MIDTERM EXAMINATION
Spring 2010
MGT201- Financial Management (Session - 2)
Question No: 1 ( Marks: 1 ) - Please choose one
Among the pairs given below select a(n) example of a principal and a(n) example of an agent respectively.
► Shareholder; manager
► Manager; owner
► Accountant; bondholder
► Shareholder; bondholder
Question No: 2 ( Marks: 1 ) - Please choose one
Which group of ratios measures a firm's ability to meet short-term obligations?
► Liquidity ratios
► Debt ratios
► Coverage ratios
► Profitability ratios
Question No: 3 ( Marks: 1 ) - Please choose one
Which of the following would be considered a cash-flow item from an "investing" activity?
► Cash outflow to the government for taxes
► Cash outflow to shareholders as dividends
► Cash outflow to lenders as interest
► Cash outflow to purchase bonds issued by another company
Question No: 4 ( Marks: 1 ) - Please choose one
All of the following influence capital budgeting cash flows EXCEPT __________.
► Choice of depreciation method for tax purposes
► Economic length of the project
► Projected sales (revenues) for the project
► Sunk costs of the project
Question No: 5 ( Marks: 1 ) - Please choose one
An investment proposal should be judged in whether or not it provides:
► A return equal to the return require by the investor
► A return more than required by investor
► A return less than required by investor
► A return equal to or more than required by investor
Question No: 6 ( Marks: 1 ) - Please choose one
Which of the following technique would be used for a project that has non-normal cash flows?
► Internal rate of return
► Multiple internal rate of return
► Modified internal rate of return
► Net present value
Question No: 7 ( Marks: 1 ) - Please choose one
Which of the following statements is correct in distinguishing between serial bonds and sinking-fund bonds?
► Serial bonds mature at a variety of dates, but sinking-fund bonds mature at a single date
► Serial bonds provide for the deliberate retirement of bonds prior to maturity, but sinking-fund bonds do not provide for the deliberate retirement of bonds prior to maturity
► Serial bonds do not provide for the deliberate retirement of bonds prior to maturity, but sinking-fund bonds do provide for the deliberate retirement of bonds prior to maturity
► None of the above are correct since a serial bond is identical to a sinking fund bond
Question No: 8 ( Marks: 1 ) - Please choose one
The value of a bond is directly derived from which of the following?
► Cash flows
► Coupon receipts
► Par recovery at maturity
► All of the given options
Question No: 9 ( Marks: 1 ) - Please choose one
Which of the following affects the price of the bond?
► Market interest rate
► Required rate of return
► Interest rate risk
► All of the given options
Question No: 10 ( Marks: 1 ) - Please choose one
If all things equal, when diversification is most effective?
► Securities' returns are positively correlated
► Securities' returns are uncorrelated
► Securities' returns are high
► Securities' returns are negatively correlated
Question No: 11 ( Marks: 1 ) - Please choose one
You wish to earn a return of 12% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of Rs. 2 in the upcoming year. The expected growth rate of dividends is 9% for stock A and 10% for stock B. The intrinsic value of stock A:
► Will be greater than the intrinsic value of stock B
► Will be the same as the intrinsic value of stock B
► Will be less than the intrinsic value of stock B
► None of the given options
Question No: 12 ( Marks: 1 ) - Please choose one
In the dividend discount model, which of the following is (are) NOT incorporated into the discount rate?
► Real risk-free rate
► Risk premium for stocks
► Return on assets
► Expected inflation rate
Question No: 13 ( Marks: 1 ) - Please choose one
Which of the following is NOT a major cause of systematic risk.
► A worldwide recession
► A world war
► World energy supply
► Company management change
Question No: 14 ( Marks: 1 ) - Please choose one
Which of the following term may be defined as incidental cash flows that arise because of the effect of new project on the running business?
► Sunk cost
► Opportunity cost
► Externalities
► Contingencies
Question No: 15 ( Marks: 1 ) - Please choose one
A preferred stock will pay a dividend of Rs. 2.75 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow. You require a return of 10% on this stock. Use the constant growth model to calculate the intrinsic value of this preferred stock.
► Rs. 0.275
► Rs. 27.50
► Rs. 31.82
► Rs. 56.25
Solution:
PV = DIVI/rPE
= 2.75/10%
= 2.75/0.10
= 27.50
Question No: 16 ( Marks: 1 ) - Please choose one
What is the present value of Rs.1,000 to be paid at the end of 5 years if the interest rate is 8% compounded annually?
► Rs.680.58
► Rs.1,462.23
► Rs.322.69
► Rs.401.98
Solution:
F V = PV × (1 + i )n
PV = FV / (1 + i )n
= 1000 / (1 + 0.08)5
= 680.27
Question No: 17 ( Marks: 1 ) - Please choose one
What is the present value of Rs.53,000 to be paid at the end of 15 years if the interest rate is 9% compounded annually?
► Rs.25,300
► Rs.34,122
► Rs.14,549
► Rs.11,989
Solution:
F V = PV × (1 + i )n
PV = FV / (1 + i )n
= 53,000 / (1 + 0.09)^15
= 14,549
Question No: 18 ( Marks: 1 ) - Please choose one
The objective of ________ is to maximize the shareholder’s wealth.
► Financial economics
► Financial management
► Financial accounting
► Financial engineering
Question No: 19 ( Marks: 1 ) - Please choose one
Which of the following accounting equation is accurate?
► Assets +Equity = Liabilities + Expenses
► Assets + Expenses = Liabilities +Expenses + Revenue
► Assets + Liabilities = Equity + Expenses + Revenue
► Assets + Revenue + Liabilities = Equity
Question No: 20 ( Marks: 1 ) - Please choose one
Through which of the following formula desired growth rate can be calculated?
► Return on equity × (1- payout ratio)
► Return on equity / (1- payout ratio)
► Return on equity + (1+ payout ratio)
► Return on equity - (1/ payout ratio)
Question No: 21 ( Marks: 1 ) - Please choose one
Which of the following is a type of annuity in which no time span is involved?
► Ordinary annuity
► Annuity due
► Perpetuity
► None of the given options
Question No: 22 ( Marks: 1 ) - Please choose one
Which of the following is not a type of problem in capital rationing?
► Size difference of projects
► Timing difference of projects
► Different lives of different projects
► Different cash flow streams
Question No: 23 ( Marks: 1 ) - Please choose one
Market price of a share will be determined from __________.
► Supply of share only
► Demand of share only
► Price of share of Benchmark Company
► From demand and supply in the market
Question No: 24 ( Marks: 1 ) - Please choose one
Which of the following is called hybrid equity as it is the combination of both equity and debt factor?
► Common stocks
► Preferred stocks
► Bonds & securities
► All of the given options
Question No: 25 ( Marks: 1 ) - Please choose one
Which of the following can be used as measure of return?
► Forecasted selling price
► Forecasted purchase price
► Forecasted dividend
► Forecasted time span of project
Question No: 26 ( Marks: 1 ) - Please choose one
Which of the following formula could be used to calculate expected rate of return
?
► Po / Po × P1
► P1 + Po / Po
► P1 – Po / Po
► Po – P1 / Po
Question No: 27 ( Marks: 1 ) - Please choose one
Finance consists of which of the following area(s)?
► Money and capital market
► Investment
► Financial management
► All of the given options
Question No: 28 ( Marks: 1 ) - Please choose one
A proposal is accepted if payback period falls within the time period of 3 years. According to the given criteria, which of the following project is most suitable to accept?
Payback period
Project A 1.66
Project B 2.66
Project C 3.66
► Project A
► Project B
► Project C
► Project A & B
Question No: 29 ( Marks: 3 )
Define interest rate risk and investment risk.
The Interest Rate Risk for Long Term Bonds ie. For the 10 years is more than the Interest Rate Risk for Short Term Bonds i.e. 1 year bonds; provided the coupon rate for the bonds is similar.
When investor buy a long term bond he is locked in investment for long term period there are more chances of fluctuation in interest rate and the inflation rate. So, the impact of interest rate changes on Long Term bonds is greater. Long Term Bond Prices fluctuate more because their Coupon Rates are fixed or locked for a long time even though Market Interest Rates are fluctuating daily; therefore the price of Long Bonds has to constantly keep adjusting.
Price of the long term bond fluctuates more as compared to the short term bond. Because, you
have a long term bond with fix coupon rate but the market interest rate is fluctuating in between the years.
When we talk about the investment this is different from the forecasted and this to represent risk. we need to keep in mind the distinction between Stand Alone Risk (or Single Investment Risk) as oppose to market or Portfolio Risk or collection of investments risk, which is a risk of particular investment compare to other investments you have made. In Portfolio risk we are
interested in overall risk of entire collection of investments that made by the company.
Hence the interest rate risk is to the specific concern while the investment risk is to effect the whole business.
Question No: 30 ( Marks: 3 )
A stock is expected to pay a dividend of Rs.0.75 at the end of the year. The required rate of return is ks = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?
Data:
P0 =?
D1 = 0.75
g = 6.4%
ROR = 10.5%
Solution:-
P0 = D1 / (ror – g)
P0 = 0.75 / (0.105- 0.064)
Po = 0.75/0.041
P0 = 18.29
Question No: 31 ( Marks: 5 )
There are some risks (Unique Risk) that we can diversify but some of the risks (Market risks) are not diversifiable. Explain both types of risk.
Question No: 32 ( Marks: 5 )
Hammad Inc. is considering two alternative, mutually exclusive projects. Both projects require an initial investment of Rs. 10,000 and are typical, average-risk projects for the firm. Project A has an expected life of 2 years with after-tax cash inflow of Rs. 6,000 and Rs. 8,000 at the end of year 1 and 2, respectively.
Project B has an expected life of 4 years with after-tax cash inflow of Rs. 4,000 at the end of each of next 4 years. The firm’s cost of capital is 10 percent.
If the projects cannot be repeated, which project will be selected, and what is the net present value?
Solution:
Net Present Value:
Project A: Initial investment, I0 = Rs 10,000
Cash flow in yr 1, CF1 = Rs 6000
Cash flow in yr 2, CF2 = Rs 8000
Discount rate, I = 10 %
No. of yrs, n = 4
NPV = - I0 + CF1/(1+i)n + CF2/(1+i)n + CF3/(1+i) n + CF4/(1+i) n
= -10,000 + 6000/(1.10) + 8000/(1.12)2
= -10,000 + 5454.54 + 6611.57
= - 10,000 +12066.11
= 2066.11
Project B: Initial investment, I0 = Rs 10,000
Cash flow in yr 1, CF1 = Rs 4000
Cash flow in yr 2, CF2 = Rs 4000
Cash flow in yr 3, CF3 = Rs 4000
Cash flow in yr 4, CF¬4 = Rs 4000
Discount rate, I = 10 %
No. of yrs, n = 4
NPV = - I0 + CF1/(1+i)n + CF2/(1+i)n + CF3/(1+i) n + CF4/(1+i) n
= -10,000 + 4000/(1.10) + 4000/(1.10)2+ 4000/(1.10)3+ 4000/(1.10)4
= -10,000 + 3636.36 + 3305.8 + 3005.25 + 2732.053
= -10,000 + 12679.463
= 2679.463
