Corporate Finance & Risk Management (BAF-6-CFR)
Seminar 1. Questions
Role of the senior financial advisor
Question 1
Assume you are Finance director of a MNC and provide the MD with a report for presentation at the next board meeting which:
a) Evaluates the argument that maximisation of shareholder wealth should be the only true objective of a company.
b) Discusses the advantages and disadvantages of the following goals
1. Cash flow generations
2. Profitability as measured by profits after tax and return on investment
3. Risk adjusted returns to shareholders.
Advanced investment appraisal
Q2- Multiple choice questions |CFA PAST PAPERS | CFA Institute | WILEY
1. With regard to net present value (NPV) profiles, the point at which a profile crosses the horizontal axis is best described as:
A. The point at which two projects have the same NPV.
B. The sum of the undiscounted cash flows from a project.
C. A project’s internal rate of return when the project’s NPV is equal to zero.
2. With regard to net present value (NPV) profiles, the point at which a profile crosses the vertical axis is best described as:
A. The point at which two projects have the same NPV.
B. The sum of the undiscounted cash flows from a project.
C. A project’s internal rate of return when the project’s NPV is equal to zero.
3. With regard to the net present value (NPV) profiles of two projects, the cross- over rate is best described as the discount rate at which:
A. Two projects have the same NPV.
B. Two projects have the same internal rate of return.
C. A project’s NPV changes from positive to negative
4. Shirley has evaluated an investment proposal and found that its payback period is one year, it has a negative NPV, and it has a positive IRR.
Is this combination of results possible?
A. Yes
B. No, because a project with a positive IRR has a positive NPV.
C. No, because a project with such a rapid payback period has a positive NPV.
5. An investment has an outlay of 100 and after – tax cash flows of 40 annually for 4 years. A project enhancement increases the outlay by 15 and the annual after – tax cash flows by 5. As a result, the vertical intercept of the NPV profile of the enhanced project shifts:
A. Up and the horizontal intercept shifts left.
B. Up and the horizontal intercept shifts right.
C. Down and the horizontal intercept shifts left.
Question 3
Consider the following information regarding two comparable investment projects, for which the investor requires the same rate of return of 22%:
Project A
Project B
Years Expected Cash flows GBP
Years Expected Cash flows GBP
0 – 600,000 0 – 600,000
1 400,000 1 100,000
2 200,000 2 200,000
3 100,000 3 400,000
a. Which one has the higher net present value (NPV)? Explain without any calculation.
b. Given the expected stream of cash flows of those two projects, which factors may negatively affect their comparison?
c. Rank the projects using
• NPV
• IRR
Question 4. ACCA AFM – Past paper
CD is a furniture manufacturer in the UK. It manufactures a limited range of furniture products to a very high quality and sells to a small number of retail outlets word wide.
At a recent meeting with one of its major customers it became clear that the market is changing and the final consumer of CD’s products is now interested in variety and choice rather than exclusivity and exceptional quality.
CD is therefore reviewing two mutually exclusive alternatives to apply to a selection of its products:
Alternative 1
To continue to manufacture, but expand its product range and reduce its quality. The net present value (NPV), internal rate of return (IRR) and modified rate of return (MIRR) for this alternative have already been calculated as follows:
NPV = £1.45 million using a nominal discount rate of 9%
IRR = 10.5 % MIRR = Approximately 13.2%
Payback = 2.6 years Discounted payback = 3.05 years
Alternative 2
import furniture carcasses in ‘flat packs from the US. The imports would be in a variety of types of wood and unvarnished. CD would buy in bulk from its US suppliers, assemble and varnish the furniture and re-sell, mainly to existing customers. An initial investigation into potential sources of supply and costs of transportation has already been carried out by a consultancy entity at a cost of £75,000. CD’s Finance director has provided estimates of net sterling and US$ cash flows for this alternative.
These net cash flows, in real terms, are shown below.
Year 0 1 2 3
US$ millions (25) 2.60 3.80 4.10
£millions 0 3.70 4.20 4.60
The following information is relevant:
• CD evaluates all its investments using nominal sterling cash flows and a nominal discount rate. All non – UK customers are invoiced in US$. US$ nominal cash flows are converted to sterling at the forward rate and discounted at the UK nominal rate.
• For the purposes of evaluation, assume the entity has a three-year time horizon for investment appraisals.
• Based on recent economic forecasts, inflation rates in the US are expected to be constant at 4% per annum. UK inflation rates are expected to be 3%per annum. The current exchange rate is £1= US$1.6
• Note: Ignore taxation
Required.
a) Evaluate alternative 2, using net present value, discounted pay back, internal rate of return and the (approximate) Modified internal rate of return.
b) Calculate the project duration for alternative 2 and discuss the significance of your results if you are told that the duration for alternative one is 3.2 years.
c) Evaluate the two alternatives and recommend which alternative the entity should choose. Include in your answer a discussion about what other criteria should be considered before a final decision is taken
