Case Study 1
1 2 3 4
Calculate the cost of capital for the Layout the relevant cash flows for As an alternative to the expansion, the
project. the project and calculate the NPV. CEO has suggested a wholesale price
What should the company do? increase from £1.40 to £1.50 per bottle. share?
Under this scenario, demand would be
estimated to fall by 5% from the current
level to 3.8m units for the first three years
and then return to the level prevailing
before the price rise for the last two
Dec-14 years. If this option were chosen, there
would be extra maintenance and
operating costs of £40,000 per year and
an extra £30,000 marketing costs per
year, but no extra working capital. What
is the value of this alternative? What
should the company do?
Calculate the cost of capital for the Construct a cash flow schedule for The CEO has been talking about the
project. the project and work out the NPV of project needing to achieve an average
the project. What should the accounting rate of return of at least 20%
company do? before he would be willing to go ahead
with the project. You have some
misgivings about this method. Write a
note to the CEO outlining your objections
and explaining why you feel that NPV is
Jun-14
the superior method.
Calculate the APV of the project if it Calculate the APV of the project if it It has been said that APV is a better
was funded entirely with a new issue was funded with 40% new debt and technique than WACC/NPV to use to
of equity. 60% new equity. Comment on the evaluate leveraged buyouts (LBOs) and
suitability of the project under the management buyouts (MBOs). Why do
Dec-13 different funding arrangements you think this is, and in what other
corporate situations do you think APV
would be superior to WACC (or more
useful)?
Rosethorns wishes to conduct the Calculate the forward exchange Calculate the NPV and produce the final
evaluation of the project in UK £, so rates for the next five years result in euros.
it will need a UK based cost of capital
to discount the cash flows. Calculate
this cost of capital for the project.
Jun-13
If you were advising ProNeill, what Calculate the current level of Analyse the earnings per share
would be the arguments you would earnings per share at the company. performance of the two funding choices.
put for and against the different If the management team were
funding options? incentivised on the basis of earnings per
share growth, which route would they
take? What advice would you give to the
board?
Dec-12
Case Study 2
1 2
Explain the concept of beta measures and
how would you estimate a beta value for a
If this project did not turn out how Pomona
expected, they might have to think of
abandoning it. Real options can be used to
evaluate the abandonment decision.
Describe how you would do this.
If the project went well and Pomona
decided to sell it, how would a potential
buyer value the project? Compare cash flow
valuations against earnings valuations. What
are the dangers in each method?
Biotechnology firms usually have very low
levels of gearing, what reasons can you give
for that? They also have high betas, why
would this be?
In recent years there has been considerable
use made by companies of the convertible
bond. Discuss the reasons why companies
have been using these bonds and what their
advantages and disadvantages are from
shareholders point of view. Refer to recent
examples if possible
Calculate the value of Rosethorns’ real
option
What are the advantages and disadvantages
of hedging? Explain who would be happier
that the company was hedging -
shareholders or bondholders. Describe how
Rosethorns might hedge the risk of their
operations and what they would use.
The management is also considering the
payout policy followed by the company.
Traditionally the company has paid out a
healthy regular dividend, but some on the
board are arguing for the dividend payment
to be cut back in favour of share buybacks,
while actually increasing the amount of cash
returned to shareholders on an annual
basis.
Comment on the appropriateness of this
policy and the possible motives behind it. E.
What are the advantages and disadvantages
of eps growth versus Economic Value Added
as a reward measure for top managers at
this company and any company
Explain what the following terms mean in relation
to options:
(i) Out of the money
(ii) Exercise value
(iii) Put-call parity
Working capital management is an important part Companies will hold varying levels of stock. Explain what
of running a company and its importance is often the benefits and costs of holding inventory are.
overlooked. Why do companies hold cash
balances and how would they manage their cash
balances in an effective manner?
Conflicts of interest exist between managers and
shareholders, but there also exists agency
problems between senior managers and middle
managers within a company. Discuss how you
view this second set of agency problems and
discuss the tools available to resolve these
problems
Discuss the factors that affect the business risk of Identify and discuss the factors that a company should
a company. Use the example of a construction
company and a food retail company to illustrate
your answer
If Interest Rate Parity holds, what is the three
month forward exchange rate between the
Russian ruble and the euro, and what would be
the five year forward exchange rate based on
these figures?
You have bought Walcott (month) put options with an
exercise price of 380p. At the time of purchase the share
price was 395p and you paid 26p for the option.
(i) Is the option in the money or out of the money?
(ii) If the share price is 358p at the expiry of the option,
what is the gain or loss from the option position? Why has
this outcome happened?
Discuss two areas where information asymmetry is a
problem in financial markets, identifying the problems
caused by it and the actions that can be taken to minimise
the effects of information asymmetry
take into consideration before it takes on financial risk
A German company is considering an inward investment
in Russia, involving the construction of a manufacturing
plant, with the manufactured units being sold into the
Russian market. Describe the methods of evaluating that
investment, and explain which method is preferred and
why.
3
Jensen plc is a UK technology company and is
subject to takeover rumours. The shares are
volatile on the market. You want to make some
money, but you are not sure which way the shares
will go. You decide to buy calls and put options on
the company. The shares are 285p in the market
just now and the volatility of the shares is 40%.
You feel that buying a three month option should
capture any takeover if it happens. The risk free
rate of interest is 4% and the exercise price you are
interested in is 300p for both the calls and the
puts. Price the call using the Black-Scholes option
pricing formula, and from there price the put
option.
Companies need to extend credit to customers in
order to generate sales. Explain how a company
efficiently manages its receivables.
The UK supermarket retailer Tesco uses its
payables as a means of financing its business.
Explain the methods a company would use to
manage its payables.
Discuss the agency problems associated with too
little debt in a company’s balance sheet
Companies in the real financial markets don’t have
100% debt in their capital structure. Discuss the
factors that work against companies having 100%
debt in their balance sheet as suggested in
Modigliani and Miller with taxes (MM with taxes).
What advice would you give to the German
company regarding hedging this investment?
Justify your answer.
Advise the company on the appropriateness of the
different hedging products available. Explain why
you would use certain products and not others.
 From the above balance sheet and
profit and loss accounts, extract the
relevant cash flows and construct a
Jun-12 cash flow schedule for the project.
Lay out the cash flows to support the
lease or borrow to buy decision, and
calculate which option is preferable?
Show your cost of capital
calculations.
Dec-11
Calculate the cost of capital for
Gourmet Globe.
Jun-11
Layout the cash flow schedule for
this project, calculate the cost of
capital and then calculate the NPV of clearly your reasoning in each case.
Dec-10 the project.
a. Lay out the cash flows for the
project.
Jun-10
a. Layout the cash flows for the wind b. Calculate the WACC and calculate
farm project and justify your
inclusion or exclusion of the different ahead with the project?
items.
Dec-09
a. Calculate the cost of capital for the b. Lay out the cash flows for the
project.
Jun-09
Calculate the adjusted present value
for the project, showing all
calculations. Comment on your
result.
A company is about to enter into a
sale and leaseback of its retail
premises. What are the factors it
should consider and what are the
disadvantages of this type of
exercise?
Layout the cash flow schedule for
this project and calculate the NPV of
the
project. Should the company go
ahead with the project?
What difference do you think they
would make to the project? State
b. Calculate the cost of capital for
the project and calculate the NPV of
the project. Should the company go
ahead with the project or just sell
the equipment?
the NPV. Should the company go
project, with explanations as to why capital budgeting project and explain how
you have included or excluded
certain cash flows. Calculate the
NPV. Should the project be
accepted?
Explain the attractions of APV to Explain what the opportunity cost concept is Calculate the value of the company using the Discuss how a large company would make use of an In this example, the equity has been valued as if it
companies compared to WACC/NPV. Give in capital budgeting and give two examples binomial option method. If a put were available, interest rate swap, and explain how the swap works. were a call option. Explain your understanding of
examples of where companies might of opportunity costs. what would its price be? the concept of equity being regarded as a call
make use of the APV technique. option in a geared company. Try and explain what
the option variables are in the company and how
they affect the value.
(c) Discuss the advantages that leasing Discuss (i) the impact on the lease – buy Calculate the spot rates that will hold for years From these spot rates, calculate the one-year forward There is a coupon paying bond that has four years
offers a company. decision of different depreciation methods, one, two, three and four. rates that would start in years one, two and three. to redemption. The annual coupon is £7.00, what
and (ii) explain how the analysis of the lease Calculate the two-year forward rate that starts in year is the price of the bond and its duration? E .
– buy decision would change if the company one. Explain what is meant by the term ‘duration’ with
was in a non-taxpaying position. The regard to interest rates and how the measure
accounting depreciation figure will be the would be used.
one used for tax purposes. E. There are
agency problems in the process of capital
budgeting. Discuss what these are and how
they can be overcome
For capital budgeting purposes (in The APV method is often used as an What are the main factors that should be Discuss further the three views that the board have put What can the company’s P/E ratio be used for?
general), how are the following treated in alternative to NPV. Explain what you considered by company directors when forward. What are the What are the problems with
cash understand about APV. What are its deciding on company dividend policy? merits or drawbacks of each policy? using this ratio?
flow analysis? advantages and disadvantages?
Inflation poses a problem in cash flow Explain in detail why accounting figures are 1. Explain what you understand by the terms What explanation can you give for different levels of You have to advise the company what it should do
analysis. In general, how is it dealt with, inappropriate to use to calculate the NPV of ‘operational gearing’ and ‘financial gearing’. gearing in different industries? Discuss the factors with the surplus cash. What are the alterna-tives?
and in this example describe how would a project. involved. What effects would your recommendations have
you conduct the analysis to deal with on the capital structure? Discuss the factors have
inflation? you taken into consideration in your analysis
c. The company has another project d. In evaluating a project, real option a. What is the current level of EPS at the If the company is aiming to maximise earnings per share c. This company rewards its managers for
where the NPV is negative £50,000, but analysis is applying new practices to try and company? growth which option should be chosen? (Show all achieving earnings per share growth and
where the managers are arguing that give more flexibility to managers in running workings.) profitability targets. What are the advantages and
there is a real option involved where the business. Discuss four of the traditional disadvantages of EPS growth versus Economic
there is the option to expand the capital budgeting evaluation methods and Value Added as a reward measure for top
investment after 5 years. This would highlight their strengths and weaknesses. managers at this company and any company? Fully
require an investment of £700,000 at the explain what EVA is and how it works.
end of year 5 and this would produce a
stream of cash flows with a present value
of £650,000 at the end year 5. The project
would be of the same risk as the one in
part (a), the applicable risk free rate is the
same and the volatility of the cash flows is
35%. This investment would extend the
life of the original project by another 5
years.
What is the value of this real option?
What impact would this have on the
decision regarding the original project?
c. The company may have the opportunity d. Explain the concept of investment inter- 1. Explain clearly what is meant by ‘dividend 2. Discuss the ways in which taxation will impact on the 3. What are the agency concerns surrounding the
of extending this project and the firm is relatedness and give a non-textbook irrelevancy’. company’s dividend decision. dividend payment and the share repurchase?
able to test and research new equipment example of how it works.
on site. The finance director says the
project NPV is actually higher because
there is a real option attached to the
project. Explain what a real option is and
how it works. Give two examples of
situations where you could use real
options.
c. Explain what biases there might be in a d. Describe the different methods of 1. Describe and explain when you would be likely 2. Draw and clearly label the payoff diagram for a seller of 3. Identify the five variables that go into the Black-
depreciation that are allowed and explain to use (i) options, (ii) forwards, (iii) futures, and a put option. Scholes option pricing model and explain how
they might be overcome. what impact they will have on the NPV of a (iv) swaps. Clearly differentiate as to where you movements in these variables affect the price of a
project. would use each particular product and explain put option.
why that product is suited to that situation.
 a. Calculate the cost of capital that
would be used to evaluate this
investment decision.
Dec-08
b. Work out the equivalent annual
cost for each machine and explain
which system you would choose.
c. Book values or market values? Indicate
which one is used in calculating the WACC
and why it is that one and not the other
one.
d. Describe the impact that inflation has on 1. Identify and discuss four key factors in the 2. Explain why in a company that is in financial distress 3. Discuss the likely capital structure implications
depreciation, salvage values, and their tax in company borrowing decision. managers may favour a riskier project to a safe project? of the following two examples:
capital budgeting. e. Explain what the main a. A company earns very little profits and pays no
differences are between accounting figures tax.
and cash flows for use in capital budgeting. b. Managers at a company believe the shares to be
Describe how you would obtain a figure for undervalued.
free cash flows (FCF*) from an income
statement and balance sheet.

a. How much should you pay for this b. If there was a put option available c. Draw a payoff diagram for the original d. Identify and discuss examples of the main 1. In capital budgeting, describe how the following 2. How does capital rationing affect a company and how 3. What is the problem with IRR and mutually
option? on this project, how much should it option strategy in part (a). categories of real options and explain how items are treated in the project appraisal: can capital budgeting techniques help resolve the exclusive projects, and how can it be overcome?
cost? you would use and analyse real options.e. It  Product cannibalisation problem?
is often said that the equity in a geared  Depreciation
company resembles a call option. Using the  Interest charges
Black–Scholes variables discuss how the
model works in general. f. Your company
Jun-08 also uses large amounts of cocoa in
producing chocolate products. Describe how
you could use the futures market to protect
yourself as a buyer of cocoa and draw the
payoff diagram for your futures strategy.

a. What is the required rate of return b. Explain the two methods by which c. The spot rate is $1.90/£1. Calculate the d. The company has estimated that the Comment on the return and risk to the company 2. For each of the main elements of working capital,
(WACC%) on the project foreign projects can be evaluated. forward rates for the next five years. project incremental cash flows (FCF*) for from these actions. And discuss more generally explain how companies might exercise better control over
denominated in US dollars? the next five years are $30m, $40m, $60m, return and risk with regard to managing a these items.
$70m, and $30m, respectively. The initial company’s working capital.
Dec-07 outlay for the project is $135m. What is the
NPV?e. Where do very good projects come
from and why is it so hard to find and
maintain them?

a. Lay out the relevant cash flows to
the project and explain why you are
including or excluding items.
Jun-07
b. Calculate the cost of capital and
the NPV of the project. Would you
accept or reject the project?
c. How would you treat the following d. Explain how you would conduct an EVA 1. Discuss the factors that affect the business risk 2. Discuss the factors that a company should consider 3. Discuss the factors that work against companies
items in capital budgeting terms? analysis on a firm and how you would of a company. Use the example of a software before it takes on financial risk. having 100% debt in their balance sheet as
 opportunity costs interpret the results, and comment on any company or a chemicals company to illustrate suggested in Modigliani and Miller with taxes.
 costs associated with a new product strengths and weaknesses of the method. your answer.
launch replacing a previous model
 interest payments
 depreciation

a. If you were advising the family,
what would be the arguments you
would put for and against equity or
Dec-06 debt issues by this company?
b. Calculate the current level of
earnings per share at the company.
Analyse the earnings per share
performance of the two funding choices.
If the management team was paid on the
basis of earnings per share growth, which
route would they take? What advice
would you give to Bill Pitt?
d. Discuss the suitability of the payback,
average return on investment, and
profitability index as methods of project
evaluation.e. Discuss how you analyse the
decision to lease or buy an asset.
1. Discuss the effects of diversification in terms of 2. Explain the ideas behind the Capital Asset Pricing 3. Describe how you would estimate the risk of a
the market model. Model. project when a company has moved into a new
area for the project, and there is not a company
that operates solely in that field.

a. Lay out the relevant cash flows to b. Calculate the cost of capital for c. Discuss why capital rationing might d. Discuss the impact of inflation on a 1. Explain why dividends are the basis for share 2. Explain how the price earnings ratio and the discount 3. Discuss the strengths and weaknesses of the
this project. the project and calculate the NPV. occur and clearly explain how a company project’s cash flows and how this should be valuation. rate are related. price earnings ratio.
Jun-06 Should they go ahead with the would choose among a number of handled in the analysis.
project? projects under a limited budget.

a. What is the NPV of the project? b. Discuss why we use cash flows c. Describe how the problem of poor d. Describe the other disadvantages of IRR 1. Explain what is meant by the term ‘duration’ 2. The set of spot interest rates is 5%, 5.5%, 6%, 6.5%, and 3. Explain what the yield to maturity of a bond is
Should the company go ahead with and not accounting profits when project selection by the internal rate of relative to NPV and discuss how these other with regard to interest rate changes. 7% for each of the next five years. There are two five year and discuss how the coupon effect on the yield to
the expansion? Explain your decision evaluating projects. return method in mutually exclusive problems may be overcome. bonds, one with a coupon of 6% and one with a coupon of maturity works.
Dec-05 whether to include or exclude the projects can be overcome. 10%. Calculate the duration of each of the bonds and
above items in your cash flow. comment on your results.