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Financial Management - March 2024

MIDTERM TEST

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1. The aim of a company’s investment policy should be to: (2 Points)

A Maximise future profits

B Maximise shareholder wealth

C Maximise the total value of the company

D Maximise future cash flows

2. A machine that was bought in January 20X4 for $44,000 and has been depreciated by
$8,000 per year is expected to be sold in December 20X6 for $17,600.
What is the net cash inflow that will appear in the cash budget for December 20X6m, to
the nearest dollar? (2 Points)

3. There are a number of motives that influence how much a business wishes to hold in cash.
Complete the following statement:
When a company holds cash in order to make the payments that are necessary to keep
the business going, such as wages, taxes and payments to suppliers, the motive behind
this is the _________________ motive

Pick from list: speculative, transactions, finance, precautionary

(2 Points)

4. A company has a number of projects available to it but has a limit of $20,000 on its capital
investment fuds. Each project has an initial outlay today followed by a constant annual cash
inflow in perpetuity comme cing in one year’s time. The projects are as follows. Initial outlay
Inflow per year
$ $
Project E 6,000 900
Project F 8,000 1,000
Project G 10,000 3,500
Project H 12,000 3,600
Project I 20,000 4,600
The company’s cost of capital is 10% per year and all projects are independent and
indivisible.
What is the maximum net present value that can be generated, to the nearest dollar?
(2 Points)

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5. An asset costing $24,000 is expected to last for three years, after which it can be sold for
$16,000. The corporation tax rate is 30%, tax-allowable depreciation of 25% is available,
and the cost of capital is 10%. Tax is payable at the end of each financial year.

Capital expenditure occurs on the first day of a financial year, and the tax depreciation
allowances are claimed as early as possible.

What is the cash flow in respect of tax allowable depreciation that will be used at time
2
of the net present value calculation? (2 Points)

A $1,350

B $896

C $1,013

D $3,375

6. Which of the following is an example of a financial objective that a company might

choose to pursue? (2 Points)

A Achieving returns of 15% on new manufacturing equipment

B Improving brand awareness within Europe

C Dealing honestly and fairly with customers on all occasions

D Producing environmentally friendly products

7. If an increase in inventory levels is funded by an increase in the bank overdraft, what

will be the effect of the quick (liquidity) ratio? (2 Points)

A Increase

B Decrease

C Remain the same

D Increase, decrease or remain the same depending on the initial size of the quick ratio

8. A company has identified two mutually-exclusive projects which have an equivalent effect
on the risk profile of the company.
Project 1 Project 2
Discounted payback period 2.6 years 3.0 years
Net present value $17,000 $15,000
Internal rate of return 16% 20%
Average accounting rate of return 17% 19%
Cost of capital is 15%.
Assuming that the directors wish to maximise shareholder wealth and that no shortage
of
capital is expected, which project should the company choose and why? (2 Points)

A Project 1 because it has the shorter payback period

B Project 1 because it has the higher net present value

C Project 2 because it has the higher internal rate of return

D Project 2 because it has the higher accounting rate of return

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9. What is the payback period of the following investment?

Year 0: $325,000 spent on a new machine
Years 1 to 6: $50,000 cash inflow per annum
Years 7 to 10: $25,000 cash inflow per annum
Year 11: Machine sold for $62,857 (2 Points)

A 7 years

B 6 years

C 6.25 years

D 7.25 years

10. A firm has to choose between two mutually-exclusive projects, the outcomes of which
depend on the weather. The following estimates have been made:
Weather Sunshine Rain
Probability 0.7 0.3
NPV($000) NPV ($000)
Project 1 100 1,400
Project 2 0 600
Project 3 180 200
Project 4 50 600
Which project should be selected on the basis of expected market values? (2 Points)

A Project 1

B Project 2

C Project 3

D Project 4

11. Consider the truthfulness of the following statements.

1 The optimum replacement period (cycle) will be the period that has the lowest equivalent
annual cost, although in practice other factors may influence the final decision.
2 The replacement analysis model assumes that the firm replaces like with like each time it
needs to replace an existing asset. (2 Points)

Statement 1 Statement 2

A True True

B True False

C False True

D False False

12. The concept of ‘value for money’ in a not for profit organisation can be defined as ‘achieving
the desired level and quality of service at the most economical cost’.
Performance measures have been developed to permit evaluation of value for money in
public sector organisations.

Which of the following is not a measure fundamental to the understanding of value for
money? (2 Points)

A Economy

B Evolution

C Efficiency

D Effectiveness

13. What is the present value of a perpetuity of $21,000 starting immediately, to the nearest
dollar? Interest rates are 10%. (2 Points)

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14. The following scenario relates to questions 16–20.

Freakshow Co is considering investing in a new project.
The following information relates to the new project:
Capital cost, payable immediately $100,000
Length of project 5 years
Post tax operating cash flow in the first year $30,000
Annual rate of inflation 5%

Freakshow Co’s real cost of capital is 9.5%.

What is the net present value (NPV) of the project (to the nearest $1,000)?
(2 Points)

15. What is the internal rate of return of the project (to the nearest whole percentage
point)?Use discount rates of 15% and 20% in your calculation. (2 Points)

16. Which of the following is not an advantage of the IRR? (2 Points)

A It considers the whole life of the project

B It uses cash flows not profits

C It is a measure of absolute return

D It considers the time value of money

17. The company is also considering spending $60,000 on a machine that will have an
estimated life of ten years and no residual value. The machine is to be depreciated by 10%
of its cost each year. Estimated operating cash flows are:
Year $
1 (2,000)
2 13,000
3 20,000
4–6 25,000 each year
7–10 30,000 each year
What is the average accounting rate of return (ARR), calculated as average annual
profits divided by the average investment? (2 Points)

A 75%

B 55%

C 38%

D 28%

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18. The following scenario relates to questions 21-25.

Blacker Co is considering undertaking a new investment project. The company’s financial
manager has prepared the following net present value analysis:
$ Today Year 1 Year 2 Year 3 Year 4 Year 5
Year 6
Sales
revenue 100,000 100,000 100,000 100,000 100,000
100,000
Variable
costs 30,000 30,000 30,000 30,000 30,000
30,000
Fixed costs 40,000 40,000 40,000 40,000 40,000
40,000
Investment (120,000)
Sale
proceeds
20,000
Net cash
flows (120,000) 30,000 30,000 30,000 30,000 30,000
50,000
DF @10% 1 0.909 0.826 0.751 0.683 0.621
0.564
PV (120,000) 27,270 24,780 22,530 20,490 18,630
28,200

NPV $21,900
The calculations have been prepared on the assumption that the selling price of the
company’s only product will be $20 per unit, and that 30,000 units of the product will be sold
in total.

What is the sensitivity to changes in the selling price? (2 Points)

A 3.7%

B 5.0%

C 7.2%

D 12.2%

19. What is the sensitivity to changes in the sales volume? (2 Points)

A 3.7%

B 5.0%

C 7.2%

D 12.2%

20. What is the sensitivity to changes in the discount rate, to the nearest 10%? (2 Points)

21. What is the discounted payback period of the project? (2 Points)

A 3 years

B 4 years

C 5 years

D 6 years

22. Which of the following statements is incorrect? (2 Points)

A Capital rationing for divisible projects ranks the projects in order of the profitability analysis figure.

B The net total working capital cash flows over the full life of a project should add up to zero.

C Tax-allowable depreciation is not a relevant cash flow for investment apraisal purposes.

D An investor would require a lower return on their investment in a situation where positive inflation applies
over the life of the investment compared to if no inflation were present.

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23. The following scenario relates to questions 26–30.

Breccon Co is planning to introduce a new product, DV, to its range next year.
The marketing department has estimated that demand for the DV will be 8,000 per year for
the life of the project. The following information relating to the investment proposal has now
been prepared
Initial investment (first day of accounting period) $250,000
Selling price $45 per unit
Variable operating costs $28 per unit
Fixed operating costs $36,000 per year
No machinery scrap value is expected at the end of four years, when production of DV is
planned to end. For investment appraisal purposes, Breccon uses a cost of capital of 10% per
year and has a target return on capital employed of 20% per year. Ignore taxation.

What is the net present value for the investment proposal? (2 Points)

A $317,000

B −$181,000

C $67,000

D −$150,000

24. Calculate the return on capital employed (accounting rate of return) based on average
investment for the investment proposal. Show answer to the nearest whole number.
(2 Points)

25. If taxation is introduced at a rate of 30% and tax-allowable depreciation is available on

a reducing balance basis of 25%, which figure is the present value of the tax savings on
the tax-allowable depreciation closest to? Assume that tax is paid a year in arrears.
(2 Points)

A $75,001

B $63,947

C $56,445

D $52,902

26. Select the correct words to complete the following sentences.

The discounted payback period for a project will be longer / shorter than the non
discounted
payback period.
If the payback period calculated is longer / shorter than the company’s target payback
period, the project should be accepted. (2 Points)

27. If the cost of capital of 10% is the money discount rate and the general inflation rate
is2%, calculate the real discount rate. (2 Points)

A 7.8%

B 8%

C 12%

D 12.2%

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28. Foxton Co’s capital structure is as follows.

$m
50c ordinary shares 14
8% $1 preference shares 7
12.5% loan notes 20X6 6
–––
27
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The loan notes are redeemable at nominal value in 20X6. The current market prices of the
company’s securities are as follows.

50c ordinary shares 235c

8% $1 preference shares 94c
12.5% loan notes 20X6 $110

The company is paying corporation tax at the rate of 30%. The cost of the company’s
ordinary equity capital has been estimated at 16% pa and the cost of debt to the company is
10%.

What is the company’s weighted average cost of capital for capital investment appraisal
purposes? (2 Points)

A 9.71%

B 13.53%

C 14.87%

D 16.73%

29. Cameo Co, which has an issued capital of 3 million shares, having a current market value of
$2.90 each, makes a rights issue of one new share for every two existing shares at a price of
$2.30.

What is the theoretical ex-rights price of the shares? (2 Points)

A $2.70 per share

B $3.47 per share

C $4.05 per share

D $4.15 per share

30. Which of the following is not a source of finance within the Islamic banking model? (2 Points)

A Murabaha

B Sukuk

C Kharaj

D Mudaraba

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