Financial Management Mock September 2021 Rizwan Maniya

Section A – Each question worth 2 marks

1. If an increase in inventory levels is funded by an increase in the bank overdraft, what will be the effect of
the quick (liquidity) ratio?

a) Increase
b) Decrease
c) Remain the same
d) Increase, decrease or remain the same depending on the initial size of the quick ratio

2. There are a number of motives that influence how much a business wishes to hold in cash.

When a company holds cash in order to make the certain outflows such as wages, taxes and payments to
suppliers, the motive behind this is:

a) The speculative motive

b) The transactions motive
c) The finance motive
d) The precautionary motive

3. An asset costing $24,000 is expected to last for three years, after which it can be sold for $16,000. The
corporation tax rate is 30%, tax-allowable depreciation of 25% is available, and the cost of capital is 10%. Tax is
payable at the end of each financial year.

Capital expenditure occurs on the last day of a financial year, and the tax depreciation allowances are claimed
as early as possible.

What is the cash flow in respect of tax allowable depreciation that will be used at time 2 of the net present
value calculation?

a) $1,013
b) $896
c) $1,350
d) $3,375

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4. Which of the following statements is true?

a) The Expected Value technique takes into account the investor’s attitude to risk and considers the fact
that some investors are more likely to take risks than others.
b) Using mathematical models, a simulation exercise produces a distribution of the possible outcomes
from a project. The probability of different outcomes can then be calculated.
c) Sensitivity analysis assesses the likelihood of a variable changing
d) The lower the sensitivity margin, the less sensitive the decision to the particular parameter being
considered.

5.The director/shareholder conflict has been addressed by the requirements of a number of corporate
governance codes.

Which of the following statements is not true?

a) At least sixty percent of the members of the board, excluding the chairman, should be independent
non-executive directors
b) All directors should submit themselves for re-election at least every three years
c) There should be clear disclosure of directors’ emoluments
d) Non-executive directors should not hold share option in their company

6.According to the expectations theory, investors’ expectations of decreasing inflation will result in which of
the following?

a) A downward-sloping yield curve

b) An upward-sloping yield curve
c) A flat yield curve
d) A humped yield curve

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7. The following options are held by Frances Co at their expiry date:

(1) A call option on GBP 500,000 in exchange for USD at an exercise price of GBP 1 = USD 1.90. The exchange
rate at the expiry date is GBP 1 = USD 1.95.

(2) A put option on GBP 400,000 in exchange for Singapore Dollars at an exercise price of GBP 1 = SGD 2.90.
The exchange rate at the expiry date is GBP 1 = SGD 2.95.

Which one of the following combinations (exercise/lapse) should be undertaken by the company?

Call Put

a) Exercise Lapse
b) Exercise Exercise
c) Lapse Exercise
d) Lapse Lapse

8.Which of the following relate to finance leases as opposed to operating leases?

1 Maintained and insured by the lessee

2 Asset appears on statement of financial position of the lessor
3 Equipment leased for a shorter period than its expected useful life

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

9.Which of the following statements is incorrect?

a) Money markets are markets for short-term capital.

b) Money markets are operated by banks and other financial institutions.
c) Money market instruments include equities and corporate bonds.
d) Money market instruments are traded over the counter between institutional investors.

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10.The treasury department in Aloha Co has calculated, using the Miller-Orr model, that the lowest cash
balance they should have is $2m, and the highest is $11m. If the cash balance goes above $11m they transfer
the cash into money market securities.

Which of the following is/are true?

1 When the balance reaches $11m they would buy $6m of securities
2 When the balance falls to $2 they will sell $3m of securities
3 If the variance of daily cash flows increases, the spread between upper and lower limit will be increased

a) 1 and 2 only
b) 3 only
c) 2 and 3 only
d) 1, 2 and 3

11. G Co decides to offer a 2.5% early settlement discount that half of all customers take up. They pay in one
month instead of the usual two months. G Co pays 8% per year for its overdraft facility.
What impact will this have?

Cash operating cycle Reported profits

a) Unaffected Reduce
b) Reduce Reduce
c) Unaffected Increase
d) Reduce Increase

12. Comment on the validity of the following statements.

1- Financial intermediation refers to the process whereby potential borrowers are brought together with
potential lenders by a third party.

2- There are two main types of financial markets: the primary market deals in new securities and the
secondary market deals in second-hand’ securities.

a) A Statement 1: True Statement 2: False

b) B Statement 1: True Statement 2: True
c) C Statement 1: False Statement 2: False
d) D Statement 1: False Statement 2: True

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13. Bilbo Co is an unlisted company with 800,000 issued shares. Seema is one of the founders and owns 20%
of the issued shares. Bilbo Co has just paid its annual dividend of $0.30 per share. It is expected that next
year's dividend will be $0.32 per share. After that it is expected that dividends will grow indefinitely at 2% per
year. Shareholders expect a 12% return from their investment.

Using the dividend valuation model, calculate the value of Seema's shareholding.

a) $512,000
b) $522,240
c) $489,600
d) $480,000

14. Which TWO of the following are consistent with traditional capital structure theory?

a) There is no optimal capital structure

b) The value of the company remains unchanged with increased gearing
c) The cost of equity is higher when there is a high proportion of debt capital
d) There is a point at which the weighted average cost of capital is minimized

15. Which TWO of the following statements concerning the interest rate risk management method of
smoothing are true?

a) The debt portfolio will consist of a mixture of fixed and floating rate debt
b) Interest payments will still increase if the interest rate rises
c) Investments with a fixed cash flow will be financed with fixed rate debt
d) Full benefit will be obtained from a fall in interest rates
e) The net effect will be an interest payment which is fixed overall

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Financial Management Mock September 2021 Rizwan Maniya

Section B – Each question is worth 2 marks

Q16. Nash Co is a listed company having multiple shareholders. A group of shareholders have met at the
company’s annual dinner party & have made some following statements which are as follows:
Adam: “The Company has previously provided good dividends to its shareholders & it is likely that dividends
will continue in the foreseeable future with high valued share”

Bruce: “By looking at the recently published annual report I would be able to make a great deal of profit &
consider buying a new car”

Charlie: “The Company has faced a huge redundancy payment due to the closure of a department & it is likely
to affect the value of shares”

David: “If I was to tell you all that Nash Co is likely to invest in a huge project but has not disclosed to the
public, what will you do?”

Ephraim: “The value of shares fluctuates too much around the intrinsic value; I am considering selling these
shares in near future”

1 Which type of market does Bruce likely to be in?

a) Weak market
b) Insider market
c) Political market
d) Semi-strong market

2 Charlie is anxious about the share valuation due to which of the following factors?
a) Investor Speculation
b) Past information
c) One-off event
d) Technical analysis

3 Which of the following factors does Ephraim apply to its shares?

a) Fundamental analysis
b) Random Walk
c) Seasonal variation
d) Availability of information

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4. Which of the following shareholders uses technical analysis to value its shares?

a) Adam
b) Bruce
c) Charlie
d) Ephraim

5 Which of the shareholders is likely to have insider information?

a) Adam
b) Bruce
c) Charlie
d) David

Q17. Geezer Co was recently audited & a conclusion was drawn that working capital was very high. The main
area of concern is its inventory levels which have been significantly high due to which company had used bank
overdraft to cover its expenses. The directors have arranged a meeting to discuss possible solutions to reduce
excess inventory levels.

1. Which of the following are not the benefits of JIT system?

a) Inventory levels at a minimum

b) Reduction in production time
c) Just in time results in extra cost paid to supplier in form of premium
d) Quality production
e) None of the above

2. Which of the following statements are not correct?

a) Just in time has low re-order cost

b) Companies can fulfill orders quickly if demand is high & JIT system is used
c) Re-order of inventory when inventory falls below the buffer level is called periodic review

3.Calculate the amount of inventory in hand when an order is placed (52 weeks/annum)? If the company
accepts the economic order quantity method for inventory & it takes two weeks for an order to be delivered.

a) 29 units
b) 58 units
c) 115 units
d) 230 units

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4.Using the information calculate the economic order quantity? The purchase price for each unit is $600 &
delivery charges are $8/unit. The yearly demand is 3,000 units. The procurement manager has a salary of
$19,000. The orders are placed in a year is 1,000. The cost of storage is $5/unit & the other holding cost is 10%
of purchase price.

a) 20 units
b) 27 units
c) 32 units
d) 40 units

5.Select the appropriate options in relation to economic order quantity.

a) Assumes fluctuating purchase prices of inventory

b) There is zero lead time
c) Demands for inventory are constant
d) Assumes no minimum level of inventory are kept

Q3. Tito Co is looking into the financing options to obtain a new subsidiary. Tito Co has estimated that they will
need to borrow the USA $200,000 in two months’ time for six months. The company is concerned about the
fluctuations in interest rates and is considering hedging this risk. Tito Co has been advised to consider using a
forward rate agreement. The FRA’s are as follows:

2 months V 6 months 2.1% - 3.6%

2 months V 8 months 4.7% - 5%

1.Which of the following statements is/are true in relation to forward rate agreements?

a) They are difficult to obtain for periods over one year

b) FRA may not protect the borrower from adverse changes in the market
c) FRA’s are over the counter contracts

2.Select the appropriate option.

a) Purchasing power parity theory tends to hold true in the short-term

b) Inflation rates cannot be used to calculate expected future spot rates
c) Current spot rates are not based on interest rates

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3. The expected future spot rate in one year is $1.4505/€1. The predicted inflation rates for the year ahead are:

Dollar 2% per year

Euro 3.5% per year

Calculate the current spot rate to 4 decimal places.

_______$/€

4.What will be the refundable percentage if the market interest rate is 6%?

a) 1.3%
b) 2.4%
c) 3.6.%
d) 4.7%

5.What will be the interest payment on the market interest rate of 4%?

a) $700
b) $3,600
c) $4,700
d) $5,000

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Section C
Q1.

Equity finance million

Ordinary shares ($1 nominal value) 28
Reserves 25
Non-current liabilities
6% Convertible bonds ($100 nominal value) 45
8% Preference shares ($1 nominal value) 10
5% Bank Loan 15
Current liabilities
Trade payables 60

Helly Co has an equity beta of 1.4 and the ex-dividend market value of the company’s equity is $140 million.
The ex-interest market value of the convertible bonds is $48 million, and the ex-dividend market value of the
preference shares is $7.75 million. The convertible bonds of Helly Co have a conversion ratio of 23 ordinary
shares per bond. The conversion date and redemption date are both on the same date in five years’ time. The
current ordinary share price of Helly Co is expected to increase by 3.5% per year for the foreseeable future.
The equity risk premium is 5% per year and the risk-free rate of return is 4% per year.

Helly Co is also appraising an investment project named Royale which will not have any impact on its business
risk or financial risk. The project will cost $20m, payable in full at the start of the first year of operation. The
project life is expected to be four years. Forecast sales volumes, selling price, variable cost and fixed costs are
as follows

Year 1 2 3 4
Sales (units/year) 250,000 320,000 280,000 570,000
Selling price($/unit) 125 162 140 105
Variable cost ($/unit) 54 62 68 57
Fixed costs($’000/year) 2000 2400 2100 3000

Selling price and cost information are in current price terms. Selling price inflation of 4% per year, variable
cost inflation of 2.5% per year and fixed cost inflation of 3% per year. Helly Co pays corporation tax of 26%,
with the tax liability being settled in the following year of which it arises. The company can claim tax-allowable

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depreciation on the full initial investment on a 25% reducing balance basis. The investment project is expected
to have 1.05m terminal value at the end of four years.

Required:

(a) Calculate the market value after-tax weighted average cost of capital of Helly Co. (8 marks)

(b) Calculate nominal method NPV for Royale. (9 marks)

(c) Discuss the circumstances under which the weighted average cost of capital (WACC) can be used as a
discount rate in investment appraisal. (3 marks)

(20 marks)

Q2.

The directors of Bexing Co formally disclosed their overriding objective at a recent annual general meeting
when the chairman announced:
'We aim for growth in our equity value in the stock markets.'
This announcement displeased the employee representatives on the Works Council. They have argued that
the company’s management should favor growth both of profits and of turnover, so providing additional
employment opportunities. The company disclosed the following five-year summary of results in its recently
published annual report:
20X1 20X2 20X3 20X4 20X5
Turnover 156,826 167,844 176,408 180,913 164,220
Profit after taxation 17,251 20,458 18,650 20,612 22,193
Dividend/share 50 cents 60 cents 70 cents 70 cents 80 cents
P/E ratio (times) 5.7 5.3 6.0 5.5 6.5
dividend per share 12.8 13.5 13.5 14.5 15.0
(cents)

There were 30 million shares in issue throughout the above five-year period.
Bexing Co is planning to expand its existing business. The investment cost of $6.5 million will be met by a 2 for
5 rights issues. The rights issue price will be at a 20% discount to the current share price. It is assumed that the
P/E ratio remain constant after the rights issue.

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The finance director of Bexing Co expects that the expansion of existing business will allow earnings per share
to grow by the same rate as in the previous years.
Bexing Co has a cost of equity of 10%.

Required
(a) Assess whether the directors have, thus far, met their stated objective. (5 marks)

(b) (i) Calculate theoretical ex rights price prior to investing in the proposed business expansion.
(ii) Calculate the expected share price following the proposed business expansion using price earnings ratio
method.
(iii) Discuss whether the proposed business expansion is an acceptable use of the finance raised by the
rights issue, and evaluate the expected effect on the wealth of the shareholders of Bexing Co.
(11 marks)
(c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the
capital asset pricing model. (4 marks)

(20 marks)

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