PRACTICE EXAM FOR FINANCIAL MANAGEMENT

FALL 2020

Q.1. XYZ Corporation is considering the purchase of a new machine for $250,000, which will
be depreciated on a straight-line basis over 5 years with no salvage value. In order to put this
machine in operating order, it is necessary to pay installation charges of $50,000. The new
machine will replace an existing machine, purchased 3 years ago at a cost of $240,000, that is
depreciated on a straight-line basis (with no salvage value) over its 8-year life. The old machine
can be sold for $255,000 to a scrap dealer. The company is in the 46 percent tax bracket, and
capital gains are taxed at a rate of 28 percent.

Required: Calculate the cost of initial investment.

Q.2. Descon Corporation, a large, diversified manufacturer of aircraft components, is trying to

determine the initial investment required to replace an old machine with a new, more
sophisticated odel. The proposed machine’s purchase price is $370,000, and an additional
$10,000 will be necessary to install it. It will be depreciated using a 5-year recovery period. The
present (old) machine was purchased 3 years ago at a cost of $220,000 and was being
depreciated using a 5-year recovery period. The firm has found a buyer willing to pay $260,000
for the present machine and to remove it at the buyer’s expense. The firm expects that a $45,000
increase in current assets and an $20,000 increase in current liabilities will accompany the
replacement. The firm pays taxes at a rate of 40 percent.

5 year depreciation schedule:

Year Percentage
1 20
2 32
3 19
4 12
5 17

Required: Calculate the cost of the initial investment.

Q.3. For each of the following cases, compute the total taxes resulting from the sale of the
asset. Assume a 28% capital gain tax and a 46 percent ordinary tax rate. The asset was purchased
for $75,000 three years ago and has a book value of $40,000.
(a) The asset is sold for $80,000.
(b) The asset is sold for $70,000.
(c) The asset is sold for $40,000.
(d) The asset is sold for $38,000.

The firm in the above case is also considering replacing their old machine with a new one. The
new machine costs $90,000 plus $10,000 to install. For each of the four situations given above,
calculate the initial cost of investment for the replacement of machine (use a tabular
presentation).
Q.4. The Denver Company has $15,000 that it plans to invest in marketable securities. It is
choosing between Zong Company bonds, which yield 7%, State of Arkansas muni bonds, which
yield 5.5%, and Zong preferred stock, with a dividend yield of 7.5%. Denver’s corporate tax rate
is 36%, and 70 percent of the dividends received are tax exempt. The State of Arkansas muni
bonds are tax free. Assuming that the investments are equally risky and that Denver chooses
strictly on the basis of after-tax returns, which security should be selected? What is the after-tax
rate of return on the highest yielding security? Make a comparison of the returns of the three
securities in percentages and in dollars value.

Q.5. Discuss the salient features of the various forms of organizations.