1 A company has constructed a model for predicting profits.

Net profit or loss

depends on two variables: gross profit and overheads. The following are
independent probability distributions of the two variables.

Gross profit Probability Overheads Probability

£ £
12,000 0.1 6,000 0.3
6,000 0.4 4,000 0.3
4,000 0.4 3,000 0.3
3,000 0.1 2,000 0.1

What is the probability that the company will make a positive net profit?

A 0.27
B 0.55
C 0.73
D 0.82

2 The annual sales volume and the unit contribution margin of a new product are
uncertain. Estimates for these two variables are as follows.

Sales volume Unit Contribution Probability

(units) probability
80,000 0.1 £2.00 0.5
75,000 0.6 £1.50 0.5
50,000 0.3
[68,000 expected value] [£1.75 expected value]

The sales volume and unit contribution margin have been assumed to be
independent.

If the annual fixed costs are £130,000, what is the probability that the company
will make a loss?

A 0.30
B 0.50
C 0.65
D 1.00

3 Adrian is contemplating purchasing for £60,000 a machine which he will use to

produce 10,000 disks per annum for five years. These disks will be sold for £9
each and unit variable costs are expected to be £5. Incremental fixed costs will
be £14,000 per annum for production costs and £5,000 per annum for selling and
administration costs. Adrian has a rate of time preference of 10% per annum.

By how many units must the estimate of production and sales volume fall for the
project to be regarded as not worth while?

A 575
B 1,293
C 1,623
D 2,463
4 The price of a company’s share is currently £40 ex-div. The latest dividend is £3
per share.

If the company’s cost of equity is 10% per annum, what is the implicit constant
annual dividend growth rate?

A 2.33%
B 2.50%
C 7.50%
D 10.00%

5 Four years ago a company paid a dividend of £610,000 on a share capital of 4

million ordinary shares of 50p. It has just paid a dividend of £960,000 on the
same share capital, and the current market price of the shares is 300p.

What is the estimated cost of equity capital?

A 20.0%
B 21.0%
C 22.3%
D 23.5%

6 A firm has achieved an average growth in dividends over the last five years of
10.5% per annum. It is now widely believed that the long-run average annual
dividend growth rate will be 9.16% per annum. The firm’s current net dividend
yield is 4.8%.

What is the cost of equity capital?

A 13.96%
B 14.40%
C 15.30%
D 15.80%

7 Oldcourt plc’s capital structure is as follows.

£m
£1 ordinary shares 12
8% £1 preference shares 6
12.5% irredeemable loan stock 8
—–
26
—–

The current market prices of the company’s securities are as follows.

£1 ordinary shares 225p

8% preference shares 92p
12.5% loan stock £100

The company is paying corporation tax at the rate of 30%. The cost of the
company’s ordinary equity capital has been estimated at 15% per annum.

The company’s weighted average cost of capital for capital investment appraisal
purposes is
 A 12.66%
B 12.76%
C 12.91%
D 13.49%

8 Earnings and interest payments for the following firm are constant in perpetuity.
All prices are ex-dividend or ex-interest with payments made annually. The firm
has 100 million shares issued and fully paid at a nominal value of 25p and a
market price of 120p. The dividends per share are 24p. The issued debt consists
of £160 million (nominal value) of irredeemable loans with a coupon rate of 6%.
The debt is currently traded at £50 per £100 nominal. The rate of corporation tax
is 30%.

What is the firm’s post-tax weighted average cost of capital?

A 10.97%
B 12.00%
C 14.40%
D 15.36%

9
A UK oil trader, Teresa, is considering purchasing oil on the spot market for
speculative purposes. The current spot price is $18 a barrel. However, she
expects the price to decline to $16 a barrel in one month's time. If she
bought on the spot market today, she would hold the oil for one month at a
cost of £0.002 a barrel for the month, after which she could sell the oil on
the spot market. The current US dollar exchange rate is $1.50/£.

If she expects the exchange rate to be $1.30/£1 in one month's time, what
is her expected gain/loss on the oil deal?

A £0.306 gain per barrel

B £0.027 gain per barrel
C £1.540 loss per barrel
D £6.202 loss per barrel

10 A UK company is to pay a German supplier €100,000 in three months’ time.

Which of the following options would reduce the company's exchange rate
exposure?

Option 1 Borrow euro immediately such that the amount borrowed can
be deposited for 3 months to accumulate with interest to
€100,000

Option 2 Arrange a forward contract to sell the required amount of euro

in three months’ time

A Option 1 only
B Option 2 only
C Neither option
D Both options
11. Hawk plc makes an offer for the entire share capital of Pigeon plc of one
share in Hawk plc plus £1 in cash for each of Pigeon plc's existing
shares. Prior to knowledge of the bid becoming public, the share price
and number of shares in issue in each of the companies were as follows:

Number of shares Market price

Hawk plc 40 million £1.00

Pigeon plc 10 million £1.80

Hawk plc believes that the merger will result in synergistic benefits with a
net present value of £17 million.

If Hawk plc is successful in acquiring all the share capital of Pigeon plc
and the market's assessment of the merger coincides with Hawk plc's
beliefs, what are the benefits that accrue to the shareholders of Pigeon
plc?

A £2 million
B £3 million
C £5 million
D £9 million

12. A company incorporates additional debt finance into its capital structure.
The level of operating risk is maintained as previously.

Assuming perfect capital markets exist with taxation, what should

happen to the company's cost of equity and weighted average cost of
capital (WACC)?

Cost of equity WACC

A Increase Decrease
B Increase Constant
C Constant Decrease
D Constant Constant
13. If, for a given level of activity, a firm's ratio of fixed costs to variable costs rose
and at the same time its ratio of debt to equity rose, what would be the impact
on the firm's financial and operating risk?

Financial risk Operating risk

A Increase Increase
B Decrease Increase
C Increase Decrease
D Decrease Decrease
14. A UK company has just despatched a shipment of goods to the US. The
sale has been invoiced in US dollars and payment is to be made in three
months' time. Neither the UK exporter nor the US importer uses the
forward foreign exchange market to cover exchange risk.

If sterling were to strengthen substantially against the US dollar, what

would be the foreign exchange gain or loss effects upon the UK exporter
and the US importer?

UK US
exporter importer

A Loss Gain
B Loss No effect
C Gain Gain
D Gain No effect

15. The following two statements relate to the financial gearing of listed
companies:

Statement One
‘An increase in financial gearing normally increases both the required
return and the risk of the ordinary shareholders.’

Statement Two
‘In perfect capital markets, with taxation, the company's capital
structure does not affect its total market value, but it does affect the
WACC.’

What is the validity of the two statements?

Statement One Statement Two

A True True
B True False
C False True
D False False