AF208: FINANCIAL MANAGEMENT

Faculty of Business and Economics / School of Accounting & Finance

Final Examination
Semester 1 2018

Print Mode

Duration of Exam: 3 hours + 10 minutes

Reading Time: 10 minutes
Writing Time: 3 hours

Instructions:
1. This exam has THREE (3) sections; Multiple Choice, Word Problems and
Case Studies
2. Questions start from Page TWO (2)
3. There is a total of 17 (1-17) pages including the cover page.
4. Section A has 40 MULTIPLE CHOICE Questions. ALL are Compulsory.
5. Answers for Section A should be marked by a circle (O) in the answer
sheet provided separately.
6. Submit Answer Sheet for SECTION A with the ANSWER Booklet.
7. All questions in SECTION B and SECTION C are COMPULSORY.
8. Write answers for Section B and Section C on a fresh page in the answer
booklet provided.
9. Formulae are provided on pages 11-12.
10. The examination is worth (Total 100 marks) 50% of your overall mark.
11. You are allowed to use a silent, non-programmable calculator.
SECTION A: MULTIPLE CHOICE (40 MARKS)
Circle the letter which corresponds to the best answer in the Multiple-Choice
Grid provided. Each question is worth 1 mark. [Suggested Time: 72 minutes]
1. Which of the following is not a source of capital?
A. Borrowings
B. Preference shares
C. Ordinary shares
D. Trade credit

2. Cost of capital is:

A. the maximum rate of return on the firm’s investments that will compensate suppliers
of capital to the firm
B. the minimum rate of return on the firm’s investments that will compensate suppliers of
capital to the firm
C. equal to a firm’s dividend yield
D. equal to a firm’s dividend yield plus expected growth

3. When calculating a firm’s weighted average cost of capital, the preferred method of
weighting each source of capital is to use:
A. book values
B. amortised historical costs
C. current market values
D. target weights

4. A firm is planning to issue 10 million shares at $4 each. If the costs of the issue are
$500 000, the net proceeds of the issue are:
A. $3 500 000
B. $40 500 000
C. $39 500 000
D. $39 950 000

5. A firm has the following capital structure:

Source After-tax cost Market value

% pa $m
Term loans 10.00 2,000
Preference shares 9.00 1,000
Ordinary shares 12.00 6,000

Its after-tax weighted-average cost of capital is:

A. 10.22%
B. 9.00%
C. 11.22%
D. 3.22%
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6. A company has recently paid an annual dividend of $1.30 per share. What is the
after-tax cost of retained earnings if dividends are expected to grow indefinitely at the
rate of 8% pa and the shares are currently priced at $28.08?
A. 12.63%
B. 4.63%
C. 13.00%
D. 5.00%

7. A company has a beta value of 1.5. The risk-free rate is 6% and the equity risk
premium is 8%. What is the after-tax cost of the company’s ordinary shares using the
Capital Asset Pricing Model?
A. 16.70%
B. 15.70%
C. 18.00%
D. 11.21%

8. The main difference between estimating the cost of new ordinary shares and
estimating the cost of retained earnings is the use of:
A. net proceeds rather than book value
B. net proceeds rather than intrinsic value
C. net proceeds rather than current market price
D. retained earnings per share rather than current market price

9. The main sources of corporate capital can be ranked according to their risk (from
most risky to least risky) as follows:
A. bonds, preference shares, ordinary shares
B. preference shares, bonds, ordinary shares
C. ordinary shares, preference shares, bonds
D. preference shares, ordinary shares, bonds

10. A problem(s) with applying the CAPM to calculate the cost of ordinary shares is the:
A. difficulty associated with estimating beta
B. CAPM does not incorporate floatation costs
C. difficulties associated with using CAPM to calculate the before-tax cost of ordinary
shares.
D. All of the above

11. Which of the following is not a common characteristic of investment decisions?

A. Zero risk
B. Relatively long time frame
C. Relatively large initial outlay
D. Difficult to reverse

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12. Sunk costs are cash outflows that occur:
A. at the start of a project
B. during a project
C. at the end of a project
D. before the evaluation of a project

13. Which of the following does not affect net working capital?
A. Depreciation
B. Increases in stocks of raw materials
C. Increases in stocks of finished goods
D. Increases in accounts payable

14. The minimum rate of return that will make a project acceptable is the:
A. internal rate of return
B. weighted average cost of capital (WACC)
C. hurdle rate
D. risk-free rate

15. The one advantage of IRR over NPV is it:

A. assumes that project cash inflows are reinvested at the IRR of the project
B. assumes that project cash inflows are reinvested at the discount rate
C. assumes that project cash inflows are reinvested at the WACC
D. is easier for people without a formal finance background to interpret a rate of return
than it is to understand what the dollar NPV means

16. A company is considering manufacturing a new product for which it requires a new
machine. The purchase price of the new machine is $700 000. Inwards freight and
installation costs would be $1800. It would cost $2000 to train an operator of the
machine. Initial advertising to promote the new product would cost $3000. The new
machine would replace an old machine with a net salvage value of $5000. The new
machine would be installed at the same location as the old machine. It would occupy
24 square metres of a machine shop measuring 30 metres  20 metres. Occupancy
costs of the machine shop are $8000 per year. The initial outlay for the new product
is:
A. $701 800
B. $706 800
C. $698 800
D. $654 740

17. A project will generate cash inflows of $10 000 next year and $20 000 in the following
year. Initial costs are $5000. The cost of capital is 8% The NPV of this project is:
A. $20 306
B. $22 400
C. $21 406
D. $23 295

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18. Which of the following five indivisible projects should a company invest in, given a
capital budget constraint of $1 million?

Project Initial outlay Net Present Value

$ $
A 300 000 66 000
B 200 000 40 000
C 600 000 90 000
D 400 000 56 000
E 500 000 55 000
A. C, D
B. A, B
C. A, B, D
D. A, C

19. Which of the following measures is most suitable for evaluating mutually exclusive
projects of unequal lives?
A. Net Present Value
B. Internal Rate of Return
C. Accounting Rate of Return
D. Equivalent Annual Annuity

20 Which of the following statements is false?

A. The accounting rate of return method implicitly takes the time value of money into
account
B. Payback period ignores the impact of time value of money
C. NPV takes the time value of money into account
D. None of the above

21. Floor-plan finance is most likely to be used by:

A. a supermarket
B. a real estate agent
C. a retailer of motor vehicles
D. a firm of public accountants

22. A firm purchases on credit. Credit terms require settlement by the end of the month
following the month of invoicing, but a discount of 2% is offered for settlement within
7 days of invoicing. The firm decides to take the prompt settlement discount on all
invoices received after the 20th day of the month. What is the cost of forgoing the
discount on the other invoices (assuming an average credit period of 50 days)?
A. 14.90%
B. 15.89%
C. 14.6%
D. 15.55%

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23. In managing the level of working capital, which of the following is generally not a
concern:
A. the cost and risk of long-term funding
B. the need to maintain liquidity
C. the need to earn the required rate of return on the assets
D. none of the above

24. Factoring business normally require client firms to satisfy which of the following?
A. Sell goods on normal, credit terms
B. Have efficient debtors’ ledgers
C. Have a spread of debtors
D. All of the above

25. Efficient credit collection:

A. increases credit sales
B. increases the value of debtors
C. reduces the value of creditors
D. reduces the value of debtors

26. Which of the following is not encompassed within the just-in-time (JIT) philosophy?
A. Reduction in setup times
B. Zero defects
C. Multi-skilled workers
D. Larger inventories

27. Which of the following are types of inventory holding costs?

A. Insurance costs
B. Financing costs
C. Wholesale price changes
D. All of the above

28. If demand for soft drinks is 5000 per year and ordering and holding costs are $1.25
and $1.75 respectively, then the economic order quantity (EOQ) is:
A. 95
B. 85
C. 118
D. 93

29. Which of the following is not an assumption underlying economic order quantity
(EOQ) theory?
A. Demand is known
B. Demand is constant
C. Delivery is lagged
D. Ordering costs are known

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30. A company’s shares are trading at $14 when it decides to make a 2-for-11 rights issue
at an issue price of $10.80. The theoretical price of a right is:
A. $3.20
B. $2.71
C. $3.78
D. $13.51

31. Which of the following statements is false?

A. Corporate bonds are debt instruments
B. The issuer of corporate bonds receives the face value of the bonds at issue
C. The face value on corporate bonds is repaid when the bonds mature
D. Corporate bonds always pay semi-annual coupons

32. Which of the following are features of some preference shares?

A. Cumulativeness
B. Non-participating
C. Participating
D. All of the above

33. Which of the following is not a reason that companies issue options?
A. To set in place a programmed raising of funds in the future
B. To reward and motivate employees
C. To increase the interest on debt contracts
D. To make equity issues more attractive

34. Which of the following ratios is least likely to be affected by the capital structure of a
firm?
A. gross profit margin
B. earnings per share
C. return on equity
D. times interest earned

35. In the context of a company, which of the following groups is least likely to be able to
predict impending financial distress?
A. the company’s shareholders
B. the company’s directors
C. senior credit managers within the company’s major suppliers
D. insolvency practitioners

36. Given a times interest earned of 10 and an annual interest expense of $20000, profit
before interest and tax is:
A. $20000
B. $2000
C. $2000000
D. $200000

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37. Which of the following is not an assumption underlying the dividend irrelevance
theory?
A. investment decisions of a company are dependent on its dividend policy
B. no business or personal taxes
C. no transaction costs relating to the purchase or sale of shares
D. complete and costless information about companies is available to investors

38. Which of the following is not an alternative to paying a cash dividend?

A. dividends reinvested in shares
B. bonus shares instead of dividends
C. shares repurchased by company
D. share purchase plan

39. In the life cycle of a typical company, the start-up phase is immediately followed by
which of the following phases?
A. high growth
B. rapid expansion
C. maturity
D. decline

40. An optimal dividend policy refers to the policy that:

A. maximises share price
B. maximises dividend per share
C. maximises total dividends
D. maximises the market value of the firm

SECTION B: WORD PROBLEMS (15 MARKS)

Answer all questions [Suggested Time: 27 minutes]
Question 1 [4 Marks]

Briefly define the cost of capital concept and explain how a company’s cost of capital is
determined.

Question 2 [4 Marks]

Briefly describe and explain the three motives for holding cash suggested by John Maynard
Keynes.

Question 3 [4 Marks]

Briefly describe 2 benefits and 2 costs of providing credit to customers.

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Question 4 [3 Marks]

FSC Ltd buys 20 litre drums of herbicide by the pallet of 50 drums. Each drum sells for $200 and
costs $150 landed in the store. About 3000 drums of this size are sold each year. Occasionally
(averaging one drum in every 8 pallets) a drum is damaged in the store and is unsaleable. It costs
$10 additionally to dispose of the damaged drum and contents and clean up the mess. Other
holding costs average $10 per pallet. Order costs are estimated to be $1. What is the EOQ?

SECTION C: CASE STUDY (45 MARKS)

Answer all questions [Suggested Time: 81 minutes]
Question 5 [20 marks]

Cape Schnack Limited

Projected income statement
for the year ended 31 October 2019
Forecast source
Contract revenues 29 530 500 Management information
Cost of goods sold 23 624 400 % of sales
Gross profit 5 906 100

Maintenance 2 394 000 133% of prior year expense

Insurance 1 199 000 Management information
Depreciation and amortisation 700 000 Management information
Borrowing costs expense 161 200 Management information
Profit (loss) from ordinary activities 1 451 900
Income tax expense 435 570 30% of forecast profit
Net profit (loss) 1 016 330
Dividends paid 50 000 Same as prior year
Transfer to retained earnings 966 330

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 Cape Schnack Limited
Projected balance sheet
as at 31 October 2019
Current assets
Cash
Receivables
Inventories
Total current assets
Non-current assets
Land and buildings
Plant and equipment
Goodwill
Total non-current assets
Total assets
Current liabilities
Payables
Interest-bearing liabilities
Current tax liability
Total current liabilities
Non-current liabilities
Interest-bearing liabilities
Total non-current liabilities
Total liabilities
Equity
Contributed equity
Retained profits
Total equity
Equity minus net assets
Less funding for new project
Financing required
Required:
Forecast source
30 000 Management information
2 000 000 October’s contract receipts
1 000 Same as prior year balance
2031000
520 000 Opening balance less depreciation
6 960 000 Opening balance less depreciation
490 000 Opening balance less amortisation
7 970 000
10 001 000
360 000 18% of October’s contract receipts
40 000 Management information
108 892 25% of annual tax expense
508 892
Opening balance less principal
5 958 000 reduction
5 958 000
6 466 893
3 000 000 Opening balance
Opening balance plus income statement
1 777 432 pro-forma
4 777 432
1 243 325
4 000 000
2 756 676
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 (a) Using the 2019 projected financial statements for Cape Schnack Ltd, calculate Earnings
per Share, Dividends per share, Return on Equity, Net Tangible Asset Backing per share,
Debt to Equity and Times Interest Earned Ratios. [7 Marks]
(b) Assume that the company is planning to issue 500 000 ordinary shares to raise
$2,756,676 as identified in the projected statements. Recalculate Earnings per Share,
Dividends per share, Return on Equity, Net Tangible Asset Backing per share, Debt to
Equity and Times Interest Earned Ratios. [7 Marks]
(c) Explain the change in each ratio and use it to justify whether lenders will consider Cape
Schnack Ltd as a risky investment [6 marks]

Question 6 [25 marks]

Tim and Kim have a partnership and both partners all have a marginal tax rate of 42%. They
would like you to evaluate a project for them and have provided the following details:

Year 1 Year 2 Year 3 Year 4 Year 5

Cash Sales 500 000 600 000 700 000 600 000 500 000

 The initial investment in the project is $800 000 for factory equipment. The tax office
allows prime cost depreciation at the rate of 25% p.a. on these assets.
 The assets purchased at the commencement of the project will be sold at the end of the
project for $100 000.
 The assets require a tax-deductible overhaul that will cost $20 000 before production
can begin in year 4.
 Working capital will be 10% of revenues for each year. The working capital
investment has to be made at the start of each period. All working capital will be
recovered.
 Cost of goods sold is 25% of sales.
 Wages are $110 000 per annum
 The required return of the partners is 15%.

Required:
Find the relevant cash flows for the project and then calculate NPV for the project. Make a
recommendation whether the project should be accepted.

THE END

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