FINA252
Exam date:28th December 2015
Multiple Choice
[QUESTION]
Coupon rate is the:
A. annual coupon divided by the face value of a share
B. annual coupon divided by the face value of a debenture
C. annual coupon divided by the selling price of a debenture
D. annual coupon divided by the selling price of a share
[QUESTION]
All other things being equal, the longer the time to maturity:
A. the lower the coupon rate
B. the lower the price of a debenture
C. the higher the coupon rate
D. the greater the interest rate risk
[QUESTION]
All other things being equal, the lower the coupon rate:
A. the longer the time to maturity
B. the higher the price of the debenture
C. the lower the price of the debenture
D. the greater the interest rate risk
[QUESTION]
Periodic distributions of profit by a company to its shareholders are:
A. interest
B. coupon
C. dividends
D. both interest and coupon
[QUESTION]
The internal rate of return on a bond is known as the:
A. required rate of return
B. coupon rate
C. discount rate
D. yield to maturity
[QUESTION]
There is an inverse relationship between interest rates and:
A. coupon
B. bond prices
C. term to maturity
D. face value
[QUESTION]
The debt securities that issued and backed by the centre government is called:
A. treasuries
B. agencies
C. munis
D. corporates
[QUESTION]
The debt securities that issued by government owned institutions is called:
A. treasuries
B. agencies
C. munis
D. corporates
[QUESTION]
The debt securities that issued by local government is called:
A. treasuries
B. agencies
C. munis
D. corporates
[QUESTION]
The debt securities that issued by corporations is called:
A. treasuries
B. agencies
C. munis
D. corporates
[QUESTION]
Four distinct categories of government bond is known as:
A. treasury bills, treasury notes, treasury bonds and treasury inflation protected securities.
B. treasuries, agencies, minus and corporates
C. coupon payment, face value, maturity and coupon rate
D. none of the above
[QUESTION]
If the market interest rate is the same as the coupon rate, the bond’s value is:
A. less than the face value.
B. more than the face value
C. the same as the face value
D. none of the given answers
[QUESTION]
If the market interest rate rises above the coupon rate, the bond’s value:
A. rises above the face value
B. falls below the face value
C. equal the face value
D. none of the above
[QUESTION]
If the market interest rate falls below the coupon rate, the bond’s value:
A. rises above the face value
B. falls below the face value
C. equal the face value
D. none of the above
[QUESTION]
Total return has two components: one of them is the dividend yield and the other is:
A. required return
B. current price
C. capital gains yield
D. cash dividend rate
[QUESTION]
Total return (r) can be shown as:
D
A. r  0  g
B. r 
C. r 
P0
D1
P0
D1
P0
g
D. none of the above
[QUESTION]
D1
P0
is called the
A. current yield
B. dividend yield
C. total return
D. required return
[QUESTION]
A share’s cash dividend divided by its current price is known as:
A. dividend growth rate
B. dividend Yield
C. coupon payment
D. total return
[QUESTION]
The dividend growth rate or the rate at which the value of an investment grows is known
as:
A. investment growth rate
B. dividend rate
C. dividend yield
D. capital gains yield
[QUESTION]
The model that determines the current share price of a share as its dividend next period
D
divided by the discount rate less the dividend growth rate (or P0  1 ) is the
r -g
A. growth model
B. valuation model
C. cash flow model
D. constant dividend growth model
[QUESTION]
The changes in the firm’s future cash flow that are a direct consequence of undertaking a
project are called:
A. net cash flows
B. after-tax cash flows
C. discounted cash flows
D. incremental cash flows
[QUESTION]
In capital budgeting analysis, the primary objective should be to choose projects that:
A. maximise future cash inflows
B. minimise initial investment
C. have a payback of less than three years
D. maximise firm value
[QUESTION]
When an asset is sold at a price (salvage value) different from the book value of the asset,
you will have a(n):
A. loss on sale
B. gain on sale
C. gain or loss on sale
D. opportunity cost
[QUESTION]
When an asset’s salvage value more than the book value of the asset, you will have a(n):
A. loss on sale
B. gain on sale
C. gain or loss on sale
D. opportunity cost
[QUESTION]
When an asset’s salvage value less than the book value of the asset, you will have a(n):
A. loss on sale
B. gain on sale
C. gain or loss on sale
D. opportunity cost
[QUESTION]
The difference between the total value of assets and the total value of liabilities is the __.
A. net cash flows
B. net working capital
C. shareholders’ equity
D. operating profit
[QUESTION]
A debt that is not due in less than one year is classified as a(n) ________.
A. indirect liability
B. direct liability
C. non-current liability
D. current liability
[QUESTION]
Assets are classified as ________.
A. tangible and intangible
B. current and fixed (non-current)
C. cash and accounts receivable
D. direct and indirect
[QUESTION]
The difference between a firm’s current assets and current liabilities is called:
A. accounting profits
B. excess profits
C. net working capital
D. both accounting profits and net working capital
[QUESTION]
Which of the following would be considered a current asset on a firm’s balance sheet?
A. accounts receivable
B. inventory
C. plant and machinery
D. both accounts receivable and inventory
[QUESTION] : The value of a firm’s assets is equal to the sum of its liabilities and:
A. liquidity
B. operating cash flows
C. retained earnings
D. shareholders’ equity
True/False
[QUESTION]
Shareholder’s equity is the difference between assets and liabilities.
A: True
B: False
[QUESTION]
Non-current assets are for the most part liquid.
A: True
B: False
[QUESTION]
Liquidity refers to the speed and ease with which an asset can be converted into cash.
A. True
B. False
[QUESTION]
The more risk an investment has, the higher its expected return will be.
A. True
B. False
[QUESTION]
A dollar received today is more value than a dollar received in the future.
A. True
B. False
[QUESTION]
Cash Flow, not accounting profit, is used as company’s value measurement tool.
A. True
B. False
[QUESTION]
It is hard to find exceptionally profitable projects in perfectly competitive market.
A. True
B. False
[QUESTION]
The process of diversification can reduce risk.
A. True
B. False
[QUESTION]
A firm has many options to invest their funds but firm has to select the most appropriate
assets for investment which will bring maximum benefit for the firm.
A. True
B. False
[QUESTION]
Mainly sources of finance can be divided into two categories: owners fund (shareholders
fund) and borrowers fund.
A. True
B. False
[QUESTION]
The market value and the book value are always the same.
A. True
B. False
[QUESTION]
Revenues + Expenses = Profit.
A. True
B. False
[QUESTION]
Maturity is the specified date at which the principal amount of a bond is paid.
A. True
B. False
[QUESTION]
Capital gains yield is a share’s cash dividend divided by its current price.
A. True
B. False
[QUESTION]
YTM is the market interest rate that equates a debenture’s present value of interest and
principal repayment with its price.
A. True
B. False
[QUESTION]
Dividend on a preference share has zero growth and is constant through time.
A. True
B. False
[QUESTION]
A share is more difficult to value than a bond since a share has no maturity.
A: True
B: False
[QUESTION]
Under the assumption that the dividend has a zero growth rate, the per share value is
given by P0 = D / r.
A. True
B. False
[QUESTION]
The number of years until the face value is paid is called the bond’s time to maturity.
A. True
B. False
[QUESTION]
When an asset is sold at a different price to the book value, you must have a gain on sale
of the asset.
A. True
B. False
[QUESTION]
A capital gain occurs if an asset is sold for more than its cost.
A. True
B. False
[QUESTION]
The after-tax cash flow and the accounting profit are the same.
A. True
B. False
PROBLEM SOLUTIONS
Q1.
Calculate total current assets, total non-current (fixed) assets, total
current liabilities, total non-current (fixed) liabilities, and owner’s
equity from the following Balance Sheet.
Example Balance Sheet
ASSETS
Cash
Accounts receivable
Inventory
Plant and equipment
Business premises
Vehicles
$
$
$
$
$
$
20,000
15,000
150,000
50,000
650,000
70,000
Accounts payable
Notes payable
Credit card debt
Tax liability
Long term business loan 1
Long term business loan 2
$
$
$
$
$
$
25,000
10,000
5,000
30,000
450,000
50,000
LIABILITIES
Answer:
Total current assets = cash + accounts receivable + inventory = $(20,000 +
15,000 + 150,000) = $185,000
Total non-current (fixed) assets = plant and equipment + business premises +
vehicles = $(50,000 + 650,000 + 70,000) = $770,000
Total current liabilities = accounts payable + notes payable + credit card debt +
tax liability = $(25,000 + 10,000 + 5,000 + 30,000) = $70,000
Total non-current liabilities = long term business loan1 + long term business
loan2 = $(450,000 + 50,000) = $500,000
Owner’s equity = total assets – total liabilities = $(185,000+ 770,000) - $(70,000
+ 500,000) = $995,000 – $570,000 = $385,000
Fill in the gaps of the ARAMCO’s Income Statement for 2014 which is
given below.
ARAMCO’s Statement of Income
for the year ended 31 December 2014
Year 2014
(in million)
Sales (Revenue)
201.9
Cost of goods sold
158.4
Gross profits
?
Depreciation
25.4
Earnings before interest and taxes (EBIT)
?
Interest expenses
?
Taxable Income (Earnings before taxes)
12.6
Taxes (20% of taxable income)
?
Net profits
?
Dividends
2.08
Addition to retained earnings
?
Answer:
Gross profits = Sales (Revenue) – Cost of goods sold = $(201.9 –
158.4) = $43.5 million
EBIT = gross profits – depreciation = $(43.5 – 25.4) = $18.1 million
Interest expenses = EBIT - Taxable income = $(18.1 – 12.6) =
$5.5 million
Taxes = 20% of $12.6 = $(12.6 x 0.20) = $2.52 million
Net Profits = Taxable income – tax = $(12.6 – 2.52) = $10.08
million
Addition to retained = Net profits – dividends = $(10.08 – 2.08) =
$8.0million
ARAMCO’s Statement of Income
for the year ended 31 December 2014
Year 2014
(in million)
Sales (Revenue)
201.9
Cost of goods sold
158.4
Gross profits
43.5
Depreciation
25.4
Earnings before interest and taxes (EBIT)
18.1
Interest expenses
5.5
Taxable Income (Earnings before taxes)
12.6
Taxes (20% of taxable income)
2.52
Q2.
ARAMCO’s Statement of Income
for the year ended 31 December 2014
Year 2014
(in million)
Net profits
10.08
Dividends
2.08
Addition to retained earnings
8.0
Q3.
A bond with a face value of $1000 and a coupon rate of 6 per cent
has 10 years to maturity. What is the market price of this bond if the
market interest rate is 12 per cent?
Answer:
The market price of a bond (V)  PV of coupon payments  PV of face value
1  1/ 1  r t 
 F
 C 
r
1  r t
Here C = 6% of the face value = 1000 x 0.06 = $60
r = market interest rate = 12% = 0.12
t = 10 years
F = face value of the bond = $1000
V  $60 

1  1/ 1.12 
0.12
 $60  5.6502  
10
  $1000
1.1210
$1000
3.1058
 $660.99
So The bond price = $660.99
Q4.
If ARAMCO is expected to pay cash dividends of $10 per share
(constant dividends with zero growth) and ARAMCO has a 10%
required rate of return, what is the value of the stock?
Answer:
With zero dividends growth, the value of the stock (P0) = D/r
Here P0 = the value of the stock
r = required rate of return = 10% = 0.10
D = dividends per share = $10
So, P0 = $(10/0.10) = $100
Q5.
If ARAMCO has just paid a dividend of 50 cents per share (D0), which
is expected to grow at 5 per cent per annum (g). What price should
you pay for the share if the required rate of return (r) on the
investment is 12 per cent?
Answer:
With the constant growth of dividends, the price (value) of a share is:
𝑃0 =
𝐷0 ×(1+𝑔)
𝑟−𝑔
Here, D0 = 50 cents = $0.50
g = 5% = 0.05
r = 12% = 0.12
So, 𝑃0
=
0.50×(1+0.05)
0.12−0.05
=
0.50×1.05
0.07
=
0.525
0.07
= $7.5
Q6.
ARAMCO has just paid a dividend of 50 cents per share(D0) and that
dividend is expected to grow at a rate of 10 per cent per annum for
the next 3 years, and at a rate of 5 per cent per annum(g) forever after
that. Assuming a required rate of return of 15 per cent (r), calculate
the current market price of the share.
Answer:
With the non-constant growth of dividends, the price (value) of a share is:
D3
P3
D1
D2
P0 



1
2
3
1  r  1  r  1  r  1  r 3
Here, D1 = D0 x (1 + g) = 0.50 x (1+0.05) = $0.525
D2 = D1 x (1 + g) = 0.525 x (1+0.05) = $0.551
D3 = D2 x (1 + g) = 0.551 x (1+0.05) = $0.579
D4 = D3 x (1 + g) = 0.579 x (1+0.05) = $0.608
r = 15% = 0.15
g = 5% = 0.05
D4
0.608
0.608


 6.08
r  g 0.15  0.05 0.10
So, the current market price of the share
0.525
0.551
0.579
6.08
=
P0 



1
2
3
1  0.15 1  0.15 1  0.15 1  0.153
0.525
0.551
0.579
6.08
P0 



1.15 1.3225 1.521 1.521
P0 = $0.4565 + $0.4166 + $0.3807 + $3.9974 = $5.251
Q7.
P3 
a. From the given information of the above table, calculate the
depreciation value of 1st year.
Answer:
1st year depreciation value = purchase price x 30% = $60,000 x 0.30 =
$18,000
b. From the given information of the above table, calculate the
depreciated value at the end of 1st year.
Answer:
Depreciated value at the end of 1st year = purchase price – depreciation
value = $60,000 – $18,000 = $42,000
c. Calculate the depreciation value of 2nd year.
Answer:
2nd year depreciation value = depreciated value of 1st year x 30% =
$42,000 x 0.30 = $12,600
d. Calculate the depreciated value at the end of 2nd year.
Answer:
Depreciated value at the end of 2nd year = depreciated value 1st year depreciation value of 2nd year = $42,000 – $12,600 = $29,400
e. Calculate the depreciation value of 3rd year.
Answer:
3rd year depreciation value = depreciated value of 2nd year x 30% =
$29,400 x 0.30 = $8,820
f. Calculate the depreciated value at the end of 3rd year.
Answer:
Depreciated value at the end of 3rd year = depreciated value of 2nd year depreciation value of 3rd year = $29,400 – $8,820 = $20,580
g. If company disposed that good at the end of 3rd year, calculate how
much profits/loss will be.
Answer:
Profits/Loss = salvage value - depreciated value at the end of 3rd year = $
$20,000 – $20,580 = - $580 (Loss)
h. Calculate the taxable income for 1st year, 2nd year, and 3rd year.
Answer:
Taxable income for 1st year = 1st year cash flow – depreciation value in 1st
year = $31,000 - $18,000 = $13,000
Taxable income for 2nd year = 2nd year cash flow – depreciation value in
2nd year = $25,000 - $12,600 = $12,400
Taxable income for 3rd year = 3rd year cash flow – depreciation value in 3rd
year – loss = $20,000 - $8,820 - $580 = $10,600
i. Calculate the amount of tax that paid in 1st year, 2nd year, and 3rd
year.
Answer:
Tax in 1st year = (Taxable income for 1st year) x (tax rate) = $13,000 x
20% = $13,000 x 0.2 = $2,600
Tax in 2nd year = (Taxable income for 2nd year) x (tax rate) = $12,400 x
20% = $12,400 x 0.2 = $2,480
Tax in 3rd year = (Taxable income for 3rd year) x (tax rate) = $10,600 x
20% = $10,600 x 0.2 = $2,120
j. Calculate the net cash flow in year 0, 1st year, 2nd year, and 3rd year
Answer:
Net cash flow in year 0 = $-60,000 (price that paid)
Net cash flow in 1st year = 1st year cash flow –paid tax in 1st year =
$31,000 - $2,600 = $28,400
Net cash flow in 2nd year = 2nd year cash flow – paid tax in 2nd year =
$25,000 - $2,480 = $22,520
Net cash flow in 3rd year = 3rd year cash flow – paid tax in 3rd year +
salvage value = $20,000 - $2,120 + 20,000 = $37,880
k. Calculate the PV of net cash flows in year 0, 1st year, 2nd year, and 3rd
year
Answers:
PV of year 0 net cash flow = -$60,000
PV of 1st year cash flow = FV/(1+r)1 = 28,400/(1+0.12) = 28,400/1.12
= $25,357.14
PV of 2nd year cash flow = FV/(1+r)2 = 22,520/(1+0.12)2 = 22,520/(1.12)2
= $17,952.81
PV of 3rd year cash flow = FV/(1+r)3 = 37,880/(1+0.12)3 = 37,880/(1.12)3
= $21,921.30
l. Calculate the NPV of the good and explain the decision.
Answer:
NPV = - 60,000+ 25,357.14 + 17,952.81 + 21,921.3 = -$ 5,231.25
Decision: NPV < 0, therefore investment rejected.