Questions and Answers of Multinational Business Finance

What are the limitations of the results of a sensitivity analysis such as the one carried out in Example 6.1 (Greene plc)?Data from Example 6.1Greene plc has the opportunity to invest in a machine
When deducing the expected NPV of a project, you can:(a) identify all possible outcomes (and their individual NPVs) and deduce the expected NPV from them; or(b) deduce the expected value of each of
What is the difference between the ‘specific’ and ‘systematic’ risk of a project? Why might it be helpful to distinguish between these two?
What does the word ‘utility’ mean in the context of utility theory?
What is a risk-averse person? Are most of us risk-averse?
It is possible to wager on the spin of a fair coin, such that £100 will be paid out if the coin lands head up and nothing if it lands tail up. What can you say about how much a riskloving individual
A project will yield one of three NPVs whose amount and probabilities of occurrence are as follows:What is the expected NPV of the project and its variance? NPV CH - 1,000 +1,000 +2,000 Probability
Portfolio theory tends to define risky investments in terms of just two factors: expected returns and variance (or standard deviation) of those expected returns.What assumptions need to be made about
Easton Ltd needs to purchase a machine to manufacture a new product. The choice lies between two machines (A and B). Each machine has an estimated life of three years with no expected scrap
In problem 6.1 , assume that the 2,000 level is the ‘best estimate’ of annual demand. Also assume that only Machine A is available.(a) Should the business acquire Machine A on the basis of its
Plaything plc has just developed a new mechanical toy, the Nipper. The development costs totalled £300,000. To assess the commercial viability of the Nipper a market survey has been undertaken at a
Block plc has £6 million of cash available for investment. Four possible projects have been identified. Each involves an immediate outflow of cash and is seen as having two possible outcomes as
Hi Fido plc manufactures high fidelity sound reproduction equipment for the household market. It has recently spent £500,000 developing a new loudspeaker, called the Tracker. A decision now needs to
Focus plc has several wholly owned subsidiaries engaged in activities that are outside the business’s core business. A decision has recently been taken to concentrate exclusively on the core
Tufty plc produces a small range of industrial pumps using automated methods. The business is now considering production of a new model of pump, starting on 1 January 20X3. The business wishes to
What sort of factors relating to a business specialising in operating ferries crossing the English Channel would tend to give rise to(a) specific risk and(b) systematic risk?
The year-end level of a representative stock exchange index and of the price of an ordinary share of Ace plc were as follows:You are required, on the basis of the above, to calculate beta. (Ignore
‘The expected return from a portfolio of securities is the average of the expected returns of the individual securities that make up the portfolio, weighted by the value of the securities in the
You have overheard the following statement: ‘If an investor holds shares in about 20 different businesses all of the risk is eliminated and the portfolio will give a return equal to the risk-free
What can be said about the portfolio that is represented by any point along the efficient frontier of risky investment portfolios?
You have overheard the following statement: ‘According to portfolio theory, shares are priced on the basis of their systematic riskiness. This means, therefore, that a piece of bad news relating
What is meant by ‘two-fund separation’?
‘Recently, equity returns have been lower than the returns available from short-term government securities. Clearly, in such a period, the capital asset pricing model doesn’t work because equity
The following are the annual returns for the ordinary shares of Court plc and for a representative equity price index:(a) What is the beta for Court plc’s ordinary shares?(b) If the risk-free rate
‘The capital asset pricing model tells us that a security with a beta of 2 will be expected to yield a return twice that of a security whose beta is 1.’ Is this statement true?
What justification can there be for using the rate of return derived from capital (stock) market returns as the discount rate to be applied in the appraisal of a real investment project within a
From the point of view of the borrowing business, loan capital tends to be cheap but risky. In what sense is it risky?
Many businesses issue loan notes, which carry the right for holders to convert them into ordinary shares in the same business at a later date.Why might a business choose to issue convertible loan
Why are retained earnings not a free source of finance?
Most businesses, particularly larger ones, have outstanding claims (financial obligations)of a wide variety of types from a wide variety of claimants at any given moment.Why is there this diversity?
If retained earnings are not a free source of finance, why are they nonetheless such a popular source of finance?
Polecat plc has 18 million £0.50 ordinary shares in issue. The current stock market value of these is £1.70 per share. The directors have decided to make a one-for-three rights issue at £1.25
Loan notes, listed on the stock market, have a ‘coupon’ rate (interest rate specified in the contract between the business and the lenders) of 10 per cent. Does this necessarily mean that the
Memphis plc has 20 million £0.10 ordinary shares in issue. On 7 June the stock market closing price of the shares was £1.20. Early on the morning of 8 June, the business publicly announced that it
What factors tend to affect the market value of particular convertible loan notes?
The management of Memphis plc (Problem 8.4 ) is reconsidering its decision on the rights issue price. It is now contemplating an issue price of £1 per new share. One of its concerns is the effect
In what way can it be said that finance leasing is a source of long-term finance?
What are the two roles of members of the LSE in respect of their secondary market activities?
‘The shares of XYZ plc are underpriced at the moment.’ How logical is this statement about some shares quoted on the LSE?
When UK shareholders have shares that they wish to sell, must the sale be made through the LSE?
‘Capital market efficiency in the semi-strong form implies that all investors have all of the knowledge that is publicly available and which bears on the value of all securities traded in the
What is ‘price efficiency’ in the context of stock markets?
‘In view of the fact that the market is efficient in the semi-strong form, there is no value to investors in businesses publishing financial reports, because the information contained in those
Is a market that is ‘strong-form efficient’ necessarily ‘semi-strong-form efficient’?
‘A graph of the daily price of a share looks similar to that which would be obtained by plotting a series of cumulative random numbers. This shows clearly that share prices move randomly at the
Without any knowledge of the evidence surrounding the efficiency of the LSE, would you expect it to be efficient? Explain your response.
‘A particular professionally managed UK equity investment fund produced better returns last year than any of its rivals. This means that it is likely to outperform its rivals again this
Must all of the world’s stock markets be price efficient? Explain your response.
‘An efficient capital market is one in which the market portfolio contains no systematic risk.’Is this statement correct? Explain.
What determines the value of an economic asset (as opposed to an asset that has value for reason of sentiment)?
Gregoris plc has some loan notes, currently quoted at £104 per £100 nominal value.These will pay interest at the rate of 8 per cent p.a. of the nominal value at the end of each of the next four
Loan notes that were originally issued at par are currently quoted in the capital market at £93 per £100 nominal value. Repayment of the nominal value in full is due in exactly five years’ time.
If we know the projected cash flows from loan notes and their current market value, what approach would we take to deducing the cost of the loan notes?
Shah plc has a cost of equity of 17 per cent p.a. The business is expected to pay a dividend in one year’s time of £0.27 per share. Dividends are expected to grow at a steady 5 per cent each year
A business’s ordinary shares are currently trading at £2.00 (ex dividend) each in the capital market. Next year’s dividend is expected to be £0.14 per share and subsequent dividends are
Fortunate plc’s capital structure (taken from the statement of financial position) is as follows:The business pays corporation tax at the rate of 20 per cent and is expected to earn a consistent
Why do many businesses have a ‘target’ gearing ratio?
The convertible loan notes of Tower plc currently trade in the capital market at £140 per £100 nominal. The notes pay annual interest of £9.625 per £100 nominal. They may be converted in exactly
What is wrong with using the cost of the specific capital used to finance a project as the discount rate in relation to that project?
Doverdale plc has some convertible loan notes, with a current market value of £109 per £100 nominal value, on which it will pay interest at the rate of 12 per cent on their nominal value in one
Hazelwood plc is financed by:(a) 1 million ordinary shares (nominal value £1 each). These are expected to yield a dividend of £0.10 per share in one year’s time. Dividends are expected to grow by
Da Silva plc’s shares are not traded in any recognised market. Its sole activity is saloon car hire. It is financed by a combination of 2 million £0.50 ordinary shares and a £1.5 million bank
When calculating the weighted average cost of capital (WACC), should we use market values or the statement of financial position values as the weights of debt and equity?Explain your response.
Vocalise plc has recently assessed a new capital investment project that will expand its activities. This project has an estimated expected net present value of £4 million.This will require finance
When deducing the cost of equity through a dividend model, must we assume either a constant level of future dividends or a constant level of growth of dividends? Explain your response.
Why is debt finance usually cheaper than equity finance in the same business?
Shiraz plc is financed by 10 million shares, whose current market value is £2.40 a share, and 10 per cent loan notes, with a nominal and market value of £14 million. The return on the ordinary
According to MM, what happens to the cost of equity as gearing increases (ignoring taxation)?
Merlot plc is financed by 10 million shares, whose current market value is £2.40 a share, and 10 per cent loan notes with a nominal and market value of £14 million. The business plans to issue
According to MM, and taking account of taxation, what happens to the cost of equity as gearing increases?
Particulate plc is an all-equity-financed business with a market value of £35 million and a cost of capital (after tax) of 20 per cent p.a.The business intends to purchase and cancel £8 million of
One of the MM assumptions is ‘no bankruptcy costs’. What costs does this represent?
Mile Long Merchants (MLM) Limited runs two small supermarkets. MLM’s equity is owned entirely by members of the Long family.The directors are keen to open an additional supermarket. The cost of
How do we know that the managements of most businesses believe in the benefits of gearing?
Ali plc is a Stock Exchange listed business. It is all-equity-financed by 40 million 25p ordinary shares, which are currently quoted at £1.60 each. In the recent past, annual profit has been an
What is the difference between the value of an ungeared and a geared business according to MM (taking account of taxation)?
Cavendish plc is a Stock Exchange listed business whose main activity is producing a low-value material used in large quantities in the building/construction industries. Production is such that a
Arthur Graham plc (AG) is a Stock Exchange listed business that owns a chain of builders’ merchants throughout the south of England. AG is currently financed principally by equity, as a result of
According to MM, what is the difference between the value of a dividend received now and one received in the future, if the shareholders are indifferent as to whether they receive the dividend now or
The shareholders of Distributors plc have an opportunity cost of capital of 20 per cent. The business makes a steady profit of £25 million each year, which is all paid out as a dividend. The
According to MM, what rule should a business follow in paying dividends to its shareholders?
‘According to Modigliani and Miller, shareholders are indifferent between a dividend and a capital gain.’ Comment on this statement, which you have overheard.
What is a ‘homemade dividend’ in the context of MM? Why might a shareholder want such a dividend?
HLM plc, an all-equity-financed business, has just paid a dividend totalling £1.5 million. This amount has been paid on a regular basis for many years and the market expects this to continue. The
What, in outline, is the traditional view on the payment of dividends?
Durodorso plc is a Stock Exchange listed business that has built up a cash mountain, equal in size to about 25 per cent of its market capitalisation, as a result of the continuation of restricted
Why is the MM position on dividends partly dependent on their assumption of no taxes?
‘It is widely accepted that dividend valuation models are an acceptable way of valuing businesses. Modigliani and Miller said that dividends are irrelevant to valuation and so flew in the face of
Images plc is an all-equity-financed, Stock Exchange listed business. It has been a steady profit and cash flow generator over recent years. It has distributed all of its after-tax profit as
Why should we find that businesses attract a ‘clientele’ of shareholders as a result of their dividend policy?
Bellini plc is a Stock Exchange listed business. The directors are contemplating the idea as the business purchasing some of its own shares in the market, and cancelling them, as an alternative to
Breadwinner plc, a £500 million market value, all-equity-financed listed business, has been in the habit of making just one dividend payment each year. The business has just paid a dividend of 21p a
Butterworth plc is a UK listed business. For many years it has paid an annual dividend on its ordinary shares that was 8 per cent higher than that of the previous year. The market expects that this
Why is working capital a particularly important area of concern for financial managers?
Dixon plc uses a component, which it buys in from a supplier, in its manufacturing process. The estimated annual usage is 23,000 units and these are used fairly steadily throughout the year. It is
Pithead Products Ltd plans to sell its single product for £35 a unit.Credit plans for the next six months are as follows:● 70 per cent of sales are made on credit and 30 per cent for cash.Of the
What is meant by ‘overtrading’ and how does it arise?
Arcadia Ltd has only one product, a garden gnome, for which it plans to increase production and sales during the first half of next year. The plans for the next eight months are as follows:The
How is ‘obsolescence’ a cost of holding inventories?
In what ways is the basic inventories reorder model deficient in representing reality?

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