PARISGRADUATESCHOOL OF MANAGEMENT
BACHELOR OF BUSINESS ADMINISTRATION
FINAL EXAMINATION
SUBJECT : C 306 BUSINESS FINANCIAL MANAGEMENT
DATE:TIME: 6:30 PM – 9:30 PM
DURATION: 3 HOURS
PGSM – Bachelor of Business Administration
C 306 Business Financial ManagementPage 1 of 7
SECTION A ( 2 mark each )
Answer all questions.
1. Which of the following is a basic principle when estimating a project's cash flows?
a. cash flows should be measured on a pretax basis
b. cash flows should ignore depreciation because it is a non-cash charge
c. only direct effects of a project should be included in cash flow calculations
d. cash flows should be measured on an incremental basis
Net operating cash flows
2. Which of the following items is not considered as a part of the net investment calculation?
a. the first year’s net cash flow
b. increase in net working capital
c. salvage of an old piece of equipment that is being replaced
d. installation and shipping charges
3. . A drill press costs $30,000 and is expected to have a 10-year life. The drill press will be depreciated on a straight-line basis over 10 years to a zero estimated salvage value. This machine is expected to reduce the firm's cash operating costs by $4,500 per year. If the firm is in the 40 percent marginal tax bracket, determine the annual net cash flows generated by the drill press.
a. $4,500
b. $900
c. $5,700
d. $3,900
4. . The disadvantages of the payback approach include:
a. cash flows after the payback period are ignored in the calculation
b. payback ignores the time value of money
c. payback fails to provide an objective decision-making criterion
d. all of the above
5. The relationship between NPV and IRR is such that:
a. both approaches always provide the same ranking of alternative investment projects.
b. the IRR of a project is equal to the firm's cost of capital if the NPV of a project is $0.
c. if the NPV of a project is negative, the IRR must be greater than the cost of capital.
d. none of the above
6. The net present value method assumes that cash flows are reinvested at the ______, whereas the internal rate of return method assumes that cash flows are reinvested at the ______.
a. discount rate, required rate of return
b. cost of capital, market rate of return
c. firm's cost of capital, computed internal rate of return
d. marginal cost of capital, discount rate
7. Two prominent finance researchers (Modigliani and Miller) showed that
a. the firm's optimal capital structure consists of approximately equal proportions of debt and equity
b. the value of the firm is independent of its capital structure in perfect capital markets with no income taxes
c. the firm's cost of capital is minimized when its capital structure consists of approximately equal proportions of debt and equity
d. none of the above
8. . Which of the following statements (if any) is (are) true concerning the optimal capital structure?
a. At the optimal capital structure, the weighted cost of capital is maximized.
b. At the optimal capital structure, the value of the firm is maximized.
c. a and b
d. none of the above
9. According to Miller and Modigliani it is that really determines a firm's value.
a. investment policy
b. dividend policy
c. a and b
d. none of the above
10. Firms with the ______earnings growth tend to have the ______dividend payout ratio.
a. highest, highest
b. highest, lowest
c. lowest, lowest
d. none of the above are correct
11. The dividend ______states that investors will tend to be attracted to firms that have dividend policies consistent with the investor’s objectives
a. "clientele effect"
b. "informational content"
c. signal
d. passive residual theory
12. What is the inventory conversion period for O’Brian's if it has sales of $320,000, an average inventory of $5,333, and a cash conversion cycle of 20 days? Assume that the cost of sales is 55 percent of sales.
a. 6 days
b. 11 days
c. 13.5 days
d. 15 days
13. When the level of working capital is increased, all of the following are expected to occur except
a. expected profitability decreases
b. expected profitability increases
c. risk decreases
d. none of the above
14. All other things being equal, a policy of holding a relatively ______proportion of the firm's total assets in the form of current assets will tend to result in a ______expected profitability or rate of return on the total assets of the firm.
a. large, higher
b. small, higher
c. constant, higher
d. constant, lower
15. The value of an option depends on the stock’s price, the risk-free rate, and the
a.Exercise price.
b.Variability of the stock price.
c.Option’s time to maturity.
d.All of the statements above are correct.
16. American Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. American’s analysts project that the merger will result in incremental net cash flows with a present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Eastern is 16 percent. Eastern has 4 million shares outstanding. Eastern’s current price is $16.25. What is the maximum price per share that American should offer?
a. $16.25
b. $16.97
c. $17.42
d. $18.13
17. If one Swiss franc can purchase $0.71 U. S. dollars, how many Swiss francs can one U. S. dollar buy?
a.0.71
b.1.41
c.1.00
d.2.81
18. The effect of a one dollar increase in depreciation expenses is to ______the typical firm's net cash flows by ______one dollar.
a. increase, less than
b. increase, exactly
c. decrease, more than
d. increase, more than
19. Laurier Inc. is a household products firm that is considering developing a new detergent. In evaluating whether to go ahead with the new detergent project, which of the following items should Laurier explicitly include in its cash flow analysis?
a.The company will produce the detergent in a vacant facility that they renovated five years ago at a cost of $700,000.
b.The company will need to use some equipment that it could have leased to another company. This equipment lease could have generated $200,000 per year in after-tax income.
c.The new detergent is likely to significantly reduce the sales of the other detergent products the company currently sells.
d.Statements b and c are correct.
20. Albany Motors recently completed a 2-for-1 stock split. Prior to the split, the company had 20 million shares outstanding and its stock price was $45 per share. After the split, the total market value of the company’s stock equaled $900 million. What was the price per share of the company’s stock following the stock split?
a.$45.00
b.$30.00
c.$22.50
d.$15.00
SECTION B ( 5 marks each )
Answer all questions and show all workings.
1. . Faris currently has a capital structure of 40 percent debt and 60 percent equity, but is considering a new product that will be produced and marketed by a separate division. The new division will have a capital structure of 70 percent debt and 30 percent equity. Faris has a current beta of 1.1, but is not sure what the beta for the new division will be. AMX is a firm that produces a product similar to the product under consideration by Faris. AMX has a beta of 1.6, a capital structure of 40 percent debt and 60 percent equity and a marginal tax rate of 40 percent. If Faris’ tax rate is 40 percent, estimate the levered beta for the new product division?
2. . Calculate the market value of Lotle Group, a firm with total assets of $80 million and $30 million of perpetual debt in its capital structure. The firm's cost of equity is 14% and the cost of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of $9 million and a marginal tax rate of 40%.
3. Technico has determined that its optimal capital structure is 40% debt, at which point its weighted cost of capital, ka, is 13.7%. Due to financial problems, the firm has decided to raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%. What is the effect on the stock price of Technico? The current dividend is $1.60 and the long-term growth rate of dividends is expected to be 8.5%.
4. Gates Industries balance sheet and income statement for the year ending December 31, 1978 are as follows:
Balance Sheet ($ million)
Cash $10.0 Accounts payable $15.0
Accounts receivable 15.0 Salaries, benefits, & payroll taxes payable 3.0
Inventories* 12.0 Long-term debt 15.0
Fixed assets (net) 30.0 Stockholders' equity 34.0
Total assets $67.0 Total liab. & stock. equity $67.0
Income Statement ($ million)
Net sales (all credit) $125.0
Cost of sales 75.0
Selling, general, & adm. expenses 30.0
Other expenses 13.0
Earnings after tax $ 7.0
*Note: Average inventories also equal $12.0 (million).
Determine the length of the firm's cash conversion cycle.
5. St. John’s Paper is considering purchasing equipment today that has a depreciable cost of $1 million. The equipment will be depreciated on a MACRS 5-year basis, which implies the following depreciation schedule:
MACRS
Depreciation
YearRate
10.20
20.32
30.19
40.12
50.11
60.06
Assume that the company sells the equipment after three years for $400,000 and the company’s tax rate is 40 percent. Determine the after tax net cash proceed from the sale of the asset.
6. Suppose you believe that Du Pont’s stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $510.25 you could buy a 5-month put option giving you the right to sell 100 shares at a price of $83.00 per share. If you bought a 100-share contract for $510.25 and Du Pont’s stock price actually dropped to $63.00, what would be your net profit (after transactions costs but before taxes)?
7. Suppose a U. S. firm buys $200,000 worth of television tubes from a French manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U. S. deficit has caused the dollar to depreciate against the franc recently. The current exchange rate is 5.50 FF per U. S. dollar. The 90-day forward rate is 5.45 FF/dollar. The firm goes into the forward market today and buys enough French francs at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 French francs per U. S. dollar. How much in U. S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge?
8. Creative Furniture is considering two mutually exclusive projects that would automate part of their production facilities. Project A costs $120,000 and would produce net cash flows of $37,000 annually for 5 years. Project B also costs $120,000 and will produce annual net cash flows of $25,000 for 10 years. Creative's cost of capital is 11 percent. Using the equivalent annual annuity method, which project should be chosen?
9. Elliott Mfg. is considering acquiring Fox Inc. Fox’s cash flows have been estimated in detail for the next three years and are $40M, $45M and $50M respectively. A terminal value consistent with that estimate has been calculated at $700M. The risk-adjusted discount rate for analysis is 12%. If Fox, Inc. has 12 million shares outstanding, what is the most Elliott should offer, per share, for its stock?10. As10. Assume the following facts about a company:
Capital (000’s) / EBIT (000’s) / $1,000
Debt / — / Less Interest Expense / —
Equity / $3,000 / EBT / $1,000
Total Capital / $3,000 / Taxes @ 40% / 400
Shares @ $10 = 300 / Earnings after Tax / $ 600
What will be the company’s new EPS if it borrows money at 10% interest and uses it to retire stock until capital is 40% debt? The stock can be purchased at its book value of $10 per share.
C306/Jan2007