SET 1

INTERNATIONAL ISLAMIC UNIVERSITY MALAYSIA

ENDOFSEMESTEREXAMINATION
SEMESTER2,2010/2011SESSION

KULLIYYAHOFECONOMICSANDMANAGEMENTSCIENCES
Programme : ENM/BBA/BECS

Level of Study : 1 & 2

Time
Duration

Date

: 9.4. 2011

Section(s)

: 14

: 9.00 a.m. 12.00 noon

: 3 Hr(s) 0 Min(s)

Course Code : FIN 3010

Course Title : Financial Management I

This Examination Paper Consists of 10 Printed Pages Including A Cover Page With 2 Parts)
INSTRUCTION TO CANDIDATES:
DO NOT OPEN THE QUESTION BOOKLET UNTIL YOU ARE ASKED TO DO SO
Answer ALL questions: (Total: 100 marks)
Part 1: Answer the MCQs in the answer sheet provided
Part 2: Answer in the answer booklet provided
Please refer to the instructor ONLY if you think something is seriously wrong with any of the
questions. DO NOT ask instructor to interpret and clarify the question.

Any form of cheating or attempt to cheat is a serious offence which may

lead to dismissal.
APPROVED BY:

EMERITUS PROF. DR. MOHAMED SULAIMAN

Head, Department of Business Administration
Kulliyyah of Economics and Management Sciences

SET 1
PART 1: Thirty (30) multiple choice questions (37.5 marks)
INSTRUCTION TO STUDENTS:
Please answer in the MCQ answer sheet provided.
1) The primary role of a financial system is to
a. channel funds from savers to borrowers who need funds for investment projects.
b. regulate the banking system.
c. provide employees in financial institutions with a code of ethics.
d. enable financial managers to evaluate investment projects with a system that always
selects the correct opportunity for their firm.
e. make savvy investors rich.

2) Under shareholder wealth maximization, the directive to managers is to ____________ the

firms cash flows while _____________ risk.
a. decrease; maximizing
b. decrease; minimizing
c. increase; maximizing
d. increase; minimizing
e. None of the above.

3) Total shareholder wealth can be calculated by

a. dividing the value of the firms assets by the number of outstanding shares.
b. finding earnings per share by dividing the profits earned over the last year by the
number of outstanding shares.
c. multiplying the number of shares outstanding by the market price per share.
d. multiplying the number of shares outstanding by the book value per share.
e. subtracting the book value of bonds from the book value of assets.

4) An increase in interest rates

a. should raise stock prices since this change will lead investors to conclude that future
profits will rise.
b. is likely to depress economic activity by lowering investment spending, but it has no
direct effect on consumer spending.
c. lowers the cost of borrowing since the increase is offset by lower principal payments
on outstanding debt.
d. may lead to a decline in corporate profits.
e. can only be explained by the market segmentation theory of the yield curve.

5) If interest rates are 5%, which of the following will produce the largest amount of money in
four years?
a. $500 earning simple interest
b. $400 with interest compounded annually
c. $300 with interest compounded semiannually
d. $100 with interest compounded quarterly
e. $25 with interest compounded monthly
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SET 1

6) Current assets values may be estimated by calculating

a. the future value of all cash flows expected from the asset.
b. a sum of all cash flows forecasted from the use and/or sale of the asset.
c. the present value of all future cash flows expected from the asset.
d. the cash flows expected from the asset without adjusting for the time value of
money.
e. only the present value of cash flows to be received in the first two years since later
cash flows are too uncertain to be considered.

7) Which of the following most closely defines the term risk in finance?
a. A situation in which the required return on an asset equals its expected return.
b. Knowing that you will lose money on an investment.
c. A measure of the magnitude of cash flows.
d. A measure of the variability of cash flows.
e. A decision in which the potential outcomes are known with certainty.

8) An expected return from a portfolio

a. will exceed the highest expected return from any of the securities in the portfolio.
b. will be lower than the expected return from the security in the portfolio with the
lowest yield because portfolios have less risk than individual securities.
c. can be calculated more accurately than the expected return from any of the securities
in the portfolio.
d. will lie somewhere between the highest and lowest expected returns from securities
in the portfolio.
e. cannot be computed if there are fewer than three securities in the portfolio.

9) In a well-diversified portfolio, the most relevant type of risk to a well-diversified investor is

a. unsystematic risk.
b. firm-specific risk.
c. market risk.
d. exchange rate risk.
e. interest rate risk.

10) The standard deviation of an individual stock return measures

a. market risk only.
b. firm-specific risk only.
c. total risk.
d. diversifiable risk only.
e. systematic risk only.

SET 1

11) Which of the following statements is true?

a. Most bonds pay interest monthly.
b. Financial assets always sell for the value of their compounded future cash flows.
c. All investors agree about the magnitude of the future cash flows from an asset.
d. The possibility that a tangible asset may require future repairs should not be
considered in calculating its present value.
e. Corporations usually attempt to set coupon rates so that the yield on its newly-issued
bonds is close to similar bonds traded in the secondary market.

12) A $1,000 par value bond has a coupon rate of 5%. Bonds of similar risk currently yield 7%.
This bond should be selling
a. at a discount.
b. at a premium.
c. for its par value.
d. at the price Treasury bonds of the same maturity are currently selling for.
e. Cannot be determined without further information.

13) As the maturity date of a bond approaches

a. the price of the bond approaches its face value.
b. the bond will always sell at a premium.
c. the bond will always sell at a discount.
d. its price will not change.
e. default risk increases.

14) Which of the following statements is true?

a. Bonds are usually higher-risk investments than common stock.
b. Bondholders are repaid before stockholders after a firms liquidation.
c. Investors often shift their portfolio weights from bonds to stock in response to small
declines in bond yields.
d. Coupon payments from most bonds fluctuate as market interest rates change.
e. Bonds often earn capital gains but seldom incur capital losses.

15) An increase in a firms market risk should be reflected in what part(s) of the Gordon growth
(Dividend Discount Model) model?
a. The dividend growth rate
b. The required return
c. Next years dividend
d. Answers (a) and (b) only
e. All of the above.

SET 1
16) A common source of error in estimating dividend growth rates is
a. mathematical errors committed by stock analysts.
b. the erratic earnings records of many firms.
c. the fact that growth rate predictions must be based on historical information.
d. analysts lack of training in modern forecasting techniques.
e. the fact that the Gordon growth model cannot be applied to real world situations.
17) The degree of market efficiency in which stock prices incorporate only all publicly
available information is called
a. weak form efficient.
b. semi-strong form efficient.
c. strong form efficient.
d. allocative efficient.
e. informational efficient.

18) When evaluating a project, a firms managers should select projects whose cash flows
a. result in a return that exceeds the cost of funds to finance the project.
b. are subject to less risk than competing projects.
c. produce higher returns than the firms average cost of capital.
d. have the lowest NPVs after discounting cash flows by the projects capital cost.
e. exceed some target cash flow level set by management.

19) Which of the following is not a component cost generally used to compute the WACC or
the WMCC?
a. After-tax cost of debt
b. Cost of preferred stock
c. Cost of retained earnings
d. Cost of new equity
e. All of the above are components generally used to compute the WACC.

20) Which of the following is not typically considered in the study of the capital budgeting
process?
a. The timing of the cash flows from a project.
b. The opportunity cost of the investment being considered.
c. The time value of money.
d. The amount of funds available for investment.
e. Non-cash expenses.

21) A project requires a current expenditure of $300 and expects to generate $100 cash inflows
at the end of each of the next 5 years. What conclusion can be drawn from examining an
NPV profile for this project?
a. Accept the project if the cost of capital exceeds 20%
b. Accept the project if the cost of capital is below 20%
c. Reject the project if the cost of capital exceeds 10%
d. Reject the project if the cost of capital exceeds 7%
e. Reject the project if the cost of capital exceeds 5%
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SET 1

22) The internal rate of return may be defined as the

a. percentage increase in the value of an investment over its useful life.
b. the minimum return required by investors to hold a firms securities.
c. the discount rate at which a projects NPV is negative.
d. the discount rate at which a projects NPV equals zero.
e. the maximum rate of return expected from a project.
23) Perhaps the greatest disadvantage of using the IRR method to evaluate investment
opportunities is
a. dealing with uncertain cash flows from the project.
b. the assumption that all cash flows from the project will be reinvested at the IRR.
c. the inability to calculate most IRRs without a computer.
d. the need to compare IRR with the firms cost of capital which cannot be estimated
precisely.
e. the fact that the technique does not account for risk.

24) The NPV method assumes that cash inflows are reinvested at the
a. internal rate of return.
b. firms cost of capital.
c. average yield on corporate bonds.
d. average yield from an equity index fund.
e. risk-adjusted hurdle rate.

25) Financing costs should be excluded from the estimated cash flows associated with a project
because
a. the cost of capital is already reflected in the discount rate and including interest
expense would be double-counting.
b. most projects do not require external financing.
c. the cost of capital is difficult to estimate accurately.
d. capital costs are relevant only when there are mutually exclusive projects.
e. projects funded with equity always have an advantage over those financed with debt
because of interest payments.

26) The book value of an asset may be found by

a. consulting with a qualified appraiser.
b. adding yearly depreciation expenses to the purchase price of the asset.
c. selling the asset.
d. adding total accumulated depreciation to the assets original value.
e. subtracting total accumulated depreciation from the assets original value.

SET 1
27) Wycliff Jeans Co. is a privately-held firm that has never paid a dividend. To establish a
share price before going public, investment bankers found that the P/E ratio for similar firms
is 15 and that Wycliffs projected EPS is $4.00. Based on these findings, what is the
estimated price per share of Wycliff stock?
a. $ 3.75
b. $ 4.00
c. $50.00
d. $60.00
e. $75.00

28) Billy Bob Co. contemplates acquiring another firm. The acquisition would slightly increase
Billy Bobs risk from a beta of 1.0 to a beta of 1.1. If T-bills current provide a return of
6.0% and the long-term return on the stock market is 11.0%, then Billy Bobs cost of equity
is
a. 6.0%
b. 11.0%
c. 14.3%
d. 15.0%
e. 11.5%

29) Kathy and her husband Chet plan to purchase a home in five years. If the present price of the
house they prefer is $200,000 and housing prices are expected to rise 5% per year, how
much will their house cost in five years?
a. $255,260
b. $210,000
c. $205,000
d. $250,000
e. $215,000

30) Maria wants to have $40,000 in her savings account in ten years. She currently has $10,000
in the account, and the account pays interest of 4%. How much should Maria save each year
to accomplish her goal?
a. $2,099
b. $3,332
c. $750
d. $4,565
e. $2,722

SET 1
PART 2: (62.5 marks)
INSTRUCTION TO STUDENTS:
i) Please answer all the six questions in the answer booklet provided.
ii) Draw the time line and show all workings, where applicable. Partial credits will be
given for your workings.

Question 1: (12.5 marks)

a) Sam was injured in an accident, and the insurance company has offered him the choice of
$49,000 per year for 15 years, with the first payment being made today, or a lump sum. If a
fair return is 7.5%, how large must the lump sum be to leave him as well off financially as
with the annuity?
(3.5 marks)

b) Your uncle has $1,135,000 and wants to retire. He expects to live for another 25 years and
to earn 7.5% on his invested funds. How much could he withdraw at the end of each of the
next 25 years and end up with zero in the account?
(3 marks)

c) Your sister turned 35 today, and she is planning to save $20,000 per year for retirement,
with the first deposit to be made one year from today. She will invest in a unit trust fund
that is expected to provide a return of 7.5% per year. She plans to retire 30 years from
today, when she turns 65, and she expects to live for 25 years after retirement, to age 90.
Under these assumptions, how much can she spend each year after she retires? Her first
withdrawal will be made at the end of her first retirement year.
(6 marks)
(Note: For question 1, please round-up all calculations to the nearest $1)

Question 2: (9 marks)
A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells
for $900. If the yield to maturity remains at its current rate, what will the price be 5 years from
now? (Note: Please round-up all calculations to the two decimal places)

Question 3: (9 marks)
Huang Company's last dividend was $1.25. The dividend growth rate is expected to be constant at
30% for 3 years, after which dividends are expected to grow at a rate of 6% forever. The
companys beta is 0.87, 10-year government securities yields 4.31% and expected market return is
12%. Based on this model and the assumptions hold, what is stock intrinsic value? (Note: Please
round-up all calculations to the two decimal places)

SET 1

Question 4: (10 marks)

a. Al-Ikhwan Sportswear stock has a 50% chance of producing a 25% return, a 30% chance of
producing a 10% return, and a 20% chance of producing a -28% return. What is the
company's expected rate of return? (Note: Please round-up all calculations to the two
decimal places)
(4 marks)
b. Johan Arif holds a $200,000 portfolio consisting of the following stocks. The portfolio's
beta is 0.875.
Stock
A
B
C
D
Total

Investment
$50,000
$50,000
$50,000
$50,000
$200,000

Beta
0.50
0.80
1.00
1.20

If Johan replaces Stock A with another stock, E, which has a beta of 1.50, what will the
portfolio's new beta be? (Note: Please round-up all calculations to the two decimal places)
6 marks)

Question 5: (10 marks)

Assume that you are on the financial staff of Wan Hussein Garments Company and you have
collected the following data:
The companys outstanding 7.5% coupon bond, with 10 years to maturity is currently being
traded at $982.82. Interest is paid semi-annually.
The next expected dividend is $0.65 a share, the dividend is expected to grow at a constant
rate of 6.00% a year, the price of the common stock is $19.00 per share, the flotation cost for
selling new shares is 10%.
The target capital structure is 45% debt and 55% common equity. Companys tax rate is
40%.
What is the firm's WACC, assuming it must issue new common stocks to finance its capital budget?
(Note: Please round-up all calculations to the two decimal places)

SET 1

Question 6: (12 marks)

Besta Food Industries Sdn Bhd (BFI) is considering a new average-risk investment project whose
data are shown below. The equipment would be depreciated on a straight-line basis towards a zero
salvage value over the projects 4 year life. The equipment is expected to be sold at the end of the
projects life.
BFI would require some additional working capital that would be recovered at the end of the
projects life. The revenues and other operating costs are expected to be constant over the projects
life.
The company evaluates all average risk investment proposal using its weighted average cost of
capital. What are the projects NPV and IRR? Is the project viable? (Note: Please round-up all
calculations to the nearest $1)
Equipment cost
Installation & commissioning cost

$ 80,000
$ 10,000

Required new operating working capital:Inventory

Accounts receivable
Accruals
Accounts payable

$ 11,000
$ 19,000
$ 3,000
$ 12,000

Sales revenues
Operating costs (excluding depreciation)
Straight-line depreciation, useful life

$ 85,000
$ 42,500
4 years

Estimated selling price of equipment at end of project

Tax rate
Weighted average cost of capital

$ 6,000
35.0%
15.0%

10