january 2016

Finance
PRACTICE QUESTIONS FOR CFS & CPA

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Practice Questions Finance

1 Meeting financial objectives generates more profits but not without non-financial objectives.
Therefore, it is essential to identify each type of objectives separately for planning purpose.

Which of the following can be identified as a non-financial objective of an organisation?

a Achieve and maintain a AA bond rating
b Conformance with IS0 9000
c Maintain a positive cash flow
d Maintain earnings per share 15% annually

2 Hat plc is undertaking a project that worth $10m. The management of Hat plc wishes to raise the
sum by issuing rights share at a discount of 20%. Hat plc has in issue 50m $1 ordinary shares. The
current market value is $100m.

What is the amount of new shares needed for rights issue? (to the nearest whole number)
a 4,170,000
b 5,000,000
c 6,250,000
d 25,000,000

3 The opinion of an investor regarding efficient market hypothesis is:

In a market which is strong-form efficient, it can be expected that any existence of creative
accounting or window-dressing of financial accounts will adversely affect the market.

State whether his opinion is correct.

a The investor is having wrong opinion.
b The investor is having a slight misunderstanding as he is addressing creative accounting and
window-dressing as synonymous.
c The investor is having a correct opinion.
d The investor is wrong because creative accounting or window-dressing of financial accounts is
relevant in efficient market hypothesis.

4 Consider the following opinion that address efficient market hypothesis:

1. Markets which are semi-strong form efficient will not react to or be affected by window dressing
or creative accounting.
2. Share prices in markets which are weak-form efficient follow a random pattern of movement and
it is not possible to predict future movements by studying past patterns.

Which of the following is a correct combination?

a Statement 1 = True; Statement 2 = True
b Statement 1 = True; Statement 2 = False
c Statement 1 = False; Statement 2 = True
d Statement 1 = False; Statement 2 = False

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Practice Questions Finance

5 Declaration and issuance of bonus share will have influence on numbers of factors of a listed
company.

Which one of the following will NOT be directly affected by a bonus issue?
a Earnings per share
b Financial gearing
c Issued share capital
d Outstanding share capital

6 Consider the following statements:

1. EPS shows the amount of profit attributable to each ordinary share. But, it does not represent
actual income of the ordinary shareholders.
2. Dividend per share is the ordinary dividend for the year to ordinary number of shares expressed in
terms of percentages (%).
3. Dividend pay-out ratio is the percentage of earnings paid to shareholders as dividends. This shows
how well earnings support the dividend payments.
4. Dividend cover represents how many times dividend could have paid from the profit attributable
to creditors.

Which of the above (if any) is not appropriate?

a 1 and 2 only
b 2 only
c 1 and 3 only
d 2 and 4 only

7 When Wikii Co order for new supplies of inventory W3s, deliveries by supplier are sometimes made
in 5 working days and sometimes take as long as 20 days. Daily consumption can be as low as 1 unit
and as high as 6 units. The company maintains a buffer inventory of 40 units. The economic order
quantity for W3s is 45 units.

What is the maximum number of units of this item that the Wikii could hold?
a 120 units
b 145 units
c 160 units
d 200 units

8 Harrods Ltd anticipates it would require an investment of $20,000 in current liability for the
forthcoming year. It has targeted to maintain current ratio at 3:1, turnover to current assets at 5:1,
and acid test ratio at 4:2.

What would be the likely forecast sales turnover and inventory level of Harrods Ltd, based on its
targeted ratios?
a Sales turnover = $120,000; Inventory = $60,000
b Sales turnover = $300,000; Inventory = $20,000
c Sales turnover = $120,000; Inventory = $40,000
d Sales turnover = $300,000; Inventory = $60,000

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Practice Questions Finance

9 Which of the following situations indicates a company is over-capitalised?

(i) Low sales revenue to working capital ratio
(ii) High debt to equity ratio
(iii) Sudden increase in quick ratio
a (i) & (ii)
b (ii) & (iii)
c (i) & (iii)
d (i) ,(ii) & (iii)

10 Which ONE of the following has the job of trying to ensure a successful issue for the company's
shares, by advising on an issue price for the shares, and trying to interest institutional investors in
buying some of the shares?
a A sponsoring member firm
b An issuing house
c An underwriter
d An intermediary

11 If Thm Ltd needs assurance that all if its issued shares are not bought by general public will be
subscribed, it needs to pursue the services of:

a A sponsoring member firm

b An issuing house
c An underwriter
d An intermediary

12 Bat has spent $2 million developing a new product and a further $800,000 on market research to
find out whether a market launch would be worth undertaking. The findings of the market research
were as follows.

(a) To launch the product on the market, the company would have to spend a further $800,000 on
equipment. This would be depreciated over three years by the straight-line method, and would have
an estimated resale value of $200,000 at the end of this time.
(b) The product would have a life of just three years, and profits after depreciation would be
$500,000 in the first year, $600,000 in the second year and $300,000 in the third year.
(c) There would be an initial investment of $120,000 in working capital in the first year and a further
$140,000 of working capital would be needed in Year 2.
(d) Instead of investing in the product launch, the company could sell the rights to the product to
another company for $500,000.

What are the estimated net cash flows from this project?
a $560,000
b $800,000
c $900,000
d $960,000

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Practice Questions Finance

13 Teai plc and Kophi plc are joint stock listed company. Teai plc and Kophi plc companies shares have
been estimated with a beta value of 0.8 and 1.5 respectively. The expected market return is 12% .Teai
plc shareholders expect a return of minimum 10%. Kophi plcs shareholders expected rate of return
can be calculated based CAPM method.

Which ONE of the following is the correct expected rate of return of Kophi plcs shareholders?
a 2%
b 10%
c 12%
d 17%

14 ABC's shares have a beta value of 1.2. The market return is 10% and the risk-free rate of return is 6%.

What is the expected return on ABC's equity is?

a 10%
b 10.8%
c 14.8%
d 15%

15 Company X and Company Y both pay an annual cash return to shareholders of 34.5 cents per share
and this is expected to continue in perpetuity. The risk-free rate of return is 8% and the current
average market rate of return is 12%. Company X's coefficient is 1.8 and Company Y's is 0.8.

What would be the predicted market value of each company's shares?

a X = 220 cents; Y = 803cents
b X = 308 cents; Y = 227 cents
c X = 227 cents; Y = 308 cents
d X = 803 cents; Y = 220 cents

16 A company is financed by a mixture of equity and debt capital, whose market values are in the ratio
3:1. The debt capital, which is considered risk-free, yields 10% before tax. The average stock market
return on equity capital is 16%. The beta value of the company's equity capital is estimated as 0.95.
The tax rate is 30%.

What would be an appropriate cost of capital to be used for investment appraisal of new projects
with the same systematic risk characteristics as the company's current investment portfolio?
a 7.0%
b 10%
c 13.5%
d 15.7%

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Practice Questions Finance

17 A company issues $25 million of 5% convertible bonds at 102.00. The bonds are convertible in five
years' time into ordinary shares of the company, at the rate of 15 shares for each $100 of bonds. The
current share price is $5.60.

What is the value of conversion?

a $84
b $100
c $110
d $120

18 CD has issued 50,000 units of convertible debentures, each with a nominal value of $100 and a
coupon rate of interest of 10% payable yearly. Each $100 of convertible debentures may be
converted into 40 ordinary shares of CD in three years time. Any stock not converted will be
redeemed at 110.

Estimate the likely current market price for $100 of the debentures, if investors in the debentures
now require a pre-tax return of only 8%, and the expected value of CD's ordinary shares on the
conversion day is 2.50 per share.

a $111.11 per $100 of debentures

b $113.11 per $100 of debentures
c $115.11 per $100 of debentures
d $118.11 per $100 of debentures

19 5URL Co has only $60,000 to invest in the following divisible projects. None of the projects are
repeatable and can be delayed.

Year 0 Year 1 Year 2 Year 3 Year 4

A (50,000) (20,000) 20,000 40,000 40,000
B (28,000) (50,000) 40,000 40,000 20,000
C (30,000) (30,000) 30,000 40,000 10,000

The cost of capital is 10%. Capital investment is made only in Year 0.

What is the approximate NPV from total investment (to the nearest whole number)?

Present value table (extracted)

Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683

a $63,084
b $56,800
c $62,310
d $44,230

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Practice Questions Finance

20 Tes plc, a UK company, expects to receive US$5m in 6 months time. In order to hedge the
possible exchange rate risk, which ONE of the following should Tes plc consider to undertake?
a Sell US dollar futures
b Sell Euro futures
c Buy US dollar options
d Buy Euro futures

21 SG Co has been offered with a project. The project will need an initial investment on a non-
current asset of $100,000 and a further $5,000 on working capital. The estimated duration of the
project would be for 5 years. However, the project would need a further investment of $5,000 at
the end of year 4 as SG Co would need to replace one of its machinery. The cash flows from the
project would be as follows:

1 $10,000
2 $20,000
3 $30,000
4 $40,000
5 $60,000

SG Cos cost of capital is 10%.

Mr. Drake, finance manager of SG Co, as an initial appraisal of the project, calculate the
discounted payback period. What would be his likely result?

Present value table (extracted)

1 0.909
2 0.826
3 0.751
4 0.683
5 0.621
a 4 years 8 months
b 4 years 9 months
c 4 years 10 months
d 4 years 11 months

22 Compute NI Ltds cash cycle (assume period length is 360 days) based on the data provided
below:

$000
Sales 100
Cost of sales 40
Inventories 10
Trade receivables 20
Trade payables 5
a 25 days
b 63 days
c 117 days
d 119 days

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Practice Questions Finance

23 Little Inc. sells kids dress. The demand for this product is 40,000 units a year, at a steady rate. The
purchase price of the product is $25 per unit. It costs $20 to place an order, and 40c to hold a
unit for a year. Little Inc. uses economic order quantity as its ordering size.

What is the total annual cost of trading in this product? (assume 52 weeks a year)
a $1,000,800
b $1,008,400
c $1,004,000
d $1,000,400

24 A German company needs to pay US dollars to an American supplier in 90 days. How can it
hedge the transaction using futures?
a buy euro futures now, and close its position in 90 days by selling euro futures.
b buy euro futures now, and close its position in 90 days by buy euro futures.
c sell euro futures now, and close its position in 90 days by buying euro futures.
d sell euro futures now, and close its position in 90 days by selling euro futures.

25 A UK company expects to receive 5 million US dollars in six months' time from a customer. How
can it hedge this receipt on the US futures market? The current spot rate is /$ 1.4310 and the
relevant sterling futures contract is trading at /$ 1.4275.

What is the number of contracts to be used to hedge the risk, if the spot rate in six months' time
is /$1.4800 and the futures price is $1.4790.
a 52 contracts
b 54 contracts
c 56 contracts
d 58 contracts

26 A put option based on Max Cos share has a premium of 80c and its strike (exercise) price is 520c.
Sigmas underlying share is currently quoted at 450c.

What does the premium consist of?

a Only intrinsic value
b Only time value
c Both intrinsic value and time value
d Neither intrinsic nor time value

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Practice Questions Finance

27 Why a company should needs to smooth out dividend payments?

a Companies are likely to have a short-term target for a dividend pay-out ratio, and will try to
avoid volatility in dividends from one year to the next. Companies therefore generally smooth
out dividend payments by adjusting only gradually to changes in earnings: large fluctuations
might undermine investors' confidence.
b Companies are likely to have a long-term target for a dividend pay-out ratio, and will try to
avoid volatility in dividends from one year to the next. Companies therefore generally smooth
out dividend payments by adjusting only gradually to changes in earnings: large fluctuations
might undermine investors' confidence.
c Companies are likely to have a long-term target for a dividend pay-out ratio, and will try to
avoid volatility in dividends from one year to the next. Companies therefore generally smooth
out dividend payments by adjusting only gradually to changes in earnings: smaller
fluctuations might undermine investors' confidence.
d Companies are likely to have a long-term target for a dividend pay-out ratio, and will try to
avoid volatility in dividends from one year to the next. Companies therefore generally smooth
out dividend payments by adjusting only gradually to changes in earnings: large fluctuations
might boost investors' confidence.

28 Consider the following statements regarding residual theory:

(i) If a company can identify projects with positive NPVs it should invest in them.
(ii) Only when these investment opportunities are exhausted should dividends be paid.

Which of the above is NOT consistent with residual theory?

a (i) only
b (ii) only
c (i) & (ii)
d None

29 Consider the following statements regarding scrip dividends:

(i) A scrip dividend is a dividend payment which takes the form of new shares instead of cash.
(ii) A scrip dividend is a way of retaining profits within the business, and at the same time
paying a dividend.
(iii) A scrip dividend converts profit reserves into issued share capital.

Which of the above is false?

a (i) & (ii)
b (i) & (iii)
c (i), (ii) & (iii)
d None

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Practice Questions Finance

30 A company issued some 6% bonds a few years ago. The bonds pay interest annually, and now
have exactly five years remaining to maturity (the most recent interest payment just having been
made). They will be redeemed at par. Investors in bonds of this type currently require a yield of
7% per annum.

What will be the market value of these bonds?

Year Discount factor at 7%
1 0.935
2 0.873
3 0.816
4 0.763
5 0.713
a $91.36
b $91.63
c $95.19
d $95.91
31 ESP Co has recently announced after-tax profits of $12 million and has a market capitalisation of
$60 million. The company expects profits to increase by 25% for the forthcoming year. The
company is committed to increasing the dividend by 4% per annum for the foreseeable future.
The company will maintain a constant dividend cover of 15 times throughout.

What is the predicted rate of return from the ordinary shares?

a 4.1%
b 11.5%
c 17.3%
d 20.7%

32 An investor holds some warrants that can be used to subscribe for ordinary shares on a one-for-
one basis at an exercise price of $2.50 during a specified future period. The current share price is
$2.25 and the warrants are quoted at 50c.

What is the warrant conversion premium?

a $0.75
b $2.00
c $2.75
d $3.00

33 A company has issued share warrants. Each warrant gives its holder the right to subscribe for one
new share in the company, in about three years time, at an exercise price of 780c. The warrants
are traded on the Stock Exchange and have a market value of 68c. The current market price of
the shares is 762c.

What is the premium on the warrants?

a 18c
b 68c
c 86c
d 848c

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Practice Questions Finance

34 SIX People Inc. order inventory size of 1,000 units using EOQ. An analysis of its suppliers lead
time, Tihon Ltd, and daily usage rates for the inventory shows that:

Maximum, average and minimum supply lead time taken by Tihon Ltd are 30 days, 22 days and
16 days consecutively. The maximum, average and minimum daily usage rates by SIX People Inc.
are 35 units, 30 units and 20 units consecutively. SIX People Inc. do not wish to run out of this
item inventory as this is the major component of its final product.

What would be the possible average buffer inventory and the maximum inventory that SIX
People Inc. should hold in its capacity?
a Average buffer inventory = 390 units; Maximum level of inventory = 1,730 units.
b Average buffer inventory = 390 units; Maximum level of inventory = 2,050 units.
c Average buffer inventory = 660 units; Maximum level of inventory = 1,730 units.
d Average buffer inventory = 660 units; Maximum level of inventory = 2,050 units.

35 Apl Ltd has recently declared a dividend of $0.50 per share and maintains a constant dividend
payout ratio of 20%. The market value of each share is $5.50 cum div.

What is the ex div price earnings ratio of Apl Ltd?

a 0.5 times
b 2.0 times
c 2.2 times
d 50.0 times

36 GMG Ltd. received a confidential letter from a Core Plc on 31 December 2014. Core Plc is
interested in buying all the shares in GMG Ltd at a premium of 40% on their current market value.
The directors of GMG Ltd agreed to accept the offer and made a public announcement of this
decision on 5 January 2015.

Taking into consideration that the market is either semi-strong and / or strong form efficient,
which ONE of the following share price reactions (increase/ insignificant) should be more logical
as on 5 January 2015?
a Under semi-strong form = increase; under strong form = increase
b Under semi-strong form = increase; under strong form = insignificant
c Under semi-strong form = insignificant; under strong form = increase
d Under semi-strong form = insignificant; under strong form = insignificant

37 Which ONE of the following is an indication that a business is over-capitalised?

a A higher than average payment period for trade payables
b A lower than average sales to working capital ratio
c A lower than average quick ratio
d A lower than average receivables period

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Practice Questions Finance

38 What categories of currency risk arise from the following:

(i) When a company borrows in a foreign currency and make interest payments in that
currency, and repay the loan principal in that currency at maturity
(ii) Whenever there is a foreign subsidiary in a group of companies.
a (i) = translation risk; (ii) = transaction risk
b (i) = transaction risk; (ii) = translation risk
c (i) = transaction risk; (ii) = economic risk
d (i) = translation risk; (ii) = economic risk

39 Which of the following methods of managing different currency risk is appropriate?

(i) Matching receipts and payments to reduce or eliminate its foreign exchange transaction
exposure
(ii) Leading or lagging might be used to take advantage of foreign exchange rate
movements
(iii) Matching assets and liabilities can be used to manage economic risk.
a (i) and (ii) only
b (i) and (iii) only
c (ii) and (iii) only
d (i), (ii) and (iii)

40 Mr. Orsi holds the following European-style options at expiry date.

(i) A put option on 6,000 shares in Lock with an exercise price of 545c. The current market
price of the shares is 510c.
(ii) A call option on 10,000 shares in Trim with an exercise price of 378c. The current market
price of the shares is 330c.
(iii) A call option on 500,000 euros in exchange for the dollar, at an exchange rate of 1=
US$0.9000 when the current exchange rate is $0.9500.
(iv) A put option on 250,000 in exchange for the dollar at a strike rate of 1 = US$1.4500,
when the current exchange rate is $1.4100.
(v) A call option on a notional loan, giving you the right to borrow a quantity of funds for six
months at a strike rate (LIBOR) of 5%, when the current six-month LIBOR is 5.6%.

State in which case Mr. Orsi would exercise the option or allow the option to lapse?
a (i) Exercise; (ii) Exercise; (iii) Exercise; (iv) Allow the option to lapse; (v) Exercise
b (i) Exercise; (ii) Allow the option to lapse; (iii) Exercise; (iv) Allow the option to lapse; (v)
Exercise
c (i) Exercise; (ii) Allow the option to lapse; (iii) Exercise; (iv) Exercise; (v) Exercise
d (i) Allow the option to lapse; (ii) Exercise; (iii) Exercise; (iv) Allow the option to lapse; (v)
Exercise

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Practice Questions Finance

41 A US company has just provided a service to a UK company for 500,000. Settlement is due in
three months time and the US company wants to hedge the risk of a fall in the value of the UK
sterling over the next three months. The following methods of hedging are being considered:
(i) Buy sterling call options now
(ii) Buy sterling put options now
(iii) Sell sterling futures now
(iv) Buy sterling futures now

Which of the above would provide a hedge against exchange rate risk?
a (i), (ii) and (iv)
b (ii) and (iii)
c (iii) and (iv)
d (i) and (iv)

42 IPho Ltd has irredeemable 4% debt capital in issue with a nominal value of 20m. The current
market value of the debt capital is 10 million and the tax rate is 25%. The current market value
of equity shares of IPho Ltd is 30 million. The weighted average cost of capital has been
determined as 10%.

The cost of equity of IPho Ltd would therefore be:

a 11.3%
b 11.8%
c 12.3%
d 12.8%

43 Which of the following is / are not an assumption(s) made when the weighted average cost of
capital is used in investment appraisal?
(i) The project is small relative to the overall size of the company.
(ii) The weighted average cost of capital reflects the company's long-term future capital
structure, and capital costs.
(iii) The project has the same degree of business risk as the company has now.
(iv) New investments must be financed by new sources of funds: retained earnings, new
share issues, new loans.
(v) The cost of capital to be applied to project evaluation reflects the marginal cost of new
capital.
a (i) and (v) only
b (v) only
c (iii) only
d None

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Practice Questions Finance

44 In order to find the estimated market value of an equity share of Heav Co, the following data has
been provided by its finance manager:

Constant dividend payout ratio = 40%.

Recent payment of dividend = 0.20 per equity share
Return on all new investments from retained profits = 10%.

The estimated market value of equity share would therefore be:

a 2.15
b 3.47
c 5.00
d 5.30

45 Broad Ltd and Oak Co both pay a constant dividend of $045 per share. Broad Ltd has a beta of
15 and Oak Co has a beta of 1.2. The market share price of Broad Ltd is $4.50 and the market
share price of Oak Co is $4.20.

The market rate of return is 10% and the risk free rate is 7%.

What would be the market price of shares of Broad Ltd and Oak Co using CAPM analysis?
a Broad Ltd = $3.19; Oak Co = $4.42.
b Broad Ltd = $3.91; Oak Co = $4.24.
c Broad Ltd = $4.24; Oak Co = $3.91.
d Broad Ltd = $4.50; Oak Co = $4.20.

46 Metro Co recently evaluated an investment project of 5 years with initial cash outlay has positive
annual net cash flows. The IRR and DPP methods for the appraisal of this project has been used.
A further analysis revealed that the figure for cost of capital used was inappropriate as it ignores
the cost of preference share capital and the correct figure should be higher.

What will be the possible effect on the IRR and DPP after using the correct cost of capital?
a IRR = No change; DPP = No change
b IRR = Increase; DPP = Increase
c IRR = Decrease; DPP = Decrease
d IRR = No change; DPP = Increase

47 Consider the following statements and determine which ONE (if any) is / are correct?
(i) A beta factor in excess of 1.0, its expected returns are higher than the average returns for
the market as a whole.
(ii) Individual securities will be either more or less risky than the market average in a fairly
predictable way. The measure of this relationship between market returns and an
individual security's returns, reflecting differences in systematic risk characteristics, can be
developed into a beta factor for the individual security.
a (i) and (ii) are correct
b (i) is correct but (ii) is incorrect
c (i) is incorrect but (ii) is correct
d (i) and (ii) are incorrect

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Practice Questions Finance

48 Consider the following statements and determine which ONE (if any) is / are correct?
(i) A company will aim to issue convertibles with the greatest possible conversion premium
as this will mean that, for the amount of capital raised, it will, on conversion, have to issue
the lowest number of new ordinary shares.
(ii) Convertible loan stock issued at par normally has a lower coupon rate of interest than
straight debentures. This lower yield is the price the investor has to pay for the conversion
rights. It is also one of the reasons why the issue of convertible stock is attractive to a
company.
a (i) and (ii) are correct
b (i) is correct but (ii) is incorrect
c (i) is incorrect but (ii) is correct
d (i) and (ii) are incorrect

49 According to Modigliani and Miller (no taxes), which of the following is / are consistent?
(i) The cost of debt remains unchanged as the level of gearing increases.
(ii) The cost of equity rises in such a way as to keep the weighted average cost of capital
constant.
a (i) only
b (ii) only
c (i) and (ii)
d None

50 Does risks to economic exposure can be minimised using the following methods?
(i) Matching assets and liabilities
(ii) Leading and lagging
(iii) Money market hedge
(iv) International diversification of operations
a Only (i) and (ii)
b Only (ii) and (iv)
c Only (i) and (iv)
d Only (iii) and (iv)

51 A company wishes to change its depreciation policy, by increasing the economic life of its assets,
in order to improve its performance in its accounts and market image.

Such perception of the management of this company is suitable in what type of market
efficiency?
a No form of efficiency
b Weak-form of efficiency
c Semi-strong form of efficiency
d Strong-form of efficiency

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Practice Questions Finance

52 Trout plc keeps caviar in stock for which annual demand is 2000,000 kgs. The cost of placing an
order for the caviar is $100 and the cost of holding one kg of caviar is $1.00 per year. Trout plc
uses the economic order quantity (EOQ) to derive the optimal order quantity for caviar. It can be
assumed that demand for the item will remain constant throughout the year.

What is the annual cost of stock holding and stock ordering for caviar?
a $10,000
b $20,000
c $30,000
d $40,000

53 Consider the following statements:

(i) Money cost of capital should be applied to estimated future cash flows after excluding
inflationary effect.
(ii) Real cost of capital should be applied to estimated future cash flows after inclusion of
inflationary effect.

Which of the above statement (if any) is / are correct?

a (i) only
b (ii) only
c Both (i) and (ii)
d Neither (i) nor (ii)

54 Leo Ltd has 50 million $050 ordinary shares in issue. The total market value of these shares is
$150 million. At the end of Leo Ltds fourth year of operation, after-tax profits were $20 million
and are expected to rise by 25% in the forthcoming year. Leo Ltd has a constant dividend payout
ratio of 40% and intends to increase the dividend by 5% per year after payment of the
forthcoming years dividend.

What is the expected rate of return (i.e. dividend yield) from the ordinary shares of Leo Ltd?
a 510%
b 1033%
c 1167%
d 1500%

55 The following exchange rates of UK sterling () against the Japanese yen () have been quoted:

Spot 1 = 170
1 year forward, 1 = 162
The interest rate in Japan is 1% per year for a six-month deposit or borrowing.

What is the annual interest rate (approx.) for one year deposit or borrowing in the UK?
a 6%
b 7%
c 8%
d 9%

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Practice Questions Finance

56 A company is considering an investment in a capital project to increase output and sales of one
of its products, Product CBz. As a result of the investment, sales of Product CBz would rise by
10,000 units each year. Relevant information for Product CBz is as follows:

$
Selling price per unit 20
Variable cost per unit 8
Current fixed cost per unit 6

Fixed cost spending would rise from $600,000 each year to $680,000.

What would be the relevant annual cash flows when evaluating this project?
a $40,000
b $60,000
c $80,000
d $120,000

57 Noka plc had evaluated a new project using NPV and discounted payback method. The project
was expected to provide substantial cash inflows, i.e. positive NPV, with DPP similar to companys
acceptable limit. However, a recent investigation by the financial manager revealed that the
companys cost of capital was higher than had been previously estimated.

What would be the effect on NPV and DPP taking account of the higher cost of capital?
NPV DPP
a Increase Increase
b Increase Decrease
c Decrease Increase
d Decrease Decrease

58 Wall Ltd is a manufacturer of fine-papers. Shares of Wall Ltd has a beta factor of 0.8. The average
market returns rose by 2% during the winter quarter. As a consequence of this change the actual
return on shares of Wall Ltd should increase by 1.6% while the actual return was later established
as an increase of 2.5%.

Which of the following would be more appropriate in explaining the differences between the
actual returns (2.5%) and expected returns (1.6%)?
a The difference between the actual change and expected change of 1.6% due to general
market factors would be attributed to unsystematic risk factors unique to Wall Ltd or to the
paper industry.
b The difference between the actual change and a change of 1.6% due to general market
factors would be attributed to systematic risk factors unique to Wall Ltd or to the paper
industry.
c The difference between the market change and a change of 1.6% due to industrial factors
would be attributed to unsystematic risk factors unique to the company or to the paper
industry.
d The difference between the actual change and a change of 1.6% due to industrial factors
would be attributed to unsystematic risk factors unique to Wall Ltd or to the paper industry.

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Practice Questions Finance

59 Convertible loan stock is fixed return securities which can, at the option of the holder, be
converted into ordinary shares of the same company.

Which ONE of the following is not a benefit of convertible loan stock?

a The issuing company can obtain finance at lower rates of interest.
b It introduces an element of gearing, albeit short-term.
c It can avoid redemption problems (cash flow)
d It does dilute shareholder control initially.

60 Mr. Roger was recently appointed as assistant manager in the finance department of Jerq plc.
During his 4 months period of job, he observed that the board of directors of Jerq plc used to
raise finance by issuing convertible loan notes with lowest possible conversion premium.

Which of the following correctly explains the consequence of such practices by the board of
directors of Jerq plc?
a Convertibles with the lowest possible conversion premium as this will mean that, for the
amount of capital raised, Jerq plc will, on conversion, have to issue the lowest number of new
ordinary shares.
b Convertibles with the lowest possible conversion premium as this will mean that, for the
amount of capital raised, Jerq plc will, on conversion, have to issue the highest number of
new ordinary shares.
c Convertibles with the lowest possible conversion premium as this will mean that, for the
amount of capital raised, Jerq plc will, on conversion, have to issue the same number of new
ordinary shares.
d Convertibles with the lowest possible conversion premium as this will mean that, for the
amount of capital raised, Jerq plc will, on conversion, have to issue the lowest number of new
preference shares.

61 Mr. Warren Buffet is a sole trader who makes packaging material for medicine. He has been in
this business for several years. Recently Mr. Warren asked his friend Mr. George Washington, a
chartered accountant, to examine his business accounts for he believes retained earnings were
quite poor in relation to sales figures. Extracts from Mr. Georges report shows that during the
past two years, there was:
i. A rapid increase in sales revenue.
ii. A rapid increase in the volume of current assets. Inventory turnover and receivables
turnover slowed down.
iii. Only a small increase in Mr. Warren's capital. Most of the increase in assets is financed by
credit, especially:
Trade payables
A bank overdraft, which often reaches or even exceeds the limit of the facilities agreed by
the bank.

Which of the above findings of Mr. George Washington are indications of overtrading by Mr.
Warren Buffet?
a (i) and (ii) only
b (ii) and (iii) only
c (i) and (iii) only
d (i), (ii) and (iii)

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Practice Questions Finance

62 According to Modigliani and Miller the cost of equity will always fall with decreased gearing
because
a The firm is less likely to go bankrupt
b Debt is allowable against tax
c The return to shareholders becomes less variable
d The tax shield on debt increases the value of the shareholders' equity

63 According to Modigliani and Miller, if the tax relief on debt interest is ignored, the level of capital
gearing increases when
a The cost of equity will decrease
b The value of the business will increase
c The weighted average cost of capital will remain unchanged
d The cost of debt capital will remain unchanged

64 What is the purpose of hedging?

a To protect a profit already made from having undertaken a risky position
b To reduce costs
c To reduce or eliminate exposure to risk
d To make a profit by accepting risk

65 Which of the following is correct?

a If interest rates rise, the market price of bond futures will fall.
b If interest rates rise, the value of put options on bond futures will rise.
c If interest rates rise, the coupon on a bond will fall.
d If interest rates rise, the coupon on a bond will rise.

66 Which of the following is the best description of interest rate risk?

a The risk from borrowing
b The risk from not being able to meet interest payments on debt obligations
c The risk that interest rates will rise
d The risk to profit, cash flow or a company's valuation from changes in interest rates

67 Mawathir plc is a Malaysian company, trading in Europe and remitting profits to the Malaysia.
The directors are considering methods that they can use to minimise their exposure to foreign
exchange risk. Which of the following will not protect them from exchange risks?
a Matching
b Forward contracts
c Invoicing in European local currencies
d Leading and lagging

68 Which one of the following is not a feature of a capital market with 'strong form' efficiency?
a Share prices change quickly to reflect all new information about future prospects
b Transaction costs are not significant
c No individual dominates the market
d Individual share price movements can always be predicted from past price movements

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Practice Questions Finance

69 Dark plc has 200 million shares in issue, currently priced at $6 each on the stock market. It is
planning an investment costing $100 million, which would be financed by a mixture of retained
profits and new debt capital. It has been estimated that the investment will have a net present
value of $120 million.

On 3rd April, the board of directors met to approve the capital expenditure. At the meeting, the
company's advisers confirmed that the required debt capital would be available at the expected
cost.

On 10th April, the company made an announcement about the investment to the stock market.
Investors welcomed the announcement and the estimated forecast of returns has been generally
accepted as credible.

There are no other factors influencing the share price in this period. If the stock market displays
semi-strong form efficiency, what will be the share price after the events of 3rd April and 10th
April respectively?
a $6 per share after 3rd April and $6 per share after 10th April
b $6 per share after 3rd April and $6.10 per share after 10th April
c $6 per share after 3rd April and $6.60 per share after 10th April
d $6.60 per share after 3rd April and $6.60 per share after 10th April

70 Agartala Co has recently made a tender offer of shares and received responses from different
bidders as follows:
Share Price $4.00 $3.25 $2.50 $1.75
Number of shares at each share price (000) 850 950 1,100 1,200

What striking price is required to maximise receipts from the issue?

a $3.35
b $4.00
c $2.50
d $1.75

71 Cody Ltd uses the NPV approach in evaluating possible projects. Relevant data of a particular
project are given below for further evaluation.

% pa
Cost of capital (real terms) 15
Inflation expected 10
The annual cash inflow to increase by 16
The annual cash outlay to increase by 12

Which of the following sets of adjustments will lead to the correct NPV being calculated?
a Cash inflow and cash outflow to be unadjusted and discounted by 15% pa
b Cash inflow and cash outflow to be increased by 10% pa and discounted by 25% pa
c Cash inflow to be increased by 16% pa, cash outflow to be increased by 12% pa and both
discounted by 26.5% pa
d Cash inflow to be increased by 16% pa, cash outflow to be increased by 12% pa and both
discounted by 25% pa

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Practice Questions Finance

72 Asio Ltd is considering of investing in a project with positive cash flows, as expected by the
project specific director. The company uses discounted cash flow techniques in evaluating such
projects and to apply a discount rate based on the real rate of return.

State when should a company like Asio Ltd use real rate of return as a basis for discount rate?
a Real rate of return should be used if the cash flows are expressed in terms of the value of the
currency at time 0.
b Real rate of return should be used if the cash flows are expressed in terms of the actual
number of currency that will be received or paid on the various future dates.
c Real rate of return should be used if the cash flows are expressed in terms of changes in
inflation over the period of projects life.
d Real rate of return should be used if the cash flows are expressed without any inflationary
changes over the period of projects life.

73 Bert plc is an equity financed mountain bicycle manufacturing company. It has 40 million ordinary
shares in issue and a market capitalisation of $78.4 million (ex-div). Extracts from its financial
statements for the year to 31 August 2010 are shown below:

$'000
Profit before taxation 17,014
Less: Corporation tax at 28% (4,764)
Profit after taxation 12,250

The dividend payout ratio was 100%. Annual earnings and the dividend payout ratio have not
changed over the last few years and are expected to continue at present levels for the
foreseeable future.

Which ONE of the following is the expected rate of return from the ordinary shares?
a 21.7%
b 15.6%
c 6.4%
d 4.6%

74 Lamia Plc has 50m $0.50 ordinary shares in issue with a total market capitalisation of $150m. For
the year ended 20Y2 after-tax profits were $20m and are expected to rise by 25% in the
forthcoming year. Lamia Plc has a steady dividend payout ratio of 40% and divided are to be
increased by 5% per year after payment of the forthcoming years dividend.

Identify the correct expected rate of return from the ordinary shares?
a 5.07%
b 10.33%
c 11.67%
d 15.05%

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Practice Questions Finance

75 For some companies retained profits are an insufficient source of funds. The company might be
making losses, and so might require new funds to restore its financial position. A company might
have also plans for capital investment in excess of what it can finance 'internally' through retained
profits. If so, it will need to raise extra finance usually from external sources. If it chooses to raise
the extra capital in the form of equity, it must issue new shares.

A new issue of ordinary shares might be made in a variety of circumstances.

Which ONE of the following is NOT a circumstance for issue of new ordinary shares?
a To raise cash for major overhauling of factory building.
b To raise more cash for investment.
c To 'float' the company on the stock market.
d To finance the takeover of another company.

76 Which ONE of the following is the correct definition of a placing?

a A placing of shares involves an offer of shares to selected investors rather than to the general
public.
b A placing of shares is an invitation to the general public to subscribe for shares not yet in
issue.
c A placing of shares is an invitation to the general public to subscribe for shares already in
issue.
d A placing of shares is a means of raising finance through an offer of shares to existing
shareholders.

77 The following data has been obtained from Mr. Kerr, warehouse executive of Sand Co, in relation
to product C19:

$
The annual demand 40,000
Cost of holding one unit for one year 2.50
Cost of placing an order 20

It is assumed that demand for C19 will remain constant and Sand Co employs the economic
order quantity (EOQ) model to derive optimal order quantity for the item.

What is the combined annual cost of holding and ordering this item?
a $8,250
b $8,125
c $3,000
d $2,000

78 A scrip issue with perfect information

a Decreases earnings per share
b Decreases the debt/equity ratio of the company
c Increases individual shareholder wealth
d Increases the market price of the share

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Practice Questions Finance

79 ZZ is a manufacturing group serving the construction industry. Extracts from its income
statements for 2009 and the previous year 2008, together with end-of-year statement of financial
position extracts, are as follows.

2009 2008
$m $m
Sales revenue 2065 1,788.70
Cost of sales 1479 1,304.00
Gross profit 586 484.7
Current assets
Inventories 119 109
Receivables (see note 1) 401 347.4
Short-term investments 4 18.8
Cash and cash equivalent 48 48
572 523.2
Current liabilities
Loans and overdrafts 49 35.3
Income tax payable 62 46.7
Dividend payable 19 14.3
Other (see note 2) 371 324
501 420.3

Net current assets 71 102.9

2009 2008
Notes $m $m
1 Trade receivables 329.8 285.4
2 Trade payables 236.2 210.8

Calculate the cash cycle in each year, using the information available.
2009 2008
a 29 30
b 30 29
c 29 29
d 30 30

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Practice Questions Finance

80 A company's capital structure is as follows.

m
20m 50p ordinary shares 10
Reserves 4
13% loan stock 20X4 7
21

The loan stock is redeemable at par in 20X4. Current market prices for the company's securities
are: 50p ordinary shares, 280p; 13% loan stock 20X4, 100. The company is paying corporation
tax at a rate of 28%. The cost of the company's equity capital has been estimated as 12% pa.

What is the company's per annum weighted average cost of capital for investment appraisal
purposes?
a 12.1%
b 11.7%
c 11.1%
d 8.5%

81 Company should finance new investment opportunities, based on pecking order theory, in which
of the following order:

(I) Internal finance

(II) External finance
(III) Bonds
(IV) Convertible bonds
(V) Equity
a (I), (II), (III), (IV), (V)
b (I), (III), (II), (IV), (V)
c (V), (IV), (III), (II), (I)
d (I), (V), (III), (II), (IV)

82 The current US dollar/sterling spot rate is $1.50 to 1, and the dollar is at a premium against
sterling for forward exchange contracts.

What would happen to the spot rate and forward rates if interest rates went up in the UK on
sterling but not in the USA on the dollar?
Spot rate Forward premium
a Dollar would weaken Would increase
b Dollar would strengthen Would increase
c Dollar would strengthen Would get smaller
d Dollar would weaken Would get smaller

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Practice Questions Finance

83 The spot rate of exchange is 1 = $1.4400. Annual interest rates are 4% in the UK and 10% in the
US. The three-month forward rate of exchange should be:
a 1 = $1.5231
b 1 = $1.4616
c 1 = $1.5264
d 1 = $1.4614

84 The treasurer of Clark plc wishes to sell 200,000 Swiss francs that the company will receive in
three months' time from a customer in Berne. The SF/ exchange rates are:

Spot 2.23 2.24

3 months forward 3.25 3c premium

If the company took out a forward exchange contract, what would it receive in sterling in 3
months time from the exchange of its Swiss franc income?
a 88,106
b 88,398
c 90,498
d 91,013

85 Calculate the interest rate per annum for a six-month deposit or borrowing in the US dollar
($), based on the data provided below:

Exchange rates of US dollar ($) against the UK sterling () have been quoted:
Spot $1 = 1.7574
Six months forward = 1.7245

The interest rate in UK is 5% per year for a six-month deposit or borrowing.

a 4.45%
b 9.95%
c 7.00%
d 8.90%

86 The equity shares of Laird plc have a beta value of 0.90. The risk-free rate of return is 5% and the
market risk premium is 4%. Corporation tax is 25%. What is the required return on the shares of
Laird plc?
a 7.7%
b 8.1%
c 8.6%
d 13.1%

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Practice Questions Finance

87 Calculate the expected cost and predicted value of an equity share in Shiny plc if its earnings per
share is $0.80 with a constant annual dividend payout ratio of 25%.

Note:
Shiny plc has equity beta of 1.2.
The risk-free rate of return is 5%
The market rate of return is 8%
a Expected cost = 8.6%; Predicted value = $2.33
b Expected cost = 20.6%; Predicted value = $3.88
c Expected cost = 3.6%; Predicted value = $5.56
d Expected cost = 8.6%; Predicted value = $9.30

88 Three-month sterling June futures are quoted on LIFFE at 93.50. Call options on three-month
sterling June futures at 93.00 are quoted at 0.66. This premium of 0.66 represents
a 0.66 intrinsic value
b 0.66 time value
c 0.50 intrinsic value and 0.16 time value
d 0.16 intrinsic value and 0.50 time value

89 It is now mid-August. In about two or three months' time Gear plc will need to borrow 6,000,000
for six months and wishes to obtain protection against the possibility of rising interest rates. Gear
plc has been advised to sell the 'three-month sterling' 500,000 interest rate contracts traded on
LIFFE.

Gear plc should:

a Sell 24 of the December contracts
b Sell 12 of the December contracts
c Sell 24 of the September contracts
d Sell 12 of the September contracts

90 State which of the following is correct:

(I) An European-style option gives the right to its holder to exercise the option on a specific
future date
(II) An American style option gives the right to its holder to exercise the option at any time
up to and including a specific future expiry date
a (I) is correct but (II) is incorrect
b (I) is incorrect but (II) is correct
c Both (I) and (II) are correct
d Both (I) and (II) are incorrect

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Practice Questions Finance

91 The supplier of Stream plc has offered a credit terms of 3/15 net 40. Stream plc had purchased
goods amounting $12,000 from this supplier 2 days earlier.

Stream plc is considering whether to take the advantage of cash discount with payment made on
the last possible day. The opportunity cost of funds for Stream plc is 30%.

What is the net saving or cost at the normal time of payment of taking a cash discount?
a Net saving $123
b Net cost $32
c Net saving $121
d Net cost 114

92 In three months' time you will have 6 million to put on deposit for four months. You are
concerned that interest rates will fall and wish to arrange an FRA to hedge the risk and fix an
effective interest rate for the future deposit. What will you do to hedge the exposure?
a Sell a 3 7 FRA
b Sell a 3 4 FRA
c Buy a 3 4 FRA
d Buy a 3 7 FRA

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Practice Questions Finance

SOLUTION
1 B
2 C
3 C
4 A
5 B
6 D
7 D Re-order level
20 (max Usage) x 6 (max lead time) 120
Add: Buffer inventory 40
160
Less: 1 (min usage) x 5 (min lead time) (5)
Inventory held when fresh deliveries are made 155
Add: Re-order quantity (EOQ) 45
The maximum number of units held its therefore 200
8 B
9 C
10 B
11 C
12 C
13 D
14 B
15 C
16 C
17 A
18 B
19 A
20 C
21 C
22 C
23 A
24 C
25 C
26 C
27 B
28 D
29 D
30 D
31 D Dividend = ($12m x 1.25)/1.5 = $10m
Using the dividend growth model:
Ke = (D1/Po) + g
= (10.0/60.0) + 0.04
= 20.7

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Practice Questions Finance

32 A $
Cost of warrant 0.50
Exercise price 2.50
3.00
Current share price 2.25
Premium 0.75
33 C cents
Cost of warrant 68
Exercise price 780
848
Current share price (762)
Premium 86
34 A Re-order level = 30 x 35 = 1,050 units
Average usage = 22 x 30 = 660 units
Average buffer inventory = 1,050 660 = 390 units
Max. level of inventory = 1,000 + 1,050 (16 x 20) = 1,730 units
35 B MV per share ex div = $5.5 0.5 = $5.00
EPS = $05 x 100/20 = $2.5
P/E ratio
MV per share ex div = $5.00/$2.5
EPS = 2.0 times
36 B
37 B
38 B
39 D
40 C (i) Exercise. Mr. Orsi can sell the shares (put option) at 545c when the market price
is just 510c. Mr. Orsi will make a gain of 35c per share on the 6,000 shares.
(ii) Allow the option to lapse. Mr. Orsi can buy the shares in the market at 330c, and
will not want to exercise the right to buy them at 378c, ie for 48c per share more.
(iii) Exercise. Mr. Orsi can buy 500,000 (call option) for $450,000 at 0.9000 by
exercising the option, when it would cost Mr. Orsi ( 0.9500) $475,000 to buy the
euros in the spot currency market. Mr. Orsis gain will be $25,000.
(iv) Exercise. Mr. Orsi can sell the 250,000 for ( 1.4500) $362,500 by exercising the
put option, when Mr. Orsi would only receive ( 1.4100) $352,500 by selling
them in the spot currency market. Mr. Orsis gain will be $10,000.
(v) Exercise. It is cheaper to exercise the option and borrow at 5% than to borrow at
the current market rate of 5.6%.
41 D
42 A The cost of debt capital: 4% x (200/100) x (1 025) = 60%
WACC:
10% = [(10/40) x 60%] + [(30/40) x Keg%]
075 Keg = 85%
Keg = 113%
43 D
44 D The annual rate of growth in future dividends g = bR is 10% x 60% = 6%
Using the dividend growth model, the expected market value of each share is:
Po = Do(1 + g)/(r g)

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Practice Questions Finance

Po = 020(1 + 006)/010 006) = 530

45 B
46 D
47 A
48 A
49 C
50 C
51 B
52 C
53 D
54 C Share price = $150m/50m = $300
Dividend per share = ($20m x 125) x 04/50m = $020
Expected return = (20/300) + 005
= 1167%
55 A An investor could invest in Japanese at 1% or invest in UK.

Assume 100 is converted to at spot 17,000
Invested at 10% for 1 year 170
17,170
Converted to UK at the forward rate (17,170/$162) = 105.98 or 106
Interest rate is 6% per year.
56 A It is assumed that all relevant costs are variable costs.
Net cash flow
$
Increase in sales 10,000 $20 200,000
Increase in variable costs 10,000 $8 (80,000)
Increase in annual contribution 120,000
Increase in fixed cost spending (80,000)
Increase in annual cash profits 40,000

57 C Higher cost of capital will decrease the present value of cash inflows, which will in turn
decrease the NPV and increase the discounted payback period.
58 A
59 D It does not dilute shareholder control initially.
60 B
61 D
62 C The return to shareholders becomes less variable when gearing is lower.
63 D
64 C
65 A
66 D If interest rates rise, the market price of bonds will fall, and so the price of bond futures
will also fall. Call options on bond futures will increase in value and put options on bond
futures will fall in value. The coupon rate of a bond is unaffected by rises or falls in
general interest rates.

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Practice Questions Finance

67 C Leading and lagging means advancing or delaying payments to a time when the
exchange rate is favourable. Matching receipts and payments in the same currency
reduces the need to convert currencies. Forward contracts hedge against changes in
exchange rate and provide certainty in conversion. Invoicing in local currency means that
profits are held in local currency. Remitting these profits to the UK will then be open to
exchange risk.
68 D The market will consider information about the company's future prospects, which do
not depend on how it has performed in the past.

A is not correct as the key to market efficiency is the availability and processing of
information. If all relevant information is easily available to all investors, and investors
respond to information in a rational way, then share prices will move quickly to reflect
this information in a logical manner.

B is not correct as the transaction costs of buying and selling should not be so high as to
discourage trading significantly.

C is not correct as the market should be large enough so that no one individual can, by
his actions, affect the movement of the market.
69 C The correct answer is: $6 per share after 3rd April and $6.60 per share after 10th April.
When a market displays semi-strong form efficiency, share prices react both to
announcements about historical results and also to information such as company
announcements. On 3rd April, nothing is disclosed to the stock market, so there will be
no change in the share price. When the announcement is made on 10th April, the shares
should increase by the NPV of the investment, i.e. by $120 million or $0.60 per share.
70 C
71 C Money cost of capital: (1.15 x 1.1) 1 = 26.5%.
72 A
73 B Berts cost of capital: Dividends / market capitalisation = $40.78m/$25.12m = 15.625%.
74 C
75 A
76 A
77 D
78 A It increases the number of shares without affecting the value of the company, so market
price per share and earnings per share will fall.

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Practice Questions Finance

79 A 20X3 20X4
Receivables 329.8/2065.0x365 285.4/1788.7x365
collection period = 58 days = 58 days
Inventory 119.8/2,065.0x365 109.0/1304.0x365
turnover period = 29 days = 31 days
Payables 236.2/1,478.6x365 210.8/1,304.0x365
payment period = 58 days = 59 days
Cash cycle (58 + 29 58) (58 + 31 59)
= 29 days = 30 days

The company is a manufacturing group serving the construction industry, and so might
be expected to have a comparatively lengthy receivables' collection period, because of
the relatively poor cash flow in the construction industry. It is clear that the company
compensates for this by ensuring that they do not pay for raw materials and other costs
before they have sold their inventories of finished goods (hence the similarity of
receivables and payables turnover periods).
80 B kd = coupon rate (1 T) for redeemable debt standing at par in the market and
redeemable at par.

kd = 13 (1 0.28) = 9.36%
ke = 12%
ke = EKe + DKd / (E + D) = (20m x 2.80 x 7m x 9.36%)/(20m x 2.80+7m)
=11.7%
81 A
82 A The increase in UK interest rates would strengthen sterling against the dollar at the spot
rate, because sterling becomes a more attractive currency to buy and invest in.
The forward rate premium is measured approximately by
(1+US dollar interest rate)/(1+sterling interest rate)

So, for example, if US interest rates are 9%, and UK rates went up from 14% to 15%, the
forward rate would change from 1.09/1.14 = 0.956 to 1.09/1.15 = 0.948 of the spot rate.
The premium would increase from 0.044 (4.4% of the spot rate) to 0.052 (5.2% of the
spot rate).
83 D 1 invested now for three months will accumulate to 1.01 (+ (1 0.04 1/4))
$1.44 invested now for three months will accumulate to $1.476(s+ ($1.44 0.10 1/4))
Three-month forward rate will equate these two figures = 1.476/1.01 = 1 = 1.4614
84 C 200,000 / (2.24 0.03) = 90,498
If you chose 91,013, you used the rate at which Clark plc would buy Swiss francs.
If you chose 88,398, you used the rate at which Clark plc would buy Swiss francs and
added the premium rather than subtracting it.
85 D
86 C Return per CAPM = Rf + (Rm Rf)
Return = 5% + (0.90 4%) = 8.6%
Note: market risk premium = (Rm Rf)
87 A

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Practice Questions Finance

88 C The option is in-the-money, because an investor could exercise the call to buy a future at
93.00 and sell the future at 93.50, a gain of 0.50. The intrinsic value of an option is the
amount by which it is in-the-money. The intrinsic value is therefore 0.50 and the rest of
the premium must be its time value.
89 A The loan will need to be taken out in October/November for 6 months therefore
December futures would be most appropriate. Since the loan is for 6 months the number
of three-month futures required will be double the number based upon value.
Number of contracts required = 6,000,000 / 500,000 6/3 = 24 contracts
90 C
91 C
92 A To fix a rate for interest income, you should sell an FRA. An FRA for a four-month interest
period starting at the end of three months is a 3 7 FRA.

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