Financial Management (Mock Exam Questions) Flashcards
(17 cards)
Use the above information to calculate MacyGold plc’s weighted average cost of capital (WACC) using market values as weights
= 9.3%
What will have been the consequences of the company using a discount rate of 12% in the past?
Answer requires all 3 points:
. With a WACC of 9.3%, using a hurdle rate of 12% means the company have traditionally set their discount rate too high
. This will have reduced the NPV of the projects they appraise and lead to projects that should have been accepted being rejected
. This will reduce the value of the company to investors and hence reduce the wealth of its shareholders
Respond to the following three statements as to whether they are true or false, explaining your reasoning:
(1) A company’s cost of equity is the single most important and difficult to calculate figure in the WACC calculation.
(2) Bank loans will always be cheaper than debt finance raised via a bond issue.
(3) Once calculated, there is little need for a company to recalculate its WACC in future years.
Calculate the following figures for the project that PBP is appraising:
(1) Payback Period
Calculate the following figures for the project that PBP is appraising:
(2) Return on Capital Employed (Accounting Rate of Return
Calculate the following figures for the project that PBP is appraising:
(3) Net Present Value
Comment on the acceptability of the investment based on your findings and evaluations:
1. The ROCE (19.3%) is less than the target value (20%) set by the company - hence is not acceptable on this basis
2. The payback period (3.67 years) is more than the company’s target (3 years) - hence is not acceptable on this basis
3. The NPV is positive and hence the projected should be accepted
Calculate the Internal Rate of Return of the project in part (a).
Discuss the reasons why Net Present Value is preferred by academics to other methods of evaluating investment projects.
NPV is considered to be theoretically superior as an investment appraisal method on many counts. Among other points, students could discuss in detail the following:
. It satisfies the assumed primary financial objective of any company management, namely, to maximise the company’s share price. This is achieved by maximising the NPV of corporate investment projects.
. NPV considers the whole of the project. Compared to payback period.
. NPV takes account of the time value of money. As compared to A.R.R and Payback Period.
. NPV discounts cash flows, which are of most interest to investors, rather than accounting profits, which are open to manipulation. Compared to ARR that uses accounting profit.
. Risk can be incorporated by adjusting the discount rate.
. Inflation can be incorporated into both cash flows and discount rate.
. There is an easy decision rule: accept projects with a positive NPV.
(a) Calculate the theoretical ex-rights price (TERP) following the rights issue.
= £3.88
(b) If the before-tax-return of investing in the increased tent-manufacturing facility is estimated to be 14%, using appropriate calculations, demonstrate whether this project will increase shareholder wealth and hence the rights issue should go ahead.
(c) An alternative to funding the project via rights issue would be to raise debt finance. Identify and explain THREE factors which will influence whether the company raises debt finance via a bank loan or a bond issue.
Students can discuss any 3 of the following points in their answer:
. Cost: Is the company able to get the debt at a lower annual cost by using disintermediation or via a bank loan.
. Issue costs: the arrangement fees associated with bank loans are nearly almost lower than the issue costs of bonds
. Speed with which finance is required: it is quicker to arrange a bank loan than arrange an issue of debt securities.
**. Type of interest rate: does the company want to raise debt via a fixed interest rate (most likely via bonds) or rather than a floating rate (most likely bank loans)
. Flexibility: there is more flexibility in regard to terms and conditions using debentures.
. Variety: bonds give companies the ability to issue a number of different varieties of debt including convertibles and bonds with warrant attached compared to the more standardised bank loans.
. Security requirements: more favourable in terms of issue bonds (loan stock does not need to be secured) rather than a bank loans (almost always have to be secured).
. Repayment versus redemption: the redemption of bonds tends to occur in one big amount while bank loans can have the facility to make repayments over time.
