FINANCIAL MANAGEMEMT –I FINAL EXAM 3rd YEAR AcFn & MgMt 40% 2:30 HRS. MASTEWAL D.

Name: _________________________________________________ ID ______________ Sec_____

Add: Yes No

Part I: True or False Items

Write “True” if the statement is correct and “False” if the statement is incorrect (1pts. each)

1. The present value of a given sum to be received in five years will be exactly twice as great as
the present value of an equal sum to be received in ten years.
2. The present value of a cash flow decreases as it moves further into the future.
3. Projects with shorter payback periods are always more profitable than projects with longer
payback periods.
4. The preference rule for ranking projects by the profitability index is: the higher the
profitability index, the more desirable the project.
5. Capital budgeting techniques are usually used only for projects with large cash outlays.

Part II: Multiple Choice Items (25.5pts.)

Choose the Best Answer from the Given Alternatives (1.5 pts. each)

1. An investment project is most likely to be accepted by the payback period rule and not
accepted by the NPV rule if the project has;
A. A large initial investment with moderate positive cash flows over a long period of time
B. A very large negative cash flow at the termination of the project
C. Most of the cash flows at the beginning of the project
D. All projects approved by the payback period rule will be accepted by the NPV rule
2. ABC Company is financed by 60% with equity and 40% with debt. Currently, its debt has a
before-tax interest rate of 12%. ABC common stock trades at $515 per share and its most recent
dividend was $1.00. Future dividends are expected to grow by 4%. If the tax rate is 34%, what is
ABC WACC?
A. 7.39% D. 11.20%
B. 9.57% E. None of the above
C. 9.73%
3. What dividend yield would be reported in the financial press for a stock that currently pays a $1
dividend per quarter and the most recent stock price was $40?
A. 2.5% C. 15%
B. 4.% D. 10%
4. Which of the following presents the correct relationships? As the coupon rate of bond increases,
the bonds;
A. Face value increases C. Interest payment increased
B. Current price decreases D. Maturity date is extended
5. As debt is added to the capital structure, the;
FINANCIAL MANAGEMEMT –I FINAL EXAM 3rd YEAR AcFn & MgMt 40% 2:30 HRS. MASTEWAL D.

A. WACC will continually decline C. cost of debt can be expected to be raise

B. WACC will continually increase D. WACC will be unaffected

6. A project of $2000, 000 yielded annually a profit of $300,000 after depreciation at 12.5% and is
subject to income tax at 50%. Calculate pay-back period;
A. 5 year C. 4 years
B. 5.3 year D. 4.5 years
7. Which of the following is not considered a capital component for the purpose of
calculating the weighted average cost of capital (WACC) as it applies to capital budgeting?
A. Long-term debt. C. preferred stock
B. Common stock. D. Accounts payable and accruals
8. Which of the following statements is most correct?
A. Since the money is readily available, the cost of retained earnings is usually a lot cheaper than
the cost of debt financing.
B. When calculating the cost of preferred stock, a company needs to adjust for taxes, because
preferred stock dividends are tax deductible.
C. When calculating the cost of debt, a company needs to adjust for taxes, because interest
payments are tax deductible.
D. Statements A and B are Correct.
E. Statements B and C are correct.
9. Which of the following statements about the cost of capital is incorrect?
A. A company’s target capital structure affects its weighted average cost of capital.
B. Weighted average cost of capital calculations should be based on the after-tax costs of all the
individual capital components.
C. If a company’s tax rate increases, then, all else equal, its weighted average cost of capital
will increase.
D. Flotation costs can increase the weighted average cost of capital.
E. An increase in the risk-free rate is likely to increase the marginal costs of both debt and
equity financing.
10. Your company’s stock sells for $50 per share, its last dividend (D0) was $2.00, its growth rate is a
constant 5 percent, and the company will incur a flotation cost of 15 percent if it sells new common
stock. What is the firm’s cost of new equity, ke?
A. 9.20% D. 11.75%
B. 9.94% E. 12.30%
C. 10.50%
11. Which one of the following statements about the payback method of capital budgeting is correct?
A. The payback method does not consider the time value of money.
B. The payback method considers cash flows after the payback has been reached.
C. The payback method uses discounted cash flow techniques.
D. The payback method will lead to the same decision as other methods of capital budgeting.
FINANCIAL MANAGEMEMT –I FINAL EXAM 3rd YEAR AcFn & MgMt 40% 2:30 HRS. MASTEWAL D.

12. Hanley Company purchased a machine for $125,000 that will be depreciated on the straight-line
basis over a five-year period with no salvage value. The related cash flow from operations is
expected to be $45,000 a year. These cash flows from operations occur uniformly throughout the
year. What is the payback period?
A. 2.1 years. C. 4.2 years
B. 2.3 years. D. 2.8 years
13. The best capital budgeting method for ranking investment projects of different dollar amounts is ;
A. The project profitability index C. Accounting rate of return method
B. Net present value D. Payback period
14. The annual cash flows for a project after depreciation and income tax is $ 11,375 on the last
year of the project.
The investment in the project $ 56,125
Estimated life 5 years
Salvage value $ 3,000
Depreciation charged on straight-line basis
15. The annual cash flows for the last year of project is;
A. $ 16,000 B. $ 19,000 C. $ 25,000 D. $ 22,000
16. Why the cost of retained earning ignores the floatation cost
A. Retained earnings are not securities like stocks and bonds and so do not have market price.
B. It is a security like a bond and stock, therefore they have no market value
C. Its cost is the similar to cost of common stock
D. It is similarity to the cost of preferred stock
17. Investment in a preferred stock provides a single cash flow in the form of:,

A. Interest payment B. Fixed Dividend C. Retained earnings D. Capital budgeting

18. Which of the following capital budgeting techniques takes into account the incremental income
(accounting information) rather than cash flows:
A. Net present value C. Accounting rate of return
B. Internal rate of return D. Cash payback period
Part -III: Work Out (20%)
Show every necessary step
1. Longstreet Communications Inc. (LCI) has the following capital structure, which it considers
to be optimal: debt = 25%, preferred stock = 15%, and common stock = 60%. LCI’s tax rate is
40%, and investors expect earnings and dividends to grow at a constant rate of 6% in the
future. LCI paid a dividend of $3.70 per share last year and its stock currently sells at a price
of $60 per share. Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and
LCI’s beta is 1.3. The following terms would apply to new security offerings. Preferred: New
preferred could be sold to the public at a price of $100 per share, with a dividend of $9.
FINANCIAL MANAGEMEMT –I FINAL EXAM 3rd YEAR AcFn & MgMt 40% 2:30 HRS. MASTEWAL D.

Flotation costs of $5 per share would be incurred. Debt could be sold at an interest rate of 9%.
Common: New common equity will be raised only by retaining earnings.
A. Find the component costs of debt, preferred stock, and common stock. (6pts)
B. What is the WACC? (2pts)
2. ABC Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%.
LL believes it could issue new bonds at par that would provide a similar yield to maturity. If
its marginal tax rate is 35%, what is ABC’s after-tax cost of debt? (2pts)
3. Barkon Stores has a beta of 0.8. The yield on a 3-month T-bill is 4% and the yield on a 10-
year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in
the market last year was 15%. What is the estimated cost of common equity using the CAPM?
(2pts)