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Topic List

1. Internal Sources of Finance Exam Question


Reference
a. Retained earnings
Advantages and disadvantages
b. Increase working capital management efficiency

2. Dividend Policy
a. Factors influencing dividend policy Dec 10 Q4d
b. Theories of dividend policy
Residual theory
Irrelevancy theory by M&M Dec 07 Q3a
Dec 09 Q2d
Pilot 14 Q5b
Bird-in-the-hand Dec 09 Q2d
Pilot 14 Q5b
Signaling effect Dec 09 Q2d
Pilot 14 Q5b
Clientele effect Dec 09 Q2d
Pilot 14 Q5b
Information asymmetry Dec 09 Q2d

3. Alternative to Cash Dividends


a. Scrip dividend Jun 11 Q3c
b. Stock spilt
c. Share repurchase

4. Short-term Finance
a. Overdrafts
b. Short-term loan
c. Trade credit
d. Lease finance Dec 07 Q3d
Jun 10 Q2d
Dec 10 Q2a
Jun 11 Q3b
5. Long-term Finance
a. Reasons for seeking debt finance Jun 10 Q2d
Dec 10 Q2a
b. Factors affecting choice of debt finance Jun 08 Q2e
Jun 12 Q3b
Jun 13 Q4d
c. Types of bonds Dec 12 Q3d
Jun 14 Q4d

6. Venture Capital (VC)


a. Meaning Jun 13 Q4d
b. Interested in the types of business
c. Factors to be considered by management to use VC
d. Factors to be considered by VC when invest

7. Equity Finance
a. Reasons for equity finance Jun 11 Q3b
Jun 13 Q4d
b. Stock exchange listing
c. Placing Jun 09 Q4c
d. Rights issue Dec 07 Q3c
Jun 08 Q2b
Dec 08 Q1a
Jun 09 Q4b,c
Dec 09 Q3a
Jun 11 Q3b
Dec 11 Q4a
Jun 14 Q4c
e. Public offer

8. Islamic Finance
a. General principles
b. Difference between Islamic finance and conventional
finance
c. Concept of interest (Riba) Dec 13 Q4c
d. Other financial instruments
Trade credit (Murabaha) Dec 13 Q4c
Lease finance (Ijara) Dec 13 Q4c
Equity finance (Mudaraba) Jun 12 Q3c
Dec 13 Q4c
Debt finance (Sukuk) Dec 13 Q4c
Venture capital (Musharaka) Dec 13 Q4c

9. Gearing and Capital Structure Considerations


a. Problems of high level of gearing
b. Operating gearing Jun 12 Q4d(i)
c. Financial gearing Dec 07 Q3b
Jun 12 Q4d(ii)
Dec 12 Q4c
Pilot 14 Q5a(ii)

10. Ratio Analysis


a. Shareholder wealth ratios Pilot Q1c
Dec 08 Q1c
Jun 09 Q4a,b
Dec 09 Q3b
Jun 11 Q3a
Dec 11 Q4b,c
Jun 13 Q4b,c
Jun 14 Q4a
b. Debt holder ratios Pilot Q1c
Jun 09 Q4a
Jun 10 Q2c
Dec 10 Q2a
Jun 11 Q3a
Jun 13 Q4c

11. Finance for SMEs


a. Financing problem for small businesses
b. Measures to ease the financing problems
c. Appropriate sources of finance for SMEs
d. Impact of different sources of finance
Chapter 11 Dividend Policy

1. Bellever Engineering plc makes a bonus issue of shares during the year.

Which one of the following will occur as a result of the issue?

A Liquidity will be increased


B Total shareholders funds will be increased
C Earnings per share will be lowered
D The gearing ratio will be lowered

2. Which one of the following statements concerning financing is correct?

A Warrant holders receive a dividend on the warrants held


B A share repurchase will reduce distributable reserves
C Securitisation involves converting assets that provide a future stream of income
into equity
D Preference share capital may be secured on the assets of the company

3. Which of the following are assumptions for Modigliani and Millers dividend
irrelevance theory?

1 Perfect capital markets


2 No taxes or tax preferences
3 No transaction costs
4 No inflation

A 1,2,3 only
B 1,2,4 only
C 2,3,4 only
D 1,2,3,4
4. Various views have been expressed concerning the most appropriate dividend policy for
a company to adopt.

Which one of the following reflects the views expressed by Miller and Modigliani?

A The dividend policy selected by a company should be of no consequence to


shareholders.
B Dividends should only be paid to shareholders if a company has no investment
opportunities available that have the potential for positive returns.
C A company should seek to maximise dividend payouts in order to maximise
shareholder wealth.
D Shareholders should be paid high dividends in order to have funds available to
invest outside the company.

5. Consider the following statements concerning dividend policy.

According to the Modigliani and Miller (without taxes) view of dividend policy:

1. dividends should be distributed only when investment opportunities are exhausted.


2. the value of a business is determined by the earning power of its assets rather than
by its dividend policy.

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False
6. Consider the following statements concerning dividend policy:

1. The traditional view states that dividends should be paid only when investment
opportunities are exhausted.
2. The Modigliani and Miller view (without taxes) states that dividend policy is
irrelevant to shareholder wealth.

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

7. In Modigliani & Millers Dividend Irrelevance theory, the process of manufacturing


dividends or home made dividend refers to which of the following?

A Dividends from manufacturing businesses.


B Investors selling some shares to realise some capital gain.
C Creative accounting to allow dividends to be paid.
D Investing plans designed to create regular returns to shareholders.

8. Which of the below best describes the signalling effect of dividend


policy/announcements?

A The current dividend policy signals future dividend patterns.


B A dividend that is different to investor expectations signals information about the
business to the investors.
C It flags reported financial results to follow.
D It indicates cash flow health or otherwise.
9. Consider the following statements concerning a stock split:

A stock split will


1. convert reserves into share capital
2. reduce the market price of a listed companys shares.

Which one of the following combinations (true/false) is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

10. A scrip issue with perfect information

A decreases EPS
B decreases the debt/equity ratio of the company
C increases individual shareholder wealth
D increase the market price of the share

11. Aldan Co has 2 million $050 ordinary shares in issue and the market capitalisation of
the company is $280m. The company is about to make a 1-for-4 scrip issue,
immediately followed by a 2-for-1 share split.

What will be the theoretical value of a share following the above transactions and the
number of shares held by an investor that held 1,000 shares prior to these transactions?

Share value following No. of shares held


transactions following transactions
A $14.00 2,500
B $5.60 2,500
C $8.75 625
D $1.87 7,500
12. Three companies (A, B and C) have the following dividend payments history:

2012 2013 2014


A Dividend 100 110 121
A Earnings 200 200 201
B Dividend 50 150 25
B Earnings 100 300 50
C Dividend Nil 300 NIL
C Earnings 400 350 500

Which best describes their apparent dividend policies?

A B C
A Constant growth Constant pay-out Residual
B Constant pay-out Constant growth Residual
C High pay-out Residual Random
D Constant growth Residual Random

Question 1 Factors in formulating dividend policy


Discuss the factors to be considered in formulating the dividend policy of a stock-exchange
listed company. (10 marks)
(ACCA F9 Financial Management December 2010 Q4(d))

Question 2 Dividend policy affects share price


Discuss whether a change in dividend policy will affect the share price of DD Co. (7 marks)
(ACCA F9 Financial Management December 2009 Q2(d))
Chapter 12 Sources of Finance

I. Short-term sources of finance

1. Which of the following is not a benefit, to the borrower, of an overdraft as opposed to a


short-term loan?

A Flexible repayment schedule


B Only charged for the amount drawn down
C Easy to arrange
D Lower interest rates

II. Debt finance and equity finance

2. The following statements have been made about the benefits of debt finance compared
to equity finance:

Statement 1: Interest payments on debt attract tax relief.


Statement 2: Control of the company is diluted.

Which of the above statements is true?

A Both of them
B Statement 1 only
C Statement 2 only
D Neither of them

3. Statement 1: Positive covenants are promises by a borrower to do something.


Statement 2: Quantitative covenants are promises to keep within financial limits set by
the lender.

Which of the above statements is true/false?

Statement 1 Statement 2
A False True
B False False
C True False
D True True
4. Consider the following two statements concerning the returns to investors from debt
capital.

(1) Junk bonds normally offer a higher rate of interest than investment-grade bonds
(2) Convertible bonds normally offer a higher rate of interest than non-convertible
bonds

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

5. Which one of the following statements concerning sources of finance is correct?

A Retained earnings represent a free source of finance to the business


B Invoice discounting involves the administration of debtors by the invoice
discounter
C A bank overdraft is normally regarded as a long-term source of finance
D Mezzanine finance normally has both a debt and an equity element

6. Consider the following statements.

1. A participating preference share gives the holder the right to participate in voting
at the Annual General Meeting.
2. A cumulative preference share gives the holder the right to dividends due but
which have not been paid in the past.

Which one of the following combinations (true/false) is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False
7. Consider the following two statements concerning convertible loan stock.

(i) The conversion value of convertible loan stock is normally below the face value
of the loan stock at the time of issue.
(ii) The coupon rate for convertible loan stock is normally lower than the coupon rate
for non-convertible loan stock.

Which of the following combinations (true/false) concerning the above statements is


correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

8. Consider the following statements concerning the issue of shares.

1. A bonus issue raises finance through an offer of shares to existing shareholders.


2. A placing of shares makes shares directly available to the general public.
3. An offer for subscription is an invitation to the general public to subscribe for
shares not yet in issue.
4. A rights issue raises finance through an offer of shares to existing shareholders.

Which two of the above statements are correct?

A 1 and 2
B 1 and 3
C 2 and 4
D 3 and 4
9. Three important sources of long-term finance are loan capital, ordinary shares and
preference shares.

Which one of the following correctly ranks these sources of finance according to their
relative cost to the business? (Where 1 represents the source of finance that is normally
the most expensive and 3 represents the source that is normally the least expensive.)

Loan capital Ordinary shares Preference shares


A 1 2 3
B 2 3 1
C 3 1 2
D 2 1 3

10. Consider the following statements.

(1) Both a stock split and a scrip issue convert equity reserves into ordinary share
capital.
(2) Both a rights issue and a Stock Exchange placing exclude the general public from
subscribing to the issue of new shares.

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False
11. Consider the following statements concerning sources of finance.

1. Invoice discounting requires the discounter to invoice the clients customers for
goods or services provided.
2. A bank bill offers a bank customer the opportunity to discount the bill of exchange
at the bank.
3. Operating leases are rental agreements where the lessor retains responsibility for
servicing and maintaining the leased equipment.
4. Junk bond is a term for bonds that have been given a rating by a credit-rating
agency that is below investment grade.

Which two of the above statements are correct?

A 1 and 2
B 1 and 3
C 2 and 4
D 3 and 4

12. Which one of the following statements concerning sources of finance is correct?

A Warrant holders are eligible to receive a dividend on a companys profits


B The coupon rate on convertible bonds is usually lower than the coupon rate on
non-convertible bonds
C Retained earnings represent a free source of finance to the business
D An operating lease is an asset rental agreement where the term of the lease is for
most or all of the useful life of the asset
13. Consider the following statements concerning loan finance:

1. Providers of mezzanine finance have a preferential right, ahead of other lenders, to


the repayment of capital if the business is liquidated.
2. Holders of junk bonds expect to receive a higher yield from their investment than
holders of investment-grade bonds.

Which one of the following combinations (true/false) is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

14. Consider the following statements concerning sources of finance:

1. Retained earnings represent a free source of finance for a business.


2. Convertible loan notes are normally issued at a lower rate of interest than non-
convertible loan notes.
3. Under an operating lease, the lessor is responsible for the upkeep of the asset.
4. Under an invoice discounting arrangement, the invoice discounter will collect the
receivables on behalf of the client.

Which of the above statements are correct?

A 1 and 2
B 1 and 3
C 2 and 3
D 3 and4
15. The following methods of issuing shares may be used by a quoted company:

1. An intermediaries offer
2. An offer for subscription
3. A rights issue
4. A placing

Which of the above methods allow the investing public to participate in the share issue?

A 1 and 2
B 2 only
C 3 and 4
D 4 only

16. Which of the following is least likely to be a reason for seeking a stock market listing?

A Enhancement of the companys image


B Transfer of capital to other users
C Improving existing owners control over the business
D Access to a wider pool of finance
Question 3 Financial ratios and financing methods
The following financial position statement as at 30 November 2010 refers to Nugfer Co, a
stock exchange-listed company, which wishes to raise $200m in cash in order to acquire a
competitor.

Assets $m $m $m
Non-current assets 300
Current assets 211
Total assets 511
Equity and liabilities
Share capital 100
Retained earnings 121
Total equity 221
Non-current liabilities
Long-term borrowings 100
Current liabilities
Trade payables 30
Short-term borrowings 160
190
Total liabilities 290
Total equity and liabilities 511

The recent performance of Nugfer Co in profitability terms is as follows:

Year ending 30 November 2007 2008 2009 2010


$m $m $m $m
Revenue 122.6 127.3 156.6 189.3
Operating profit 41.7 43.3 50.1 56.7
Finance charges (interest) 6.0 6.2 12.5 18.8
Profit before tax 35.7 37.1 37.6 37.9
Profit after tax 25.0 26.0 26.3 26.5
Notes:
1. The long-term borrowings are 6% bonds that are repayable in 2012
2. The short-term borrowings consist of an overdraft at an annual interest rate of 8%
3. The current assets do not include any cash deposits
4. Nugfer Co has not paid any dividends in the last four years
5. The number of ordinary shares issued by the company has not changed in recent years
6. The target company has no debt finance and its forecast profit before interest and tax
for 2011 is $28 million

Required:

(a) Evaluate suitable methods of raising the $200 million required by Nugfer Co,
supporting your evaluation with both analysis and critical discussion. (15 marks)
(Amended ACCA F9 Financial Management December 2010 Q2)
III. Rights issue

17. Hera plc has 5 million shares in issue that have a current market value of $1000 per
share. The company has decided to make a one-for-four rights issue at a discount of
20% on the current market value.

What will be the theoretical value of the rights attached to each original share?

A $0.40
B $0.50
C $1.60
D $2.40

18. Agate plc is a company that is listed on the London Stock Exchange. It intends to
announce immediately a one-for-four rights issue at an issue price of $500. The current
share price of the company is $800.

What will be the theoretical value of the rights attached to each original share?

A $240
B $185
C $075
D $060

19. Selene plc has ordinary shares in issue and the directors of the company have decided to
make a one-for-three rights issue. The current market value of each share is 800 and
the rights shares will be offered at a discount of 40% on this current market value.

What will be the theoretical value of the rights attached to each original share?

A $060
B $080
C $180
D $240
20. Columbus plc has 10 million shares in issue and has a market capitalisation of $60
million. The company has recently announced a one-for-four rights issue at a discount
of 40% on the current market value. What is the theoretical value of the rights attached
to each original share?

A $048
B $060
C $138
D $192

21. Sayan Co is listed on a stock market and is about to announce a one-for-three rights
issue at an issue price of $1200. The current share price of the company is $1600.

What will be the theoretical value of the rights attached to each original share?

A $075
B $100
C $133
D $300
Question 4 Dividend policy, theoretical ex-rights price, financial risk and operating
lease
The following financial information relates to Echo Co:
Income statement information for the last year
$m
Profit before interest and tax 12
Interest 3
Profit before tax 9
Income tax expense 3
Profit for the period 6
Dividends 2
Retained profit for the year 4

Statement of financial position information as at the end of the last year


$m $m
Ordinary shares, par value 50c 5
Retained earnings 15
Total equity 20
8% loan notes, redeemable in three years time 30
50
Average data on companies similar to Echo Co:
Interest coverage ratio 8 times
Long-term debt/equity (book value basis) 80%

The board of Echo Co is considering several proposals that have been made by its finance
director. Each proposal is independent of any other proposal.

Proposal A
The current dividend per share should be increased by 20% in order to make the company
more attractive to equity investors.

Proposal B
A bond issue should be made in order to raise $15 million of new debt capital. Although
there are no investment opportunities currently available, the cash raised would be invested
on a short-term basis until a suitable investment opportunity arose. The loan notes would
pay interest at a rate of 10% per year and be redeemable in eight years time at par.
Proposal C
A 1 for 4 rights issue should be made at a 20% discount to the current share price of $230
per share in order to reduce gearing and the financial risk of the company.

Required:
(a) Analyse and discuss Proposal A. (5 marks)
(b) Evaluate and discuss Proposal B. (7 marks)
(c) Calculate the theoretical ex rights price per share and the amount of finance that
would be raised under Proposal C. Evaluate and discuss the proposal to use these
funds to reduce gearing and financial risk. (7 marks)
(d) Discuss the attractions of operating leasing as a source of finance. (6 marks)
(Total 25 marks)
(ACCA F9 Financial Management December 2007 Q3)

Question 5 Share price calculation, rights issue, semi-strong form, equity finance and
debt finance
THP Co is planning to buy CRX Co, a company in the same business sector, and is
considering paying cash for the shares of the company. The cash would be raised by THP Co
through a 1 for 3 rights issue at a 20% discount to its current share price.

The purchase price of the 1 million issued shares of CRX Co would be equal to the rights
issue funds raised, less issue costs of $320,000. Earnings per share of CRX Co at the time of
acquisition would be 448c per share. As a result of acquiring CRX Co, THP Co expects to
gain annual after-tax savings of $96,000.

THP Co maintains a payout ratio of 50% and earnings per share are currently 64c per share.
Dividend growth of 5% per year is expected for the foreseeable future and the company has
a cost of equity of 12% per year.

Information from THP Cos statement of financial position:


Equity and liabilities $000
Shares ($1 par value) 3,000
Reserves 4,300
7,300
Non-current liabilities
8% loan notes 5,000
Current liabilities 2,200
Total equity and liabilities 14,500

Required:

(a) Calculate the current ex dividend share price of THP Co and the current market
capitalisation of THP Co using the dividend growth model. (4 marks)
(b) Assuming the rights issue takes place and ignoring the proposed use of the funds
raised, calculate:
(i) the rights issue price per share;
(ii) the cash raised;
(iii) the theoretical ex rights price per share; and
(iv) the market capitalisation of THP Co. (5 marks)
(c) Using the price/earnings ratio method, calculate the share price and market
capitalisation of CRX Co before the acquisition. (3 marks)
(d) Assuming a semi-strong form efficient capital market, calculate and comment on the
post acquisition market capitalisation of THP Co in the following circumstances:
(i) THP Co does not announce the expected annual after-tax savings; and
(ii) the expected after-tax savings are made public. (5 marks)
(e) Discuss the factors that THP Co should consider, in its circumstances, in choosing
between equity finance and debt finance as a source of finance from which to make a
cash offer for CRX Co. (8 marks)
(25 marks)
(ACCA F9 Financial Management June 2008 Q2)

Question 6 Rights Issue


Tirwen plc is a medium-sized manufacturing company which is considering a 1 for 5 rights
issue at a 15% discount to the current market price of 400 per share. Issue costs are
expected to be 220,000 and these costs will be paid out of the funds raised. It is proposed
that the rights issue funds raised will be used to redeem some of the existing debentures at
par. Financial information relating to Tirwen plc is as follows:

Current statement of financial position


000 000 000
Non-current assets 6,550
Current assets
Stock 2,000
Debtors 1,500
Cash 300 3,800
10,350
Equity
Ordinary shares (par value 50p) 2,000
Reserves 1,500
3,500
Non-current liabilities
12% debentures 2012 4,500

Current liabilities
Trade creditors 1,100
Overdraft 1,250 2,350
Total equity and liabilities 10,350

Other information:
Price/earnings ratio of Tirwen plc: 15.24
Overdraft interest rate: 7%
Corporation tax rate: 30%
Sector averages: debt/equity ratio (book value): 100%
Interest cover: 6 times

Required:

(a) Ignoring issue costs and any use that may be made of the funds raised by the rights
issue, calculate:
(i) the theoretical ex rights price per share;
(ii) the value of rights per existing share. (3 marks)
(b) What alternative actions are open to the owner of 1,000 shares in Tirwen plc as
regards the rights issue? Determine the effect of each of these actions on the wealth of
the investor. (6 marks)
(c) Calculate the current earnings per share and the revised earnings per share if the rights
issue funds are used to redeem some of the existing debentures. (6 marks)
(d) Evaluate whether the proposal to redeem some of the debentures would increase the
wealth of the shareholders of Tirwen plc. Assume that the price/earnings ratio of
Tirwen plc remains constant. (3 marks)
(e) Discuss the reasons why a rights issue could be an attractive source of finance for
Tirwen plc. Your discussion should include an evaluation of the effect of the rights
issue on the debt/equity ratio and interest cover. (7 marks)
(Total 25 marks)
(ACCA 2.4 Financial Management and Control December 2004 Q3)

IV. Finance for SMEs

22. Consider the following statements concerning the financing problems of SME.

(i) Funding gap


(ii) Maturity gap
(iii) Inadequate security
(iv) Uncertainty concerning the business

Which of the above statements are correct?

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


B (i), (iii) and (iv) only
C (ii), (iii) and (iv) only
D (i), (ii), (iii) and (iv)

Question 7 SME sources of finance problems


(a) Discuss the difficulties that may be experienced by a small company which is seeking
to obtain additional funding to finance an expansion of business operations.
(8 marks)
(ACCA 2.4 Financial Management and Control June 2006 Q2(c))
(b) Discuss the potential sources of finance for SMEs excluding sources from capital
markets. (5 marks)
Chapter 13 Islamic Financing

1. With reference to Islamic finance, the term Riba refers to

A a form of equity where a partnership exists and profits and losses are shared
B the predetermined interest collected by a lender, which the lender receives over
and above the principal amount that it has lent out
C a form of credit sale
D a form of lease

2. Which of the following describes a sukuk?

A A bond in Islamic finance where the lender owns the underlying asset and shares
in the risks and rewards of ownership.
B Equity in Islamic finance where profits are shared according to a pre agreed
contract dividends are not paid as such.
C Trade credit in Islamic finance where a pre agreed mark up is agreed in advance
for the convenience of paying later.
D A lease in Islamic finance where the lessor retains ownership and the risk and
rewards of ownership of the underlying asset.

Question 8 Rights issue, debt financing and Islamic finance


FMY Co manufactures glass bottles for the drinks industry. It has been trading for 15 years.
The company at present has no long-term debt although it does have an overdraft facility
that is used for short-term financing needs.

The company is forecasting post-tax earnings of $4.5 million on revenue of $32 million for
the current year. These sales and earnings levels are expected to continue unless new
investment is undertaken. The Managing Director, who is also a significant shareholder, is
planning a major expansion programme that will require raising $5 million of new finance
for capital investment. This investment yields a positive net present value of $1.2 million
when evaluated at the companys post-tax cost of capital of 12%, and is expected to increase
post-tax earning by $1 million per annum (before considering the method of financing the
expansion).

The Board is considering two alternative methods of financing this expansion:


1. A 1 for 4 rights issue to existing shareholders. There are currently 10 million shares in
issue, each of which is trading at $2.20.
2. Medium-term (five years) debt, interest rate fixed at 8.6%, secured on the companys
non-current assets, mainly land and buildings.

The company pays tax one year in arrears at 30%.

Required:

(a) Comment on the effect of each suggested method of financing on the valuation of the
company. Your answer should refer to capital structure theories amongst other things.
(11 marks)
(b) Explain the major differences between Islamic finance and other conventional forms
of finance such as those being considered by FMY Co. (4 marks)
(Total 15 marks)
Chapter 14 Financial Ratios

1. The following are extracts from the statement of profit or loss of CQB Co:

$000
Sales income 60,000
Cost of sales 50,000
Profit before interest and tax 10,000
Interest 4,000
Profit before tax 6,000
Tax 4,500
Profit after tax 1,500

60% of the cost of sales is variable costs

What is the operational gearing of CQB Co?

A 5.0 times
B 2.0 times
C 0.5 times
D 3.0 times
(ACCA F9 Financial Management Pilot Paper 2014)

2. Which of the following would be implied by a decrease in a companys operating


gearing ratio? The company

A is less profitable
B is more risky
C has a lower proportion of costs that are variable
D has profits which are less sensitive to changes in sales volume
3. If for a given level of activity a firms ratio of variable costs to fixed costs were to fall
and, at the same time, its ratio of debt to equity were also to fall, what would be the
effect on the firms financial and operating risk?

Financial risk Operating risk


A Decreases Decreases
B Increases Decreases
C Decreases Increases
D Increases Increases

4. If a company that currently pays its workforce on a piece rate system were to automate
its production line, it would expect its operating gearing to

A decrease
B increase
C remain the same
D increase or decrease depending on the nature of the production process

5. Consider the following statements concerning financial gearing.

Higher financial gearing increases the risks of:

(i) share price volatility


(ii) earnings per share volatility
(iii) loan default

Which of the above statements are correct?

A (i) and (ii)


B (i) and (iii)
C (iii) only
D (i), (ii) and (iii)
6. Watern plc has ordinary shares in issue with a par value of $050 and a price earnings
ratio of 10 times. The dividend per share is $015 and the dividend cover ratio is 20
times.

What is the dividend yield of a share in the company? (Ignore taxation)

A 200%
B 50%
C 30%
D 15%

7. Kepler plc has $1 ordinary shares in issue. For the year just ended, the company
generated earnings per share of 25c. The dividend payout ratio for the year is 60% and
the price/earnings ratio is 20 times. Ignore taxation.

What is the gross dividend yield ratio of the company?

A 30%
B 50%
C 83%
D 150%

8. Pembroke plc has ordinary shares with a par value of $100 in issue. The company has a
price earnings ratio of 20 times and had earnings per share of $050 for the financial
year that has just ended. The gross dividend yield is 20%.

What is the dividend cover ratio of the company?

A 04 times
B 25 times
C 25 times
D 50 times
9. Starling Ltd wishes to forecast its financial performance and position for the
forthcoming year. The forecast model used by the company incorporates the following
relationships:

Sales : long-term capital employed 2:1


Debt : equity ratio 1:4
Sales : operating profit 10 : 1
Corporation tax : net profit before tax 0.2 : 1

The sales for the forthcoming year are expected to be $6 million and the interest
payments for the period are expected to be $100,000.

What is the forecast return on ordinary shareholders funds (ROSF) for the period?

A 167%
B 200%
C 250%
D 667%.

10. Trinity plc wishes to forecast its financial performance and position for the forthcoming
year. The forecast model used by the company incorporates the following relationships:

Sales: total capital employed 3:1


Debt: total capital employed 04:1
Sales: net profit after tax 20:1
The sales for the forthcoming year are expected to be $30 million.

What is the forecast return on ordinary shareholders funds for the period?

A 28%
B 107%
C 150%
D 250%
11. TKQ Co has just paid a dividend of 21c per share and its share price is $350 per share.
One year ago its share price was $310 per share.

Working to one decimal place, what is the total shareholder return over the period?

A 174%
B 182%
C 189%
D 197%
(ACCA F9 Financial Management Pilot Paper 2014)

12. Attis plc has reported pre-tax profits of $48 million and after-tax profits of $32 million
for the year that has just ended. The company expects pre-tax and after-tax profits to
increase by a further 25% in the forthcoming year and then to stabilise at this figure.
The company has 80 million $050 ordinary shares in issue and the market
capitalisation of the company is $320 million. The dividend cover ratio of the company
is held at a constant 25 times.

Which one of the following is the expected rate of return from the ordinary shares?

A 40%
B 50%
C 75%
D 400%

13. Chrysotile plc has ordinary shares with a par value of $050 in issue. The company
generated earnings per share of 45c for the financial year that has just ended. The
dividend cover ratio is 25 times and the gross dividend yield is 2% (Ignore taxation).

What is the price/earnings ratio of the company?

A 28 times
B 50 times
C 200 times
D 400 times
14. Oxon Co has ordinary shares in issue with a nominal value of $100. The dividend
payout ratio is 20% and the gross dividend yield is 4%. The earnings per share is $060.

What is the price/earnings ratio of the company?

A 250 times
B 138 times
C 50 times
D 18 times

15. Meta plc has the following capital structure:

$000
$0.50 ordinary shares 4,000
Retained profits 5,000
9,000

The company has a return on ordinary shareholders funds of 10 per cent and this level
of return is expected to continue after a forthcoming 1-for-4 rights issue at $120 per
share.

What will be the earnings per share (in cent) following the rights issue?

A 150
B 100
C 114
D 228

16. The financial performance of Eboracum Co for the most recent year produced the
following ratios:

Dividend cover 5 times


Interest cover 6 times
Dividend per share $020

The company has ordinary share capital of $10m made up of $050 ordinary shares. The
company pays tax at 20%.
What is the net profit before interest and taxation of the company?

A $12m
B $150m
C $288m
D $300m

17. Consider the following:

1. Altay Co has a current ratio of 15:1 and an operating cash cycle of 35 days and
the company has decided to increase the operating cash cycle by five days.
2. Rhodope Co has a debt/equity ratio of 45%. The company has decided to make a
one-for-two scrip issue of equity shares.

What will happen (increase/decrease) to the current ratio of Altay Co and to the
debt/equity ratio of Rhodope Co if these changes are made?

Current ratio of Altay Co Debt/equity ratio of Rhodope Co


A Increase Decrease
B Increase No effect
C No effect No effect
D Decrease Increase

18. Tarim Co has ordinary shares in issue with a par value of $025. For the financial year
just ended, the company had earnings per share of $020 and a dividend cover of 20
times. At the year end the dividend yield was 40%.

What is the price/earnings ratio of the company at the year end?

A 20 times
B 80 times
C 125 times
D 250 times
Question 9 Dividend valuation model, capital gearing, WACC and dividend policy
DD Co has a dividend payout ratio of 40% and has maintained this payout ratio for several
years. The current dividend per share of the company is 50c per share and it expects that its
next dividend per share, payable in one years time, will be 52c per share.

The capital structure of the company is as follows:

$m $m
Equity
Ordinary shares (par value $1 per share) 25
Reserves 35
60
Debt
Bond A (par value $100) 20
Bond B (par value $100) 10
30
90

Bond A will be redeemed at par in ten years time and pays annual interest of 9%. The cost
of debt of this bond is 983% per year. The current ex interest market price of the bond is
$9508.

Bond B will be redeemed at par in four years time and pays annual interest of 8%. The cost
of debt of this bond is 782% per year. The current ex interest market price of the bond is
$10201.

DD Co has a cost of equity of 124%. Ignore taxation.

Required:

(a) Calculate the following values for DD Co:


(i) ex dividend share price, using the dividend growth model; (3 marks)
(ii) capital gearing (debt divided by debt plus equity) using market value; and
(2 marks)
(iii) market value weighted average cost of capital. (2 marks)
(b) Discuss whether a change in dividend policy will affect the share price of DD Co.
(8 marks)
(ACCA F9 Financial Management Pilot Paper 2014)

Question 10 Shareholders wealth maximization, rights issue and merits of equity


financing
JJG Co is planning to raise $15 million of new finance for a major expansion of existing
business and is considering a rights issue, a placing or an issue of bonds. The corporate
objectives of JJG Co, as stated in its Annual Report, are to maximise the wealth of its
shareholders and to achieve continuous growth in earnings per share. Recent financial
information on JJG Co is as follows:

2008 2007 2006 2005


Turnover ($m) 28.0 24.0 19.1 16.8
Profit before interest and tax ($m) 9.8 8.5 7.5 6.8
Earnings ($m) 5.5 4.7 4.1 3.6
Dividends ($m) 2.2 1.9 1.6 1.6

Ordinary shares ($m) 5.5 5.5 5.5 5.5


Reserves ($m) 13.7 10.4 7.6 5.1
8% Bonds, redeemable 2015 ($m) 20 20 20 20
Share price ($) 8.64 5.74 3.35 2.67

The par value of the shares of JJG Co is $100 per share. The general level of inflation has
averaged 4% per year in the period under consideration. The bonds of JJG Co are currently
trading at their par value of $100. The following values for the business sector of JJG Co
are available:

Average return on capital employed 25%


Average return on shareholders funds 20%
Average interest coverage ratio 20 times
Average debt/equity ratio (market value analysis) 50%
Return predicted by the capital asset pricing model 14%

Required:

(a) Evaluate the financial performance of JJG Co, and analyse and discuss the extent to
which the company has achieved its stated corporate objectives of:
(i) maximising the wealth of its shareholders;
(ii) achieving continuous growth in earnings per share.

Note: up to 7 marks are available for financial analysis.


(12 marks)
(b) If the new finance is raised via a rights issue at $750 per share and the major
expansion of business has not yet begun, calculate and comment on the effect of the
rights issue on:
(i) the share price of JJG Co;
(ii) the earnings per share of the company; and
(iii) the debt/equity ratio.
(6 marks)
(c) Analyse and discuss the relative merits of a rights issue, a placing and an issue of
bonds as ways of raising the finance for the expansion. (7 marks)
(Total 25 marks)
(ACCA F9 Financial Management June 2009 Q4)

Question 11 Dividend valuation, effect on EPS and interest cover of financing, and
factors for sources of finance
GXG Co is an e-business which designs and sells computer applications (apps) for mobile
phones. The company needs to raise $3,200,000 for research and development and is
considering three financing options.

Option 1
GXG Co could suspend dividends for two years, and then pay dividends of 25 cents per
share from the end of the third year, increasing dividends annually by 4% per year in
subsequent years. Dividends in recent years have grown by 3% per year.

Option 2
GXG Co could seek a stock market listing, raising $32 million after issue costs of $100,000
by issuing new shares to new shareholders at a price of $250 per share.

Option 3
GXG Co could issue $3,200,000 of bonds paying annual interest of 6%, redeemable after
ten years at par.

Recent financial information relating to GXG Co is as follows:


$000
Operating profit 3,450
Interest 200
Profit before taxation 3,250
Taxation 650
Profit after taxation 2,600
Dividends 1,600

Ordinary shares (nominal value 50 cents) 5,000

Under options 2 and 3, the funds invested would earn a before-tax return of 18% per year.

The profit tax rate paid by the company is 20% per year.

GXG Co has a cost of equity of 9% per year, which is expected to remain constant.

Required:

(a) Using the dividend valuation model, calculate the value of GXG Co under option 1,
and advise whether option 1 will be acceptable to shareholders. (6 marks)
(b) Calculate the effect on earnings per share of the proposal to raise finance by a stock
market listing (option 2), and comment on the acceptability of the proposal to existing
shareholders. (5 marks)
(c) Calculate the effect on earnings per share and interest cover of the proposal to raise
finance by issuing new debt (option 3), and comment on your findings. (5 marks)
(d) Discuss the factors to be considered in choosing between traded bonds, new equity
issued via a placing and venture capital as sources of finance. (9 marks)
(25 marks)
(ACCA F9 Financial Management June 2013 Q4)