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THE UNIVERSITY OF THE WEST INDIES

OPEN CAMPUS
SEMESTER II

Examinations of April/May 2012 Course Code and Name Title: MGMT 2023 FINANCIAL MANAGEMENT Date: May 9th 2012 Time: 9:00 AM Paper No: 1

Duration 2 Hrs.

INSTRUCTIONS TO CANDIDATES:

This paper has _10_ pages and _18_ questions. The paper comprises of three (3) sections. Students are required to answer ALL questions in Section one (1) and Section two (2), and ANY question in Section three (3).

Multiple Choice Answer Sheet is attached Attach the Multiple Choice Answer Sheet to the Final Examination booklet. Time Value of Money Tables are attached You may use a financial or scientific calculator Total marks 60.

The University of the West Indies Course Code MGMT2023 ________________________________________________________________________________________


DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012/03/15

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SECTION 1 [15 Marks COMPULSORY] Answer all questions in this section. 1) Which of the following is/are true about the balance sheet and income statement? I. The income statement reflects a summary of activity that occurs over some period of time while the balance sheet is a snapshot taken at a single point in time II. Both represent a summary of activity that occurs over some period of time III. The two, combined, give a reasonable estimate of the firm's cash flows and market values a) I only b) II only c) III only d) I and III only

2) An investor has a 2-stock portfolio with $50,000 invested in Palmer Manufacturing and $50,000 in Nickles Corporation. Palmers beta is 1.20 and Nickles beta is 1.00. What is the portfolios beta? a) 0.94 b) 1.02 c) 1.10 d) 1.18 3) If $100 is placed in an account earning a nominal 4 percent, compounded quarterly, what will it be worth in 5 years? a) $122.02 b) $105.10 c) $135.41 d) $120.90 Dove Inc has bonds on the market with 10 years to maturity, yield to maturity of 12 percent and a coupon rate of 8 percent. If these bonds make quarterly coupon payments, what is the current price of the bond? a) $765.85 b) $769.30 c) $773.81 d) $902.11

4)

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

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5)

What is the payback period for the following set of cash flows?
Year 1 2 3 4 5 Cash Flows -$67,000 $20,000 $28,000 $35,000 $19,000

(a) (b) (c) (d) 6)

2.11 years 2.54 years 3.13 years 4.00 years

BRB just issued some new preferred stock. The issue will pay an $11 annual dividend and has a current price of $118 per share. What is the required rate of return on the BRBs preferred stock? a) 8.14 percent b) 6.75 percent c) 9.32 percent d) 8.74 percent According to the Capital Pricing Model (CAPM), a securitys expected return is equal to the risk free rate plus a premium: (a) equal to the securitys beta (b) based on the total risk of the security (c) based on the unsystematic risk of the security (d) based on the systematic risk of the security

7)

8)

Net Operating Working Capital (NOWC) is defined as the sum of all_______________ minus the sum of all ___________________. a) Non-interest bearing current liabilities; current assets b) Current assets; non-interest bearing current liabilities c) Cash equivalents and assets; current liabilities d) Current assets; current liabilities

9)

Assume that net working capital is positive, what effect would a cash purchase of inventory have on a firms current ratio? (a) Current ratio would decrease (b) Current ratio would increase (c) Current ratio would be greater than 1.0 (d) There would be no change

10) A firm has current liabilities of $2.5 million, a quick ratio of 0.75 and an inventory balance of $1 million, what is its current ratio? (a) 0.52 (b) 0.75 (c) 1.15 (d) 1.40

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

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11) Which of the following ratios is a debt or leverage ratio indicating the ability to pay fixed debt costs? (a) Debt ratio (b) Debt to equity ratio (c) Times Interest Earned (d) Current ratio 12) Treasury bills (T-bills) with a face value of $100 and an original maturity of 2 years were issued 18 months ago at a price of $92 but are currently priced to offer a yield of 3%. What would be the correct yield and current market price of the treasury bills?
(a) (b) (c) (d) At issue, the T-bills offered a yield of 4.26 %, and their current market price is $97.09 At issue, the T-bills offered a yield of 4.26%, and their current market price is $98.53 At issue the T-bills offered a yield of 8.07%, and their current market price is $97.09 At issue the T-bills offered a yield of 8.07%, and their current market price is $98.53

13) Prestige Autos turns out 1,500 batteries a day at a cost of $6 per battery for materials and labor. It takes the firm 22 days to convert raw materials into a battery. Prestige allows its customers 40 days in which to pay for the batteries, and the firm generally pays its suppliers in 30 days. What is the length of Prestiges cash conversion cycle? (a) (b) (c) (d) 12 days 32 days 48 days 92 days

14) Which of these is not an objective of cash management?


(a) (b) (c) (d) To minimize the opportunity cost of holding a positive balance in a non-interest bearing account. To minimize the length of time that cheques are held as float To speed up cash collections and control cash disbursements. To facilitate trade with customers and suppliers

15) You are the money manager of a $4 million investment fund. The fund consists of 4 stocks with the following investments and betas:
Stock A B C D Investment $400,000 600,000 1,000,000 2,000,000 Beta 1.50 (0.50) 1.25 0.75

If the market required return is 14 percent and the risk-free rate is 6 percent, what is the funds required rate of return? a) 3.50% b) 12.1% c) 11.4% d) 14.4%

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

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SECTION 2 Answer all questions in this section. QUESTION 16 [30 Marks] COMPULSORY The following Balance Sheet extract relates to the Snapple Company: Bonds payable Common Stock Preferred Stock Additional Information: The bonds are 8%, annual coupon bonds, with 9 years to maturity and are currently selling for 95% of par. The companys common shares which have a book value of $25 per share are currently selling at $20 per share. The company has an equity beta of 1.5 and the current Treasury bill rate is 3.5%. The market risk premium is 1.5% The preferred dividends are 5% preferred shares with a book value of $100 per share. These shares are currently selling at $80 per share. The Companys tax rate is 35%. Required: a) b) c) d) e) f) g) Calculate Snapples cost of debt. [5 marks] Calculate Snapples cost of equity. [5 marks] Calculate Snapples cost of preferred shares. [3 marks] Calculate Snapples Weighted Average Cost of Capital [8 marks] Explain why the cost of debt is cheaper than the cost of equity. [3 marks] Explain why the cost of retained earnings is equivalent to the cost of an existing issue of common stock. [4 marks] Outline two (2) reasons why a firms cost of capital is critically important. [2 marks] $1,000,000 $3,000,000 $2,000,000

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

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SECTION 3 Answer any one (1) question from this section Each question worth [15 Marks] Question 17 [15 Marks] Following is data on 2 stocks and the market portfolio Probability of outcome State of the economy Deep Recession Mild Recession Average Recession Mild Boom Strong Boom Required: a) Calculate the expected returns on stocks X and Y. [3 marks] b) Calculate the standard deviation of X and Y respectively, and determine which stock is riskier.
[4 marks]

Stock X -3.0 6.0 11.0 14.0 19.0

Stock Y -2.0 9.0 12.0 15.0 26.0

Market Portfolio -13.0 1.0 15.0 29.0 43.0

0.05 0.20 0.50 0.20 0.05

c) Determine the expected return on a portfolio of 70% of X and 30% of Y. [3 marks] d) Compare and contrast the risk of the market portfolio as opposed to the risks of the individual stocks within the portfolio. [3 marks] e) Explain what would happen if a stock with a beta of 0.4 was added to the portfolio above. [2 marks] Question 18 [15 Marks] The Beacon Inc. is considering two mutually exclusive projects, each with an initial investment of $150,000. The companys board of directors has set up a 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two projects are as follows: Year 1 2 3 4 5 6 Cash Inflows (CFt) Project A Project B $45,000 $75,000 $45,000 $60,000 $45,000 $30,000 $45,000 $30,000 $45,000 $30,000 $45,000 $30,000

Required: a) Calculate the payback period for each project. [2 marks] b) Calculate the NPV for each project at 7% and 9%. [6 marks] c) Based on b) above which project would you choose and why.[ 2 marks] d) Briefly explain why firms engage in capital rationing [2 marks] e) What are Real Options? What are some major types of real options? [3 marks] END OF PAPER
The University of the West Indies Course Code MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

Page 7

TIME VALUE OF MONEY TABLES

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

Page 8

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

Page 9

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23

Page 10

The University of the West Indies

Course Code

MGMT2023

________________________________________________________________________________________
DO NOT WRITE OR TYPE ON THE BACK OF THIS SHEET: USE ONE SIDE ONLY

INSTRUCTIONS: Each page must be signed by the FIRST AND SECOND EXAMINERS. Completed forms should be handed to the Assistant Registrar (Examinations).

..................................... First Examiner Date: 2012/03/23

............................................ Second Examiner Date: 2012 /03/23