Question 1

A company is funded by:

• $40 million of debt (market value)

• $60 million of equity (market value)

The company plans to:

• Issue a bond and use the funds raised to buy back shares at their current market value.

• Structure the deal so that the market value of debt becomes equal to the market value of equity.

According to Modigliani and Miller's theory with tax and assuming a corporate income tax rate of 20%, this

plan would:

Options :

A : increase the company-s asset beta.

B : decrease the company-s equity beta.

C : increase shareholder wealth.

D : increase the market value of the company-s equity.

Answer: C

Question 2

A company is planning to issue a 5 year $100 million bond at a fixed rate of 6%.

It is also considering whether or not to enter into a 10 year $100 million swap to receive 5% fixed and pay

Libor + 1% once a year.

The company predicts that Libor will be 4% over the life of the 5 years.

What is the impact of the swap on the company's annual interest cost assuming that

the Libor prediction is correct?

Options :

A : Increase by 1%.

B : Fall by 1%.

C : Remain the same.

D : Fall by 2%.

Answer: C

Question 3

Company Y plans to diversify into an activity where Company X has an equity beta of 1.6, a debt beta of zero

and gearing of 50% (debt/debt plus equity).

The risk-free rate of return is 5% and the market portfolio is expected to return 10%.

The rate of corporate income tax is 30%.

What would be the risk-adjusted cost of equity if Company Y has 60% equity and 40?bt?

Options :

A : 11.6%

B : 11.9%

C : 9.1%

D : 13%

Answer: B

Question 4

The Board of Directors of a listed company is considering the company's dividend/retentions policy.

The inflation rate in the economy is currently high and is expected to remain so for the foreseeable future.

The board are unsure what impact the high level of inflation might have on the dividend policy.

Which THREE of the following statements are true?

Options :

A : The high inflation rate does not need to be considered when determining the dividend policy.

B : Consideration should be given to the fact that shareholders will have a desire for real growth in dividend.

C : Retained earnings for reinvestment will have to earn a return in excess of the inflation level.

D : The impact of inflation on the cash flows should be considered when formulating the dividend policy.

E : In periods of high inflation 100% of earnings should always be paid out as dividends so that shareholders can protect their wealth against the impact of inflation.

Answer: B,C,D

Question 5

The Treasurer of Z intends to use interest rate options to set an interest rate cap on Z’s borrowings. Which of the following statement is correct?

Options :

A : The Treasurer should buy an interested rate floor and sell an interested cap ta the same time

B : The Treasurer will retain the benefit of movcTcnt3 in interest ratc3 below the floor limit.

C : The cost of a collar is lower than the cost of a cap a one.

D : The Treasurer will have to negotiate the options with Z-s Dark

Answer: C

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