Question 1 Three senior managers of Endurance plc are discussing the company’s financial gearing. Mr Rogers believes that the financial gearing is 55%, Mr Yasim believes that it is 89% and Mr Zhang 134%. Summarised consolidated profit and loss account for the year ended 31 December 2008 £000 Turnover 56,300 Less cost of sales 45,100 Gross profit 11,200 Less administrative and other expenses 6,450 Operating profit 4,750 Less interest payable 1,154 Profit before taxation 3,596 Less taxation 1,259 2,337 Extraordinary items 580 Profit for the financial year 2,917 Less dividend paid and proposed 970 Retained profit for the year 1,947 Summarised consolidated balance sheet as at 31 December 2008 £’000 Non current assets 16,700 Current assets Stocks 7,040 Debtors 4,800 Cash at bank and in hand 2,700 14,540 Creditors: amounts falling due within one year 8% loan stock 2009 1,000 Bank loans and overdrafts 2,800 Trade creditors 7,200 Corporation tax 1,140 Proposed dividends 510 Accruals and deferred income 2,860 15,510 Net current liabilities 970 Total assets less current liabilities 15,730 Creditors: amounts falling due after more than one year Bank loans (5,600) 12% debentures repayable in 14 years’ time (1,800) Net assets 8,330 Capital and reserves Called up share capital (10p par value) 2,200 Share premium account 1,940 Profit and loss account 4,190 8,330 Current market data for Endurance plc Ordinary share price 94p 8% loan stock price £98 12% debentures price £108 Required a) Explain how each manager has estimated the financial gearing and suggest how each manager might argue that his is the most appropriate measure of financial gearing. State with reasons which measure of gearing you prefer; (10 marks) b) Explain why financial gearing might be important to a company; (4 marks) c) Discuss what factors might limit the amount of debt finance that a company uses. (6 marks) (Total 20 marks) Question 2 The managing director of ZJUT plc wishes to provide an extra return to the company’s shareholders and has suggested these three possibilities. I. A 2 for 5 bonus issue (capitalisation issue) in addition to the normal dividend. II. A 1 for 5 scrip dividend instead of the normal cash dividend. III. A 1 for 1 share (stock) split in addition to the normal dividend. Summarised balance sheet of ZJUT plc (as at the end of last year) £m Non current assets 65 Current assets 130 Less current liabilities (55) 140 Ordinary shares (50 pence par value) 25 Share premium account 50 Revenue reserves 40 Shareholders’ funds 115 11% debenture 25 140 The company’s shares are trading at 300 pence cum div and the company has £50,000,000 of profit from this year’s activities available to ordinary shareholders of which £30,000,000 will be paid as dividend if option (1) or (3) is chosen. None of the £40,000,000 revenue reserves would be distributed. This year’s financial accounts have not yet been finalised. Required a) Evaluate the likely effect on the company’s share price of the three possibilities above (6 marks) b) Discuss reasons why a company might wish to make: i. a scrip dividend ii. a share (stock) split (7 marks) c) The managing director has heard that it is possible for the company to purchase its own shares. Explain why the purchase of its own shares might be useful to a company. (7 marks) (Total 20 mark) Question 3 Trevor plc plans to buy a new machine to meet expected demand for a new product, product T. This machine will cost £250,000 and last for four years, at the end of which time it will be sold for £5,000. Trevor plc expects demand for product T to be as follows: Year Demand (units) 1 35,000 2 40,000 3 50,000 4 25,000 The selling price for Product T is expected to be £12.00 per unit and variable cost of production is expected to be £7.80 per unit. Incremental annual fixed production overheads of £25,000 per year will be incurred. Selling price and costs are all in current price terms. Due to the current high rate of inflation caused by the global financial crisis, selling price and costs are expected to increase as follows: Increase Selling price of product t: 3% per year Variable cost of production: 4% per year Fixed production overheads: 6% per year Other information Trevor plc has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year. Required a) Calculate the net present value of buying the new machine and advise Trevor plc accordingly. (10 marks) b) Comment on the validity of your result and decision in (a) above. (4 marks) c) Discuss the reasons why the NPV method of investment appraisal might be considered superior over other investment appraisal techniques. (6 marks) (Total 20 marks) Question 4 You are presented with the following different views of stock market behaviour. 1. If a company publishes an earnings figure that is better than the market expects, the shares of that company will usually experience an abnormally high return both on the day of the earnings announcement and over the two or three days following the date of the announcement. 2. The return on professionally managed portfolios of equities is likely to be no better than that which could be achieved by a naïve investor who holds the market portfolio. 3. Share prices usually seem to rise sharply in the first few days of a new fiscal year. However, this can be explained by the fact that many investors sell losing stocks just before the fiscal year end in order to establish a tax loss for Capital Gains Tax purposes. This causes abnormal downturn pressure which is released when the new fiscal year begins. Required a) Discuss the three forms of Efficient Market Hypothesis (EMH) and their implications to investors. (10 marks) b) Discuss what each of the above three statements would tell you about the efficiency of the stock market. Where appropriate relate your comments to one or more forms of the EMH. (10 marks) (Total 20 marks) Question 5 (a) Explain what is meant by the Agency problem in Finance and how does it arise? (5 marks) (b) Identify the methods use to solve the agency problem and critically discuss the extent to which each of the method meets the intended objective of the firm. (15 marks) (Total 20 marks)
Posted on: Sun, 09 Mar 2014 16:39:08 +0000
Trending Topics
Recently Viewed Topics
© 2015