MIDTERM EXAM

COURSE TITLE: FINANCE II

PROFESSOR NAME: Marwa Jerbi
Program: UPM
Term: Summer
Date: June 2022
Time: 90 mins

INVIGILATORS
Invigilator(s) name(s) Signature(s)

Statement of Academic Integrity

MSB does not tolerate academic fraud, an act by a student that may result in a false academic evaluation of that student or of another
student. Without limiting the generality of this definition, academic fraud occurs when a student commits any of the following offences:
plagiarism or cheating of any kind, use of books, notes, mathematical tables, dictionaries or other study aid unless an explicit written
note to the contrary appears on the exam, to have in his/her possession cameras, tape recorders, cell phones, or any other
communication device which has not been previously authorized in writing.

Statement to be signed by the student:

I have read the text on academic integrity and I pledge not to have committed or attempted to commit academic fraud in this
examination.

Signature: ______________________________________

Note: an examination copy or booklet without that signed statement will not be graded and will receive a final exam grade of
zero.

INSTRUCTIONS
1. Books and notes Not allowed.
2. Calculators are Allowed.
3. Cell phones are Not allowed.
 First name:……………………………..Last name:………………………………………

Part1- MCQ: Multiple choice single answer questions: Select the best answer and (10mn; 16pts)

1. Which one of the following statements is correct concerning the weighted average cost of capital (WACC)?
A. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate
multiplied by the par value of the stock.
B. The weight of the common stock used in the computation of the WACC is based on the number of
shares outstanding multiplied by the book value per share.
C. None of the above?
D. All of the above
(4 pts)

2. A profitability index of 0.65 for a project means that:

A. The present value ofbenefits is 65% greater than the project's costs
B. The project's NPV is greater than zero
C. The project returns 65 cents in present value for each current dollar invested
D. None of the above
(4 pts)

3. when dealing with two profitable Mutually exclusive projects,

A. The firm should invest in both projects
B. The firm ranks the projects, invest in the most profitable and if the project undertaken is really
profitable, that may create the opportunity to invest in the second project a year from now.

C. The firm ranks the projects and invest in the most profitable
D. None of the above
(4pts)

4. The common dividend of M&M corp has a negative growth rate of 1.5% and a cost of re=18%. The current
stock price is 11.42$. the amount of the last dividend paid is closest to
A. 2.11$
B. 2.41$
C. 2.26$
D. None of the above
(4 pts)

Solution
G=-1.5% ; RRR=re=18% ; P0=11.42$
 D0= ?
 P0= D1/(re-g)  D1=P0*(re-g)=11.42*(18%-1.5%)
 D0= D1/(1+g)= D1/(1-1.5%)=2.26$

Part2- Problems: (80 min, 82 pts)- Provide details and formulas while working on the problems

Problem 1 (25min; 28 pts)

SOFRI Corporation would like to finance a new average risk project with an initial investment amount equal to
1Million dollars using four types of financing sources:
• Retained earnings: represent 15% of the total investment.

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• Debt financing represents 60% of the new common shares’ weight.
• Preferred shares of stock: represent 80% of the retained earnings’ weight.
The company has a tax rate of 35% and the before tax cost of debt is 9%.
The fixed rate perpetual preferred stock was issued three years ago at 30$. It is trading today at 56$ and the
preferred dividend is 6$.
The common stock of SOFRI is trading at 100$ and is currently paying a 10$ dividend per share. The growth
rate is equal to 7.5%
Flotation costs represent 2% of the new common equity value and they are tax deductible
The project is expected to generate the following future cash flows:
CF1: $300,000; CF2: $350,000; CF3: $400,000; CF4: $450,000.
Instructions:
1. Provide the weight of each of the four financing sources. (5pts)
Solution
• Wre is given 15%
• Wp= 80%* Wre  Wp=80%*15%=12% (2pt)
• Wd = 60% *wcs
 15%+12%+wcs+60%wcs=1 1.6wcs=1-27%  WCS= 0.456=45.6% (2pt) 
Wd=45.6%*60%= 27.4% (1pt)

2. Provide the cost of each of the four financing sources then compute the WACC.(11pts)
Solution
• After tax Cost of debt=rd*(1-t)= 9%*(1-35%) =5.85% (2pt)
• Cost of preferred shares= rp= Dp/Pp=6/56=11% (3pt)
• Cost of common shares rcs= cost of retained earnings rre= cost of equity (re)=
(D1/P0)+g=((10*(1+7.5%)/100)+7.5%=18%(4pt)
 WACC= (27.4%*5.85%)+((15%+45.6%)*18%)+(12%*11%)=13.83% (2pt)

3. Calculate the NPV of the project and Interpret! (12pt)

Solution
300 000 350 000 400 000 450 000
• PV of future cash flows= 1
+ 2
+ 3
+ 4
=1,071,989.22 (4pt)
1.1388 1.1388 1.1388 1.1388
• I0=1,000,000$
• Flotation costs =2%*46%*1,000,000=9200 (2pt)  Flotation costs after tax=9200*(1-
35%)=5980$ (2pt)  NPV=1,071,989.22-1,000,000-5980=66,009.22 (2pt) NPV>0
good project, accept(2pt)

Problem 2 (20 min; 18 pts)

The following information are associated to two mutually exclusive projects A and B
CF 0 CF 1 CF 2 CF 3 CF 4 IRR WACC
Project A -400 160 160 160 160 21.8% 10%
Project B -400 0 0 0 800 18.9% 10%

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Instructions:
1. If you take into account both NPV and IRR, Which Project would you select? Explain! (8pts)

Solution
Project A because it has the highest IRR higher than WACC
NPV A= 107.17$ (3pts)
NPV B=146.4$ (3pts)
 Choose B
 Based on IRR choose A(1pts)
 Here we have ranking conflicts  use npv  choose B(1pts)

2. In which conditions can we face the multiple and /or no IRR problems? (2pts)

Solution
Unconventional CF pattern

3. If the target regular payback period is 2 years, and the investor wants to take the decision based on
liquidity, should he invest in project A? (6pts)

Solution
Payback period of A is 2.5 years > target  reject
4. Provide one drawback and one advantage of the discounted payback period criteria (2pts)

Solution
Take into account TVM
Do not consider cash flows after PBP

Problem 3: (40 mn; 38pts)

FOUR Inc. would like to undertake a new project having the following characteristics:
Duration: 3 years
Initial investment amount:
Working capital: 60 days of sales (consider 1 year = 360 days)
Land: acquisition price: 200,000 TND. Land price is expected to grow up at annual rate of 6%
Building: 260,000 TND totally depreciable over 25 years according to taxation requirements. The company’s
management expects to sell it at the end of the project at 240,000 TND.
Industrial equipment: 150,000 TND totally depreciable over 10 years according to taxation requirements. The
company’s management expects to sell it at the end of the project at 80,000 TND.
Additional investments:

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The company is planning to acquire another industrial equipment at the end of year 2 for an acquisition price of
140,000 TND. This equipment is totally depreciable over 10 years according to taxation requirements. The
company’s management expects to sell it at the end of the project at 80,000 TND.
Expected annual sales and costs:

End year 1 End year 2 End Year 3

Annual sales (units) 65,000 90,000 100,000
Per unit variable cost (TND) 26 26 26
Per unit selling price 50 50 50
Total operating fixed costs 500,000 500,000 500,000
without D&A (TND)

Tax rate: 20%

WACC: 15%
Instructions:
Calculate the project’s NPV. Interpret!

Problem 3 - Solution
 I0 Calculation:
I0 = 200000+260000+150000+6100000+541666.6667=1,151,666.667(3pts)
 Calculation related to LT assets:

Annual dep= Accum Original NBV Salv value SV-BV Tax effect
acquisition price/nbr of dep cost
years
Building 10400 31200 260000 228800 240000 11200 2240
Equip 15000 45000 150000 105000 80000 -25000 -5000
for year 1 and 25400
2
starting from 39400
year 3 add eq
2 dep

Industrial 14000 14000 140000 126000 80000 -46000 -9200

equipement 2

Land 0 0 200000 200000 238203.2 38203.2 7640.64

Tax loss 9880.64
Tax ben 14200
total SV 638203.2

 Calculation related to NWC:

Y1 Y2 Y3
Sales 3250000 4500000 5000000
Daily 9027.77778 12500 13888.89
WK 541666.667 750000 833333.3
Changes 208333.3333 83333.33

 Calculation of FCFs:

CF calculation (32pts)
End year 1 End year 2 End Year 3
Sales= annual units * per unit price (2pts) 3250000 4500000 5000000
substract VC=annual units* per unit variable (2pts) 1690000 2340000 2600000
cost

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 substract FC= Total operating fixed costs (1pts) 500,000 500,000 500,000
without D&A
substract DA= annual dep (building, equip, (4pts) 25400 25400 39400
vehic1, vehicule 2 starting from year2)

Operating income = sales- VC-VF-DA (1pts) 1,034,600 1,634,600 1,860,600

substract Tax= operating income *20% (1pts) 206920 326920 372120

operating income after tax = OI-T (1pts) 827,680 1,307,680 1,488,480
Add back DA (1pts) 25400 25400 39400
substract industrial eq 2 (2pts) -140000
add if decrease and substract if increase in (4pts) -208333.3333 -83333.3333
NWK= change in NWC
add recovery of net working capital= (1pts) 833333.3333
corresponding NWC for Year 3
add Total Salv value (3pts) 638203.2
add Tax ben (4pts) 14200
substract Tax loss (4pts) 9880.64
FCF= OI after tax +DA-new inv+/- change (1pts) 644,747 1,109,747 3,003,736
in NWC + recovery NWC+ total salv
value+tax bene-tax loss
 NPV Calculation: (3pts)

CF 1 CF 2 CF 3 CF 4
NPV = + + + −I 0
(1+0.12) (1+ 0.12)2 (1+ 0.12) (1+0.12)
1 3 4

Total
Disc FCF 560649.2754 839127.914 1975005.108 3374782.297

NPV= sum of FCF discounted - 2223115.6308

I0

 I0  3pts
 CFC 32 pts
 NPV 3pts

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