Name: ____________________
ID: ___________________
Birla Institute of Technology & Science, Pilani
FIN F 315 / ECON F 315 Financial Management
Comprehensive Exam - 09 May 2019 Weight-age 43% (130 marks) Time 180 Min.
Part A (Closed Book). There are thirty questions and each question carries 2 marks. There
is ONLY one correct option for each question. Write your final answer in the table given
below. 1 mark will be deducted for every wrong answer.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
1. If a project has a net present value equal to zero, then:
A. the initial cost of the project exceeds the present value of the project’s subsequent
cash flows
B. the internal rate of return exceeds the discount rate
C. the project produces cash inflows that exceed the minimum required inflows
D. any delay in receiving the projected cash inflows will cause the project’s NPV to
be negative
E. the discount rate exceeds the internal rate of return
Ans: D
2. For investment projects, the internal rate of return (IRR):
A. rule indicates acceptance of an investment when the IRR is less than the discount
rate
B. is the rate generated solely by the cash flows of the investment
C. is used primarily to rank projects of varying sizes
D. is the rate that causes the net present value of a project to equal the project’s
initial cost
E. can effectively be used to compare all types of projects
Ans: B
3. Matt is analyzing two mutually exclusive projects of similar size. Both projects have 5year lives. Project A has an NPV of $18,389, a payback period of 2.38 years, an IRR of
15.9 percent, and a discount rate of 13.6 percent. Project B has an NPV of $19,748, a
payback period of 2.69 years, an IRR of 13.4 percent, and a discount rate of 12.8 percent.
He can afford to fund either project, but not both. Matt should accept:
A. Project A because of its payback period
B. both projects as they both have positive NPVs
C. Project B based on its NPV
D. Project A because of its IRR
E. neither project based on their IRRs
Ans: C
4. If a project is assigned a required rate of return of zero, then
A. the timing of the project's cash flows has no bearing on the value of the project
B. the project will always be accepted
C. the project will always be rejected
D. whether the project is accepted or rejected will depend on the timing of the cash
flows
E. the project can never add value for the shareholders
Ans: A
5. The payback method
A. determines a cutoff point so that all projects accepted by the NPV rule will be
accepted by the payback period rule
B. determines a cutoff point equal to the point where all initial capital investments
have been fully depreciated
C. requires an arbitrary choice of a cutoff point
D. varies the cutoff point with the market rate of interest
E. is rarely used in actual practice
Ans: C
6. The modified internal rate of return:
A. is used as the discount rate for all NPV calculations
B. applies only to profitability calculations
C. is used to make accept/reject decisions when no discount rate can be assigned
D. is computed by combining cash flows until only one change in sign remains
E. assumes all projects are financing projects
Ans: D
7. The two fatal flaws of the internal rate of return decision rule are the:
A. arbitrary determination of a discount rate and the failure to consider initial
expenditures
B. arbitrary determination of a discount rate and the failure to correctly analyze
mutually exclusive investment projects
C. arbitrary determination of a discount rate and the multiple rate of return problem
D. failure to consider initial expenditures and failure to correctly analyze mutually
exclusive investment projects
E. failure to correctly analyze mutually exclusive investment projects and the
multiple rate of return problem
Ans: E
8. The elements that cause problems with the use of the IRR in projects that are mutually
exclusive are referred to as the:
A. discount rate and scale problems
B. timing and scale problems
C. discount rate and timing problems
D. scale and reversing flow problems
E. timing and reversing flow problems
Ans: B
9. Geet is considering an investment costing $55,000 that has cash flows of $35,000 in Year
2, $36,000 in Year 3, and −$5,000 in Year 4. He requires a rate of return of 8 percent and
has a required discounted payback period of three years. If the risk free rate is 7%, based
on the discounted payback method should he make this investment? All things
considered, do you agree with this decision? Why or why not?
A. yes; because the NPV is positive and the project pays back on a discounted basis
within the assigned time period and the final cash outflow is ignored by payback
B. yes; but only because the discounted payback requirement is met
C. no; although the project earns more than 8 percent, there is no situation where the
project can pay back on a discounted basis within three years
D. no; because the discounted payback period is too short
E. yes; discounted payback indicates acceptance but that is not a wise decision as the
NPV is negative and the final cash outflow is ignored by payback
Ans: E
10. A proposed new venture will cost $175,000 and should produce annual cash flows of
$48,500, $85,000, $40,000, and $40,000 for Years 1 to 4, respectively. The required
payback period and discounted payback period is 3 years. The discount rate is 9 percent.
Which methods indicate project acceptance and which indicate project rejection?
A. accept: NPV, IRR, PI, payback; reject: discounted payback
B. accept: NPV, IRR, PI; reject: payback, discounted payback
C. accept: payback, PI; reject: NPV, IRR, discounted payback
D. accept: payback, discounted payback; reject: NPV, IRR, PI
E. accept: NPV, IRR; reject: PI, payback, discounted payback
Ans: B
11. A financing project has an initial cash inflow of $42,000 and cash outflows of $15,600,
$22,200, and $18,000 for Years 1 to 3, respectively. If the required rate of return is 13
percent the manager should:
A. Accept
B. Reject
C. Indifferent due to break-even
D. None of the above
Ans: B
12. Two mutually exclusive projects have 3-year lives and a required rate of return of 10.5
percent. Project A costs $75,000 and has cash flows of $18,500, $42,900, and $28,600 for
Years 1 to 3, respectively. Project B costs $72,000 and has cash flows of $22,000,
$38,000, and $26,500 for Years 1 to 3, respectively. Using the IRR, which project, or
projects, if either, should be accepted?
A. accept both projects
B. select either project as there is no significant difference between them
C. accept Project A and reject Project B
D. accept Project B and reject Project A
E. reject both projects
Ans: E
13. Samiksha is charged with determining which small projects should be funded. Along
with this assignment, she has been granted the use of $15,000 for a maximum of two
years. She is considering three projects. Project A costs $7,500 and has cash flows of
$4,000 a year for Years 1 to 3. Project B costs $8,000 and has cash flows of $3,000,
$4,000, and $3,000 for Years 1 to 3, respectively. Project C costs $2,000 and has a cash
inflow of $2,500 in Year 2. What decisions should she make regarding these projects if
she assigns them a mandatory discount rate of 8.5 percent?
A. accept either Projects A and C or Projects B and C, but not all three as there is
insufficient financing
B. accept Project C and reject Projects A and B because only Project C has a
discounted payback that is less than two years
C. accept Projects A and C and reject Project B as they have the shortest discounted
payback periods than fit within the $15,000 allocation
D. accept Projects A and C and reject Project B as A and B payback within two years
E. accept Projects B and C and reject Project A as this combination uses the most
initial capital
Ans: B
14. A $25 investment returns $27.50 at the end of one year with no risk. Given this, you
know that the NPV:
A. is zero at any given discount rate
B. is negative if the required return is less than 10 percent
C. equals 1.0 if the required return is 10 percent
D. is zero if the required return is equal to 10 percent
E. must be positive at any given discount rate
Ans: D
15. Consider an investment with an initial cost of $20,000 that expected to last for 5 years.
The expected cash flows in Years 1 and 2 are $5,000 each, in Years 3 and 4 are $5,500
each, and the Year 5 cash flow is $1,000. Assume each annual cash flow is spread evenly
over its respective year. What is the payback period, in years?
A. 3.18
B. 3.82
C. 4.00
D. 4.55
E. None of the above
Ans: B
16. An investment project has an initial cost of $260 and cash flows $75, $105, $100, and
$50 for Years 1 to 4, respectively. The cost of capital is 12 percent. What is the
discounted payback period, in years?
A. 3.76
B. 3.42
C. 3.68
D. 3.92
E. None of the above
Ans: E
17. An investment with an initial cost of $4,000 produces cash flows of $3,400, −$500,
$2,800, −$100, and $6,000 for Years 1 to 5, respectively. How many IRR’s does this
project have?
A. 4
B. 3
C. 2
D. 5
E. 6
Ans: D
18. A proposed project costs $300 and has cash flows of $80, $200, $75, and $90 for Years 1
to 4, respectively. Because of its high risk, the project has been assigned a discount rate
of 16 percent. In dollars, how much will this project return in today’s dollars for every $1
invested?
A. $1.01
B. $0.99
C. $1.05
D. $0.95
E. $1.03
Ans: C
19. You own 25 percent of ABC Inc. You have decided to retire and want to sell your shares
in this closely held, all-equity firm. The other shareholders have agreed to have the firm
borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this
firm today if you ignore taxes?
A. $4.8 million
B. $5.1 million
C. $5.4 million
D. $4.5 million
E. None of the above
Ans: E
20. A firm has a debt-equity ratio of .64, a pretax cost of debt of 8.5 percent, and the
unlevered WACC of this firm is 12.6 percent. What is the cost of equity if you ignore
taxes?
A. 8.06%
B. 9.8%
C. 11.12%
D. 15.22%
E. None of the above
Ans: D
21. The Winter Wear Company has expected perpetual earnings before interest and taxes of
$3,800, an unlevered cost of capital of 15.4 percent and a tax rate of 35 percent. The
company also has $2,600 of total debt outstanding with a coupon rate of 5.7 percent. The
debt is selling at par value. What is the value of this firm?
A. $33,426.88
B. $16,948.96
C. 16,323.44
D. 12,055.04
E. None of the above
Ans: B
22. ABC Ltd. currently an all-equity firm that has 22,000 shares of stock outstanding with a
market price of $27 a share. The current cost of equity is 12 percent and the tax rate is 35
percent. The firm is considering adding $225,000 of debt with a coupon rate of 6.25
percent to its capital structure. The debt will sell at par. What will be the levered value of
the equity?
A. $325,500
B. $447,750
C. $721,250
D. $672,750
E. $594,000
Ans: B
23. The Montana Hills Co. has expected perpetual earnings before interest and taxes of
$17,100, an unlevered cost of capital of 12.4 percent, and debt with both a book and face
value of $25,000. The debt has an annual 6.2 percent coupon. If the tax rate is 34 percent,
what is the value of the firm?
A. $91,016.13
B. $137,903.23
C. $99,516.13
D. $106,666.67
E. $146,403.23
Ans: C
24. Joe's Leisure Time Sports is an unlevered firm with an aftertax perpetual net income of
$78,400. The unlevered cost of capital is 11.4 percent and the tax rate is 35 percent. What
is the value of this firm?
A. $447,017.54
B. $581,818.02
C. $687,719.30
D. $613,309.24
E. 537,900.46
Ans: C
25. The Spartan Co. has an unlevered cost of capital of 11.6 percent, a cost of debt of 7.9
percent, and a tax rate of 35 percent. What is the target debt-equity ratio if the targeted
levered cost of equity is 12.6 percent?
A. .42
B. .44
C. .49
D. .56
E. .62
Ans: A
26. Salmon Inc. has debt with both a face and a market value of $227,000. This debt has a
coupon rate of 7 percent and pays interest annually. The expected perpetual earnings
before interest and taxes is $87,200, the tax rate is 35 percent, and the unlevered cost of
capital is 12 percent. What is the firm's cost of equity (in %)?
A. 12.92
B. 13.28
C. 13.92
D. 14.27
E. 16.65
Ans: D
27. Aspen's Distributors has a levered cost of equity of 13.84 percent and an unlevered cost
of capital of 12.5 percent. The company has $5,000 in debt that is selling at par. The
levered value of the firm is $14,600 and the tax rate is 34 percent. What is the pretax cost
of debt (in %)?
A. 7.92
B. 8.16
C. 8.60
D. 8.84
E. 9.00
Ans: C
28. Your firm has a $250,000 bond issue outstanding. These bonds have a coupon rate of 7
percent, pay interest semiannually, and have a current market price equal to 103 percent
of face value. What is the amount of the annual interest tax shield given a tax rate of 35
percent?
A. $6,125
B. $6,419
C. 6,309
D. 17,500
E. 18,025
Ans: A
29. Juanita's Steak House has $12,000 of debt outstanding that is selling at par and has a
coupon rate of 8 percent. The tax rate is 34 percent. What is the present value of the tax
shield?
A. $2,823
B. $2,887
C. $4,080
D. $4,500
E. $4,633
Ans: C
30. Based on MM with taxes and without taxes, how much time should a financial manager
spend analyzing the capital structure of his/her firm?
A. No time at all.
B. No time should be spent under MM (no taxes) scenario but if taxes are present
then manager must carry out the analysis to find that optimal level of debt that
maximizes the levered firm value.
C. The manager has nothing to decide
D. Both A and C
E. None of the above
Ans: D
Part B – 80 Marks
Note: Generally the working capital over the project’s life is required at the beginning of
the project and by the end of project’s life the working capital requirement becomes zero.
Each wrong answer attracts a penalty of 2 Marks. The paper is of 80 marks, hence, there is a
bonus of 10 marks!
1. ABC Ltd. is considering a 3-year project with an initial cost for fixed assets of $618,000.
The project will reduce operating costs by $265,000 a year. The equipment will be
depreciated straight-line to a zero book value over the life of the project. At the end of the
project, the equipment will be sold for an estimated $60,000. The tax rate is 34 percent.
The project will require $23,000 in extra inventory over the project’s life. Given the
information, what is the NPV if the discount rate assigned to the project is 14 percent?
5 Marks
A.
B.
C.
D.
E.
$-2,646
$-30,086.23 *** there was a typo in the q. paper. Hence, NAs will also qualify.
$32,593.78
$43,106.54
$16,884.40
Ans: B
2. A firm is considering the installation of a new computer system that will cut annual
operating costs by $12,000. The system will cost $42,000 to purchase and install. This
system is expected to have a 5-year life and will be depreciated to zero using straight-line
depreciation. What is the amount of the earnings before interest and taxes for each year of
this project?
5 Marks
A. -$20,400
B. $5,400
C. $3,600
D. $12,000
E. $20,400
Ans: C
Question 4-7 are based on the below case:
Lotus Corporation is contemplating replacement of its existing milling machine with an
improved version that would increase the production from 12,000 components per year to
18,000. Due to improved design the new component would also fetch a better price of Rs
90 as against existing price of Rs 85 per piece. New machine costs Rs 12 lacs with
additional amount on installation and training of Rs 1.50 lacs to be spent. The existing
milling machine’s current market price is Rs 3.5 lacs and has a book value of Rs 4 lacs.
The remaining life of the existing machine is 5 years and the firm follows a policy of
straight line method for depreciation of fixed assets. The life of the new machine too is 5
years. Installation of new machine would entail some extra recurring cost. The operator
salary would be increased from Rs 50,000 to Rs 70,000 per month. However it would
save the cost on maintenance and power. While the production would increase by 50%
the rise in maintenance cost would be 20% from existing Rs 10,000 per month. Similarly
the power consumption would increase by 25% only from existing Rs 6,000 per month.
There would be no change in any other cost. Changes in working capital may be ignored.
Corporate tax rate is 40% and the hurdle rate for project acceptance is set to 10%.
Answer the following questions assuming the firm undertakes the replacement:
3. The incremental annual depreciation for project evaluation is ($):
5M
A.
B.
C.
D.
E.
90,000
190,000
110,000
101,000
350,000
Ans: B
4. The initial cash flow is ($):
A.
B.
C.
D.
E.
5M
1,350,000
1,000,000
9,80,000
9,40,000
1,550,000
Ans: C
5.
A.
B.
C.
D.
E.
The incremental increase in annual expenses (excluding depreciation) is ($): 5 M
265,500
243,500
23,500
103,000
282,000
Ans: E
6.
A.
B.
C.
D.
E.
Annual operating cash flow is ($):
266,800
298,800
-75,200
79,900
276,700
5M
Ans: A
Solution:
Initial cash out flow
Rs Lacs
Cost of new machine
12.00
Add; Installation and training cost
1.50
Less: Sale proceeds of existing machine
3.50
less: Tax saved of the machine sold
0.20
Net initial cash outflow
9.80 (Q4)
Book value
4.00
Current
Proposed
Incremental
Incremental revenue
Production/Sales (pcs/month) 12,000
18,000
Selling price (Rs/pc)
85
90
Incremental Cash Cost, Rs
Salary
50,000
70,000
Fuel
10,000
12,000
Power
6,000
7,500
Total monthly cost
66,000
89,500
23,500
Rs Lacs
Current
Proposed Incremental
Annual Revenue
10.200
16.200
6.000
Annual Cost
7.920
10.740
2.820 (Q5)
Annual cash profit 2.280
5.460
3.180
Depreciation
0.800
2.700
1.900 (Q3)
Taxable Profit
1.480
2.760
1.280
Tax 40%
0.592
1.104
0.512
Cash flow
1.688
4.356
2.668 (Q6)
7. ZEL Company's bonds were issued several years ago and now have 20 years to maturity
left; no special features such as call date etc. are attached to these bonds. These bonds
have a 9.25% annual coupon, paid semiannually, sells at a price of $1,075, and have a par
value of $1,000. If the firm's tax rate is 40%, the component cost of debt for use in the
WACC is closest to?
5M
A. 4.27%
B. 3.94%
C. 5.63%
D. 6.08%
E. 3.57%
Ans: C *** After tax cost of debt (multiply bond’s YTM by (1-t). Closest to 5.08%
8. TSW Inc. had the following data for last year: Net income = $800; Net operating profit
after taxes (NOPAT) = $700; Total assets = $3,000; and Total operating capital = $2,000.
Information for the just-completed year is as follows: Net income = $1,000; Net
operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating
capital = $2,500. How much free cash flow did the firm generate during the justcompleted year?
5M
A. $383
B. $425
C. $468
D. $514
E. $566
Ans: B
ANS: B
9. ABC Corporation has the following balance sheet. How much net operating working
capital does the firm have?
5M
Cash
Short-term investments
Accounts receivable
Inventory
Current assets
Net fixed assets
Total assets
A.
B.
C.
D.
E.
$ 10 Accounts payable
Accruals
50 Notes payable
40
Current liabilities
$130 Long-term debt
100 Common equity
Retained earnings
$230 Total liab. & equity
$ 20
20
50
$ 90
0
30
50
$230
$54
$60
$66
$72.6
$79.86
Ans: B
10. The CEO of Harding Media Inc. as asked you to help estimate its cost of common equity.
You have obtained the following data: D0 = $0.85; P0 = $22.00; and g = 6.00% (constant).
The CEO thinks, however, that the stock price is temporarily depressed, and that it will
soon rise to $40.00. Based on the DCF approach, by how much would the cost of
common equity would change if the stock price suddenly changes as the CEO expects?
5M
A. -1.49%
B.
C.
D.
E.
-1.66%
-1.84%
-2.03%
-2.23%
Ans: C
ANS: C
D0
P0
g
D1 = D0 * (1 + g)
rs = D1/P0 + g
Difference, rs0 - rs1
Old Price
$0.85
$22.00
6.00%
$0.901
10.10%
-1.84%
New Price
$0.85
$40.00
6.00%
$0.901
8.25%
11. You own a 1-year call option on 1 acre of Mumbai real estate. The exercise price is Rs
200 crores, and best estimate regarding the future cash flows from the asset is that it is
expected to generate Rs 17 crore of after-tax free cash flows per annum from next year to
the owner till perpetuity. The required rate of return given the riskiness of the project is
10%. The land is currently used as a parking lot and generates Rs 2 crores per annum
which is just enough to cover real estate taxes. The annual standard deviation is 20
percent and the interest rate is 8 percent. How much is your call worth (in crores)?
8M
A. 6.93
B. 7.99
C. 6.88
D. 2.51
E. 6.05
Ans: 7.99 (using BSM)
12. A firm is analyzing a proposed project. The company expects to sell 3,000 units, with an
expected swing in sales of plus/minus 15 percent. The expected variable cost per unit is
$8 and the expected fixed costs are $12,500. Cost estimates are considered accurate
within a plus or minus 5 percent range. The depreciation expense is $4,000. The sale
price is estimated at $18 a unit, plus or minus 2 percent. The project requires $24,000 of
fixed assets, which will be worthless when the project ends in six years. Also required is
$6,500 of net working capital for the life of the project. The tax rate is 34 percent and the
required rate of return is 12 percent. Given the information, what is the net present value
of the worst-case scenario?
A. $2,979.40
8 Marks
B. −$4,008.16
C. −$3,810.29
D. −$6,705.72
E. $6,308.15
Ans: D
Next two questions are based on the following case:
13. A new project (Pr. N) is being considered by ABC Ltd. has an initial cost of $250,000.
The project's subsequent cash flows are critically dependent on the performance of an old
existing project, Pr. O. There is a 50% chance that the Pr. O will do very well, in which
case the Pr. N’s expected cash flows will be $110,000 at the end of each of the next 5
years. There is a 50% chance that the Pr. O will not perform well, in which case the Pr.
N’s expected cash flows will be $25,000 at the end of each of the next 5 years. Assume
that the cost of capital is 12%. What is Pr. N’s expected net present value?
7M
A. – $6,678
B. – $3,251
C. $15,303
D. $20,004
E. $45,965
Ans: A
Find the project's expected cash flows in Years 1 through 5:
(0.5)($110,000) + (0.5)($25,000) = $67,500. NPV = -$6,678
14. Now assume that one year from now the firm will know the performance of Pr. O. Also,
assume that after receiving the cash flows at t = 1, the firm has the option to abandon the
project, in which case it will receive an additional $100,000 at t = 1 but no cash flows
after t = 1. Assuming that the cost of capital remains at 12%, what is the estimated value
of the abandonment option, without using any option pricing model?
7M
A. $0
B. $2,075
C. $4,067
D. $8,945
E. $10,745
F. None of the above
Ans: E
No abandonment:
Abandonment:
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