Corporate Finance And Investment Analysis
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A non-executive director on your board of directors has made the following statements.
You have been discussing the low leverage levels in the business with your CFO and
have been advising her on optimal capital structure. Which of the below statements
would you recommend your CFO pay attention to and which might not contain useful
advice?
Statement 1: We currently have very little debt in our capital structure. We have so
much equity that it is lowering the returns for shareholders.
Statement - Correct Answer Answer: c
Statement 1 is correct. Having an unlevered balance sheet means shareholders may
suffer poor returns on equity because debt is an amplifier.
Statement 2 is correct. Debt is a way to boost returns when things are going well with a
business. Because managing debt is an expertise, it is best to add debt to a capital
structure gradually. Adding debt will lower the cost of capital because it is cheaper than
equity. When things go well, debt boosts returns to shareholders. Of course, we must
also remember that debt amplifies losses as well as gains.
Statement 3 is incorrect. Every extra euro of debt that is added to a capital structure
adds financial risk.
Which of the below statements about sources of finance is / are correct?
1. To raise short-term financing internally, a company can squeeze its working capital
cycle by reducing inventory turnover, delaying payments to suppliers and having tighter
credit control.
2. The long-term internal source of finance is retained earnings.
3. The common long-term external sources of finance are equity via common shares
and debt.
4. The only short-term external source of finance for a firm is a bank overdra - Correct
Answer Answer: c
Statement 1 is incorrect because a company can squeeze its working capital by
reducing inventory size/amount/levels not by reducing inventory turnover. Inventory
turnover is how quickly a company sells through its inventory and if a company reduces
inventory turnover, that would imply holding more inventory not less which would not
raise short-term finance internally but imply a higher working capital requirement.
Statement 2 is correct. Statement 3 is also correct. Statement 4 is incorrect because a
firm can also use debt factoring or invoice discounting to raise short-term external
money. (see slide 10, lecture 7)
The board of Expander Ltd are considering acquiring a competitor company for €50
million. The CEO and CFO are presenting the board with financing options for the deal.
They make the following statements.
,1. If we raise equity to fund this acquisition, our shareholders will be diluted and this
may have a negative impact on our ability to raise equity in future.
2. If we fund this acquisition entirely through debt, our cost of capital will decrease which
will make our company less risky overall - Correct Answer Answer: b
Statement 1 is correct - existing shareholders get diluted when new equity is raised and
this may affect the company's ability to raise equity in future. (It will depend as always
on whether the company can buy assets with the extra money that generates enough
return to equity to offset the dilution that existing shareholders suffered during the equity
raise)
Statement 2 is incorrect - if the acquisition is funded entirely through debt, it is correct
that the cost of capital will decrease since debt is cheaper than equity. However, this
makes the company more risky rather than less risky. Adding debt to a business adds
financial risk.
Statement 3 is also incorrect - it depends on the mixture of debt and equity that is used
as to whether the overall leverage is increased. If the mixture was 90% equity and 10%
debt, that would not increase the overall leverage, it would decrease it. The second part
of the question is correct - IF the leverage increased, that WOULD inc
Which of the following formulas represents the cost of equity?
a) Re = D1 X P0 + g
b) Re = D1 + P0 + g
c) Re = D1/(P0 - g)
d) Re = D1/(P0 + g) - Correct Answer Answer: D
This is the Gordon growth model or the dividend discount model. See lecture 1, slide 81
Which of the following is NOT a practical consideration when using WACC (Weighted
Average Cost of Capital)?
a) The weighting of debt and equity should be based on their current market values.
b) It is recommended to use the target capital structure to reflect the firm's intended
proportion of debt and equity.
c) Changing WACC is an effective method for scenario analysis. By moving the WACC
up and down the firm can easily adjust for different levels of risk.
d) The WACC should be updated freq - Correct Answer Answer: c)
It is not advisable to move the WACC downwards unless the unusual situation arises
that the firm can actually source money at the cheaper (lower) cost. It is common to
adjust the WACC upwards for risk. But again, it would be considered bad practice to
adjust the WACC downwards, even with a strong reasoning. See lecture 1, slide 89. All
the other options are listed as practical considerations when using WACC and are
correct.
, Which of the following statements about time value of money is not correct?
a. There is an opportunity cost to waiting to receive money because you could have
earned interest.
b. Flight or default risk is a factor if money is owed in the future.
c. Goods in the present are usually cheaper than goods in the future and this is a factor
that contributes to the time value of money.
d. Money has an inherent value that is stable and does not change over time. - Correct
Answer Answer: d
Time value of money is because of three factors - opportunity cost (answer a), default
risk (answer b) and inflation (answer c). Answer d contradicts time value of money
which is an important finance concept.
A colleague in your company has made the following comments about corporate
finance. Which of these do you agree with?
Statement 1: The goal of corporate finance is to ensure that products are sold for a
profit
Statement 2: It is only when a firm invests in assets whose returns exceed their funding
cost that it creates value
Statement 3: Shareholder value is maximised when a firm pays out dividends
a. I agree with statements 1 and 3
b. I agree only with statement 2
c. I agree with statement - Correct Answer Answer: b
Statement 1 is incorrect - the goal of corporate finance is to maximise the value of the
firm which goes further than selling products for a profit, sufficient returns on capital
employed also need to be generated. Statement 2 is correct. This is the corporate
finance "trick" that every for-profit business is trying to achieve. Please re-read the
module outline for this module! Statement 3 is false, shareholder value is maximised
when assets earn as far as possible above their cost of funding. This value may or may
not be paid back to the shareholders as a dividend. It can also be retained on the
balance sheet which usually causes the share price to increase, giving shareholders
returns though capital gains rather than income (dividends).
Your firm has paid a consulting firm €50,000 to conduct market research into building a
new factory in Poland in order to meet demand for your products there. The
management team has decided after reviewing the report to go ahead with the
investment. You have been asked to evaluate the project using an appropriate
corporate finance method to justify this investment to shareholders. There is some
verified & Updated Already Pass A+
A non-executive director on your board of directors has made the following statements.
You have been discussing the low leverage levels in the business with your CFO and
have been advising her on optimal capital structure. Which of the below statements
would you recommend your CFO pay attention to and which might not contain useful
advice?
Statement 1: We currently have very little debt in our capital structure. We have so
much equity that it is lowering the returns for shareholders.
Statement - Correct Answer Answer: c
Statement 1 is correct. Having an unlevered balance sheet means shareholders may
suffer poor returns on equity because debt is an amplifier.
Statement 2 is correct. Debt is a way to boost returns when things are going well with a
business. Because managing debt is an expertise, it is best to add debt to a capital
structure gradually. Adding debt will lower the cost of capital because it is cheaper than
equity. When things go well, debt boosts returns to shareholders. Of course, we must
also remember that debt amplifies losses as well as gains.
Statement 3 is incorrect. Every extra euro of debt that is added to a capital structure
adds financial risk.
Which of the below statements about sources of finance is / are correct?
1. To raise short-term financing internally, a company can squeeze its working capital
cycle by reducing inventory turnover, delaying payments to suppliers and having tighter
credit control.
2. The long-term internal source of finance is retained earnings.
3. The common long-term external sources of finance are equity via common shares
and debt.
4. The only short-term external source of finance for a firm is a bank overdra - Correct
Answer Answer: c
Statement 1 is incorrect because a company can squeeze its working capital by
reducing inventory size/amount/levels not by reducing inventory turnover. Inventory
turnover is how quickly a company sells through its inventory and if a company reduces
inventory turnover, that would imply holding more inventory not less which would not
raise short-term finance internally but imply a higher working capital requirement.
Statement 2 is correct. Statement 3 is also correct. Statement 4 is incorrect because a
firm can also use debt factoring or invoice discounting to raise short-term external
money. (see slide 10, lecture 7)
The board of Expander Ltd are considering acquiring a competitor company for €50
million. The CEO and CFO are presenting the board with financing options for the deal.
They make the following statements.
,1. If we raise equity to fund this acquisition, our shareholders will be diluted and this
may have a negative impact on our ability to raise equity in future.
2. If we fund this acquisition entirely through debt, our cost of capital will decrease which
will make our company less risky overall - Correct Answer Answer: b
Statement 1 is correct - existing shareholders get diluted when new equity is raised and
this may affect the company's ability to raise equity in future. (It will depend as always
on whether the company can buy assets with the extra money that generates enough
return to equity to offset the dilution that existing shareholders suffered during the equity
raise)
Statement 2 is incorrect - if the acquisition is funded entirely through debt, it is correct
that the cost of capital will decrease since debt is cheaper than equity. However, this
makes the company more risky rather than less risky. Adding debt to a business adds
financial risk.
Statement 3 is also incorrect - it depends on the mixture of debt and equity that is used
as to whether the overall leverage is increased. If the mixture was 90% equity and 10%
debt, that would not increase the overall leverage, it would decrease it. The second part
of the question is correct - IF the leverage increased, that WOULD inc
Which of the following formulas represents the cost of equity?
a) Re = D1 X P0 + g
b) Re = D1 + P0 + g
c) Re = D1/(P0 - g)
d) Re = D1/(P0 + g) - Correct Answer Answer: D
This is the Gordon growth model or the dividend discount model. See lecture 1, slide 81
Which of the following is NOT a practical consideration when using WACC (Weighted
Average Cost of Capital)?
a) The weighting of debt and equity should be based on their current market values.
b) It is recommended to use the target capital structure to reflect the firm's intended
proportion of debt and equity.
c) Changing WACC is an effective method for scenario analysis. By moving the WACC
up and down the firm can easily adjust for different levels of risk.
d) The WACC should be updated freq - Correct Answer Answer: c)
It is not advisable to move the WACC downwards unless the unusual situation arises
that the firm can actually source money at the cheaper (lower) cost. It is common to
adjust the WACC upwards for risk. But again, it would be considered bad practice to
adjust the WACC downwards, even with a strong reasoning. See lecture 1, slide 89. All
the other options are listed as practical considerations when using WACC and are
correct.
, Which of the following statements about time value of money is not correct?
a. There is an opportunity cost to waiting to receive money because you could have
earned interest.
b. Flight or default risk is a factor if money is owed in the future.
c. Goods in the present are usually cheaper than goods in the future and this is a factor
that contributes to the time value of money.
d. Money has an inherent value that is stable and does not change over time. - Correct
Answer Answer: d
Time value of money is because of three factors - opportunity cost (answer a), default
risk (answer b) and inflation (answer c). Answer d contradicts time value of money
which is an important finance concept.
A colleague in your company has made the following comments about corporate
finance. Which of these do you agree with?
Statement 1: The goal of corporate finance is to ensure that products are sold for a
profit
Statement 2: It is only when a firm invests in assets whose returns exceed their funding
cost that it creates value
Statement 3: Shareholder value is maximised when a firm pays out dividends
a. I agree with statements 1 and 3
b. I agree only with statement 2
c. I agree with statement - Correct Answer Answer: b
Statement 1 is incorrect - the goal of corporate finance is to maximise the value of the
firm which goes further than selling products for a profit, sufficient returns on capital
employed also need to be generated. Statement 2 is correct. This is the corporate
finance "trick" that every for-profit business is trying to achieve. Please re-read the
module outline for this module! Statement 3 is false, shareholder value is maximised
when assets earn as far as possible above their cost of funding. This value may or may
not be paid back to the shareholders as a dividend. It can also be retained on the
balance sheet which usually causes the share price to increase, giving shareholders
returns though capital gains rather than income (dividends).
Your firm has paid a consulting firm €50,000 to conduct market research into building a
new factory in Poland in order to meet demand for your products there. The
management team has decided after reviewing the report to go ahead with the
investment. You have been asked to evaluate the project using an appropriate
corporate finance method to justify this investment to shareholders. There is some
