MCQs Questions Financial Management F9
MCQs Questions Financial Management F9
MCQs Questions Financial Management F9
1. Which of the following is one of the 3E’s “value for money” concepts?
A. Earnings
B. Equity
C. Evaluation
D. Effectiveness
A. Profit maximisation
B. Market share growth
C. Manimising the firm’s cost of capital
D. Maximising earnings per share
6. Hathaway Co has just paid a dividend of $0.21 per share and its share price is $3.50 per
share. One year ago its share price was $3.60 per share
Working to one decimal place, what is the total shareholder return over the
period?
A. 8.9%
B. 8.6%
C. 3.1%
D. 0.9%
$'000
Sales revenue 60,000
Cost of sales 50,000
A. 2.0 times
B. 2.5 times
C. 0.5 times
D. 3.0 times
10. Which of the following statements about financial management are correct?
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
11. Which of the following statements about a company with low operating gearing is
true?
Year 0 1 2 3
$ $ $ $
Earnings per
share o.30 0.318 0.339 0.357
Dividends per
share 0.13 0.132 0.133 0.15
Share price at start of year 1.95 1.98 2.01 2.25
A. The dividend payout ratio is greater than 40% in every year in period
B. Mean growth in dividends per share over the period is 4%
C. Total shareholder return for the third year is 26%
D. Mean growth in earnings per share over the period is 6% per year
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
14. Which of the following is LEAST likely to fall within financial management?
A. The dividend payment to shareholders is increased
B. Funds are raised to finance an investment project
C. Surplus assets are sold off
D. Non-executive directors are appointed to the remuneration committee
15. The following are extracts from the statement of financial position of a company:
The ordinary shares have a nominal value of $0.50 per share and are trading at
$5.00 per share. The preference shares have a nominal value of $1.00 per share
and are trading at $0.80 per share. The loan notes have a nominal value of $100 and
are trading at $105 per loan note.
What is the market value weighted gearing of the company, defined as prior
charge capital/equity?
A. 15.0%
B. 13.0%
C. 11.8%
D. 7.3%
16. Kent Co had sales growth of 10% over the past year. EBIT grew by 15% and earnings
per share (EPS) grew by 25% over the same period
What is the total shareholder return over the period, to one decimal place?
A. 17.4
B. 18.2
C. 18.9
D. 19.7
18. Value for money is an important objective for not-for - profit organizations
A. Insurance company
B. Pension fund
C. Credit rating agency
D. Islamic bank
5. Which of the following is likely to have the lowest expected rate of return?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
A. 1 only
B. 1 and 3 only
C. 2 and 4 only
D. 2,3 and 4
10. Which of the following government policies would not lend to raise national
income over time?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
3. INVESTMENT DECISIONS
A. 3.25 years
B. 2.67 years
C. 2.5 years
D. 2 years
2. A project requires an initial outlay of $1,000. The forecast cash inflows are:
Year 1 $200
Year 2 $200
Year 3 $400
Year 4 $400
A. 4.0 years
B. 3.5 years
C. 3.4 years
D. 3.0 years
A. The discounted payback method takes into account cash flows for all periods
B. The payback method ignores all cash flows after the end of the payback period
C. The net present value rule is to accept investment opportunities when their rates
of return exceed the company’s weighted average cost of capital
D. The internal rate of return is to accept the investment of the weighted average
cost of capital is greater than the internal rate of return
Year 1 $10,000
Year 2 $15,000
Year 3 $20,000
Year 4 $27,000
A. 3.10
B. 3.25
C. 2.90
D. 3.14
6. Kunchman Kookies will invest $100,000 in new equipment. The firm’s discount rate is
8% and the operating cash flows from the investment are expected to be as follows;
Year 1 $35,000
Year 2 $38,000
Year 3 $20,000
Year 4 $10,000
A. 2.3
B. 3.1
C. 4.0
D. 4.7
4. DISCOUNTED CASH FLOWS TECHNIQUES
The new machine will cost $ 190,000 and has a five year life with zero scrap
value
The investment in the new machine will also require an increase in working
capital of $35,000
Tax-allowable depreciation is available on a straight-line basis
Gunning is subject to a 40% tax rate and has a 10% cost of capital
What is the present value of the tax saving on the first year’s tax- allowable
depreciation?
A. $13,817
B. $15,200
C. $16,762
D. $20,725
2. Wendy’s Sandwich Shop acquires an asset for $100,000 that has no residual value and
a 10-year life. Wendy’s tax rate is 40% tax allowable depreciation is available on a
straight-line basis
A. $10,000
B. $6,000
C. $4,000
D. $2,000
3. Which of the following events would decrease the internal rate of return of a
potential investment?
4. Which of the following changes would result in the highest present value for a
series of cash flows?
6. ABC Co plans to buy a new machine. The cost of the machine is $ 100,000 and it has a
five- year life with no disposal value. The machine will be depreciated on a straight line
basis which matches the policy for tax allowable depreciation. The machine will increase
annual operating cash flows by $50,000 ABC’s profit tax rate is 35%
A. $19,500
B. $30,000
C. $32,500
D. $39,500
8. A project has an initial cash outflow followed by several years of cash inflows.
What would be the effects on the internal rate of return (IRR) of the project and its
discounted payback period (PPP) of a decrease in the company’s cost of capital?
IRR DPP
A Decrease Decrease
B Decrease Increase
C No change Decrease
D No change Increase
9. A company has a “money” cost of capital of 21% per year. The general inflation rate is
9% per year
A. 9%
B. 11%
C. 12%
D. 21%
Which of the following sets of adjustments will lead to the correct calculation of
net present value?
Discount
Cash inflow Cash outflow rate
5% annual 5% annual
A increase increase 15.5%
6% annual 4% annual
B increase increase 15.0%
6% annual 4% annual
C increase increase 15.5%
D Unadjusted Unadjusted 10.0%
5. APPLICATIONS OF DISCOUNTED CASH FLOW TECHNIQUES
In deciding to replace the old machine, which of the following factors should
ABC not consider?
Asset 1 has a 10-year economic life with a zero residual value. It can be purchased
for $80,000 payable immediately. Alternatively, it can be leased with 10 lease rentals
of $12,000 per year payable annually in advance.
Asset 2 has a five- year economic life. It can be purchased for $81,000 payable
immediately and will have a residual value of $40,000 after five years. Alternatively, it
can be leased with five lease rentals of $14,000 per year payable annually in arrears
What is the net present value (to the nearest $10) to the lessor if it purchases
the machine then leases it to the user on the above terms if it applies an annual
discount rate of 10%?
A. $990 positive
B. $10,460 positive
C. $1,960 negative
D. $11,440 negative
5. A machine costing $150,000 has a useful life of eight years, after which time its
estimated resale value will be $25,000. Annual running costs will be $5,000 for the
first three years of use and then $8,000 for each of the next five years. All running
costs are payable on the last day of the year of which they relate
Using a discount rate of 20%, what is the equivalent annual cost of the machine
(to the nearest $100)?
A. 46,600
B. 43,900
C. 43,400
D. 21,100
6. PROJECT APPRAISAL UNDER RISK
Number
Number of power of
cuts per months months
0 3
1 2
2 4
3 3
12
Each power cut results in additional costs of $400. For $500 per month, Deet can
lease a generator to provide electricity during power cuts
If Deet leases the generator what is the estimated annual savings/ (additional
cost)?
A. ($3,600)
B. ($1,200)
C. $1,600
D. $1,900
2. Excalibur Co has developed a model to predict sales levels for its beachwear based on
long-range weather forecasts. The probability of various temperatures and related
sales units are as follows:
What sales volume, in units, would Excalibur Co anticipate using the expected
value approach?
A. 31,000
B. 40,250
C. 50,000
D. 155,000
The shopkeeper must order each week’s sales in advance and any items left in
inventory at the end of the week are scrapped. The items cost the shopkeeper $2.50
and he sells them for $3 each
A. 300
B. 400
C. 450
D. 500
4. A company has constructed a model for predicting profits. Net profit or loss depends
on two variables: gross profit and overheads. The following are independent probability
distribution of the two variables :
What is the probability that the company will make a positive net profit?
A. 0.27
B. 0.55
C. 0.73
D. 0.83
By how many units must the estimate of production and sales volume fall for
the project to be regarded as not worthwhile?
A. 575
B. 1,293
C. 1,623
D. 2,463
$'0000
Present value of sales revenue 50,025
Present value of variable cost 25,475
Present value of contribution 24,550
Present value of fixed
costs 18,250
What is the sensitivity of the net present value of the investment project to a
change in fixed costs?
A. 7.1%
B. 5.3%
C. 5.1%
D. 2.6%
7. An investment project has a cost of $12,000, payable at the start of the first year of
operation. The possible future cash flows arising from the investment project have the
following present values and associated probabilities :
PV of PV of
Year 1 cash Year 2 cash
flow($) Probability flow($) Probability
16,000 0.15 20,000 0.75
12,000 0.6 -20,000 0.25
-4,000 0.25
A. $11,850
B. $28,700
C. $11,100
D. $76,300
7. EQUITY FINANCE AND DEBT FINANCE
2. When issuing new loan notes what would be the primary reason for a debt
covenant limiting the firm’s future level of debt?
3. Bander Co is determining how to finance some long-term projects. Bander has decided
that it prefers the flexibility of no fixed servicing cost, no fixed maturity date and an
increase in the credit rating of the company.
4. Which of the following statements about corporate debt and equity securities
is/are true?
1. Both debt and equity holders have an ownership interest in the company
2. Both debt and equity securities have an obligation to pay income
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
5. Which of the following types of loan note is most likely to maintain a constant
market value?
A. Zero-coupon
B. Floating-rate
C. Irredeemable
D. Convertible
6. A company currently has 1,000 ordinary shares in issue and no debt. It has the choice
of raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 ordinary
shares
What level of earnings before interest and taxes (EBIT) would result in the same
earnings per share (EPS) for the two financing options?
A. $27,000
B. $21,000
C. $18,000
D. $10,800
7. A company currently has 10 million $1 shares in issue with a market value of $3 per
share
The company wishes to raise new funds using a 1 for 4 rights issue. The resulting
theoretical ex-rights price per share has been calculated as $2.80
A. $2,500,000
B. $4,000,000
C. $5,000,000
D. $7,000,000
10. The stock exchange may provide a quotation for a company’s existing shares without
that company making any new shares available to the market
A. 2 only
B. 1 and 3
C. 1,2 and 3
D. 2 and 3
12. Which of the following statements about a rights issue are correct?
1. The new shares are normally issued at a discount to the existing price
2. There will be no change in shareholder wealth
3. The main purpose of a right issue is to raise finance
4. The new shares must be issued to the existing shareholders
13. Which of the following statements about a bonus (scrip) issue is correct?
1. Which of the following usually determines the optimal capital structure for an
organisation?
A. Risk-free rate
B. Accounting rate of return
C. Weighted average cost of capital
D. Cost of equity
3. A company with a tax rate of 30% has the following capital structure:
Pre-tax cost of
Weight Instrument capital
40% Loan notes 6%
50% Ordinary shares 12%
10% Preference shares 8%
A. 9.2%
B. 7.7%
C. 8.2%
D. 8.5%
4. A company has in issue 9% $20 nominal value preference shares. Their current
market price is $40 and the company’s tax rate is 30%.
A. 4.5%
B. 3.15%
C. 9.0%
D. 6.3%
5. Which three elements are needed to estimate the cost of equity using the
dividend growth model?
A. Current dividends per share, expected growth rate in earnings per share and
current market price per share
B. Current earnings per share, expected growth rate in dividends per share and
current market price per share
C. Current earnings per share, expected growth rate in earnings per share and
current book value per share
D. Current dividends per share, expected growth rate in dividends per share and
current market price per share
6. A firm has a share price of $30, a forecast dividend per share after one year of $3 and
thereafter an expected growth rate of 10%
A. 21.1%
B. 12.2%
C. 11.0%
D. 20.0%
7. A firm has a bank loan with a 10% interest rate. The firm also has in issue 8%
preference shares trading at nominal value and has estimated that its cost of ordinary
shares is 18%. The firm has a 30% tax rate
What is the weighted average cost of capital if the firm uses a capital
structure comprising 50% debt and an even split between preference and
ordinary shares?
A. 11.50%
B. 10.00%
C. 9.40%
D. 8.05%
8. A firm’s weighted average cost of capital is minimised when its debt to equity ratio is
4:1
Which of the following statements is most accurate?
A. The value of the firm is maximised when it uses more equity that debt
B. A higher ratio than 4:1 means dents holders will require a lower return
C. A higher ratio than 4:1 means an equity holders will require a higher
return
D. The value of the firm will be maximised if it is 75% debt financed
9. Recent statistics relating to the ordinary shares of Calc Co , a quoted, are as follows:
A. 13.8
B. 15.2
C. 15.7
D. 23.8
10. A firm has achieved an average growth in dividends over the last five years of 10.5%
per year. It is now widely believed that the long-run average annual dividend growth
rate will be 9.16% per year. The firm’s current dividend yield is 4.8%
A. 13.96%
B. 14.40%
C. 15.30%
D. 15.80%
11. Which of the following statements about capital structure theory is correct?
A. In the traditional view, there is a linear relationship between the cost of equity
and financial risk
B. Modigliani and Miller said that, in the absence of tax, the cost of equity would
remain constant
C. Pecking order theory does not suggest an optimal debt to equity ratio
D. Modigliani and Miller said that, in the presence of tax, the weighted average
cost of capital would remain constant
A. 11.82%
B. 12.99%
C. 9.74%
D. 14.26%
2. The risk-free rate of return is 3% and the market premium is 6.5%. A firm’s equity
beta is 1.15 and asset beta 0.85
What will the firm’s cost of equity be if it redeems all outstanding debt?
A. 7.0%
B. 10.5%
C. 8.5%
D. 6.0%
3. A firm’s equity beta is 1.10 and its asset beta is 0.85. The market premium is 4.5%
and the risk-free rate 3%
A. 7.95%
B. 4.65%
C. 6.83%
D. 4.28%
A. Business risk
B. Unsystematic risk
C. Financial risk
D. Systematic risk
5. The risk-free rate of return is 6% and the required return on a security with a beta
factor of 1.2 is 15.6%
A. 11.52%
B. 13.00%
C. 14.00%
D. 17.52%
6. The beta of company X’s shares is 1.6, the risk free rate is 5% and the required return
on company X’s shares is 16.2% company Y is quoted in the same stock market, but
its shares have a beta of 1.4
A. 12.0%
B. 13.0%
C. 13.2%
D. 14.8%
A. Equity beta
B. Debt beta
C. Volatility of net income
D. Asset beta
8. Which of the following are assumptions of the capital asset pricing model?
A. 2 only
B. 1 and 3
C. 1,2 and 3
D. 2 and 3
2. During the year, Mason Co.’s current assets increased by $120,000 and current
liabilities decreased by $50,000
A. Increased by $70,000
B. Decreased by $170,000
C. Increased by $170,000
D. Decreased by $70,000
5. Which working capital financing policy exposes the firm to the greatest risk of
being unable to meet its obligations as they fall due?
6. A company has a current ratio of 2.3 and a quick ratio of 0.8. It increases its
overdraft in order to buy more inventory as a cash purchase.
A. 3 days
B. 27 days
C. 57 days
D. 169 days
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
10. A company has annual credit sales of 27 million and related cost of sales of 15
million
The company has the following targets for the next year:
What is the net investment in working capital required for the next year?
A. $8,125,000
B. $4,375,000
C. $2,875,000
D. $6,375,000
2. In inventory management, which of the following will tend to increase the level
of safety stock?
Opening finished goods inventory for the current year was 15% of the prior year’s
annual sales volume at cost and closing finished goods inventory was 22% of the
current- year’s annual sales volume at cost
What was the company’s inventory turnover for the current year?
A. 4.55 times
B. 5.61 times
C. 6.51 times
D. 6.81 times
E.
5. Which of the following statements about the economic order quantity (EOQ)
and the reorder level (ROL) are true?
6. Which of the following is LEAST relevant to the economic order quantity model
for inventory?
A. Safety stock
B. Annual demand
C. Holding costs
D. Order costs
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
Which of the following comparable maturity investment will earn Lang the
highest expected return?
A. Certificates of deposit
B. Treasury bills
C. Commercial paper
D. Bank deposits
2. Which of the following securities has the least amount of default risk?
3. Which of the following best describes the risk associated with the ability to sell
a short- term investment quickly without significant impact on price?
1. The greater the variability in cash flows, the greater is the spread between the
upper and lower cash balance limits
2. When short-term investments are liquidated the firm’s cash balances should
return to the lower limit
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
5. A company uses the Baumol cash management model. Cash disbursements are
constant at 20,000 each month. Short-term investment yield 5% per year, while cash
held in the company’s bank account earns zero interest. Switching costs (that is, for
each purchase or sale of short-term investments) are $30 for each transaction
What is the optimal amount (to the nearest $100) to be transferred in each
transaction?
A. $500
B. $1,700
C. $4,900
D. $17,000
6. Which of the following is an assumption of the Baumol model not the Miller-
Orr model?
7. A company needs $150,000 each year for regular payments. Converting the
company’s short- term investment into cash to meet these regular payments incurs a
fixed cost of $400 per transaction. These short-term investments pay interest of 5 per
year, while the company earns interest of only 1% per year on cash deposits
A. 38,730
B. 48,990
C. 54,772
D. 63,246
13. MANAGEMENT OF ACCOUNTS RECEIVABLES AND PAYABLE
1. A supplier offers a 3% discount for payment within 10 days or full payment within 45
days.
Assuming a 360-day year what is the annualized cost of not taking the discount?
A. 37.11
B. 36.00
C. 24.74
D. 31.81
2. A company has daily sales of 150,000. A debt factor has guaranteed to reduce the
company’s receivables collection time by four days for a monthly fee of 2,500. Cash
surpluses can be invested in money market deposits yielding 4% per annum
What is the additional annual income/ (loss) for using the cash management
service?
A. $6,000
B. $(6,000)
C. $12,000
D. $(12,000)
3. Amicable Wireless Co offers customers credit terms of 2% discount for payment within
10 days or full payment within 25 days. 60% of Amicable’s customers take the 2%
discount and pay on day 10. The remainder of Amicable’s customers pay on day 30.
A. 16
B. 12
C. 18
D. 20
4. The CFO of a company is concerned about the company’s accounts receivables turnover
ratio. The company currently offers customers terms of 3 discount for settlement within 10
days or full payment within 30 days.
Which of the following strategies would most likely improve the company’s
accounts receivable turnover ratio?
5. Scrimpy Co buys materials from Frugal Enterprises. Frugal offers discount terms of 2%
discount for payment within 10 days or full payment within 30 days.
Assuming a 360-day year, what is the annual percentage cost associated with
Scrimpy’s failure to take advantage of the discount offered by Frugal?
A. 2.0%
B. 33.3%
C. 36.0%
D. 36.7%
6. Which of the following statements about debt factoring and invoice discounting is
true?
7. The management of XYZ Co has annual credit sales of $20 million and accounts
receivable of $4 million. Working capital is financed by an overdraft at 12% interest per
year. Assume 365 days in a year
What is the annual finance cost saving if the management reduces the collection
period by 60 days?
A. $85,479
B. $394,521
C. $78,904
D. $68,384
2. Hedgehog international is a UK based firm which must pay $500,000 to its foreign
supplier in 90 days the current spot rate is $1.60 per £1. Hedgehog purchases an
option to buy the dollar in 90 days at $1.64 per £1, paying a premium of $0.03 per £1.
The spot rate after 90 days is $1.58 per £1.
5. In evaluating the impact of relative inflation rates on the demand for a foreign
currency, which of the following is true?
A. Inflation is irrelevant to currency demand
B. As inflation associated with a foreign economy increases in relation to a
domestic economy, demand for the foreign currency falls
C. As inflation associated with a foreign economy increases in relation to a
domestic economy, demand for the foreign currency increases
D. As inflation associated with a foreign economy decreases in relation to a
domestic economy, demand for the foreign currency falls
6. A company has several long-term floating rate loan notes outstanding and is
considering hedging interest rate risk
7. Which of the following statements about the terms structure of interest rates
is/are true?
1. An “inverted” yield curve is where long-term interest rates are higher than short-
term interest rates
2. A rising yield curve is caused when investors prefer to buy for long-dated loan
notes
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
A. The flexible nature of currency futures means that they can always be
matched with a specific currency exposure
B. Currency options carry an obligation to the holder to exercise the option at
maturity
C. Forward contracts require the payment of a premium
D. A money market hedge should give approximately the same result as a
forward contract
9. The home currency of GB Co is sterling (£) and it trades with a company in a foreign
country whose home currency is the rupee. The following information is available:
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
11. “There is a risk that the value of out export earnings will fall over the next few years due
to appreciating domestic currency”
A. Translation risk
B. Economic risk
C. Transaction risk
D. Financial risk
12. In relation to the term structure of interest rates what is a “normal” yield curve?
A. Upward sloping
B. Downward sloping
C. U-shaped
D. Horizontal
13. Burger Queen Co conducts business in a number of different countries and is trying to
evaluate its economic exposure to long-term exchange rate trends
15. What is the effect on a UK-based company when a foreign competitor’s currency
becomes weaker compared to sterling?
16. An investor plans to exchange $1,000 into euros now, invest the resulting euros for 12
months, and then exchange the euros back into dollars at the of the 12-month period.
The spot exchange rate is €1.415 per $1 and the euro interest rate is 2% per year. The
dollar interest rate is 1.8% per year
A. €1.223 per $1
B. €1.412 per $1
C. €1.418 per $1
D. €1.439 per $1
17. A company whose home currency is the dollar ($) expects to receive 500,000 pesos in
six months’ time from a customer in a foreign country. The following interest rates and
exchange rates are available to the company:
Working to the nearest $100, what is the six-month dollar value of the expected
receipt using a money-market hedge?
A. $32,500
B. $33,700
C. $31,800
D. %31,900
18. Which of the following interest rate derivatives are characterised by a standard
contract size?
A. 1 only
B. 1 and 4
C. 2 and 3
D. 3 and 4
19. Which of the following statements about the causes of interest rate fluctuations
are true?
1. Liquidity preference theory suggests that investors want more compensation for
long-term lending than for short-term lending
2. According to expectations theory, the shape of the yield curve gives information
on how inflation rates are expected to influence interest rates in the future
3. An inverted yield curve can occur if government policy is to keep short-term
interest rates high in order to control inflation
4. Market segmentation theory suggests long-term interest rates depend on how
easily investors can switch between market segments of different maturity
A. 1 only
B. 1 and 3 only
C. 2 and 4
D. 1,3 and 4
20. Which of the following derivatives would protect a firm from falling income on
short-term investments but allow it to benefit if yields rise?
2. A company has just paid a dividend per share of $0.32 and is expected to pay a
dividend of $0.336 in one year’s time. The company has a cost of equity of 13%.
What is the market price of the company’s shares to the nearest cent on an ex-
dividend basis?
A. 3.20
B. 4.41
C. 2.59
D. 4.20
3. Jack co owns a $1,000 nominal value of the loan note purchased at nominal value with
an annual coupon of 5%
What would happen to the market value of the loan note if market interest rates
later decreased to 4% and why?
A. Increase because the loan note pays a higher coupon than the current market
rate
B. Stay the same since the loan note pays a fixed coupon
C. Stay the same since the firm’s credit rating has not changed
D. Decrease since market interest rates have declined
4. Fernwell wants to buy shares of Gurst Co in two years. Fernwell uses the dividend
valuations model with an assumed dividend growth rate of 5%
If Fernwell’s discount rate is 10% and Gurst’s current year dividend is $20, what
is the approximate price Fernwell will pay?
A. $400
B. $420
C. $441
D. $463
5. Harken co.’s price earnings ratio is 10, its earnings in the current year is $5 per share
but the earnings forecast for the next year is $8 per share.
7. A financial manager believes that his actions will cause earnings to increase and the
firm’s share price to rise in direct proportion to earnings
A. Overconfidence
B. Excessive optimism
C. Illusion of control
D. Confirmation bias
8. A loan note has a fixed annual coupon of 7% and it will be repaid at its nominal value of
$100 in one year’s time. Similar loan notes have a gross redemption yield (i.e. yield to
maturity) of 8%.
A. $99.07
B. $100.00
C. $100.93
D. $106.07
9. Which of the following statements about the efficient market hypothesis is/are
true?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
10. A firm maintains a 30% pay-out ratio. Future projects are expected to generate an
annual post-tax return on investment of 15 % and pre-tax return of 20%.
What is the firm’s expected annual rate of growth?
A. 4.5%
B. 6.0%
C. 10.5%
D. 14.0%
11. Warren analyses publicly available information about firms and uses this to try and
predict their share price movements
12. Korma Co has paid the following dividends per share in recent years:
The dividend for 20X6 has just been paid and korma co has a cost of equity of 12%.
A. $4.01
B. $4.66
C. $4.07
D. $4.55
13. Donald co has 8% convertible loan notes in issue which are redeemable in five years’
time at their nominal value of $100 per loan note. Alternatively, each loan note could be
converted after five years into 60 equity shares with a nominal value of $1 each
The equity shares of Donald Co are currently trading at $1.25 per share and this share
price is expected to grow by 4% per year. The yield to maturity ( gross redemption
yield) of the loan notes is 10%
What is the current market value of each loan note to the nearest dollar?
A. $91
B. $92
C. $100
D. $103
14. Stern Bear is using dividend valuation model with a constant growth rate to estimate the
value of an ordinary share.
16. The following financial information relates to QK Co, whose ordinary shares have a
nominal value of $0.50 per share:
$m $m
Non-current assets 120
Current assets
Inventory 8
Trade receivables 12 20
Total assets 140
Equity
Ordinary shares 25
Reserves 80 105
Non-current liabilities 20
Current liabilities 15
Total equity and liabilities 140
On a historic basis, what is the net asset value per share of QK Co?
17. TQK Co has just paid a dividend of $0.21 per share and its share price one year ago
was $3.10 per share. The total shareholder return for the year was 19.7%.
A. $3.50
B. $3.71
C. $3.31
D. $3.35
18. A company has 7% loan notes in issue which are redeemable in seven years’ time at a
5% premium to their nominal value of $100 per loan note. The before-tax cost of debt of
the company is 9% and the after-tax cost of debt of the company is 6%
A. $92.67
B. $108.90
C. $89.93
D. $103.14
19. Luke co has 8% convertible loan notes issue which is redeemable in five years’ time at
their nominal value of $100 per loan note. Alternatively each loan note could be
converted after five years into 70 equity shares with a nominal value of $1 each.
The equity shares of Luke Co are currently trading at $1.25 per share and this share
price is expected to grow by 4% per year. The before-tax cost of debt of Luke Co is
10% and the after-tax cost of debt of Luke Co is 7%
What is the current market value of each loan note to the nearest dollar?
A. $92
B. $96
C. $104
D. $109
20. Which of the following are possible reasons for estimating the market value of a
private firm’s shares?
21. Which of the following are limitations of valuing a firm’s equity based on the net
assets as reported in its statement of financial position prepared in accordance
with international financial reporting standards?
A. 1 only
B. 1 and 2 only
C. 1,2 and 4
D. 2,3 and 4
SECTION B QUESTIONS
THE FINANCIAL MANAGEMENT FUCTION
1. QSX CO
A shareholder of QSX Co is concerned about the recent performance of the company and
has collected the following information:
Year to 31 May
20X6 20X5 20X4
$ $ $
Earnings per
share 0.589 0.642 0.607
Dividend per
share 0.400 0.385 0.37
Closing ex-dividend share price 6.48 8.35 7.4
A. 12.8%
B. -22.4%
C. 11.4%
D. -12.4%
2. What was the total shareholder return for the year to 31 May 20X6?
A. -22.7%
B. 27.2%
C. -17.6%
D. -22.4%
3. What was the average earnings yield for the period 20X4 to 20X6?
A. 9.1%
B. 5.2%
C. 6.3%
D. 8.3%
A. Return on capital employed can be defined as profit before interest and tax
divided by the sum of shareholder’s funds and prior charge capital
B. Return on equity is the product of net profit margin and net asset turnover
C. Dividend yield can be defined as dividend per share divided by the ex-dividend
share price
D. Return on equity can be defined as profit before interest and tax divided by
shareholder’s funds
INVESTMENT DECISIONS
1. BACKPAY CO
Backpay Co is considering investing $50,000 in a new machine. The machine will have scrap
value of $10,000 at the end of its five year life. It is expected that 20,000 units will be sold each
year at a selling price of $3.00 per unit. Variable production costs are expected to be $1.65 per
unit, while incremental fixed costs are expected to be $10,000 per year.
A. 1.9 years
B. 2.9 years
C. 1.0 years
D. 2.5 years
A. 34%
B. 45%
C. 57%
D. 30%
3. Backpay Co is also evaluating an investment project with the following forecast cash flow:
Year 0 1 2 3 4
Cash flow ($m) -6.5 2.4 3.1 2.1 1.8
Using discount rates of 15% and 20%, what is the internal rate of return of the
investment project?
A. 15.8%
B. 17.2%
C. 17.8%
D. 19.4%
4. The chairman of Backpay Co is concerned about how government economic policy may
affect the success of the firm’s future projects.
Which of the following is/are usually seen as forms of market failure where
regulation may be a solution?
1. Imperfect competition
2. Social costs or externalities
3. Imperfect information
A. 1 only
B. 1 and 2 only
C. 2 and 3 only
D. 1,2 and 3
A. 1 only
B. 1 and 3
C. 2 and 4 only
D. 2,3 and 4
Runrag Co is an unlisted firm evaluating a project which it proposes to finance with a bank loan.
The cost of the machinery, which is payable immediately, is $1.5 million, and the scrap value of
the machinery at the end of four year is expected to be $100,000. Tax-allowable depreciation
can be claimed on this investment on a 25% reducing balance basis. Information on future
returns from the investment has been forecast to be as follows:
Year 1 2 3 4
Sales volume (units/year) 50,000 95,000 140,000 75,000
Selling price ($/unit) 25.00 24.00 23.00 23.00
Variable cost ($/unit) 10.00 11.00 12.00 12.50
Fixed costs ($/year) 105,000 115,000 125,000 125,000
This information must be adjusted to allow for selling price inflation of 4% per year and variable
cost inflation of 2.5% per year. Fixed costs, which are wholly attributable to the project, have
already been adjusted for inflation. Runrag Co pays profit tax 30% per year.
A. $3,622,000
B. $1,540,000
C. $1,688,000
D. $1,813,000
3. Which of the following would be the appropriate rate to estimate the project’s net
present value?
4. Which of the following methods can deal adequately with project risk?
1. Sensitivity analysis
2. Simulation
3. Probability analysis
A. 1 only
B. 1 and 2 only
C. 2 and 3 only
D. 1,2 and 3
5. Which of the following may be appropriate alternative sources of finance for the
project?
1. Peer-to-peer lending
2. Rights issue on the stock market
3. Crowdfunding
4. Internal equity
A. 1 and 3 only
B. 1,2 and 4
C. 2 and 4 only
D. 2,3 and 4
A company is trying to determine the optimal replacement cycle for the computers used by its
sales team. The following information is relevant to the decision:
The cost of each computer is $2,400. Maintenance costs are payable at the end of each full
year at ownership, but not in the year of replacement (e.g. if the notebook is owned for three
years, then the maintenance cost is payable at the end of year 1 and at the end of year 2).
Interval
between
replacement
(year) Trade in value Maintenance cost
$ $
1 1,200 Nil
2 800 75 (payable at the end of Year 1)
3 To be determined 150 ( payable at the end of Year2)
The company uses a relatively high discount rate of 14% as it faces capital rationing.
1. What is the annual equivalent cost of replacing the computer every year?
A. $1,348
B. $1,537
C. $1,413
D. $1,611
2. What is the year 3 trade-in value given that the annual equivalent cost of a 3-year
replacement cycle is $1,024?
A. $268
B. $727
C. $412
D. $301
3. Which of the following are potential tax implications of the asset replacement
decision?
A. 1 only
B. 1 and 2 only
C. 2 and 3 only
D. 1,2 and 3
4. Which of the following factors may encourage the company to replace the computers
relatively often?
1. Changing technology
2. Supplier discounts
3. Environmental impacts
A. 1 only
B. 1 and 2 only
C. 2 and 3 only
D. 1,2 and 3
5. Which of the following would NOT explain why the company faces capital rationing?
A. Asymmetry of information
B. Poor credit rating
C. Strict government monetary policy
D. Large proportion of tangible assets
$'000
Ordinary shares ($0.50 per share) 2,000
Reserves 1,500
3,500
Non-current liabilities : 12% loan notes 4,500
Total equity and liabilities 8,000
1. What is the value of rights per existing Stardust Co share, ignoring the proposed use
of the funds raised in the rights issue?
A. $0.12
B. $0.10
C. $0.50
D. $0.68
2. What is Stardust Co.’s expected earnings per share, if the rights issue funds are used
for redeem some of the existing loan notes?
A. $0.42
B. $0.29
C. $0.47
D. $0.26
3. Which of the following could be alternatively methods for Stardust Co to raise funds
for redeeming some of the existing loan notes?
1. Scrip issue
2. Placement
3. Sale and leaseback
A. 2 and 3 only
B. 3 only
C. 1 only
D. 1,2 and 3
4. Stardust Co will also need finance in future in order to expand its business.
Which of the following correctly ranks management’s preference for finance
according to Pecking Order Theory?
1. Bank overdraft
2. Peer-to-peer lending
3. Securitisation
4. Loan notes
A. 1 only
B. 2 and 3 only
C. 2,3 and 4
D. 1,2 and 3
DDD Co has two loan notes in issue, each with a nominal value of $100:
Loan note A will be redeemed at nominal value in 10 years’ time and pays annual interest of
9%. The current ex-interest market price of this loan note is $95.08.
Loan note B will be redeemed at a premium of 5% in four years’ time and pays annual interest
of 8%. The pre-tax cost of debt of this loan note is 7%
1. Which of the following is closest to the pre-tax cost of dent of loan note A?
A. 9%
B. 10%
C. 8%
D. 14%
A. $105.00
B. $80.12
C. $103.40
D. $107.21
3. Which of the following are possible reasons why loan note A and loan note B have
different pre-tax costs of debt?
A. 1 and 2 only
B. 1 only
C. 1 and 3 only
D. 3 only
1. Loan notes are assets for the issuer but liabilities for the buyer
2. Loan note markets can be classified into exchange and over-the-counter
markets
3. A secondary market is where securities are bought and sold by investors
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
5. What happens to the market price of a loan note if the general level of interest rates in
the economy rises?
A. The market price of the loan note rises
B. The market price of the lone note falls
C. The market price of loan note may rise or fall
D. The market price of loan note is unaffected as the loan note pay fixed interest
2. BKB CO
Equity finance $m $m
Ordinary shares ($0.5 nominal value) 25
Reserves 15
40
Non-current liabilities
7% Convertible loan notes ($100 nominal value) 20
5% Preference shares ($1 nominal value) 10
30
Current liabilities 10
Trade payables 15
Overdraft 25
BKB Co has an equity beta of 1.2 and an asset beta of 0.9. The ex-dividend market value of the
company’s equity is $250 million. The ex-dividend market value of the preference shares is
$6.25 million.
The convertible loan notes of BKB Co have a conversion ratio of 19 ordinary shares per $100
nominal value loan note. The conversion date and redemption date are both on the same date
in seven years’ time. The current ordinary share price of BKB Co is expected to increase by 4%
per year for the foreseeable future.
The equity risk premium is 5% per year and the risk-free rate of return is 3% per year. BKB Co
pays profit tax at an annual rate of 30% per year.
A. 9%
B. 5.4%
C. 7.5%
D. 4.8%
A. 5%
B. 3.5%
C. 5.6%
D. 8%
4. Which of the following correctly ranks BKB Co.’s securities in terms of risk to the
investor (highest risk first)?
1. The asset beta reflects both business risk and financial risk
2. Total risk is the sum of systematic risk and unsystematic risk
3. Assuming that the beta of debt is zero will understate financial risk when
ungearing an equity beta
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
INVENTORY MANAGEMENT
1. PLOT CO
The following scenario relates to question 1-5
Plot Co sells both Product P and Product Q, with sales of both products occurring evenly
throughout the year.
Product P
Plot Co currently places one order per month for 25,000 units of Product P. Each order costs
$267 to place. The cost of holding Products P in inventory is $0.10 per unit per year.
Product Q
The annual demand for Product Q is 456,000 units per year and Plot Co buys in this product at
$1 per unit on 60 days credit. The supplier has offered an early settlement discount of 1% for
settlement of invoices within 20 days
Other information
Plot Co finances working capital with short-term finance costing 5% per year. Assume that
there are 365 days in each year
1. What is the total annual ordering and holding cost (to the nearest $100) if Plot Co
uses the economic order quantity for Product P?
A. $6,000
B. $4,454
C. $2,300
D. $4,000
2. What is the increase in Plot Co.’s annual finance costs (to the nearest $100) if it
accepts the early settlement discount for Product Q?
A. $2,500
B. $1,300
C. $1,700
D. $2,300
3. Which of the following are potential advantages for Plot Co of accepting the early
payment discount for Product Q?
A. 1, 2 and 3
B. 2 and 3 only
C. 1 only
D. 2 only
5. Which of the following statements about working capital management are correct?
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
2. CAT CO
CAT Co currently places one order per month for 10,000 components which are used in its
manufacturing processes. The cost per component is $7.50, the cost of ordering is $200 per
order and the cost of holding components in inventory is $1.00 per component per year.
Warehouse space is rented on a daily basis.
The supplier has offered a bulk purchase discount of 3.6% on orders of 30,000 or more
components. If the bulk purchase discount is taken, the cost of holding components in inventory
would increase to $2.20 per component per year
The supplier has also offered a 2% settlement discount for payment within 20 days. CAT Co
currently takes 60 day’s credit from the supplier and has an overdraft rate of 15% per annum.
Assume there are 360 days in one year.
1. What is the total annual cost of ordering, purchasing and holding inventory if the bulk
purchase discount is taken?
A. $901,400
B. $883,400
C. $934,400
D. $936,160
2. Which of the following is most likely if CAT Co changes from renting warehouse
space on a daily basis to signing a long-term lease?
3. What is the annual value of the settlement discount (in percentage terms) and should
the discount be accepted or rejected?
Value of discount Decision
A 18.40% Reject
B 18.00% Accept
C 18.40% Accept
D 18.00% Reject
A. 2 only
B. 1,2 and 3
C. 2 and 3 only
D. 1 only
A. 1 only
B. 1,2 and 3
C. 2 and 3 only
D. 3 only
In the last year KXP Co had sales of $15million and cost of sales of $12 million. All sales were
on 30 days credit.
Extracts from the company’s most recent statement of financial position are as follows:
$'000
Inventory 1,151
Trade receivables 2,466
Trade payables 1,808
Overdraft 3,000
KXP Co proposes introducing an early settlement discount of 1% for payment within 25 days,
while increasing its normal credit period to 45 days. It is expected that, on average, 50% of
customers will take the discount and pay within 30 days, 30% of customers will pay after 46
days, and 20% of customers will not change their current paying behavior.
KXP Co currently uses the economic order quantity (EOQ) model for purchases of Product Z,
annual demand for which is 180,000 units. The supplier has offered a 2% bulk purchase
discount for orders of Product Z of 35,000 units or more. Each order costs KXP Co $150 to
place and the holding cost is $0.24 per unit per year.
1. Which of the following statements best describes KXP Co.’s policy for financing
current assets?
A. A “matching” policy
B. An “aggressive policy”
C. A “conservative policy”
D. No conclusion can be made without knowing the proportion of ”permanent” and
“fluctuating” current assets
2. What will KXP Co.’s receivables days be following the introduction of the early
settlement discount?
A. 32 days
B. 38 days
C. 26 days
D. 30 days
A. 2 only
B. 1 only
C. Neither 1 nor 2
D. 1 and 2
4. Which of the following are assumptions of the economic order quantity (EOQ) model?
1. Constant demand
2. Holding costs depend on the maximum level of inventory
3. No risk of stock outs
4. Cost per order is independent of order quantity
A. 1,2, 3 and 4
B. 1,3 and 4
C. 3 and 4 only
D. 1 only
5. What is the increase in annual holding costs if KXP Co accepts the bulk purchase
discount for product Z?
A. $2,400
B. $4,200
C. $4,800
D. $8,400
2. WIDNOR CO
Widnor Co has credit sales of $26,750,000 per year and 1% of these turn into bad debts.
Customers are offered 50 days credit but on average take an additional 10 days. Widnor Co has
a cost of short-term finance of 5% per year.
The finance director is considering a proposal from a factoring company which would manage
Widnor Co.’s sales ledger on a with-recourse basis. The factor believes it can reduce average
trade receivables days to 35 days, while cutting bad debts by 70%
The factor would also advance Widnor Co 80% of the value of invoices raised at an interest rate
of 7% per year.
1. What is the level of Widnor Co.’s bad debts expense if it accepts the factor’s offer?
A. $80,250
B. $187,250
C. $nil
D. $267,500
2. What is Widnor Co.’s overall cost of financing receivables (to the nearest $000) if it
accepts the factor’s offer?
A. $1,766,000
B. $1,498,000
C. $123,000
D. $172,000
3. Which of the following methods could Widnor Co use to assess the creditworthiness
of potential customers?
1. Trade references
2. Credit rating agencies
3. Financial statements analysis
4. Analysis of the yield curve
A. 1,2, 3 and 4
B. 1,2 and 3 only
C. 3 and 4 only
D. 1 and 2 only
4. As the proposed factoring arrangement would improve the firm’s cash provision Widnor’s
finance director is evaluating alternative short-term investments.
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
5. Widnor’s chairman is concerned that the firm’s share price has been falling by more than its
competitors. The chairman believes this may be due to market inefficiency rather than poor
company performance.
Which of the following statements about the efficient markets hypothesis are correct?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
RISK MANAGEMENT
1. PKA CO
The following scenario relates to question 1-5 PKA Co is a European company that has used a
foreign supplier for the first time and must pay $250,000 to the supplier in six months’ time. The
following information has been provided by the company’s bank:
Assume that it is now 1 December and that PKA has no surplus cash at the present time. PKA’s
home currency is the euro.
1. What are the appropriate six-month interest rates for PKA Co to use if the company
hedges the dollar payment using money market hedge?
Borrowing
rate Deposit rate
A 6.10% 3.50%
B 4.00% 5.40%
C 2.00% 2.70%
D 3.05% 1.75%
A. £126,582
B. £126,326
C. £493,750
D. £126,072
3. Which of the following statements relating to interest rate parity theory are correct?
1. The currency with a higher interest rate would be expected to strengthen against the
other currency
2. The theory operates using real interest rates rather than nominal interest rates
3. The forward rate cam be found by multiplying the spot rate by the ratio of the interest
rates on each currency
A. 1,2 and 3
B. 3 only
C. 1 and 3 only
D. 2 and 3 only
4. Which of the following are possible methods for PKA Co to hedge foreign
currency risk?
1. Invoice in euros
2. Forward rate agreements (FRAs)
3. Leading and laggings
4. Currency futures
A. 1,2,3 and 4
B. 1 and 3 only
C. 1,3 and 4
D. 2 and 3 only
5. PKA Co also expects to receive export earnings of $500,000 in three months’ time.
Which of the following is the correct procedure for hedging this receipt using a
money market hedge?
2. GN CO
It now plans to invest in a European storage, packing and distribution network. The investment
will cost €13 million and is to be financed by equal amounts of equity and debt.
The debt finance will be provided by an immediate €6.5 million loan note issue. The interest rate
on the loan note issue is 8% per year, with interest being payable in euros on a six-monthly
basis.
The equity finance will be an immediate rights issue in GN’s home country to raise $5 million
after issue costs of $300,000. GN’s current share price is $2.50 per share and the rights issue
would be made at a 20% discount.
The spot exchange rate is $1=€1.30. The sic month forward rate is $1=€1.2876 and the 12-
month forward rate is $1=€1.2752.
1. Transaction risk
2. Translation risk
3. Economic risk
A. 1 only
B. 1,2 and 3
C. 3 only
D. 1 and 3 only
A. 2.65 million
B. 2 million
C. 2.5 million
D. 2.12 million
3. What is the dollar cost in the forward market hedging the first interest payment of the
loan note?
A. $403,852
B. $407,779
C. $203,890
D. $201,926
4. Which of the following is correct procedure for hedging the first interest payment on
the loan note?
5. Which of the following methods could GN Co use to hedge the currency risk on the
loan note?
1. Currency swap
2. Netting
3. Interest rate futures
A. 1 only
B. 1,2 and 3
C. 3 only
D. 1 and 2 only
3. ZIGZAG CO
1. What is the future dollar value if the €500,000 receipt is hedged using a forward
contract?
A. $995,00
B. $252,398
C. $990,500
D. $251,256
2. What sum should ZigZag Co borrow today to establish a money market hedge on
€500,000 receipt?
A. $476,150
B. $235,849
C. $487,805
D. $242,718
3. What is the one-year expected spot rate predicted by purchasing power parity
theory?
A. €1.971 per $
B. €1.995 per $
C. €1.981 per $
D. €1.990 per $
5. Which of the following may result from depreciation in the value of a country’s
currency?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
4. PZK CO
Spot exchange
rate: 4.1780-4.2080 euros per $
Six month forward exchange rate: 4.2302-4.2606 euros per $
12 month forward exchange rate: 4.2825-4.3132 euros per $
1. What is the loss or gain compared to its current dollar value which PZK Co will incur
by taking out a forward exchange contract on the future euro receipt?
A. $3,520 loss
B. $3,544 gain
C. $6,955 loss
D. $7,009 gain
2. Which of the following derivatives could be used to hedge the future euro receipt?
3. What is the annual euro interest rate implied by the 12 month forward exchange rate if
the dollar interest rate is 4% per year?
A. 3.3%
B. 5.3%
C. 6.6%
D. 1.5%
The chairman of PZK Co has been reading about macroeconomics and asks you the
following questions:
A. 2 only
B. 1 and 2 only
C. 1 and 3 only
D. 1,2 and 3
1. The general level of interest rates is affected by investors ‘ desire for a real
return
2. Market segmentation theory can explain kinks (discontinuities) in the yield curve
3. When interest rates are expected to fall, the yield curve could be sloping
downwards.
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
5. ROSE CO
Deposit
rate Borrowing rate
Euros 4.00% 8.00%
Dollars 2.00% 3.50%
The risk-free interest rate on the euro is 5.0% per year and on the dollar is 2.2% per year. The
inflation rate in Rose Co.’s home country is 1.5% per year and the European Union is 3.0% per
year.
1. Which of the following would correctly set up a money market hedge on the €750,000
receipt expected in six months’ time?
2. Which of the following would correctly hedge on the €500,000 payment expected in 12
months’ time?
3. If Rose Co continues to trade with the European Union for many years which of the
following currency risks will it potentially be exposed to?
1. Transaction risk
2. Translation risk
3. Economic risk
A. 1 only
B. 1,2 and 3
C. 3 only
D. 1 and 3 only
4. Which of the following would be the 12-month forward exchange rate?
A. €2.413 per $1
B. €2.286 per $1
C. €2.172 per $1
D. €2.315 per $1
5. Rise Co is planning to issue debt and is considering the use of interest rate derivatives
to protect against a rise in interest rates.
1. Interest rate options allow the buyer to take advantage of favorable interest rate
movements
2. A forward rate agreement does not allow a borrower to benefit from a decrease
in interest rates
3. Borrowers hedging against an interest rate increase will buy interest rate futures
now and sell them at a later date
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
BUSINESS VALUATION
1. PHOBIA CO
Investors currently require a return of 7% per annum on Phobia Co.’s loan notes.
A. $118
B. $89
C. $122
D. $131
2. What is the floor value (to the nearest $1) of each $100 loan note?
A. $108
B. $121
C. $100
D. $93
5. In relation to hedging interest rate risk, which of the following statements is correct?
A. The flexible nature of interest rate futures mean that they can always be matched
with a specific interest rate exposure
B. Interest rate options carry an obligation to the holder to complete the contract at
maturity
C. Forward rate agreements are the interest rate equivalent of forward exchange
contracts
D. Matching is where a balance is maintained between fixed rate and floating rate
debt
2. NSX
The finance director has proposed that, in order to conserve cash within the company, no
dividend would be paid in the next three years. It would then possible to pay a dividend of $0.70
per share in the fourth year and an annual dividend increase of 3% per year in subsequent
years.
NSX Co.’s chairman is considering methods of aligning management’s objectives with those of
shareholders and of raising new capital from financial intermediaries.
1. What is the share price of NSX Co, using the dividend growth model, based on the
existing dividend policy?
A. $6.48
B. $6.93
C. $6.67
D. $5.89
2. What is the share price of NSX Co, using the dividend growth model, if the proposed
change in dividend policy is implemented?
A. $10.30
B. $7.74
C. $10.00
D. $7.51
3. What was the average total shareholder return for the period 20X4-20X6?
A. 0.2%
B. -6.0%
C. 6.0%
D. -0.2%
A. 1 and 2 only
B. 1 and 3 only
C. 2 only
D. 1,2 and 3
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
3. NN CO
$m $m
Assets
Non-current
assets 101
Current assets
Inventory 11
Trade
receivables 21
Cash 10
42
Total assets 143
NN Co has just paid an ordinary dividend of $0.66 per share and has a cost of equity of 12%.
The ordinary dividends of the company have grown in recent years by an average rate of 3%
per year. The ordinary shares of the company have a nominal value of $0.50 per share.
The irredeemable preference shares have a nominal value of $0.50 per share and pay an
annual dividend of 8%. The ex-dividend market value of the preference shares is $0.67 per
share.
1. What is the total equity value of NN Co using the dividend growth model?
A. $378 million
B. $367 million
C. $733 million
D. $755 million
A. $143 million
B. $69 million
C. $94 million
D. $50 million
A. 8.0%
B. 6.4%
C. 6.0%
D. 5.4%
In terms of capital market efficiency, to which of the following does the investor’s
belief relate?
A. Fundamental analysis
B. Operational efficiency
C. Technical analysis
D. Semi-strong from efficiency
4. CLOSER CO
$m
Profit after tax (earnings) 66.6
Ordinary dividends 40.0
Equity
Ordinary shares ($1 nominal) 80
Reserves 410
490
Non-current liabilities
6% Preference shares 40
8% Loan notes ($100
nominal) 120
160
Current liabilities 70
720
Total equity and liabilities
The non-current assets include a property with a market value 20% above its book value of
$200m. Current assets include receivables of $100m but 10% of these are considered
irrecoverable.
The dividends of Closer Co will grow in the future at a rate of 4% per year. The finance director
of Closer Co thinks that an earnings yield of 11% per year can be used for valuation purposes.
Closer Co has a cost of equity of 10% per year.
1. What is the total equity value of Closer Co.’s using an asset-based valuation?
A. $490m
B. $720m
C. $750m
D. $520m
2. What is the total equity value of Closer Co using the dividend growth model?
A. $693m
B. $667m
C. $1110m
D. $594m
3. What is the total equity value of Closer Co using the earnings yield method?
A. $666m
B. $605m
C. $989m
D. $951m
A. 1 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
5. WWW CO
The following scenario relates to question 1-5
The shares of WWW Co have a nominal value of $0.50 per share and a market value of $4.00
per share. The 8% loan notes are redeemable at a nominal value of $100 per loan note in seven
years’ time and the before-tax cost of debt of WWW Co is 6% per year.
A. 2 and 3 only
B. 2 only
C. 3 only
D. 1,2 and 3
A. $67.2 million
B. $207.2 million
C. $185 million
D. $160 million
3. What is the market value (to the nearest $1) of each of WWW Co.’s loan notes?
A. $111
B. $100
C. $108
D. $98
A. 27%
B. 37%
C. 48%
D. 32%
6. GXG CO
GXG Co is considering an issue of $3,200,000 of loan notes paying annual interest of 6%.
Investment of the funds raised would increase operating profit by $576,000 per year.
$'000
Operating profit 3,450
Interest 200
Profit after
taxation 2600
Dividends 1600
GXG Co has a cost of equity of 9% per year. Dividends are expected to grow by 3% per year.
1. What is the total value of GXG Co.’s equity using the dividend growth model?
A. $27.5 million
B. $26.7 million
C. $44.6 million
D. $33.3 million
2. Which of the following would occur following the loan note issue?
A. 1,2 and 3
B. 2 and 3 only
C. 2 only
D. 3 only
3. What is GXG Co.’s interest cover following the loan note issue and investment of the
fund raised?
A. 17 times
B. 9 times
C. 20 times
D. 10 times
4. GXG Co.’s chairman has been reading about project appraisal techniques.
1. The sensitivity of a project variable can be calculated by dividing the project net
present value by the present value of the cash flows relating to that project
variable
2. The expected net present value is the value expected to occur if an investment
project with several possible outcomes is undertaken once
3. The discounted payback period is the time taken for the cumulative net present
value to change from negative to positive
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
$’000
Present value of sales revenue 50,025
Present value of variable costs 25,475
Present value of contribution 24,550
Present value of fixed costs 18,250
Present value of operating
income 6,300
Initial investment 5,000
Net present value 1,300
What is the sensitivity of the net present value of the investment project to a change
in sales volume?
A. A 7·1%
B. B 2·6%
C. C 5·1%
D. D 5·3%
3. Gurdip plots the historic movements of share prices and uses this analysis to make her
investment decisions.
A. A In the traditional view, there is a linear relationship between the cost of equity and
financial risk
B. B Modigliani and Miller said that, in the absence of tax, the cost of equity would
remain constant
C. C Pecking order theory indicates that preference shares are preferred to convertible
debt as a source of finance
D. D Business risk is assumed to be constant as the capital structure changes
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
7. The following are extracts from the statement of profit or loss of CQB Co:
$’000
Sales revenue 60,000
Cost of sales 50,000
Profit before interest and
10,000
tax
Interest 4,000
Profit before tax 6,000
Tax 4,500
Profit after tax 1,500
8. The management of XYZ Co has annual credit sales of $20 million and accounts receivable
of $4 million. Working capital is financed by an overdraft at 12% interest per year. Assume
365 days in a year.
What is the annual finance cost saving if the management reduces the collection
period to 60 days?
A. $85,479
B. $394,521
C. $78,904
D. $68,384
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
10. SKV Co has paid the following dividends per share in recent years:
Year 20X4 20X3 20X2 20X1 Dividend ($ per share) 0·360 0·338 0·328 0·311
The dividend for 20X4 has just been paid and SKV Co has a cost of equity of 12%.
Using the geometric average historical dividend growth rate and the dividend growth
model, what is the market price of SKV Co shares on an ex dividend basis?
A. A $4·67
B. B $5·14
C. C $5·40
D. D $6·97
11. ‘There is a risk that the value of our foreign currency-denominated assets and liabilities will
change when we prepare our accounts’
To which risk does the above statement refer?
A. A Translation risk
B. B Economic risk
C. C Transaction risk
D. D Interest rate risk
A. 103 days
B. 131 days
C. 235 days
D. 31 days
13. Which of the following is/are usually seen as benefits of financial intermediation?
A. 1 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
14. Which of the following statements concerning working capital management are
correct?
1) The twin objectives of working capital management are profitability and liquidity
2) A conservative approach to working capital investment will increase profitability
3) Working capital management is a key factor in a company’s long-term success
A. 1 and 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
15. Governments have a number of economic targets as part of their monetary policy.
Which of the following targets relate predominantly to monetary policy?
A. 1 only
B. 1 and 3
C. 2 and 4 only
D. 2, 3 and 4
Section B
$m $m
Equity finance
Ordinary shares 30·0
Reserves 38·4
68·4
Non-current liabilities
Bank loans 15·0
8% convertible loan notes 40·0
5% redeemable preference shares 15.0
The 8% loan notes are convertible into eight ordinary shares per loan note in seven years’ time.
If not converted, the loan notes can be redeemed on the same future date at their nominal value
of $100. Par Co has a cost of debt of 9% per year.
The ordinary shares of Par Co have a nominal value of $1 per share. The current ex dividend
share price of the company is $10·90 per share and share prices are expected to grow by 6%
per year for the foreseeable future. The equity beta of Par Co is 1·2.
16. The loan notes are secured on non-current assets of Par Co and the bank loan is secured
by a floating charge on the current assets of the company.
In terms of risk to the investor, what are the riskiest and least risky sources of finance
for Par Co?
Riskiest Least risky
17. What is the conversion value of the 8% loan notes of Par Co after seven years?
A. $16·39
B. $111·98
C. $131·12
D. $71·72
18. Assuming the conversion value after seven years is $126·15, what is the current
market value of the 8% loan notes of Par Co?
A. $115·20
B. $109·26
C. $94·93
D. $69·00
19. Which of the following statements relating to the capital asset pricing model is
correct?
20. Which of the following statements are problems in using the price/earnings ratio
method to value a company?
A. 1 and 2 only
B. 3 and 4 only
C. 1, 3 and 4 only
D. 1, 2, 3 and 4
The following scenario relates to questions 21–25
ZPS Co, whose home currency is the dollar, took out a fixed-interest peso bank loan several
years ago when peso interest rates were relatively cheap compared to dollar interest rates. ZPS
Co does not have any income in pesos. Economic difficulties have now increased peso interest
rates while dollar interest rates have remained relatively stable.
ZPS Co must pay interest on the dates set by the bank. A payment of 5,000,000 pesos is due in
six months’ time. The following information is available:
Borrow Deposit
A. A $390,472
B. B $387,928
C. C $400,000
D. D $397,393
22. Which of the following statements relate to purchasing power parity theory?
1) The theory holds in the long term rather than the short term
2) The exchange rate reflects the different cost of living in two countries
3) The forward rate can be found by multiplying the spot rate by the ratio of the interest
rates of the two countries
A. 1, 2 and 3
B. 1 and 2 only
C. 1 and 3 only
D. 2 only
23. What are the appropriate six-month interest rates for ZPS Co to use if the company
hedges the peso payment using a money market hedge?
24. Which of the following methods are possible ways for ZPS Co to hedge its existing
foreign currency risk?
A. 1, 2, 3 and 4
B. 1 and 3 only
C. 2 and 4 only
D. 2, 3 and 4 only
25. ZPS Co also trades with companies in Europe which use the Euro as their home currency.
In three months’ time ZPS Co will receive €300,000 from a customer.
Which of the following is the correct procedure for hedging this receipt using a
money market hedge?
Ridag Co plans to replace an existing machine and must choose between two machines.
Machine 1 has an initial cost of $200,000 and will have a scrap value of $25,000 after four
years. Machine 2 has an initial cost of $225,000 and will have a scrap value of $50,000 after
three years. Annual maintenance costs of the two machines are as follows:
Year 1 2 3 4
Where relevant, all information relating to this project has already been adjusted to include
expected future inflation. Taxation and tax allowable depreciation must be ignored in relation to
Machine 1 and Machine 2.
Ridag Co has a nominal before-tax weighted average cost of capital of 12% and a nominal
after-tax weighted average cost of capital of 7%.
26. In relation to Ridag Co, which of the following statements about competition and
deregulation are true?
A. A 1 and 4
B. B 2 and 3
C. C 1 and 3
D. D 2 and 4
A. A $90,412
B. B $68,646
C. C $83,388
D. D $70,609
28 Which of the following statements about Ridag Co using the equivalent annual cost
method are true?
1) Ridag Co cannot use the equivalent annual cost method to compare Machine 1 and
Machine 2 because they have different useful lives
2) The machine which has the lowest total present value of costs should be selected by
Ridag Co
A. 1 only
B. Both 1 and 2
C. 2 only
D. Neither 1 nor 2
29 Doubt has been cast over the accuracy of the year 2 and year 3 maintenance costs for
Machine 2. On further investigation it was found that the following potential cash flows are now
predicted:
2 18,000 0·3
2 25,000 0·7
3 23,000 0·2
3 24,000 0·35
3 30,000 0·45
What is the expected present value of the maintenance costs for year 3?
A. $26,500
B. $18,868
C. $21,624
D. $35,173
30. Ridag Co is appraising a different project, with a positive NPV. It is concerned about the risk
and uncertainty associated with this other project.
Which of the following statements about risk, uncertainty and the project is true?
A. Sensitivity analysis takes into account the interrelationship between project variables
B. Probability analysis can be used to assess the uncertainty associated with the project
C. Uncertainty can be said to increase with project life, while risk increases with the
variability of returns
D. A discount rate of 5% could be used to lessen the effect of later cash flows on the
decision
1. The owners of a private company wish to dispose of their entire investment in the company.
The company has an issued share capital of $1m of $0·50 nominal value ordinary shares.
The owners have made the following valuations of the company’s assets and liabilities.
Non-current assets (book value) $30m
Current assets $18m
Non-current liabilities $12m
Current liabilities $10m
The net realisable value of the non-current assets exceeds their book value by $4m. The
current assets include $2m of accounts receivable which are thought to be irrecoverable.
What is the minimum price per share which the owners should accept for the
company?
A. $14
B. $25
C. $28
D. $13
2. Which of the following financial instruments will NOT be traded on a money market?
A Commercial paper
B Convertible loan notes
C Treasury bills
D Certificates of deposit
In which of the following areas of financial management will the impact of working
capital management be smallest?
A Liquidity management
B Interest rate management
C Management of relationship with the bank
D Dividend policy
(1) It is the difference between the spot exchange rate and currency futures exchange rate
(2) It is the possibility that the movements in the currency futures price and spot price will be
different
(3) It is the difference between fixed and floating interest rates
(4) It is one of the reasons for an imperfect currency futures hedge
A 1 only
B 1 and 3
C 2 and 4 only
D 2, 3 and 4
5. Crag Co has sales of $200m per year and the gross profit margin is 40%. Finished goods
inventory days vary throughout the year within the following range:
Maximum Minimum
Inventory (days) 120 90
All purchases and sales are made on a cash basis and no inventory of raw materials or work
in progress is carried.
Crag Co intends to finance permanent current assets with equity and fluctuating current
assets with its overdraft.
In relation to finished goods inventory and assuming a 360-day year, how much
finance will be needed from the overdraft?
A $10m
B $17m
C $30m
D $40m
A. As risk rises, the market value of the security will fall to ensure that investors receive an
increased yield
B. As risk rises, the market value of the security will fall to ensure that investors receive a
reduced yield
C. As risk rises, the market value of the security will rise to ensure that investors receive an
increased yield
D. As risk rises, the market value of the security will rise to ensure that investors receive a
reduced yield
7. Pop Co is switching from using mainly long-term fixed rate finance to fund its working capital
to using mainly short-term variable rate finance.
Which of the following statements about the change in Pop Co.’s working capital
financing policy is true?
9. A company has annual after-tax operating cash flows of $2 million per year which are
expected to continue in perpetuity. The company has a cost of equity of 10%, a before-tax
cost of debt of 5% and an after-tax weighted average cost of capital of 8% per year.
Corporation tax is 20%.
A. $20m
B. $40m
C. $50m
D. $25m
10. Which of the following would you expect to be the responsibility of financial
management?
11. Lane Co has in issue 3% convertible loan notes which are redeemable in five years’ time at
their nominal value of $100 per loan note. Alternatively, each loan note can be converted in
five years’ time into 25 Lane Co ordinary shares.
The current share price of Lane Co is $3·60 per share and future share price growth is
expected to be 5% per year.
The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%.
A. $82·71
B. $73·47
C. $67·26
D. $94·20
12. Country X uses the dollar as its currency and country Y uses the dinar. Country X’s
expected inflation rate is 5% per year, compared to 2% per year in country Y. Country Y’s
nominal interest rate is 4% per year and the current spot exchange rate between the two
countries is 1·5000 dinar per $1.
According to the four-way equivalence model, which of the following statements
is/are true?
A. A 1 only
B. B 1 and 2 only
C. C 2 and 3 only
D. D 1, 2 and 3
13. Which of the following government actions would lead to an increase in aggregate
demand?
A. A 1 only
B. B 1 and 3
C. C 2 and 4 only
D. D 2, 3 and 4
$000
In addition, extracts from its latest statement of financial position are as follows:
$000
Equity 10,000
A. 14%
B. 18%
C. 20%
D. 25%
15. Drumlin Co has $5m of $0·50 nominal value ordinary shares in issue. It recently announced
a 1 for 4 rights issue at $6 per share. Its share price on the announcement of the rights
issue was $8 per share.
A. $1·60
B. $0·40
C. $0·50
D. $1·50
Section B
Herd Co is based in a country whose currency is the dollar ($). The company expects to receive
€1,500,000 in six months’ time from Find Co, a foreign customer. The finance director of Herd
Co is concerned that the euro (€) may depreciate against the dollar before the foreign customer
makes payment and she is looking at hedging the receipt.
Herd Co has in issue loan notes with a total nominal value of $4 million which can be redeemed
in 10 years’ time. The interest paid on the loan notes is at a variable rate linked to LIBOR. The
finance director of Herd Co believes that interest rates may increase in the near future.
The spot exchange rate is €1·543 per $1. The domestic short-term interest rate is 2% per year,
while the foreign short-term interest rate is 5% per year.
16. What is the six-month forward exchange rate predicted by interest rate parity?
A. €1·499 per $1
B. €1·520 per $1
C. €1·566 per $1
D. €1·588 per $1
17. As regards the euro receipt, what is the primary nature of the risk faced by Herd Co?
A. Transaction risk
B. Economic risk
C. Translation risk
D. Business risk
18. Which of the following hedging methods will NOT be suitable for hedging the euro
receipt?
19. Which of the following statements support the finance director’s belief that the euro
will depreciate against the dollar?
1) The dollar inflation rate is greater than the euro inflation rate
2) The dollar nominal interest rate is less than the euro nominal interest rate
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
20. As regards the interest rate risk faced by Herd Co, which of the following statements
is correct?
A. In exchange for a premium, Herd Co could hedge its interest rate risk by buying interest
rate options
B. Buying a floor will give Herd Co a hedge against interest rate increases
C. Herd Co can hedge its interest rate risk by buying interest rate futures now in order to
sell them at a future date
D. Taking out a variable rate overdraft will allow Herd Co to hedge the interest rate risk
through matching
Ring Co has in issue ordinary shares with a nominal value of $0·25 per share. These shares are
traded on an efficient capital market. It is now 20X6 and the company has just paid a dividend of
$0·450 per share. Recent dividends of the company are as follows:
Ring Co also has in issue loan notes which are redeemable in seven years’ time at their nominal
value of $100 per loan note and which pay interest of 6% per year.
The finance director of Ring Co wishes to determine the value of the company.
Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The
company pays corporation tax of 25% per year.
21. Using the dividend growth model, what is the market value of each ordinary share?
A. $8·59
B. $9·00
C. $9·45
D. $7·77
A. $109·34
B. $112·01
C. $116·57
D. $118·68
23. The finance director of Ring Co has been advised to calculate the net asset value
(NAV) of the company. Which of the following formulae calculates correctly the NAV
of Ring Co?
25. Which of the following statements about capital market efficiency is/are correct?
1) Insider information cannot be used to make abnormal gains in a strong form efficient
capital market
2) In a weak form efficient capital market, Ring Co.’s share price reacts to new information
the day after it is announced
3) Ring Co.’s share price reacts quickly and accurately to newly-released information in a
semi-strong form efficient capital market
A. 1 and 2 only
B. 1 and 3 only
C. 3 only
D. 1, 2 and 3
The following scenario relates to questions 26 to 30.
The following information relates to an investment project which is being evaluated by the
directors of Fence Co, a listed company. The initial investment, payable at the start of the first
year of operation, is $3·9 million.
Year 1 2 3 4
The directors believe that this investment project will increase shareholder wealth if it achieves a
return on capital employed greater than 15%. As a matter of policy, the directors require all
investment projects to be evaluated using both the payback and return on capital employed
methods. Shareholders have recently criticised the directors for using these investment
appraisal methods, claiming that Fence Co ought to be using the academically-preferred net
present value method.
The directors have a remuneration package which includes a financial reward for achieving an
annual return on capital employed greater than 15%. The remuneration package does not
include a share option scheme.
A. 2·75 years
B. 1·50 years
C. 2·65 years
D. 1·55 years
27. Based on the average investment method, what is the return on capital employed of
the investment project?
A. 13·3%
B. 26·0%
C. 52·0%
D. 73·5%
28. Which of the following statements about investment appraisal methods is correct?
A. The return on capital employed method considers the time value of money
B. Return on capital employed must be greater than the cost of equity if a project is to be
accepted
C. Riskier projects should be evaluated with longer payback periods
D. Payback period ignores the timing of cash flows within the payback period
A. 1 and 2 only
B. 1 only
C. 2 and 3 only
D. 1, 2 and 3
30. Which of the following statements about Fence Co directors’ remuneration package
is/are correct?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
Section A
A. 2 and 4
B. 1 and 3
C. 3 and 4
D. 1 and 2
3. Frost Co is planning 1 for 4 rights issue with an issue price at a 10% discount to the current
share price.
The EPS is currently $0.50 and the shares of Frost Co are trading on a price/earnings ratio
of 20 times. The market capitalisation of the company is $50m.
A. $9.80
B. $9.75
C. $10.20
D. $9.20
A. The earnings yield method and the dividend growth model should give similar values for
a company
B. Market capitalisation represents the maximum value for a company
C. The price/earnings ratio is the reciprocal of the earnings yield
D. The price/earnings ratio should be increased if the company being valued is riskier than
the valuing company
5. Small and medium-sized entities (SME) have restricted access to capital markets.
What is the term given to the difference between the finance required to operate an SME
and the amount obtained?
A. Forecast gap
B. Maturity gap
C. Funding gap
D. Asset gap
6. Max Co is a large multinational company which experts to have a $10m cash deficit in one
month’s time. The deficit is expected to last no more than two months.
Max Co wishes to resolve its short-term liquidity problem by issuing an appropriate instrument
on the money market.
A. Commercial paper
B. Interest rate futures
C. Corporate loan notes
D. Treasury bills
A. The return from investing in larger companies has been shown to be greater than the
average return from all companies
B. Weak from efficiency arises when investors tend not to make rational investment
decisions
C. Allocation efficiency means that transaction costs are kept to a minimum
D. Research has shown that, over time, share prices appear to follow a random walk
Green Co, a listed company, had the following share prices during the year ended 31 December
20X5:
During the year, Green Co paid a total dividend of $0.15 per share
A. 26%
B. 22%
C. 32%
D. 36%
Carp Co has announced that it will pay an annual dividend equal to 55% of earnings. Its
earnings per share is $0.80, and it has ten million shares in issue. The return on equity of
Carp Co is 20% and its current cum dividend share price is $4.60.
A. 19.4%
B. 20.5%
C. 28.0%
D. 22.7%
Mile Co is looking to change its working policy to match the rest of the industry. The following
results are expected for the coming year:
$000
Revenue 20,500
Cost of sales (12,800)
Gross profit 7,700
Revenue and cost of sales can be assumed to be spread evenly throughout the year. The
working capital ratios of Mile Co, compared with the industry, are as follows:
Mile Co Industry
Receivables days 50 42
Inventory days 45 35
Payable days 40 35
11. If Mile Co matches its working capital cycle with the industry, what will be the
decrease in its net working capital?
A. $624,600
B. $730,100
C. $835,600
D. $975,300
A. A prospective merger would need to result in a company having a market share greater
than 80% before it can be described as a monopoly
B. A government may intervene to weaken its country’s exchange rate in order to eliminate
a balance of payments deficit
C. A relatively high rate of domestic inflation will lead to a strengthening currency
D. Government fiscal policy involves the management of interest rates
13. Which of the following statements about interest rate risk hedging is correct?
A. An interest rate floor can be used to hedge an expected increase in interest rates
B. The cost of an interest rate floor is higher than the cost of an interest rate collar
C. The premium on an interest rate option is payable when it is exercised
D. The standardised nature of interest rate futures means that over- an under-hedging can
be avoided
A. Value for money is usually taken to mean economy, efficiency and engagement
B. Cum dividend means the buyer of the share is not entitled to receive dividend shortly to
be paid
C. The dividend payout ratio compares the dividend per share with the market price per
share
D. The agency problem means that shareholder wealth is not being maximised
Swap Co is due to receive goods costing $2,500. The terms of trade state that payment must be
received within three months. However, a discount of 1.5% will be given for payment within one
month.
15. Which of the following is the annual percentage cost of ignoring the discount and
paying in three months?
A. 6.23%
B. 9.34%
C. 6.14%
D. 9.49%
Section B
The following scenario relates to questions 16 to 20.
Park Co is based in a country whose currency is the dollar ($). The company regularly imports
goods denominated in euro (€) and regularly sells goods denominated in dinars. Two of the
future transactions of the company are as follows:
Park Co has the following exchange rates and interest rates available to it:
Bid Offer
Borrow Deposit
The finance director of Park Co believes that the upward-sloping yield curve reported in the
financial media means that the general level of interest rates will increase in the future, and
therefore expects the reported six-month interest rates to increase.
16. What is the future dollar value of the dinar receipt using a money market hedge?
A. $197,752
B. $201,602
C. $208,623
D. $210,629
17. In hedging the foreign currency risk of the two transactions, which of the following
hedges will Park Co find to be effective?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1, 2 and 3
18. Which hedging methods will assist Park Co in reducing its overall foreign currency
risk?
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
1. Purchasing power parity can be used to predict the forward exchange rate
2. The international Fisher effect can be used to predict the real interest rate.
A. 1 only
B. 2 only
C. Both 1 and 2
D. Neither 1 nor 2
20. Which of the following statements is consistent with an upward-sloping yield curve?
A. The risk of borrowers defaulting on their loans increases with the duration of the lending
B. Liquidity preference theory implies that short-term interest rates contain a premium over
long-term interest rates to compensate for long liquidity
C. Banks are reluctant to lend short-term, while government debt repayments have
significantly increased the amount of long-term funds available
D. The government has increased short-term interest rates in order to combat rising
inflation in the economy
The finance director of Coral Co has been asked to provide values for the company’s equity and
loan notes. Coral Co us a listed company and has the following long term finance
$m
The ordinary shares of Coral Co have a nominal value of $0.25 per share and are currently
trading on an ex dividend basis at $7.10 per share. An economic recovery has been forecast
and so share prices are expected to grow by 9% per year for the foreseeable future.
The loan notes are redeemable after six years at their nominal value of $100 per loan note, or
can be converted after six years into 10 ordinary shares of Coral Co per loan note. The loan
notes are traded on the capital market.
The before-tax cost of debt of Coral Co is 5% and the company pays corporation tax of 20% per
year.
A. $221.52m
B. $55.38m
C. $31.2m
D. $229.52m
22. Assuming conversion, what is the market value of each loan note of Coral Co?
A. $110.13
B. $112.67
C. $119.58
D. $125.70
23. Which of the following statements about the equity market value of Coral Co is/are
true?
1. The equity market value will change frequently due to capital market forces
2. The capital market is semi-strong from efficient, the equity market value will not be
affected by the release to the public of insider information.
3. Over time, the equity market value of Coral Co will follow a random walk
A. 1 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
24. Which of the following assumptions is/are made by dividend growth model?
A. 2 only
B. 1 and 3 only
C. 2 and 3 only
D. 1,2 and 3
25. Why might valuations of the equity and loan notes of Coral Co be necessary?
A. 1 and 2 only
B. 1 and 3 only
C. 3 only
D. 1, 2 and 3
Link Co has been prevented by the competition authorities from buying a competitor, Twist Co,
on the basis that this prevents a company a monopoly position arising. Link Co has therefore
decided to expand existing business operations instead and as a result the finance director has
prepared the following evaluation of a proposed investment project for the company:
$000
The project life is expected to be four years and the finance director has used a discount rate of
10% in the evaluation. The investment project has no scrap value
The finance director is considering financing the investment project by new issue of debt.
26. What is the change in sales volume which will make the NPV zero?
A. 7.7%
B. 13.2%
C. 18.4%
D. 22.1%
27. Which of the following statements relating to sensitivity analysis is/are correct?
Although critical factors may be identified, the management of Link Co may have no control over
them
A weakness of sensitivity analysis is that it ignores interdependency between project variables
Sensitivity analysis can be used by Link Co to assess the risk of an investment project
A. 1 and 2 only
B. 1 only
C. 2 and 3 only
D. 1,2 and 3
28. Using the average investment method and assuming operating cash flows of
$729,000 per year, what is the return on capital employed of the investment project?
A. 16%
B. 28%
C. 31%
D. 64%
30. Which of the following statements relating to competition policy is/are correct?
A. 1 and 2 only
B. 3 only
C. 2 and 3 only
D. 1,2 and 3