Section 1 - Compulsory (30 marks)

INSTRUCTIONS: Answer all questions in this section

1. Given the following information for Macro Drive Inc.

2017

Selling and Administrative Expenses $150,000

Depreciation Expense 280,000

Interest Expense 140,000

Sales 1,400,000

Taxes 135,500

Cost of Goods Sold 500,000

Required:

a. Prepare (in good form) an income statement for 2017 for Macro Drive Inc. (3 marks)

b. Assume that Micro Drive Inc. has 50,000 shares outstanding, calculate the Earnings Per Share (EPS) for the company for the period ending 2017. (2 marks)

c. Differentiate between accounting income and free cash flow (FCF). Why is FCF the most important measure of cash flow? (5 marks)

For the next 10 questions, choose the letter that carries the correct response. Each question is worth 2 marks.

2. Maximizing shareholder's wealth means maximizing the value of the firm's

a. assets.

b. investments.

c. common stocks.

d. profits.

3. The market price of a share of stock is determined by

a. the New York Stock Exchange.

b. the company's management.

c. individuals buying and selling the stock.

d. the Federal Reserve.

4. All of the following statements about financial statements are true except

a. the owner's equity represents the book value of the owner's investment in the asset of the firm.

b. the balance sheet is a statement of the firm's financial position over a specified time interval.

c. non-current assets are those that are not expected to be converted into cash within the firm's operating cycle.

d. change in retained earnings is affected by a firm's net income and common stock dividends paid.

5. To determine the present value of a future sum, we need to multiply it by:

a. 1/(1+i)n

b. 1/(1+n)1

c. (1+n)i

d. (1+i)n

6. A bond maturing in 10 years pays $80 each year and $1,000 upon maturity. Assuming 10 percent to be the discount rate, the present value of the bond is:

a. $1,010.84

b. $925.74

c. $877.50

d. $1,000

7. Leonardo Brown purchased a new house for $150,000. He paid $30,000 down and agreed to pay the rest over the next 25 years in 25 equal annual payments that included principal payments plus 10 percent compound interest on the unpaid balance. What will be the amount of the annual equal payments?

a. $13, 500.35

b. $13,200.23

c. $12, 800.50

d. $12,795.23

8. Under the capital asset pricing model, the relevant risk is:

a. diversifiable risk.

b. systematic risk.

c. financial risk

d. unsystematic risk

9. If the required return for a security is 15% and the risk-free rate is 6%, the risk premium is:

a. 0%

b. 6%

c. 10%

d. 9%

10. Which of the following provisions is unique to preferred stock and usually not available to common stockholders?

a. The cumulative feature.

b. A claim on assets.

c. A claim on income.

d. The payment of dividends.

11. An investment with a beta of 0.80 means that the returns of the investment are:

a. more volatile than the market returns.

b. less volatile than the market returns.

c. perfectly correlated with the market returns.

d. perfectly uncorrelated with the market returns.

Section 2 - 30 marks

INSTRUCTIONS: There are three questions in this section. You are required to attempt ANY TWO (2) complete questions. Each question is worth 15 marks.

Question 12

The current capital structure of Stewart-Line Corporation is as follows:

Bonds (7%, $1,000 par 15 years) $750,000

Preferred Stock ($100 par, 7.25% dividend) 1,000,000

Common stock:

Par Value ($2.50 par) $500,000

Retained earnings 350,000 850,000

Total $2,600,000

Other information about Stewart-Line Corporation:

The market price is $975 for the bonds, $60 for the preferred stock, and $21 for common stock. Flotation costs are 9% for bonds and 5% for preferred stock. The firm's tax rate is 46%. Common stock will pay a $2.80 dividend which is not expected to grow.

Required:

a. Calculate the weighted cost of capital using only internal common equity. (12 marks)

b. Why do we need to determine the firm's overall weighted cost of capital and not just the individual component cost of capital? (3 marks)

Question 13

X-Cell Limited is in the process of evaluating a project which will allow the firm to branch into a new product line. The projected cash flows for its new product line is as follows:

Year Cash Flows

0 ($153,000)

1 78,000

2 67,000

3 49,000

Required:

a. Calculate the payback period for the project. What is the key drawback of the payback method of project appraisal? (3 marks)

b. If the required return is 11 percent, should the firm accept the project based on the IRR rule?

(2 marks)

c. Suppose X-Cell uses the NPV decision rule. At a required return of 9 percent, should the firm accept the project? Will your decision change if the required return was 15 percent and why? (5 marks)

d. Why is NPV considered to be a superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flows is computed to be $2,500. What does this number represent to the firm's shareholders? (5 marks)

Question 14

The following parts of this question are independent of each other.

a. A financial manager is quoted as saying, "When evaluating projects, we're only concerned with the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects." Critically evaluate this statement. (5 marks)

b. Fill in the blanks with the most appropriate word or phrase.

i. The sale of a new bond issue takes place in the _______markets.

ii. Equity instruments are traded in the ________markets.

iii. Short term securities such as treasury bills and banker's acceptances are bought in the _______ markets.

iv. A/An ___________ is the first time a company's stock is sold to the public.

v. The principle of finance which supports the fact that the markets are quick and the prices are fair is called the _______ ________ _______ principle.

(5 marks)

c. Home Cleaning Products' common stock sells for $44.96 a share and has a market rate of return of 12.8 percent. The company just paid an annual dividend of $1.04 per share. What is the dividend growth rate? (3 marks)

d. Explain the importance of a company have an effective insider trading policy. (2 marks)

END OF QUESTION PAPER