QUESTION: 61

A company has in a 5% corporate bond in issue on which there are two loan covenants.

· Interest cover must not fall below 3 times

· Retained earnings for the year must not fall below $3.5 million

The Company has 200 million shares in issue.

The most recent dividend per share was $0.04.

The Company intends increasing dividends by 10% next year.

Financial projections for next year are as follows:

Advise the Board of Directors which of the following will be the status of compliance with the loan covenants next year?

The company will be in compliance with both covenants.
The company will be in breach of both covenants.
The company will breach the covenant in respect of retained earnings only.
The company will be in breach of the covenant in respect of interest cover only.

Answer(s): C

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QUESTION: 62

The Board of Directors of a listed company wish to estimate a reasonable valuation of the

entire share capital of the company in the event of a takeover bid.

The company's current profit before taxation is $4.0 million.

The rate of corporate tax is 25%.

The average P/E multiple of listed companies in the same industry is 8 times current earnings.

The P/E multiple of recent takeovers in the same industry have ranged from 9 times to 10 times current earnings.

The average P/E multiple of the top 100 companies on the stock market is 15 times current earnings.

Advise the Board of Directors which of the following is a reasonable estimate of a range of values of the entire share capital in the event of a bid being made for the whole company?

Minimum = $36 million, and maximum = $40 million.
Minimum = $27 million, and maximum = $30 million.
Minimum = $32 million, and maximum = $60 million.
Minimum = $24 million, and maximum = $45 million.

Answer(s): B

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QUESTION: 63

Company B is an all equity financed company with a cost of equity of 10%.

It is considering issuing bonds in order to achieve a gearing level of 20% debt and 80% equity.

These bonds will pay a coupon rate of 5% and have an interest yield of 6%.

Company B pays corporate tax at the rate of 25%.

According to Modigliani and Miller's theory of capital structure with tax, what will be Company B's new cost of equity?

Answer(s): B

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QUESTION: 64

A listed company in a high growth industry, where innovation is a key driver of success has always operated a residual dividend policy, resulting in volatility in dividends due to periodic significant investments in research and development.

The company has recently come under pressure from some investors to change its dividend policy so that shareholders receive a consistent growing dividend. In addition, they suggested that the company should use more debt finance.

If the suggested change is made to the financial policies, which THREE of the following statements are true?

It may give a signal to the market that the company is entering a period of stable growth.
There may be a change to the shareholder profile due to 'the clientele effect'.
The directors will not have to take shareholder dividend preferences into consideration in future.
Retained earnings have a lower cost than debt finance.
The company's financial risk will increase due to its increased use of debt finance.

Answer(s): A,B,E

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