ICAP PRC-3 Business finance and ethics: practice questions with answers

Question 1

Hingol Sanitaryware Ltd, a listed company, needs Rs 400 million for a new kiln. Its directors want to raise equity in a way that offers new shares first to existing shareholders in proportion to their holdings, so that no shareholder's control need be diluted. Which source of finance meets this aim?

1. A A rights issue
2. B A placing with an investment fund
3. C An issue of sukuk
4. D Venture capital

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Answer: A. A rights issue is an offer of new ordinary shares to existing shareholders in proportion to their current holdings, usually at a discount to market price. A shareholder who takes up the rights keeps the same percentage of the company, so control is not diluted. Placings, public offers to new investors and venture capital all bring in new owners and dilute existing ones.

Question 2

Codevista (Pvt) Ltd is a two-year-old Karachi software start-up with high growth potential, few tangible assets and no profit record. It needs Rs 150 million to expand, and its founders are willing to give an investor a minority equity stake and a seat on the board. Which source of finance matches this situation?

1. A A secured bank term loan
2. B Trade credit from suppliers
3. C Venture capital
4. D An initial public offering

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Answer: C. Venture capital is equity finance for young, unproven businesses with high growth potential. The investor accepts high risk in exchange for a share of ownership and often a board seat, aiming to exit later (for example through a sale or listing). It suits Codevista because it lacks the security and profit history lenders want, and as a private company it cannot raise money from the public.

Question 3

Alpha Ltd and Beta Ltd have identical operations and identical EBIT. Alpha is financed entirely by ordinary shares; Beta is financed partly by long-term debt with a fixed interest charge. Next year both companies' EBIT falls by 20%. Which statement about their earnings per share (EPS) is correct?

1. A Both companies' EPS falls by exactly 20%
2. B Alpha's EPS falls by more than 20%
3. C Beta's EPS falls by less than 20%
4. D Beta's EPS falls by more than 20%

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Answer: D. Financial leverage (gearing) means using finance with a fixed charge, such as debt, alongside equity. Because interest does not change with EBIT, any change in EBIT is magnified in earnings after interest and therefore in EPS: DFL = EBIT / (EBIT - interest) is greater than 1 for a geared company.

Alpha (no debt): DFL = 1, so EPS falls by exactly 20%. Beta (geared): DFL > 1, so EPS falls by more than 20%. Higher gearing raises the volatility of EPS, which is financial risk borne by ordinary shareholders.

Question 4

Imran is the procurement manager of Gujrat Fans Ltd. He is leading the evaluation of three bids to supply copper wire, and he learns that one bidder is owned by his brother-in-law. What is this situation and the appropriate response?

1. A A conflict of interest: Imran should declare it and step aside
2. B Bribery: Imran should report the bidder to the police at once
3. C No ethical issue arises if the relative's bid is the cheapest
4. D A conflict of interest: Imran should keep the link private to protect his relative

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Answer: A. A conflict of interest arises when a person's private interests (family, financial or personal) could influence, or be seen to influence, decisions made on behalf of the business. It does not require any wrongdoing to have occurred yet.

The usual response is to disclose the interest to the employer and withdraw from the decision, so that someone independent evaluates the bids. Bribery, by contrast, is offering, giving or accepting an inducement to act improperly.

Question 5

Kalabagh Builders Ltd has a well-written code of conduct and values statement that stress honesty. However, staff regularly see its directors bypass purchasing rules and claim personal expenses as business costs, and many employees now do the same. Which weakness does this most directly show?

1. A The lack of a written code of conduct
2. B Weak corporate social responsibility
3. C The lack of a values statement
4. D A poor tone at the top

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Answer: D. Tone at the top is the ethical climate set by the board and senior management through their own behaviour. Employees take their lead from what leaders do, not just what written documents say. A code of conduct and values statement are only effective if leaders visibly follow them and enforce them. Here, directors breaking their own rules has spread the same behaviour through the company.

Question 6

Noorpur Sports Ltd designs footballs in Sialkot, buys synthetic leather from suppliers in three countries and sells mainly through online retailers in Europe. Which feature of globalization makes this business model possible?

1. A Higher tariffs that protect home producers from imports
2. B Import substitution policies in developing nations
3. C Lower trade barriers and freer cross-border flows
4. D Fixed exchange rates set by the WTO

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Answer: C. Globalization is the growing integration of national economies. Its features include:

- reduced barriers to trade (lower tariffs and quotas, WTO trade rules);
- freer movement of goods, services, capital, technology and information;
- global supply chains and markets, helped by cheaper transport and digital communication;
- the growth of multinational enterprises.

Noorpur Sports' global sourcing and online exports depend on these freer cross-border flows.