financial management sept 13 exam paper

Examination Problems for Fundamentals of Financial Management 2004-2005 (Paper B)overall goal in mind.A. Financial managementB. Profit maximizationC. Agency theoryD. Social responsibility2.A major disadvantage of the corporate form of organization is the ( ).A. double taxation of dividendsB. inability of the firm to raise large sums of additional capitalC. limited liability of shareholdersD. limited life of the corporate form.3. Interest paid (earned) on both the original principal borrowed (lent) and previous interest earned is often referred to as ( ).A. present valueB. simple interestC. future valueD. compound interest4. If the intrinsic value of a share of common stock is less than its market value, which of the following is the most reasonable conclusion?A. The stock has a low level of risk.B. The stock offers a high dividend payout ratio.C. The market is undervaluing the stock.D. The market is overvaluing the stock.5. A 250 face value share of preferred stock, pays a 20 annual dividend and investors require a 7% return on this investment. If the security is currently selling for 276, what is the difference (overvaluation) between its intrinsic and market value (rounded to the nearest whole dollar)?A. approximately 26B. approximately 10C. approximately 6D. approximately 16. Felton Farm Supplies, Inc., has an 8 percent return on total assets of 300,000 and a net profit margin of 5 percent. What are its sales?A. 3,750,000B. 480,000C. 300,000D. 1,500,0007. A company can improve (lower) its debt-to-total asset ratio by doing which of the following?A. Borrow more.B. Shift short-term to long-term debt.C. Shift long-term to short-term debt.D. isssue common stock.8. The DuPont Approach breaks down the earning power on shareholders' book value (ROE) as follows: ROE = ( ).A. Net profit margin × Total asset turnover × Equity multiplierB. Total asset turnover × Gross profit margin × Debt ratioC. Total asset turnover × Net profit marginD. Total asset turnover × Gross profit margin × Equity multiplier9. Which of the following items concerns financing decision? ( )A. sales forecastingB. bond issuingC. receivables collectionD. investment project selection10. Which of the following items is the function of a treasurer? ( )A. cost accountingB. internal controlC. capital budgetingD. general ledger11. For financial instruments, ( ) is judged in relation to the ability to sell a significant volume of securities in a short period of time without significant price concession.A. maturityB. marketabilityC. defaultD. inflation12. ( ) is the value at some future time of a present amount of money, or a series of payments, evaluated at a given interest rate.A. future valueB. present valueC. intrinsic valueD. market value13.Ellesmere Corporation issues 1 million $1 par value bonds. The stated interest rate is 6% per year and the interest is paid twice a year. What is the real interest rate of the bond? ( )A. 6%B.3%C. 12%D. (1+6%/2)2-114. Assume that dividends of a common stock will be maintained at D forever, and the required return of the stockholder is r, the par value of the stock is m, the value of the stock is ( )A. mB. m+DC. m+D/rD. D/r15. Which of the following items has the most risk? ( )A. treasury billB. corporate bondC. preferred stockD. common stock16. ( ) equals the gross profit divided by net sales of a firm.A. gross profit marginB. net profit marginC. return on investmentD. return on equity17. ( A ) is the ratios that measure a firm’s ability to meet short-term obligationsA. liquidity ratiosB. leverage ratios c. coverage ratios D. activity ratios18. ( A ) is the result of Net Profi t Margin × total asset turnover × (total assets/shareholders’ equity)A. Return on equityB. return on investmentC. current ratioD. quick ratio19. Government tax law adjustment is ( A ) to a firm.A. general economic riskB. inflation and deflation riskC. firm-specific riskD. international risk20 ( A ) equals the gross profit divided by net sales of a firm.A. gross profit marginB. net profit marginC. return on investmentD. return on equity II. Statement judgement (10 Points) (Please write your answer in the following1. Until around the first half of the 1900s, financial managers primarily raised funds and managed their firm’s cash positions. ( )2. In general, the higher the marketability of a security, the greater the yield necessary to attract investors ( )3. Discount Rate is the interest rate used to convert future values to present values. ( )4. The expected return of a portfolio is simply a weighted average of the expected return of the securities comprising that portfolio ( )5. The type of analysis varies according to the specific interests of the party involved ( )6. In a sole proprietorship, the owner is personally responsible for all financial obligations of thefirm. ( )7. When a stock goes "ex-rights, " its market price theoretically declines. ( )8. The market price of a particular bond is much greater today than it was yesterday. The calculated yield to maturity (YTM) based on today's market price would, therefore, be greater than the calculated YTM based on yesterday's market price. ( )9. A short average collection period assures us that accounts receivable are being efficiently managed. ( )10. Simple interest is interest that is paid on only the original amount borrowed (lent) ( )III. Questions (10 points) (Please write your answer on the answer paper)1. The method of depreciation does not alter the total amount deducted from income during the life of an asset. What does it alter and why is that important? (5 )2. What is primary and secondary market? (5)IV. Problems (60 Points) (Please write your answer on the answer paper)1. you need to have $100000 at the end of 10 years. To accumulate this sum, you have decided to save a certain amount at the end of each next 10 years and deposit it in the bank. The bank pays 8% interest compounded annually for long-term deposit. How much will you have to save each year? (PVIF(8%,10)=0.463, PVIFA(8%,10)=0.671, FVIF(8%,10)=2.159, FVIFA(8%,10)=14.487)2.Just today, Bird Seed Company’s common stock paid a $1.50 annual dividend per share and hada closing price of $24. Assume that the market’s required return for this investment is 12% and that dividends are expected to grow at a constant rate forever.a. calculate the implied growth rate in dividends.b. what is expected dividend yield and capital gains yield?3. The data for various companies in the same industry are as follows: (amounts are in millionDetermine the total asset turnover, net profit margin, and write your computation result in the table.4. You expect to deposit the following cash flows at the end of years 1 through 5, 1,000; 4,000; 9,000; 5,000; and 2,000 respectively. Alternatively, you could deposit a single amount today at the beginning of year 1 (end of year 0). How much is the single deposit needed to be today if you can earn 10% compounded annually? (10/ )5.Stock A has an expected growth rate of 16% for the first 3 years and 8% thereafter. Each share of stock just received an annual 3.24 dividend per share. The appropriate discount rate is 15%.What is the value of the common stock under this scenario? (10/ )6. The following common stocks are available for investment:COMMON STOCK (TICKER SYMBOL) BETANanyang Business Systems (NBS) 1.40Yunnan Garden Supply, Inc. (YUWHO) .80Bird Nest Soups Company (SLURP) .60! (WACHO) 1.80Park City Cola Company (BURP) 1.05Oldies Records, Ltd. (SHABOOM) .90a. If you invest 20 percent of your funds in each of the first four securities, and 10 percent in each of the last two, what is the beta of your portfolio? (5/ )b. If the risk-free rate is 8 percent and the expected return on the market portfolio is 14 percent, what will be the portfolio's expected return? (5/ )Solutions (B)1. Depreciation changes the timing of tax payments. The longer these payments can be delayed, the better off the business is.2. A primary market is a “new issues” market. Here, funds raised through the sale of new securities flow from ultimate savers to the ultimate investors in real assetsIn a secondary market, existing securities are bought and sold. Transactions in these already existing securities do not provide additional funds to finance capital investmentIV. Problems (60 Points) (Please write your answer on the answer paper)1. Answer:100000=A FVIF(8%,10)=14.487A A=100000/14.487=69032. Answer:a. 24=1.5(1+g)/(0.12-g), g=0.054b. dividend yield=0.12-g=0.066, capital gains yield=0.0541. (10/ ) Many different methods to lead to a correct solution.PV of this mixed flows problem = 1,000(PVIF10%,1) + 4,000(PVIF10%,2) + 9,000(PVIF10%,3) + 5,000(PVIF10%,4) + 2,000(PVIF10%,5) = 15,633.62.5. (1) Determine the annual dividends.D0 = $3.24 (this has been paid already)D1 = D0(1+g1)1 = $3.24(1.16)1 =3.76D2 = D0(1+g1)2 = $3.24(1.16)2 =4.36D3 = D0(1+g1)3 = $3.24(1.16)3 =5.06D4 = D3(1+g2)1 = $5.06(1.08)1 =5.46P3 = 5.46 / (.15 - .08) = $78 [CG Model](2) Determine the PV of cash flows.PV(D1) = D1(PVIF15%, 1) = 3.76 (.870) = 3.27PV(D2) = D2(PVIF15%, 2) = 4.36 (.756) = 3.30PV(D3) = D3(PVIF15%, 3) = 5.06 (.658) = 3.33PV(P3) = P3(PVIF15%, 3) = 78 (.658) = 51.32(3) Calculate the intrinsic value by summing all the cash flow present values.V = 3.27 + 3.30 + 3.33 + 51.326. a) (5/) The beta of a portfolio is simply a weighted average of the betas of the individual securities that make up the portfolio.TICKER SYMBOL BETA PROPORTION WEIGHTED BETANBS 1.40 .2 .280YUWHO .80 .2 .160SLURP .60 .2 .120W ACHO 1.80 .2 .360BURP 1.05 .1 .105SHABOOM .90 .1 .0901.0 1.115The portfolio beta is 1.115.b) (5/ ) Expected portfolio return=.08 + (.14 - .08)(1.115)= .08 + .0669 = .1469 or 14.69%。

1.Financial management Concerns the acquisition, financing and management of assets withsome overall goal in mind.2.Agency (theory) A branch of economics relating to the behavior of principals (such as owners)and their agents (such as managers).3.Stakeholders All constitutes with a stake in the fortunes of the company. They includeshareholders, creditors, customers, employees, suppliers and local communities.4.Corporate governance the systems by which corporations are managed and controlled. Itencompasses the relationships among a company's shareholders, board of directors, and senior management.5.Investment banker A financial institution that underwrites (purchases at a fixed price on afixed date) new securities for resale.6.Annuity A series of equal payments or receipts occurring over a specified number of periods.In an ordinary annuity, payments or receipts occur at the end of each period; in an annuity due, payments or receipts occur at the beginning of each period.mon stock Securities that represent the ultimate ownership (and risk) position in acorporation8.Yield to maturity (YTM) The expected rate of return on a bond if bought at its current marketprice and held to maturity.9.Risk The variability of returns from those that are expected.10.Coefficient of variation (CV) The ratio of the standard deviation of a distribution to the meanof that distribution. It is a measure of relative risk.11.Certainty equivalent (CE) The amount of cash someone would require with certainty at apoint in time to make the individual indifferent between that certain amount and an amount expected to be received with risk at the same point in time.12.Portfolio A combination of two or more securities or assets.13.Characteristic line A line that describes the relationship between an individual security'sreturns and returns on the market portfolio. The slope of this line is beta.14.Beta An index of systematic risk. It measures the sensitivity of a stock's returns to changes inreturns on the market portfolio. The beta of a portfolio is simply a weighted average of the individual stock betas in the portfolio.15.Fund Broadening our conception of funds to include all of the firm's investments and claims(against those investments) allow us to capture all of these transactions as both sources and use of funds. working capital Current assets minus current liabilities.17.Gross working capita l The firm's investment in current assets (like cash and marketablesecurities, receivables, and inventory).18.Working capital management The administration of the firm's current assets and thefinancing needed to support current assets.19.Spontaneous financing Trade credit, and other payables and accruals, that arisespontaneously in the firm's day-to-day operations.20.Outsourcing Subcontracting a certain business operation to an outside firm instead of doingit “in-house”1. We assume in this book that the goal of the firm is to maximize the wealth of the firm's present owners.2. In the USA, there are 4 basic forms of business organization: sole proprietorships, partnerships, corporations, and limited liability companies(LLCs).3. The notion of compound interest is crucial to understanding the mathematics of finance.4. As a result, interest is earned on interest as well as the initial principal. It is this interest-on-interest, or compounding, affect that accounts for the dramatic difference between simple and compound interest.5. The intrinsic value of a security, on the other hand, is what the price of a security should be if properly priced based on all factors bearing on valuation.6. The valuation approach taken in this chapter is one of determining a security's intrinsic value——what the security ought to be worth based on hard facts.7. The relationship between expected return and systematic risk, and the valuation of securities that follows, is the essence of Nobel Laureate William Sharpe's capital-asset pricing model (CAPM).8. The various collection and disbursement methods that a firm employs to improve its cash management efficiency constitute two sides of the coin.Multiple choices:1.Partnerships including general partnerships and limited partnerships2.Financial markets can be broken into 2 classes- the money market and the capital market.the money market is concerned with the buying and selling of short-term government and corporate debt securities. The capital market, deals with relatively long-term debt and equity instrument.3.Within money and capital markets there exist both primar y and secondary market.4.Risk characteristics: default risk, marketability, maturity, taxability and embedded options.5. 3 attitude toward risk:Certainty equivalent < expected value, risk aversion is present.Certainty equivalent = expected value, risk indifference is present.Certainty equivalent > expected value, risk preference is present.6.Total risk= systematic risk + unsystematic riskSystematic risk is due to risk factors that affect the overall market – such as changes in the nation’s economy, tax reform by congress and etc. tUnsystematic risk is risk unique to a particular company or industry; it is independent ofeconomic, political, and other factors that affect all securities in a systematic manner.7.The relationship between expected return and systematic risk and the valuation of securitiesthat follows, is the essence of capital- asset pricing model ( CAPM)8.Three forms of market efficiency:Weak- form efficiency: current prices fully reflect the historical sequence of price. In short, knowing past price patterns will not help you improve forecast of future prices.Semistrong-form efficiency: current price fully reflect all publicly available information,including such things as annual reports and news items.Strong-form efficiency: current price fully reflect all information, both public and private9.Financial statements:Balance sheet summarizes the assets liabilities, and owners’ equity of a business at amoment in time.The income statement summarizes the revenues and expenses of the firm over a particular period of time.From these two statements, certain derivative statements can be produced, such as astatement of retained earnings, a sources and uses of funds statement, and a statement of cash flows.10.The commonly used financial ratios are of essentially two kinds: balance sheet ratios, incomestatement rations. We can further subdivide our financial ratios into five distinct types:liquidity, financial leverage (or debt), coverage, activity, and profitability ratios.11.Each activity’s cash inflow or outflow is segregated according to one of three broad categorytypes: operating, investing, or financing activity.12.Classification of working capitaltime, as either permanent or temporary.13.Two broad aspects of working capital management: what level of currents assets to maintainand how to finance current assets.14.A number of methods are designed to speed up the collection process by doing one or moreof the following: (1) expedite preparing and mailing the invoice; (2) accelerate the mailing of payments form customers to the firm; (3) reduce the time during which paymentsreceived by the firm remain uncollected funds.15.The firm’s portfolio of short-term marketable securities can be thought of as a pie cut into 3:ready cash segment: optimal balance of marketable securities held to take care fo probable deficiencies in the firm’s cash account.controllable cash segment: marketable securities held for meeting controllable outflow, such as taxes and dividendsfree cash segment: “free” marketable securities (that’s available for as yet unassignedpurposes)16.Variables in marketable securities selection: safety, marketability, yield, maturity.Chapter 2 The Business, Tax, and Financial EnvironmentsProblems2. The Loann Le Milling Company is going to purchase a new piece of testing equipment for $28,000 and a new machine for $53,000. The equipment falls in the three-year property class, and the machine is in the five-year class. What annual depreciation will the company be able to take on the two assets?4. the Castle Cork Company was founded in 20X1 and had the following taxable income through 20X5：20X1 20X2 20X3 20X4 20X5$0 $35,000 $68,000 -$120,000 $52,000 Compute the corporate income tax or tax refund in each year, assuming the graduated tax rates discussed in the chapter.Chapter 3 The Time Value of MoneySelf-Correction Problems6. Your late Uncle Vern’s will entitles you to receive $1,000 at the end of every other year for the next two decades. The first cash flow is two years from now. At a 10 percent compound annual interest rate, what is the present value of this unusual cash-flow pattern? (Try to solve this problem in as few steps as you can.)9. Xu Lin recently obtained a 10-year, $50,000 loan. The loan carries an 8 percent compound annual interest rate and calls for annual installment payments of $7,451.47 at the end of each of the next 10 years.a. How much (in dollars) of the first year’s payment is principal?b. How much total interest will be paid over the life of the loan? (Hint: You do not need to construct a loan amortization table to answer this question. Some simple math is all you need.)Problems9. The H & L Bark Company is considering the purchase of a debarking machine that is expected to provide cash flows as follows:END OF YEAR1 2 3 4 5$1,200 $2,000 $2,400 $1,900 $1,600 CashflowEND OF YEAR6 7 8 9 10$1,400 $1,400 $1,400 $1,400 $1,400 CashflowIf the appropriate annual discount rate is 14 percent, what is the present value of this cash-flow stream?19. Assume that you will be opening a savings account today by depositing $100,000.The savings account pays 5 percent compound annual interest, and this rate is assumed to remain in effect for all future periods. Four years from today you will withdraw R dollars. You will continue to make additional annual withdrawals of R dollars for a while longer-making your last withdrawal at the end of year 9- to achieve the following pattern of cash flows over time. (Note: Today is time period zero; one year from today is the end of time period 1; etc.)Cash withdrawals at the END of year …How large must R be to leave you with exactly a zero balance after your final R withdrawal is made at the end of year 9? (Tip: Making use of an annuity table or formula will make your work a lot easier!)Chapter 4 The Valuation of Long-Term SecuritiesProblems10. Just today, Fawlty Foods, Inc.’s common stock paid a $1.40 annual dividend per share and hada closing price of $21. Assume that the market’s required return, or capitalization rate, for this investment is 12 percent and that dividends are expected to grow at a constant rate forever.a. Calculate the implied growth rate in dividends.b. What is the expected dividend yield?c. What is the expected capital gains yield?11. The Great Northern Specific Railway has noncallable, perpetual bonds outstanding. When originally issued, the perpetual bonds sold for $955 per bond; today (January 1) their current market price is $1,120 per bond. The company pays a semiannual interest payment of $45 per bond on June 30 and December 31 each year.a. As of today(January 1), what is the implied semiannual yield on these bonds?b. Using your answer to Part (a), what is the (nominal annual ) yield on these bonds? The (effective annual) yield on these bonds?12. Assume that everything stated in Problem 11 remains the same except that the bonds are not perpetual. Instead, they have a $1,000 par value and mature in 10 years.a. Determine the implied semiannual yield to maturity (YTM) on these bonds. (Tip: If all you have to work with are present value tables, you can still determine an approximation of the semiannual YTM by making use of a trial-and-error procedure coupled with interpolation. In fact, the answer to Problem 11, Part (a)- rounded to the nearest percent- gives you a good starting point for a trial-and-error approach.)b. Using your answer to Part (a), what is the (nominal annual) YTM on these bonds? The (effective annual) YTM on these bonds?Chapter 5 Risk and ReturnSelf- Correction Problems1.Suppose that your estimates of the possible one-year returns from investing in the commona.What are the expected return and standard deviation?b.Assume that the parameters that you just determined [under part (a)] pertain to anormal probability distribution. What is the probability that return will be zero or less?Less than 10 percent? More than 40 percent? (Assume a normal distribution.) Problems2.Summer Storme is analyzing an investment. The expected one-year return on the investmentis 20 percent. The probability distribution of possible returns is approximately normal with a standard deviation of 15 percent.a.What are the chances that the investment will result in a negative return?b.What is the probability that the return will be greater than 10 percent? 20 percent? 30percent? 40 percent? 50 percent?Chapter 6Problems 6Stoney Mason, Inc, has sales of $6 million, a total assets turnover ratio of 6 for the year, and net profits of $120,000.a)What is the company's return on assets or earning power?b)The company is considering the installation of new point-of sales cash registersthroughout its stores. This equipment is expected to increase efficiency in inventory control, reduce clerical errors, and improve record keeping throughout the system. The new equipment will increase the investment in assets by 20 percent and is expected to increase the net profit margin from 2 to 3 percent. No change in sales is expected. What is the effect of the new equipment on the return on assets ratio or earning power?Chapter 9Problems 2The List Company, which can earn 7 percent on money market instruments, currently has a lockbox arrangement with a New Orleans bank for its Southern customers. The bank handles $3 million a day in return for a compensating balance of 2$ million.a)The List Company has discovered that it could divide the southern region into asouth-western region (with $1 million a day in collections, which could be handled by aDallas bank for a $1 million compensating balance). In each case, collections would beone-half day quicker than with the New Orleans arrangement. What would be theannual savings (or cost) of dividing the southern region?b)In an effort to retain the business, the New Orleans bank has offered to handle thecollections strictly on a fee basis (no compensating balance). What would be themaximum fee the New Orleans bank could charge and still retain List's business?。

FINANCIALMANAGEMENT Financial ManagementIntroductionFinancial management plays a vital role in every organization, regardless of its size or industry. It involves the planning, organizing, controlling, and monitoring of financial resources to achieve the goals and objectives of the organization. Effective financial management helps in maximizing profits, minimizing costs, and ensuring the overall financial health of the organization.Importance of Financial ManagementFinancial management is crucial for several reasons. First, it helps in ensuring the availability of funds when needed. By accurately analyzing and predicting future cash flows, financial managers can determine the amount of funds required for various activities within the organization. This includes managing working capital, capital budgeting, and evaluating investment opportunities.Second, financial management assists in making informed business decisions. By providing financial information and analysis, managers can evaluate different alternatives and choose the most appropriate course of action. Financial management techniques such as cost analysis, breakeven analysis, and financial ratios help in assessing the financial viability and profitability of different projects or products.Third, financial management helps in mitigating financial risks. Every business faces various financial risks such as credit risk, market risk, and interest rate risk. Financial managers employ several risk management techniques such as hedging, diversification, and insurance to minimize the impact of these risks on the organization.Key Components of Financial ManagementFinancial management comprises several key components that work together to ensure effective management of resources. These components include:1. Financial Planning: Financial planning involves setting financial goals and developing strategies to achieve them. It includes forecasting sales, estimating expenses, and creating a budget that aligns with organizational objectives.2. Financial Analysis: Financial analysis involves the interpretation and evaluation of financial statements to assess the financial performance of the organization. It includes analyzing key financial ratios, such as liquidity ratios, profitability ratios, and leverage ratios.3. Capital Budgeting: Capital budgeting involves analyzing and evaluating investment opportunities to determine which projects or assets are most financially viable. This is crucial for allocating resources efficiently and ensuring optimal return on investment.4. Cash Flow Management: Cash flow management is about monitoring and controlling the inflow and outflow of cash within the organization. It involves managing working capital, maintaining appropriate cash reserves, and managing cash flows to ensure smooth operations.5. Risk Management: Risk management involves identifying, assessing, and mitigating financial risks that may impact the organization. Financial managers employ various risk management techniques such as insurance, hedging, and diversification to protect the organization from potential financial losses.6. Financial Reporting: Financial reporting involves preparing and presenting financial statements and reports to stakeholders, including shareholders, creditors, and regulatory authorities. These reports provide an overview of the financial position and performance of the organization, ensuring transparency and accountability.ConclusionFinancial management is a critical function in any organization, providing the necessary tools and techniques to manage financial resources effectively. By implementing sound financial management practices, organizations can improve profitability, minimize costs, and ensure long-term financial sustainability. Financial planning, analysis, capital budgeting, cash flow management, risk management, and financial reporting are the key components that contribute to successful financial management. It is essential for organizations to have competent financial managers who can navigate the complexities of the financial landscape and make informed decisions to drive growth and success.。

ContemporaryFinancialManagement10th现代财务管理英文版全套习题Contemporary Financial Management 10th现代财务管理英文版全套习题ContentsChapter 1 The Role and Objective of Financial Management 1 Chapter 2 The Domestic and International Financial Marketplace 13 Appendix 2A Taxes 26Chapter 3 Evaluation of Financial Performance 31Chapter 4 Financial Planning and Forecasting 51Chapter 5 The Time Value of Money 66Appendix 5A Continuous Compounding and Discounting 95 Chapter 6 Analysis of Risk and Return 99Chapter 7 Fixed Income Securities: Characteristics and Valuation 127 Chapter 8 Common Stock: Characteristics, Valuation, and Issuance 153 Chapter 9 Capital Budgeting and Cash Flow Analysis 179 Chapter 10 Capital Budgeting: Decision Criteria and Real Option Considerations 202 Appendix 10A Mutually Exclusive Investments Having Unequal Lives 221 Chapter 11 Capital Budgeting and Risk 228Chapter 12 The Cost of Capital 246Chapter 13 Capital Structure Concepts 270Chapter 14 Capital Structure Management in Practice 285 Chapter 15 Dividend Policy 306Chapter 16 Working Capital Policy and Short-Term Financing 327 Chapter 17 The Management of Cash and Marketable Securities 344 Chapter18 Management of Accounts Receivable and Inventories 360 Chapter 19 Lease and Intermediate-Term Financing 376 Chapter20 Financing with Derivatives 388Appendix 20B Bond Refunding Analysis 404Chapter 21 Risk Management 408Chapter 22 International Financial Management 415Chapter 23 Corporate Restructuring 425Chapter 1The Role and Objective of Financial ManagementMULTIPLE CHOICE1. The primary objective of the firm is:a. Shareholder wealth maximizationb. Social responsibilityc. Long run survivald. Profit maximizationANS: A OBJ: TYPE: Fact TOP: A Foundation Concept2. The limitations of the profit maximization goal include:a. It lacks a time dimension (i.e., it is static)b. It fails to consider riskc. The definition of profit is ambiguousd. All the above are limitationsANS: D OBJ: TYPE: FactTOP: Maximization of shareholder wealth: Managerial strategies3. The shareholder wealth maximization goal states that management should seek tomaximize the _______ of the expected future returns to the owners of the firm.a. Future valueb. Compound valuec. Percentage valued. Present valueANS: D OBJ: TYPE: Fact TOP: A Foundation Concept4. Shareholder returns can take the form ofa. Periodic dividend paymentsb. Proceeds from the sale of the stockc. Periodic interest paymentsd. Periodic dividend payments and proceeds from the sale of the stockANS: D OBJ: TYPE: Fact TOP: A Foundation Concept5. Shareholder wealth is measured by the ________ of the shareholders' common stockholdings.a. Book valueb. Market valuec. Historic valued. Compound valueANS: B OBJ: TYPE: Fact TOP: A Foundation Concept6. The objective of maximizing shareholder wealth, as measured by the market value of thefirm's stocka. does not consider the timing of the benefits receivedb. provides a way to consider the risk of the returns being offeredc. benefits only certain stockholdersd. neither considers the timing of the benefits received norbenefits only certainstockholdersANS: B OBJ: TYPE: Fact TOP: A Foundation Concept7. The two most important disciplines on which financial management relies area. accounting and productionb. accounting and marketingc. economics and marketingd. accounting and economicsANS: D OBJ: TYPE: Fact TOP: Financial management and other disciplines8. The most widely accepted objective of the firm is toa. minimize riskb. maximize profitsc. maximize shareholder wealthd. maximize earnings per shareANS: C OBJ: TYPE: Fact TOP: A Foundation Concept9. The ______ the risk of receiving future cash flows, the ______ will be the present valueof those cash flows.a. greater, greaterb. greater, lowerc. lower, lowerd. lower, greaterANS: B OBJ: TYPE: Fact TOP: Risk10. A major advantage of using the maximization of shareholder wealth as the primary goalof the firm is that this goal considersa. the timing and the risk of the expected benefits to be receivedb. the investor's consumption utilityc. the value of closely held partnershipsd. all the aboveANS: A OBJ: TYPE: Fact TOP: A Foundation Concept11. The primary reason for the divergence between the shareholder wealth maximization goaland the actual goals pursued by management has been attributed toa. separation of social responsibility and stakeholders' concernsb. separation of ownership and controlc. separation of personal welfare and long-run profit goalsd. the granting of "golden parachute" contractsANS: B OBJ: TYPE: Fact TOP: Divergent objectives12. Giving top management _______ is one method that ensures managers will act in theinterest of shareholders in merger decisions.a. "golden parachute" contractsb. excellent payc. executive perksd. job securityANS: A OBJ: TYPE: Fact TOP: Divergent objectives13. _____ arise from the divergent objectives between owners and managers.a. Shareholder relationshipsb. Stakeholder problemsc. Creditor problemsd. Agency problemsANS: D OBJ: TYPE: Fact TOP: Agency problems14. Agency costs include all of the following except:a. expenditures to monitor management's actionsb. providing stock as part of management's compensationc. flotation costsd. bonding expendituresANS: C OBJ: TYPE: Fact TOP: Stockholders and managers15. A potential agency conflict can arise betweenstockholders and creditors because ownersmaya. increase the risk of a firm's investmentsb. decrease the amount of debt outstandingc. decrease the risk of a firm's investmentsd. increase the firm's net worthANS: A OBJ: TYPE: Fact TOP: Stockholders and creditors16. When KKR acquired RJR Nabisco, the ______ in the debt ratio, resulted in a(n) ______in the value of the firm's outstanding bonds.a. decrease, increaseb. increase, increasec. decrease, declined. increase, declineANS: D OBJ: TYPE: Fact TOP: Stockholders and creditors17. Agency problems may give rise to costs that ______ the market value of firms.a. increaseb. decreasec. do not affectd. are not important toANS: B OBJ: TYPE: Fact TOP: Stockholders and managers18. All of the following are problems with the microeconomic profit maximization modelexcept:a. the absence of a time dimensionb. offers financial managers insights to a wide range of problemsc. does not consider the risk of alternative decisionsd. the problem of defining profitsANS: B OBJ: TYPE: FactTOP: Maximization of shareholder wealth: Managerial strategies19. ________ are largely outside of the direct control of managers.a. investment strategiesb. economic environment factorsc. major policy decisionsd. dividend policiesANS: B OBJ: TYPE: Fact TOP: Managerial actions to influence value20. The success of a firm is linked to its stakeholders. This group includes:a. community neighborsb. suppliersc. employeesd. all the aboveANS: D OBJ: TYPE: Fact TOP: Social responsibility concerns21. Techniques identified by John Casey that managers could keep in mind when addressingthe ethical dimensions of a business problem include all of the following except:a. collect all the facts bearing on the problemb. clarify the parameters of the problemc. involve all parties with a financial interest in the outcomed. seek equity for those who may be affectedANS: C OBJ: TYPE: FactTOP: Ethical issues: the practice of financial management22. Many small business owners are _________ diversified with respect to their personalwealth.a. poorlyb. highlyc. welld. 90%ANS: A OBJ: TYPE: FactTOP: Entrepreneurial finance issues: Shareholder wealth maximizat23. __________ deals with economic decisions of individuals, households, and firms.a. Economic accountingb. Microeconomicsc. Blue Chip econometricsd. MacroeconomicsANS: B OBJ: TYPE: Fact TOP: Economics24. Financial management draws heavily on the following related disciplines:a. accountingb. macroeconomicsc. microeconomicsd. all of the aboveANS: D OBJ: TYPE: Fact TOP: Financial management and other disciplines25. The chief financial officer (CFO) normally has responsibilityfor all the following except:a. advertising strategyb. managing interest rate riskc. trading foreign currenciesd. accounting functionsANS: A OBJ: TYPE: Fact TOP: Organization of the financial management function26. The controller normally has responsibility for all _______ related activities, while thetreasurer is normally concerned with ________.a. acquisition, data processingb. tax, cost accountingc. tax, financial accountingd. accounting, expenditure of fundsANS: D OBJ: TYPE: Fact TOP: Organization of the financial management function27. According to the shareholder wealth maximization goal, management should seek tomaximize the __________ of the __________ to owners.a. present value; expected pretax cash flowsb. future value; expected pretax cash flowsc. present value; expected future returnsd. future value; expected future returnsANS: C OBJ: TYPE: Fact TOP: A foundation concept28. Shareholder wealth is measured by the __________.a. book value of the shareholders' common stock holdingsb. market value of the shareholders' common stock holdingsc. book value of the company's assetsd. market value of the company's assetsANS: B OBJ: TYPE: Fact TOP: Determinants of value29. Among the most important agency relationships in the context of finance is (are) therelationship(s) between __________.a. stockholders and creditorsb. management and workersc. stockholders and creditors, and management and workersd. management and creditorsANS: A OBJ: TYPE: Fact TOP: Agency problems30. Protective covenants in a company's bond indentures are used in agency relationshipsinvolving __________.a. stockholders and managersb. stockholders and creditorsc. management and workersd. management and creditorsANS: B OBJ: TYPE: Fact TOP: Stockholders and creditors31. The chief financial officer (CFO) of a corporation normally reports to the_______________________ of the company.a. chairman of the board of directorsb. chief operating officerc. controllerd. chief executive officerANS: D OBJ: TYPE: Fact TOP: Organization of the financial management function32. The ___________ has a goal of serving as a bridge between academic study of financeand the application of financial principles by financial managers.a. Financial Executives Instituteb. Financial Management Associationc. American Finance Associationd. Institution of Financial AnalystsANS: B OBJ: TYPE: Fact TOP: Professional finance affiliation33. All of the following economic environment factors affectstock prices except:a. investment strategiesb. competitionc. tax ratesd. currency exchange ratesANS: A OBJ: TYPE: Fact TOP: Managerial actions to influence value34. The major factors that determine the market value of a company's shares of stock includethe __________ .a. risk of its cash flowsb. timing of its cash flowsc. book value of its assetsd. risk of its cash flows and the timing of its cash flowsANS: D OBJ: TYPE: Fact TOP: Determinants of value35. There is often a divergence between the shareholder wealth maximization goal and theactual goals pursued by management. The primary reason for this is __________.a. geographical dispersion of shareholdersb. separation of ownership and controlc. age differences between managers and shareholdersd. that both have their own agendasANS: B OBJ: TYPE: Fact TOP: Divergent objectives36. The existence of divergent objectives between owners and managers is one example of aclass of problems arising from __________.a. social responsibility concernsb. age differences between managers and ownersc. agency relationshipsd. union-management relationsANS: C OBJ: TYPE: Fact TOP: Agency problems37. The activities of the treasurer include all of the following except:a. financial planningb. tax preparationc. credit analysisd. pension fund managementANS: B OBJ: TYPE: Fact TOP: Organization of the financial management function38. The most important managerial objective is to:a. make MC=MRb. maximize profitsc. minimize agency costsd. none of the aboveANS: D OBJ: TYPE: Fact TOP: A foundation concept39. _______ are important because the financial health of a firm depends on the firm beingable to generate sufficient cash to pay its creditors, employees, suppliers, and owners.a. cash salesb. cash flowsc. cash profitsd. net profitsANS: B OBJ: TYPE: Fact TOP: A foundation concept40. One method of decreasing the cash outflows of a firm is toa. decrease depreciationb. increase capital expendituresc. decrease dividendsd. increase debt repaymentANS: C OBJ: TYPE: Fact TOP: Cash flow41. If a firm shows an accounting net income, thena. it will not have a cash flow problemb. it will not have a problem obtaining a bank loanc. it will be able to repay all current liabilities on timed. none of the aboveANS: D OBJ: TYPE: Fact TOP: Cash flow42. Cash flow concepts are _____ but generally accepted accounting principles are ______ inthe determination of a firm's net income.a. unambiguous, ambiguousb. ambiguous, unambiguousc. ambiguous, also ambiguousd. unambiguous, straightforwardANS: A OBJ: TYPE: Fact TOP: Importance of cash flow43. Accounting-based measures of performance include all the following excepta. return on equityb. cash flowc. return on assetsd. market shareANS: B OBJ: TYPE: Fact TOP: Cash flows and shareholder wealth44. Accounting-based measures of performance _____ subject to short-term manipulation bymanagers; cash flows ______ subject to short-term manipulation.a. are, are notb. are not, arec. are, are alsod. are not, also are notANS: A OBJ: TYPE: Fact TOP: Cash flows and shareholder wealth45. The net present value rule provides appropriate guidance for financial decision makerswhen costs are incurred immediately buta. future cash flows are not known with certaintyb. marginal costs are equal to marginal revenuec. result in a stream of benefits over several future time periodsd. marginal costs are greater then marginal revenueANS: C OBJ: TYPE: Fact TOP: Net present value rule46. Corporate officers normally include all the following except:a. Secretaryb. Chief operating officerc. Treasurerd. Financial analystANS: D OBJ: TYPE: Fact TOP: Corporate organization47. The difference between a firm's annual after-tax operating profit and its total annual costof capital is known as:a. earned incomeb. Economic Value Addedc. Managerial Value Addedd. operating incomeANS: B OBJ: TYPE: Fact TOP: Divergent objectives48. ____ equals the number of shares outstanding times the market price per share.a. Book valueb. Stakeholders wealthc. Total shareholder wealthd. Economic valueANS: C OBJ: TYPE: Fact TOP: A Foundation Concept49. Which of the following companies requires that its top officers own common stock in thecompany that is at least equal to their annual salary.a. Ford Motor Companyb. Tucson Electric Power Companyc. Panhandle Easternd. Anheuser-BuschANS: A OBJ: TYPE: Fact TOP: Divergent Objectives50. The net present value of an investment made by a firm represents the contribution of thatinvestment to the ____ of the firm.a. book valueb. profitc. valued. cash flowANS: C OBJ: TYPE: Fact TOP: Net present value rule51. A major advantage of the corporate form of business over both sole proprietorships andpartnerships is thea. limited liabilityb. reduction in taxesc. ease of formationd. ability to maintain ownershipANS: A OBJ: TYPE: Fact TOP: Corporation52. Which of the following is not an advantage that thecorporate form of business has overeither the sole proprietorship or partnership?a. ability to raise capitalb. ease of changing ownershipc. limited liabilityd. elimination of double taxesANS: D OBJ: TYPE: Fact TOP: Corporation53. A major disadvantage of a sole proprietorship is the fact thata. it is expensive to establishb. the owner has unlimited personal liabilityc. it is easy to finance growthd. the owner pays taxes on all the incomeANS: B OBJ: TYPE: Fact TOP: Sole proprietorship54. In a limited partnership, the limited partners may limit their:a. tax liabilityb. liabilityc. tax write-offd. ability to attract new productsANS: B OBJ: TYPE: Fact TOP: Partnership55. Corporate securities represent claims against thea. corporate officers of the firmb. agents of the corporationc. liabilities and net worth of the firmd. assets and future earnings of the firmANS: D OBJ: TYPE: Fact TOP: Corporate securities56. _________ is (are) referred to as a residual form of ownershipin a corporation.。

EXAM PAPER 1I. True(T) or False(F). Please fill in the bracket with T or F. (15%)1. In financial management, the more appropriate goal of the firm is maximization of shareholderwealth. ( )2. The component cost of preferred stock must be adjusted for taxes which the stockholdersmust pay on the dividends. ( )3. If an investment project has a profitability index of 1.15, the project’s internal rate of returnexceeds its net present value. ( )4. With an annuity due the payments occur at the end of each period. ( )5. If the firm decides to impose a capital constraint on investment projects, the appropriatedecision criterion is to select the set of projects with the highest NPV subject to the capital constraint. ( )6. Business risk refers to the relative dispersion in the firm’s EBIT. ( )7. Net working capital equals current assets less current liabilities. ( )8. Under MM’s model with corporate taxes, the benefits of debt financing stem solely from the taxdeductibility of interest payments. ( )9. Investors can only expect to receive a return for incurring unsystematic risk. ( )10. The Security Market Line is a risk-return trade-off for combinations of the market portfolio andthe riskless asset. ( )II. Multiple Choice (15%)1. Dorset Ltd wishes to calculate its weighted average cost of capital for use in investmentappraisal. The company is financed by 150 million $1 ordinary shares, which have a current market value of $2, and $100 million 12 per cent irredeemable debentures, which are currently quoted at $150 per $100 nominal value. The cost of ordinary share capital is 11 per cent and the rate of corporation tax is 25 per cent.What is the weighted average cost of capital for Dorset Ltd? (To one decimal place)A. 9·0 per centB. 9·3 per centC. 10·4 per centD. 11·4 per cent2. Cheshire Ltd has developed a revolutionary form of tyre gauge at a cost of $300,000 to date.To produce the tyre gauge, a new machine will be acquired immediately at a cost of $750,000.The machine will be sold at the end of the five years for $350,000 and will be depreciated over its life using the straight-line method.The tyre gauge has an expected life of five years and estimated future profits from the product are: Years1 2 3 4 5$000 $000 $000 $000 $000Estimated profit 80 160 240 140 130What is the payback period for the new tyre gauge? (To the nearest month)A. 3 years 2 monthsB. 4 years 2 monthsC. 4 years 3 monthsD. 4 years 11 months3. Cumbria Ltd has $1 ordinary shares in issue that have a current market value of $3. Thedividend expected for next year is $0·40 and future dividends are expected to grow at the rate of 5 per cent per annum. The rate of corporation tax is 20 per cent and the dividend Growth model is used to calculate the cost of ordinary shares.What is the cost of ordinary shares to the business?A. 6·1%B. 15·7%C. 18·3%D. 19·0%4. Calcite Ltd used the NPV and IRR methods of investment appraisal to evaluate a project thathas an initial cash outlay followed by annual net cash inflows over its life. After the evaluationhad been undertaken, it was discovered that the cost of capital had been incorrectly calculated and that the correct cost of capital figure was in fact higher than that used.What will be the effect on the NPV and IRR figures of correcting for this error?Effect onNPV IRRA. Decrease DecreaseB. Decrease No changeC. Increase IncreaseD. Increase No Change5. A business evaluates an investment project that has an initial outlay followed by annual netcash inflows of $10 million throughout its infinite life. The evaluation of the inflows produced a present value of $50 million and a profitability (present value) index of 2·0.What is the internal rate of return and initial outlay of this project?IRR Initial outlay% $mA. 20 25B. 20 100C. 40 25D. 10 1006. Quartz Ltd pays an annual dividend of 30 cent per share to shareholders, which is expected tocontinue in perpetuity. The average rate of return for the market is 9% and the company has a beta coefficient of 1·5. The risk-free rate of return is 4%.What is the expected rate of return for the shareholders of the company and the predicted value of the shares in the company?Expected rate Predictedof return value(%) (cent)A. 23·5 705B. 17·5 171C. 16·5 182D. 11·5 2617. Tourmaline Ltd pays its major credit supplier 40 days after receiving the goods and receives nosettlement discount. The supplier has recently offered the company revised credit terms of 3/10, net 40.If Tourmaline Ltd refuses the settlement discount and pays in full after 40 days, what is the approximate, implied, interest cost that is incurred by the company per year?A. 10·3%B. 27·4%C. 28·2%D. 37·6%8. Carrickfergus Ltd wishes to forecast its financial performance and position for the forthcomingyear. The forecast model used by the company incorporates the following relationships: Sales: total assets employed 2·5:1Current assets: current liabilities 1·8:1Quick assets: current liabilities 1·2:1Fixed assets: current assets 1·0:1If sales for the forthcoming year are expected to be $800,000, what is the forecast closing stock figure?A. $53,333B. $71,111C. $85,926D. $96,000.9. The Modigliani and Miller (no taxes) proposition concerning capital gearing states that, as thelevel of capital gearing increases from zero,A. the cost of equity capital will remain unchangedB. the weighted average cost of capital will decreaseC. the value of the business will remain unchangedD. the cost of loan capital will increase.10. A study of the shares of companies listed on a particular stock market found that:(i) share prices were independent of past share price movements and followed a random path. (ii) some investors used the published accounts of the companies to analyse performance and, by doing so, made abnormal gains over many years.Which of the following would be consistent with these findings?A. The stock market is inefficientB. The stock market is efficient in the weak formC. The stock market is efficient in the semi-strong formD. The stock market is efficient in the strong form11. The economic order quantity (EOQ) for stocks can be calculated by using an equation of theform:)/2(ZXY EOQ=What is Z in the above equation?A. Cost of placing an orderB. Annual demand for the item of stockC. Cost of holding one unit of stock for one yearD. The lead time between placing an order and receiving the goods12. Which of the following is associated with the problem of “overtrading”?A. Higher-than-normal earnings per shareB. Higher-than-normal sales to capital employed ratioC. Lower-than-normal gearing ratioD. Lower-than-normal stock turnover ratio13. Investors have an expected rate of return of 8% from ordinary shares in Algol Ltd, which have abeta of 1·2. The expected returns to the market are 7%.What will be the expected rate of return from ordinary shares in Rigel Ltd, which have a beta of 1.8?A. 9·0%B. 10·5%C. 11·0%D. 12·6%.14. Chrysotile Ltd has ordinary shares with a par value of $0·50 in issue. The company generatedearnings per share of 45c for the financial year that has just ended. The dividend cover ratio is 2·5 times and the gross dividend yield is 2% (Ignore taxation).What is the price/earnings ratio of the company?A. 2·8 timesB. 5·0 timesC. 20·0 timesD. 40·0 times15. Ethical behavior is important because it:A. builds customer loyaltyB. builds a good reputationC. avoids fines and legal expensesD. all of the aboveIII. Solving the following problems. (60 marks)1. Brambling (Electronics) Ltd is a research-led business that specialises in the development of surveillance equipment. The company has recently developed a new form of camera with a powerful fibre-optic lens and is currently considering whether or not to produce the camera. The Board of Directors will soon meet to make a final decision and has the following information available to help it decide:(i) The cost of developing the camera has been $1,400,000 to date and the company iscommitted to spending a further $350,000 within the next two months.(ii) The company has spare production capacity and can produce the camera using machinery that will cost $4,700,000 and which will be purchased immediately. It isexpected to be sold at the end of four years for $800,000.(iii) Total fixed costs identified with the production of the camera are $1,725,000 per year.This includes a depreciation charge in respect of the machinery of $975,000 per yearand a charge allocated to represent a fair share of the fixed costs of the business as awhole of $250,000 per year.(iv) The cameras are expected to sell for $10,000 each and the marketing department believes that the business can sell 800 cameras per year over the next four years.(v) The variable costs of production are $7,000 per camera.(vi) If the business decides not to produce the camera it can sell the patents immediately for $1,300,000.The company has a cost of capital of 12%.Ignore taxation.Required:(a) Calculate the net present value of producing and selling the new camera versus thealternative of selling the patent. (6 marks)(b) Carry out a separate sensitivity analysis to show by how much the following factorswould have to change before the proposal to produce and sell the new camera has an NPV of zero:(i) the initial outlay on the machinery;(ii) the discount rate;(iii) the residual value of the machinery;(iv) the annual net operating cash flows. (11 marks)(c) Briefly evaluate your findings in (a) and (b) above. (3 marks)(20 marks)2.Grebe Ltd operates a chain of cellular telephone stores in the UK. An abbreviated profit and loss account and balance sheet of the business for the year that has just ended is as follows: Abbreviated profit and loss account for the year ended 31 May 2003$000SalesOperating profit for the year Debenture interest payable 6,450 800 160Net profit before taxation Corporation tax (20%)Net profit after taxation Dividends proposed Retained profit for the year 640 128 512 256 256Abbreviated balance sheet as at 31 May 2003$000$000 Fixed assets at written down valuesCurrent assetsLess Creditors: amounts falling due within one yearLess Creditors: amounts falling due after more than one yearCapital and reserves$0·50 Ordinary sharesRetained profit 1,8001,1003,5007004,2002,0002,2006001,6002,200The company is expecting a surge in sales following advances in cellular telephone technology that should translate into additional operating profits of $180,000 per year for the foreseeable future. However, the company will need to invest $1,200,000 immediately in expanding the asset base of the business if it is to achieve these additional profits.The business has approached a large supplier that already has an equity investment in the business to see whether it would be prepared to provide further funds for the business. The supplier has indicated it would be willing to provide the necessary funds by either:(i) an issue of $0·50 ordinary shares at a premium of $1·50 per share, or(ii) an issue of $1,200,000 10% debentures at par.The Board of Directors of Grebe Ltd has already announced that it will maintain the same dividend payout ratio in future years as in the past and that this policy will be unaffected by the form of finance raised.Required:(a) For each of the financing options, calculate the forecast earnings per share for theforthcoming year;(10 marks)(b) Calculate the level of operating profit at which the earnings per share will be the sameunder each financing option. (10 marks)(20 marks)3. Bartok Ltd produces a single product. Financial data concerning the product is as follows:$ $Selling price per unit 20Variable cost per unit 17Fixed costs per unit 2 19Net profit 1At present, total credit sales for the product are $1·2m and the average collection period is one month. In order to stimulate sales for the product, the company is considering liberalising its credit policy so as to allow an average collection period of 1 1/2 months. This change of policy will allow the company to break into the US market where, currently, it has no presence. As a result of this breakthrough, sales will increase by 25%. However, there would be an additional investment required in stocks of $150,000 and an increase in trade creditors of $50,000.The company requires a 25% rate of return on its investments.Ignore taxation.Required:(a) Evaluate the proposal to increase the average collection period for debtorsassuming:(i) all customers take advantage of the longer credit period (8 marks)(ii) only new customers take advantage of the longer credit period. (8 marks)(b) Identify and discuss the main factors which influence the credit terms granted tocustomers by a company. (4 marks)(20 marks)ANSWERS FOR EXAM PAPER 1I. (10%, 1 mark each)1. T2. F3. F4. F5. T6. T7. T8. T9. F 10. FII. (30%, two marks each)1. B2. A3. C4. B5. C6. D7. D8. A9. C 10. B 11. C 12. B 13. C 14. C 15. DIII. (60%, 20marks each)1. (a) Annual operating cash flows can be calculated as follows:$m $m Sales (800 x $10,000) LessVariable costs (800 x $7,000) Fixed costs5·6 0·58·0 6·1 1·9(2 marks)Cash flows relating to the project are as follows:Year0 $m1 $m 2$m 3 $m 4 $m Machinery Opportunity cost Annual cash flows(4·7) (1·3) (6·0)1·9 1·91·9 1·91·9 1·90.8 1·9 2·7(2 marks)The net present value of the project is:$m $m $m $m $mCash flows Discount rate (12%) Present valueNPV (6·0)1·0(6·0)0·291·90·891·691·90·801·521·90·711·352·70·641·73(2maks)(b) (i) The increase required in the initial outlay on machinery before the project becomes nolonger profitable will be $0·29m. The machinery is already expressed in present value terms and so this figure is the same as the net present value of the project. This figure is 6·2% higher than the initial cost figure stated. (2 marks)(ii) If the discount rate is increased to 14%, the NPV of the project is:$m $m $m $m $mCash flows Discount rate (14%) Present valueNPV (6·0)1·0(6·0)0·011·90·881·671·90·771·461·90·681·292·70·591·59Thus, the project will become unprofitable at approximately 14% cost of capital.This represents a 16·7% increase in the cost of capital. (3 marks)(iii) The decrease in the residual value of the equipment (R) that will make the project no longer profitable is calculated as follows:(R x discount factor at the end of four years) – NPV of the project = 0This can be rearranged as follows:(R x discount factor at the end of four years) = NPV of the projectR x 0.64 = $0·29 mR = $0·29m/0·64= $0·45mThis represents a 43·8% decrease in the estimated residual value. (3marks)(iv) The decrease in annual net operating cash flows (C) to make the project no longer profitable is calculated as follows:(C x annuity factor for a four-year period) – NPV = 0This can be rearranged as follows:(C x annuity factor for a four-year period) = NPV C x 3·04 = $0·29m C = $0·29m/3·04 C = $0·095mThis represents a decrease of 5·0% on the estimated annual net operating cash flows. (3marks)(c) The net present value calculations in (a) above indicate that the project will increaseshareholder wealth if it is accepted. The sensitivity calculations in (b) above show by how much each of the key variables will have to change before the project becomes no longer profitable. It can be seen that the most sensitive factor is the annual net operating cash flows followed by the initial cost of the machinery, the discount rate and finally the residual value of the machinery. The annual net operating cash flows will require only a five per cent decrease before the project ceases to be profitable. (3marks)2 (a) Forecast profit and loss account for the year ended 31 May 2004Shares $000Debentures$000 Profit before interest and taxation Debenture interest payable Profit before taxation Corporation tax (20%) Profit after taxation DividendRetained profit for the year Forecast earnings per share980 160 820 164 656 328 328$656,000/1,800,000=36·4c (5marks)980 280 700 140 560 280 280$560,000/1,200,000 46·7c (5marks)(b) The level of operating profit, or profit before interest and taxation (PBIT), at which earnings per share under each method are equal (PBIT = x) is calculated as follows:Shares Debentures(x – B/E PBIT)(1 – tax rate) (x – B/E PBIT)(1 – tax rate)––––––––––––––––––––––– = –––––––––––––––––––––––No. of shares No. of sharesThe level of PBIT at which earnings per share are equal is:(x – $0·16m)(1 – 0·20) (x – $0·28m)(1 – 0·20)–––––––––––––––––––– = –––––––––––––––––––– (3 marks)1·8m 1·2m(0·8 x – $0·128m) (0·8 x – $0·224m)––––––––––––––––– = ––––––––––––––––1·8m 1·2m0·96m x – $0·1536m = 1·44m x – $0·4032m0·48m x = $0·2496mx = $0·52m (2 marks)3. (a) (i) The contribution per unit is $3 (i.e. $20 - $17). A 25% increase in sales will lead to anincrease of sales revenue of $0·3m or 15,000 units (i.e. $0·3m/$20). Hence the increase in contribution and profit will be:15,000 x $3 = $45,000 (4marks)The additional investment required will be:$Increase in stocksIncrease in debtors [($1·5m/12 ) x 11/2m] - [(1·2m/12) x 1m)]Increase in creditorsNet increase in working capitalReturn on investment 150,00087,500237,50050,000187,500= 45,000 x 100% 187,500= 24·0 %(6 marks)(ii) The additional investment required will be:$Increase in stocksIncrease in debtors [($0·3m/12) x 11/2]Increase in creditorsNet increase in working capital Return on investment 150,00037,500187,50050,000137,500= 45,000 x 100% 137,500= 32·7 %(6 marks)Thus, it is if new customers only take advantage of the longer credit period that the proposed change in policy will meet the profit requirements of the company.(b) The main factors that influence the credit terms granted to customers are: Management policies/Market strength /Order size and frequency /Profitability /Resources of the business /Resources of the customer/Industry norms, etc.(4 marks)。