Name: ______________________________

Seat Number: ________________________

INSTITUTE OF BUSINESS ADMINISTRATION

SECOND TERM EXAM (A)
SPRING2016
FINANCIAL MANAGEMENT(FIN401)

Maximum marks: 20
Date: April 8, 2016

Important Instructions:
 Detach the objective answer sheet from the question paper and attempt all questions on
the objective answer sheet.
 Don’t show any rough calculations on the question paper or the objective answer sheet.
Use the answer booklet for the rough work.
 The answers once marked or written on the objective answer sheet shall not be changed.
 There is no negative marking for wrong answers.
 Tables for PVIFA and FVIFA are attached with the question paper.

Answer the following multiple-choice questions.

1. If the cost of capital increases, which of the following is true?

a. The IRR decreases
b. The simple payback period decreases
c. NPV decreases
d. All of the above

2. The initial outlay for an investment project is $4 million. The present value of all cash
flows over the life of the project is shown below for the following four interest rates:
Interest rate (%) PV of cash flows (million)
6 5.7
8 4.8
10 4
12 3.2

If the required rate of return is 13%, which of the following statement is correct?
a. The NPV is positive
b. The IRR is less than 5%
c. The simple payback period is less than 2 years
d. None of the above

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 3. High Speed Company has an expected ROE of 15%. The dividend growth rate will be
________ if the firm follows a policy of paying 50% of earnings in the form of
dividends.
a. 3.0%
b. 4.8%
c. 7.5%
d. 6.0%

4. Assume that at the end of the next year, Bolton Company will pay a $2.00 dividend per
share, an increase from the current dividend of $1.50 per share. After that, the dividend
is expected to increase at a constant rate of 5%. If you require a 12% return on the stock,
the value of the stock is ________.
a. $28.57
b. $28.79
c. $30.00
d. $31.78

5.The most appropriate discount rate to use when applying a FCFE valuation model is the
___________.
a. required rate of return on equity
b. WACC
c. risk-free rate
d. a or c depending on the debt level of the firm

6.Siri had a FCFE of $1.6M last year and has 3.2M shares outstanding. Siri's required return
on equity is 12% and WACC is 9.8%. If FCFE is expected to grow at 9% forever, the
intrinsic value of Siri's shares is ____________.
a. $68.13
b. $18.17
c. $26.35
d. $14.76

7. FCFE forecasts for TechnoSchaft for the next four years are as follows:
Year 1 2 3 4
FCFE ($ per share) 0.90 1.08 1.296 3.491

From year 5, FCFE is expected to increase at 6% forever. The cost of equity for the company is
12.4% and WACC is 10.5%. The value per share is:
a. $43.78
b. $42.25
c. $40.98
d. $35.98

8. FCFF of the firm is used for:

a. Paying interest

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 b. Paying preferred dividends
c. Paying common dividends
d. All of these

9. FCF valuation should be used:

a. When the company is a non-dividend paying company
b. When the company has no debt in its capital structure
c. When the company does not plan to expand its operations
d. All of these

10. Suppose that a project with an initial investment of $50,000 is expected to generate an
annual cash flow of $14,000 for each of the next 7 years. This project should not be
accepted if the cost of capital is:
a. 8 percent.
b. 12 percent.
c. 15 percent.
d. 21 percent.

11. An analyst following Barklows Corporation has collected the following information:
FCFF for the year just ended $86,000,000
Value of Debt $600,000,000
Value of Preferred Equity $200,000,000
WACC 10%
Cost of Equity 14%
Constant growth in FCFF 4%
Number of common shares 50,000,000

The fair value of Barklows common stock using FCFF valuation is:
a. $10.35
b. $13.81
c. $15.24
d. None of these

12. General Motors ( GM) sells for $66.00 per share. The expected dividend for next year is
$2.40. Use the single-period DDM to predict GMs stock price one year from today. The
risk-free rate of return is 5.3%, the equity risk premium is 6.0 percent, and GM’s beta is
0.90.
a. $70.66
b. $67.25
c. $66.20
d. $73.10

13. An analyst frequently uses dividend discount models such as the Gordon growth model
for the consumer noncyclical stocks that he covers. The current dividend for Procter &
Gamble Co. is $1.46, and the dividend eight years ago was $0.585. The current stock
price is $80.00. The analyst assumes that the future dividend growth rate will be exactly

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 half of the historical dividend growth rate. What is Procter & Gamble’s expected rate of
return using the Gordon growth model? (Hint: first calculate the historical growth rate).
a. 7%
b. 8%
c. 9%
d. 10%

14. NiSource Preferred B is a fixed-rate perpetual preferred stock paying a $3.88 annual
dividend. If the required rate of return is 7.88 percent, what is the value of one share? If
the price of this preferred stock were $46.00, what would be the yield?
a. $44.5 and 7.43%
b. $49.24 and 8.43%
c. $50.85 and 9.43%
d. $52.25 and 10.43%

15. If interest expense increases by Rs 100,000 and income tax rate is assumed to be 40%,
FCFF and FCFE will change as follows:
FCFF (Rs.) FCFE (Rs.)
a. + 60,000 zero
b. Zero -100,000
c. - 60,000 zero
d. Zero - 60,000

16. If investment in plant and equipment increases by Rs 1,000,000 (and income tax is
assumed to be 30%), FCFF and FCFE will change as follows:
FCFF (Rs.) FCFE (Rs.)
a. -700,000 -700,000
b. Zero -700,000
c. zero zero
d. -1,000,000 -1,000,000

17. The following information has been taken from the income statement and statement of
cash flows (for the year ending 31st December 2015) of ABC Company:
- Interest expense $130,000
- Borrowings $500,000
- Loan Repayments $450,000
- Depreciation Expense $800,000
- Increase in working capital $400,000

If FCFF is $156,000 and income tax rate is 40%, FCFE will be:
a. $128,000
b. $928,000
c. $176,000
d. $ 26,000

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18. Identify the point that is not valid for capital budgeting purposes.
a. Projects are evaluated on stand-alone basis.
b. Evaluation is based on incremental operating cash flows.
c. Only investment in fixed assets is considered and investment in working
capital is ignored.
d. Cash flows are computed on after-tax basis.

19. Free cash flows should not be used for valuation of stocks instead of DDM when:
a. the company is non-dividend paying
b. the company is dividend paying, but dividends are much higher or smaller
than the free cash flows to equity
c. the company’s free cash flows do not align with the company’s profitability.
d. the investor takes a control perspective

20. Free Cash Flow to the Firm (FCFF) can be calculated as:
a. EBIT + Non-cash charges – Investment in fixed capital & working capital
b. Net Income + Interest expense + Non cash charges – Investment in fixed
capital & working capital.
c. Operating cash flow (GAAP based) + Interest Expense – Fixed Investment.
d. None of the above.

21. Conceptually, residual income for a given time period is:

a. the earnings for that period in excess of the investors’ required return on
beginning of period investment (common stockholders’ equity).
b. the residual income left over after distribution of dividends.
c. the earnings in excess of previous year’s earnings.
d. the residue left over after deduction of operating cash expenses from cash
revenues.

22. According to the residual income model a stock’s value is equal to:
a. present value of future residual earnings per share
b. present value of all future retained earnings per share
c. book value/share + present value of future residual earnings per share
d. total assets per share + present value of future residual earnings/share

23. An analyst of KLL Company has assembled the following information for the year 2015:
Rs. in million
Net Income available to common shareholders 240
Non cash charges (Depreciation etc) 300
Interest expense 100
Investment in fixed capital 400
Investment in working capital 45
Income tax rate = 40%

The correct FCFF is:

a. Rs 195 million

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 b. Rs 155 million
c. Rs 240 million
d. Rs 540 million

24. An automobile manufacturing Company is considering including two pieces of

equipment, a press machine and a die making machine, in this year’s capital budget. The
projects are independent. The cash outlay for the press is Rs.17,100,000 and that for the
die making machine it is Rs 22,430,000. The firm’s cost of capital is 14 %. After-tax cash
inflows are as follows:
Year Press Machine Die Machine
1 Rs. 5,100,000 Rs. 7,500,000

2 Rs. 5,100,000 Rs. 7,500,000

3 Rs. 5,100,000 Rs. 7,500,000

4 Rs. 5,100,000 Rs. 7,500,000

5 Rs. 5,100,000 Rs. 7,500,000

Calculate the NPV (rounded to closest thousand) for each project and indicate the correct
accept/reject decision.

Press Machine Die Machine

a. NPV Rs 409,000 (Accept) Rs 3,318,000(Accept)
b. NPV Rs17,509,000(Accept) Rs 25,748,000(Accept)
c. NPV Rs14,509,000(Accept) Rs 20,549,000(Accept)
d. NPV None of the above

25. Identify the incorrect statement.

The weakness of Simple Payback Period method is that,
a. It ignores the time value of money.
b. It doesn’t indicate anything about profitability or value addition of the project.
c. It indicates the liquidity of the project.
d. It ignores the cash flows beyond the payback period.

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