SECTION A

ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.

1. Boss Co is a large listed company financed by both equity and debt.

In which of the following areas of financial management will the impact of working capital management be smallest?

2. In relation to an irredeemable security paying a fixed rate of interest, which of the following statements is correct?

3. A company has annual after-tax operating cash flows of $4m 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%.

What is the theoretical value of the company?

4. Country A uses the dollar as its currency and country B uses the dinar.

Country A's expected inflation is 5% per year, compared to 2% per year in country B. Country B's nominal interest rate is 4% per year and the current spot exchange rate between the countries is 1.5000 dinar per $1.

Indicate, by ticking the relevant boxes in the table below, whether each of the following statements are true or false, according to the four-way equivalence model.

A. Country A’s nominal interest rate should be 7.06% per year

B. The future (expected) spot rate after one year should be 1.4571 dinar per $1

C. Country A’s real interest rate should be higher than that of country B

5. NYC Co has $5m of $0.50 nominal value ordinary shares in issue. It recently announced a one for four rights issue at $6 per share. Its share price on the announcement of the rights issue was $8 per share.

What is the theoretical value of a right per existing share (to two decimal places)?

6. Crunchy Co is planning a 1 for 4 rights issues with an issue price at a 10% discount to the current share price.

The EPS is currently $0.50 and the shares of Crunchy Co are trading on a price/earnings ratio of 20 times. The market capitalisation of the company is $50m.

What is the theoretical ex rights price per share (to two decimal places)?

7. Henry Co is a large multinational company which expects to have a $10m cash deficit in one month's time. The deficit is expected to last no more than two months.

Henry Co wishes to resolve its short-term liquidity problem by issuing an appropriate instrument on the money market.

Which of the following instruments should Henry Co issue?

8. Blue Co, a listed company, had the following share prices during the year ended 31 December 20X5:

During the year, Blue Co paid a total dividend of $0.15 per share.

What is the total shareholder return for 20X9? 

9. Indicate, by ticking the relevant boxes, whether the following statements are true?

10. Penny 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.

Which of the following is the annual percentage cost of ignoring the discount and paying within three months?

11. PY Co's P/E ratio is 12. Its competitor's earnings yield is 10%.

When comparing PY Co to its competitor, which of the following is correct?

12. Max Co is appraising a project with the following financial information:

What is the return on capital employed of the project based on average investment?

13. Tyrin Co has annual sales of $15 million. 30% of sales are for cash and the rest are on credit. Tyrin Co finances its working capital with an overdraft at an annual interest rate of 10%.

Tyrin Co's receivables are currently $1 million.

Assume a 360-day year.

What is the finance cost saving if receivables are reduced to 30 days?

14. Cham Co is planning to issue a loan note with a coupon rate of 5%.

At redemption each $100 nominal value loan note is either redeemable in five years' time or convertible into five ordinary shares.

The share price of Cham Co is expected to grow at a rate of 3% per year from its current level of $18.98.

Corporation tax is payable by the company at a rate of 20%. Investors expect a yield of 6%.

What is the current market value of each loan note?

15. An issue of a 9% redeemable loan note in ATV Co is planned. This loan note is due to mature in five years' time at a premium of 15%, or convertible into 25 ordinary shares at that point. The current share price is $4, expected to grow at 10% per year. ATV pays corporation tax at a rate of 30%.

Which TWO of the following factors will cause the cost of this debt to increase?

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.

Smith Co's sales are exported to a European country and are invoiced in euros.

Smith Co expects to receive €500,000 from export sales at the end of three months. A forward rate of €1.680–€1.687 per $1 has been offered by the company's bank and the spot rate is €1.670– €1.675 per $1.

Other relevant financial information is as follows:

Short-term dollar borrowing rate     5% per year

Short-term dollar deposit rate          4% per year

Smith Co can borrow short term in the euro at 9% per year.

Assume there are 365 days in each year.

16. Which of the following are valid courses of action for Smith Co to reduce the risk of the euro value dropping relative to the dollar before the €500,000 is received?

17. What is the dollar value of a forward market hedge (to the nearest whole number) in three months' time?

18. What is the dollar value of a money market hedge in three months' time?

19. Smith Co is considering futures contracts. Which of the following statements are true of futures contracts?

20. The following statements refer to types of foreign currency risk.

1. The risk that Smith Co will make exchange losses when the accounting results of its foreign branches are expressed in the home currency
2. The risk that exchange rate movements will affect the international competitiveness of Smith Co

What types of risk do the statements refer to?

A. Statement 1

B. Statement 2

The following scenario relates to questions 21-25.

Ridag Co operates in an industry which has recently been deregulated as the Government seeks to increase competition in the industry.

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 4 years. Machine 2 has an initial cost of $225,000 and will have a scrap value of $50,000 after 3 years. Annual maintenance costs of the two machines are as follows:

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%.

21. In relation to Ridag Co, which TWO of the following statements about competition and deregulation are true?

22. What is the equivalent annual cost of Machine 1?

23. Is each of the following statements about Ridag Co using the equivalent annual cost method true?

A. Ridag Co cannot use the equivalent annual cost method to compare Machine 1 and Machine 2 because they have different useful lives.

B. The machine which has the lowest total present value of costs should be selected by Ridag Co.

24. 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:

What is the expected present value of the maintenance costs for Year 3 (to the nearest $)

25. 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?

The following scenario relates to questions 26-30.

Martin Co is concerned about its cash position and has taken to delaying payments to some suppliers in order to ease that problem. Each month the purchase ledger department sorts the total value of invoices for that month into three sub-divisions, X, Y and Z depending on the priority of invoice.

Division X invoices, amounting to $2,000,000, are urgent and paid after 30 days

Division Y invoices, amounting to $3,000,000, are less urgent and paid after 60 days; and Division Z invoices, amounting to $4,000,000, are least urgent and paid after 90 days.

Several suppliers have reacted to this by offering Martin Co a 2% cash discount if the accounts are settled within 15 days. Martin Co is currently considering whether or not to accept this. Another supplier, who Martin Co now waits 90 days to pay, has been threatening legal action over the $300,000 currently owed. Martin Co feels that some sort of compromise might be needed.

Martin Co’s cost of capital is 12% per annum.

Assume that there are 30 days in a month and that purchases accrue evenly over the year.

26. Martin Co is considering the advantage of the early settlement discount from those it currently pays after:

1. 60 days
2. 90 days

From which payables should Martin take the 2% cash discount?

27. What is Martin Co’s payables period (to the nearest day)?

28. Which of the following is NOT a symptom of over-trading?

29. To avoid a court action, Marin Co is thinking of offering to repay the creditor it owes $300,000 in instalments as follows (all figures in $000)

How much will Martin Co save, in present value terms, if the creditor accepts the instalment offer instead of Martin having to pay in full immediately (to the nearest $00)?

30. A company can make decisions that affect its level of working capital. These can be described as either aggressive or conservative policies.

Indicate, by choosing the relevant boxes, whether the following policies are aggressive or conservative.

A. Both fluctuating and permanent current assets financed by short-term funds

B. Delay paying creditors (payables) for as long as possible

SECTION C

BOTH questions are compulsory and MUST be attempted

31. Pin Co

Pin Co. is looking to spend $15m to expand its existing business. This expansion is expected to increase profit before interest and tax by 20%. Recent financial information relating to Pin Co can be summarised as follows:

Pin Co is not sure whether to finance the expansion with debt or with equity. If debt is chosen, the company will issue $15m of 8% loan notes at their nominal value of $100 per loan note. If equity is chosen, the company will have a 1 for 4 rights issue at a 20% discount to the current market price of $6.25 per share. Pin Co has 12 million shares in issue. The company pays corporation tax at 30%.

A. Evaluate whether, on financial grounds, Pin Co should finance the expansion with debt or equity.

B. Explain and discuss the relationship between systematic risk and unsystematic risk.

C. Discuss the assumptions made by the capital asset pricing model.

32. Lavania Co

Lavania Co. is a construction company. It uses a large earth moving vehicle called the Buster to prepare foundations for buildings. It needs to decide whether the cheapest replacement interval for the Buster is three or four years.

The following details are available:

Lavania Co purchases the Buster from a manufacturer for $800,000, payable one year after delivery. Its resale value will fall by 40% of the purchase price at the end of its first year of operation. The resale value will then reduce by 25% of its previous year’s resale value for each further year of operation.

Yearly maintenance costs are $20,000 at the end of its first year of operations, rising by 5% per year. Maintenance must be provided in the year of sale.

Yearly fuel costs are $28,000 in the first year rising by $5,000 for each extra year it is operated.

If the Buster is operated beyond three years it is subject to a government safety and carbon emissions test. The test would be paid for and would take place at the beginning of the fourth year of operation. Correction of any faults discovered by this test is mandatory. There is an 80% chance that the test and remedial work will cost Lavania Co $50,000, and a 20% chance it will cost $120,000.

Lavania Co’s cost of capital is 8%.

Ignore taxation

A. Calculate the equivalent annual cost of the three-year and four-year replacement intervals for the Buster and advise Lavania Co which replacement interval to adopt.

B. Discuss why replacement interval decisions should be based upon equivalent annual cost (EAC).

C. Discuss why discounted cash flow methods of investment appraisal are considered superior to non-discounted cash flow methods.