Business Finance Decision Mock Exam Questions PDF

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Business Finance Decisions –

TIME ALLOWED:2 HOURS

READING TIME:10 Minutes

EXAMINATION INSTRUCTIONS: There are TWO sections in this paper: Section A – Answer ALL questions from this section. Section B – Answer FOUR questions from this section. Supplementary Papers Included: Formulae sheets, present value and annuity tables are attached.

Business Finance Decisions Formulae Sheet The Net Present Value 𝑁𝑃𝑉 = 𝐼 +

𝐶 𝐶 𝐶 +⋯+ +  (1 + 𝑟) (1 + 𝑟 ) (1 + 𝑟)

The Capital Asset Pricing Model (CAPM) 𝐸(𝑅 ) = 𝑅 + 𝛽 𝐸(𝑅 ) − 𝑅 

The Dividend Growth Model 𝐾 =

𝐷 𝐷 (1 + 𝑔) +𝑔 +𝑔 = 𝑃 𝑃

The Weighted Average Cost of Capital 𝑉 𝑉 𝑉 𝐾 = 󰇩 󰇪 𝐾 + 󰇩 󰇪 𝐾 + 󰇩 󰇪𝐾 𝑉 + 𝑉 + 𝑉 𝑉 + 𝑉 + 𝑉 𝑉 + 𝑉 + 𝑉 

The Cash Conversion Cycle 𝐶𝐶𝐶 = 𝑅𝑀𝑃 + 𝑊𝐼𝑃𝑃 + 𝐹𝐺𝑃 + 𝑇𝑅𝑃 − 𝑇𝑃𝑃 1

Business Finance Decisions –

Section A: Answer ALL questions in this section. Each question carries 2 marks.

Q1

Which of the following ratios gives the best guide to a company’s ability to pay its trade creditors? A. B. C. D.

Q2

Which of the following most accurately describes capital gearing? A. B. C. D.

Q3

Price-earnings ratio Acid test ratio Return on capital employed Interest cover

The ratio of capital employed to working capital. The ratio of capital employed to total interest charges paid. The ratio of long-term debt to shareholders’ funds or total assets. None of the above.

Consider the following two statements concerning share issues: Statement (1): Retained profits are a free source of finance to a business. Statement (2): Investors normally view loan notes as being more risky than preference shares. Which one of the following combinations (true/false) relating to the above statements is correct? Statement (1) A. True B. True C. False D. False

Q4

Statement (2) True False True False

The conflict between the goals of a firm’s owners and the goals of its nonowner manager is A. B. C. D.

the agency problem. incompatibility. serious only when profits decline. Of little importance in most large firms. 2

Business Finance Decisions –

Q5

Which of the following capital budgeting techniques ignores the time value of money? A. B. C. D.

Q6

What is meant by the term ‘annuity’? A. B. C. D.

Q7

A series of payments or receipts of equal amounts for a finite period Bonds that pay a variable rate of interest The annual total of a number of payments None of the above

A firm is considering an investment that will generate a cash flow in exactly five years’ time. If the discount rate is 15 per cent, to obtain the present value of this projected cash flow, we have to multiply the amount of the cash flow by: A. B. C. D.

Q8

Payback period Net present value Internal rate of return None of the above

1/(1.15)5 (1.15)5 1/(0.15)5 (0.15)5

What term is used for the weighted cost of equity and debt in proportion to their contribution to the total capital of the firm? A. B. C. D.

Weighted average cost of capital Weighted amalgamated costs of capital Weighted and capitalized costs None of the above

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Business Finance Decisions –

Q9

Which of the following has the highest present value at a discount rate of 10 percent? A. B. C. D.

Q10

£115 now £30 paid every year for the next 5 years £125 paid two years from now £13 paid every year forever

Perry Barr plc is considering investing in a project that has an initial cash outlay followed by a series of net cash inflows. The business applied the NPV and IRR methods to evaluate the project but, after the evaluation had been undertaken, it was found that the correct cost of capital figure was lower than that used in the evaluation. What will be the effect of correcting for this error on the NPV and IRR figures?

A. B. C. D.

NPV Decrease Decrease Increase Increase

IRR Decrease No change Increase No change

Section B: Answer FOUR Questions Only

Question 11: (a) Explain how a financial manager can, in practice, maximise the wealth of shareholders. Explain the relationship with maximisation of the company’s share price

(14 marks) (b) What flaws may exist in using this model for calculation of share price. (6 marks) Total (20 marks)

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Business Finance Decisions –

Question 12: The Perry Barr plc is a manufacturing company located in Birmingham. Recently, the Management of Perry Barr plc is considering an initial investment of £440,000 on some plant and machinery to manufacture a new product. The project also requires £200,000 on working capital. The expected sales and cost of the project are as follows: Year

Sales

1 2 3

£850,000 £980,000 £1,000,000

Variable Costs Fixed Costs £500,000 £600,000 £610,000

£150,000 £150,000 £150,000

The plant and equipment will be depreciated on a straight-line basis over three years. The investment in working capital will be recovered at the end of Year 3, and the equipment would be sold for only £20,000. Additional Information: 

Perry Barr plc pays corporation tax at an effective rate of 20% at the end of each year. The company does not expect this to change over the life of the project.



The company’s after-tax cost of capital is 12 per cent per annum.

Required (a) Derive the annual net cash-flows of the project.

(14 marks)

(b) Calculate the net present value of the project and state the decision rule for this investment appraisal. (6 marks) Total (20 marks)

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Business Finance Decisions –

Question 13: Perry Barr plc is financed by: 

10 million ordinary shares (nominal value £1 each), which are expected to yield a dividend of £0.10 per share in one year’s time; dividends are expected to grow by 10 per cent of the previous year’s dividend each year; the current market price of the share is £1.80 each;



A bank term loan of £10 million at 3 per cent over the bank base rate. The base rate is currently 4.5per cent.



9 percent £20 million irredeemable preference shares of £1 nominal value each. The preference shares are currently at 145 pence each.

Additional Information: 

The corporate tax rate is 20 per cent.

Required: (a) For Perry Barr plc, Calculate the weighted average cost of capital (15 marks) (b) Explain why the cost of equity capital is usually higher than the cost of debt capital. (5 marks)

Total (20 marks)

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Business Finance Decisions –

Question 14: The following information has been extracted from the financial statements of Perry Barr plc (assume a 365-day year): Income statement extracts £000 Turnover Cost of sales: Raw materials Labour

£000 12,000

5,800 3,060 8,860 3,140

Gross profit Financial position statement extracts £000 Current assets: Inventories of raw materials Inventories of finished goods Trade receivables Cash and bank

£000

1,634 2,018 1,538 500 5,690

Current liabilities Trade payables Overdraft Other expense

1,092 300 76 1,468

Required

(a) Calculate the length of the cash conversion cycle of Perry Barr plc (12 marks) (b) Discuss its significance to the company. Discuss ways in which Perry Barr plc could shorten its cash conversion cycle. (8 marks) Total (20 marks)

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Business Finance Decisions –

Question 15:

Becky King Ltd, an unquoted company is considering a listing on the London Stock Exchange.

(a) Discuss the advantages and disadvantages Becky King Ltd would encounter if they followed this avenue? (14 marks) (b)

How else might a company increase their equity capital. (6 marks) Total (20 marks)

Question 16 The current market price of a share is £2.50. A dividend of 20p has just been paid. Assuming the expected annual growth rate for the dividend is 5 per cent to perpetuity, calculate the cost of equity. Example 2 Year

Dividend (£)

2002

15,000

2003

15,500

2004

17,200

2005

18,100

2006

19,000

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Business Finance Decisions –

Calculate the growth rate. If the number of shares is 100,000 and the current share price is 380p, calculate the cost of equity.

Question 17 The past pattern of dividends of a company is; 2001 20p 2002 21p 2003 24p 2004 25p 2005 28p 2006 30p 2007 31p (just declared) The current share price is 486p. What is the cost of equity?

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