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WorksheetsFM - Risk Management, Ratios, Buss. Valuation
Total questions: 35
Worksheet time: 2hrs 30mins
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?
$14
$25
$28
$13
Which of the following are descriptions of basis risk?
(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.
1 only
1 and 3
2 and 4 only
2, 3 and 4
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%.
What is the theoretical value of the company?
$20m
$40m
$50m
$25m
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%.
What is the current market value of a Lane Co convertible loan note?
$73·47
$73·47
$67·26
$94·20
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.
What is the theoretical value of a right per existing share?
$1·60
$0·40
$0·50
$1·50
Herd Co is based in a country whose currency is the dollar ($). 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.
What is the six-month forward exchange rate predicted by interest rate parity?
€1·499 per $1
€1·520 per $1
€1·566 per $1
€1·588 per $1
Herd Co is based in a country whose currency is the dollar ($). 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 $1. The domestic short-term interest rate is 2% per year, while the foreign short-term interest rate is 5% per year.
As regards the euro receipt, what is the primary nature of the risk faced by Herd Co?
Transaction risk
Economic risk
Translation risk
Business risk
Herd Co is based in a country whose currency is the dollar ($). 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 $1. The domestic short-term interest rate is 2% per year, while the foreign short-term interest rate is 5% per year.
Which of the following hedging methods will NOT be suitable for hedging the euro receipt?
Forward exchange contract
Money market hedge
Currency futures
Currency swap
Herd Co is based in a country whose currency is the dollar ($). 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 $1. The domestic short-term interest rate is 2% per year, while the foreign short-term interest rate is 5% per year.
Which of the following statements support the finance director’s belief that the euro will depreciate against the dollar?
(1) The dollar inflation rate is greater than the euro inflation rate
(2) The dollar nominal interest rate is less than the euro nominal interest rate
1 only
2 only
Both 1 and 2
Neither 1 nor 2
Herd Co is based in a country whose currency is the dollar ($). 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.
As regards the interest rate risk faced by Herd Co, which of the following statements is correct?
In exchange for a premium, Herd Co could hedge its interest rate risk by buying interest rate options
Buying a floor will give Herd Co a hedge against interest rate increases
Taking out a variable rate overdraft will allow Herd Co to hedge the interest rate risk through matching
Taking out a variable rate overdraft will allow Herd Co to hedge the interest rate risk through matching
A company has just paid an ordinary share dividend of 32.0 cents and is expected to pay a dividend of 33.6 cents 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?
$3.20
$4.41
$2.59
$4.20
Company A’s shares have a higher beta factor than company B’s.
Which of the following is true about company A?
Total risk is higher than company B
It is exposed to more systematic risk factors than company B
Its shares are under priced
It is exposed to higher levels of systematic risk than company B
TKQ Co has just paid a dividend of 21 cents per share and its share price one year ago was $3·10 per share. The total shareholder return for the year was 19·7%.
What is the current share price?
$3·50
$3·71
$3·31
$3·35
Which of the following statements is/are correct?
1. Securitisation is the conversion of illiquid assets into marketable securities
2. The reverse yield gap refers to equity yields being higher than debt yields
3. Disintermediation arises where borrowers deal directly with lending individuals
2 only
1 and 3 only
2 and 3 only
1, 2 and 3
Which of the following statements are correct?
1. Maximising market share is an example of a financial objective
2. Shareholder wealth maximisation is the primary financial objective for a company listed on a stock exchange
3. Financial objectives should be quantitative so that their achievement can be measured.
1 and 2 only
1 and 3 only
2 and 3 only
1, 2 and 3
Which of the following statements is correct?
Tax allowable depreciation is a relevant cash flow when evaluating borrowing to buy compared to leasing as a financing choice
Asset replacement decisions require relevant cash flows to be discounted by the after-tax cost of debt
If capital is rationed, divisible investment projects can be ranked by the profitability index when determining the optimum investment schedule
Government restrictions on bank lending are associated with soft capital rationing
Which of the following statements is correct?
Once purchased, currency futures have a range of close-out dates
Currency swaps can be used to hedge exchange rate risk over longer periods than the forward market
Banks will allow forward exchange contracts to lapse if they are not used by a company
Currency options are paid for when they are exercised
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%.
What is the current market value of each loan note?
$92·67
$108·90
$89·93
$103·14
Which of the following statements concerning profit are correct?
1. Accounting profit is not the same as economic profit
2. Profit takes account of risk
3. Accounting profit can be manipulated by managers.
1 and 3 only
1 and 2 only
2 and 3 only
1, 2 and 3
Which of the following statements is/are correct?
1. An increase in the cost of equity leads to a fall in share price
2. Investors faced with increased risk will expect increased return as compensation
3. The cost of debt is usually lower than the cost of preference shares.
2 only
1 and 3 only
2 and 3 only
1, 2 and 3
The following are extracts from the statement of financial position of a company :
The ordinary shares have a nominal value of 50 cents 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 80 cents per share. The bonds have a nominal value of $100 and are trading at $105 per bond.
What is the market value based gearing of the company, defined as prior charge capital/equity?
15·0%
13·0%
11·8%
7·3%
Which of the following statements is correct?
Governments may choose to raise interest rates so that the level of general expenditure in the economy will increase
The normal yield curve slopes upward to reflect increasing compensation to investors for being unable to use their cash now
The yield on long-term loan notes is lower than the yield on short-term loan notes because long-term debt is less risky for a company than short-term debt
Expectations theory states that future interest rates reflect expectations of future inflation rate movements
A company has just paid an ordinary share dividend of 32·0 cents and is expected to pay a dividend of 33·6 cents 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?
$3·20
$4·41
$2·59
$4·20
Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March.
Notes:
1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one month’s credit.
2. Production of goods for sale takes place one month before sales.
3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is held. Raw material purchases are on one months’ credit.
4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of production.
5. The opening cash balance at 1 January is expected to be $40,000.
6. A long-term loan of $300,000 will be received at the beginning of March.
7. A machine costing $400,000 will be purchased for cash in March.
Calculate the forecast current ratio at the end of the three-month period.
4·1 times
4·6 times
4·9 times
4·8 times
Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March.
Notes:
1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one month’s credit.
2. Production of goods for sale takes place one month before sales.
3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is held. Raw material purchases are on one months’ credit.
4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of production.
5. The opening cash balance at 1 January is expected to be $40,000.
6. A long-term loan of $300,000 will be received at the beginning of March.
7. A machine costing $400,000 will be purchased for cash in March.
Calculate Inventory at the end of the three-month period.
$750,000
$150,000
$600,000
$10,00,000
Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March.
Notes:
1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one month’s credit.
2. Production of goods for sale takes place one month before sales.
3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is held. Raw material purchases are on one months’ credit.
4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of production.
5. The opening cash balance at 1 January is expected to be $40,000.
6. A long-term loan of $300,000 will be received at the beginning of March.
7. A machine costing $400,000 will be purchased for cash in March.
Calculate Trade receivables at the end of the three-month period.
$1,172,000
$1,170,000
$1,176,000
None of the above
Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March.
Notes:
1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one month’s credit.
2. Production of goods for sale takes place one month before sales.
3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is held. Raw material purchases are on one months’ credit.
4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of production.
5. The opening cash balance at 1 January is expected to be $40,000.
6. A long-term loan of $300,000 will be received at the beginning of March.
7. A machine costing $400,000 will be purchased for cash in March.
Calculate Cash balance at the end of the three-month. period:
$792,000.
$992,000.
$892,000.
None of the above
Which of the following ratios would be used to assess the liquidity of a company?
(i) Return on capital employed
(ii) Gross profit percentage
(iii) Acid test ratio
(iv) Gearing ratio.
(i) and (ii) only
(iii) only
(iv) only
(iii) and (iv) only
Comment on the validity of the following statements, in relation to the Efficient Market Hypothesis.
Statement 1: An inefficient market is one in which the value of securities is not always an accurate reflection of the available information.
Statement 2: In a semi-strong form market the share price incorporates all past information and all publicly-available information.
True True
True False
False True
False False
AJP Co is an unlisted company. The owner and manager of the business is approaching retirement and is considering the sale of his business. Financial information is as follows:
Number of ordinary shares 5,000
Latest earnings per share $7
Estimated equity beta 1.5
Latest free cash flow available to the owner $33,000 (after salary payment)
The owner and manager pays himself an annual salary of $200,000 which is $60,000 more than could be reasonably expected for such a role.
What would be a suitable earnings figure to use for a business valuation based on the P/E ratio?
$33,000
$75,000
$77,000
$95,000
AJP Co is an unlisted company. The owner and manager of the business is approaching retirement and is considering the sale of his business. Financial information is as follows:
Number of ordinary shares 5,000
Latest earnings per share $7
Estimated equity beta 1.5
Latest free cash flow available to the owner $33,000 (after salary payment)
The owner and manager pays himself an annual salary of $200,000 which is $60,000 more than could be reasonably expected for such a role.
If after taking other factors into consideration a suitable earnings figure of $50,000 is determined and unlisted companies are generally to be considered 20% less valuable than listed ones in this industry, estimate the total value of AJP using the P/E method.
$350,000
$360,000
$450,000
$687,500
AJP Co is an unlisted company. The owner and manager of the business is approaching retirement and is considering the sale of his business. Financial information is as follows:
Number of ordinary shares 5,000
Latest earnings per share $7
Estimated equity beta 1.5
Latest free cash flow available to the owner $33,000 (after salary payment)
The owner and manager pays himself an annual salary of $200,000 which is $60,000 more than could be reasonably expected for such a role.
If valuing a business using asset values, when would a valuation using net realisable values NOT be appropriate?
For the seller to use as a maximum price
When the business is not a going concern
For a purchaser who wishes to immediately break up the business after purchase
If the business is a property investment company
AJP Co is an unlisted company. The owner and manager of the business is approaching retirement and is considering the sale of his business. Financial information is as follows:
Number of ordinary shares 5,000
Latest earnings per share $7
Estimated equity beta 1.5
Latest free cash flow available to the owner $33,000 (after salary payment)
The owner and manager pays himself an annual salary of $200,000 which is $60,000 more than could be reasonably expected for such a role.
Calculate a price per share using the dividend valuation model.
$30.00
$31.50
$33.08
$55.13
AJP Co is an unlisted company. The owner and manager of the business is approaching retirement and is considering the sale of his business. Financial information is as follows:
Number of ordinary shares 5,000
Latest earnings per share $7
Estimated equity beta 1.5
Latest free cash flow available to the owner $33,000 (after salary payment)
The owner and manager pays himself an annual salary of $200,000 which is $60,000 more than could be reasonably expected for such a role.
Which of the following would not be deducted in a calculation of free cash flows?
Annual investment in non-current assets
Ongoing directors’ salaries
Dividends
Tax
Which of the following is the correct statement of the conclusion of Modigliani and Miller on the relevance of dividend policy?
Increase in retentions result in a higher growth rate
All shareholders are indifferent between receiving dividend income and capital gains
The value of the shareholders’ equity is determined solely by the firm’s investment selection criteria
Discounting the dividends is not an appropriate way to value the firm’s equity
