FINAL EXAMINATION

(Final Exam Weightage:25%)

PRINCIPLE OF FINANCE (FINN 100)

PART 1: (11:30AM-01:30PM)
Wednesday, 5th May 2020
Instructions:
1. The exam comprises of TWO Parts:
➢ The First Part (70% of the Final Exam) consists of Seven (7) quantitative questions. The LMS
Assignment TAB will open at 11:30AM sharp. You are expected to solve all questions. Please
show important steps as these will be marked. Jotting down the data from the question will not
be considered as a step. The LMS Assignment TAB for Part 1 will close at Exactly 01:30PM. Part 1
submission will not be acceptable after 01:30PM.
➢ The Second Part (30% of the Final Exam) consists of Three (3) theoretical questions. The LMS
Assignment TAB will open at 1:30PM sharp. You are expected to answer all questions. The LMS
Assignment TAB for Part 2 will close at Exactly 02:15PM. Part 2 submission will not be acceptable
after 02:15PM.
2. In case of Part 1 (quantitative questions), ensure that you provide key steps.
3. Write in a legible handwriting. What cannot be read will not be included in grading. No questions will be
referred to students for legibility.
4. Dirty and bad writing, drawings will receive an accumulated penalty as well.
5. In case of theory, single explanation should not be more than ONE A4 page with your own handwriting
approx. font range (12-14pt). Avoid useless explanations/discussion.
6. Any plagiarism, copy-paste or cheating, even if it is a small amount e.g., a one to two lines, will be
immediately referred to Disciplinary Committee.
7. This is a closed book exam. You are not allowed to use any resources on LMS or available anywhere else
in completing the exam.
8. The use of calculator or financial calculator is allowed. Excel or any other software is not allowed.

[No extra time is allowed. Give a quick look at each question before you begin. Please ensure
that you allocate the time according to the complexity of the problem. Only write important
steps.]

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 Quantitative Section (70%)

1. Dr. Wasay has done some savings. Since he belongs to a medical profession, he needs your help to make
an investment decision. He has found a project which has a beta coefficient of 1.75. What would you
recommend him to do if this project has an 11.5% rate of return while the market portfolio offers a rate of
return of 8.5% and the State Bank of Pakistan has a T-bill in the market which offers 5.5%? [POINTS: 5]

2. Cherat Cement has given the following information:

Pan X Plan Y
Interest Expenses Rs.25 million Rs.50 million
Preferred Dividends Rs. 3 million Rs. 1.5 million
Common Shares Outstanding 200 million 100 million
Cherat Cement tax rate is 21%

You have to find the EBIT level at which you should be indifferent to either plan, if.? [POINTS: 5]

3. You have to choose one project out of two projects namely, A and B. Project A costs Rs. 6,000,000 and has
cashflows of Rs. 4,000,000 in each of the next 2 years. Project B costs Rs. 6,000,000 and generates
cashflows of Rs. 5,000,000 and Rs.2,750,000 for the next 2 years, respectively. [POINTS: 10]

i) Prepare NPV profile for each project.

ii) Which project you will choose if the cost of capital is 10%.
iii) Which project you will choose if the cost of capital is 25%.

4. Indus Motor Company (IMC) is trying to find the optimal capital structure. Presently, IMC holds 40% debt
ratio while it expects to have dividend of Rs. 489 per share next year. IMC assume that these dividends will
grow at a constant rate of 5% forever. The investor demand 10.89% return on their investment. The IMC is
presenting an alternative capital structure to its Board of Directors which they claim will enhance the value
of the firm. The proposed changes require the firm to increase its debt ratio to 50% which will increase the
dividend to Rs.524 per share. The increase in debt ratio will cause an increase in the dividend growth rate
which is expected to be 6% forever. High debt increases the risk and hence the investors demand higher
return of 11.34% on their investments. [POINTS: 10]

i) What is the value per share for Indus Motor under the current capital structure?
ii) What is the value per share for Indus Motor under the proposed capital structure?
iii) Should Indus Motor make the capital structure change? Explain in one line.

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5. Atlas Honda uses 24,000 units of an automobile product per year on a continuous basis. The automobile
has a carrying costs of Rs.600 per year and ordering costs are Rs.2500 per order. It normally takes 20 days
to receive a shipment after an order is placed and Atlas Honda requires a safety stock of 8 days of usage in
inventory. [POINTS: 10]

i) What is the economic order quantity?

ii) What is the total cost per year to order and carry this item?
iii) Its supplier has notified Atlas that if Atlas increases its order quantity by 580 units, they will give it a
discount. Calculate the Rupee discount that the suppliers will have to give to Atlas Honda to result in
a net benefit to the company.

6. PSO has decided to invest Rs.100,000,000 in a new headquarters in Karachi and needs to determine the
best way to finance the entire construction. PSO currently has Rs.500,000,000 of 10 percent bonds and
40,000,000 common shares outstanding. The PSO can obtain the Rs.100,000,000 of financing through a 10
percent bond issue or the sale of 10,000,000 shares of common stock. The firm has a 40 percent tax rate.
[POINTS: 10]

i) What is the degree of financial leverage for each plan at Rs.250,000,000 of EBIT?
ii) What is the financial breakeven point for each plan?

7. Nishat Company, a manufacturer of sports and exercise apparel, is considering replacing an existing piece
of equipment with a more sophisticated machine. [POINTS: 20]
The following information is given:
Facts
Existing Machine Proposed Machine
Cost=Rs.100,000 Cost=Rs.150,000
Purchased 2 years ago Installation=Rs.20,000
Depreciation using MACRS over a 5-year Depreciation using MACRS over a 5-year
recovery schedule recovery schedule
Current market value=Rs.105,000
Five-year usable life remaining Five-year usable life expected
Earnings before Depreciation and Taxes
Existing Machine Proposed Machine
Year Year
1 Rs. 160,000 1 Rs. 170,000
2 Rs. 150,000 2 Rs. 170,000
3 Rs. 140,000 3 Rs. 170,000
4 Rs. 140,000 4 Rs. 170,000
5 Rs. 140,000 5 Rs. 170,000
Nishath pays 40% taxes on ordinary income and capital gains.

i) Summarize the incremental after-tax cash flow (relevant cash flows) for years t = 0 through t = 5.
ii) Given 15% cost of capital, Compute the net present value.
iii) Should the project be accepted?

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