ACCOUNTING TEST

Section A. You must answer ALL questions in this section.
This section carries 55 marks
B&H is a large UK based company investing in various assets and sectors around the
globe. Its optimal capital structure is 60% debt and 40% equity. B&H’s cost of debt is
8%. The risk-free rate of interest is 3%. The expected return on the market portfolio is
12%. B&H’s corporate tax rate is 25%. B&H’s beta is estimated at 1.2 and the cost of
equity (after tax) is 13.8%. Please answer questions Q1 to Q4 related to B&H.

Q1. [Total 15 marks]
a. Calculate the market risk premium. [3 marks]
b. Calculate B&H’s weighted average cost of capital. [5 marks]
c. Discuss the impact on the cost of equity if corporate tax increases. [7 marks]

Q2. B&H is now looking to expand its investments more globally: [Total 20 marks]
a) Assume the annual interest rate for borrowing in the EU is 3.1%, if B&H borrows
EUR1,000,000 today for one year, how much money would B&H owe at
maturity in EUR? [5 marks]
b) Consider that B&H wants to use the money they borrowed today (from part a)
to invest in the US. Using the information in table 1, how much USD will B&H
get from the bank today? [5 marks]
Table 1
Bid Ask
Spot rate USD 1.42 = EUR 1 USD 1.45 = EUR 1
1 year forward rate USD 1.48 = EUR 1 USD 1.50 = EUR 1
c) B&H wants to estimate the payable amount in its own home currency GBP in
one year. Given the expected spot rate in one year is 1.24EUR=1GBP, and the
forward rate for one-year maturity is 1.22EUR=1GBP, should B&H hedge its
payment using a forward contract or not? And why? [10 marks]

3
Q3. [10 marks]
In table 2 below you are given the expected transactions and standard deviation of the
affiliates of B&H around the world. The inter-affiliate cash flows are uncorrelated with
one another. Calculate the standard deviation of the portfolio of cash held by the
centralized depository of B&H in the UK for the following affiliate members in various
countries:
Table 2
Affiliate Expected Transactions Standard Deviation
UK £100,000 £40,000
Europe £150,000 £60,000
US £175,000 £30,000
Africa £200,000 £70,000

Q4. [10 marks]
B&H is now assessing the possibility to make a new foreign direct investment in
Thailand. The initial cost of the project in Thai Baht currency is THB 10,000,000. The
annual cash flows over the five-year economic life of the project in THB are estimated
to be 3,000,000; 4,000,000; 5,000,000; 6000,000; and 7,000,000. Long-run inflation is
forecasted to be 3% per annum in the UK and 6% per annum in Thailand.
The current spot rate is 1GBP = THB 40.00
– If the new cost of capital of B&H is 10%. Calculate the NPV of the project in
GBP (Note: the cost of capital is related to the parent company which is UK
based).
Section B. You must answer ALL questions in this section.
This section carries 45 marks (each question carries 15 marks with a maximum
word limit of just 300)

Q5.
a. Discuss the main barriers to cross-listing abroad. [8 marks]
b. What is effective cash management within a firm? Discuss the key factors
contributing to effective cash management. Discuss the reasons why cash
management process is more difficult in a MNC.
[7 marks]
4

Q6.
Define and explain letter of credit (L/C), its principle parties and principle
advantages, Discuss how the L/C facilitates international trade. [15 marks]

Q7.
What are the advantages and disadvantages of investing in a foreign market through
a greenfield foreign direct investment compared to an acquisition of a local firm in the
target market? [15 marks]

End of the paper

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