A&F Exams

When a company sells the issue of securities (stocks) to existing stockholders, it is called a(an):

rights offering

The Modern Language Corporation earned $2.6 million on net assets of $30 million. The cost of capital is 11.50%. Calculate the EVA:

$-0.85 million

A year ago a bank entered into a $50 million five-year interest rate swap. It agreed to pay company A each year a fixed rate of 5% and to receive in return LIBOR. When the bank entered into this swap, LIBOR was 4%, but now interest rates have risen, so on the same new interest rate swap the bank could expect to pay 5½% and receive LIBOR. Suppose that at this point company A approaches the bank and asks to terminate the swap. If there are four annual payments still remaining, how much should the bank charge A to terminate? Answer in million $.

$0.876

Arctic Fuel buys one million gallons of January heating-oil futures contracts at the futures price of $3.2 per gallon. The initial margin is set to 2 per cent of the full value of the futures contract at time when contract is entered. In the two following days the price of the January contract changes to $3.22 per gallon on day 1 and $3.24 per gallon on day 2. What is the balance of the margin account at the end of day 2?

$104,000

According to behavioural finance the following statements are correct: I) One of the potential reasons for long-run underperformance following initial public offering (IPO) is that firms enter when there is a hot issue market. II) IPO initial underpricing (IPO) is caused by underwriters pressing the firm for low price to make sure there is a demand. First day returns increase value of insider's wealth, so they do not 'suffer' by leaving the money on the table. III) Post-earnings announcement drift is caused by underreaction to the information content of earnings announcements. (a) I, II and III (b) I only (c) I and II only (d) III only

(a) I, II and III

Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $44 million and $17 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative and thus achieve synergies of $4.50 million (present value). Velcro Saddles can either pay $21 million cash for Pogo or offer Pogo a 36 percent holding in Velcro Saddles. (a) What is the cost of the cash offer? (b) What is the cost of the stock alternative? (c) What is the NPV of the acquisition for Velcro Saddles' shareholders under the cash offer? (d) What is its NPV for Velcro Saddles' shareholders under the stock offer?

(answers in millions) a) 4 b) 6.58 c) 0.5 d) -2.08

Which of the following statements is incorrect with regards to non-controlling interests in subsidiaries? (a) The requirement to eliminate the effects of intragroup transactions holds whether or not there are non-controlling interests. (b) The non-controlling interest's share in the dividends paid or proposed by the subsidiary is eliminated on consolidation. (c) The non-controlling interest's share of the profits of the subsidiary is calculated after adjustments to eliminate income and expenses of the subsidiary that are unrealised from the economic entity's perspective. (d) Management fees paid in an intragroup transaction are considered realised when determining noncontrolling interests in a subsidiary.

(b) The non-controlling interest's share in the dividends paid or proposed by the subsidiary is eliminated on consolidation.

The decision to expense or capitalise an item is important because: (a) It may have direct implications for the value of the organisation and wealth of managers. (b) It may have an impact on contractual arrangements that are based on accounting numbers related to profits and/or assets. (c) It may give managers scope to maximise personal wealth, in line with Positive Accounting Theories. (d) All of the given answers are correct

(d) All of the given answers are correct

The following statements are true about payout policy: I) Miller and Modigliani state that in a world without taxes, transaction costs, or other market imperfections, the firm's choice of dividend policy is irrelevant to the value of the firm. Payout policy should depend on the life cycle of a firm and its free cash flow. II) Managers are reluctant to make dividend changes that may have to be reversed, as they are worried about withdrawing a dividend increase. Thus, announcement of dividend increase is a potential signal of managers' confidence in future earnings. III) Share repurchases may indicate an underpriced stock, but the initial abnormal return to the repurchase announcements is usually weaker than the stock price reaction to dividend increases. (a) I and III only (b) I and II only (c) II only (d) I, II and III

(d) I, II and III

An equitable or constructive obligation arises when:

-Social or moral sanctions or custom -Leaves the entity no realistic alternative other than to make a -Sacrifice of future benefits -Management communicates its decision to commit to the future sacrifice of economic benefits -To the parties concerned.

IAS 16 prescribes that, if assets within the same class are revalued and some assets increased in value while others decreased in value:

-Total increment for all assets (same class): credited to revaluation reserve -Total decrement for all assets (same class): recognised as loss in the income statement.

The Mexican economy is predicted to average double-digit inflation over the next year at 10 percent per year. The inflation forecast for the United States for the same period is 4 percent per year. If the current exchange rate is $0.091/peso, what is the expected exchange rate in one year?

0.08604/peso

In 2015 Florax made a rights issue at 6.9/share of one new share for every four shares held (1:4). There were 9.1 million shares outstanding before the issue, and the marker value of share capital was 89,180,000. If you need 4 rights to buy a new share, what is the value of a right?

0.580

Sampras plc issued 20 million of convertible notes on 1 July 2013. The notes have life of 6 hears and FV of 20 each. Annual interest of 5% is payable at the end of each year. The notes were issued at their face value and can be converted at any time over their lives. Organizations with a similar risk profile to Sampras have issued debt with similar terms, but without the option to convert at the rate of 7% What are the appropriate accounting entries to record the issue of the convertible notes and the first payment of interest in accordance with guidance provided in IAS 32?

1 July 2013 Dr Cash 20,000,000 Cr Convertible notes liability 138,093,384 Cr Option to convert notes to equity 1,906,616 30 June 2014 Dr Interest Exp 1,266,537 Cr Cash 1,000,000 Cr Convertible notes liability 266,537

Rational Semiconductor has an equity market capitalization of $11 million: 1 million shares at $11 per share. This year the firm has generated good earnings and is now considering payout of surplus cash of $1 million, either through cash dividend, or through stock repurchase (buyback). What is the amount of shares outstanding and the share price after payout through dividend [2 marks] and through repurchase [2 marks]?

1 million shares at $10 per share with dividend payout. 909,091 shares at $11 per share with repurchase.

Explain shortly why companies should manage their financial risks

1. Make financial planning simpler and reduce the odds of a cash shortfall 2. Focus on business and business risk 3. Reduce the risk of financial distress or bankruptcy (make it easier to borrow) 4. Reduce agency costs through reduced monitoring (Easier to motivate managers when performance of the firm is more related to variables that the managers can control)

e) Explain shortly why companies should manage their financial risks. [3 marks]

1. Make financial planning simpler and reduce the odds of a cash shortfall 2. Focus on business and business risk 3. Reduce the risk of financial distress or bankruptcy which makes it easier to borrow 4. Reduce agency costs through reduced monitoring 5. Easier to motivate managers when performance of the firm is more related to variables that the managers can control

A year ago a bank entered into a 60-million five year interest rate swap. It agreed to pay company A each year a fixed rate of 3% and to receive in return LIBOR. When the bank entered into this swap, LIBOR was 2% but now interest rats have risen, so on a new swap, the bank could expect to pay 3.5% and receive LIBOR. Suppose that at this point Company A approaches the bank and asks to terminate the swap. If there are four annual payments still remaining, how much should the bank charge A to terminate? Answer in million $.

1.102 million

Company A is based in the US and uses US dollars (USD) as its currency. Today is Feb 1st, and on July30th the company will receive payment of €170,000. The current exchange rate is USD1.340/1€. If inflation in the Euro zone is 2% per annum and 4% per annum in the US, what is the expected exchange rate on July 30th? [3 marks]

1.353073

Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes to make a rights issue at $18 of one new share for each three shares held. The company currently has outstanding 300,000 shares priced at $25 a share. If you need three rights to buy the new share what is the value of one right?

1.75

Yellow Plc purchased an asset 6 years ago for €75 000. At that time it was deemed to have a residual value of €15 000 and estimated useful life of 6 years. After 4 years of use the asset was overhauled at a cost of €35 000. The overhaul extended the useful life of the asset by 4 more years but reduced its residual value to €7000. Assuming the straight-line method of depreciation is applied, calculate the depreciation expense in the year after the overhaul (rounded to the nearest euro)?

10 500

Assume the following data: Market price per share A: $20 B: $10 Number of shares A: 1,000,000 B: 500,000 Market value of the firm A:$20 million B: $5 million AB: $30 million If Firm A intends to pay $7 million cash for Firm B, then calculate the cost of the merger.

2 million

Suppose the spot rate on the Brazilian real is BRL/USD 2.5288 (BRL 2.5288 = USD 1), and the 90-day forward rate is BRL/USD 2.5944 (BRL 2.5944 = USD1). If the three-month interest rate on dollars is 0.18 percent (0.0018), what do you think is the three-month interest rate on the Brazilian real?

2.78%

Double Mount Ltd purchased a machine at a cost of Åí100,000, but negotiating from a strong position they managed to reduce the price from 110,000. To install the machine there where 20,000 direct costs and additionally 5,000 in overhead costs and its expected salvage value is 10,000. The machine was operational to beginning of fiscal year 2013, but due to excess capacity the machine was not used for two years. Its expected useful life is 10 years. To the beginning of fiscal year 2018 it received an ad on gadget, that can be used to other machines too. Its cost was 30,000 and has an expected useful life of nine years with no salvage value. Double Mount uses sum-of-digits depreciation. What is the total depreciation for the machine and the gadget for fiscal years 2013, 2018 and 2026?

20,000; 16,000; 667

The stock price of Heavy Metal (HM) changes only once a month: either it goes up by 20 percent or it falls by 16.7 percent. Its price now is $40. The interest rate is 1% per month. What is the value of a one-month call option with an exercise price of $40?

3.82

At the beginning of the year a five-year government bond with a face value of $1000 and annual coupon payments of 5% offers a yield (YTM) of 3%. One year later, due to the fall in interest rates, the bond yields only 2.5%. What return has the bondholder who purchased the bond in the beginning of the year earned over the 12-month period?

4.8%

Firm A has a value of 90 million and Firm B has a value of 60 million. Merging the two would enable cost savings with PV of 20 million. Firm A purchases Firm B for 75 million. How much do Firm A's shareholders gain from this merger?

5 million

The one-year spot interest rate is r1 = 5.1 percent, and the two-year rate is r2 = 6.1 percent. If the expectations theory is correct, what is the expected one-year interest rate in one year's time?

7.1%

Aladdin Plc sells inventory for a profit to its subsidiary Jasmine Plc to be used as machinery in Jasmine Plc's production process. The consolidation worksheet of Aladdin Plc with respect to this transaction only should not include: (a) a debit to sales. (b) a credit to cost of sales. (c) a credit to inventories. (d) a credit to machinery

A credit to inventories.

On July 2014 Michaela plc issues 1 million in 5-year bonds that pay interest each six months at a coupon rate = 10%. At the time of issuing the securities, the marker requires a rate of return of 8%. Interest expense is determined using the effective-interest method. A) Determine the issue price B) Provide the journal entries at: 1 July 2014 30 June 2015 30 June 2016

A) PV of principal = £1 000 000 x 0.6755642= 675 564 PV of annuity = £50 000 x 8.1108957 = 405 545 675 564 + 405 545 = 1 081 109 Jul 01, 2014 Dr Cash 1 081 109 Cr Debenture liability 1 081 109 Jun 30, 2015 Dr Interest Exp 42 974 Dr Debenture liability 7 026 Cr Cash 50 000 Jun 30, 2016 Dr Interest Exp 42 401 Dr Debenture liability 7 599 Cr Cash 50 000 B) The interest expense is determined by multiplying the opening liability (which is measured at present value) by the required market rate of interest, in this case 4% per annum.

Ch12: The structure of futures contracts as they are traded in future markets is best described in which of the following? (a) All parties that trade in futures make a (relatively small) specific deposit before they enter into the contract. The contract is marked to market on a daily basis and gains on the contract are added to the deposit and losses are deducted. When the deposit reaches a minimum level a margin call will be made to require the trader to reinstate the original deposit. (b) The purchaser of the futures contract is given a set price at which they can exercise the futures contract at or up to a specified date. If during that time or up to that date the buyer of the futures contract decides to exercise it, the buyer pays the exercise price and the seller of the contract agrees to deliver the item within a specified period of the exercise date. In the case of financial futures, they are often closed out before delivery is required. (c) All buyers of futures contracts make a specific deposit that is held in trust by the other party to the contract. As the buyer makes gains, these are deducted from the amount of deposit held by the seller. As the seller makes gains on the contract, the buyer is required to increase the deposit to maintain the same percentage value of deposit. At the delivery date on the contract the deposit has already accumulated the gains and losses and all that is required is for the seller to deliver on the contract. In the case of financial futures, they are often closed out before delivery is required. (d) A futures contract contains an agreement to buy and sell a specified item or financial asset or index at a future date and at an agreed price. The parties to the contract are not required to make any financial commitment at the beginning of the contract, hence futures contracts are considered highly levered and risky for speculation purposes. The buyer pays the agreed sum on delivery by the seller or the contract is closed out before the delivery date.

All parties that trade in futures make a (relatively small) specific deposit before they enter into the contract. The contract is marked to market on a daily basis and gains on the contract are added to the deposit and losses are deducted. When the deposit reaches a minimum level a margin call will be made to require the trader to reinstate (place again) the original deposit.

How should borrowing costs relating to an asset being constructed over a substantial period of time be treated in the financial statements?

Capitalized as part of the cost of the asset

On January 31st this year 'Dagens Industri' published an article titled 'Osunt stort focus på hög utdelning' (eng. 'Unhealthy focus on high dividends'). The article is critical about the ambition of Swedish listed companies to give stable or growing dividends each year. 'In the end it is the earnings that over time drive dividends, not the opposite', the article concludes. Referring to 'the free cash flow' and 'dividend irrelevance theorem' explain shortly what should be the driving forces behind payout decisions in firms. [3 marks] Why in practice firms may believe high payouts increase firm value? (provide arguments of 'the rightists'). [3 marks]

Companies should make payout only when there is free cash flow. When is there a 'free cash flow'? 1. Is the company generating positive free cash flow after making all investments with positive NPVs and is the positive free cash flow likely to continue? 2. Is the firm's debt ratio prudent (wise)? 3. Are the company's holdings of cash a sufficient cushion for unexpected opportunities? If there are positive NPV business opportunities the cash should be rather reinvested than given back. Payout decisions should be driven by the life cycle of the firm. According to dividend irrelevance theorem after keeping assets, investments, borrowing fixed the only way to pay dividend is through new stock issue, which dilutes the value of current stock. Dividend payout does not change firm value. However, the rightist claim dividends can create value. Arguments: 1. Clientele for high dividend stocks -Financial institutions restricted from holding stocks lacking established dividend records. -Trust and endowment funds may prefer high-dividend stocks -The elderly: dividends as regular income, no transaction costs to sell small amounts of stocks -Some clienteles of investors may welcome the self-discipline that comes from only spending only dividend income (no dip into capital). 2. High payout ratios prevents managers from misusing or wasting funds (agency costs) -Stock price falls when investors sense excessive perks or empire building.

You own a treasury bond which matures in 7 years. Principal amount of the bond is $1000, and a coupon rate is 9%. Similar bonds yield 4% annually. What is the impact of a 1% fall in interest rates on the price of the bond?

Price is up by 5.67% FV 1000 n 7.0000 cpn 90 YTM 1.0400 P YTM = 4% 1299.9178 1300 PV(FV) 759.9178 PV(CPN) 540.0000 FV 1000.0000 n 7.0000 cpn 90.0000 YTM 1.0300 P YTM = 3% 1373.7915 1374 PV(FV) 813.0915 PV(CPN) 560.7000 Price diff 5.69%

Company A wants to lock in the cost of crude oil to be used in next quarter's production. It buys threemonth futures contracts for 1000 barrels of Brent crude oil with a price $70 per barrel. The spot price per barrel is $69 at the time the contract is entered. Suppose the price rises to $72 per barrel in three months' time. Company A considers hedging currency risk with options. The contract size is in €10,000, exercise price is USD1.350/1€ and premiums for options are quoted in the table (USD cents per 1 Euro). Exercise price USD/EUR: 1.350 Call option: 1.24 cents Put option: 1.54 cents (f) How many and which type of options should Company A buy? [2 marks] (g) What is the expected net amount received in USD when using options? [3 marks]

Company A receives payment in Euros and want currency (USD/EUR) to appreciate. To safeguard this, they need to take short position in currency if it depreciates (they will receive gain). f) 17 contracts put options g) $226,882 Company A Contract size 10,000 EX 1.3500 Premiums Call option (cents) 1.24 Put Option (cents) #Contracts 17.0 Payment (EUR) 170,000 Current rate USD/EUR 1.34 Gain (USD) $229,500.00 Premium -2618 2618 Net gain $226,882.00

What term might be used to describe an underwriter who influences an analyst in the same firm to modify a report so as to create a favorable impression of a securities issue?

Conflict of interest

On 30 June 2014 Parent plc acquired all the issued capital of Daughter plc for a cost of 1,000,000. At the date of acquisition, the acquired shares had the right to share in a dividend that had been declared on 30 June, the total amount of the dividend being 200,000. Parent plc will not recognize the dividend until it is received. It was ultimately received on 1 February 2015. The statement of financial position of Daughter plc at 30 June 2014 was as follows: Balance sheets of Daughter plc as at 30 June 2014 in $000 ASSETS Non-current assets Plant and equipment 600 Accumulated depreciation—plant and equipment -100 Land 600 1,100 Current assets Inventory 100 Accounts receivable 60 Cash 200 360 Total assets 1,460 EQUITY AND LIABILITIES Equity and reserves Share capital 650 Retained earnings 300 Revaluation surplus 50 1000 Non-current liabilities Loan 400 Current liabilities Accounts payable 60 Total liabilities 460 Total equity and liabilities 1,460

Dr Accumulated depreciation 100,000 Cr Plant and equipment 100,000 Dr Plant and equipment 63,125 Cr Revaluation surplus 63,125 Dr Revaluation surplus 12,625 Cr Deferred tax liability 12,625 Dr Share capital 650,000 Dr Retained earnings 300,000 Dr Revaluation surplus 100,500 Cr Gain on consolidation 50,500 Cr Investment into Daughter plc 1,000,000

Risky Plc issues £8 million in 5-year, 6%, semi-annual coupon debentures in a private placement. The rate of return required by the debenture holder is 8%. What is the journal entry to record the issue of the debentures (round to the nearest pound)?

Dr Cash 7 351 128 Cr Debentures 7 351 128

Risky plc issues 8 million in 5 year, 6%, semi-annual coupon bonds in a private placement. The rate of return required by the bond holder is 8%. What is the journal entry to record the issue off the bonds (round to nearest pound)?

Dr Cash 7 351 128 Cr Bonds 7 351 128

Hanks Plc owns has a machine that was purchased for Åí120,000. After 4 years of use the machine had accumulated depreciation of 48,000 but was revalued to 88,000. Two years later the machine was sold for 80,000 and had accumulated depreciation at the time of sale of 29,333. What journal entries would be required to record the sale of the machine in accordance with IASB 16 requirements? A continuation of Hanks Plc. What was the machine's expected useful life?

Dr Cash 80,000 Dr Accumulated depreciation 29,333 Cr Machine 88,000 Cr Profit on sale 21,333

In a previous period, Banshee Plc wrote off its 'dynamic mover' equipment, but new information has shown that it is probable that the future economic benefits exceed its cost of £40 000. What is the appropriate accounting entry?

Dr Dr Equipment - dynamic mover 40 000 Cr Gain from reversal of previous impairment loss 40 000

Bruno Enterprises has constructed a heavy weight hydraulic lifter that it plans to use in maintaining and repairing its fleet of 18 wheeler trucks. The cost to build the lifter was wages of 11,000; raw materials of 19,000; depreciation of 4,000 and supplies of 1,000. Wages have not yet been paid. The equipment is judged to have probable future economic benefits greater than its cost. What would be the accounting entry to record this event?

Dr Equipment - hydraulic lifter 35,000 Cr Wages payable 11,000 Cr Raw materials inventory 19,000 Cr Accumulated depreciation 4,000 Cr Supplies 1,000

Lessee X enters a five-year lease agreement with lessor Y of an asset. The annual lease payments are fixed at 1000 per year, paid at the end of each year. Lessee's incremental borrowing cost is 5%. There are no direct costs identified. Determine the lease liability and right-to-use asset at the initiation date.

Dr Right-to-use asset 4,330 Cr Lease liability 4,330

The spot is between euros and U.S dollars is EUR/USD 0.9410 (0.9410 euros for 1 USD). If the inflation over the next three months is forecasted 0.5% in the euro zone and 0.75% in the U.S, what is the expected future spot rate EUR/USD in three months?

EUR/USD 0.9387

What happens if discretionary accruals increases with £100. Which of the following statements are correct? (a) Earnings management increases (b) Earnings changes with £100 (c) Non-discretionary accruals decreases (d) The cash flow changes

Earnings changes with £100

One can describe a currency forward contract as:

agreeing today to buy or sell a specified amount of a currency at a later date at a price set today.

Glass4Windows is involved in a research and development project to create a filtering window that removes the need for curtains. For the current year ended 30 June 2016 expenditure on the project is as follows: Research £235,000 Development costs £350,000 The window is expected to earn revenues of £70,000 per year for the 10 years commencing 1 July 2016. Assuming straight-line amortisation, how much of the research and development cost should be expensed this period and what amount should be amortised in the year ended 30 June 2019?

Expensed in 2016: £235,000; amortisation in 2019: £35,000

(e) Explain shortly how the acquirer's stock price reaction on announcement could differ for mergers financed by purely cash and purely stock.

Find answer in text

Explain shortly what is the relation between interest rates and bond prices. [2 marks]

Find answer in text

Buderup Plc issues £9 million in 12-year, 6 percent, semi-annual coupon debentures. The rate of return required by the market is 10 percent per annum. What are the journal entries to record the first and second payments of interest assuming that Buderup uses the effectiveinterest method to amortise any discount or premium (rounded to the nearest pound)?

First payment: Dr Interest expense 325,812 Cr Debentures 55,812 Cr Cash 270,000 Second payment: Dr Interest expense 328,603 Cr Debentures 58,603 Cr Cash 270,000

REVERSED - CHANGE SLIDE . A = 1,036 B = 90 C = 60 D = 1,146 E = 573 F = 500 G = 110 H = -6 I = 573 J = 110

Focus on calculating preferred dividends! The following are partial financial statements for an industrial firm that you are required to analyze and value. All amounts are in millions of pounds. The firm's statutory tax rate is 35.3 percent. Supply the missing numbers, A to J. [20 marks] How is the tax rate relevant here?

Explain shortly why warrants have value, even in case when the share price is much lower than the exercise price (refer to two components of option's price). [2 marks]

Intrinsic value is the difference between stock price and exercise price for calls (and strike price and stock price for puts). Even when the option is at the money our out of the money (intrinsic value is zero), the option still has time value. Time value is due to possible favourable changes in price of the underlying asset in the future, while the downside movements are limited (payoffs are not symmetric).

If an asset's 'value in use' exceeds its market value, then:

It would be expected that the entity would retain the asset

If an asset's 'value in use' exceeds its market value then:

It would be expected that the entity would retain the asset.

Malibu Ltd acquired a building on 1 July 2017 at a cost of 736,000. The useful life of the building was estimated as 20 years with no residual value. Malibu Ltd uses the straight-line method of depreciation. On 30 June 2013 the estimate of the useful life of the building was revised to 15 years. Prepare journal entries for depreciation of the building for the years ended 30 June 2012, 2013 and 2014, and state the carrying amount of the building at the end of each of the three reporting periods

Jun 30, 2012 Dr Dep Exp 36 800 Cr Acc Dep 36 000 736000/20 years = 36800 per year Carrying amount: cost - acc dep. = 736 000 - 184 000 = 552 000 Jun 30, 2013 Dr Dep Exp 34 500 Cr Acc Dep 34 500 552 000 / 16 years = 34 500 per year Carrying amount: 736 000 - 218 500 = 517 500 Jun 30, 2014 Dr Dep Exp 34 500 Cr Acc Dep 34 500 Carrying amount: 736 000 - 253 000 = 483 000

Pandorax inc wants to lock in the cost of 10,000 ounces of silver to be used in the next Q production. It buys 3-month future contacts for 10,000 ounces at a price of 22.5/ounce. At the time the contract is entered, the spot price is 21/ounce. Suppose the spot price rises to 21.5 in 3-months time. Calculate the loss or gain on the futures contract and the total cost of buying silver by Pandorax in 3 months time.

Loss on features: 10,000; total cost 225,000

If an impairment loss recognized in periods for a revalued asset no longer exists, IAS 36 Impairment of Assets requires a reporting entity to:

Reverse the impairment loss to increase the asset to it's recoverable amount

Lessee X enters a five-year lease agreement with lessor Y of an asset. The annual lease payments are fixed at 1000 per year, paid at the end of each year. Lessee's incremental borrowing cost is 5%. There are no direct costs identified. Determine the lease liability and right-to-use asset at the initiation date.

Right-to-use asset: 4,330 Lease liability: 4,330

There is a concern that research and development may be reduced as a result of the requirements in IAS 38 because:

The 'horizon problem' suggests managers will not invest in long-term projects that do not immediately increase profits.

Which of the following actions by an acquiring firm signals its belief that postmerger gains will be substantially larger than expected?

The acquiring firm makes a cash offer, since this allows the acquirer to solely benefit from gains not yet reflected in the market.

Explain shortly why equity is a call option on company's assets.

The bondholders effectively acquire the company's assets and the shareholders gain a call option to buy them back by paying off the debt.

Velcro Saddles offers defined benefits pension plans to its employees (debt-equivalent obligation). Pension liabilities to already retired employees amount to $80 million (present value) and have duration of 8.5 years. Fixed-income securities A and B are available to hedge against interest rate changes. Security A has duration of 5 years and security B has duration of 9.5 years. (f) What combination of A and B should be used by Velcro Saddles for hedging (i.e. how much of each security should Velcro Saddles invest in)? Answer in $m (with two decimals) [4 marks]

The following investment would hedge the interest rate risk $m17.78 (17.6 also correct) in A and $m62.22 in B (62.4 also correct)

Advertising costs are not typically capitalized because:

The future economic benefits cannot generally be measured reliably

Explain shortly why value of debt equals value of debt assuming no chance of default minus value of put.

The stockholders have a right to walk away from their firm's debts in exchange for handing over the firm's assets to its creditors. This is a put option to sell firm's assets for amount due to bondholders.

Tantrax Plc has just purchased a piece of equipment for 45,000. It is expected to operate at its normal output level for 20 years, but the product it is used to manufacture is expected to be marketable only for the next 13 years. The expected salvage vases are 5,000 after 20 years and 8,000 after 13 years. The equipment is expected to generate output consistently over its life. What depreciation should be charged in each of the first three years of the equipments life?

Year 1: 2846.15 Year 2: 2846.15 Year 3: 2846.15

Hugo Plc has acquired a machine for £26,000 and it cost a further £2,000 to install and set up the machine for operation. It is expected to operate within normal parameters for 6 years. It will be technologically obsolete in 10 years. The expected salvage values are £1,500 after 10 years and £2,000 after 6 years. The benefits to be derived from the machine are expected to be greater in the early years of its life. What depreciation should be charged in each of the first two years of the equipment's life using sum-of-digits depreciation?

Year 1: £7,428.57, Year 2: £6,190.48, Year 3: £4,952.38

A compound instrument, such as a convertible note, comprises two components. They are:

a financial liability (contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity).

Woodie plc issues £7 million in convertible bonds on 1 July 2015. They are issued at their face value and pay an interest rate of 4 per cent. The interest is paid at the end of each year. The bonds may be converted to ordinary shares in Woodie plc at any time in the next 3 years. Organisations similar to Woodie plc have recently issued similar debt instruments but without the option for conversion to ordinary shares. These instruments issued by the other entities offer interest at a rate of 6 per cent. On 1 July 2016 all the holders of the convertible notes decide to convert the bonds to shares in Woodie plc. Provide the journal entries to: a) record the issue of the securities on 1 July 2015 b) recognise the interest payment on 30 June 2016 c) recognise the conversion of the bonds to ordinary shares on 1 July 2016.

a) 1 July 2015 Dr Cash at bank 7 000 000 Cr Convertible bonds liability 6 625 640 Cr Option to convert bonds liability - equity 374 360 June 30, 2016 Dr Interest Expense 397 538 Cr Cash 280 000 Cr Convertible bonds liability 117 538 July 01, 2016 Dr Convertible bond liability 6 743 178 Dr Option to convert bonds liability-equity 374 36 Cr Share capital 7 117 538 Note that IAS 32 requires compound equity instruments to be disclosed as part equity and part liability. We can identify the present value of the 3 year bonds and then allocate the difference between the present value of these bonds and the issue price of £7000000 to the equity component. b) The stream of interest expenses across the 3 years can be summarised as in the table below, where interest expense for a given year is calculated by multiplying the present value of the liability at the beginning of the period by the market rate of interest, this being 6 percent. c) Exam 190319

a) New Technology issued warrants (stock options issued by the company), which gave their holders a right to buy the stock at any point in the next seven years for $43 a share. The share price of New Technology was $21 at time of issue. The standard deviation of New Technology's stock was 41% a year. Assume the risk free interest rate of 4%. a) Calculate the call value of New Technology's warrants using the Black- Scholes formula. [8 marks]

a) P = 21 EX = 43.00 σ = 0.41 t = 7 rf = 0.04 D1= ln(21/(43/(1.04^7))/(0.41*7^0.5) + (0.41*7^0.5)/2 = 0,134793 D2= 0,134793-0.41*7^0.5 = -0,94997 N(d1) = 0,553612 (with tables either 0.5517 or 0.5596) N(d2) = 0,171065 (with tables either 0.1736 or 0.1711) Call value = [N(d1) × P] - [N(d2) × PV(EX)] = [0,553612× 21] - [0,171065× (43.00/1.047 )] = $6,036057

Company B fell on hard times and its firm value dropped to $50million, $20million below the face value of its outstanding debt (a zero coupon bond with 5 years to maturity). Assume that standard deviation in Company B's asset value is 40%. Risk free rate is 4%. (a) What is the value of equity? Use the Black Scholes model. (b) Explain shortly why the company's equity has value even though the face value of debt exceeds value of its assets? [2 marks]

a) 15 (14.92 with tables) b) The debt matures in 5 years, there is still a chance that the company will get back on track. Intrinsic value of option is zero, but there is time value of call option.

The following is true about IPOs (initial public offerings): I) According to traditionalists the initial underpricing of an IPO reflects compensation for risk due to information asymmetry. II) According to behaviorists in case of initial underpricing of an IPO insiders do not suffer from 'leaving money on the table' as first-day returns increase value of their wealth. III) IPOs are on average initially underpriced. a) I, II and III b) I only c) I and II only d) III only

a) I, II and III

Shalley Construction Inc. wants to lock in the cost of 100 metric tons of aluminum to be used in next quarter's production. It buys three-month futures contracts for 100 metric tons at a price of $1,750 per ton. Spot price at the time the contract is entered is $1,690 per ton. Suppose the spot price of aluminum rises to $1,710 per ton in three months' time a) Calculate the loss or gain on the futures contract (note: gain should be provided as a positive number and loss as a negative number) [2 marks] and the total cost of buying aluminum by Shalley Construction AB in three-months time. [2 marks]

a) If the spot price rises to $1,710 per ounce in three months' time, Shalley Construction has a loss on the futures contract equal to: 100 × ($1,750-$1,710) = - $4000 Shalley Construction has locked in the cost of purchasing 100 metric tons of aluminum at $1,750 ton, or: 100 × $1,750 = $175,000. The cost in the spot market ($171,000) plus the loss in the futures markets ($-4,000) gives a total cost of $175,000

A year ago Company A entered into a $56 million five-year interest rate swap. The bank agreed to pay Company A each year a fixed rate of 5% and to receive in return LIBOR. When Company A entered into this swap, LIBOR was 5%, but now interest rates have risen, so on a four-year interest rate swap the bank would pay 5.% and receive LIBOR. a) Is the swap showing a profit or loss for Company A? b) Suppose that at this point company A approaches the bank and asks to terminate the swap. If there are four annual payments still remaining, how much should the bank charge A to terminate?

a) Loss b) Termination charge = $981,442.03

According to the IASB Conceptual Framework an asset should have a number of characteristics, including: a) It must be owned by the entity. b) It must be expected to provide future economic benefits to the entity. c) The transaction giving rise to the ownership must have already occurred. d) The future economic benefits must be very likely to eventuate.

b) It must be expected to provide future economic benefits to the entity.

Shalley Construction Inc. uses USD as its currency, but part of its revenues is denominated in EUR. The company will receive payment of EUR 1,000,000 in six months and it wants to hedge its currency risk. The spot rate today is USD/EUR 1.125 (USD 1.125 = EUR 1). Shalley Construction Inc. considers hedging currency risk with options. The contract size is EUR 10 000, exercise price is USD/EUR 1.14 (USD 1.14= EUR1), and premiums for options are quoted in the table (USD cents per 1 Euro). Exercise price USD/EUR: 1.14 Call option: 1.25 cents Put option: 1.55 cents b) The interest rate in the United States is 3% for six months and the euro interest rate is 2% for six months. What is the forward rate USD/EUR? [2 marks] c) How many and which type of option contracts should Shalley Construction Inc. buy [2 marks] and what will be the net amount received in US dollars if Shalley Construction Inc. exercises the options? [2 marks]

b) The forward rate increases by the interest rate differential.1.125*1.03/1.02= 1.136 USD/EUR c) 100 put options 100000*1.14 - 1,000,000*0.0155= USD 1,124,500.

Recoverable amount of an asset is defined in IAS 36 as the higher of its fair value less costs to sell and its value in use. In the case where an asset's carrying amount is less than its recoverable amount, which action is consistent with IAS 36?

b) recognise difference as impairment loss

What issues need to be addressed to determine how to allocate the cost of an asset? a) the depreciation method, the probable future benefit and the years to obsolescence b) the depreciable base, its useful life and the method of cost apportionment c) the cost of the asset, its residual value and the method of cost apportionment d) the probable future benefit, the depreciation method and the depreciable base

b) the depreciable base, its useful life and the method of cost apportionment

Financial assets do not include: a) Cash b) notes receivable c) an equity instrument of another entity d) inventories

d) inventories

The value of a bond is given by: a) bond value = asset value - value of put option on assets. b) bond value = value of an equivalent default-free bond + value of put option on the stock, and bond value = asset value + value of call option on the stock. c) bond value = asset value - value of call option on assets, and bond value = value of an equivalent default-free bond - value of put option on assets. d) bond value = asset value + value of call option on the stock.

c) bond value = asset value - value of call option on assets and bond value = value of an equivalent default-free bond - value of put option on assets.

Blue Plc sold inventory items (with a cost of £90 000) to its subsidiary Maroon Plc for £120 000. Half of the inventory items were sold by Maroon Plc to external parties before the financial year end. Ignoring taxes, which of the following statements is correct with respect to this transaction only? a) Consolidated sales will decrease by £60 000. b) Consolidated sales will decrease by £100 000. c) Consolidated profit will decrease by £15 000. d) Consolidated profit will decrease by £20 000.

c) Consolidated profit will decrease by £15 000.

Company A wants to lock in the cost of crude oil to be used in next quarter's production. It buys three month futures contracts for 1000 barrels of Brent crude oil with a price $70 per barrel. The spot price per barrel is $69 at the time the contract is entered. Suppose the price rises to $72 per barrel in three months' time. (c) Calculate loss or gain on the futures contracts (d) Total cost of buying crude oil for Company A

c) Gain on futures $2,000 d) Total cost $70,000

A government bond with face value of 1,000 matures in 4 years, makes annual CPN payments of 4% and offers a yield of 2% annually compounded. Suppose at there end of the year the bond still yields 2%. Which of the following statements are true? I) The bondholder earned a return of 2% over the 12-month period II) The bond sells at a premium both bath the beginning and at the end of the year III ) Current yield is higher than YTM a) I only b) I and II only c) I, II and III d) III only

c) I, II and III

In the book "Earnings quality" by Dechow, Patricia M., and Catherine M. Schrand (2004) the authors discuss different motives for earnings management. Which of the following factors are common incentives for managers to engage in earnings management? I) To issue securities at higher prices or to profit from insider trading. II) To meet the expectations of analysts and investors. III) To increase the size of their earnings-based compensation bonuses. a) I only b) I and II only c) I, II, and III d) None of the mentioned alternatives

c) I, II, and III

Which of the following items are required to calculate "value in use" of an asset? a) exit and entry prices b) purchase price and cost of disposal c) estimated net future cash flows and appropriate discount rate d) estimated net future cash flows

c) estimated net future cash flows and appropriate discount rate

Magnifique is based in Italy and it produces marble. The firm is tendering for an order in Saudi Arabia. The payment will be made in 18 months in Saudi Arabian Riyals (SAR). Cost of production is expected to be €400,000, and an usual markup is 30%. As a treasurer you need to recommend a tender price, and you consider hedging the exchange rate risk with options. The spot exchange rate is 1EUR=4.2235SAR. Yearly inflation rates are 3% in the Euro zone, and 1% in Saudi Arabia. d) What is a suggested tender price? [7 marks]

d) Expected rate in 18 months = = 4.2235*(1.01/1.03)^(18/12) = 4,101085 To make order competitive the firm could use the expected spot rate as a basis for the tender (400000*1.30* 4,101085= 2,132,564 SAR) plus the option premium!

Generally, a firm is able to find positive NPV-opportunities among it's I) Financing decisions II) Capital investment decisions III) Short-term borrowing decisions a) I only b) II and III only c) III only d) II only

d) II only

Which of the following is a possible exception to the efficient-market theory? (a) Underwriters charge investors more for IPO shares than they pay the issuing firms. (b) IPO spreads are lower on larger issues. (c) The issuance of equity is interpreted as an unfavorable signal by investors. (d) The long-run returns of IPOs tend to underperform the market.

d) The long-run returns of IPOs tend to underperform the market.

Which of the alternatives is correct when a market has low transaction costs? a) in general, it will increase stock prices b) in general, it will decrease stock prices c) in general, it will have no implication on stock prices d) in general, market will be more efficient

d) in general, market will be more efficient

The following statements are true: I) According to behaviorists long-term reversals of stock returns are due to overreaction and underreaction of investors. II) According to traditionalists long-term reversals of stock returns reflect differential risk of past losers and past winners, rather than mispricing. III) Post earnings announcement drift and a positive stock price drift following stock splits are two examples of evidence that financial markets are efficient. e) I only f) I and II only g) I, II, and III h) II and III only

f) I and II only

Helios, a private equity firm, plans for a buyout of Florax from the stock exchange. Floral fell on hard times and it's firm value dropped to 75 million, while the face value of it's outstanding debt amounted to 100 million (a zero coupon bond with 5 yeas to maturity). Assume that the standard deviation in Florax asset value is 30%. i. Risk free rate is 3%. What is the equity value of Florax? (Use Black-Scholes). ii. Explain shortly why the company's equity has a value even though the face value of debt exceeds value of its assets

i. D1=LN(75/(100/1,03^5))/(0,3*5^0,5)+0,3*5^0,5/2= 0,126877 D2=D1-0,3*5^0,5 = -0,54394 N(d1)= 0,550481 N(d2)= 0,29324 Equity = Call=75*0,550481-0,29324*100/1,03^5=16 ii. The debt matures in 5 years, there is still a chance that the company will get back on track. Intrinsic value of option is zero, but there is time value of call option.

Explain shortly the following phenomena and explain why these phenomena are considered as evidence against the efficient market hypothesis i. Post earnings announcement drift ii. Long-term reversals of stock returns

i. PEAD: Stocks do not adjust immediately to earnings surprises. They exhibit post-earnings announcement-drift. The stocks with best earnings outperform stocks with the worst earnings over the next six months from the announcement day. Behaviorists: Analysts underreact to the information in earnings announcements. This is against EMH. ii. Long term Reversals: Losers (stocks with worst returns) over the three-year period outperform the market over the next five years by 30 %. Winners (stocks with best returns) over the three-year period underperform the market over the next five years by 10%. This is against efficient market hypothesis as it could be driven by over- and underreaction of investors. Investors overreact to stocks that have been past losers, causing them to become undervalued. Investors overreact to stocks that have been past winners, causing them to become overvalued. (In contrast traditionalists would think losers are more risky thus they should bring higher return)

A government bond with face value of $1,000 matures in 4 years, makes annual coupon payments of 4 percent and offers a yield of 2 percent annually compounded. (g) Suppose that at the end of the year the bond yields 1 percent. What return has the bondholder earned over the 12-month period? [4 marks]

r = 4.84%

Flower Inc reports earnings of £1,250, net cash flows of £850, and discretionary accruals of £120. To use Dechow's (1994) construct: What is Flower's aggregate accruals?

£400

O'Brien's Construction Plc exchanged equipment that had a book value of £40 000 for a truck that had a book value (in the other entity's books) of £38 000. The fair value of the equipment is £45 000 and the fair value of the truck is £48 000. Further cost incurred to prepare the truck for use by O'Briens was £700 for signage. What is the acquisition cost of the truck?

£45 700

Boysone Plc has constructed a piece of complex equipment to be used in its updated production facility. The construction took a year to complete and although the equipment was ready for use, the rest of the facility was not completed and so the equipment was not put into use for another 6 months; that is, on 1 July 2013. The cost of constructing the equipment was £70,000 and it is expected to have an operating life of 12 years. It is very likely to be technologically obsolete in 10 years. It is expected to have a scrap value at the end of its life (at whatever time) of £5,000. The expected pattern of benefits derived from the equipment is uniform throughout its life. What is the amount of depreciation to be charged in the year ending 31 December 2013 (rounded to the nearest pound)?

£6,500

Wasabi Mines is contemplating purchase of Haiku, Inc. The market values of the two companies are ¥15 billion and ¥10.5 billion, respectively. Wasabi thinks that the combined companies can cut operating costs and it estimates the present value of the synergies at ¥3 billion. Wasabi thinks that a successful cash bid will probably cost ¥13 billion. It is also considering offering Haiku shareholders a 40% stake in the merged firm. What is the NPV of the acquisition under the stock offer?

¥2.1billion

If an entity issued a convertible note at a price of €40.00 and it was determined that a debt instrument of similar risk and rate of interest of 10%—but without the option to convert to equity—could be sold for €32.00, what would be the equity component of the convertible note?

€8.00