AFM CAT ONE

Question 1

The home currency of ACB Co is the dollar ($) and it trades with a company in a foreign country whose home currency is the Dinar. The following information is available:

Spot rate        20.00 Dinar per $

DETAILS                       Home country                Foreign country

Interest rate                               3% per year                       7% per year

Inflation rate                              2% per year                        5% per year

What is the six‐month forward exchange rate?

Question 2

An investment project has a cost of Ksh12,000, payable at the start of the first year of operation. The possible future cash flows arising from the investment project have the following present values and associated probabilities:

PV of  Year 1 cash flow (Ksh)       Probability

16,000                                                 0.15

12,000                                                 0.60

(4,000)                                                 0.25

PV of  Year 2 cash flow (Ksh)           Probability

20,000                                                     0.75

(2,000)                                                     0.25

What is the expected value of the net present value of the investment project?

Question 3

A company has a ‘money’ cost of capital of 21% per annum. The inflation is currently estimated at 8% per annum.

What is the ‘real’ cost of capital?

Question 4

A company has the following pattern of cash flow for a project:

Year          Cash flow(Ksh)

0                   (100,000)

1                    40,000

2                     20,000

3                    30,000

4                      5,000

5                     40,000

The company uses a discount rate of 10%.  In what year does discounted payback occur?(5Marks)

Question 5

The equity shares of Nice plc have a beta value of 0.80.  The risk free rate of return is 6%

and the market risk premium is 4%.  Corporation tax is 30%.

What is the required return on the shares of Nice plc?(2Marks)

Question 6

Kadzenga ltd is considering investing Ksh 50,000 in a new machine with an expected life of five years. The machine will have no scrap value at the end of five years. It is expected that 20,000 units will be sold each year at a selling price of Ksh 3.00 per unit. Variable production costs are expected to be Ksh1.65 per unit, while incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be Ksh10,000 per year. Kadzenga ltd uses a discount rate of 12% for investment appraisal purposes and expects investment projects to recover their initial investment within two years.

Required:

6a  Evaluate the sensitivity of the project’s net present value to a change in the

following project variables:

6 a i) sales volume

Kadzenga ltd is considering investing Ksh 50,000 in a new machine with an expected life of five years. The machine will have no scrap value at the end of five years. It is expected that 20,000 units will be sold each year at a selling price of Ksh 3.00 per unit. Variable production costs are expected to be Ksh1.65 per unit, while incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be Ksh10,000 per year. Kadzenga ltd uses a discount rate of 12% for investment appraisal purposes and expects investment projects to recover their initial investment within two years.

Required:

6a  Evaluate the sensitivity of the project’s net present value to a change in the

following project variables:

6 a  ii) sales price

Kadzenga ltd is considering investing Ksh 50,000 in a new machine with an expected life of five years. The machine will have no scrap value at the end of five years. It is expected that 20,000 units will be sold each year at a selling price of Ksh 3.00 per unit. Variable production costs are expected to be Ksh1.65 per unit, while incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be Ksh10,000 per year. Kadzenga ltd uses a discount rate of 12% for investment appraisal purposes and expects investment projects to recover their initial investment within two years.

Required:

6a  Evaluate the sensitivity of the project’s net present value to a change in the

following project variables:

6a iii variable cost

Question 6

Kadzenga ltd is considering investing Ksh 50,000 in a new machine with an expected life of five years. The machine will have no scrap value at the end of five years. It is expected that 20,000 units will be sold each year at a selling price of Ksh 3.00 per unit. Variable production costs are expected to be Ksh1.65 per unit, while incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be Ksh10,000 per year. Kadzenga ltd uses a discount rate of 12% for investment appraisal purposes and expects investment projects to recover their initial investment within two years.

6 (b) Upon further investigation it is found that there is a significant chance that the

expected sales volume of 20,000 units per year will not be achieved. The sales

manager of Kadzessnga ltd suggests that sales volumes could depend on expected

economic states that could be assigned the following probabilities:

Economic state                  Poor           Normal             Good

Probability                            0.3               0.6                    0.1

Annual sale volume (units) 17,500   20,000               22,500

Required:

Calculate the expected net present value of the project.  (5 marks)

Question 7

A company issued its 12% irredeemable loan notes at 95. The current market price is 92. The company is paying corporation tax at a rate of 30%.

What is the current net cost of capital per annum of these loan notes?

Question 8

 Which of the following is the best statement of the conclusion of Modigliani and Miller on the relevance of dividend policy? (2Marks)

Question 9

Supa plc has 50 million shares in issue, and its capital structure has been unchanged for many years. Its dividend payments in the years 2001 to 2005 were as follows.

End of year             Dividends(Ksh000)

2001                        2,200

2002                        2,578

2003                        3,108

2004                        3,560

2005                        4,236

Dividends are expected to grow at the same average rate into the future.

According to the dividend valuation model, what should be the market price per share at the start of 2006 if the required return on the shares is 25% per annum?

Question 10

• You are required to define the following;

A forward exchange contract 

Question 11

You are required to define the following?

Fixed forward exchange contracts)

Question 12

You are required to define the following?

Option forward exchange contracts

Question 13

Explain how inflation rates can be used to forecast exchange rates.

Question 14

Nedwen Co is a UK‐based company which has the following expected transactions..

One month:    Expected receipt of $240,000

One month:    Expected payment of $140,000

Three months:    Expected receipts of $300,000

The finance manager has collected the following information:

One month forward rate ($ per £): 1.7832

Three months forward rate ($ per £): 1.7850

Required:

 Calculate the expected sterling receipts using the forward market in one month 

Question 15

Nedwen Co is a UK‐based company which has the following expected transactions..

One month:    Expected receipt of $240,000

One month:    Expected payment of $140,000

Three months:    Expected receipts of $300,000

The finance manager has collected the following information:

One month forward rate ($ per £): 1.7832

Three months forward rate ($ per £): 1.7850

Required:

 Calculate the expected sterling receipts using the forward market in three months 

Question 16

Explain briefly the relationships between:

 Exchange rates and interest rates; 

Question 17

Explain briefly the relationships between:

 Exchange rates and inflation rates. 

Question 18

ZPS Co, whose home currency is the dollar, took out a fixed‐interest peso bank loan several years ago when peso interest rates were relatively cheap compared to dollar interest rates. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable. ZPS Co must pay interest of 5,000,000 pesos in six months’ time. The following information is available.

Spot rate: 12.500 – 12.582 pesos per $

Six‐month forward rate: 12.805 – 12.889 pesos per $

Interest rates which can be used by ZPS Co:

Borrow                            Deposit

Peso interest rates:            10.0% per year                7.5% per year

Dollar interest rates:           4.5% per year                 3.5% per year

Required:

Calculate  a forward market  to hedge the interest payment of 5 million pesos in six months’ time. Assume that ZPS Co would need to borrow any cash it uses in hedging exchange rate risk.

Question 19

ZPS Co, whose home currency is the dollar, took out a fixed‐interest peso bank loan several years ago when peso interest rates were relatively cheap compared to dollar interest rates. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable. ZPS Co must pay interest of 5,000,000 pesos in six months’ time. The following information is available.

Spot rate: 12.500 – 12.582 pesos per $

Six‐month forward rate: 12.805 – 12.889 pesos per $

Interest rates which can be used by ZPS Co:

Borrow                            Deposit

Peso interest rates:            10.0% per year                7.5% per year

Dollar interest rates:           4.5% per year                 3.5% per year

Required:

Calculate  a money market  to hedge the interest payment of 5 million pesos in six months’ time. Assume that ZPS Co would need to borrow any cash it uses in hedging exchange rate risk.