Q1 D Insider trading cannot give abnormal returns in a strong form

efficient capital market

In a strong for efficient market the share price of a company reflects all public/private
information hence there can be no abnormal returns from insider trading

Q2 A The promise of receiving a £1000 in a year's time carries less risk

than receiving a £1000 today
This is false the promise of receiving a £1000 in a year's time carries more risk than
receiving it today.

Q3 B £4.00
In a weak form efficient market, the information from a private meeting will not reflect
in the share price. Hence, there will be no change in share price as no information is
made public.

Q4 A £5.50
In a semi - strong form efficient market, all relevant public information will reflect in
the share price
Value of Rub plc 10 million shares @ £6 each = £60m
Value of Wic plc 5 million shares @ £4 each = £20m
Combined value = £80m
Less Purchase price = £25m
Post purchase value of Rub plc £55m

Day 4 share price of Rub plc = £55m / 10m = £5.50

Day 4 share price of Wic plc = £5.00 as this is the price that will be paid by Rub plc

Q5 A Rub plc £6.50 & Wic plc £5.00

In a strong form efficient market, the information from a private meeting will reflect in
the share price.
Value of Rub plc 10 million shares @ £6 each = £60m
Value of Wic plc 5 million shares @ £4 each = £20m
Combined value = £80m
Less Purchase price = £25m
Add PV of Savings = £10m
Post purchase value of Rub plc £65m

Day 2 share price of Rub plc = £65m / 10m = £6.50

Day 2 share price of Wic plc = £5.00 as this is the price that will be paid by Rub plc

Q6 C share splits
The statement defines share splits

Q7 C £1.87
Dividend growth rate = 5.45/ 5 - 1 = 0.09 or 9% per year
Using the DGM, ex div share price = 5.45/ (0.12 - 0.09) = £1.82 per share
Cum div share price = 1.82 + 0.05 = £1.87

Q8 D preference shares are secured on company assets

Preference shares are not secured on company assets
Q9 A Preference shares 41.67p & Irredeemable debt £80.00
Preference shares: (0.10 x 50)/ 0.12 = 41.67 pence
Irredeemable debt: (8/ 0.10) = £80

Q10 B The gearing of the company, expressed on a market value basis,

is very high
If a company is highly geared they will not want to take on more debt

Q11 C 6.83 Using Bond approximation/6.16 per cent using linear

interpolation
At 5%: (6*0.72*4.329) + (100*0.784) -87.5 = 9.60
At 10%: (6*0.72*3.791) + (100*0.621) -87.5 = (9.02)
Kd = 5+((5*9.6)/(9.6+9.02))

Q12 A 11 per cent

Cost of debt = 100 x (9 x (1 - 0.28))/ 98.30 = 6.60%
E = 5.10 x 8.0m/ 0.50 = £81.6m
D = 9.5m x 98.30/ 100 = £9.34m
E + D = 81.6m + 9.34m = £90.94m
WACC = ((11.5 x 81.6m) + (6.60 x 9.34m))/ 90.94m = 11%

Q13 B New equity issue is slightly cheaper than retained earnings due to
the savings on issue costs
New equity issue has issue costs and hence are slightly more expensive than
retained earnings

Q14 C 12 per cent

Total cash income = 450,000 + 450,000 + 250,000 + 500,000 + 300,000 = 1,950,000
Total depreciation = Initial investment less scrap value = £1,500,000
Total accounting profit = 1,950,000 - 1,500,000 = £450,000
Average annual accounting profit = 450,000/ 5 = £90,000
Average investment = 1,500,000/ 2 = £750,000
ROCE = 100 x 90,000/750,000 = 12%

Q 15 A In single-period capital rationing, divisible, non-deferrable and

non-repeatable projects can be ranked using the profitability index to achieve
the optimal investment schedule
This is true and all other statements are false
Q16 Honest plc

(a) Calculation of ENPV

Year 1 PV P Y2 PV P PV Sum P ENPV

(1 mark) (2 mark) (1 mark) (1 mark)
£
£17,540 0.4 nil 0.35 £17,540 0.14 2,455.6
£23,070 0.65 £40,610 0.26 10,558.6

£35,080 0.6 £30,760 0.45 £65,840 0.27 17,776.8

£46,140 0.55 £81,220 0.33 26,802.6

57,593.6
Less initial investment 50,000
Expected net present value 7,593.6 (1 mark)
Q17 A company which is restricted in the amount of capital available for investment is said to be
in a capital rationing situation and will not be able to undertake all positive NPV projects.
Hard capital rationing (due to external factors) may arise because:

(1) The capital markets may be depressed

(2) Investors may consider the company to be too risky
(3) The cost of raising tiny amounts of capital may be too high

(1 mark per listing of relevant point or 2 marks for discussion of relevant points: maximum 4
marks)

(1) NPV For Project 1:

Year Cash flow £ Tax (£) NCF (£) DF (14%) PV (£)

(3 marks) (1 mark)
0.5 mark
per correct
year cash
flow
0 Investment (50,000) (50,000) 1.000 (50,000)
1 Income 10,000 10,000 0.877 8,770
2 Tax benefit 12,400 12,400 0.769 9,536
2 NCF 12,000 (3,100) 8,900 0.769 6,844
3 NCF 14,000 (3,720) 10,280 0.675 6,939
4 NCF 16,000 (4,340) 11,660 0.592 6,903
5 NCF 18,000 (4,960) 13,040 0.519 6,768
5 Scrap+WC 26,000 26,000 0.519 13,494
6 Tax on NCF (5,580) (5,580) 0.456 (2,545)
6 Balancing* (4,960)* (4,960) 0.456 (2,262)
(1 mark) NPV 4,447
*(16,000 X 0.31) = £4,960 = balancing charge because 100% initial capital allowance gave
too much tax benefit, as scrap value was not allowed for.

IRR (Project 1):

Year NCF (£) DF (20%) PV (£)

(1 mark)
0 (50,000) 1.000 (50,000)
1 10,000 0.833 8330
2 12,400 0.694 8605.6
2 8,900 0.694 6176.6
3 10,280 0.579 5952.12
4 11,660 0.482 5620.12
5 13,040 0.402 5242.08
5 26,000 0.402 10452
6 -5,580 0.335 -1869.3
6 -4,960 0.335 -1661.6
(1 mark) NPV -3,152.38

Hence IRR = 14% + (20% - 14%) x 4,447)/ (4,447 + 3152.38) = 17.51% (1 mark)