[FM/F9: Tài liệu ôn thi] Part C: Business Finance

Part C sẽ ôn lại 5 dạng bài tập quan trọng môn Financial Management (F9) với chủ đề Business Finance.

1. Tổng quan:

 

Topic	Question types	Question index
		MCQ	Case
Business finance	1. WACC, Cost of equity & debt	1-7
	2. Capital structure	8
	3. Sources of finance	9,10
	4. Optimal capital structure	11
	5. Project specific cost of capital	12,13
Reference: BPP ACCA F9 - Financial Management StudyText

2. Dạng bài tập chi tiết

Mức độ: Quan trọng

2.1. Dạng 1: WACC, Cost of Equity & Debt

Ref: Tóm tắt kiến thức Dạng 1: Impact of cost of capital on investments

Trắc nghiệm

Câu 1: Basic 

Learning outcome: Abc

Question:

A company has a capital structure as follows:

	$’m
10m $0.5 ordinary shares	5
Reserves	20
13% irredeemable loans notes	7

The ordinary shares are currently quoted at $3.00, and the loan notes at $90. The company has
a cost of equity of 12% and pays corporation tax at a rate of 25%.

What is the WACC of this company?

Guidance

This is a straightforward application of WACC formula:

→ Identify capital & debt elements in the capital structure & calculate relevent elements following the formula

Please practice as much as posible this type of question to save up calculating time.

Answer: 11.8%

Equity: Ordinary share:

Ke = 12% (given); Ve = $3*10m = $30m

Debt: Irredeemable loan notes:

Kd = i(1-T)/Po = 13(1-0.25)/90= 10.83%

Vd =7*(90/100) = $6.3m

Ve + Vd = 30 + 6.3 = $36.3m

• WACC = (30*12% + 6.3*10.83%)/36.3 = 11.79%

Câu 2: DIO has a capital structure has follow

	$’m
50c ordinary share	12
8% $1 preference shares	6
12.5% loan notes 20X6	8
	26

The company is paying corporation tax at the rate of 30%. The cost of the company’s ordinary equity capital has been estimated at 18% pa. The loan notes are redeemable at nominal value in 20X6. The current market prices of the company’s securities are as follows

50c ordinary share	250c
8% preference shares	92c
12.5% loan notes 20X6	$100

WACC for investment appraisal purpose?

Guidance: Same approach as Question 1.

Answer: 16.29%

Câu 3: Basic

PIA Co is about to pay a $0.50 dividend on each ordinary share. Its earnings per share was
$1.50. Net assets per share are $6. The current share price is $4.50 per share.
What is the cost of equity (to the nearest whole percentage)?

Guidance: Use Gordon's growth approximation

g = br, with	b: the proportion of profits retained
	r:  rate of return on investment

Answer: 31%
g = proportion of profits retained * rate of return on investment
b = (EPS-dividend)/EPS = ($1.50 – $0.5)/$1.50 = 66.7%
r = EPS/net assets per share = $1.5/$6 = 0.25 so 25%
g = 66.7% * 25% = 16.7%

Note: Share price given is cum div => Subtract dividend from cum-div share price

Câu 4: P Co has 10% redeemable loan notes in issue trading at $90. The loan notes are
redeemable at a 10% premium in 5 years' time, or convertible at that point into 20 ordinary
shares. The current share price is $2.50 and is expected to grow at 10% per year for the
foreseeable future. P Co pays 30% corporation tax. What is the best estimate of the cost of these loan notes (to one decimal place)?

Guidance:

Step 1: Calculate & choose the higher between the conversion value or cash alternative value

Step 2: Calculate the cost of redeemable debt using the IRR method

Pick 2 % cost and calculate the PV of cash flows at these 2% cost.

• Apply IRR calculation to get the cost of debt needed.
• 

Answer: 11.5%

Conversion value: Future share price = current share price including growth = $2.50 * 1.15
= $4.03.
So conversion value = 20 * $4.03 = $80.60. The cash alternative = 100 * 1.1 = $110

Therefore, investors would not convert and therefore redemption value = $110.
Kd = IRR of the after-tax cash flows as follows:

Time	$	DF at 10%	PV 10%	DF 15%	PV 15%
0	-90	1	-90		-90
1-5	10(1-0.3) = 7	3.791	26.54	3.352	23.46
5	110	0.621	68.31	0.497	54.67
			4.85		-11.87

IRR = 10+ 4.854.85--11.8715-10 = 11.5%

Câu 5:

Which TWO of the following are most likely to result in a company’s financial gearing
being high?

A. Low taxable profits

B. High tax rates

C. Inexpensive share issue costs 

D. Intangible assets being a low proportion of total assets

Answer: B & D

High tax rates mean that there is a larger tax shield on interest payments on debt finance,
making debt more attractive (B). 

Intangible assets being a low proportion of assets (D). Debt providers are more likely to lend if there are tangible assets to secure the debt against. If few of the assets are intangible then more are tangible and hence finance providers will be more willing to lend. 

With more potential debt providers, gearing is more likely to be high.

Câu 6: Basic

Green Co, a listed company, had the following share prices during the year ended
31 December 20X5:

At start of 20X5	$2.5
The highest price in the year	$3.15
Lowest price in the year	$2.4
At the end of 20X5	$3.0

During the year, Green Co paid a total dividend of $0.15 per share. What’s the total shareholder return (TSR) for 20X5?

Guidance: TSR = (Change in share price + dividend)/(beginning share price) *100

Answer: 26%

TSR = (3-2.5+0.15)/2.5 *100 = 26% 

Câu 7: Intermediate

Frost Co is planning a 1 for 4 rights issue with an issue price at a 10% discount to the
current share price.
The EPS is currently $0.50 and the shares of Frost Co are trading on a price/earnings ratio of
20 times. The market capitalisation of the company is $50m. What is the theoretical ex-rights price per share (to two decimal places)?

Guidance: Apply the TERP formula: TERP = Total share value/number of shares

Answer: $9.8 per share

Current share price = $0.5 × 20 = $10 per share
Rights issue price = $10 × 90/100 = $9 per share
Number of shares in issue = $50m/$10 = 5m
Number of shares to be issued = 5m × 1/4 = 1.25m shares
TERP = (5m × $10 + 1.25m × $9)/6.25m = $9.80 per share.

Mức độ: Ít quan trọng

2.2. Dạng 2: Capital structure

Ref: Tóm tắt kiến thức Dạng 2: Capital structure

Câu 8: Basic

In relation to preference shares as a source of capital for a company, fill in the gaps below
to complete the sentence.

Preference shares are a form of …….. capital which carry ……. risk from the company point
of view than ordinary shares.

Choose from the following: equity, loan, lower, higher

Guidance: Apply knowledge from the source of finance knowledge & their relating level of risk.

Answer:

Preference shares are a form of equity capital that carries a higher risk than ordinary shares.

Although they share many features in common with loan capital, preference shares give
their holders certain ownership rights in the company, which means that their position is
legally very different from that of lenders. Risk-wise, from the investor's point of view, they are
lower risk than ordinary shares and higher risk than debt. From the company's point of view,
they are at higher risk than ordinary shares as they carry a requirement to pay dividends that
ordinary shares do not.

2.3. Dạng 3: Sources of finance

Ref: Tóm tắt kiến thức Dạng 3: Sources of finance

Câu 9: basic

Small and medium-sized entities (SMEs) can have difficulty raising finance due to the
maturity gap

What is the maturity gap?

A. Lack of available funds from shareholders

B. Venture capitalists need an exit route for their investment within a specific time period

C. The business finds it difficult to obtain short-term funding but easier to obtain long term funding secured against its non-current assets

D. The lack of business history makes borrowing riskier for lenders

Answer: C

The maturity gap relates to the fact that using its non-current assets an SME may find it easier to secure long-term finance when it may actually need short- or medium-term finance.

Câu 11: basic

(SMEs) have restricted access to capital markets. The difference between the finance required to operate an SME and the amount obtained is known as:

A. Forecasted gap               B. Maturity gap               C. Funding gap               D. Asset gap

Answer: C. funding gap

Mức độ: Quan trọng (tiếp)

2.4. Dạng 4: Optimal capital structure

Trắc nghiệm

Câu 12: The board of Freedling Co are in discussion about the various risk types that face the
business. It is evident that there is considerable confusion and disagreement.

Operating risk
Some of the directors feel that given the increasing volume of trade having fixed costs is the
best thing to do. 'How can it be risky to have fixed costs when we know how much they are
and that they don’t change overly much from one year to the next was one comment.
There was also a discussion about changing the cost structure. It was thought that this
would be difficult as most staff, for example, were paid a salary and moving them on to an
the hourly rate would be opposed by them.

Gearing risk
The directors were more aware in this area, with some favouring a more traditional view of gearing and others remembering Modigliani and Miller (M&M) fondly from their studies.

a)  Indicate, by clicking in the relevant boxes, whether the following statements on
operating gearing are true or false?

Statement	True	False
Given the level of fixed costs do not change considerably from one year to the next, having a lot of fixed cost in Freedling’s cost structure would mean that they had low levels of operating risk

b) In relation to changing the cost structure of Freedling which of the following statements are true?

(1)	Cost structures are very difficult to change. Once a business is set up the mix of variable and fixed cost is also set and changes are often simply not possible
(2)	If you change from a fixed cost to a variable cost dominated structure the variable cost per unit is often greater than the fixed cost per unit.

A. Both statements are true

B. Both statements are false

C. Only (1) is true

D. Only (2) is true

c) Assuming the board were considering raising more debt, indicate, by clicking in the
relevant boxes, whether the assertion that the WACC of the business would fall
holds true or not in the following models.

Statement	Holds true	Does not hold true
Under M&M no tax
Under M&M with tax
At the low level of gearing under the traditional theory of gearing

d) Under M&M no tax which of the following statements are true?

(1)	It does not matter how a business raises finance
(2)	Shareholders, given the M&M assumptions, will recognise the level of risk inherent in any extra debt and compensate themselves by a commensurate increase in required return to leave the company WACC unaltered and without any inherent gain.

Guidance & Answer:

a)  False, False

Having fixed costs in a cost structure is risky since they have to be paid and are often
unavoidable in the short run if the business starts to turn downwards. This has a
magnifying effect on the businesses profit for a given volume change

b)  D

Cost structures can be changed. For example, property can be rented on a need only
basis thus avoiding the heavy fixed cost of a lease for example. 

Equally it is often the case that a business will pay more for the flexibility of having variable costs rather than fixed costs.

c)  False, True, True

Under M&M no tax the WACC would generally not change => (1) is false.

M&M argued that the level of gearing was not relevant to a company WACC. With corporation tax introduced into their model a tax benefit tended to pull down the WACC as gearing
increased. => (2 is true)

Under the traditional theory of gearing, modest amounts of debt often went unnoticed by shareholders and this lack of response (in the form of increased demands for higher return) meant the WACC fell. => (3) is true

d)  Only (2) is true

It is a common error to think that M&M claimed 'it does not matter how a business
raises its finance'. 

(2) is true. As company requires more debt, it gears up, leaving higher financial risks. This results in increase in required return by investors and be offset with decrease in WACC with higher amount of cheaper debt.

2.5. Dạng 5: Project specific cost of capital

Ref: Tóm tắt kiến thức Dạng 5: Project specific cost of capital

Câu 13:

The board of a major bank is discussing their investment appraisal methodology as they
have a new project under consideration. They have agreed that using the CAPM approach
is sensible as they feel it likely that most of their shareholders will have a well-diversified
shareholding in the stock market as a whole.
There has been some dispute about which risks constitute specific risks in the bank and
which risks are more systematic in nature partly driven by the nature of the banks
operations. Equally, no one seems quite sure what the required return derived from the
CAPM formula actually represents.
The finance director has produced the following data relating to the bank itself, the
financial market and the new project it is considering:

Data:

Required return on existing debt	6%
Cost of existing debt to the bank	4.8%
Return on short dated government securities	5.2%
Return in the stock market	12.8%
Equity beta of the bank	1.35
Beta of the new project	1.52
Asset beta of the bank	1.15

a) Which of the following risks could be correctly described as a systematic risk in this
case?

A. The interest rates set by the bank

B. The risk of default by the banks' customers on loans made

C. The recessionary pressures in the country in which the bank operates

D. The demand for loans made to the bank

b) In the CAPM what would be the value to use for the risk-free rate of return (Rf), from the data above?

A. 6%

B. 4.8%

C. 5.2%

D. 4.16% (the after-tax return on short-dated government securities)

c)  In the CAPM formula R = Rf + βj(Rm – Rf) where βj represents the project beta, R represents the cost of equity capital/the required return on the new project and the market risk premium is represented by (Rm – Rf)/Rm.
Pick the correct answers to complete the sentences.

d)  What is the percentage required return on the new project as derived from the
CAPM formula above, to two decimal places?

e)  What is the meaning of a beta value of 1?

A. The investment is risk-free

B. The investment has the same level of risk as to the bank

C. The investments total risk is as risky as the market

D. The investment has the same level of systematic risk as the market

Guidance & Answer:

a)  C
b)  C
c)  “In the CAPM formula R = Rf + βj(Rm – Rf) where βj represents the project beta, R
represents the required return on the new project and the market risk premium is
represented by (Rm – Rf).”
The CAPM gives you the required return of equity shareholders for the level of risk
indicated by the value of the beta used, therefore if the beta is that of the project
then the R value is the return required for the project. The market risk premium is
represented by Rm – Rf. Rm on its own is the market return.
d)  16.75%

R = Rf + βj(Rm – Rf)

R = 5.2 + 1.52(12.8 – 5.2)
R = 16.75%

e)  D. The investment has the same level of systematic risk as the market.

 

Author: Cam Tu