MIDTERM EXAMINATION
Spring 2009
MGT201- Financial Management (Session - 2)
Question No: 1 ( Marks: 1 ) - Please choose one
Why companies invest in projects with negative NPV? ► Because there is hidden value in each project
► Because they have chance of rapid growth
► Because they have invested a lot
► All of the given options
Question No: 2 ( Marks: 1 ) - Please choose one
Mutually exclusive means that you can invest in _________ project(s) and having chosen ______ you cannot choose another. ► One; one
► Two; two
► Two; one
► Three; one
Question No: 3 ( Marks: 1 ) - Please choose one
The weighted average of possible returns, with the weights being the probabilities of occurrence is referred to as __________. ► A probability distribution
► The expected return
► The standard deviation
► Coefficient of variation
Question No: 4 ( Marks: 1 ) - Please choose one
A set of possible values that a random variable can assume and their associated probabilities of occurrence are referred to as __________. ► Probability distribution
► The expected return
► The standard deviation
► Coefficient of variation
Question No: 5 ( Marks: 1 ) - Please choose one
The present value of growth opportunities (PVGO) is equal toI) The difference between a stock's price and its no-growth value per share
II) The stock's price
III) Zero if its return on equity equals the discount rate
IV) The net present value of favorable investment opportunities
► I and IV
► II and IV
► I, III, and IV
► II, III, and IV
Question No: 6 ( Marks: 1 ) - Please choose one
Which of the following is CORRECT, if a firm has a required rate of return equal to the ROE? ►The firm can increase market price and P/E by retaining more earnings
►The firm can increase market price and P/E by increasing the growth rate
►The amount of earnings retained by the firm does not affect market price or the P/E
►None of the given options
Question No: 7 ( Marks: 1 ) - Please choose one
Which of the following would tend to reduce a firm's P/E ratio? ►The firm significantly decreases financial leverage
►The firm increases return on equity for the long term
►The level of inflation is expected to increase to double-digit levels
►The rate of return on Treasury bills decreases
Question No: 8 ( Marks: 1 ) - Please choose one
A company whose stock is selling at a P/E ratio greater than the P/E ratio of a market index, most likely has _________. ►An anticipated earnings growth rate which is less than that of the average firm
►A dividend yield which is less than that of the average firm
►Less predictable earnings growth than that of the average firm
►Greater cyclicality of earnings growth than that of the average firm
Question No: 9 ( 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: 10 ( Marks: 1 ) - Please choose one
The market capitalization rate on the stock of Steel Company is 12%. The expected ROE is 13% and the expected EPS are Rs. 3.60. If the firm's plowback ratio is 50%, what will be the P/E ratio?►7.69
►8.33
►9.09
►11.11
Question No: 11 ( Marks: 1 ) - Please choose one
How dividend yield on a stock is similar to the current yield on a bond?►Both represent how much each security’s price will increase in a year
►Both represent the security’s annual income divided by its price
►Both are an accurate representation of the total annual return an investor can expect to earn by owning the security
►Both incorporate the par value in their calculation
Question No: 12 ( Marks: 1 ) - Please choose one
Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends. ►6.0%
►4.8%
►7.2%
►3.0%
Question No: 13 ( Marks: 1 ) - Please choose one
The value of direct claim security is derived from which of the following? ► Fundamental analysis
► Underlying real asset
► Supply and demand of securities in the market
► All of the given options
Question No: 14 ( Marks: 1 ) - Please choose one
Which of the following value of the shares changes with investor’s perception about the company’s future and supply and demand situation? ► Par value
► Market value
► Intrinsic value
► Face value
Question No: 15 ( Marks: 1 ) - Please choose one
How efficient portfolios of "N" risky securities are formed? ► These are formed with the securities that have the highest rates of return regardless of their standard deviations
► They have the highest risk and rates of return and the highest standard deviations
► They are selected from those securities with the lowest standard deviations regardless of their returns
► They have the highest rates of return for a given level of risk
Question No: 16 ( Marks: 1 ) - Please choose one
When a bond will sell at a discount? ► The coupon rate is greater than the current yield and the current yield is greater than yield to maturity
► The coupon rate is greater than yield to maturity
► The coupon rate is less than the current yield and the current yield is greater than the yield to maturity
► The coupon rate is less than the current yield and the current yield is less than yield to maturity
Question No: 17 ( Marks: 1 ) - Please choose one
Which of the following is a characteristic of a coupon bond? ► Pays interest on a regular basis (typically every six months)
► Does not pay interest on a regular basis but pays a lump sum at maturity
► Can always be converted into a specific number of shares of common stock in the issuing company
► Always sells at par
Question No: 18 ( Marks: 1 ) - Please choose one
A coupon bond pays annual interest, has a par value of Rs.1,000, matures in 4 years, has a coupon rate of 10%, and has a yield to maturity of 12%. What is the current yield on this bond? ► 10.65%
► 10.45%
► 10.95%
► 10.52%
Question No: 19 ( Marks: 1 ) - Please choose one
If a 7% coupon bond is trading for Rs. 975 it has a current yield of _________ percent. ► 7.00
► 6.53
► 8.53
► 7.18
Question No: 20 ( Marks: 1 ) - Please choose one
Interest rate risk for long term bonds is more than the interest rate risk for short term bonds provided the _________ for the bonds is similar. ► Interest rate risk
► Market rate
► Coupon rate
► Inflation rate
Question No: 21 ( Marks: 1 ) - Please choose one
When market is offering lower rate of return than the bond, the bond becomes valuable, with respect to the given scenario which of the following is correct? ► Market interest rate < coupon interest rate, market value of bond is > par value
► Market interest rate > coupon interest rate, market value of bond is > par value
► Market interest rate < coupon interest rate, market value of bond is < par value
► Market interest rate = coupon interest rate, market value of bond is > par value
Question No: 22 ( 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: 23 ( Marks: 1 ) - Please choose one
Bond is a type of Direct Claim Security whose value is NOT secured by __________. ► Tangible assets
► Intangible assets
► Fixed assets
► Real assets
Question No: 24 ( Marks: 1 ) - Please choose one
__________ is a long-term, unsecured debt instrument with a lower claim on assets and income than other classes of debt. ► A subordinated debenture
► A debenture
► A junk bond
► An income bond
Question No: 25 ( Marks: 1 ) - Please choose one
A 12% coupon rate, Rs.1,000 par bond currently trades at 90 one year after issuance. Which of the following is the most likely call price? ► Rs. 87
► Rs. 90
► Rs. 102
► Rs. 112
Question No: 26 ( Marks: 1 ) - Please choose one
Which of the following is a legal agreement between the corporation issuing bonds and the bondholders that establish the terms of the bond issue? ► Indenture
► Debenture
► Bond
► Bond trustee
Question No: 27 ( Marks: 1 ) - Please choose one
Companies and individuals running different types of businesses have to make the choices of the asset according to which of the following? ► Life span of the project
► Validity of the project
► Cost of the capital
► Return on asset
Question No: 28 ( 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: 29 ( Marks: 1 ) - Please choose one
Why net present value is the most important criteria for selecting the project in capital budgeting? ► Because it has a direct link with the shareholders dividends maximization
► Because it has direct link with shareholders wealth maximization
► Because it helps in quick judgment regarding the investment in real assets
► Because we have a simple formula to calculate the cash flows
Question No: 30 ( Marks: 1 ) - Please choose one
From which of the following category would be the cash flow received from sales revenue and other income during the life of the project? ► Cash flow from financing activity
► Cash flow from operating activity
► Cash flow from investing activity
► All of the given options
Question No: 31 ( 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: 32 ( Marks: 1 ) - Please choose one
ABC Co. will earn Rs. 350 million in cash flow in four years from now. Assuming an 8.5% weighted average cost of capital, what is that cash flow worth today? ► Rs.253 million
► Rs.323 million
► Rs.380 million
► Rs.180 million
Question No: 33 ( Marks: 1 ) - Please choose one
An 8-year annuity due has a future value of Rs.1,000. If the interest rate is 5 percent, the amount of each annuity payment is closest to which of the following? ► Rs.109.39
► Rs.147.36
► Rs.154.73
► Rs.99.74
Question No: 34 ( Marks: 1 ) - Please choose one
As interest rates go up, the present value of a stream of fixed cash flows _____. ► Goes down
► Goes up
► Stays the same
► Can not be found
Question No: 35 ( Marks: 1 ) - Please choose one
An annuity due is always worth _____ a comparable annuity. ► Less than
► More than
► Equal to
► Can not be found
Question No: 36 ( Marks: 1 ) - Please choose one
What is the present value of an annuity that pays 100 per year for 10 years if the required rate of return is 7%? ► Rs.1000
► Rs.702.40
► Rs.545.45
► Rs.13,816
Question No: 37 ( Marks: 1 ) - Please choose one
Which of the following would be considered a cash-flow item from a "financing" activity? ► A cash outflow to the government for taxes
► A cash outflow to repurchase the firm's own common stock
► A cash outflow to lenders as interest
► A cash outflow to purchase bonds issued by another company
Question No: 38 ( Marks: 1 ) - Please choose one
Which group of ratios relates profits to sales and investment? ► Liquidity ratios
► Debt ratios
► Coverage ratios
► Profitability ratios
Question No: 39 ( Marks: 1 ) - Please choose one
Which of the following statements is the least likely to be correct? ► A firm that has a high degree of business risk is less likely to want to incur financial risk
► There exists little or no negotiation with suppliers of capital regarding the financing needs of the firm
► Financial ratios are relevant for making internal comparisons
► It is important to make external comparisons or financial ratios
Question No: 40 ( Marks: 1 ) - Please choose one
Which of the following statement (in general) is correct? ► A low receivables turnover is desirable
► The lower the total debt-to-equity ratio, the lower the financial risk for a firm
► An increase in net profit margin with no change in sales or assets means a weaker ROI
► The higher the tax rate for a firm, the lower the interest coverage ratio
Question No: 41 ( Marks: 10 )
You are a financial analyst for the Hittle Company. The director of capital budgeting has asked you to analyze two proposed capital investments Project X and Project Y. Each project has a cost of Rs. 10,000 and the cost of capital for both projects is 12%. The projects’ expected cash flows are as follows: | Year | Expected net cash flows | |
| Project X | Project Y | |
| 0 | (10,000) | (10,000) |
| 1 | 6,500 | 3,500 |
| 2 | 3,000 | 3,500 |
| 3 | 3,000 | 3,500 |
| 4 | 1,000 | 3,500 |
i. Calculate each project’s payback, net present value (NPV), internal rate of return (IRR), and profitability index (PI).
ii. Which project or projects should be accepted if they are independent?
iii. Which project should be accepted if they are mutually exclusive?
ANSWER:
1. Payback: PROJECT X: Cost of project = Rs. 10,000
Payback period is the time required by the project to recover its costs.
Year 1 the project will recover Rs. 6,500
Year 2 the project will recover Rs 3000
Year 3 project will recover the remaining Rs. 500 in 1st month of 3rd yr. So payback period for Project X is 2 yrs and 1 month.
PROJECT Y: Cost of project= Rs 10,000
Year 1 project will recover Rs 3,500
Year 2 project will recover Rs 3,500
Year 3 project will recover remaining Rs 3000 in approximately 11 months of 3rd yr.
So payback period of project Y is 2 yrs and 11 months.
2. Net Present Value:
Project X: Initial investment, I0 = Rs 10,000
Cash flow in yr 1, CF1 = Rs 6500
Cash flow in yr 2, CF2 = Rs 3000
Cash flow in yr 3, CF3 = Rs 3000
Cash flow in yr 4, CF4 = Rs 1000
Discount rate, I = 12 %
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 + 6500/(1.12) + 3000/(1.12)2+ 3000/(1.12)3+ 1000/(1.12)4
= Rs 966
Project Y: Initial investment, I0 = Rs 10,000
Cash flow in yr 1, CF1 = Rs 3500
Cash flow in yr 2, CF2 = Rs 3500
Cash flow in yr 3, CF3 = Rs 3500
Cash flow in yr 4, CF4 = Rs 3500
Discount rate, I = 12 %
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 + 3500/(1.12) + 3500/(1.12)2+ 3500/(1.12)3+ 3500/(1.12)4
= Rs 631
- IRR: Project X: Put NPV = 0
NPV = - 10000 + 6500/(1+i) + 3000(1+i)2+ 3000(1+i) 3+ 1000/(1+i) 4
- Profitability Index:
Project X: PI= Sum(CFt/(1+i)t)/Io
= 10,966/10000 = 1.096
Project Y : PI= Sum(CFt/(1+i)t)/Io
= 10631/10000 = 1.0631
Result: Since NPV and PI of project X are higher than that of project Y so Project X will be accepted.
www.forum.ysapak.com