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business
theory of corporate finance

Questions and Answers of Theory Of Corporate Finance

=+Problem 6.4 Nancy King plc has 240 million ordinary shares already in issue, with a current market price of 330p per share. The company plans to raise an extra £180 million of equity capital by
=+b. Show the investor’s profit/loss on the deal if the shares end up at $330 per share.148 6 Ordinary Share Capital
=+Problem 6.3 An investor believes that the share price of company Y is overvalued at $300 and is going to drop in price. As she does not hold the stock, the investor decided to short sell 20 shares
=+Problem 6.2 An investor buys 100 shares of company X at $20 per share. The company pays a dividend of $2 per share. By the end of the year, the shares of company X are trading at $25 per share.a.
=+b. Explain the importance of market capitalization and the difference between market capitalization and free-float market capitalization.
=+Problem 6.1a. Identify three components of the Dow Jones Industrial Average (DJIA) and find the market capitalization of each.
=+(ii) What is the current yield on the bond?
=+(i) What is the current market price of the bond?
=+(b) The bond now has 2 years to maturity, the next interest payment is due in one year, and the yield to maturity stands at 3 per cent.
=+Problem 5.4 Some years ago, a company issued a 20-year bond with face value of£100 and coupon rate of 5 per cent, paid annually.(a) The bond now has 3 years to maturity, the next interest payment
=+(b) What would be the price of the bond after 5 years, if the yield to maturity at that time stood at 1.5 per cent?
=+Problem 5.3 You bought a 10-year zero-coupon bond with a face value of $1000, for $853.(a) What is the yield to maturity on the bond?
=+(b) What will the price of the bond be if the interest rate is:(i) 5 per cent(ii) 3 per cent?References 127
=+Problem 5.2 The Arcadian government’s irredeemable bond is considered risk-free.It pays an annual coupon of 4 per cent on 100 par value, and the next interest payment is due in one year’s
=+(c) What happens if the interest rate rises to 15 per cent?
=+(b) What happens to the value if the interest rate falls to 10 per cent a year?
=+Problem 5.1(a) What is the value of a perpetuity of 600p (£6) a year if the interest rate is 12 per cent and the first payment is due in one year’s time?
=+ Is there adequate depth of management?
=+ How good is the management, especially financial management and management control?
=+• What sort of business is it? Profitable? Risky? Stable?
=+ If their financial position were to get much worse, would they continue to provide regular accurate up-to-date reports?
=+ What about their character: would a possible default really concern them?
=+• Is the borrower both honest and competent? What is their track record?
=+ How low, at worst, could their second-hand value be, if the whole industry is in a downturn?
=+• In a crisis, how quickly could the borrower sell-off fixed assets?
=+• How quickly could the borrower liquidate current assets if need be, to pay loan interest or to repay principal?
=+• To what extent could the company reduce planned spending at lower levels of output?
=+• How far might the borrower’s profits and cash inflows fall in a downturn?
=+Why should a European fashion house consider establishing operations in the United States, given the foreign exchange risks to which this activity exposes the firm?
=+(b) Officine Générale is now considering entering the US market by opening an actual store and an office in New York.
=+Show the cash flows involved under a forward hedge and under a hedge strategy that involves purchasing options.
=+$1.21/e. Put and Call options on euro, with an exercise price of $1.22/e are selling for $0.03/e and $0.01/e, respectively.(a) Explain how Bloomingdale’s can hedge the foreign exchange risk to
=+Problem 4.3 Bloomingdale’s Inc., an American luxury department store, has just signed a contract to buy e500,000 worth of top brands from Officine Générale, a French fashion house. According to
=+Calculate the NPV of the proposed project under the alternative scenario and its IRR.
=+Problem 4.2 While Centric Brands Group is quite optimistic about the project, it decided to consider an alternative scenario where the economy recovers and demand for office space in New York gets
=+(b) Conduct a sensitivity analysis to determine by how much each of the following variables would have to change in order for the company’s management to change its mind about going ahead with
=+(a) Calculate the NPV of the proposed project, and comment upon its viability.
=+b) Conduct a sensitivity analysis to determine by how much each of the following variables would have to change before the company would change its mind about going ahead with the new product:1.
=+the first year (year 1), reducing by 10 per cent in each year of the project’s life.1 Depreciation—an expense allowable for tax—is to be charged on the equipment using the straight-line basis
=+The Hair Factory company is considering the production of a new product with a life expectancy of 4 years. This is a new hair treatment oil which is expected to fetch a price of $12.50 per unit and
=+a return of at least 12 per cent a year (after-tax) on this kind of investment.Should Park Products buy the machine?
=+depreciation over the life of the asset is permitted (Ignore any tax time-lags). At the end of its expected five-year life, the machine could probably be sold for about e5,000 (Ignore any tax
=+Problem 3.3 Colin Park is enthusiastic about a new machine (A), which he thinks would enable Park Products to reduce operating costs by e20,000 a year (before tax of 30 per cent). The machine costs
=+d. To what figure could the current £30,000 annual pre-tax operating cash inflows fall, and the project still be acceptable?
=+c. What is the project’s internal rate of return?
=+b. Should the project be accepted if the firm’s after-tax cut off rate is 20 per cent?
=+• Tax at 30 per cent is assumed payable on profits on the last day of the year in which they are earned.• For tax purposes, straight-line depreciation is used.a. Show the net cash flows year by
=+Problem 3.2 Refer to Problem 3.1 above. Additional information is as follows:• In order to make room for the new equipment, existing assets which the firm currently use need to be sold and can
=+c. what is the internal rate of return on the project?
=+b. should the project be accepted if the firm’s cut off rate is 20 per cent?
=+latter of which can be recovered in full at the end of the project. The annual sales revenue for the project is forecast to be $80,000, and the annual running costs $60,000(including straight-line
=+Problem 3.1 Stephen Collier Inc is considering an investment project requiring the investment of $50,000 in new fixed assets and $12,000 in additional inventory, the
=+vi. What is the IRR?
=+v. What is the NPV at 15 per cent a year?
=+iv. What is the payback period?
=+iii. What is the annual net cash inflow?
=+ii. What is the average accounting return on investment?
=+b. A company expects to reduce labour costs by $20,000 a year if it invests $50,000 in new equipment which will last five years. Ignoring tax:i. What is the annual increase in accounting profit?
=+Problem 2.4a. Project T requires an initial investment of £200,000 (which is non-returnable), and is expected to produce cash inflows of £70,000 a year at the end of each of the next five years.
=+c. What is the discounted payback period of each project?58 2 Basic Capital Project Appraisal
=+b. What is the payback period of each project?
=+a. Which of these two projects has the higher net present value at a discount rate of 15 per cent a year? By how much?
=+Problem 2.3 A firm is considering one of two projects, H and J:End of year 0 1 2 3 4 H cash flows (e) −1000 +500 +400 +350 +300 J cash flows (e) −1000 +400 +400 +400 +400
=+What happens to the present value of each project if the discount rate:i. falls to 4 per cent a year?ii. increases to 8 per cent a year?
=+d. Three projects each requiring an initial investment of £4,200 each produce a net present value of zero after discounting at 6 per cent a year:1. a 5-year annuity of £997.2. a 10-year annuity
=+iv. A pension of $5,000 a year receivable from the end of Year 20 to the end of Year 40 at an interest rate of 15 per cent a year?
=+iii. $800 a year receivable from the beginning of Year 4 to the end of Year 8 at an interest rate of 12 per cent a year?
=+ii. $4,000 a year payable from the end of Year 5 to the end of Year 10 at an interest rate of 15 per cent a year?
=+i. $1,200 a year receivable from the end of Year 3 to the end of Year 7 at an interest rate of 20 per cent a year?
=+c. What is the present value of:
=+ii. What annual money returns would be needed to yield a 20 per cent per year internal rate of return?
=+b. A project requiring an initial outlay of £5,400 will yield returns of £1,000 a year for 10 years.i. What is the internal rate of return (IRR) on the project?
=+a. A project is expected to yield e1 million at the end of Year 10. The initial outlay is e463,000. What is the internal rate of return (IRR) on the project?
=+2.9 A Concluding Note 57d. At 12 per cent a year, which would you prefer:i. $500 a year for seven years, or ii. $700 a year for five years?Problem 2.2
=+iii. £1,000 a year for the next 20 years, discounted at 3 per cent a year?
=+c. Which would you rather have (starting at the end of year 1):i. £3,000 a year for the next 20 years, discounted at 20 per cent a year?ii. £2,000 a year for the next 20 years, discounted at 12
=+b. At 12 per cent a year, what is the present value of an annuity of e200:i. for 8 years?ii. for 20 years?iii. for 50 years?iv. for 30 years, between 21 and 50?v. for ever (a ‘perpetuity’)
=+Problem 2.1a. Calculate the present value of the following future cash flows at the given annual rate of interest (r) in each case:i. £550 1 year away, r = 10%.ii. £1,728 3 years away, r =
=+c) (i) Current ratio; (ii) Acid-test ratio; (iii) Working capital to sales ratio.
=+b) (i) Cost of goods sold ratio; (ii) Gross profit; (iii) Gross profit margin ratio
=+Problem 1.4 Centaur’s accounts contain the following items:• Annual sales: $5,000,000• Cost of goods sold: $3,000,000• Inventory: $400,000• Receivables: $300,000• Payables:
=+c) What is the amount of working capital?
=+b) What is the acid-test ratio?
=+Problem 1.3 A company with current liabilities of £120,000 has the following current assets: inventory £80,000; receivables £60,000 and cash £40,000.a) What is the current ratio?
=+were still expected to amount to £50,000 over ten years. What effect, if any, would this have on:i. the annual depreciation charge?ii. annual post-depreciation profits?iii. cash flow?
=+d) Soon after buying the machine, the firm decides it would be sensible to rely on only five years’ useful life from the machine. Annual pre-depreciation profits
=+c) Would your answer to (a) change if annual pre-depreciation profits of only£15,000 were expected next year? Why or why not?
=+b) Assuming that annual pre-depreciation profits amount to £50,000, what would the annual post-depreciation profits be?
=+Problem 1.2 A firm buys a machine for £200,000, expecting it to last for ten years.32 1 Cash and Working Capitala) What depreciation would you suggest is charged each year as an expense against
=+Problem 1.1 A company is set up with $200,000 cash; and during its first six months the following events and transactions occur:• January: machinery is bought for $100,000 cash.• February:

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