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Calculate the value of the thermodynamic decomposition temperature(Td)for the reaction NH4Cl(s)===NH3(g)+HCl(g) at the standard state.
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(b) Calculate the value of the closing stocks of finished goods at the end of the three-month period, and the value
of cost of sales for the period. (3 marks)
(c) Critically discuss the statement (in note 12) of the managing director of GBC and suggest how the company
could calculate the value of the service provision to the population of the Western region. (6 marks)
The ordinary shares of Tinep Co have a nominal value of 50 cents per share and are currently trading on the stock market on an ex dividend basis at $5·85 per share. Tinep Co has an equity beta of 1·15.
The loan notes have a nominal value of $100 and are currently trading on the stock market on an ex interest basis at $103·50 per loan note. The interest on the loan notes is 6% per year before tax and they will be redeemed in six years’ time at a 6% premium to their nominal value.
The risk-free rate of return is 4% per year and the equity risk premium is 6% per year. Tinep Co pays corporation tax at an annual rate of 25% per year.
Required:
(a) Calculate the market value weighted average cost of capital and the book value weighted average cost of capital of Tinep Co, and comment briefly on any difference between the two values. (9 marks)
(b) Discuss the factors to be considered by Tinep Co in choosing to raise funds via a rights issue. (6 marks)
Fence Co plans to invest in a project which is different to its existing business operations and has identified a company in the same business area as the project, Hex Co. The equity beta of Hex Co is 1·2 and the company has an equity market value of $54 million. The market value of the debt of Hex Co is $12 million.
The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year.
Required:
(a) Calculate the current weighted average cost of capital of Fence Co. (7 marks)
(b) Calculate a cost of equity which could be used in appraising the new project. (4 marks)
(c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital asset pricing model. (6 marks)
(d) Discuss the differences between weak form, semi-strong form. and strong form. capital market efficiency, and discuss the significance of the efficient market hypothesis (EMH) for the financial manager. (8 marks)
Production and sales from the new machine are expected to be 100,000 units per year. Each unit can be sold for $16 per unit and will incur variable costs of $11 per unit. Incremental fixed costs arising from the operation of the machine will be $160,000 per year.
Warden Co has an after-tax cost of capital of 11% which it uses as a discount rate in investment appraisal. The company pays profit tax one year in arrears at an annual rate of 30% per year. Capital allowances and inflation should be ignored.
Required:
(a) Calculate the net present value of investing in the new machine and advise whether the investment is financially acceptable. (7 marks)
(b) Calculate the internal rate of return of investing in the new machine and advise whether the investment is financially acceptable. (4 marks)
(c) (i) Explain briefly the meaning of the term ‘sensitivity analysis’ in the context of investment appraisal; (1 mark) (ii) Calculate the sensitivity of the investment in the new machine to a change in selling price and to a change in discount rate, and comment on your findings. (6 marks)
(d) Discuss the nature and causes of the problem of capital rationing in the context of investment appraisal, and explain how this problem can be overcome in reaching the optimal investment decision for a company. (7 marks)
Section B – TWO questions ONLY to be attempted
The finance division of GoSlo Motor Corporation has made a number of loans to customers with a current pool value of $200 million. The loans have an average term to maturity of four years. The loans generate a steady income to the business of 10·5% per annum. The company will use 95% of the loan’s pool as collateral for a collateralised loan obligation structured as follows:
– 80% of the collateral value to support a tranche of A-rated floating rate loan notes offering investors LIBOR plus 140 basis points.
– 10% of the collateral value to support a tranche of B-rated fixed rate loan notes offering investors 11%.
– 10% of the collateral value to support a tranche as subordinated certificates (unrated).
In order to minimise interest rate risk, the company has decided to enter into a fixed for variable rate swap on the A-rated floating rate notes exchanging LIBOR for 8·5%.
Service charges of $240,000 per annum will be charged for administering the income receivable from the loans.
You may ignore prepayment risk.
Required:
(a) Calculate the expected returns of the investments in each of the three tranches described above. Estimate the sensitivity of the subordinated certificates to a reduction of 1% in the returns generated by the pool. (10 marks)
(b) Explain the purpose and the methods of credit enhancement that can be employed on a securitisation such as this scheme. (4 marks)
(c) Discuss the risks inherent to the investors in a scheme such as this. (6 marks)
Notes
1 Variable production costs would be $12 per unit for production volumes up to and including 100,000 units each year. However, if production exceeds 100,000 units each year, the variable production cost per unit would fall to $11 for all units produced.
2 Advertising costs would be $900,000 per annum at a selling price of $30 and $970,000 per annum at a price of $35.
3 Fixed production costs would be $450,000 per annum.
Required:
(a) Calculate each of the six possible profit outcomes which could arise for Gam Co in the coming year. (8 marks)
(b) Calculate the expected value of profit for each of the two price options and recommend, on this basis, which option Gam Co would choose. (3 marks)
(c) Briefly explain the maximin decision rule and identify which price should be chosen by management if they use this rule to decide which price should be charged. (3 marks)
(d) Discuss the factors which may give rise to uncertainty when setting budgets. (6 marks)
The statement of financial position of BKB Co provides the following information:
BKB Co has an equity beta of 1·2 and the ex-dividend market value of the company’s equity is $125 million. The ex-interest market value of the convertible bonds is $21 million and the ex-dividend market value of the preference shares is $6·25 million.
The convertible bonds of BKB Co have a conversion ratio of 19 ordinary shares per bond. The conversion date and redemption date are both on the same date in five years’ time. The current ordinary share price of BKB Co is expected to increase by 4% per year for the foreseeable future.
The overdraft has a variable interest rate which is currently 6% per year and BKB Co expects this to increase in the near future. The overdraft has not changed in size over the last financial year, although one year ago the overdraft interest rate was 4% per year. The company’s bank will not allow the overdraft to increase from its current level.
The equity risk premium is 5% per year and the risk-free rate of return is 4% per year. BKB Co pays profit tax at an annual rate of 30% per year.
Required:
(a) Calculate the market value after-tax weighted average cost of capital of BKB Co, explaining clearly any assumptions you make. (12 marks)
(b) Discuss why market value weighted average cost of capital is preferred to book value weighted average cost of capital when making investment decisions. (4 marks)
(c) Comment on the interest rate risk faced by BKB Co and discuss briefly how this risk can be managed. (5 marks)
(d) Discuss the attractions to a company of convertible debt compared to a bank loan of a similar maturity as a source of finance. (4 marks)
(a) Phi Ltd is a company set up in Guangzhou. In 2014 Phi Ltd incurred the following expenses:
(1) A consultancy fee of RMB3,500 for services provided in China paid to Mr Xie, who is a China tax resident.
(2) A consultancy fee of RMB70,000 for services provided in China paid to Ms Ma, who is not a China tax resident.
(3) A royalty of RMB80,000 paid to Deji Ltd, which is a China tax resident enterprise.
(4) A royalty of RMB90,000 paid to Backa Ltd, which is not a China tax resident enterprise.
Required:
For each of the four payments, state whether Phi Ltd will be a withholding agent for income tax, and where Phi Ltd is the withholding agent, calculate the amount of income tax to be withheld.
Note: Ignore value added tax and business tax, and any tax incentives available under tax treaties. (7 marks)
(b) Jack has set up an e-shop selling goods via an internet platform. His total sales in 2014 were RMB400,000. He did not register with the tax authorities or pay any taxes in 2014. This was discovered by the tax bureaus in 2015.
Required:
State the possible consequences Jack may be exposed to under the Tax Collection and Administrative Law, as a result of his failure to comply with the tax registration and tax payment requirements. (3 marks)
Section B – TWO questions ONLY to be attempted
Your client, Eric, requires advice on the capital gains tax implications arising from the receipt of insurance proceeds and the disposal of some shares, and the inheritance tax reliefs available in respect of assets in his estate at death. His son Zak requires advice regarding the application of the personal service company (IR35) legislation.
Eric:
– Is UK resident and domiciled.
– Is a higher rate taxpayer.
– Is in ill health and is expected to die within the next few months.
Capital transactions in the tax year 2014/15:
– Eric made no disposals for capital gains tax purposes in the tax year 2014/15 other than those detailed below.
– Eric received insurance proceeds of ￡10,000 following damage to a valuable painting.
– Eric sold half of his shareholding in Malaga plc for ￡11·50 per share.
Damaged painting:
– Eric purchased the painting for ￡46,000 in July 2012.
– The painting was damaged in October 2014 such that immediately afterwards its value fell to ￡38,000.
– The insurance proceeds of ￡10,000 were received by Eric on 1 December 2014.
– Eric has not had the painting repaired.
Malaga plc shares:
– Malaga plc is a quoted trading company with 200,000 issued shares.
– 80% of Malaga plc’s chargeable assets have always been chargeable business assets.
– Eric was given 12,000 shares in Malaga plc by his sister on 1 April 2010, when they were valued at ￡126,000.
– Eric’s sister had purchased the shares for ￡96,000 on 1 March 2009.
– Gift relief was claimed in respect of the gift of the shares to Eric on 1 April 2010.
– Eric paid the inheritance tax arising in respect of this gift following his sister’s death on 1 September 2011.
– Eric has never worked for Malaga plc.
– Eric sold 6,000 shares in Malaga plc on 1 March 2015.
Assets owned by Eric and a previous lifetime gift:
– Eric owns farmland in the UK, which has been leased to a tenant farmer for the last ten years.
– The farmland has a market value of ￡420,000 and an agricultural value of ￡340,000.
– Eric’s other assets, excluding the remaining Malaga plc shares, are valued at ￡408,000.
– Eric has made only one previous lifetime gift, of ￡60,000 cash to his son Zak on 1 July 2009.
Zak:
– Is the sole shareholder, director and employee of Yoyo Ltd, a company which provides consultancy services.
– In the year ended 31 March 2016, Yoyo Ltd’s gross fee income from relevant engagements performed by Zak will be ￡110,000.
– In the tax year 2015/16, Zak will draw a salary of ￡24,000 and dividends of ￡50,000 from Yoyo Ltd.
– Neither Yoyo Ltd nor Zak has any other source of income.
Required:
(a) Calculate Eric’s total after-tax proceeds in respect of the two capital gains tax disposals in the tax year 2014/15. (6 marks)
(b) (i) On the assumption that Eric dies on 31 March 2016, advise on the availability and effect (if any), of agricultural property relief, business property relief and quick succession relief in respect of the farmland and the retained shares in Malaga plc.
Note: You are not required to prepare calculations for this part of the question. (6 marks)
(ii) Explain, with the aid of calculations, the impact on the inheritance tax liability arising on Eric’s death if Eric does not die until 1 August 2016. (3 marks)
(c) Calculate Zak’s taxable income for the tax year 2015/16 if the personal service company (IR35) legislation were to apply to the fee income received by Yoyo Ltd. (5 marks)
Required:
(a) (i) Discuss the approach taken by IFRS 9 in measuring and classifying financial assets and the main effect that IFRS 9 will have on accounting for financial assets. (11 marks)
(ii) Grainger, a public limited company, has decided to adopt IFRS 9 prior to January 2012 and has decided to restate comparative information under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. The entity has an investment in a financial asset which was carried at amortised cost under IAS 39 but will be valued at fair value through profit and loss (FVTPL) under IFRS 9. The carrying value of the assets was $105,000 on 30 April 2010 and $110,400 on 30 April 2011. The fair value of the asset was $106,500 on 30 April 2010 and $111,000 on 30 April 2011. Grainger has determined that the asset will be valued at FVTPL at 30 April 2011.
Required:
Discuss how the financial asset will be accounted for in the financial statements of Grainger in the year ended 30 April 2011. (4 marks)
(b) Recently, criticisms have been made against the current IFRS impairment model for financial assets (the incurred loss model). The issue with the incurred loss model is that impairment losses (and resulting write-downs in the reported value of financial assets) can only be recognised when there is evidence that they exist and have been incurred. Reporting entities are not allowed currently to consider the effects of expected losses. There is a view that earlier recognition of loan losses could potentially reduce the problems incurred in a credit crisis.
Grainger has a portfolio of loans of $5 million which was initially recognised on 1 May 2010. The loans mature in 10 years and carry an interest rate of 16%. Grainger estimates that no loans will default in the first two years, but from the third year onwards, loans will default at an annual rate of about 9%. If the loans default as expected, the rate of return from the portfolio will be approximately 9·07%. The number of loans are fixed without any new lending or any other impairment provisions.
Required:
(i) Discuss briefly the issues related to considering the effects of expected losses in dealing with impairment of financial assets. (4 marks)
(ii) Calculate the impact on the financial statements up to the year ended 30 April 2013 if Grainger anticipated the expected losses on the loan portfolio in year three. (4 marks)
Professional marks will be awarded in question 4 for clarity and quality of discussion. (2 marks)
