Question 1

The directors of a financial services company need to calculate a valuation of their company’s equity in

preparation for an upcoming initial Public Offering (IPO) of shares. At a recent board meeting they discussed

the various methods of business valuation.

The Chief Executive suggested using a Price-earing (P./E) method of valuation, but the finance Director

argued that a valuation based on forecast cash flows to equity would be more appropriate.

Which THREE of the following are advantages of valuation based on forecast cash flows to equity, compared

to a valuating using a price earnings methods?

Options :

A : Using cash is theoretically superior to using profits in a valuation calculation.

B : It give on estimate of the likely shareholder value that will be created.

C : The calculations are much simpler.

D : It incorporates the time value of money.

E : It avoids the problem of having to forecast a sustainable level of future growth.

Answer: A,C,D

Question 2

A listed company in a high growth industry, where innovation is a key driver of success has always operated a

residual dividend policy, resulting in volatility in dividends due to periodic significant investments in research

and development.

The company has recently come under pressure from some investors to change its dividend policy so that

shareholders receive a consistent growing dividend. In addition, they suggested that the company should use

more debt finance.

If the suggested change is made to the financial policies, which THREE of the following statements are true?

Options :

A : It may give a signal to the market that the company is entering a period of stable growth.

B : There may be a change to the shareholder profile due to 'the clientele effect'.

C : The directors will not have to take shareholder dividend preferences into consideration in future.

D : Retained earnings have a lower cost than debt finance.

E : The company-s financial risk will increase due to its increased use of debt finance.

Answer: A,B

Question 3

The Board of Directors of a listed company is considering the company's dividend/retentions policy.

The inflation rate in the economy is currently high and is expected to remain so for the foreseeable future.

The board are unsure what impact the high level of inflation might have on the dividend policy.

Which THREE of the following statements are true?

Options :

A : The high inflation rate does not need to be considered when determining the dividend policy.

B : Consideration should be given to the fact that shareholders will have a desire for real growth in dividend.

C : Retained earnings for reinvestment will have to earn a return in excess of the inflation level.

D : The impact of inflation on the cash flows should be considered when formulating the dividend policy.

E : In periods of high inflation 100% of earnings should always be paid out as dividends so that shareholders can protect their wealth against the impact of inflation.

Answer: B,C,D

Question 4

Z wishes to borrow at a floating rate and has been told that it can use swaps to reduce the effective interest rate

it pays. Z can borrow floating at Libor ' 1, and fixed at 10%.

Which of the following companies would be the most appropriate for Z to enter into a swap with?

Options :

A : Company A - it can borrow floating L +1 ½ and fixed at 9.5%

B : Company D - it can borrow at L +1 ½ and fixed at 10.5%

C : Company C - it can borrow at L +1 ½ and fixed at 9%

D : Company E - it can borrow floating at L +1 ½ and fixed at 12%

Answer: C

Question 5

A company based in Country D, whose currency is the D$, has an objective of maintaining an operating profit

margin of at least 10?ch year.

Relevant data:

• The company makes sales to Country E whose currency is the E$. It also makes sales to Country F whose

currency is the F$.

• All purchases are from Country G whose currency is the G$.

• The settlement of all transactions is in the currency of the customer or supplier.

Which of the following changes would be most likely to help the company achieve its objective?

Options :

A : The D$ strengthens against the E$ over time.

B : The F$ weakens against the D$ over time.

C : The D$ strengthens against the G$ over time.

D : The D$ weakens against the G$ over time.

Answer: C