UNIT 5 - Company Finance Flashcards
(33 cards)
A private company was incorporated in 2015 and has the Model Articles of Association with no amendments. The directors of the company propose to allot 1,000 ordinary shares for cash consideration. To date, no resolutions concerning the allotment of shares have been passed.
Which of the following statements best explains why the shareholders of the company do not need to pass an ordinary resolution to give the directors authority to allot the shares?
A) Because the company is allotting shares in return for cash so no authority is required.
B) Because the company is a private company with one class of shares so the directors already have permission to allot shares.
C) Because company directors can always allot ordinary shares without permission from the shareholders.
D) Because the shares to be allotted are not equity securities.
E) Because directors are permitted to allot up to 1,000 shares without shareholder approval.
CORRECT ANSWER B - The company was incorporated after the Companies Act 2006 (‘CA 2006’) came into force and is a private company with only one class of shares – this must be the case because it has the Model Articles and no resolutions relating to allotment
have been passed, so there cannot be any other types of share. No amendments have been made to the articles that might restrict the directors’ authority to allot. The directors therefore already have authority to allot the shares under s 550 CA 2006. Option A is wrong because the fact that the shares are being allotted for cash does not change whether authority is required or not. Option C is wrong because sometimes directors do need permission to allot shares, depending on the company’s articles, the type of share and company, and when it was incorporated. Option D is wrong because ordinary shares are equity securities. Option E is wrong because there is no such rule that directors can allot up to 1,000 shares without shareholder approval.
A private company incorporated in 2015 has the Model Articles of Association with no amendments. It has two shareholders, a woman and a man, who are also the only
two directors of the company. Each shareholder holds 50,000 ordinary £1 shares. The shareholders have agreed in principle that the company will buy back 25,000 shares from the man for £40,000. The company’s distributable profits are £175,000 and its net assets are £800,000.
Assume that the shareholders have not passed any relevant resolutions.
Which of the following best describes what shareholders’ resolutions would be required to effect the buyback described above?
A) One ordinary resolution, to authorise the buyback.
B) One ordinary resolution to authorise the buyback and one special resolution to authorise the use of capital.
C) One ordinary resolution to authorise the buyback and a second ordinary resolution to authorise the use of capital.
D) No shareholders’ resolutions would be required because the company has the Model Articles of Association.
E) One special resolution, to authorise the buyback.
CORRECT ANSWERS A - This is clearly a buyback out of profits, not capital, because the company’s distributable profits of £175,000 are enough to cover the agreed price for the buyback (£40,000). The net assets figure does not change the position. Accordingly, only one ordinary resolution is needed (s 694 CA 2006) to authorise the buyback. Options B and C are wrong because this is not a buyback out of capital. Options D are E are wrong because one ordinary resolution is required.
A private company has four shareholders, a chemist, a translator, a software developer and a biologist, who are also the four directors of the company. The company has the Model Articles of Association with no amendments. It has an issued share capital of £100,000 ordinary £1 shares. The chemist owns 25,000 shares, the translator owns 50,000 shares, the software developer owns 15,000 shares and the biologist owns 10,000 shares. The software developer then sells 5,000 shares to each of the other three shareholders.
Which of the following describes the chemist, the translator and the biologist’s percentage shareholdings following the transfer of the software developer’s shares as described above?
A) The chemist owns 25%, the translator owns 50% and the biologist owns 10% of the company’s shares.
B) The chemist owns 35%, the translator owns 65% and the biologist owns 12% of the company’s shares.
C) The chemist owns 29%, the translator owns 59% and the biologist owns 12% of the company’s shares.
D) The chemist owns 30%, the translator owns 55% and the biologist owns 15% of the company’s shares.
E) The chemist owns 25%, the translator owns 50% and the biologist owns 15% of the company’s shares.
CORRECT ANSWERS D - Each of the remaining shareholders obtains 5,000 more shares of the 100,000 in issue, giving the chemist 30,000, the translator 55,000 and the biologist 15,000 shares. So the chemist has 30,000/100,000, ie 30% of the shares, the translator has 55,000/ 100,000, ie 55% of the shares, and the biologist has 15,000/100,000, ie 15% of the shares.
A private company has the Model Articles of Association with no amendments. The company proposes to borrow £500,000 from a bank. The loan agreement will be signed as a contract by the company. The company does not have a company seal or a company secretary.
Which of the following best describes the minimum execution formalities required in order for the loan agreement to be binding on the company?
A) The loan agreement must be signed by two directors, whose signatures must be witnessed.
B) The loan agreement must be signed by the company by a person acting under its authority express or implied.
C) The loan agreement must be signed by two authorised signatories, whose signatures must be witnessed.
D) The loan agreement must be signed by two directors or one director in the presence of a witness who attests the director’s signature.
E) The loan agreement must be signed by the company by two directors acting under its authority express or implied.
CORRECT ANSWERS B - This is the minimum required for a contract as set out in s 43 CA 2006. The other options involve two signatories or one signatory and a witness, which is unnecessary for a contract.
A bank has loaned money to a company on two occasions, and both times requested a charge over the company’s assets. The company has also granted security to another lender, a building society. Details of the security are set out below:
1 May 2019: The bank lent the company £250,000, secured by way of a fixed charge over the company’s factory. The charge was not registered.
1 June 2020: The bank extended the company’s overdraft facility. In return, the company executed a debenture in favour of the bank in which it granted it a floating charge over the company’s whole undertaking, to secure all monies outstanding to the bank at any time. The charge was correctly registered at Companies House.
20 January 2022: The building society was granted a fixed charge over the company’s factory to secure a loan of £50,000. The charge was correctly registered at Companies House.
Will the building society’s charge take priority over the bank’s charges?
A) Yes, because it was correctly registered at Companies House and the bank’s charges were not.
B) Yes, because the bank’s fixed charge is void and the building society’s charge, because it is fixed, takes priority over the bank’s floating charge.
C) No, because the bank’s second charge secures all monies outstanding to the bank at any time and was created before the building society’s charge, so the bank will take priority.
D) No, because the bank’s charges were created first and one of them was registered so the building society’s charge must take second place to the bank’s charges.
E) No, because the bank’s second charge secures all monies outstanding to the bank at any time and therefore the bank will take priority.
CORRECT ANSWERS B - If a charge is not registered, it is still valid and enforceable between the chargor and chargee, but void against the liquidator and third parties. Fixed charges always rank ahead of floating charges, even if the floating charge was registered first. Fixed charges rank in order of date of creation, as long as they are registered.
A company has the Model Articles of Association with no amendments and an issued share capital of £100,000 ordinary £1 shares. There are two shareholders, a woman and a man. The woman owns 50,001 shares and the man, with whom the woman sometimes has a difficult working relationship, owns 49,999 shares. The company is seeking finance – it needs £200,000 to expand its business (the import and distribution of road bikes). The company will either borrow the money or issue 50,000 new shares to the man’s wife for £200,000.
Which of the following best describes which is the better option in this case?
A) A loan would be better because interest rates are currently low.
B) A loan would be better because allotting more shares would make it difficult for the woman to pass or block ordinary resolutions.
C) A loan would be better because allotting more shares would make it more difficult for the woman to pass special resolutions.
D) Allotting more shares would be better because the company will not have to pay interest.
E) Allotting more shares to the man’s wife would be better because the current shareholders already know her.
CORRECT ANSWER B - Currently the woman can block and pass ordinary resolutions alone, because she has 50.001% of the shares. The allotment of more shares would dilute her voting power to less than 50% of the shares, so she could neither pass nor block an ordinary resolution without either the man or his wife voting in the same way. Option C is wrong because she will not be able to pass special resolutions alone after the allotment but cannot do so before the allotment either. Options A, D and E sounds plausible but these are weak arguments compared with option B.
The following information is from the accounts of a business:
* Sales - 150,000
* Fixed assets - 100,000
* Cost of sales - 50,000
* Current assets - 22,000
* Current liabilities - 10,000
* Long-term liabilities - 53,000
* Capital employed - 59,000
Which of the following best describes the value of the business’s net current assets and net assets?
A) The business’s net current assets are 12,000 and its net assets are 59,000.
B) The business’s net current assets are 12,000 and its net assets are 118,000.
C) The business’s net current assets are 112,000 and its net assets are 118,000.
D) The business’s net current assets are 122,000 and its net assets are 12,000.
E) The business’s net current assets are 40,000 and its net assets are 59,000.
CORRECT ANSWERS A - Net current assets are calculated by subtracting current liabilities from current assets, so the calculation is 22,000 – 10,000, resulting in a figure of £12,000 for net current assets. Net assets are calculated by subtracting both current and long-term liabilities from fixed and current assets. The calculation is (100,000 + 22,000) less (10,000 + 53,000), that is, 122,000 – 63,000, resulting in a net assets figure of 59,000.
A client, which is a partnership, gives you the following information about its business over the course of the financial year:
(a) It has a trading profit of £200,000; and
(b) The client has received an electricity bill for £500 but has not yet paid it.
Which of the following best describes where the figures listed in (a) and (b) above will appear on the client’s balance sheet and/or profit and loss account when the client’s final accounts are prepared for the financial year?
A) Item (a) will appear on both the profit and loss account and on the balance sheet, and item (b) will appear on the balance sheet as an accrual.
B) Item (a) will appear on both the profit and loss account and on the balance sheet, and item (b) will appear on the balance sheet as a prepayment.
C) Item (a) will appear on the balance sheet as income, and item (b) will appear on the profit and loss account as an expense.
D) Item (a) will appear on the balance sheet as income, and item (b) will appear on the balance sheet as an expense.
E) Both items will appear on both the profit and loss account and balance sheet.
CORRECT ANSWER E - Trading profit is shown at the end of the profit and loss account – this
is what the profit and loss account is designed to calculate. It is also shown on the balance sheet under ‘capital employed’. When preparing final accounts, unpaid bills must be included as an adjustment. The unpaid electricity bill will appear in the profit and loss account as an expense, and in the balance sheet as an additional current liability, under ‘accruals’.
Which of the following best describes the authorised share capital of a company?
A) Shares which have been designated as able to be traded on the London Stock Exchange.
B) The value someone is prepared to pay for the shares, also known as the market value.
C) The value designated to the shares by the company, also known as the par value.
D) The maximum number of shares that can exist in the company. Companies with model articles have an unlimited authorised share capital.
E) The number of shares that have been issued in the company. Companies with model articles have an unlimited authorised share capital.
CORRECT ANSWER D - Authorised share capital was a concept used far more widely in earlier versions of the companies act but it is still relevant today. Older companies may still have a limit in how many shares can be issued in total, or newer companies can add one if they wish to.
The authorised share capital is the maximum amount of shares that can exist and the issued share capital is the amount of shares that actually do exist.
Which of the following best describes the concept of pre-emption rights under the Companies Act 2006?
A) A method of protecting existing shareholders by placing safeguards to protect their existing voting and ownership percentages.
B) A way of ensuring that new shareholders cannot disrupt the company’s operations.
C) A method of protecting the company from unscrupulous directors by vetting them before they are appointed.
D) A way of ensuring that new shareholders can never buy shares when an existing shareholder would like to.
E) A way of existing shareholders preventing the issue of new shares.
CORRECT ANSWER A - Pre-emption rights are designed to protect the rights of existing shareholders by putting safeguards in place to prevent their ownership and control from being diluted. By default, they give existing shareholders a right of first refusal over new shares being issued. To disapply pre-emption rights over equity securities issued for cash consideration, at least 75% of the shareholders must agree.For our purposes “ equity securties “ are ordinary shares.
When allotting shares, in a private limited company, what will happen to the net asset value in the balance sheet?
A) The net asset value will go up by the nominal value of the share being sold multiplied by the total number of shares being sold.
B) The net asset value will go up by the sale price of the share being sold multiplied by the total number of shares being sold.
C) The net asset value will go down by the nominal value of the share being sold multiplied by the total number of shares being sold.
D) The net asset value will go down by the sale price of the share being sold multiplied by the total number of shares being sold.
E) Nothing
CORRECT ANSWER B - The new shareholder will pay the sale price of the share to the company. This price may coincidentally be the same as the nominal value or the company may charge a premium. The company will receive the money and it will not have to pay that money back - therefore net asset value will increase.
Which of the following would be considered “wholly cash consideration”?
A) 95p
B) £1,000,000 and a pencil
C) A building, worth £500,000
D) An agreement to provide consultancy services for free
E) It is not possible to provide wholly cash consideration
CORRECT ANSWER A - Wholly cash consideration has no minimum value and must be entirely cash.
Which of the following is an “equity security”?
A) Security allocated on a pro rata basis between shareholders
B) Any type of share
C) A preference share
D) An ordinary share
E) A preference share and an ordinary share
CORRECT ANSWER D - S560 CA06 defines ordinary shares as being equity securities. Preference shares are usually restricted to a certain amount of interest that they can receive and therefore do not qualify as an ordinary share.
When a private limited company borrows money from a commercial lender, what will happen to the net asset value in the balance sheet?
A) The net asset value will go up by the value of the money being borrowed.
B) The net asset value will go down by the amount of interest and fees being charged on the loan (if any).
C) The net asset value will go down by the value of the money being borrowed.
D) The net asset value will go up by the amount of interest and fees being charged on the loan (if any).
E) Nothing
CORRECT ANSWER B - When a company borrows money, it receives cash so the current assets will increase. However, it also takes on the same corresponding liability, the obligation to repay the money. So overall, net asset value should stay the same - an increase in one area and a corresponding decrease in another.
However, commercial loans usually come with fees/charges and interest to pay so that will mean that the net asset value will go down.
If there are no charges or interest (for example if the money is being lent by a family member of one of the shareholders on favourable terms - no fees, no interest) the net asset value should remain the same.
Interest rates charged by a bank to a particular company for borrowing money are currently 15%. Three months ago, they were 6%.
Would a company be more likely to borrow money from a bank now than it would three months ago?
A) Yes, because it will mean a better return on investment.
B) Yes, because banks will have more money to lend.
C) No, because it will be more expensive to borrow the money.
D) No, because the bank’s fees will be higher.
E) No, because allotting shares does not require any repayment.
CORRECT ANSWER C - The interest rate refers to how expensive it is for the company to borrow money. An interest rate of 15% is more expensive for the company than an interest rate of 6%. The company would be more likely to use funding from other methods such as issuing shares if it is able to. It does not mean that the company will definitely not borrow the money from the bank, it just means that it is more expensive so it is likely that other options will be more attractive.
Interest rates do not affect the amount of money banks have to lend or their fees, and a higher interest rate certainly will not make for a better return on investment
Allotting shares does not require repayment, but that is unrelated to the interest rate being charged. If anything a higher interest rate would make the company more likely to allot shares now than it would have been 3 months ago.
A private company has 3 shareholders. The largest shareholder has 50.5% of the ordinary shares (50,500 shares), the middle shareholder has 25.5% of the shares (25,500 shares) and the smallest shareholder has 24% of the shares (24,000).
The company needs to raise some money in order to implement a new automation process for its packing plant.
None of the existing shareholders can afford to invest any more money. If the company decided to pursue equity finance, the company would issue the new shareholder 10,000 ordinary shares.
The company has not borrowed from a bank before and overall, its borrowings are very low.
Which of the following best describes considerations that would impact how the company choses to fund the purchase?
A) Paying interest on a loan is not tax deductible.
B) The company will not be able to issue new equity securities.
C) The new shareholder may change the way the company is run day to day.
D) Having not borrowed from a bank before, the company will not likely be able to borrow from one in the future.
E) The largest shareholder and the middle shareholder may object to issuing new shares as it would take them below key voting thresholds.
CORRECT ANSWER E - The largest shareholder owns just above the threshold to pass an ordinary resolution on their own (often referred to as having control of the company). Issuing 10,000 new shares would take them from 50.5% to 45.9% of the shares. Similarly, the middle shareholder would go from 25.5% to 23.1% which would remove their ability to block special resolutions on their own.
Paying interest on a loan is tax deductible as it is a contractual obligation. There is no reason that the company would not be able to issue equity securities. A new shareholder would not impact the way the company is run because that is the job of the directors and the new shareholder will not have the power to appoint directors or remove them on their own.
Not having borrowed money from a bank will not mean that they are unable to borrow in the future. The facts mention that overall, the company has very low borrowings which may well make the attractive to future lenders.
According to its latest balance sheet, based on the most recent accounting year, a company has total assets of £160,000, a profit and loss reserve of negative £1,000 and current assets of £50,000.
Also, in the most recent accounting year, the company made a profit of £55,000.
The directors wish to issue a dividend to the shareholders of £49,000.
Can the directors recommend the dividend?
A) Yes, because the company made a profit of £55,000 in the most recent accounting year.
B) Yes, because current assets are greater than the dividend.
C) Yes, because current assets combined with the profit and loss reserve are enough to pay the dividend.
D) No, because the amount in the profit and loss reserve is not enough to pay the dividend.
E) No, because the shareholders rather than the directors recommend the dividend.
CORRECT ANSWER D - s830 CA06 describes the fact that distributions can only be made out of profits available for the purpose. It goes on to say that these are defined by taking all the profits ever made by the company and deducting all the losses ever made. So for this purpose, profits are calculated over the company’s lifetime (indicated by the profit and loss reserve), not over the last year.
Current assets are not profits, and they are not directly relevant to whether a distribution can be paid.
Directors do recommend the dividend and shareholders vote on whether to accept it. Shareholders can reduce (but not increase) the dividend if they wish.
A company has borrowed £100,000 from a bank and also has £100,000 of share capital.
The bank charges 8% interest on the loan each year and the capital is due to be repaid as a lump sum after 5 years. The shareholders expect to receive 15% return on their investment.
The company does much better than expected and makes £500,000 profit in its first year.
How much money will the bank receive at the end of the year and how much will the shareholders be able to receive?
A) The bank will receive £108,000 and the shareholders will be able to receive up to £75,000.
B) The bank will receive £100,000 and the shareholders will be able to receive up to £15,000.
C) The bank will receive £40,000 and the shareholders will be able to receive up to £460,000.
D) The bank will receive £8,000 and the shareholders will be able to receive up to £492,000.
E) The bank will receive £108,000 and the shareholders will be able to receive up to £115,000.
CORRECT ANSWER D - Equity shareholders take the greatest risk and are also able to get the highest rewards. They own the company, and are entitled to receive all the profits as dividends (if recommended by the directors). The bank takes a very low risk and consequently gets lower rewards. It is contractually entitled to £8,000 as an interest payment. After deducting this money, there is £492,000 of profit and the shareholders are entitled to all of it.
A private limited company is preparing to allot shares to a new member. There is only one class of share and the directors have authority to allot the shares. There are no constitutional restrictions on allotment. The nominal value of the shares is £1 each and the market value of the shares is £32 each. The company and the new member have agreed that the price of 1,000 shares will be £30,000 and a licence to use the new member’s garage for the company to store goods in for 2 years.
The majority shareholder currently has just over 50% of the shares, and after the allotment they will have just under 50% of the shares. The majority shareholder is willing to buy some or all of the new shares.
With regard to pre-emption rights, does the majority shareholder have the ability to prevent the allotment of the shares to the new shareholder?
A. Yes, because the majority shareholder controls more than 50% of the votes.
B. Yes, because the majority shareholder controls more than 25% of the votes.
C. Yes, because the amount of consideration is greater than £1,000.
D. No, because the majority shareholder will not be able to vote on pre-emption rights.
E. No, because after the allotment the majority shareholder will control less than 50% of the votes.
CORRECT ANSWER D - Because the consideration includes something other than cash therefore it is not “wholly cash” and pre-emption rights do not apply to this allotment. Consequently, there will not be a vote on this issue and voting percentages are irrelevant.
A private limited company has just created a new class of shares called “Preference Shares”. When the shares were created three weeks ago, the directors were granted a right to allot them and there are no constitutional restrictions on allotment. These new shares do not carry a right to vote except in unusual circumstances, and they have a fixed rate of interest payable to the holder instead of participation in the equity of the company.
The company proposes to issue all the Preference Shares to the managing director of the company who currently owns 40% of the ordinary shares. An existing shareholder in the company has 25% of the ordinary shares and opposes this allotment.
Can the existing shareholder prevent the issue of all the Preference Shares to the managing director?
A. No, because the existing shareholder cannot block a special resolution.
B. No, because there are no pre-emption rights for this allotment.
C. No, because the managing director is already a shareholder.
D. Yes, because the existing shareholder has a right to receive 25% of the allotment.
E. Yes, because the existing shareholder could combine their votes with the other shareholders to defeat the resolution.
CORRECT ANSWER B - Pre-emption rights only apply to equity securities and preference shares are not equity securities because they have a fixed rate of interest. Therefore, voting percentages are not important to this question.
A company has a total accumulated profit of £200,000 in the most recent audited annual accounts. The company made £50,000 profit in the last accounting period. The company is valued at £900,000. The signs of growth are favourable, and the business looks to be on a very good foundation for the foreseeable future. The directors recommend a dividend of £100,000 via board resolution but the shareholders are unhappy. The shareholders would like a higher dividend payment.
Which of the following best describes the options available to the shareholders?
A. The shareholders can increase the dividend up to a maximum of £200,000.
B. The shareholders can increase the dividend up to a maximum of £900,000.
C. The shareholders cannot increase the dividend.
D. The shareholders can only accept a dividend of £50,000.
E. The shareholders cannot accept any dividend.
CORRECT ANSWER C - The shareholders are able to lower the directors’ recommended dividend, but they cannot increase it. Dividends must be paid from profits (total accumulated profits) and the payment cannot exceed the profits. Therefore, the maximum dividend that could be paid is £200,000, but only if the directors recommend it. The shareholders have no power to increase it.
A private limited company wishes to allot 50,000 ordinary £1 shares to a new shareholder. The shareholder will pay the nominal value of the shares in cash as this is very close to the market value. The company has one other class of share in existence – preference shares. The company has model articles.
Which shareholder resolutions should usually be taken to ensure the allotment can go ahead?
A. Two special resolutions
B. Two ordinary resolutions
C. One ordinary resolution and a special resolution
D. One special resolution
E. One ordinary resolution
CORRECT ANSWER C - The directors will need to be granted authority to allot via ordinary resolution because the company has more than one class of share in existence. The pre-emption rights will also need to be disapplied, and this is usually done via special resolution. The less common alternative to using a special resolution is getting the unanimous consent of the shareholders which is obviously more difficult to achieve.
A company granted a fixed charge to a creditor one week ago and has already registered it. This is the third charge it has granted over the same asset. The company has two previous charges it has granted to other creditors. The first charge is a fixed charge that was granted on 19 August 2019 and sent for registration on 19 September 2019. The second charge is a fixed charge that was granted on 21 August 2019 and was sent for registration on 4 September 2019.
Assuming there is enough money to pay all debts, if the company were to be made insolvent, what order will the charges be paid in?
A. The first charge will be paid off first, the second charge will be paid off second and the third charge paid off third.
B. The first charge will be paid off first, the third charge will be paid off second and the second charge paid off third.
C. The second charge will be paid off first, the third charge will be paid off second and the first charge paid off third.
D. The second charge will be paid off first, the first charge will be paid off second and the third charge paid off third.
E. The third charge will be paid off first, the second charge will be paid off second and the first charge paid off third.
CORRECT ANSWER C - Charges generally rank in order of creation (not in order of registration). However, the first charge was not registered within the required 21-day time limit set out under s 859A(4) of the Companies Act 2006 and therefore is void against other creditors, the administrator and the liquidator. The first charge is not technically void, just void against certain key people. The debt will rank alongside the unsecured creditors.
A private company limited by shares has a single shareholder. The company is looking to raise funds to expand the business. The company currently has 20,000 ordinary £1 shares in issue and the company is valued at £100,000. The company wants to raise an additional £150,000 in capital by selling shares. The company will issue the same type of shares to the new shareholder as the existing shareholder has.
How many shares will the company likely have to issue to reach the funding target?
A) 20,000
B) 30,000
C) 50,000
D) 100,000
E) 150,000
CORRECT ANSWER B - The market value of the shares is £100,000 for 20,000 shares so each share is worth £5 each. To raise £150,000 the company will need to sell 30,000 shares (30,000 x £5 = £150,000). The fact the par value of the shares is £1 does not affect the price the company can sell the shares for.
