SECTION A

ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.

1. Indicate, by selecting on the relevant boxes in the table below, whether each of the following financial instruments are traded on a money market.

A. Commercial paper

B. Convertible loan notes

C. Treasury bills

D. Certificates of deposit

2. Getty Co has sales of $280m per year and the gross profit margin is 40%. Finished goods inventory days vary throughout the year within the following range:

All purchases and sales are made on a cash basis and no inventory of raw materials or work in progress is carried.

Getty 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?

3. In relation to Just-in-Time inventory, which of the following statements is correct?

4. Amy Co has in issue 5% 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 Amy Co ordinary shares.

The current share price of Amy 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%.

What is the current market value of a Amy Co convertible loan note?

5. Susan Co's latest results are as follows:

In addition, extracts from its latest statement of financial position are as follows:

What is Susan Co's return on capital employed (ROCE)?

6. Which TWO of the following activities are carried out by a financial intermediary?

7. Select the correct term to complete the below sentence.

Small and medium-sized entities (SME) have restricted access to capital markets. The difference between the finance required to operate an SME and the amount obtained is known as the ……..

8. The following data is available:

What is the current six-month forward exchange rate in Country Y (to two decimal places)?

9. Ethan Co is looking to change its working capital policy to match the rest of the industry. The following results are expected for the coming year:

Revenue and cost of sales can be assumed to be spread evenly throughout the year.

The working capital ratios of Ethan Co, compared with the industry, are as follows:

Assume there are 365 days in each year.

If Ethan Co matches its working capital cycle with the industry, what will be the decrease in its net working capital?

10. Which of the following statements is true?

11. Wendy Co manufactures and sells mid-range sports-wear in S-land. Wendy Co has high financial gearing, and all of its debt is paid at a fixed rate. Wendy Co is not currently planning to raise any new debt finance.

The government in S-land have adopted a contractionary monetary policy.

How would a contractionary monetary policy affect Wendy Co?

1. Lower demand for its products
2. Higher tax rates on profits
3. Increased interest rates on its debt finance

12. Penelope Co is an ungeared company and has a weighted average cost of capital of 14%. The company is about to introduce long-term debt into its capital structure.

This is expected to increase Penelope Co's cost of equity, but to increase the overall market value of the company.

This is consistent with which TWO theories?

13. UHG Co is a public listed provider of healthcare and operates a number of privately-run hospitals. UHG Co is a state-controlled and -owned healthcare provider, it also operates a number of hospitals which are funded by the government.

Which TWO of the following are valid differences between the objectives of UHG Co and NNH Co?

14. The following information is relevant to Connolly Co, a listed company:

What is the total shareholder return for 20X1?

15. The following information relates to the ordinary shares of G Co.

Share price                       $5.00
Dividend cover                   2.5
Published dividend yield   4.8%

What is the earnings per share of G Co (to 2 decimal places)?

SECTION B

ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.

The following scenario relates to questions 16 to 20.

Gregory Co is an all-equity financed listed company. Nearly all its shares are held by financial institutions.

Gregory has recently appointed a new finance director who advocates using the capital asset pricing model as a means of evaluating risk and interpreting stock market reaction to the company.

The following initial information has been put forward by the finance director for a rival company operating in the same industry:

Equity beta

Collins Co                       0.7

The finance director notes that the risk-free rate is 5% each year and the expected rate of return on the market portfolio is 15% each year.

16. Calculate, using the capital asset pricing model, the required rate of return on equity of Collins Co (give your answer to the nearest whole number).

17. At the end of the year Gregory Co paid a dividend of 15c per share. At the year-end share price was $3.30 cum div. Share price was $2.50 at the start of the year.

What is the total shareholder return over the period (give your answer to the nearest whole number)?

18. Calculate the equity beta of Gregory Co, assuming its required annual rate of return on equity is 17% and the stock market uses the capital asset pricing model to calculate the equity beta (give your answer to one decimal place).

19. Which TWO of the following statements are true?

20. Are the following statements true or false?

A. The CAPM model assumes that investors hold a fully diversified portfolio.

B. If Gregory Co has a low price/earnings ratio, it will have a low cost of equity.

The following scenario relates to questions 21–25.

Joseph PLC, 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. Joseph PLC does not have any income in pesos. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable.

Joseph PLC must pay interest on the dates set by the bank. A payment of 5,000,000 pesos is due in 6 months' time. The following information is available:

Spot rate                                12.500–12.582 pesos per $

Six-month forward rate         12.805–12.889 pesos per $

Interest rates which can be used by Joseph PLC:

21. What is the dollar cost of a forward market hedge? (to the nearest $)

22. Indicate whether the following statements apply to interest rate parity theory, purchasing power parity theory, or both.

A. The currency of the country with the higher inflation rate will weaken against the other currency

B. The theory holds in the long-term rather than in the short-term

C. The exchange rate reflects the cost of living in the two countries

23. What are the appropriate six-month interest rates for Joseph PLC to use if the company hedges the peso payment using a money market hedge?

24. Which TWO of the following methods are possible ways for Joseph PLC to hedge its existing foreign currency risk?

25. Joseph PLC also trades with companies in Europe which use the euro as their home currency. In 3 months' time Joseph PLC will receive €300,000 from a customer.

Which of the following is the correct procedure for hedging this receipt using a money market hedge?

The following scenario relates to questions 26 to 30.

SJ 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:

SJ Co also has in issue loan notes which are redeemable in 7 years' time at their nominal value of $100 per loan note and which pay interest of 6% per year.

The finance director of SJ Co wishes to determine the value of the company.

SJ 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.

26. Using the dividend growth model, what is the market value of each ordinary share?

27. What is the market value of each $100 loan note?

28. The finance director of SJ Co has been advised to calculate the net asset value (NAV) of the company.

Which of the following formulae calculates correctly the NAV of SJ Co?

29. Which of the following statements about valuation methods is true?

30. Which of the following statements about capital market efficiency is/are correct?

SECTION C

BOTH questions are compulsory and MUST be attempted

31. Polish Co

Polish Co. wishes to improve its working capital management as part of an overall costcutting strategy to increase profitability. Two areas the company has been considering are working capital funding strategy and inventory management. Polish Co currently follows a policy of financing working capital needs as much as possible from long-term sources of finance, such as equity. The company has been considering its inventory management and has been looking specifically at component X.

Current position

Polish Co purchase 1,500,000 units of component X each year and consumes the component at a constant rate. The purchase price of component X is $14 per unit. The company places 12 orders each year. Inventory of component X in the financial statements of Polish Co is equal to average inventory of component X. The holding cost of component X, excluding finance costs, is $0.21 per unit per year. The ordering cost of component K is $252 per order.

 Economic order quantity

Polish Co wishes to investigate whether basing ordering of component X on the economic order quantity will reduce costs.

Bulk order discount

The supplier of component X has offered Polish Co a discount of 0.5% on the purchase price of component X, providing the company orders 250,000 units per order.

Other information

Polish Co has no cash but has access to short-term finance via an overdraft facility at an interest rate of 3% per year. This overdraft currently stands at $250,000.

Required

A.
(i) Calculate the annual holding and ordering costs of Polish Co's current inventory management system.
(ii) Calculate the financial effect of adopting the Economic Order Quantity as the basis for ordering inventory.
(iii) Calculate the financial effect of accepting the bulk purchase discount.
(iv) Recommend, with justification, which option should be selected

B. Discuss the key factors in determining working capital funding strategies.

32. Acaba Co

Acaba Co. is a manufacturing company that has three investment decisions for the coming year.

Investment decision 1

Six investment projects are being considered with the following details:

Project B is expected to generate the following annual cash flows:

Project B cash flows are before allowing for inflation of 4% per year for sales income and 5% per year for costs. Acaba Co has a nominal cost of capital of 10%.

Due to management reluctance to raise new finance, capital for investment in the above projects is currently restricted to $5m. Projects A, B, D and F are all independent, but projects C and E are mutually exclusive. All of the above projects are divisible and none can be delayed or repeated.

Investment decision 2

A number of Acaba Co’s employees have a company car. The entire company car fleet is now due for renewal and in the past, it has been replaced every four years. Management are not sure if this is the optimum length of time and feel that other fleet replacement cycles, such as every three or five years, should also be considered.

Investment decision 3

The management of Acaba Co are considering the financial viability of another project but as yet, no detailed financial information is available to perform an NPV appraisal. One of the reasons for this is that the various cash flows will be subject to a number of different rates of inflation that are very uncertain at present. For example, the selling price inflation may be no more than 2% per year whereas material cost inflation could be anything from 4% to 6% per year. The general rate of inflation is expected to differ from both of these. Management are not sure whether the appraisal could be performed by simply ignoring the inflation altogether.

Note: The $5m capital constraint outlined with investment decision 1 applies to that investment decision only and not to investment decisions 2 and 3.

Required

A. For investment decision 1:

(i) Calculate the net present value of project B; and
(ii) Given the capital constraint, calculate the optimum investment combination and the resulting net present value.

B. For investment decision 2, explain the approach Acaba Co should use to determine the optimum replacement cycle for the company car fleet.

C. In relation to investment decision 3, describe the two approaches for dealing with inflation AND provide a reasoned recommendation as to which approach Acaba Co’s management should follow.