Question 1

A company is planning to issue a 5 year $100 million bond at a fixed rate of 6%.

It is also considering whether or not to enter into a 10 year $100 million swap to receive 5% fixed and pay

Libor + 1% once a year.

The company predicts that Libor will be 4% over the life of the 5 years.

What is the impact of the swap on the company's annual interest cost assuming that

the Libor prediction is correct?

Options :

A : Increase by 1%.

B : Fall by 1%.

C : Remain the same.

D : Fall by 2%.

Answer: C

Question 2

A company has a cash surplus which it wishes to distribute to shareholders by a share repurchase rather than

paying a special dividend.

Which THREE of the following statements are correct?

Options :

A : The payment of a special dividend could raise shareholders' expectations of similar distributions in the future, unlike a share repurchase.

B : The share repurchase could send a negative signal to shareholders as it could be interpreted as a failure of management to find suitable investment opportunities

C : Determination of the repurchase price will be easy as shareholders will insist on receiving the open market price

D : Different tax regimes could result in shareholders having a preference for a share repurchase due to the often more preferential tax treatment of capital gains.

E : The share repurchase, if approved by the shareholders, will be binding on all of the company's shareholders.

Answer: A,B,D

Question 3

A company is undertaking a lease-or-buy evaluation, using the post-tax cost of bank borrowing as the discount

rate.

Details of the two alternatives are as follows:

Buy option:

• To be financed by a bank loan

• Tax depreciation allowances are available on a reducing-balance basis

• Assets depreciated on a straight-line basis

Lease option:

• Finance lease

• Maintenance to be paid by the lessee

• Tax relief available on interest payments and book depreciation

Which THREE of the following are relevant cashflows in the lease-or-buy appraisal?

Options :

A : Tax relief on tax depreciation allowances

B : Bank loan payments

C : Maintenance payments

D : Lease payments

E : Tax relief on the book depreciation

Answer: A,D

Question 4

Company Y plans to diversify into an activity where Company X has an equity beta of 1.6, a debt beta of zero

and gearing of 50% (debt/debt plus equity).

The risk-free rate of return is 5% and the market portfolio is expected to return 10%.

The rate of corporate income tax is 30%.

What would be the risk-adjusted cost of equity if Company Y has 60% equity and 40?bt?

Options :

A : 11.6%

B : 11.9%

C : 9.1%

D : 13%

Answer: B

Question 5

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

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

the various methods of business valuation.

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

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

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

to a valuating using a price earnings methods?

Options :

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

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

C : The calculations are much simpler.

D : It incorporates the time value of money.

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

Answer: A,C,D

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