College of Business and Economics

BA in Business, 3rd year

Mid-term Exam
Test A

Course: BUS 230 Introduction to Finance (Cohort A)

Instructor:
Student name: _____________________________
Student ID: _______________________________
Date: Oct. 11, 2016
Instructions:

1. Do NOT start the exam until you are instructed to do so. You must start and stop working
on the exam, when instructed.
2. If you have a question, remain seated and raise your hand. The proctor or the instructor
will approach you.
3. You are not allowed to leave the exam room during the exam.
4. All electronic devices, including cell phones, must be turned off and placed on the stage.
5. You are required to take only the assigned seats and complete the exam cover page with
your signature and the date.
6. Calculators cannot be shared during the exam.
7. Upon completion of the test, the stapled test with all pages (including formula sheet) intact,
will be collected by the instructor or one of the proctors. In case a page is missing,
disciplinary rule #3 will apply.
8. Exam consists of 19 questions. You have 2 hours for the whole exam.
9. Show your FULL WORKINGS AND EXPLANATIONS. Use blank spaces or the back
of the exam pages. If you make a mistake but some of your workings are correct then you
will get partial credit.
10. For multiple choice questions choose the correct answer only.

Disciplinary rules for you in case of communicating with others which is considered cheating:

1. 1st violation of the rule: student (s) will get a “W” on his/her exam paper
2. 2nd violation: student(s) will lose 20 % of the exam points
3. 3rd violation: the student(s) will be asked to leave the exam room and the exam will be automatically
graded “F”

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Question 1 (3 points): The financial goal of a corporation is to:

A. maximize
profits.

2
B. maximize
sales.

3
C. maximize the value of the firm for the
shareholders.

4
D. maximize managers'
benefits.

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Question 2 (3 points): The following are examples of real assets:
I) machinery; II) office buildings; III) warehouses; IV) common stock

A. I, II, and III

only

6
B. I and II
only

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C. IV
only

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D. I
only

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Question 3 (3 points): The rate of return is also called the: I) discount rate; II) hurdle rate; III)
opportunity cost of capital

A. I
only.

10
B. I and II
only.

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C. I, II, and
III.

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D. I and III
only.

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Question 4 (3 points): Which of the following statements regarding the net present value rule
and the rate of return rule is false?

A. Accept a project if NPV > cost of

investment.

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B. Accept a project if NPV is
positive.

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C. Accept a project if return on investment exceeds the rate of return on an equivalent-risk
investment in the financial market.

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D. Reject a project if NPV is
negative.

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Question 5 (3 points): You are considering investing in a retirement fund that requires you to
deposit $5,000 per year, and you want to know how much the fund will be worth when you
retire. What financial technique should you use to calculate this value?

A. Future value of a single

payment

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B. Future value of an
annuity

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C. Present value of an
annuity

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D. Present value of a
perpetuity

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Question 6 (3 points): If an investment project (normal project) has an IRR equal to the cost of
capital, the NPV for that project is:

A. positiv
e.

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B. negativ
e.
C. zero
.
D. unable to
determine.

Question 7 (3 points): Money that a firm has already spent, or committed to spend regardless of
whether a project is taken, is called:

A. fixed
cost.
B. opportunity
cost.
C. sunk
cost.
D. incremental
cost.

Question 8 (3 points): If the discount rate is stated in real terms then—in order to calculate the
NPV in a consistent manner—the project requires that:

A. cash flows be estimated in nominal terms.

B. cash flows be estimated in real terms.
C. accounting income be used.
D. cash flows be estimated including future
inflation.

Question 9 (3 points): Which of the following is an example of a liquidity ratio?

A. Times interest earned

(TIE)
B. P/E
ratio
C. Return on
equity
D. Quick
ratio

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Question 10 (3 points): The sale of financial assets by a corporation is also referred to as the:

A. capital budgeting
decision.
B. CFO decision.
C. financing decision.
D. investment decision.

Question 11 (3 points):

Calculate the NPV of the following cash flow sequence at the discount rate of 11%

NPV = -120,000 + (300,000/1.11) -(100,000/(1.11^2)) = 69,108.03.

Question 12 (3 points): You would like to have enough money saved to receive $80,000 per
year in perpetuity after retirement for you and your heirs. How much would you need to have
saved in your retirement fund to achieve this goal? (Assume that the perpetuity payments start
one year from the date of your retirement. The annual interest rate is 8%.)

PV = (80,000/0.08) = 1,000,000

Question 13 (5 points): You would like to have enough money saved to receive a growing
annuity for 20 years, growing at a rate of 5% per year, with the first payment of $50,000
occurring exactly one year after retirement. How much would you need to save in your
retirement fund to achieve this goal? (The interest rate is 10%.)

PV = (50,000)[(1/(0.1 - 0.05)) - {(1/(0.1 - 0.05)}{(1.05^20)/(1.10^20)}] = 605,604.20.

Question 14 (5 points): You just inherited a trust that will pay you $100,000 per year in
perpetuity. However, the first payment will not occur for exactly five more years. Assuming a
10% annual interest rate, what is the value of this trust?

PV = 100,000/0.10 = $1,000,000; PV (@ t = 0) = 1,000,000/(1.10)^4 = $683,013.

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Question 15 (5 points): If a firm has $100 in inventories, a current ratio equal to 1.2, and a
quick ratio equal to 1.1, what is the firm's Net Working Capital?

Can be solved with system of equations: X = receivables +cash & marketable securities, Y=current liabilities

(X+100)/y = 1.2; x/y = 1.1, x=1,100, y = 1,000, so the current assets = 1,100+100=1,200, current liabilities =
1,000 and therefore the NWC = 200

OR logically: if 100 decreases the ratio by 0.1, then the upper figure is 1,200 and below figure is 1,000

Question 16 (5 points): Given the following cash flows for project Z: C0 = -1,000, C1 = 600, C2 =
720, and C3 = 2,000, calculate the discounted payback period for the project at a discount rate
of 13%.

600/1.13 = 531

1000-531=469

720/1.13^2 = 564, 469/564*12 months = approx = 10 months, so Discounted payback = 1

year, 10 months

Question 17 (7 points): OM Construction Company must choose between two types of cranes.
Crane A costs $600,000, will last for five years, and will require $60,000 in maintenance each
year. Crane B costs $750,000, will last for seven years, and will require $30,000 in maintenance
each year. Maintenance costs for cranes A and B occur at the end of each year. The appropriate
discount rate is 12% per year. Which machine should OM Construction purchase?

Crane A: Annuity factor = (1/.12) × (1 - (1/(1.12^5))) = 3.6048.

Crane B: Annuity factor = (1/.12) × (1 - (1/(1.12^7))) = 4.5638.

Costs:
PV (A) = 600,000 + 60,000 (3.6048) = 816,286; - 1.5 marks
EAC = 816,286/(3.6048) = $226,444; 2 marks
PV(B) = 750,000 + 30, 000 (4.5638) = 886,913; 1.5 marks
EAC = 886,913/(4.5638) = $194,336.45. 2 marks (Accept the project with least annual cost. –
1 mark)

Question 18 (7 points): For $10,000, you can purchase a five-year annuity that will pay
$2,504.57 per year for five years. The payments occur at the end of each year. Calculate the
effective annual interest rate implied by this arrangement.

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Using a financial calculator: N = 5; PV = -10,000; PMT = 2504.57; FV = 0.
Compute: I = 8.0% [calculator setting: END].

OR

10,000 = 2,504.57 *Annuity factor, therefore annuity factor = 10,000/2,504.57=3.993, then

find at which interest rate for 5 years the annuity factor is 3.99. it is 8%

Question 19 (30 points): Bajanordn Anhasanelie company is considering an investment in new

LTE hardware which it can start to operate next year. The cost of investment is $3,500,000
which can be used for 5 years. However, Bajanordn Anhasanelie expects that technological
progress will develop new and more advanced facilities, so it anticipates to sell the hardware at
the end of year 3 for a value of $2,000,000 (when the book value will be equal to $1,400,000).
To start the operations Bajanordn Anhasanelie needs to invest $200,000 in working capital
today and maintain it on the level of 15% from forecasted sales for the next year. For
developing the business plan, Bajanordn Anhasanelie paid $500,000 in cash, and does not
expect to recover it. The sales volume for year 1 is estimated $2,000,000 and expected to grow
by 5% per year. Costs associated with maintaining the business are anticipated on the level of
70% of sales. The tax rate is 35%. Calculate the project NPV if the discount rate is 10% and
advise if Bajanordn Anhasanelie should proceed with the investment.

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