Question No. 1: Choose the correct answer. (10 Marks)
1. The accept-reject approach in capital budgeting a.
Involves the evaluation of capital expenditure proposals to determine whether they meet a firm’s acceptance criteria. b.
All independent projects could be undertaken regardless of their return. c.
Mutually exclusive projects could be undertaken provided that they do not perform the same function. d.
Projects could be undertaken if the required funding is equal or less than a predetermined level and rejected if they exceed that level.
2. The ranking approach involves a.
Ranking of investment opportunities according to their respective initial cash outflows. b.
Ranking of investment opportunities on the basis of their respective rate of return. c.
Selecting projects according to their relevance to the national economy. d.
Selecting projects if they are independent projects only.
3. If the firm ha s adequate funding for making investment decisions, then a.
All mutually exclusive projects that provide a pre-determined rate of return could be accepted and implemented. b.
There is a need for capital rationing. c.
All independent projects that provide returns greater than some specified level can be accepted and implemented. d.
All identified investment opportunities could be undertaken without the need for further analysis.
4. In a business environment, uncertainty means the a.
Possibility of making profits. b.
Difficulty of establishing a corporation. c.
Chance of sustaining a financial loss.
d.
Difficulty of finding a good location for the business.
5. Businesses may have to take capital rationing decisions a.
When they have to choose between mutually exclusive projects only. b.
When adequate funding is available for all potentially profitable investment opportunities. c.
Only in the case of independent projects. d.
When a limited amount of funding is available to invest in potentially profitable opportunities.
6. International capital budgeting analysis differs from purely domestic analysis because: a.
Cash flows may occur in a foreign currency. b.
Foreign investments are usually more profitable than domestic investments. c.
A foreign government will always support international investments. d.
International companies prefer to have branches in other countries.
7. A major disadvantages of the payback method of evaluating investment opportunities is that it

a.
Does not use a risk-adjusted discount rate. b.
Ignores time value for money. c.
It is difficult to use. d.
It takes into consideration all cash inflows of the project.
8. The net proceeds from the sale of a bond, or any other security, are the funds that are a.
Actually received from the buyer of the security less any associated costs. b.
Paid to the respective security holders. c.
The market value of the securities sold. d.
The par value of the securities sold.
9. The probability of a foreign government blocking the repatriation of profits or seizing the assets of an investing firm could be referred to as the a.
Political risk. b.
Foreign currency exchange risk. c.
Financial risk. d.
Operating risk.
10. A major benefit of debt financing is that a.
Companies can raise debt financing in any amounts they need. b.
Most of financial institutions and other lenders are willing to provide it a low cost. c.
It has a convenient duration that suits all businesses. d.
Interest payments are tax deductible.
11. The Weighted Average Cost of Capital (WACC) is the rate of return that a firm must a.
Earn on its investments to maintain its market value. b.
Pay on its long term debt. c.
Pay to its equity holders. d.
Earn to maximize the volume of its long-term finances.
12. An investment opportunity could be accepted if the a.
NPV is negative. b.
IRR is higher than the cost of capital. c.
IRR and the NPV are equal. d.
Cash flow pattern is conventional.
13. Investment opportunities that compete in some way for a company’s resources are referred to as a.
Mutually inclusive projects. b.
Mutually exclusive projects. c.
Independent projects. d.
Sunk projects.
14. The risk to the firm of being unable to pay interest to its bondholders is known as the a.
Business risk. b.
Financial risk.

c.
Market risk. d.
Opportunity risk.
15. The discount rate that will equate the present value of cash outflows with the present value of cash inflows is referred to as the a.
Project’s interest rate. b.
Commercial rate of interest. c.
Internal rate of return. d.
Weighted Average Cost of Capital.
16. If the cost of debt is 5% and the cost of equity is 10%, the weighted average cost of capital
(WACC) for a firm that has 40% debt and 60% equity in its capital structure will be a.
5% b.
8% c. 10% d. 11%
17. In the process of evaluation of projects, costs which were already incurred and which may not be recovered as a result of implementing a specific project are called a.
Opportunity costs. b.
Incremental costs. c.
Relevant costs. d.
Sunk costs.
18. In order to incorporate the risk aspect in the calculation of a project’s NPV or IRR, the financial analyst a.
Should use the payback method for evaluating the project. b.
Calculate the risk in the industry in order to adjust the terminal cash flow of the project. c.
Adjust the discount rate used in calculating the NPV or IRR. d.
Should use another evaluation technique.
19. Although both Bonds and Preferred Stock are classified as fixed-income securities, they differ in their respective risk level because: a.
Bondholders are owners and therefore face a higher degree of risk. b.
Bondholders are lenders and therefore face a higher degree of risk. c.
Preferred stockholders are owners and therefore face a higher degree of risk. d.
Preferred stockholders have a lower risk because they receive dividends before common stockholders.
20. A firm is in the process of purchasing a new machine at a cost of $40,000. The new machine will replace an obsolete asset that will be disposed of at a sale price of $11,000.
Installation costs of the new machine would amount to $5,000 and disposal costs of the old asset would amount to $1,000. Acquiring the new machine would result in an increase of current assets by $12,000 and an increase of current liabilities by $10,000. The initial investment required to fund this project would be: a.
$35,000 b.
$37,000 c. $36,000 d. $38,000

Question No. 2 10 Marks
Explain briefly why the following statements are correct.
1.
Using retained earnings as a major source of financing for capital expenditure could be the preferred option for current shareholders.
2.
When undertaking a new investment, it is assumed that the Business Risk will remain unchanged.
3.
Cost of Retained Earnings is the same as the cost of an equivalent fully subscribed issue of additional common stock.
4.
It is necessary to determine the weighted average cost of capital ( WACC ) before undertaking a new investment.
5. A firm may still accept an investment opportunity that has a zero or negative NPV.
Question No. 3. (10 Marks)
The capital structure of Gaza Computers Inc, a local company that was incorporated in 2011 is as follows: a.
1000 5% 10-year bonds of a par value of $ 100. They were issued at a discount of $ 15.
Flotation costs amounted to $ 5 per bond. All the bonds were subscribed for and were fully paid. b.
2,000,000 fully paid common stock of a par value of $ 1 per share. c.
100,000 fully paid 8% preferred stock of a par value $ 50 per share. The shares were issued at a premium of $ 8.5 per share. Flotation costs amounted to $ 1.50 per share. d.
The Company’s current balance sheet shows a Retained Earnings account of $ 20,000.
You are required to
1.
Noting that common stockholders would expect a return of 12% on their investment, calculate the weighted average cost of capital (WACC) for Gaza Computers Inc.
2.
Calculate the yield from an investor’s point of view for both the bondholders and the preferred shareholders respectively.
G O O D L U C K