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Corporate Finance 4th Edition David Hillier - Solutions

10 The most important accounting standard for warrants and convertibles is IAS 39 Financial Instruments:Recognition and Measurement. IAS 39 provides definitions for different types of financial securities, and states how the different components of a security should be valued and presented in a
1 The derivative positions held by all companies that follow IFRS must be reported at fair value. Guidance is contained in IAS 39 Financial Instruments: Recognition and Measurement. You should also be familiar with IFRS 7 Financial Instruments: Disclosures. Visit the IASPlus website for more
2 Every company that uses international accounting standards must have a statement on its hedging activity.Download the financial accounts of a company from your country. Read through the risk section and write a report on its hedging activity, if any.
1 What is the monthly mortgage payment on Finn’s mortgage?Jennifer McAfee recently received her university master’s degree and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Finn has approached her about
2 What is the most significant risk Jennifer faces in this deal?Jennifer McAfee recently received her university master’s degree and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Finn has approached her
3 How can Jennifer hedge this risk?Jennifer McAfee recently received her university master’s degree and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Finn has approached her about a mortgage for a house he
4 Suppose that, in the next three months, the market rate of interest rises to 9 per cent.(a) How much will Ian be willing to pay for the mortgage?(b) What will happen to the value of Treasury bond futures contracts? Will the long or short position increase in value?Jennifer McAfee recently
5 Suppose that, in the next three months, the market rate of interest falls to 7 per cent.(a) How much will Ian be willing to pay for the mortgage?(b) What will happen to the value of T-bond futures contracts? Will the long or short position increase in value?Jennifer McAfee recently received her
6 Are there any possible risks Jennifer faces in using Treasury bond futures contracts to hedge her interest rate risk?Jennifer McAfee recently received her university master’s degree and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to
1 Estimate the number of futures contracts required. (25 marks)Malaika plc, a British company, is planning to make a payment in euros of €150 million at the end of September.However, the nearest maturity date for a euro futures contract is at 13 December and it is now 29 January. The face value
2 Assume that, at the end of September, the spot rate turns out to be €1.55/£ and a futures contract taken out at the end of September to expire on 13 December is quoted at €1.50/£. Estimate the total gain or loss earned by Malaika plc. (25 marks)Malaika plc, a British company, is planning to
3 Review the primary differences between hedging with futures and hedging with forwards. (25 marks)Malaika plc, a British company, is planning to make a payment in euros of €150 million at the end of September.However, the nearest maturity date for a euro futures contract is at 13 December and it
4 Explain what is meant by a currency option. Provide a worked example of a currency option strategy and the reasons for its use. Explain why currency put options are not necessarily a bearish investment. (25 marks)Malaika plc, a British company, is planning to make a payment in euros of €150
1 Derivatives: Hedging and Risk Discuss the differences between hedging and speculation with derivatives. Many corporations’ risk management divisions earn significant profits each year. What does this say about derivative use in large corporations?
2 Forward Contracts Explain what is meant by a forward contract. Use a non-financial example to illustrate how a forward contract works. What are the advantages and disadvantages of forward contracts?
3 Futures Contracts What is a futures contract? What are the advantages and disadvantages of futures contracts?
4 Interest Rate Futures Contracts Explain how interest rates can be hedged by futures contracts.Provide an example of how you could use one to hedge against an increase in interest rates.
5 Duration Hedging What is duration and how can it be used to hedge against interest rate changes?Use an example to illustrate your answer.
7 Financial Risk Management Using Table 25.10, discuss the main concerns of corporations when using derivatives to manage risk.REGULAR
8 Hedging Provide an overview of the empirical determinants of hedging. If you were the corporate treasurer for a company, would you recommend hedging as a risk management strategy? Explain.
9 Hedging Strategies If a firm is buying futures contracts on lumber as a hedging strategy, what must be true about the firm’s exposure to lumber prices? If a firm is writing call options on cocoa futures as a hedging strategy, what must be true about the firm’s exposure to cocoa prices?
10 Hedging Strategies What are the three strategies a firm has at its disposal to deal with currency risk?What are the advantages and disadvantages of each? Explain.
11 Hedging Risks Vestas Wind Systems A/S, the Danish wind energy company, would like to consider hedging the risk of its operations. What are the main risks the company faces and how would it hedge these risks? Provide at least two reasons why it probably will not be possible to achieve a
14 Option Explain why a put option on a bond is conceptually the same as a call option on interest rates.
16 Swaps Suppose a firm enters a fixed for floating interest rate swap with a swap dealer. Using an example and a diagram, illustrate the cash flows that will occur as a result of the swap. Why would a swap be preferable to other derivative transactions?
17 Transactions versus Economic Exposure What is the difference between transactions and economic exposure? Which can be hedged more easily? Why?
18 Hedging Exchange Rate Risk If a Dutch company exports its goods to the UK, how would it use a futures contract on sterling to hedge its exchange rate risk? Would it buy or sell sterling futures? Does the way the exchange rate is quoted in the futures contract matter?
19 Hedging Strategies You are the finance director of a British company that is expecting a payment in euros of €200 million at the end of September and wish to hedge against currency risk. However, the nearest maturity date for a euro futures contract is 13 December and it is now 29 January. The
20 Swaps Syco SA, a distributor of food and food-related products, has announced it has signed an interest rate swap. The interest rate swap effectively converts the company’s €100 million, 4.6 per cent interest rate bonds for a variable rate payment, which is the six-month EURIBOR minus 0.52
21 Interest Swaps Consider two firms, Larss plc and Sousa plc. Larss plc has a better credit rating and can borrow cheaper than Sousa plc in both fixed and floating rate markets. Specifically, Larss pays 6.35 per cent fixed and FRB plus 0.5 per cent floating. Sousa plc pays 9.85 per cent fixed and
22 Hedging Strategies Suntharee Lhaopadchan is a Thai student who is planning a one-year stay in the United Kingdom. She expects to arrive in the United Kingdom in eight months. She is worried about depreciation in the Thai baht relative to the British pound over the next eight months and wishes to
23 Future Quotes Suppose you purchase a September cocoa futures contract on 16 May 2019, at the last price of the day. What will your profit or loss be if the cocoa prices turn out to be $3,000 per metric ton at expiration? (Refer to Table 25.3 to help answer this question.)
24 Futures Quotes Suppose you sell five May 2020 gold futures contracts on 16 April 2020, at the last price of the day at $1,648.6 per ounce. What will your profit or loss be if gold prices turn out to be $1,500 per ounce at expiration and $1,300 per ounce at expiration? Assume each contract is for
26 Marking to Market You are long 10 gold futures contracts, established at an initial settle price of €1,000 per ounce, where each contract represents 100 ounces. Over the subsequent four trading days, gold settles at €1,003, €1,009, €1,012 and €1,004, respectively. Compute the cash
27 Floating Rate Agreement Quotes Rock Spring plc decides it wants to borrow capital for a six-month period in two three-month instalments. The company can borrow at FRB + 2 per cent. FRB rates today are 4 per cent. However, because the firm must agree the contract in advance and pay later, it will
28 Duration What is the duration of a bond with four years to maturity and a coupon of 9 per cent paid annually if the bond sells at par?
29 Duration Pillow Private Bank has the following market value balance sheet:Asset or Liability Market Value (in £ billions) Duration (in years)Government deposits 28 0 Trade receivables 580 1.20 Short-term loans 390 2.65 Long-term loans 84 7.25 Mortgages 315 16.25 Liabilities Chequing and savings
30 Hedging with Futures Suppose today is 16 April 2020, your firm produces chocolate and needs 75,000 tonnes of cocoa in July 2020 for an upcoming promotion. You would like to lock in your costs today because you are concerned that cocoa prices might go up between now and June. The closing price
31 Interest Rate Swaps ABC Company and XYZ Company need to raise funds to pay for capital improvements at their manufacturing plants. ABC Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at 11 per cent fixed rate or at FRB + 1 per
32 Duration Per and Birthe Clausen have a son who will begin university three years from today. Expenses of€30,000 will need to be paid at the beginning of each of the four years that their son plans to attend university.What is the duration of this liability to the couple if they can borrow and
33 Duration What is the duration of a bond with two years to maturity if the bond has a coupon rate of 8 per cent paid semi-annually, and the market interest rate is 7 per cent?CHALLENGE
35 Forward Pricing You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is £100,000, and the one-year and 11-year spot interest rates are 5 per cent and 9 per cent, respectively.(a) What is the forward price of your
36 Forward Pricing This morning you agreed to buy a one-year Treasury bond in six months. The bond has a face value of £100,000. Use the spot interest rates listed in the table below to answer the questions that follow.Time (Months) EAR (%)6 7.42 12 8.02 18 8.79 24 9.43(a) What is the forward
1 Net Working Capital What is short-term financial planning? Why is short-term financial planning crucial to a company? Provide an example of a company that has either undergone an insolvency event or is in financial distress due to poor short-term financial planning.
2 Cash Review the different ways in which cash can increase or decrease in a firm. Use the accounting equation to support your answer. What are some of the characteristics of a firm with a long operating cycle? Similarly, what are some of the characteristics of a firm with a long cash cycle?
3 Short-term Financing Needs Which type of company is likely to have large short-term financing needs?Provide an example using a company from your country.
4 Short-term Financial Policy Your friend has recently started up a new ice-cream shop business but is worried about the seasonality of cash flows the business will face. This is because the demand for ice cream will most likely be higher in summer than in other seasons, particularly winter. He
5 Financing Strategies Give an overview of different working capital financing strategies. What are the advantages and disadvantages of each?
6 The Short-term Financial Plan Explain what is meant by cash budgeting. Review the various ways a firm can finance a short-term cash deficit and the various financing policies to manage current assets.REGULAR
7 Sources and Uses For the last year, you have gathered the following information about Rock Spring plc:(a) The company undertook a £200 million share buyback programme.(b) £300 million was invested in property, plant and equipment.(c) Deferred revenue increased by £400 million.(d) Corporation
8 Short-term Financial Management A bank has recently installed a new contactless payment system for rural communities in Malawi. Describe the effect this is likely to have on the company’s short-term financial management.
9 Operating and Cash Cycles You have just been appointed as financial manager of a food processing and manufacturing firm. The production engineer has said that the cash cycle of your firm should always be longer than its operating cycle. Do you agree with this? Explain why, or why not.
10 Shortage Costs Assume you work for Evraz plc, the coal and iron ore miner. What would be the costs of shortages in such a firm? Explain using examples.
11 Reasons for Net Working Capital Why is net working capital always zero in an ideal economy, but positive in the real economy? Does this introduce any risks to a company?
12 Operating and Cash Cycles What impact did this change in payables policy have on Power Assets’operating cycle? Its cash cycle?
13 Operating and Cash Cycles What impact do you think the policy change had on Power Assets’ suppliers?
14 Corporate Ethics Is it ethical for large firms to unilaterally lengthen their payable periods, particularly when dealing with smaller suppliers? Is an 82-day payables period necessarily bad? Explain.
15 Payables Period Why do you think Power Assets really reduced its payables period? Is its explanation that this would ‘control costs and optimize cash flow’ sensible? Will there be any direct or indirect cash benefits to Power Assets from the change in payables period? Explain.
16 Accounts Receivable You are the owner of a professional basketball team with €3.5 million in the bank and a monthly cost base of around €1 million. Worried about potentially running out of cash during the playing season, you have asked supporters to pay for season tickets up front and in
17 Changes in the Cash Account Indicate the impact of the following corporate actions on cash, using the letter I for an increase, D for a decrease or N when no change occurs.(a) A dividend is paid with funds received from a sale of debt.(b) Property is purchased and paid for with short-term
18 Cash Equation IFU Live plc has total non-current assets of £4,938 million. Non-current liabilities are£1,038 million. Current assets, other than cash, are £2,098 million. Current liabilities are £1,161 million.Total equity is worth £7,176 million. How much cash does the company have?
19 Changes in the Operating Cycle Indicate the effect that the following will have on the operating cycle.Use the letter I to indicate an increase, the letter D for a decrease and the letter N for no change.(a) Receivables average goes up.(b) Credit repayment times for customers are increased.(c)
20 Changes in Cycles Indicate the impact of the following on the cash and operating cycles, respectively.Use the letter I to indicate an increase, the letter D for a decrease and the letter N for no change.(a) The terms of cash discounts offered to customers are made less favourable.(b) The cash
21 Calculating Cash Collections Assume that Next plc has projected the following quarterly sales amounts for the coming year:Q1 Q2 Q3 Q4 Sales £824m £920m £620m £1,600m(a) Trade receivables at the beginning of the year are £145 million. Next plc has a 10-day collection period. Calculate cash
22 Calculating Cycles Consider the following financial statement information for Bulldog Ice plc. Calculate the operating and cash cycles. How do you interpret your answer?Item Beginning(£) Ending(£)Inventory 8,413 10,158 Accounts receivable 5,108 5,439 Accounts payable 6,927 7,625 Net sales
23 Calculating Payments Lewellen Products has projected the following sales for the coming year:Q1 Q2 Q3 Q4 Sales (£) 540 630 710 785 Sales in the year following this one are projected to be 15 per cent greater in each quarter.(a) Calculate payments to suppliers assuming that Lewellen places
24 Calculating Payments Marshall plc’s purchases from suppliers in a quarter are equal to 75 per cent of the next quarter’s forecast sales. The payables period is 60 days. Wages, taxes and other expenses are 20 per cent of sales, and interest and dividends are £60 per quarter. No capital
25 Calculating Cash Collections The following is the sales budget for Freezing Snow plc for the first quarter of the year:January February March Sales budget (£) 150,000 173,000 194,000 Credit sales are collected as follows:• 65 per cent in the month of the sale• 20 per cent in the month after
26 Calculating the Cash Budget Here are some important figures from the budget of Sagmo AB for the first quarter of the year:January (NKr) February (NKr) March (NKr)Credit sales 380,000 396,000 438,000 Credit purchases 147,000 175,500 200,500 Cash disbursements Wages, taxes and expenses 39,750
27 Sources and Uses Refer to the balance sheet of a hypothetical firm below. Determine whether each item is a source or a use of cash, and the amount:CONSOLIDATED BALANCE SHEET as at 31 December€ million This Year Last Year Intangible assets 2,322 2,316 Property, plant and equipment 40,549 39,810
30 Cash Management Policy Rework problem 29 assuming the following:(a) Wildcat maintains a minimum cash balance of €45 million.(b) Wildcat maintains a minimum cash balance of €15 million.Based on your answers in (a) and (b), do you think the firm can boost its profit by changing its cash
31 Short-term Finance Policy Renault SA and Peugeot SA are competing automobile manufacturing firms.Download their annual financial accounts for the most recent period from each company’s website.(a) How are the current assets of each firm financed?(b) Which firm has the larger investment in
1 Consider the following financial statement information for Orologio SpA. Calculate the operating and cash cycles. How do you interpret your answer? (40 marks)Item Beginning (€) Ending (€)Inventory 44,234 34,048 Accounts receivable 43,211 35,532 Accounts payable 35,603 53,503 Net sales 360,302
2 You have been hired by a manufacturing firm that is currently experiencing significant levels of financial distress. The managers have asked you to find ways in which the company can increase its cash levels so as to improve liquidity. Write a report to the managers, using figures to illustrate
1 Use the numbers given to complete the cash budget and short-term financial plan.You have recently been hired by Wolgemut Manufacturing to work in its established treasury department.Wolgemut Manufacturing is a small company that produces highly customized cardboard boxes in a variety of sizes for
2 Rework the cash budget and short-term financial plan assuming Wolgemut changes to a minimum cash balance of €70,000.You have recently been hired by Wolgemut Manufacturing to work in its established treasury department.Wolgemut Manufacturing is a small company that produces highly customized
3 Rework the sales budget assuming an 11 per cent growth rate in sales and a 5 per cent growth rate in sales. Assume a €90,000 target cash balance.You have recently been hired by Wolgemut Manufacturing to work in its established treasury department.Wolgemut Manufacturing is a small company that
4 Assuming the company maintains its target cash balance at €90,000, what sales growth rate would result in a zero need for short-term financing? To answer this question, you may need to set up a spreadsheet and use the ‘Solver’ function.You have recently been hired by Wolgemut Manufacturing
1 Cash and Operating Cycles Find the most recent financial statements for two companies from your country. Calculate the cash and operating cycle for each company for the most recent year. Are the numbers similar for these companies? Why, or why not?
2 Cash and Operating Cycles Download the most recent quarterly financial statements for another company from your country. Calculate the operating and cash cycle for the firm over each of the last four quarters. Comment on any changes in the operating or cash cycle over this period.
1 Reasons for Holding Cash Why do firms hold cash? What are the consequences of holding too little cash? Is it possible for a firm to have too much cash? Why would shareholders care if a firm accumulates large amounts of cash? Explain
2 Determining the Target Cash Balance Show, using both the Baumol model and the Miller–Orr model, how a firm can determine its optimal cash balance. What are the advantages and disadvantages of each?
3 Investing Idle Cash What options are available to a firm if it believes it has too much cash? How about too little?
4 Terms of the Sale Explain what is meant by the credit terms of a sale. Provide an example of a typical trade credit agreement.
5 Establishing a Credit Policy What steps are involved in establishing a credit policy?
6 Optimal Credit Policy Is it possible to have an optimal credit policy? In this context, discuss the total credit curve and its impact on a firm’s approach to trade credit.
7 Credit Analysis What are the ‘five Cs’ of credit? Give an example of what happens when one of the five Cs is not met. Are there any other factors a firm should consider?
8 Collection Policy How can a firm use an ageing schedule of payments to maximize its total collection of outstanding debtors?
9 Opportunity versus Trading Costs Konyagi plc has an average daily cash balance of £10,500.Total cash needed for the year is £65,000. The interest rate is 3 per cent, and replenishing the cash costs€17 each time. What are the opportunity cost of holding cash, the trading cost and the total
10 Costs and the Baumol Model Saint-Michel SA needs a total of €54,000 in cash during the year for transactions and other purposes. Whenever cash runs low, it sells off €20,000 in securities and transfers the cash in. The interest rate is 3 per cent per year, and selling off securities costs
11 NPV and Reducing Float Starthub Ltd has an agreement with its bank whereby the bank handles Rm500 million in collections a day and requires a Rm40,000,000 compensating balance. Starthub is contemplating cancelling the agreement and dividing its Malaysian activities so that two other banks will
12 Determining Optimal Cash Balances TByrne Ltd is currently holding €700,000 in cash. It projects that over the next year its cash outflows will exceed cash inflows by €360,000 per month. How much of the current cash holding should be retained, and how much should be used to increase the
13 Using Miller–Orr SlapShot plc has a fixed cost associated with buying and selling marketable securities of£100. The interest rate is currently 0.021 per cent per day, and the firm has estimated that the standard deviation of its daily net cash flows is £75. Management has set a lower limit
14 Using Baumol Grampian plc has a weekly cash requirement of £60,000. The cost of selling marketable securities to raise cash is £50. The interest rate is 7 per cent per annum. Determine the optimal order quantity and the optimal order period.
16 ACP and Accounts Receivable Dalglish plc sells earnings forecasts for British securities. Its credit terms are 2/10, net 30. Based on experience, 65 per cent of all customers will take the discount.(a) What is the average collection period for Dalglish?(b) If Dalglish sells 1,200 forecasts every
17 Terms of Sale A firm offers terms of 2/9, net 40. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if:(a) The discount is changed to 3 per cent(b) The credit period
18 ACP and Receivables Turnover Muziek Stad NV has an average collection period of 52 days. Its average daily investment in receivables is €46,000. What are its annual credit sales? What is the receivables turnover?
19 Early Payment Discount XYZ plc has recently won a very large order to supply a retail chain, called TT Ltd, with items over the next two years. The size of any order may vary considerably and XYZ are obliged to deliver within two days of an order being placed. This will mean that XYZ has to
20 Size of Accounts Receivable Baker Ginger Ltd sells on credit terms of net 25. Its accounts are, on average, nine days past due. If annual credit sales are £8 million, what is the company’s balance sheet amount in accounts receivable?
22 Credit Policy Evaluation Champions SA is considering a change in its cash-only sales policy. The new terms of sale would be net one month. Based on the following information, determine if Champions should proceed. Describe the build-up of receivables in this case. The required return is 1.5 per

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