Haramaya University

College of Continuing and Distance Education

Department of Accounting and Finance

Assignment for the course

Financial Management I

Name ____________________________________________

IDNO.____________________________________________

Department: _____________________________________

Center ______________________________________________

INSTRUCTIONS

1. Write Your Answers Neatly & Legibly.

2. Attempt all questions by your own.

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 ANSWER SHEET FOR MULTIPLE CHOICE PARTS

1. ____________ 11. _____________

2. _____________ 12. _____________

3. _____________ 13. _____________

4. _____________ 14. _____________

5. _____________ 15. _____________

6. _____________ 16. _____________

7. _____________ 17. _____________

8. _____________ 18. _____________

9. _____________ 19. _____________

10. _____________ 20. _____________

Multiple Choices (one point each)

1. Which of the following is not the basic principle that forms the basis for financial
management?
A. The curse of competitive markets D. Ethics
B. Incremental cash flow E. All risks are not equal
C. Inefficient capital markets
2. The focal point of financial management in a firm is:
A. The number and types of products or services provided by the firm
B. The minimization of the amount of taxes paid by the firm
C. The creation of value for shareholders
D. The birr profits earned by the firm
3. Which of the following is not the responsibility of financial management?
A. Allocation of funds to current and capital assets
B. Obtaining the best mix of financing alternatives
C. Preparation of the firm's accounting statements
D. Development of an appropriate dividend policy
4. The mix of debt and equity in a firm is referred to as the firm's:
A. Primary capital C. Cost of capital
B. Capital composition D. Capital structure
5. Which of the following is incorrect:
A. The quick ratio will never exceed the current ratio
B. Quick ratio can be improved by purchasing more inventories
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 C. Current ratio could be improved through long term borrowing
D. Quick ratio can be improved by decreasing the level of supplies
E. None
6. The net profit margin of a firm is 0.20. The amount of net income is birr20, 000 and its fixed
asset turnover is 0.5. what is the amount of fixed asset:
A. Br. 30,000 D. Br. 40,000
B. Br. 50,000 E. None of the above
C. Br. 10,000
7. A new project is expected to generate $600,000 in revenues, $200,000 in cash operating
expenses, and depreciation expense of $100,000 in each year of its 10-year life. The
corporation’s tax rate is 40%. The project will require an increase in net working capital of
$75,000 in year one and a decrease in net working capital of $50,000 in year ten. What is
the free cash flow from the project in year one?
A. $105,000 D. $355,000
B. $205,000 E. None of the above.
C. $280,000
8. Which of the following should be included in the initial outlay?
A. Taxable gain on the sale of old equipment being replaced
B. First year depreciation expense on any new equipment purchased
C. Preexisting firm overhead reallocated to the new project
D. Increased investment in inventory and accounts receivable
E. All of the above
F. None of the above
9. Which of the following should be included in an analysis of a new project’s cash flows?
A. any sales from existing products that would be lost if customers were expected to
purchase a new product instead
B. all financing costs
C. all sunk costs
D. no opportunity costs
E. None of the above
10. Project C requires a net investment of $1,000,000 and has a payback period of 5.6 years.
You analyze Project C and decide that Year 1 free cash flow is $100,000 too low, and Year
3 free cash flow is $100,000 too high. After making the necessary adjustments ________
A. The payback period for Project C will be longer than 5.6 years
B. The payback period for Project C will be shorter than 5.6 years
C. The IRR of Project C will increase
D. The NPV of Project C will decrease
E. None of the above

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11. Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14
percent. Both projects have a required return of 12 percent. Which of the following
statements is most correct?
A. Both projects have a positive net present value (NPV).
B. Project A must have a higher NPV than project B.
C. If the required return were less than 12 percent, Project B would have a higher IRR than
Project A.
D. Project B has a higher profitability index than Project A.
E. None of the above.
12. At the close of the year, a company has an inventory of br. 150,000 and cost of gods sold for
br. 975,000. If the company’s inventory turnover ratio is 5, what would be the opening
balance of inventory?
A. 195,000 D. 780,000
B. 45,000 E. None of the above
C. 825,000
13. All are true about capital budgeting except:
A. The result of capital budgeting decisions continues over an extended period.
B. Capital budgeting will improve both the timing of assets acquisition and the quality of
the acquired assets.
C. Expenditures for advertising and promotion campaigns and for research and
development programs are included in capital budgeting expenditures.
D. Capital budgeting enables the firm to raise funds early before the sales approach the
maximum capacity levels.
E. None of the above.
14. Which of the following long term investment proposal is necessary to replace worn out or
damaged fixed asset of the business firm.
A. Replacement (cost reduction)
B. Replacement (maintenance of business)
C. Cost reduction projects.
D. Expansion of existing products
E. Expansion of markets
15. Which one of the following increases the initial investment?
A. Income tax on capital gain D. Proceed from sale of old asset
B. Income tax shield E. All except D
C. Investment tax credit
16. Identify the odd, about the decision rule of capital budgeting.
A. Selecting the project whose IRR exceeds its cost of capital increases the shareholders
wealth
B. NPV equals zero signifies that the cash flows of the project are not sufficient to repay
the RRR.

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 C. PI does not reflect difference in investment size.
D. The PI is greater than 1 if the NPV of the project is greater than zero.
E. If the cross over rate is less than the cost of capital, the project with the smaller
investment should be selected.
17. The determination of cost of which of the following security needs tax adjustment to
determine its relevant cost.
A. Cost of preferred stock and cost of debt
B. Cost of debt only
C. Cost of common equity and preferred stock
D. Cost of preferred stock only
E. Cost of debt and cost of common equity
18. AD Share Company wants to acquire new equipment, the equipment has a total initial
purchase cost of br. 200,000 and it will generate uniform yearly cash inflow of br. 30,000
over its economic life of 10 years. How long will it take the equipment to cover its initial
investment if time value of money is not considered and cash flow occurs at the end of each
year?
A. 4years and 8 months D. 4 years
B. 6 years and 8 months E. 6 years
C. 6years and 6 months
19. One of the following is false about the specific cost of capital.
A. If the net proceed is equal to the par value of the bond, the effective after tax cost of
debt is exactly equals to the coupon rate of the bond.
B. When the business firm sells preferred stock, it expects to pay fixed dividends to
investors in the return for their money capital.
C. The market interest (discount) rate is a measure of specific cost of capital of common
stock.
D. The specific cost of capital of retained earnings equation uses the current market price
of the firm’s common stock as denominator.
E. If there is selling cost, specific cost of capital of retained earnings is always less than
the specific cost of capital of common stocks.
20. Which of the following statement is false about the WACC and MCC?
A. If new investment financed completely with retained earnings the MCC equals the
specific cost of capital of retained earnings.
B. If new investment financed completely with retained earnings the MCC equals the cost
of common stock issued at flotation cost of zero.
C. If the WMCC exceeds the WACC of the existing capital structure, raising additional
funds will increase the weighted average cost of the new capital structure.
D. WACC is a rate of return that must be earned by a firm in order to satisfy the
requirements of the individual specific cost of capital.
E. All are true.

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 Part Two; Work-Out Questions

1. Complete the following balance sheet using the information given. Round account
balances to the nearest dollar. (5 MARKs)
Balance Sheet Income Statement

Cash Sales (All Credit) $20,000

Accounts receivable Cost of goods sold 10,000
Inventory Operating expenses 6,000
Net fixed assets Interest expense 100
Total assets Taxes 1,365
Net income $2,535
Accounts payable
Short-term notes
payable $1,425 Ratios:
Long-term debt Profit Margin = 12.675%
Common stock $5,000 Return on Equity = 15%
Retained earnings Quick Ratio = 1.2
Total Liabilities and
equity Return on Total Assets = 10%
Fixed Asset Turnover = 1.6
Current Ratio = 2
Days Sales Outstanding = 45
2. Meacham Corp. wants to issue bonds with a 9% coupon rate, a face value of $1,000, and
12 years to maturity. Meacham estimates that the bonds will sell for $1,090 and that
flotation costs will equal $15 per bond. Meacham Corp. common stock currently sells
for $30 per share. Meacham can sell additional shares by incurring flotation costs of $3
per share. Meacham paid a dividend yesterday of $4.00 per share and expects the
dividend to grow at a constant rate of 5% per year. Meacham also expects to have $12
million of retained earnings available for use in capital budgeting projects during the
coming year. Meacham’s capital structure is 40% debt and 60% common equity.
Meacham’s marginal tax rate is 35%.
Instructions:
a. Calculate the after-tax cost of debt assuming Meacham’s bonds are its only debt
b. Calculate the cost of retained earnings
c. Calculate the cost of new common stock
d. Calculate the weighted average cost of capital assuming Meacham’s total capital budget is
$30 million

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 Part Three; Case Study
1. During the last few years, Harry Davis Industries has been too constrained by the high cost
of capital to make many capital investments. Recently, though, capital costs have been
declining, and the company has decided to look seriously at a major expansion program
proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the
financial vice president. Your first task is to estimate Harry Davis’s cost of capital. Jones has
provided you with the following data, which she believes may be relevant to your task:
(1) The firm’s tax rate is 40%.
(2) The current price of Harry Davis’s 12% coupon, semiannual payment, non-callable bonds
with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-
bearing debt on a permanent basis. New bonds would be privately placed with no flotation
cost.
(3) The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred
stock is $116.95. Harry Davis would incur flotation costs equal to 5% of the proceeds on a new
issue.
(4) Harry Davis’s common stock is currently selling at $50 per share. Its last dividend (D0) was
$3.12, and dividends are expected to grow at a constant rate of 5.8% in the foreseeable future.
Harry Davis’s beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is
estimated to be 6%. For the over-own-bond-yield-plus-judgmental risk- premium approach, the
firm uses a 3.2% risk premium.
(5) Harry Davis’s target capital structure is 30% long-term debt, 10% preferred stock, and 60%
common equity.
To help you structure the task, Leigh Jones has asked you to answer the following questions.
A. (1) what sources of capital should be included when you estimate Harry Davis’s weighted
average cost of capital?
(2) Should the component costs be figured on a before-tax or an after-tax basis?
(3) Should the costs be historical (embedded) costs or new (marginal) costs?
B. What is the market interest rate on Harry Davis’s debt, and what is the component cost of
this debt for WACC purposes?
C. (1) what is the firm’s cost of preferred stock?
(2) Harry Davis’s preferred stock is riskier to investors than its debt, yet the preferred’s yield to
investors is lower than the yield to maturity on the debt. Does this suggest that you have made
a mistake? (Hint: Think about taxes.)
D. (1) what are the two primary ways companies raises common equity?
(2) Why is there a cost associated with reinvested earnings?
(3) Harry Davis doesn’t plan to issue new shares of common stock. Using the CAPM approach,
what is Harry Davis’s estimated cost of equity?
E. (1) what is the estimated cost of equity using the discounted cash flow (DCF) approach?
(2) Suppose the firm has historically earned 15% on equity (ROE) and has paid out 62% of
earnings, and suppose investors expect similar values to obtain in the future.

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How could you use this information to estimate the future dividend growth rate, and what
growth rate would you get? Is this consistent with the 5.8% growth rate given earlier?
(3) Could the DCF method be applied if the growth rate were not constant? How?
F. What is the cost of equity based on the over-own-bond- yield-plus-judgmental-risk premium
method?
G. What is your final estimate for the cost of equity, rs?
H. What is Harry Davis’s weighted average cost of capital (WACC)?
I. What factors influence a company’s WACC?
J. Should the company use the overall, or composite, WACC as the hurdle rate for each of its
divisions?
K. What procedures can be used to estimate the risk-adjusted cost of capital for a particular
division? What approaches are used to measure a division’s beta?
L. Harry Davis is interested in establishing a new division that will focus primarily on
developing new Internet-based projects. In trying to determine the cost of capital for this new
division, you discover that specialized firms involved in similar projects have, on average, the
following characteristics: (1) their capital structure is 10% debt and 90% common equity; (2)
their cost of debt is typically 12%; and (3) they have a beta of 1.7.
Given this information, what would your estimate be for the new division’s cost of capital?
M. What are three types of project risk? How can each type of risk be considered when thinking
about the new division’s cost of capital?
N. Explain in words why new common stock that is raised externally has a higher percentage
cost than equity that is raised internally by retaining earnings.
O. (1) Harry Davis estimates that if it issues new common stock, the flotation cost will be
15%. Harry Davis incorporates the flotation costs into the DCF approach. What is the estimated
cost of newly issued common stock, taking into account the flotation cost?
(2) Suppose Harry Davis issues 30-year debt with a par value of $1,000 and a coupon rate of
10%, paid annually. If flotation costs are 2%, what is the after-tax cost of debt for the new bond
issue?
P. What four common mistakes in estimating the WACC should Harry Davis avoid?