Fight Finance

Question 77  interest tax shield

The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)###

###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp###

For a firm with debt, what is the amount of the interest tax shield per year?

(a) ##IntExp.t_c##

(b) ##IntExp/t_c##

(c) ##IntExp.(1-t_c)##

(d) ##IntExp/(1-t_c)##

(e) ##IntExp.(t_c-1)##

Question 282  expected and historical returns, income and capital returns

You're the boss of an investment bank's equities research team. Your five analysts are each trying to find the expected total return over the next year of shares in a mining company. The mining firm:

• Is regarded as a mature company since it's quite stable in size and was floated around 30 years ago. It is not a high-growth company;
• Share price is very sensitive to changes in the price of the market portfolio, economic growth, the exchange rate and commodities prices. Due to this, its standard deviation of total returns is much higher than that of the market index;
• Experienced tough times in the last 10 years due to unexpected falls in commodity prices.
• Shares are traded in an active liquid market.

Your team of analysts present their findings, and everyone has different views. While there's no definitive true answer, whose calculation of the expected total return is the most plausible? Assume that:

• The analysts' source data is correct and true, but their inferences might be wrong;
• All returns and yields are given as effective annual nominal rates.

(a) Alice says 5% pa since she calculated that this was the average total yield on government bonds over the last 10 years. She says that this is also the expected total yield implied by current prices on one year government bonds.

(b) Bob says 4% pa since he calculated that this was the average total return on the mining stock over the last 10 years.

(c) Cate says 3% pa since she calculated that this was the average growth rate of the share price over the last 10 years.

(d) Dave says 6% pa since he calculated that this was the average growth rate of the share market price index (not the accumulation index) over the last 10 years.

(e) Eve says 15% pa since she calculated that this was the discount rate implied by the dividend discount model using the current share price, forecast dividend in one year and a 3% growth rate in dividends thereafter, which is the expected long term inflation rate.

Question 431  option, no explanation

A European put option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars.

What is an expression for the payoff at maturity ##(f_T)## in dollars from having written (being short) the put option?

(a) ##\max(S_T - K, 0)##.

(b) ##-\max(S_T - K, 0)##.

(c) ##\max(K-S_T, 0)##.

(d) ##-\max(K-S_T, 0)##.

(e) ##-\min(S_T - K, 0)##.

Question 437  option, no explanation

Two call options are exactly the same, but one matures in one year and the other matures in two years. Which option would you expect to have the higher price, the option which matures or , or should they have the price?

Question 448  franking credit, personal tax on dividends, imputation tax system

A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.

The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?

(a) Personal tax of $6.43 and corporate tax of $45.

(b) Personal tax of $15 and corporate tax of $30.

(c) Personal tax of $16.5 and corporate tax of $45.

(d) Personal tax of $31.5 and corporate tax of $30.

(e) Personal tax of $45 and corporate tax of $0.

Question 504  CFFA

Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.

UBar Corp
Income Statement for
year ending 30th June 2014
	$m
Sales	293
COGS	200
Rent expense	15
Gas expense	8
Depreciation	10
EBIT	60
Interest expense	0
Taxable income	60
Taxes	18
Net income	42

UBar Corp
Balance Sheet
as at 30th June	2014	2013
	$m	$m
Assets
Cash	30	29
Accounts receivable	5	7
Pre-paid rent expense	1	0
Inventory	50	46
PPE	290	300
Total assets	376	382
Liabilities
Trade payables	20	18
Accrued gas expense	3	2
Non-current liabilities	0	0
Contributed equity	212	212
Retained profits	136	150
Asset revaluation reserve	5	0
Total L and OE	376	382

 

Note: all figures are given in millions of dollars ($m).

The firm's free cash flow over the 2014 financial year was:

(a) $51

(b) $52

(c) $58

(d) $61

(e) $62

Question 592  future, margin call

A trader buys one December futures contract on orange juice. Each contract is for the delivery of 10,000 pounds. The current futures price is $1.20 per pound. The initial margin is $5,000 per contract, and the maintenance margin is $4,000 per contract.

What is the smallest price change would that would lead to a margin call for the buyer?

(a) A price fall of $0.76 per pound.

(b) A price fall of $0.10 per pound.

(c) A price fall of $0.04 per pound.

(d) A price rise of $0.04 per pound.

(e) A price rise of $0.10 per pound.

Question 671  future, forward, hedging

It's possible for both parties in a futures or forward contract to be hedging, so neither are speculating. or ?

Question 702  utility, risk aversion, utility function, gamble

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

(a) Mr Blue would enjoy the gamble.

(b) Miss Red would be indifferent to gambling or not.

(c) Mrs Green would dislike the gamble.

(d) Mr Blue's certainty equivalent of the risky gamble is $70.71. This is more than his current wealth which is why he would like to gamble.

(e) Miss Red's certainty equivalent of the risky gamble is $50. This is the same as her current wealth which is why she is indifferent to gambling or not.

Question 909  money market, bank accepted bill

By convention, money market securities' yields are always quoted as:

(a) Simple annual rates.

(b) Effective annual rates.

(c) Annualised percentage rates compounding per month

(d) Annualised percentage rates compounding semi-annually

(e) Continuously compounded annual rates.