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Question 1

Corp governance

Answer 1

in-charge of FRM
planning management and usage of fin resources
selection of investment opportunities
-> mngt of financing costs
-> earnings retention
-> dividend distribution policy

Question 2

Gearing

Answer 2

to what extent company should be financed with debt instruments

Question 3

FRM

Answer 3

Adverse market changes => financial loss
farvorable

Question 4

Cost of Capital

Answer 4

capital structure - equity shares and bank loans
Payout=cost of equity shares are dividends (perpetuity cash flow and share price is the cost of that cash flow)
Market value = share price, what investor have to pay to get access to dividend stream

Perpetuity formula = Dividends/share price
Ke (cost of equity) = 15%
Ve (value of equity) = $10m

Bank Loans
Cost of capital: interest and repayment = redeemable cash -> Should make full IRR calculation -> ex cost of debt Kd (1-T) (deduct tax as interest is tax deductible) =10%
Vd = $10m
Market value = loan amount

Question 5

WACC

Answer 5

[Ve/(Ve+Vd)]Ke + [Vd/(Ve+Vd)]*Kd(1-T)
A company’s average funding cost… weighted by the market value of each funding type
Ke =perpetuity formula = dividends/share price
Ke = CAPM formula
Kp = cost of preference shares
Kd = irredeemable debt = not paid back so its like perpetutity
Kd = redeemable = take tax into account!
They are repetitive! PRACTICE!

Question 6

Cost of capital example

Answer 6

highlight facts
NED - although know figure - will change - exposure to systematic risk will be different - more debt
More debt - generally cheaper = lower cost (tax shield), maybe be assets secured - lower the WACC
For shareholder, more debt, means he/she more exposed to systematic risk, they are less likely to get dividends, therefore they may demand higher returns
WACC may increase or decrease - depending on the 2 factors (cheap debt vs worried shareholders) - current WACC is not appropriate
FD:

Question 7

when IRR is close to cost of capital

Answer 7

any change in estimates of NPV will have signficant impact on viability of the project1

Question 8

Risk management

Answer 8

We place between on things we don’t want to happen!!
Borrowers and buyers buy ( calls)

Borrowers are exposed to interest rates RISING
Buyers of currency are exposed to prices RISING
Buying the hedging product = make a gain if it RISES in price
Thks offsets loss on underlying asset
SAVERS AND SELLERS Sell (put)
Put is an option to sell
Selling the hedging product = make a gain if it falls in price. Make gain if fall in price!
This offsets loss in underlying transaction

Question 9

BBBc and SSSp, which instrument doesn’t fit

Answer 9

Interest Rate futures, which are other way around

Question 10

Real options

Answer 10

when you make decision based on investment appraisal of the project, NPV assumes that decision must be made immediately or not at all and once made it cannot be changed

real options recognise that investment decisions have flexibility

e.g decisions may not have to be made immediately and can be delayed to assess the impact of any uncertainties or risks attached to the project.
Or change decision on a project if circumstances surrounding the project change

By estimating value of flexibility or choice, real options give managers choices when making decision
real options take into account time available before making decision