Question

Question 1
A single person has earnings of £90,000 and a personal allowance of £6,000. This person is a member of a private health insurance scheme as part of their employment, which costs their employer £1,000. Basic rate tax of 20% is payable on taxable income up to £40,000 when 40% higher tax applies. The amount of higher rate tax that is payable is:
a) £17,200
b) £17,600
c) £18,000
d) £26,000

Question 2
According to Modigliani and Miller’s first irrelevance proposition, which is the best way to increase the value of a business?
a) Raise as much debt finance as is possible
b) Only issue equity finance
c) Minimise weighted average cost of capital by finding the optimal level of gearing
d) None of the above

Question 3
Systematic risk is allowed for in the evaluation of projects using:
a) An appropriate discount rate
b) Monte Carlo simulation
c) RAMP
d) Opportunity cost

Question 4
Which of the following is NOT the goal of the financial manager?
a) To invest in projects that expect a return in excess of the cost of borrowing
b) To maximise the share price
c) To maximise the wealth of the shareholders
d) To invest in projects that show a positive net present value

Question 5
A company has a construction project which requires significant borrowings throughout the following four years. In this situation, which of the following uses of derivatives is the most appropriate?
a) Buy interest rate futures contracts
b) Sell interest rate futures contracts
c) Buy bond futures contracts
d) Sell bond futures contracts

Question 6
Explain the economic advantages and disadvantages of a business operating as a limited company.

Question 7
Explain the principles of double taxation relief.

Question 8
A company is determining its long-term dividend policy. Explain the factors that should be taken into account.

Question 9
A prudent investor friend is reluctant to invest in ordinary shares, as he perceives them to be the most risky form of investment. Explain the advice you would give him.

Question 10
The directors of Gage plc are considering two possible projects. The first (project A) is an investment in a speculative research project. There are a number of potential problems with this project as it is dependent on the application of recent scientific discoveries being successful. There is also the possibility that the research scientists involved will leave if offered more lucrative contracts elsewhere.
The other project (project B) involves expansion of the production of an existing line to take advantage of its established market.
Gage plc has a formal system of investment appraisal and only considers projects that have a positive net present value when discounted at their cost of capital. The cost of capital is calculated by reference to the systematic risk of the individual project.
The beta for the research project is 0.5 and the beta of the new production project is 1.2. The risk free rate is 2% per annum and the risk premium is 6% per annum.
(a) Calculate the required rate of return for each of these projects.
(b) Explain with reference to your answers in (a) above, why a risky project might have a lower required rate of return than a more straightforward project.
(c) The directors can choose only one new project. Project A has a higher internal rate of return (IRR) than project B. whilst project B has a higher net present value (NPV). Explain which of the measures is the more reliable in the above case and explain whether Gage plc should choose project A or B.
(d) In order to raise the required finance, Gage plc is to make a rights issue.
Explain the role of the underwriters in such a rights issue.

Solution Preview

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1. Since it is private insurance, the contribution is taxable.
Taxable income = 90,000 – 6000 + 1000 = 85000
Tax @ 40% = 40% * (85000 – 40000) = 18000
Thus correct option is c....

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