Exam March 2013, questions PDF

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Class test: March 2013FINANCIAL MANAGEMENTTime allowed: 45 minutesAttempt ALL questions.Each question is worth ONE mark.In each case, only one of the responses (a) – (e) is correct.There is no penalty for an incorrect answer.Indicate your answer to each question by marking the appropriate box on the...

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Attempt ALL questions. Each question is worth ONE mark. In each case, only one of the responses (a) – (e) is correct. There is no penalty for an incorrect answer.

The formula for the present value of a growing annuity is:

PV

-

 1  

1  1

     





where the first expected cash flow occurs one period from today, the final expected cash flow occurs periods from today, the growth rate is and the discount rate is .

Silent pocket calculators that are not capable of text storage or retrieval are permitted, but their instruction booklets are not permitted. Mobile telephones are not permitted.

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If investors can consistently profit from analysing published financial information, then the market can, at best, be characterised as: (a) (b) (c) (d) (e)

weak-form efficient. semi-strong-form efficient. strong-form efficient. inefficient. Impossible to say without knowing more about the published information.

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A company is selling a machine for £10,000 that it originally bought five years ago for £100,000. Assume that capital allowances are calculated on a 25% reducing-balance basis, and that the company pays corporate taxes at 30 per cent. Assume that the company has sufficient taxable income to absorb all of its capital allowances. What is the effect of this disposal on the company’s tax payment for this year? (a) (b) (c) (d) (e)

Increases by £7,120 Increases by £4,120 Decreases by £4,120 Decreases by £7,120 Decreases by £13,730

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Which one of the following incremental cash-flow forecasts is increase in shareholder value?

likely to result in an

(a) (b) (c) (d) (e)

One that reflects the exploitation of a competitive advantage. One that indicates a short payback period. One that indicates a positive net present value. One that indicates a high internal rate of return relative to the hurdle rate. One that indicates a high accounting rate of return relative to the return on capital employed. ( ) ----------------------------------------------------------------------------------------------------------------

The Main Board of Company B invites two of its managers to rank a set of capital projects. Manager X uses the Net Present Value method, whereas Manager Y uses the Profitability Index. Which of the following statements is true? (a) (b) (c)

X and Y agree on which projects should be undertaken only if capital is rationed. X and Y agree on which projects should be undertaken only if capital is not rationed. X and Y always agree on which projects should be undertaken, regardless of whether capital is rationed or not. (d) X and Y never agree on which projects should be undertaken. (e) None of the above statements is true. ( ) ----------------------------------------------------------------------------------------------------------------

In project appraisal, an increase in net working capital can be modelled as: (a) (b) (c) (d) (e)

a cash inflow at the beginning of the project only. a cash outflow at the beginning of the project only. a cash inflow at the beginning and an equal cash outflow at the end of the project. a cash outflow at the beginning and an equal cash inflow at the end of the project. a decrease in the initial amount invested. ( ) ----------------------------------------------------------------------------------------------------------------

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Which one of the following statements (a) – (d) is of a firm that uses its WACC as the hurdle rate for appraising all of its capital projects, regardless of how risky those projects are? (a) (b) (c) (d) (e)

The firm’s operations will tend to become less risky over time. The firm’s operations will tend to become more risky over time. The firm will likely see its WACC fall over time. The firm will accept only projects for which the IRR equals the WACC. None of the above statements (a) – (d) is true.

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What is expected to happen to a security that offers a higher risk premium than that predicted by the Securities Market Line? (a) (b) (c) (d) (e)

Its beta will increase. Its beta will decrease. Its price will increase. Its price will decrease. Its price will not change.

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Company C maintains an average level of 15,000 units of inventory throughout the year. Storage costs equal £9 per item. The firm orders 30,000 units each month, and incurs a fixed charge of £200 each time it re-orders. How large is the economic order quantity? (a) (b) (c) (d) (e)

1,250 units. 2,000 units. 2,400 units. 4,000 units. 7,500 units.

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A firm needs to raise £600,000 via a rights issue. There are 2 million shares outstanding, trading at £1.80 per share. The issue price is £1.50 per share.

How many rights are required to purchase one new share? (a) (b) (c) (d) (e)

3 4 5 6 None of the above.

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What is the value of a right? (a) (b) (c) (d) (e)

£0.25 £0.30 £0.35 £1.75 None of the above.

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According to Myers’ (1984) pecking-order hypothesis, which of the following are reasons why managers might choose to raise debt in preference to new equity? (i) The costs of issuing debt are less than the costs of raising equity. (ii) The requirements regarding disclosure of commercially-sensitive information are less stringent for debt origination than for equity origination. (iii) To dilute the firm’s earnings per share. (a) (b) (c) (d) (e)

(i) only. (i) and (ii) only. (i) and (iii) only. (ii) and (iii) only. (i), (ii) and (iii).

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Assume a Modigliani-Miller (1963) world in which the corporate tax rate is 30%. plc and plc each have annual net operating cash flows of £250,000 in perpetuity and identical business risks. plc is all-equity financed. Its cost of equity capital equals 12%. plc has both equity and debt in its capital structure. Its debt has a market value of £1.25 million and pays an annual coupon of 8%. Assume that each company distributes all of its surplus earnings as dividends.

What is the value of (a) (b) (c) (d) (e)

plc?

£1,250,000 £1,500,000 £2,083,333 £2,375,000 £2,458,333

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What is the value of (a) (b) (c) (d) (e)

plc?

£1,250,000 £1,500,000 £2,083,333 £2,375,000 £2,458,333

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Assume a Modigliani & Miller (1958) perfect world. Company Y has a fixed capital investment policy and is part-equity, part-debt financed. Which of the following will increase if the firm decides to replace some of its equity with debt? (i) The variability of the firm’s earnings per share. (ii) The firm’s operating risk. (iii) The firm’s weighted average cost of capital (WACC). (a) (b) (c) (d) (e)

(i) only. (ii) only. (i) and (ii) only. (ii) and (iii) only. (i), (ii) and (iii).

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All other things being equal, which of the following be a reason why an investor would prefer owning shares in firms with high dividend payouts? (i) The investor needs cash. (ii) The investor is not a higher-rate taxpayer. (iii) The costs of raising new finance are significant. (a) (b) (c) (d) (e)

(i) only (ii) only. (i) and (ii) only. (ii) and (iii) only. (i), (ii) and (iii).

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