F3 Financial Strategy Question and Answers

A company is based in Country Y whose functional currency is YS. It has an investment in Country Z whose functional currency is ZS This year the company expects to generate ZS20 million profit after tax.

Tax Regime

• Corporate income tax rate in Country Y is 60%

• Corporate income tax rate in Country Z Is 30%

• Full double tax relief is available

Assume an exchange rate of YS1 = ZS5

What is the expected profit after tax in YS if the ZS profit is remitted to Country Y?

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?

A company financed by equity and debt can be valued by discounting:

An unlisted company.

• Is owned by the original founders and members of their families

• Pays annual dividends each year depending on the cash requirements of the dominant shareholders.

• Has earnings that are highly sensitive to underlying economic conditions.

• Is a small business in a large Industry where there are listed companies with comparable capital structures

Which of the following methods is likely to give the most accurate equity value for this unlisted company?

Which of the following is NOT an advantage of a share repurchase?

Company F's current profit before interest and taxation is $5.0 million.

It has a 10% long-term corporate bond in issue with a nominal value of $10 million.

Corporate tax is paid at 25%.

The industry average P/E multiple is 10.

Company X has made an approach to acquire the entire share capital of Company F for $30 million.

Company X has announced that anticipated synergies (after interest and taxation) arising from its acquisition of Company F will be $1 million each year in perpetuity. 

 

Advise the Board of Directors of Company F if the bid should be accepted, based on the above information?

Which three of the following are most likely be primary objectives for a newly established, unincorporated entity in the service sector?

Which THREE of the following would be most important if a hospital wishes to review the effectiveness of its services?

Company J is in negotiations to acquire Company K and believes it can turn around Company K's performance to match its own.

 

The following information is available for the two companies:

 

  

 

Select the maximum price for each share that Company J should place on Company K during negotiations. 

A wholly equity financed company has the following objectives:

1. Increase in profit before interest and tax by at least 10% per year.

2. Maintain a dividend payout ratio of 40% of earnings per year.

 

Relevant data:

   • There are 2 million shares in issue.

   • Profit before interest and tax in the last financial year was $5 million.

   • The corporate income tax rate is 30%.

At the beginning of the current financial year, the company raised long term debt of $2 million at 10% interest each year. 

 

Calculate the dividend per share that will be announced this year assuming the company achieves its objective of increasing profit before interest and tax by 10%.

Two listed companies in the same industry are joining together through a merger.

 

What are the likely outcomes that will occur after the merger has happened? 

Select ALL that apply.

A company's Board of Directors is assessing the likely impact of financing new projects by using either debt or equity finance.

The impact of using debt or equity finance on some key variables is uncertain.

 

Which THREE of the following statements are true?

Which of the following statements best describes a residual dividend policy?

The Board of Directors of a listed company have decided that it needs to increase its equity capital to ensure it is in a more stable financial position.

The shareholder profile is a mix of institutional and individual small shareholders.

The board is considering either:

   • A scrip dividend 

   • A zero dividend

 

Which THREE of the following would be considered disadvantages of a scrip dividend compared to a zero dividend?

Two unlisted companies TTT and YYY are being valued. The companies have similar capital structures and risk profiles and operate in the same industry sector It is easier to value TTT than to value YYY because there have recently been several well-publicised private sales of TTT shares.

Relevant company data:

What is the best estimate of YYY's share price?

Company A plans to acquire Company B, an unlisted company which has been in business for 3 years.

It has incurred losses in its first 3 years but is expected to become highly profitable in the near future.

No listed companies in the country operate the same business field as Company B, a unique new high-risk business process.

The future success of the process and hence the future growth rate in earnings and dividends is difficult to determine.

Company A is assessing the validity of using the dividend growth method to value Company B.

 Which THREE of the following are weaknesses of using the dividend growth model to value an unlisted company such as Company B?

Company T has 1,000 million shares in issue with a current share price of $10 each.

Company V has 300 million shares in issue with a current share price of $5 each.

Company T is considering acquiring Company V.

Total synergy gains of $100 million have been estimated.

The purchase of Company V's shares would be by cash at a 10% premium above the current share price.

 

In seeking approval for the acquisition, the likely reaction from T's shareholders will be:

A company currently has a 6.25% fixed rate loan but it wishes to change the interest style of the loan to variable by using an interest rate swap directly with the bank.

 

The bank has quoted the following swap rate:

   • 5.50% - 5.55% in exchange for LIBOR

LIBOR is currently 5%.

 

If the company enters into the swap and LIBOR remains at 5%, what will the company's interest cost be?

Extracts from a company's profit forecast for the next financial year as follows:

  

Since preparing the forecast, the company has decided to return surplus cash to shareholders by a share repurchase arrangement.

The share repurchase would result in the company purchasing 20% of the 1,250 million ordinary shares currently in issue and canceling them.

 

Assuming the share repurchase went ahead, the impact on the company's forecast earnings per share will be an increase of:

A company has announced a rights issue of 1 new share for every 4 existing shares. 

 

Relevant data:

   • The current market price per share is $10.00.

   • Rights are to be issued at a 20% discount to the current price.

   • The rate of return on the new funds raised is expected to be 10%.

   • The rate of return on existing funds is 5%.

What is the yield-adjusted theoretical ex-rights price?

 

Give your answer to two decimal places.

 

$ ?  

A listed company has recently announced a profit warning.

 

The company's share price fell 20% on the day of the announcement but had been fairly static in the weeks leading up to the announcement.

 

Which form of efficient market is most likely to be indicated by this share price movement?

Which THREE of the following statements are correct?

Company Z wishes to borrow $50 million for 10 years at a fixed rate of interest.

 

Two alternative approaches are being considered:

   A. Issue a 10 year bond at a fixed rate of 6%, or

   B. Borrow from the bank at Libor +2.5% for a 10 year period and simultaneously enter into a 10 year interest rate swap.

 

Current 10 year swap rates against Libor are 4.0% - 4.2%.

 

What is the difference in the net interest cost between the two alternative approaches?

The International Integrated Reporting Council (IIRC) was formed in August 2010 and brings together a cross-section of representatives from a wide variety of business sectors.

 The primary purpose of the IIRC's framework is to help enable an organsation to communicate how it:

XYZ has a variable rate loan of $200 million on which it is paying interest of Liber ‘ 3%.

XYZ entered into a swap with AG bank to convert this to a fixed rate 8% loan. AB bank charges an annual commission of 0.4% for making this arrangement

Calculate the net payment from KYZ to AB bank at the end of the first year if Libor was 2% throughout the year.

Give your answer in $ million, to one decimal place.

An all equity financed company reported earnings for the year ending 31 December 20X1 of $8 million.

One of its financial objectives is to increase earnings by 5% each year.

In the year ending 31 December 20X2 it financed a project by issuing a bond with a $1 million nominal value and a coupon rate of 4%.

The company pays corporate income tax at 20%.

 

If the company is to achieve its earnings target for the year ending 31 December 20X2, what is the minimum operating profit (profit before interest and tax) that it must achieve?

A venture capitalist has made an equity investment in a private company and is evaluating possible methods by which it can exit the investment over the next 3 years. The private company shareholders comprise the four original founders and the venture capitalist. 

 Advise the venture capitalist which THREE of the following methods will enable it to exit its equity investment?

A private company manufactures goods for export, the goods are priced in foreign currency B$.  

The company is partly owned by members of the founding family and partly by a venture capitalist who is helping to grow the business rapidly in preparation for a planned listing in three years' time.  

The company therefore has significant long term exposure to the B$. 

This exposure is hedged up to 24 months into the future based on highly probable forecast future revenue streams.  

The company does not apply hedge accounting and this has led to high volatility in reported earnings. 

 

Which of the following best explains why external consultants have recently advised the company to apply hedge accounting?

A company is based in Country Y whose functional currency is Y$. It has an investment in Country Z whose functional currency is Z$.

This year the company expects to generate Z$ 10 million profit after tax.

Tax Regime:

   • Corporate income tax rate in country Y is 50%

   • Corporate income tax rate in country Z is 20%

   • Full double tax relief is available

Assume an exchange rate of Y$ 1 = Z$ 5.

 

What is the expected profit after tax in Y$ if the Z$ profit is remitted to Country Y?

Company C invests heavily in Research and Development an need to raise $45 million to finance future projects. It has decided to use equity finance raised by a tender offer, The following tender offers have been received from potential investors:

Company C wishes to select an offer price that will project shareholders from a significant dilution of control but still raise the required amount of finance.

What offer price should Company C’s select?

The Government of Eastland is concerned that competition within its private healthcare industry is being distorted by the dominant position of the market leader, Delta Care. The Government has instructed the industry regulator to investigate whether the industry is operating fairly in the interests of patients.

Which of the following factors might the industry regulator review as part of their investigation?

Select ALL that apply.

Company C has received an unwelcome takeover bid from Company P.

Company P is approximately twice the size of Company C based on market capitalisation.

Although the two companies have some common business interests, the main aim of the bid is diversification for Company P.

The offer from Company P is a share exchange of 2 shares in Company P for 3 shares in Company C.

There is a cash alternative of $5.50 for each Company C share.

Company C has substantial cash balances which the directors were planning to use to fund an acquisition.

These plans have not been announced to the market.

 

The following share price information is relevant. All prices are in $.

  

 

Which of the following would be the most appropriate action by Company C's directors following receipt of this hostile bid?

A listed company in the retail sector has accumulated excess cash.

In recent years, it has experienced uncertainly with forecasting the required level of cash for capital expenditure due to unpredictable economic cycles.

Its excess cash is on deposit earning negligible returns.

The Board of Directors is considering the company's dividend policy, and the need to retain cash in the company.

 

Which THREE of the following are advantages of retaining excess cash in the company? 

Company AB was established 6 years ago by two individuals who each own 50% of the shares.

Each individual heads a separate division within the company, which now has annual turnover of GBP10 million and employs 40 people.

Some of the employees are very highly paid as they are important contributors to the company's profitability.

The owners of the company wish to realise the full value of their investment within the next 12 months.

 

Which TWO of the following options are most likely to be acceptable exit strategies to the two owners of the company?

A company with a market capitalisation of S50million is considering raising $1 million debt to fund a new 10-year capital investment protect

The value of this issue is considered to be small in comparison to the company's market capitalisation

The company is considering whether to raise the debt finance by either a "bond private placing' or a 'public bond issue.

Which THREE of the following statements are correct?

Company A has agreed to buy all the share capital of Company B.

The Board of Directors of Company A believes that the post-acquisition value of the expanded business can be computed using the "boot-strapping" concept.

Which of the following most accurately describes "boot-strapping" in this context?

NNN is a company financed by both equity and debt. The directors of NNN wish to calculate a valuation of the company's equity and at a recent board meeting discussed various methods of business valuation.

Which THREE of the following are appropriate methods for the directors of NNN to use in this instance?

A company wishes to raise additional debt finance and is assessing the impact this will have on key ratios. 

The following data currently applies:

   • Profit before interest and tax for the current year is $500,000

   • Long term debt of $300,000 at a fixed interest rate of 5%

   • 250,000 shares in issue with a share price of $8

The company plans to borrow an additional $200,000 on the first day of the year to invest in new project which will improve annual profit before interest and tax by $24,000.

The additional debt would carry an interest rate of 3%.

Assume the number of shares in issue remain constant but the share price will increase to $8.50 after the investment.

The rate of corporate income tax is 30%.

 

After the investment, which of the following statements is correct?

A company based in Country D, whose currency is the D$, has an objective of maintaining an operating profit margin of at least 10% each 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?

H Company has a fixed rate load at 10.0%, but wishes to swap to variable. It can borrow at LIBOR 8%.

The bank is currently quoting swap rates of 3.1% (bid) and 3.5% (ask).

What net rate will H Company pay if it enters into the swap?

An unlisted software development company has recently reported disappointing results. This was partly due to weak economic conditions but also because of its poor competitive position. The company has a number of exciting development opportunities which would enable it to achieve significant future growth. The company's growth potential has been hindered by its inability to secure sufficient new finance.

To enable the company raise new finance the Directors are considering working forwards an IPO in 10 years and accepting finance from a venture capitalist in order support in the intervening period.

The directors are keen to retain a controlling stake in the company and full representation on the board. They therefore require venture capitalists to provide funds as a mix of debt and equity and not soley equity finance.

Which THREE of the following are most likely to disrupt the directors' plans to use venture capital finance?

PTT has a number of subsidiary companies around the world, including FTT based in Europe and CTT based in Indonesia

CTT purchases all of us raw materials from FTT CTT processes these materials and the resulting products are exported to several different countries CTT pays FTT in the Indonesian currency.

Indonesia's inflation is higher than that of FTTs home country

Which of the following statements are correct?

Select ALL that apply

A listed company follows a policy of paying a constant dividend.  The following information is available:

   • Issued share capital (nominal value $0.50) $60 million

   • Current market capitalisation $480 million

The shareholders are requesting an increased dividend this year as earnings have been growing.  However, the directors wish to retain as much cash as possible to fund new investments. They therefore plan to announce a 1-for-10 scrip dividend to replace the usual cash dividend.

 

Assuming no other influence on share price, what is the expected share price following the scrip dividend?

 

Give your answer to 2 decimal places.

 

$ ?  

A company’s statement of financial position includes non-current assets which are leased, the tax regime follows the accounting treatment.

Which cash flows should be discounted when evaluating the cost of lease finance?

Which THREE of the following statements are correct in respect of the issuance of debt securities.

Extracts from a company's profit forecast for the next financial year is as follows:

Since preparing the forecast, the company has decided to return surplus cash to shareholders by a share repurchase arrangement.

The share repurchase would result in the company purchasing 20% of the 2,000 million ordinary shares currently in issue and cancelling them.

Assuming the share repurchase went ahead, the impact on the company's forecast earnings per share will be an increase of:

The long-term prospects for inflation in the UK and the USA are 1% and 4% per annum respectively.

The GBP/USD spot rate is currently GBP/USD1.40

Using purchasing power parity theory, what GBP/USD spot rate would you expect to see in six months’ time?

A company's Board of Directors wishes to determine a range of values for its equity.

The following information is available:

Estimated net asset values (total asset less total liabilities including borrowings):

   • Net book value = $20 million

   • Net realisable value = $25 million

   • Free cash flows to equity = $3.5 million each year indefinitely, post-tax.

   • Cost of equity = 10%

   • Weighted Average Cost of Capital = 7%

Advise the Board on reasonable minimum and maximum values for the equity.

A company is considering the issue of a convertible bond compared to a straight bond issue (non-convertible bond).

Director A is concerned that issuing a convertible bond will upset the shareholders for the following reasons:

   • it will dilute their control

   • the interest payments will be higher therefore reducing liquidity

   • it will increase the gearing ratio therefore increasing financial risk

Director B disagrees, and is preparing a board paper to promote the issue of the convertible bond rather than a non-convertible.

 

Advise the Director B which THREE of the following statements should be included in his board paper to promote the issue of the convertible bond?

Which of the following statements are true with regard to interest rate swaps?

Select ALL that apply.

Company R is a well-established, unlisted, road freight company.

In recent years R has come under pressure to improve its customer service and has had some cusses in doing this However, the cost of improved service levels has resulted In it marketing small losses in its latest financial year. This is the forest time R has not been profitable.

R uses a’ residual divided policy ad has paid dividends twice in the last 10 years.

Which of the following methods would be most appropriate for valuating R?

Company A is planning to acquire Company B. Both companies are listed and are of similar size based on market capitalisation No approach has yet been made to Company B's shareholders as the directors of Company A are undecided about the most suitable method of financing the offer Two methods are under consideration a share exchange or a cash offer financed by debt.

Company A currently has a gearing ratio (debt to debt plus equity) of 30% based on market values. The average gearing ratio (debt to debt plus equity) for the industry is 50% Although no formal offer has been made there have been market rumours of the proposed bid. which is seen as favorable to Company A. As a consequence. Company As share price has risen over the past few weeks while Company B's share price has fallen.

Which THREE of the following statements are most likely to be correct?

Company E is a listed company. Its directors are valuing a smaller listed company, Company F, as a possible acquisition.

The two companies operate in the same markets and have the same business risk.

Relevant data on the two companies is as follows:

  

Both companies are wholly equity financed and both pay corporate tax at 30%.

The directors of Company E believe they can "bootstrap" Company F's earnings to improve performance.

Calculate the maximum price that Company E should offer to Company F's shareholders to acquire the company.

 

Give your answer to the nearest $million.

 

A company's gearing is well below its optimal level and therefore it is considering implementing a share re-purchase programme.

This programme will be funded from the proceeds of a planned new long-term bond issue.

Its financial projections show no change to next year's expected earnings.

As a result, the company plans to pay the same total dividend in future years.

 

If the share re-purchase is implemented, which THREE of the following measures are most likely to decrease?

An unlisted company is attempting to value its equity using the dividend valuation model.

Relevant information is as follows:

   • A dividend of $500,000 has just been paid.

   • Dividend growth of 8% is expected for the foreseeable future.

   • Earnings growth of 6% is expected for the foreseeable future.

   • The cost of equity of a proxy listed company is 15%.

   • The risk premium required due to the company being unlisted is 3%.

The calculation that has been performed is as follows:

Equity value = $540,000 / (0.18 - 0.08) = $5,400,000

What is the fault with the calculation that has been performed?