BANKING ACADEMY FINAL EXAM

INTERNATIONAL SCHOOL OF Corporate Finance – No.2

BUSINESS Time allowance: 90’

Apply to: City U Program

Date of exam: …………………………… Date of approval:……………… ……..

Signature of censor 1:……………… Signature of censor 2:…………………

(Note: Students are allowed to use the materials during the exam)

PART I – 60 points (Multiple choice questions)

Each question is worth 5 points. Only one answer per question is accepted (no partial
credit). There is no penalty for wrong answers.

# According to the pecking-order theory, a firm’s leverage ratio is determined by

A) the firm’s financing needs.
B) equating the tax benefit of debt to the financial distress costs of debt.
C) the value of the tax benefit of debt.
D) the market rate of interest.

# The MM theory with taxes implies that firms should issue maximum debt. In practice,
this does not occur because:
A) bankruptcy is a disadvantage to debt.
B) debt is more risky than equity.
C) the weighted average cost of capital is inversely related to the debt-equity ratio.
D) the weighted average cost of capital is directly related to the debt-equity ratio

# Companies will generally have a ____ beta if their:

A) high; sales are highly dependent on the market cycle
B) low; stock price is relatively low.
C) high; sales are growing at a steady rate of increase.
D) high; sales are high compared to other firms in their industry

# The net working capital of a firm will decrease if there is

A) a decrease in accounts receivable.
B) an increase in inventory.
C) a decrease in accounts payable.
D) an increase in the checking account balance.

# Of the following choices, which one is an example of erosion and should be included in
a capital project analysis?
A) The anticipated loss of current sales when a new product is launched.
B) The expected decline in sales as the market for a product becomes saturated.
C) The reduction in sales that occurs when a competitor introduces a new product.
D) The sudden loss of sales due to a major employer in your community implementing
massive layoffs

# Woodard Pools is evaluating a project which will increase annual sales by $50,000 and
costs by $30,000. The project has an initial asset cost of $150,000 that will be
depreciated straight-line to a zero book value over the 10-year life of the project. Ignore
bonus depreciation. The applicable tax rate is 25 percent. What is the annual operating
cash flow for this project?
A) $18,75
B) $15,500
C) $21,350
D) $17,900

# A project is expected to create operating cash flows of $26,500 a year for four years.
The fixed assets required for the project cost $62,000 and will be worthless at the end of
the project. An additional $3,000 of net working capital will be required throughout the
life of the project. What is the project's net present value if the required rate of return is
12 percent?
A) $17,396.31
B) $14,028.18
C) $15,306.09
D) $19,208.11

# A project is expected to produce cash flows of $140,000, $225,000, and $200,000 over
the next three years, respectively. After three years, the project will be worthless. What
is the net present value of this project if the applicable discount rate is 10.1 percent and
the initial cost is $522,765?
A) −$60,141
B) $46,262
C) −$9,595
D) $51,317

# Vyshali is evaluating an investment costing $55,000 that has cash flows of $35,000 in
Year 2, $36,000 in Year 3, and −$5,000 in Year 4. Her employer requires a rate of
return of 8 percent and has a required discounted payback period of three years.
Should this project be accepted? Why?
A) No; The NPV indicates rejection as does discounted payback when all cash flows are
considered.
B) Yes; The project pays back on a discounted basis within the assigned time period and also
produces a positive NPV.
C) Yes; The discounted payback requirement is met and other methods of analysis are less
desirable.
D) No; Although the project earns more than 8 percent, there is no situation where the project
can pay back on a discounted basis within three years.
# Jaime is evaluating two independent projects. Project A costs $74,600 and has
projected cash flows of $18,700, $46,300, and $12,200 for Years 1 to 3, respectively.
Project B costs $70,000 and has cash flows of $10,600, $15,800, and $67,900 for Years 1
to 3, respectively. Jaime assigns a discount rate of 10 percent to Project A and 12
percent to Project B. Which project or projects, if either, should he accept based on the
profitability index rule?
A) Accept Project B and reject Project A.
B) Reject both projects..
C) Accept Project A and reject Project B.
D) Accept both projects.
PART II – 40 points

In this part of the exam, your answers should be carefully explained and supplemented with
relevant calculations and illustrations. Keep your answers brief, concise, and to the point
(lengthy, irrelevant statements or calculations will weaken the overall impression of your
solutions).

A firm is considering an investment in a new machine with a price of $8 million to replace its
existing machine. The current machine has a book value of $4 million and a market value of
$4.5 million. The new machine is expected to have a 4-year life, and the old machine has four
years left in which it can be used. If the firm replaces the old machine with the new machine,
it expects to save $2 million in operating costs each year over the next four years. Both
machines will have no salvage value in four years. If the firm purchases the new machine, it
also will need an investment of $200,000 in net working capital. Their capital contains 40
bonds outstanding that are selling at their par value of $1,000 each. Bonds with similar
characteristics are yielding a pretax 5.2 percent. The firm also has 8,000 shares of common
stock outstanding. The stock has a beta of 1.1 and sells for $20 per share. The U.S. T-bill is
yielding 3 percent, the market return is 8 percent and the tax rate is 20 percent. The company
uses straight-line depreciation.

Required:

a. Calculate the weighted average cost of capital

b. Calculate NPV and IRR of the project and give investment recommendation.

PART III – 10 points (Short essay)

What should be the primary goal of the financial manager of a corporation? Explain
why this is appropriate.