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  • Exam Name: Financial Strategy
  • Last Update: Mar 28, 2024
  • Questions and Answers: 435
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F3 Financial Strategy Questions and Answers

Question # 6

The table below shows the forecast for a company's next financial year:

 F3 question answer

 

The forecast incorporates the following assumptions:

   • 25% of operating costs are variable

   • Debt finance comprises a $400 million fixed rate loan at 5%

   • Corporate income tax is paid at 25%

 

The company plans to do the following next year from the forecast earnings on the assumption that earnings will be equivalent to free cash flow: 

   • Pay a total dividend of $20 million

   • Invest $40 million in new projects

 

What is the maximum % reduction in operating activity that could occur next year before the company's dividend and investment plans are affected?

 

Give your answer to the nearest 0.1%.

 

   

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Question # 7

Company W has received an unwelcome takeover bid from Company B. The offer is a share exchange of 3 shares in Company B for 5 shares in Company Wora cash alternative of $5.70 for each Company W share.

Company B is approximately twice the size of Company W based on market capitalisation. Although the two companies have some common business interested the main aim of the bid is diversification for Company B.

Company W 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.

F3 question answer

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

A.

Change the Articles of Association to increase the percentage of shareholder votes required to approve a takeover.

B.

Refer the bid to the country's competition authorities.

C.

Write to shareholders explaining fully why the company's share price is under valued.

D.

Pay a one-off special dividend.

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Question # 8

When valuing an unlisted company, a P/E ratio for a similar listed company may be used but adjustments to the P/E ratio may be necessary.

 

Which THREE of the following factors would justify a reduction in the proxy p/e ratio before use? 

A.

The relative lack of marketability of unlisted company shares.

B.

A lower level of scrutiny and regulation for unlisted companies.

C.

Unlisted companies being generally smaller and less established.

D.

Control premium not being included within the proxy p/e ratio used.

E.

The forecast earnings growth being relatively higher in the unlisted company.

F.

A profit item within the unlisted company's latest earnings which will not reoccur.

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Question # 9

A company is planning a share buyback. In which of the following circumstances would a share buyback be appropriate?

A.

The company wants to reduce its gearing.

B.

The company wants to reduce the nominal value of its shares to make them more marketable.

C.

The country in which the company operates taxes capital gains at a higher rate than income.

D.

The company has a one off cash surplus and no available investment opportunities.

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Question # 10

Listed company R is in the process of making a cash offer for the equity of unlisted company S. 

 

Company R has a market capitalisation of $200 million and a price/earnings ratio of 10.

 

Company S has a market capitalisation of $50 million and earnings of $7 million.

 

Company R intends to offer $60 million and expects to be able to realise synergistic benefits of $20 million by combining the two businesses.  This estimate excludes the estimated $8 million cost of integrating the two businesses.

 

Which of the following figures need to be used when calculating the value of the combined entity in $ millions?

A.

8, 20, 50, 60, 200 

B.

8, 20, 50, 200

C.

20, 50, 60, 200

D.

7, 10, 20, 50, 200

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Question # 11

Company AAB is located in Country A with the A$ as its functional currency It plans to grow by acquisition and has identified Company BBA as a potential takeover candidate Company BBA is located in Country B with the BS as its functional currency.

The directors of Company AAB are concerned about foreign currency risk if the acquisition goes ahead

Which of the following will be most effective in reducing Company AAB's exposure to translation risk if the acquisition is successful1?

A.

Financing the acquisition with equity in A$’s.

B.

Setting up a mufti-currency bank account to net-off receipts and payments

C.

Financing the acquisition with borrowings in BS's

D.

Using forward contracts to fix the exchange rate between the AS and the B$

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Question # 12

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?

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.

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Question # 13

A company's latest accounts show profit after tax of $20.0 million, after deducting interest of $5.0 million. The company expects earnings to grow at 5% per annum indefinitely. 

 

The company has estimated its cost of equity at 12%, which is included in the company WACC of 10%.

 

Assuming that profit after tax is equivalent to cash flows, what is the value of the equity capital?

 

Give your answer to the nearest $ million.

 

$  ?   million 

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Question # 14

Clinic A provides free healthcare to all members of the community, funded by the central Government.

Clinic B provides healthcare which has to be paid for by the individual patients. It is a listed company, owned by a large number of shareholders.

 In comparing the above two organisations and their objectives, which THREE of the following statements are correct?

A.

Clinic A is a not-for-profit organisation while Y is a for-profit organisation.

B.

Clinic A and B have the same primary financial objective - to maximise shareholder wealth.

C.

The performance of X will be appraised primarily on the basis of value for money.

D.

Clinic B is likely to have a mixture of financial and non-financial objectives.

E.

Clinic A and B will have the same primary non financial objective - provision of quality of health care.

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Question # 15

Company P is a pharmaceutical company listed on an alternative investment market.  

The company is developing a new drug which it hopes to market in approximately six years' time.

Company P is owned and managed by a group of doctors who wish to retain control of the company.  The company operates from leased laboratories with minimal fixed assets. 

Its value comes from the quality of its research staff and their research.

The company currently has one approved drug which generates sufficient cashflow to cover day to day operations but not sufficient for major new research and development.

Company P wish to raise debt finance to develop the new drug. 

 

Recommend which of the following types of debt finance would be most appropriate for Company P to help finance the development of this new drug. 

A.

6% Eurobond repayable at par in 5 years' time.

B.

5% Bond repayable at par in 7 years' time.

C.

3% Commercial Paper.

D.

4% Convertible bond with a conversion ratio of 350 ordinary shares per bond.

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Question # 16

A company plans to raise $12 million to finance an expansion project using a rights issue.

Relevant data:

• Shares will be offered at a 20% discount to the present market price of $15.00 per share.

• There are currently 2 million shares in issue.

• The project is forecast to yield a positive NPV of $6 million.

What is the yield-adjusted Theoretical Ex-Rights Price following the announcement of the rights issue?

A.

$16.00

B.

$14.00

C.

$9.00

D.

$11.00

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Question # 17

The value of a call option will increase because of:

A.

An increase in the strike price.

B.

A decrease in the volatility of the share.

C.

An increase in the time to expiry.

D.

A decrease in the market value of the share

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Question # 18

A company has stable earnings of S2 million and its shares are currently trading on a price earnings multiple {PIE) of 10 times. It has10 million shares in issue.

The company is raising S4 million debt finance to fund an expansion of its existing business which is forecast to increase annual earnings straight away by 25% and then remain at that level for the foreseeable future. The corporation tax rate is 20%. It is expected that the P/E will reduce to 8 times over the next year.

What is the most likely change in shareholder wealth resulting from this plan?

A.

Shareholder wealth will increase by $4 million.

B.

Shareholder wealth will increase by $3.2 million.

C.

Shareholder wealth will increase by $5 million

D.

No change in shareholder wealth.

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Question # 19

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

A.

free cash flow before interest at WACC.

B.

free cash flow before interest at the cost of equity.

C.

free cash flow after interest at WACC.

D.

free cash flow after interest at the cost of equity.

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Question # 20

M is an accountant who wishes to take out a forward rate agreement as a hedging instrument but the company treasurer has advised that a short-term interest rate future would be a better option.

Which of the following is true of a short-term interest ratefuture?

A.

It can be tailoredtothe exact reeds of the company.

B.

It interest rates have gone down the price of the future will have fallen.

C.

It must be kept for ne whole duration of the contract

D.

The date is flexible and the position can be closed quickly and easily.

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Question # 21

A company is financed as follows:

   • 400 million $1 shares quoted at $3.00 each.

   • $800 million 5% bonds quoted at par.

The company plans to raise $200 million long term debt to finance a project with a net present value of $100 million.

The bank that is providing the debt is insisting on a maximum gearing level covenant.  

Gearing will be based on market values and calculated as debt/(debt + equity).

 

What is the lowest figure for the gearing covenant that the bank could impose without the company breaching the agreement?

A.

43%

B.

44%

C.

45%

D.

46%

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Question # 22

A company is planning a new share issue.

The funds raised will be used to repay debt on which it is currently paying a high interest rate.

Operating profit and dividends are expected to remain unchanged in the near future.

If the share issue is implemented, which THREE of the following are most likely to increase?

A.

The cost of equity

B.

The number of shares in issue

C.

Next year's payment of corporate income tax

D.

The gearing (book value of debt as a percentage of the book value of equity + debt)

E.

Interest cover

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Question # 23

The competition authorities are investigating the takeover of Company Z by a larger company, Company Y.

Both companies are food retailers. 

The takeover terms involve using a part cash, part share exchange means of payment.

Company Z is resisting the bid, arguing that it undervalues its business, while lobbying extensively among politicians to sway public opinion against the bidder.

 

Which of the following actions by Company Y is most likely to persuade the competition authorities to approve the acquisition?

A.

Company Y increases the cash element of its bid offer.

B.

Company Y agrees to dispose of specified outlets which geographically overlap those of Company Z.

C.

Company Y guarantees to preserve employment at its cental distribution depot.

D.

Company Y undertakes to pass on any cost savings to customers.

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Question # 24

Company ADE is an unlisted company; it needs to raise a significant amount of finance to fund future expansion. The directors are considering listing the company on the local stock exchange The following discussions have taken place between some of the directors:

Director A - We consider a public issue of bonds in the capital markets, we don't need to list to issue the bonds which will save time and money.

Director B - We should list on the Alternative Investment Market (AIM) and not the main market to avoid any regulatory requirements

Director C - We should remain unlisted; we can access an unlimited amount of equity finance through a rights issue

Director D - Listing will increase Company ADE's ability to raise new equity and debt finance in the future.

Director E - If we list, Company ADE will be a more likely target for a takeover than if we remain unlisted.

Which TWO of the directors' statements are correct?

A.

Director A

B.

Director B

C.

Director C

D.

Director D

E.

Director E

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Question # 25

Under traditional theory, an increase in a company's WACC would cause the value of the company to:

A.

Increase

B.

Decrease

C.

Stay the same

D.

Either increase or decrease 

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Question # 26

A company plans to raise $12 million to finance an expansion project using a rights issue.

Relevant data:

• Shares will be offered at a 20% discount to the present market price of $15.00 per share.

• There are currently 2 million shares in issue.

• The project is forecast to yield a positive NPV of $6 million.

What is the yield-adjusted Theoretical Ex-Rights Price following the announcement of the rights issue?

A.

$16.00

B.

$14.00

C.

$9.00

D.

$11.00

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Question # 27

Company ACC. an ungeared car manufacturer has launched a takeover bid of Company BDD. a key competitor operating in the same industry Company BDD has high gearing Company ACC has a large surplus cash balance and believes that the acquisition is an opportunity to enhance shareholder wealth through the realisation of synergistic benefits. Which THREE of the following would most likely be synergistic benefits to Company ACC of purchasing Company BDD9 I

A.

Reduction in staff costs due to the removal of duplicated roles.

B.

Decreased cost of debt

C.

Enhanced profit due to reduced competition

D.

Reduction in financial risk due to diversification

E.

Cost savings in production due to economies of scale

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Question # 28

A Venture Capital Fund currently holds a significant  shareholding in a large private company as a result of funding a recent management buyout. It plans to exit this investment in 5 years time at a significant profit.

 

Which THREE of the following exit mechanisms are most likely to be preferred by the Venture Capital Fund?

A.

The management team agrees to buy back the Venture Capital Funds shareholding in 5 years time at its original cost.

B.

The private company obtains a stock market listing on a recognised exchange within the next 5 years.

C.

The Venture Capital Fund has an option to sell its shareholding to the company at twice its original cost which can be exercised in 5 years time.

D.

The Venture Capital Fund has a legal entitlement to sell its shareholding to any third party investor if the company has not obtained a stock market listing within 5 years.

E.

The management team has an option to buy the Venture Capital Fund's shares for their nominal value which can be exercised in 5 years time. 

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Question # 29

Three companies are quoted on the New York Stock Exchange. The following data applies:

F3 question answer

Which of the following statements is TRUE?

A.

Company A has the greatest business risk

B.

Companies A and B have the same capital structure

C.

Companies A and C have the same business risk

D.

Companies A and B have the same business risk

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Question # 30

ZZZ is a listed company based in Brinland. a European country. It is the largest owner and operator of residential care homes for elderly people in Brinland

Most of the residential care homes in Brinland are run by small private operators, and the standards of cafe are extremely variable However. 22Z has developed a good reputation because its client service is considered to be extremely good even though its prices are higher than those of most of its competitors.

ZZZ has expanded rapidly in the last few years, partly by acquisition and partly by organic growth consequently, the company's share price now stands at a record high, and the dividend declared at the end of the most recent accounting period was 10% higher than the previous year's dividend.

The Brinland government has recently set up a regulatory body to monitor the residential care homes industry. The regulatory body is considering introducing a variety of regulations to improve the customer experience in the industry. Following a period of consultation and investigation, the regulatory body is expected to announce a range of new regulations in the near future.

The directors of ZZZ are concerned that the new regulations may adversely affect their company

Which THREE of the following new regulations are likely to have the greatest negative impact on ZZTs performance?

A.

Imposition of a minimum staff to client ratio.

B.

Price controls, setting a maximum price that providers can charge

C.

Monopoly controls, forcing large operators to dispose of some care homes

D.

Imposition of a one-off "windfall" tax to fund training courses for carers across the industry

E.

Fines for companies that miss specified service level targets

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Question # 31

Company A is based in Country A where the functional currency is the A$. Currently all sales are to domestic customers in Country A. However, the company is planning to expand internationally by acquiring Company B, a distribution company in Country B, to enable it to sell goods worldwide The functional currency of Country B is the BS

Company A will invoice its international customers in their local currency.

Wage increases in Country B are forecast to be modest, due to high unemployment levels, but overall inflation in Country B is forecast to be significantly higher than in Country A

Which TWO of the following statements about the economic risk of the acquisition of Company B are true?

A.

Financing this acquisition with block denominated in B$ will reduce economic risk.

B.

Economic risk can be eliminated by using forward contracts to convert future cash flows into A$

C.

Higher inflation will increase the project's BS returns, so the economic risk can be ignored

D.

Exporting into a variety of international markets will reduce economic risk.

E.

Using purchasing power parity, AS is forecast to strengthen against B$, so the economic risk can be ignored

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Question # 32

A company plans to raise finance for a new project.

It is considering either the issue of a redeemable cumulative preference share or a Eurobond. 

 

Advise the directors which of the following statements would justify the issue of preference shares over a bond?

A.

Preference shares are not secured against the assets of the business - however, the Eurobond would be.

B.

If profits are poor, dividends do not have to be paid on the preference share - however, interest would need to be paid on the Eurobond.

C.

The issue of the preference share would reduce the company's gearing - however, the Eurobond would increase it.

D.

The company can claim tax relief on the dividend paid on the preference share at a higher rate than the interest paid on the Eurobond.

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Question # 33

Company R is a major food retailer.  It wishes to acquire Company S, a food manufacturer.

Company S currently supplies many stores owned by Company R with food products that it manufactures.

Company S is of similar size to Company R but has a lower credit rating.

 

Which of the following is most likely to be a synergistic benefit to R on purchasing S?

A.

Savings due to a reduction in purchase costs and more control over the value chain.

B.

Cost savings due to reducing the range of products manufactured by Company S.

C.

Lower cost of borrowing due to the acquistion of a company with a different credit rating.

D.

Reduced competition resulting in the ability to raise retail selling prices for food products.

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Question # 34

A company has forecast the following results for the next financial year:

  

The following is also relevant:

   • Profit after tax for the year can be assumed to be equivalent to free cash flow for the year.

   • Debt finance comprises a $10 million floating rate loan which currently carries an interest rate of 5%.

   • $400,000 investment in non-current assets is required to achieve required growth, all of which is to financed from next year's free cash flow.

   • The company plans to pay a dividend of $150,000 next year, financed from next year's free cash flow.

The company is concerned that interest rates could rise next year to 6% which could then affect their investment plans.

 F3 question answer

If interest rates were to rise to 6% and the company wishes to maintain its dividend amount, the planned investment expenditure will decrease by:

A.

$25,000

B.

$75,000

C.

$50,000

D.

$100,000

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Question # 35

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?

A.

The convertible bond may not dilute control as the bond holder has an option to choose conversion.

B.

The coupon rate on the convertible bond will be lower than that on a non-convertible bond.

C.

When converted into shares, the company will receive a cash inflow which can be used for future investments.

D.

Issuing a convertible bond will have a more favourable impact on the gearing ratio than a non-convertible bond.

E.

Over the life of the bond, a convertible will be more expensive than a non-convertible.

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Question # 36

A project requires an initial outlay of $2 million which can be financed with either a bank loan or finance lease.

The company will be responsible for annual maintenance under either option.

 

The tax regime is:

   • Tax depreciation allowances can be claimed on purchased assets.

   • If leased using a finance lease, tax relief can be claimed on the interest element of the lease payments and also on the accounting depreciation charge.

The trainee management accountant has begun evaluating the lease versus buy decision and has produced the following data.  He is not confident that all this information is relevant to this decision.

  F3 question answer

 

Using only the relevant data, which of the following is correct?

A.

The bank loan is $30,000 MORE expensive than the finance lease.

B.

The bank loan is $20,000 LESS expensive than the finance lease.

C.

The bank loan is $70,000 LESS expensive than the finance lease.

D.

The bank loan is $120,000 LESS expensive than the finance lease.

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Question # 37

A listed company has suffered a period of falling revenues and profit margins. It has been obliged to issue a profit warning to the market and its share price has fallen sharply. The company relies heavily on debt finance and is discussing with its banks possible refinancing options to assist with a restructuring programme.

 

Which THREE of the following are likely to be of MOST interest to the company's banks when they review the refinancing requests?

A.

Cash flow forecasts

B.

Current capital structure

C.

Trends in share price movements

D.

Shareholder profile

E.

Book value of assets

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Question # 38

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.

Interest cover will fall; P/E ratio will fall.

B.

Interest cover will fall; P/E ratio will rise.

C.

Interest cover will rise; P/E ratio will rise.

D.

Interest cover will rise; P/E ratio will fall.

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Question # 39

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.

accepted as there is $100 million of synergy which will all go to T's shareholders.

B.

accepted as there will be an increase in the value of the business of $1,500 million.

C.

rejected as T's shareholders will see a decrease in their wealth overall of $50 million.

D.

rejected as T's shareholders will not be willing to pay more than $1,500 million for V.

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Question # 40

Which THREE of the following long term changes are most likely to increase the credit rating of a company?

A.

An increase in the interest cover ratio.

B.

A decrease in the (Net debt) / (Earnings before interest, tax, depreciation and amortisation) ratio.

C.

An increase in the free cashflow generated from operations.

D.

A decrease in the (Book value of debt) / (Book value of equity) ratio.

E.

A decrease in the dividend cover ratio.

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Question # 41

A company's dividend policy is to pay out 50% of its earnings.

Its most recent earnings per share was $0.50, and it has just paid a dividend per share of $0.25.

Currently, dividends are forecast to grow at 2% each year in perpetuity and the cost of equity is 10.5%.

 

In order to grow its earnings and dividends, the company is considering undertaking a new investment funded entirely by debt finance. If the investment is undertaken:

   • Its cost of equity will immediately increase to 12% due to the increased finance risk.

   • Its earnings and dividends will immediately commence growing at 4% each year in perpetuity.

Which of the following is the expected percentage change in the share price if the new investment is undertaken?

A.

Increase = 8.3%

B.

Increase = 2%

C.

Increase = 10.5%

D.

Decrease = 7.7%

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Question # 42

The directors of a multinational group have decided to sell off a loss-making subsidiary and are considering the following methods of divestment:

1. Trade sale to an external buyer

2. A management buyout (MBO)

The MBO team and the external buyer have both offered the same price to the parent company for the subsidiary.

Which of the following is an advantage to the parent company of opting for a MBO compared to a trade sale as the preferred method of divestment?

A.

Raise the cash more quickly.

B.

Avoid a hostile reaction from key management.

C.

Focus on the core competencies of the business

D.

Retain the know edge of key management.

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Question # 43

A company enters into a floating rate borrowing with interest due every 12 months over the five year life of the borrowing. 

At the same time, the company arranges an interest rate swap to swap the interest profile on the borrowing from floating to fixed rate. 

These transactions are designated as a hedge for hedge accounting purposes under IAS 39 Financial Instruments: Recognition and Measurement.

 

Assuming the hedge is considered to be effective, how would the swap be accounted for 12 months later? 

A.

The swap would be shown at nominal value in the statement of financial position and the change in value posted to other comprehensive income.

B.

The swap would be shown at nominal value in the statement of financial position and the change in value posted to profit or loss.

C.

The swap would be shown at fair value the statement of financial position and the change in value posted to other comprehensive income.

D.

The swap would be shown at fair value the statement of financial position and the change in value posted to profit or loss.

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Question # 44

A listed company in a high technology industry has decided to value its intellectual capital using the Calculated Intangible Value method (CIV).

 

Relevant data for the company:

   • Pays corporate income tax at 30%

   • Cost of equity is 9%, pre-tax cost of debt is 7% and the WACC is 8%

   • The value spread has been calculated as $26 million

Calculate the CIV for the company.

A.

228 million

B.

289 million

C.

531 million

D.

325 million

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Question # 45

Company AEE has a 10 year 6% corporate bond in issue which has a nominal value of $400 million, which is currently trading at 95%. The bond is secured on the company's property

The Board of Directors has calculated the equity value of Company AEE as follows;

F3 question answer

Which THREE of the following are errors in the valuation?

A.

Including retained earnings from the Statement of Financial Position.

B.

Deducting $400 million for the value of the company's corporate bond.

C.

Using the company's weighted average cost of capital to discount cash flows attributable to shareholders.

D.

Using cash flows to equity rather than expected dividends as the initial cash flows.

E.

Deducting replacement capital expenditure

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Question # 46

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

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

RRR uses a 'residual' dividend policy and has paid dividends twice in the last 10 years.

Which of the following methods would be most appropriate for valuing RRR?

A.

Valuing the tangible assets and intangible assets of RRR.

B.

The P/E method, adjusting the P/E of a listed company downwards to reflect RRR's unlisted status.

C.

The earnings yield method, adjusting the earnings yield of a listed company downwards to reflect RRR's unlisted status.

D.

The dividend valuation model.

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Question # 47

A venture capitalist is considering investing in a management buy-out that would be financed as follows:

• Equity from managers

• Equity from a venture capitalist

• Mezzanine debt finance from a venture capitalist

• Senior debt from a bank

The venture capitalist is planning to work with the management to grow the business in anticipation of an initial public offering within five years.

However, the cash forecast shows a potential shortage of funds in the first year and the venture capitalist is evaluating the potential impact of cash being generated in the first year being significantly lower than forecast.

The most important risk that a shortage of cash would create for the management buyout is that the new company has insufficient funds to:

A.

pay interest on bank debt finance.

B.

pay contractual director bonuses.

C.

pay dividends to venture capitalist.

D.

invest in new capital projects required to generate growth.

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Question # 48

Company H is considering the valuation of an unlisted company which it hopes to acquire.

It has obtained the target company's financial statements.

Company H has been advised that the book value of net assets as shown in the financial statements of the target company does not provide a reliable indicator of their true value.

 

Advise the Board of Directors which of the following THREE statements are disadvantages of the net asset basis of valuation?

A.

The net book value of assets is merely a record of past transactions which complies with accounting conventions.

B.

The net book value of assets can be obtained from the financial statements. 

C.

Intangible assets are often not shown in the company's financial statements.

D.

The net realisable value is usually different from the net book value shown in the financial statements.  

E.

The net book value of current assets is normally a reliable indicator of their realisable value.

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Question # 49

F Co. is a large private company, the founder holds 60% of the company's share capital and her 2 children each hold 20% of the share capital.

The company requires a large amount of long-term finance to pursue expansion opportunities, the finance is required within the next 3 months. The family has agreed that an Initial Public Offering (IPO) should not be pursued at this time, because it would take up to 12 months to arrange.

The existing shareholders are currently considering raising the required finance from an established Venture Capitalist in the form of debt and equity. The Venture Capitalist has agreed to provide the required finance provided it can earn a return on investment of 25% per year. In addition, the Venture Capitalist requires 60% of the equity capital, a directorship in the company and a veto on all expenditure of a capital or revenue nature above a specified limit.

From the perspective of the family, which of the following are advantages of raising the required finance from the Venture Capitalist?

Select all that apply.

A.

The cost of the finance under the Venture Capital investment.

B.

The changes in shareholding as a result of the Venture Capital investment.

C.

The veto on expenditure above a specified level of a revenue or capital nature.

D.

The speed with which the finance can be obtained.

E.

The experience of the Venture Capitalist with growing businesses.

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Question # 50

A manufacturing company based in Country R. where the currency is the R$, has an objective of maintaining an operating profit margin of at least 10% each year

Relevant data:

• The company makes sales to Country S whose currency is the SS It also makes sales to Country T whose currency is the T$ " All purchases are from Country U whose currency is the US.

• The settlement of an 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?

A.

The T$ weakens against the R$ over time

B.

The R$ strengthens against the S$ over time.

C.

The R$ strengthens against the U$ over time.

D.

The R$ weakens against the U$ over time

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Question # 51

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

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

The rate of corporate tax is 25%.

It plans to continue to pay out 50% of its earnings in dividends and earnings are expected to grow by 3% each year in perpetuity.

Its cost of equity is 10%.

 

Using the dividend growth model, advise the Board of Directors of Company M which of the following provide a reasonable valuation of Company M's equity?

A.

$73.6 million

B.

$22.1 million

C.

$44.1 million

D.

$50.1 million

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Question # 52

Company X is based in Country A, whose currency is the A$.

It trades with customers in Country B, whose currency is the B$.

Company X aims to maintain its revenue from exports to Country B at 25% of total revenue.

 

Company A has the following forecast revenue:

  F3 question answer

The forecast revenue from Country B has assumed an exchange rate of A$1/B$2, that is A$1 = B$2.

 

If the B$ depreciates against the A$ by 10%, the ratio of revenue generated from Country B as a percentage of total revenue will:

A.

fall to 23.3%.

B.

rise to 27.0%.

C.

rise to 30.3%.

D.

fall to 22.7%.

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Question # 53

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?

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.

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Question # 54

Company S is planning to acquire Company T.

The shareholders in Company T will receive new shares in Company S in an all-share consideration.

 

Relevant information:

F3 question answer

 

 

The shareholders in Company T want sufficient shares to receive a 25% premium on the pre-acquisition value of their shares, based on the pre-acquisition share price.

 

Which of the following share-for-share offers will achieve the desired result?

A.

2 shares in Company S for 1 share in Company T

B.

1 share in Company S for 1 share in Company T

C.

1 share in Company S for 2 shares in Company T

D.

10 shares in Company S for 4 shares in Company T

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Question # 55

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

A.

The proportion of surgical procedures that are deemed to be successful.

B.

Average waiting times for treatment.

C.

Patient satisfaction ratings.

D.

Staff costs compared to previous years. 

E.

Revenue generated from car park charges. 

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Question # 56

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.

YS2 29 million

B.

YS1 60 million

C.

YS6.67 million

D.

YS57.14 million

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Question # 57

CI IJ has decided to move its production plant to overseas country X. This would make the product cheaper to produce. The technology used to make the product is very advanced and some of the skilled staff would have to move to country X.

The Production Director has identified that there are some political risks in moving to county X.

For each of the political risks of moving to country X shown below, select the correct method for reducing the risk.

F3 question answer

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Question # 58

The ex div share price of Company A’s shares is $.3.50

An investor in Company A currently holds 2,000 shares.

Company A plans to issue a script divided of 1 new shares for every 10 shares currently held.

After the scrip divided, what will be the total wealth of the shareholder?

Give your answer to the nearest whole $.

F3 question answer

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Question # 59

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 $.

  F3 question answer

 

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

A.

Write to shareholders explaining fully why the company's share price is undervalued.

B.

Change the Articles of Association to increase the percentage of shareholder votes required to approve a takeover.

C.

Pay a one-off special dividend.

D.

Refer the bid to the country's competition authorities.

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Question # 60

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?

A.

Lease payments, implied interested and straight-line accounting deprediation.

B.

Lease payments and straight-line accounting depreciation.

C.

Lease payments and implied interest.

D.

Lease payments, tax relief on implied interest and tax relief on straight-line account depreciation.

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Question # 61

The financial assistant of a geared company has prepared the following calculation of the company's equity value:

F3 question answer

F3 question answer

Useful information;

• Tax rate - 20%

• Cost of equity = 12%

• Weighted average cost of capital (WACC)« 10%

" Debt finance of the company comprises a $6 million 7% undated bond trading at par Valuation workings.

Which of the following errors has been made by the financial assistant?

A.

A two year discount factor is incorrect in the perpetuity calculation.

B.

Discounting at WACC is incorrect.

C.

The 20% tax charge is missing.

D.

A deduction for debt value is missing.

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Question # 62

A young, capital intensive company has a large amount of tangible assets.

Intangibles, including brand name, are considered to be of negligible value at this time

Relevant data:

• The company operates a residual dividend policy.

• The industry in which the company operates is suffering from a large amount of uncertainty at present. Forecasting the future earnings or cashflows of the company is therefore extremely difficult

• There are very few quoted companies in the industry that are similar in size or in precisely the same business sectors.

Which method of valuation would be most suitable for this company?

A.

Discounted cash flow with a proxy company's cost of capital.

B.

Earnings based using a proxy company's P/E ratio.

C.

Net asset based using replacement cost.

D.

Dividend valuation model with a proxy company's cost of equity.

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Question # 63

Company A is based in country A with the AS as its functional currency. It expects to receive BS20 million from Company B in settlement of an export invoice.

The current exchange rate is A$1 =B$2 and the daily standard deviation of this exchange rate = 0 5%

What is the one-day 95% VaR in AS?

A.

A$50,000

B.

A$164,500

C.

A$82,250

D.

A$822,500

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Question # 64

Holding cash in excess of business requirements rather than returning the cash to shareholders is most likely to result in lower:

A.

liquidity.

B.

vulnerability to a takeover bid.

C.

net profit.

D.

return on equity.

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Question # 65

Company A has just announced a takeover bid for Company B. The two companies are large companies in the same industry_ The bid is considered to be hostile.

Company B's Board of Directors intends to try to prevent the takeover as they do not consider it to be in the best interests of shareholders

Which THREE of the following are considered to be legitimate post-offer defences?

A.

Have all the assets independently professionally revalued to demonstrate that the offer undervalues the company

B.

Alter the memorandum and articles of association to state that a minimum of 75% of shareholders must agree to the bid before it can proceed

C.

Make a counter bid for Company A provided such an acquisition could enhance Company B's shareholder wealth

D.

Publish very optimistic financial forecasts for Company B even though the Board of Directors realises that these are highly unlikely to be achievable

E.

Refer the bid to the competition authorities to try to have the bid prohibited on competition grounds

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Question # 66

Company A has a cash surplus.

The discount rate used for a typical project is the company's weighted average cost of capital of 10%.

No investment projects will be available for at least 2 years.

 

Which of the following is currently most likely to increase shareholder wealth in respect of the surplus cash?

A.

Investing in a 2 year bond returning 5% each year.

B.

Investing in the local money market at 4% each year.

C.

Maintaining the cash in a current account.

D.

Paying the surplus cash as a dividend at the earliest opportunity.

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Question # 67

A large, listed company in the food and household goods industry needs to raise $50 million for a period of up to 6 months.

It has an excellent credit rating and there is almost no risk of the company defaulting on the borrowings. The company already has a commercial paper programme in place and has a good relationship with its bank.

 

Which of the following is likely to be the most cost effective method of borrowing the money?

A.

Bank overdraft

B.

6 month term loan

C.

Treasury Bills

D.

Commercial paper

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Question # 68

It is now 1 January 20X0.

Company V, a private equity company, is considering the acquisition of 40% of the equity of Company A for a total amount of $15 million.

Company A has been established to develop a new type of engine which will be launched at the end of 20X1. Company A is forecasting that the new engine will result in free cash flows to equity of $2m in its first year of operation and that this will rise by 8% per year for the foreseeable future.

The new engine is the only commercial activity that Company A is involved in.

Company V intends to sell its stake in Company A when the new engine is launched.

Company A has a cost of equity of 12%.

Assuming that Company V receives an amount that reflects the present value of their shares in company A. what is the estimated annual rate of return to Company V from this investment? (To the nearest %)

A.

3%

B.

10%

C.

16%

D.

33%

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Question # 69

Which THREE of the following non-financial objectives would be most appropriate for a listed company in the food retailing industry?

A.

Reduce customer complaints

B.

Increase customer service quality

C.

Reduce production time

D.

Improve staff morale

E.

Reduce raw material wastage

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Question # 70

A company intends to sell one of its business units, Company R by a management buyout (MBO).

A selling price of $100 million has been agreed.

The managers are discussing with a bank and a venture capital company (VCC) the following financing proposal:

  F3 question answer

The VCC requires a minimum return on its equity investment in the MBO of 30% a year on a compound basis over 5 years.

 

What is the minimum TOTAL equity value of Company R in 5 years time in order to meet the VCC's required return?

 

Give your answer to one decimal place.

 

$  ? million 

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Question # 71

A company has borrowings of S5 million on which it pays interest at 8%. It has an operating profit margin of 20%.

The company plans to increase borrowings by S2 million Interest on additional borrowings would be 10% and the operating profit margin would remain unchanged

A debt covenant attached to the new borrowings requires interest cover to be at least 4 times throughout the period of the borrowing

Interest cover is defined in the loan documentation as being based on operating profit

What is the minimum sales value required each year to avoid a breach of the interest cover covenant'

A.

S12.00 million

B.

S3.00 million

C.

TS2.40 million

D.

S2.88 million

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Question # 72

Which THREE of the following non-financial objectives would be most appropriate for a listed company in the food retailing industry?

A.

Reduce customer complaints

B.

Increase customer service quality

C.

Reduce production time

D.

Improve staff morale

E.

Reduce raw material wastage

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Question # 73

An all equity financed company reported earnings for the year ending 31 December 20X1 of $5 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 7%.

The company pays corporate income tax at 30%.

 

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.

$5.25 million

B.

$7.50 million

C.

$7.57 million

D.

$8.40 million

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Question # 74

The two founding directors of an unlisted geared company want to establish its value as they are intending to approach a venture capitalist for additional funding.

The funding will be used to invest in a major new project which has very high growth potential. The directors intend to sell 10% of the company to the venture capitalist They have prepared the following current valuation of the company using the divided valuation model:

F3 question answer

The following information is relevant.

• $60,000 is the most recent dividend paid.

• 4% is the average dividend growth over the last few years.

• 10% is an estimate of the company's cost of equity using the CAPM model with the industry average asset beta

Which THREE of the following are weaknesses of the valuation method used in these circumstances?

A.

The industry average asset beta is not an appropriate beta to use in CAPM in this case.

B.

The company is unlikely to achieve constant growth in dividends year-on-year.

C.

Future dividend growth is unlikely to reflect historical dividend growth.

D.

It is not an appropriate valuation method for a small, 10% equity stake

E.

CAPM cannot be used to estimate the cost of equity of an unlisted company.

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Question # 75

On 1 January 20X1, a company had:

• Cost of equity of 10 0%.

• Cost of debt of 5.0%

• Debt of $100Mmilion

• 100 million $1 shares trading at $4.00 each.

On 1 February 20X1:

• The company's share police fell to $3.00.

• Debt and the cost of debt remained unchanged

The company does not pay tax.

Under Modigliani and Miller's theory without lax. what is the best estimate of the movement in the cost of equity as a result of the fall in ne share price?

A.

It will stay the same at 10.0%.

B.

It will rise to 10.3%.

C.

It will fall to 9.3%.

D.

It will rise to 11.2%.

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Question # 76

A listed company is planning a share repurchase.

The following data applies

• There are 20 million shares in issue

• The share repurchase will involve buying back 10% of the shares at a price of $1.20

• The company is holding $4.8 million cash

• Earnings for the current year ended are $3.6 million

The Directors are concerned about the impact that this repurchase programme will have on the company's cash balance and current year earnings per share (EPS) ratio.

Advise the directors which of the following statements is correct?

A.

The cash balance will decrease by 10% and the EPS will decrease by 11%.

B.

The cash balance will decrease by 10% and the EPS will increase by 11%.

C.

The cash balance will decrease by 50% and EPS will decrease by11%

D.

The cash balance will decrease by 50% and EPS will increase by 11%

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Question # 77

A company is financed as follows:

   • 400 million $1 shares quoted at $3.00 each.

   • $800 million 5% bonds quoted at par.

The company plans to raise $200 million long term debt to finance a project with a net present value of $100 million.

The bank that is providing the debt is insisting on a maximum gearing level covenant.  

Gearing will be based on market values and calculated as debt/(debt + equity).

 

What is the lowest figure for the gearing covenant that the bank could impose without the company breaching the agreement?

A.

43%

B.

44%

C.

45%

D.

46%

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Question # 78

A company generates and distributes electricity and gas to households and businesses.

Forecast results for the next financial year are as follows:

F3 question answer

The Industry Regulator has announced a new price cap of $2.00 per Kilowatt.

The company expects this to cause consumption to rise by 15% but costs would remained unaltered.

The price cap is expected to cause the company's net profit to fall to:

A.

$8.75 million profit

B.

$164.00 million profit

C.

$43.00 million profit

D.

$126.50 million loss

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Question # 79

A company is deciding whether to offer a scrip dividend or a cash dividend to its shareholders. 

Although the company has excellent long-term growth prospects, it is experiencing short-term profit and cash flow problems.

 

Which of the following statements is most likely to be a reason for choosing the scrip dividend?

A.

It is a way of raising additional finance to promote future growth.

B.

It is a way of increasing earnings per share.

C.

It is a way of encouraging shareholders to allow cash to be retained in the business.

D.

It is a way of increasing dividend per share.

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Question # 80

A national airline has made an offer to acquire a smaller airline in the same country.

 

Which of the following would be of most concern to the competition authorities?

A.

After the acquisition the board propose to reduce the number of  flight destinations from the country.

B.

The board informed a major institutional shareholder about the proposed acquisition before informing other shareholders.

C.

After the acquisition the board propose to increase prices significantly on routes where no other airlines operate.

D.

The acquisition is likely to result in significant redundancies of staff currently working for the smaller airline. 

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Question # 81

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.

F3 question answer

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Question # 82

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?

A.

Venture capitalists normally expect at least one seat on the board.

B.

Venture capitalists only provide equity finance and will therefore not be interested in providing a combination of debt and equity finance.

C.

The venture capital finance offered is much more expensive than expected.

D.

Venture capitalists normally expect an exit strategy sconer than the planned IPO in 10 years'time.

E.

Venture capitalists always require ownership of more than 50% of the shares in a company to ensure control.

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Question # 83

The shares of a company in a high technology industry have been listed on a stock exchange for 10 years. During this period, it has paid no dividends but invested all retained earnings in growth. The company is now entering a period of relatively stable growth and the directors are considering beginning to pay dividends They are reviewing the following suggestions made by members of the board:

• Pay cash dividends linked to growth in earnings

• Use a residual theory approach to establish cash dividends

• Issue scrip dividends (shares instead of cash)

• Continue to pay no dividends as dividends are irrelevant to the value of the company

Which THREE of the following are correct statements for the directors to take into consideration when making a decision about future dividend policy?

A.

Modigliani and Miller argue that, ignoring taxation, as long as positive net present value projects are invested in, shareholder wealth will increase, regardless of dividend payments.

B.

Shareholder preferences for cash or scrip dividends will be influenced by their tax positions

C.

Ignoring taxation and administrative costs, shareholders can provide their own dividends by selling shares in the market

D.

Neither cash nor scrip dividends will have an effect on earnings per share

E.

The residual theory of dividends suggest that dividends should only be paid after all operating costs have been met.

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Question # 84

An analyst has valued a company using the free cash flow valuation model.

 

The analyst used the following data in determining the value:

   • Estimated free cashflow in 1 year's time = $100,000

   • Estimated growth in free cashflow after the first year = 5% each year indefinitely

   • Appropriate cost of equity = 10% 

The result produced by the analyst was as follows:

Value of equity = $100,000 (1+0.05)/0.10 = $1,050,000

The analyst made a number of errors in determining the value. 

 

By how much has the analyst undervalued the company?

A.

$950,000

B.

$2,000,000

C.

$2,100,000

D.

$1,050,000

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Question # 85

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:

A.

minimises the environmental impact of its business processes.

B.

creates value in the short, medium and long term.

C.

contributes positively to the economic well being of the environment in which it operates.  

D.

ensures that the conflicting needs of different stakeholder groups are met in an optimal manner.

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Question # 86

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:

A.

minimises the environmental impact of its business processes.

B.

creates value in the short, medium and long term.

C.

contributes positively to the economic well being of the environment in which it operates.  

D.

ensures that the conflicting needs of different stakeholder groups are met in an optimal manner.

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Question # 87

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:

F3 question answer

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?

A.

$4.50

B.

$4.00

C.

$4.75

D.

$4.25

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Question # 88

B has a S3 million loan outstanding on which the interested rate is reset every 6 months for the following 6 month and the interested is payable at the end of that 6 month period. The next 6 monthly reset period starts in 3 months and the treasurer of B thinks interested rates are likely to raise between and then.

Current 6-month rates are 6.4% and the treasurer can get a rate of 6.9% for a 6-month forward rate agreement (FRA) starting in 3 months time. By transacting an TRA the treasurer can lock in a rate today of 6.9%.

If interested rates are 7.5% in 3 months’ time, what will the net amount payable be?

Give your answer to the nearest thousand dollars.

F3 question answer

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Question # 89

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

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

There are no listed companies in the country operating in the same business field as Company HGG The future success of Company HGG's business and hence the future growth rate in earnings and dividends is difficult to determine

Company GDD is assessing the validity of using the dividend growth method to value Company HGG

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

A.

The future growth rate in earnings and dividends will be difficult to accurately determine

B.

The future projected dividend stream is used as the basis for the valuation

C.

The company has been unprofitable to date and hence, there is no established dividend payment pattern

D.

The dividend growth model does not take the time value of money into consideration

E.

The cost of capital will be difficult to estimate

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Question # 90

Which of the following statements is true of a spin-off (or demerger)?

A.

Raises finance to fund new projects.

B.

Changes the ownership structure of the core entity by introducing new shareholders. 

C.

Allows investors to identify the true value of the demerged business.

D.

Increases the risk of a takeover bid for the core entity.

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Question # 91

PPA owns $500,000 of shares in Company ABB. Company ABB has a daily volatility of 2% of its share price

Calculate the 12-day value at risk that shows the most PPA can expect to lose during a 12-day period (PPA wishes to be 90% certain that the actual loss in any month will be less than your predicted figure)

Give your answer to the nearest thousand dollars.

F3 question answer

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Question # 92

A company is currently all-equity financed.

The directors are planning to raise long term debt to finance a new project.

The debt:equity ratio after the bond issue would be 30:60 based on estimated market values.

 

According to Modigliani and Miller's Theory of Capital Structure without tax, the company's cost of equity would:

A.

stay the same.

B.

decrease.

C.

increase.

D.

increase or decrease depending on the bond's coupon rate.

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Question # 93

Company MB is in negotiations to acquire the entire share capital of Company BBA. Information about each company is as follows:

F3 question answer

It is expected that Company BBA's profit before interest and tax will be $30 million in each of the two years after acquisition. Company AAB is considering how best to structure the offer Company AAB's discount factor and appropriate cost of equity for use in valuing Company BBA is 10%

Shareholders taxation implications should be ignored

Which of the following provides the shareholders of Company BBA with the highest offer price?

A.

A cash offer of S290 million now.

B.

A cash offer at 105% of the share price of Company BBA.

C.

A share-for-share exchange of five shares in Company AAB for every eight shares in Company BBA.

D.

Cash of $270 million now plus 60% of Company BBA's profit before interest and tax for the two years after acquisition, paid in 2 years' time.

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Question # 94

ART manufactures traditional scooters. It has an equity beta of 1.4 and is financed entirely by equity. It plans to continue to be all-equity financed in future.

It is considering producing a range of electric scooters

GGG is a comparable quoted electric scooter manufacturer GGG has an equity beta of 2 4 reflecting its high level of gearing (the ratio of debt to equity is VI using market values).

The risk-free rate is 5%, and the market premium is 6%. The rate of corporation tax is 20%

What is the recommended discount rate that ART should use to assess the project to manufacture electric scooters?

F3 question answer

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Question # 95

Modigliani and Miller are the main proponents of the view that the dividend policy is irrelevant to the value of a company's shares.

They argue that a company that continually reinvests its entire earnings would generate the same shareholder wealth if it engaged in a policy of high dividends and financed its expansion with funds obtained from rights issues.

 

Which THREE of the following statements are assumptions that are required in order to support this proposition?  

A.

There are no transaction costs involved in the issue of new shares (including rights issues).

B.

There is a multiplicity of corporate and personal income tax rates.

C.

Investors act in a rational manner.

D.

The capital markets are efficient markets.

E.

Investors do not always have access to perfect information.

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Question # 96

The Board of Directors of a small listed company engaged in exploration are currently considering the future dividend policy of the company. Exploration is considered a high-risk business and consequently the company has a low level of debt finance.

 

Forecasts indicate a period of profit fluctuation in the next few years as the company is planning to embark on a major capital investment project. Debt finance is unlikely to be available due to the project's high business risk.

 

Which THREE of the following are practical considerations when determining the company's dividend/retention policy? 

A.

The timing and size of the cash flow requirements for the new investment.

B.

The fluctuating nature of the projected future profits.

C.

The legislation and regulation governing distributable profits.

D.

The dividend policies of mature listed multinational companies in the exploration industry. 

E.

The general level of interest rates and the tax savings on interest costs relating to debt finance.

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Question # 97

A company has a 4% corporate bond in issue on which there are two loan covenants.

• Interest cover must not fall below 4 times

• Retained earnings for the year must not fall below S5 00 million

The Company has 100 million shares in issue. The most recent dividend per share was $0 10 The Company intends increasing dividends by 8% next year.

Financial projections tor next year are as follows:

F3 question answer

Advise the Board of Directors which of the following will be the status of compliance with the loan covenants next year?

A.

The company will be in breach of the covenant in respect of interest cover only.

B.

The company will breach the covenant in respect of retained earnings only.

C.

The company will be in compliance with both covenants.

D.

The company will be in breach of both covenants

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Question # 98

Company T is a listed company in the retail sector.

Its current profit before interest and taxation is $5 million.

This level of profit is forecast to be maintainable in future.

Company T has a 10% corporate bond in issue with a nominal value of $10 million.

This currently trades at 90% of its nominal value.

Corporate tax is paid at 20%.

 

The following information is available:

  

 F3 question answer

Which of the following is a reasonable expectation of the equity value in the event of an attempted takeover?

A.

$32.0 million

B.

$41.6 million

C.

$65.0 million

D.

$50.2 million

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Question # 99

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?

A.

The use of equity finance reduces the company's overall financial risk.

B.

The use of equity finance will create pressure for increases in dividend per share in the future.

C.

The use of debt finance will always result in an increase in earnings per share.

D.

Retained earnings is the cheapest form of equity finance.

E.

The use of debt finance increases the cost of equity.

F.

The use of debt finance is always preferable to equity finance.

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Question # 100

A company generates and distributes electricity and gas to households and businesses. 

 

Forecast results for the next financial year are as follows:

  F3 question answer

The Industry Regulator has announced a new price cap of $1.50 per Kilowatt. 

The company expects this to cause consumption to rise by 10% but costs would remained unaltered. 

 

The price cap is expected to cause the company's net profit to fall to:

A.

$47.5 million profit

B.

$27.5 million profit

C.

$20.0 million profit

D.

$35.0 million loss

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Question # 101

A company needs to raise $40 million to finance a project. It has decided on a right issue at a discount of 20% to its current market share price.

There are currently 20 million shares in issue with a nominal value of $1 and a market price of $10.00 per share.

A.

1 new share for every 25 existing shares

B.

1 new share for every 4 existing shares

C.

1 new share for every 5 existing shares

D.

1 new share for every 20 existing shares

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Question # 102

A company has some 7% coupon bonds in issue and wishes to change its interest rate profile.  

It has decided to do this by entering into a plain coupon interest rate swap with it's bank.

 

The bank has quoted a swap rate of:      6.0% - 6.5% fixed against LIBOR.

 

What will the company's new interest rate profile be?

A.

VARIABLE at LIBOR

B.

VARIABLE at LIBOR + 0.5%

C.

VARIABLE at LIBOR + 1.0%

D.

FIXED at 6.5%

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Question # 103

Which TIIRCC of the following are most likely to reduce the long term credit rating co a company?

A.

The issue of new shares where the funds raised are invested in a project that has an NPV of nil.

B.

The issue of a new bond where the funds raised are invested in a project that has an NPV of nil.

C.

The issue of new shares where the funds raised are invested in expanding into a new nigh risk market.

D.

Loss of a major customer that contributed 30% of sales revenue.

E.

Disposal of a loss-making division where the funds raised will be used to pay a special dividend to shareholders.

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Question # 104

An entity prepares financial statements to 31 December each year.  The following data applies:

 

1 December 20X0

   • The entity purchased some inventory for $400,000.

   • In order to protect the inventory against adverse changes in fair value the entity entered into a futures contract to sell the inventory for a fixed price on 31 January 20X1.

   • The entity designated this contract as a fair value hedge of the value of the inventory.

31 December 20X0

   • The inventory had a fair value of $480,000 and the futures contract had a fair value of $75,000 (a financial liability).

What will be the impact on the statement of profit or loss and other comprehensive income for the year ended 31 December 20X0 in respect of the change in the value of the inventory and the futures contract?

A.

A loss of $75,000 will be recognised in profit or loss.

B.

A loss of $75,000 will be recognised in other comprehensive income.

C.

A net gain of $5,000 will be recognised in profit or loss.

D.

A net gain of $5,000 will be recognised in other comprehensive income.

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Question # 105

A company is concerned that a high proportion of its debt portfolio consists of variable rate finance with an interest rate of LIBOR ' 1 .0%.

It is considering using an interest rate swap to reduce interest rate risk out is concerned about additional finance cost this might create.

A bank has quoted swap rates of 3% 3.5% against LIBOR.

A bank has quoted swap rates of 3% 3.5% against LIBOR.

Is an interest rate swap likely to be beneficial to the company at current LIBOR rates?

A.

No, because it would be cheaper to repay variable rate finance aid enter into new fixed rate finance than to enter into an interest rate swap.

B.

Yes, because it will have lower interest rate risk and interest cost remains the same.

C.

Yes, because interest cost will decrease with the interest rate swap in place.

D.

No, because interest cost will increase with the interest rate swap in place.

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Question # 106

Company A is identical in all operating and risk characteristics to Company B, but their capital structures differ.

Company B is all-equity financed. Its cost of equity is 17%.

Company A has a gearing ratio (debt:equity) of 1:2. Its pre-tax cost of debt is 7%. 

Company A and Company B both pay corporate income tax at 30%.

What is the cost of equity for Company A?

A.

20.5%

B.

21.2%

C.

22.0%

D.

17.0%

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Question # 107

A listed company with a growing share price plans to finance a four-year research project with debt. 

The main criterion for the finance is to minimise the annual cashflow payments on the debt.

The research will be sold at the end of the project.

 

Which of the following would be the most suitable financing method for the company?

 

A.

Bonds with warrants

B.

Finance lease

C.

Standard bonds

D.

Bank loan

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Question # 108

A company is considering whether to lease or buy an asset.

The following data applies:

   • The bank will charge interest at 7.14% per annum

   • The asset will cost $1 million

   • Tax-allowable depreciation is available on a straight line basis over 5 years

   • There is no residual value

   • Corporate tax is paid at 30% in the year when the profit is earned

What is the NPV of the buy option?

 

Give your answer to the nearest $000.

 

$ ?  

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Question # 109

A company has a financial objective of maintaining a gearing ratio of between 30% and 40%, where gearing is defined as debt/equity at market values. 

The company has been affected by a recent economic downturn leading to a shortage of liquidity and a fall in the share price during 20X1.

 

On 31 December 20X1 the company was funded by:

•    Share capital of 4 million $1 shares trading at $4.0 per share.

•    Debt of $7 million floating rate borrowings.

 

The directors plan to raise $2 million additional borrowings in order to improve liquidity.  

They expect this to reassure investors about the company's liquidity position and result in a rise in the share price to $4.2 per share.

 

Is the planned increase in borrowings expected to help the company meet its gearing objective?

A.

No, gearing would increase but the gearing objective would be met both before and after the announcement.

B.

No, gearing would increase and the gearing objective would be exceeded both before and after the announcement.

C.

No, gearing would increase and the gearing objective would be met before the announcement but exceeded after the announcement.

D.

Yes, gearing would fall and the gearing objective would be exceeded before the announcement but met after the announcement.

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Question # 110

Company A is a large well-established listed entertainment company and Company B is a small unlisted company specializing in providing online media streaming.

Company A has a gearing ratio of 60% (using book values) and interest cover of 2.

Company A is considering making an offer for Company B, either a cash offer financial by raising additional debt finance or a share-for-share exchange.

Which of the following is most likely to occur if Company A offers a share-for exchange rather than offering cash finance by raising debt?

A.

Earnings per share would be higher.

B.

Divided per share would be higher.

C.

Gearing would be lower.

D.

There would be no dilution f of control.

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Question # 111

A company plans to acquire new machinery.

It has two financing options; buy outright using a bank loan, or a finance lease.

 

Which of the following is an advantage of a finance lease compared with a bank loan?

A.

It is "off-balance sheet" and will not affect the company's gearing.

B.

The interest rate offered might be more favourable because the lessor has the security of the asset.

C.

Tax depreciation allowances may be passed on to the company by the lessor.

D.

The lessor provides maintenance of the asset.

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Question # 112

A new company was set up two years ago using the personal financial resources of the founders.

These funds were used to acquire suitable premises.

The company has entered into a long-term lease on the premises which are not yet fully fitted out.

The founders are considering requesting loan finance from the company's bank to fund the purchase of custom-made advanced technology equipment.

No other companies are using this type of equipment.

The company expects to continue to be profitable for the forseeable future.

It re-invests some of its surplus cash in on-going essential research and development.

 

Which THREE of the following features are likely to be considered negatives by the bank when assessing the company's credit-worthiness?

A.

The equipment is advanced technology custom-made equipment. 

B.

The company will continue to remain profitable and to generate net cash.

C.

The company premises are on a long-term lease but are not yet fully fitted out.

D.

The founders invested their personal financial resources in the company.

E.

Essential on-going research and development expenditure is required.

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Question # 113

A company is currently all-equity financed.

The directors are planning to raise long term debt to finance a new project.

The debt:equity ratio after the bond issue would be 30:60 based on estimated market values.

 

According to Modigliani and Miller's Theory of Capital Structure without tax, the company's cost of equity would:

A.

stay the same.

B.

decrease.

C.

increase.

D.

increase or decrease depending on the bond's coupon rate.

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Question # 114

A company in country T is considering either exporting its product directly to customers in country P or establishing a manufacturing subsidiary in country P.

The corporate tax rate in country T is 20% and 25% tax depreciation allowances are available

Which TIIRCC of the following would be considered advantages of establishing a subsidiary in country T?

A.

The corporate tsx rate in country P is 40%.

B.

There are restrictions on companies wishing to remit profit from country P

C.

Year 1 tax depreciation allowances of 100% are available in country P.

D.

There is a double tax treaty between country T and country P.

E.

There are high customs cuties payable of products entering country P.

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Question # 115

The Board of Directors of Company T is considering a rights issue to fund a new investment opportunity which has a zero NPV.

 

The Board of Directors wishes to explain to shareholders what the theoretical impact on their wealth will be as a result of different possible actions during the rights issue.

 

Which THREE of the following statements in respect of theoretical shareholder wealth are true?

A.

If shareholders exercise their full rights there will be no impact on their wealth.

B.

If the shareholders allow their rights to lapse (do nothing) there will be no impact on their wealth.

C.

If shareholders sell their entire rights entitlement there will be no impact on their wealth.

D.

If the shareholders only partially exercise their rights and allow the remainder to lapse there will be no impact on their wealth.

E.

If shareholders partially exercise their rights and sell the remaining rights entitlement there will be no impact on their wealth.

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Question # 116

A company based in the USA has a substantial fixed rate borrowing at an interest rate of 3.5% and wishes to swap a part of this to a floating rate to take advantage of reducing interest rates Its bank has quoted swap rates of 3 4%-3 5% against 12-month USD risk-free rate.

What is the overall interest rate achieved by the company under this borrowing plus swap combination?

A.

12-month USD risk-free rate minus 0 1 % (where 0 1 % = the fixed rate of 3.6% minus the swap rate of 3 4%)

B.

12-month USD risk-free rate

C.

12-month USD risk-free rate plus 0 1% (where 0.1 % = the fixed rate of 3.5% minus the swap rate of 3 4%) D. Unchanged at 3.60% as this is the same as the swap rate

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Question # 117

The directors of the following four entities have been discussing dividend policy:

F3 question answer

Which of these four entities is most likely to have a residual dividend policy?

A.

A

B.

B

C.

C

D.

D

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Question # 118

WW is a quoted manufacturing company. The Finance Director has addressed the shareholders during WW's annual general meeting-She has told the shareholders that WW raised equity during the year and used the funds to repay a large loan that was maturing, thereby reducing WW's gearing ratio

At the conclusion of the Finance Director's speech one of the shareholders complained that it had been foolish for WW to have used equity to repay debt The shareholder argued that the Modigliani and Miller model (with tax) offers proof that debt is cheaper than equity when companies pay tax on their profits.

Which THREE arguments could the Finance Director have used in response to the shareholder?

A.

A lower gearing ratio will result in an increase in the value of the company

B.

WW was approaching a debt covenant limit and it was therefore important to reduce gearing.

C.

A lower gearing ratio creates greater flexibility for WW in the future

D.

The shareholder was confusing the cost of capital with shareholder wealth

E.

Reducing the gearing ratio has reduced the financial risk of WW which will benefit shareholders

F.

The Modigliani and Miller model would only be valid in practice if WW's shareholders were aware of the model and believed in its validity

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Question # 119

Company A has a cash surplus.

The discount rate used for a typical project is the company's weighted average cost of capital of 10%.

No investment projects will be available for at least 2 years.

 

Which of the following is currently most likely to increase shareholder wealth in respect of the surplus cash?

A.

Investing in a 2 year bond returning 5% each year.

B.

Investing in the local money market at 4% each year.

C.

Maintaining the cash in a current account.

D.

Paying the surplus cash as a dividend at the earliest opportunity.

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Question # 120

A consultancy company is dependent for profits and growth on the high value individuals it employs.

The company has relatively few tangible assets.

 

Select the most appropriate reason for the net asset valuation method being considered unsuitable for such a company.

A.

It does not account for the intangible assets.

B.

It accounts for the intangible assets at historical value.

C.

It accounts for intangible assets at net realisable value.

D.

It does not account for tangible assets.

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Question # 121

A listed company is planning to raise $21.6 million to finance a new project with a positive net present value of $5 million.  The finance is to be raised via a rights issue at a 10% discount to the current share price.  There are currently 100 million shares in issue, trading at $2.00 each.

 

Taking the new project into account,  what would the theoretical ex-rights price be?

 

Give your answer to two decimal places.

 

$ ?  

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Question # 122

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.

Interest cover will fall; P/E ratio will fall.

B.

Interest cover will fall; P/E ratio will rise.

C.

Interest cover will rise; P/E ratio will rise.

D.

Interest cover will rise; P/E ratio will fall.

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Question # 123

A venture capitalist invests in a company by means of buying

* 6 million shares for $3 a share and

• 7% bonds with a nominal value of $2 million, repayable at par in 3 years' time

The venture capitalist expects a return on the equity portion of the investment of at least 20% a year on a compound basis over the first 3 years of the investment

The company has 8 million shares in issue

What is the minimum total equity value for the company in 3 years' time required to satisfy the venture capitalist's expected return?

Give your answer to the nearest $ million

F3 question answer

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Question # 124

A geared and profitable company is evaluating the best method of financing the purchase of new machinery. It is considering either buying the machinery outright, financed by a secured bank borrowingand selling the machinery at the end of a fixed period of time or obtain the machinery under a lease for the same period of time.

Which is the correct discount rate to use when discounting the incremental cash flows of the lease against those of the buy and borrow alternative?

A.

The post-tax cost of the bank borrowing

B.

The company's cost of equity

C.

The company's WACC.

D.

The pre-tax cost of the bank borrowing

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Question # 125

Which THREE of the following remain unchanged over the life of a 10 year fixed rate bond?

A.

The coupon rate

B.

The yield

C.

The market value

D.

The nominal value

E.

The amount payable on maturity

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Question # 126

Company A, a listed company, plans to acquire Company T, which is also listed.

 Additional information is:

   • Company A has 100 million shares in issue, with market price currently at $8.00 per share.

   • Company T has 90 million shares in issue, with market price currently at $5.00 each share.

   • Synergies valued at $60 million are expected to arise from the acquisition.

   • The terms of the offer will be 2 shares in A for 3 shares in B.

Assuming the offer is accepted and the synergies are realised, what should the post-acquisition price of each of Company A's shares be?

 

Give your answer to two decimal places.

 

$ ?  .

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Question # 127

A profit-seeking company intends to acquire another company for a variety of reasons, primarily to enhance shareholder wealth.

Which THREE of the following offer the greatest potential for enhancing shareholder wealth?

A.

Achieving more press coverage for the company.

B.

Creating new opportunities for employees.

C.

Achieving greater cultural diversity.

D.

Acquiring Intellectual Property assets.

E.

Exploiting production synergies.

F.

Elimination of existing competition.

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Question # 128

A company is financed by debt and equity and pays corporate income tax at 20%.  

Its main objective is the maximisation of shareholder wealth.

It needs to raise $200 million to undertake a project with a positive NPV of $10 million.

 

The company is considering three options:

   • A rights issue.

   • A bond issue.

   • A combination of both at the current debt to equity ratio.

Estimations of the market values of debt and equity both before and after the adoption of the project have been calculated, based upon Modigliani and Miller's capital theory with tax, and are shown below:

 F3 question answer

 

 

Under Modigliani and Miller's capital theory with tax, what is the increase in shareholder wealth?

A.

$210 million if financed by equity

B.

$50 million if financed by debt

C.

$160 million if financed by a mixture of debt and equity

D.

$10 million irrespective of finance

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Question # 129

Select the most appropriate divided for each of the following statements:

F3 question answer

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Question # 130

A company which is forecast to experience a strong growth in its profitability is evaluating a potential bond issue.

Which of the following changes in corporate income tax and in bond yields would make the bond issue more attractive to the company?

A.

A decrease in corporate tax and an increase in bond yields.

B.

An increase in corporate tax and a decrease in bond yields.

C.

An increase in corporate tax and an increase in bond yields.

D.

A decrease in corporate tax and a decrease in bond yields.

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