers is a professional football club that has enjoyed considerable success in recent years. As a result, the club has accumulated £10 million to spend on its further development.
Newton Electronics Ltd has incurred expenditure of £5 million over the past three years researching and developing a miniature hearing aid. The hearing aid is now fully developed.The directors are
The accountant of your business has recently been taken ill through overwork. In his absence his assistant has prepared some calculations of the profitability of a project, which are to be discussed
C. George (Controls) Ltd manufactures a thermostat that can be used in a range of kitchen appliances. The manufacturing process is, at present, semi-automated. The equipment used cost £540,000 and
Arkwright Mills plc is considering expanding its production of a new yarn, code name X15.The plant is expected to cost £1 million and have a life of five years and a nil residual value.It will be
The directors of Mylo 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 payback method has been criticised for not taking into account the time value of money. Could this limitation be overcome? If so, would this method then be preferable to the NPV method?
How might classification help in this way?
Earlier in the chapter, we discussed the limitations of the PP method. Can you explain why it is still a reasonably popular method of investment appraisal among managers?
The directors of Manuff (Steel) Ltd are considering closing one of the business’s factories.There has been a reduction in the demand for the products made at the factory in recent years. The
A garage has an old car that it bought several months ago for £3,000. The car needs a replacement engine before it can be sold. It is possible to buy a reconditioned engine for £300. This would
What is the internal rate of return of the Chaotic Industries project from Activity 4.2?( Hint: Remember that you already know the NPV of this project at 15 per cent (from Activity 4.12).)
When we discounted the cash flows of the Billingsgate Battery Company machine project at 20 per cent, we found that the NPV was a positive figure of £24,190 (see p. 141 ).What does the NPV of the
What is the NPV of the Chaotic Industries project from Activity 4.2, assuming a 15 per cent opportunity cost of finance (discount rate)? (Use the table in Appendix A.)
What is the maximum the Billingsgate Battery Company would be prepared to pay for the machine, given the potential benefits of owning it?
See whether you can show that an investor would find £27,778, receivable now, equally acceptable to receiving £40,000 in two years’ time, assuming that there is a 20 per cent investment
Given that the Billingsgate Battery Company could invest its money at a rate of 20 per cent a year, what is the present (immediate) value of the expected first-year receipt of£20,000? In other
Can you see from the above why the PP method is not a complete answer to the problem concerning the timing of cash flows?
Sinclair Wholesalers plc is considering opening a new sales outlet in Coventry. Two possible sites have been identified for the new outlet. Site A has an area of 30,000 sq m. It will require an
Can you figure out what the major defect is? ( Hint: It is not concerned with the ability of the decision maker to forecast future events, though this too can be a problem. Try to remember the
Chaotic Industries is considering an investment in a fleet of ten delivery vans to take its products to customers. The vans will cost £15,000 each to buy, payable immediately.The annual running
Explain the key stages in the investment decision-making process.
Use each method to reach a decision on a particular investment opportunity.
Identify and discuss the four main investment appraisal methods found in practice.
Nimby plc is considering two mutually exclusive projects: Delphi and Oracle. The possible NPVs for each project and their associated probabilities are as follows:Delphi Oracle NPV£m Probability of
Devonia (Laboratories) Ltd has recently carried out successful clinical trials on a new type of skin cream, which has been developed to reduce the effects of ageing. Research and development costs
Helena Chocolate Products Ltd is considering the introduction of a new chocolate bar into its range of chocolate products. The new chocolate bar will require the purchase of a new piece of equipment
Simonson Engineers plc is considering the building of a new plant in Indonesia to produce products for the South-East Asian market. To date, £450,000 has been invested in market research and site
D’Arcy (Builders) Ltd is considering three possible investment projects: A, B and C. The expected pattern of cash flows for each project is:Project cash flows A£000 B£000 C£000 Initial outlay
Lee Caterers Ltd is about to make an investment in new kitchen equipment. It is considering whether to replace its existing kitchen equipment with cook/freeze or cook/chill technology.The following
Refer back to Example 5.6. Which project should be chosen and why? (Assume the possible outcomes are normally distributed.)
Kernow Ltd provides street-cleaning services for a small town. The work is currently labour intensive and few machines are employed. However, the business has recently been considering the purchase
Use the table provided in Appendix Bto calculate the equivalent annual annuity for each machine referred to in Example
What is the NPV for Machine B over the six-year period? Which machine is the better buy?In the case of Machine B, the NPV over the six-year period will be equal to the NPV above plus the equivalent
Describe the main approaches to the measurement of risk and discuss their limitations.
Discuss the nature of risk and explain why it is important in the context of investment decisions.
Discuss the effect of inflation on investment appraisal and explain how inflation may be taken into account.
Explain the modifications needed to the simple NPV decision rules where investment funds are limited or where there are competing projects with unequal lives.
Why should we expect this to be the case?A higher premium will often be needed to overcome resistance to the bid.
What is the attraction of this form of loan capital from the point of view of the target business’s shareholders?
Who do you think might benefit most from diversification?
What type of merger will achieve this objective? What are the potential problems of this kind of merger from the consumer’s point of view?
Identify and discuss the main methods of valuing the shares of a business.
Outline the tactics that may be used to defend against a hostile takeover bid.
Identify the likely winners and losers from takeover activity.
Discuss the advantages and disadvantages of each of the main forms of purchase consideration used in a takeover.
How might directors behave as a result of this focus on share price increases rather than dividends?
How might this affect the risk-taking behaviour of directors?
How might this alignment of interests occur?
What benchmark would be most suitable?Perhaps the best benchmark to use would be the returns made by similar businesses operating in the same industry over the same period of time.
How could the problems of interpretation mentioned above be overcome?
Try to identify at least one practical problem that may arise when using SVA calculations to reward managers. ( Hint: Think about how SVA is calculated.
Calculate the EVA margin for the second year of Scorpio plc in Example 11.3 .
Can you work out the EVA ® for the second year of Scorpio plc in Example 11.3 ?
What can managers do in order to increase EVA ®? ( Hint: Use the formula shown above as your starting point.)
Can you think of at least one practical problem of adopting an SVA approach?
What is the shareholder value figure for the business in Example 11.2 ? Would the sale of the shares at £11 per share really add value for the shareholders of Bortex plc?
Libra plc has an estimated terminal value (representing cash flows beyond the planning horizon) of £100 million. What is the present value of this figure assuming a discount rate of 12 per cent and
Discuss the advantages and disadvantages of awarding share options to senior managers as a means of promoting shareholder value.
Explain market value added (MVA) and total shareholder return (TSR)and evaluate their usefulness for investors.
Explain shareholder value analysis (SVA) and economic value added(EVA®) and discuss their role in measuring and delivering shareholder value.
Assume that Freezeqwik Ltd ( Activity 10.13 ) wishes to reduce its OCC by 30 days. Evaluate each of the options available to this business.
The financial statements of Freezeqwik Ltd, a distributor of frozen foods, for the year ended 31 December last year are:Income statement for the year ended 31 December last year£000 £000 Sales
Can you think what these reasons may be?
We mentioned above that although banks are usually prepared to supply references, their contents are not always very informative. Why might this be the case?
Assume the same facts as in Activity 10.4 . However, we are also told that the business maintains buffer inventories of 300 units. At what level should the business reorder?6. Hora plc holds
What kinds of changes in the business environment might lead to a decision to change the level of investment in working capital? Try to identify four possible changes that could affect the working
Why will it result in greater equity between the two shareholder groups?
How will the gearing ratio of a business be affected by:(a) a scrip dividend(b) a cash dividend?
Are these attitudes of managers described above consistent with another view of dividends discussed earlier?
With which theory would this behaviour be consistent? (Hint: think back to Chapter 6 .)
Can you figure out the possible reasoning behind this suggestion? Do you agree with such a suggestion?
Why should this be the case?Businesses with a stable pattern of profits are able to plan with greater certainty and are less likely to feel a need to retain profits for unexpected events.
How can lenders go about restricting shareholders’ rights to dividends? ( Hint: Think back to Chapter 6 .)
Why would managers use dividends as a means of conveying information about the business’s prospects? Why not simply issue a statement to shareholders? Try to think of at least one reason why
There is one situation where even MM would accept that ‘a bird in the hand is worth two in the bush’ (that is, that immediate dividends are preferable). Can you think what it is?( Hint: Think of
Suppose that Merton plc (see Example 9.1 ) replaces the £30,000 paid out as dividends by an issue of shares to new shareholders. Show the statement of financial position after the new issue and
Why might an increase in the dividend ( D1) not lead to an increase in share price ( P0 )?( Hint: Think of the other variables in the equation.)
Explain what share buybacks involve and discuss the main issues that they raise.
Describe the nature of scrip dividends and discuss the case for and against this form of distribution.
Identify and discuss the factors that influence dividend policy in practice.
Describe the nature of dividends and evaluate the arguments concerning their potential impact on shareholder wealth.
In Chapter 6we came across an alternative theory as to the way in which different sources of long-term capital are included in the capital structure of a business. Can you recall what it is and
In Figure 8.13we saw the traditional view of the relationships between the cost of capital and the level of borrowing and the relationship between the value of the business and the level of
What factors are likely to influence the ability of a business to repay the amount borrowed and to pay interest at due dates?
Briefly evaluate each of the proposed financing options from the perspective of an existing shareholder.
Using the projected figures above, compute the return on ordinary shareholders’ funds ratio, earnings per share, interest cover ratio, gearing ratio and degree of financial gearing, assuming the
What is the degree of financial gearing for Alpha plc and Gamma plc for Year 2?

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