76 The equity shares of Nice plc have a beta value of 0.80. The risk free rate of return is 6%
and the market risk premium is 4%. Corporation tax is 30%.
What is the required return on the shares of Nice plc?
A 7.7%
B 8.8%
C 9.2%
D 13.1%
77 Which of the following statements is correct?
A A bonus issue can be used to raise new equity finance
B A share repurchase scheme can increase both earnings per share and gearing
C Miller and Modigliani argued that the financing decision is more important than the dividend decision
D Shareholders usually have the power to increase dividends at annual general meetings of a company
78 Four companies are identical in all respects, except for their capital structures, which are as follows:
A plc B plc C plc D plc
% % % %
Equity as a proportion of total market capitalisation 70 20 65 40 Debt as a proportion of total market capitalisation 30 80 35 60 The equity beta of A plc is 0.89 and the equity beta of D plc is 1.22.
Within which ranges will the equity betas of B plc and C plc lie?
A The beta of B plc and the beta of C plc are both higher than 1.22.
B The beta of B plc is below 0.89 and the beta of C plc is in the range 0.89 to 1.22.
C The beta of B plc is above 1.22 and the beta of C plc is in the range 0.89 to 1.22.
D The beta of B plc is in the range 0.89 to 1.22 and the beta of C plc is higher than 1.22.
79 Which of the following statements concerning profit are correct?
1 Accounting profit is not the same as economic profit 2 Profit takes account of risk
3 Accounting profit can be manipulated by managers A 1 and 3 only
B 1 and 2 only C 2 and 3 only D 1, 2 and 3
80 A company issued its 12% irredeemable loan notes at 95. The current market price is 92.
The company is paying corporation tax at a rate of 30%.
What is the current net cost of capital per annum of these loan notes?
A 8.8%
B 9.1%
C 12.6%
D 13.0%
81 Ingham plc’s capital structure is as follows:
$m
50c ordinary shares 12
8% $1 preference shares 6
12.5% loan notes 20X6 8
––––
26
––––
The loan notes are redeemable at nominal value in 20X6. The current market prices of the company’s securities are as follows.
50c ordinary shares 250c
8% $1 preference shares 92c
12.5% loan notes 20X6 $100
The company is paying corporation tax at the rate of 30%. The cost of the company’s ordinary equity capital has been estimated at 18% pa.
What is the company’s weighted average cost of capital for capital investment appraisal purposes?
A 9.71%
B 13.53%
C 16.29%
D 16.73%
82 Which of the following statements is/are correct?
1 An increase in the cost of equity leads to a fall in share price
2 Investors faced with increased risk will expect increased return as compensation 3 The cost of debt is usually lower than the cost of preference shares
A 2 only B 1 and 3 only C 2 and 3 only D 1, 2 and 3
83 A company has just declared an ordinary dividend of 25.6p per share; the cum‐div market price of an ordinary share is 280p.
Assuming a dividend growth rate of 16% per annum, what is the company’s cost of equity capital?
A 11.7%
B 22.7%
C 32.6%
D 27.7%
84 Which of the following would be implied by a decrease in a company’s 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
85 Which of the following statements is part of the traditional theory of gearing?
A There must be taxes
B There must exist a minimum WACC
C Cost of debt increases as gearing decreases D Cost of equity increases as gearing decreases 86 A scrip issue with perfect information
A Decreases earnings per share
B Decreases the debt/equity ratio of the company C Increases individual shareholder wealth
D Increases the market price of the share
87 A company incorporates increasing amounts of debt finance into its capital structure, while leaving its operating risk unchanged.
Assuming that a perfect capital market exists, with corporation tax (but without personal tax), which of the following correctly describes the effect on the company’s costs of capital and total market value?
Cost of equity Weighted average cost of capital Total market value
A Increases Unaffected Increases
B Unaffected Decreases Increases
C Increases Decreases Increases
D Decreases Increases Decreases
88 If for a given level of activity a firm’s 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 firm’s financial and operating risk?
Financial risk Operating risk
A Decreases Decreases
B Increases Decreases
C Decreases Increases
D Increases Increases
89 A security’s required return can be predicted using the CAPM using the formula:
rj = rf + j (rm – rf)
Security X has a beta value of 1.6 and provides a return of 12.0%
Security Y has a beta value of 0.9 and provides a return of 13.0%
Security Z has a beta value of 1.2 and provides a return of 13.2%
Security Z is correctly priced.
The risk free return is 6%.
What does this information indicate about the pricing of securities X, Y?
Security X Security Y A underpriced overpriced B correctly priced underpriced C underpriced correctly priced D overpriced underpriced
90 The following are extracts from the statement of financial position of a company:
$000 $000
Equity
Ordinary shares 8,000
Reserves 20,000
–––––––
28,000
Non‐current liabilities
Bonds 4,000
Bank loans 6,200
Preference shares 2,000
–––––––
12,200
Current liabilities
Overdraft 1,000
Trade payables 1,500
–––––––
2,500
–––––––
Total equity and liabilities 42,700
–––––––
The ordinary shares have a nominal value of 50 cents per share and are trading at $5.00 per share. The preference shares have a nominal value of $1.00 per share and are trading at 80 cents per share. The bonds have a nominal value of $100 and are trading at $105 per bond.
What is the market value based gearing of the company, defined as prior charge capital/equity?
A 15.0%
B 13.0%
C 11.8%
D 7.3%
91 Risk that cannot be diversified away can be described as A Business risk
B Financial risk C Systematic risk D Unsystematic risk
92 An all equity company issues some irredeemable loan notes to finance a project that has the same risk as existing projects. If the company operates in a tax free environment under conditions of perfect capital markets, what is the validity of the following statements?
Statement 1: The cost of equity will fall.
Statement 2: The weighted average cost of capital will rise.
Statement 1 Statement 2
A True True
B False True
C True False
D False False
93 Which of the following is most likely to result in a company’s financial gearing being high?
A Low taxable profits B Low tax rates
C Inexpensive share issue costs
D Intangible assets being a low proportion of total assets
94 Compared to ordinary secured loan notes, convertible secured loan notes are A Likely to be more expensive to service because of their equity component B Likely to be less expensive to service because of their equity component
C Likely to be more expensive to service because converting to equity requires the holders to make additional payments
D Likely to be less expensive to service because they must rank after ordinary secured loan stock
95 Which of the following is the best statement of the conclusion of Modigliani and Miller on the relevance of dividend policy?
A All shareholders are indifferent between receiving dividend income and capital gains B Increase in retentions results in a higher growth rate
C Discounting the dividends is not an appropriate way to value the firm's equity
D The value of the shareholders' equity is determined solely by the firm's investment selection criteria
96 A company is going to take on a project using a mix of equity and debt finance in an economy where the corporation tax rate is 30%.
Assuming perfect markets, other than tax, which of the following statements is true about the project?
A βe > βa; WACC < Cost of equity calculated using βa; WACC < Cost of equity calculated
using βe
B βe < βa; WACC > Cost of equity calculated using βa; WACC > Cost of equity calculated
using βe
C βe > βa; WACC < Cost of equity calculated using βa; WACC > Cost of equity calculated
using βe
D βe < βa; WACC > Cost of equity calculated using βa; WACC < Cost of equity calculated
using βe
97 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
98 If a geared company’s asset beta is used in the CAPM formula (rj = rf + òj (rm – rf)) what will rj represent?
A The WACC of the company B The ungeared cost of equity C The geared cost of equity D None of the above
99 Which of the following does NOT directly affect a company’s cost of equity?
A Return on assets B Expected market return C Risk‐free rate of return D The company’s beta
100 Which of the following ratios is used to measure a company’s liquidity?
A Current ratio B Interest cover C Gross profit margin
D Return on capital employed
101 An analyst gathered the following data about a company:
$
Current liabilities 300
Total debt 900
Working capital 200
Capital expenditure 250
Total assets 2,000
Cash flow from operations 400
If the company would like a current ratio of 2, it could:
A Increase current assets by 100 or decrease current liabilities by 50 B Decrease current assets by 100 or increase current liabilities by 50 C Decrease current assets by 100 or decrease current liabilities by 50 D Increase current assets by 100 or increase current liabilities by 50
102 In relation to preference shares as a source of capital for a company, which of the following statements is correct?
A Preference shares are a form of loan capital which carry lower risk than ordinary shares
B Preference shares are a form of equity capital which carry higher risk than ordinary shares
C Preference shares are a form of loan capital which carry higher risk than ordinary shares
D Preference shares are a form of equity capital which carry lower risk than ordinary shares
103 The dividend cover ratio is a measure of
A How many times the company’s earnings could pay the dividend
B The interest or coupon rate expressed as a percentage of the market price
C The returns to the investor by taking about of dividend income and capital growth D How much of the overall dividend pay‐out the individual shareholders are entitled to 104 In relation to finance leases, which of the following statements is not true?
A The lease agreement cannot be cancelled.
B One lease exists for the whole of useful life of the asset C The lessor retains the risks and rewards of ownership D The lessee is responsible for repairs and maintenance