FINAL TERM EXAMINATION
Spring 2010
FIN622- Corporate Finance (Session - 1)
Solved by Marina khan
Time: 90 min
M - 69
Question No: 1 ( M - 1 ) .
Which of the following statements is TRUE regarding Profitability Index?
► It ignores time value of money
► It ignores future cash flows
► It ignores the scale of investment
► It ignores return on investment
Question No: 2 ( M - 1 ) .
Which of the following is a tool that identifies the strengths, weaknesses, opportunities and threats of an organization?
► SWOT Analysis
► Trend Analysis
► Fundamental Analysis
► Technical Analysis
Question No: 3 ( M - 1 ) .
If sensitivity analysis concludes that the largest impact on profits would come from changes in the sales level, then which of the following recommendations should be considered?
► Fixed costs should be traded for variable costs
► Variable costs should be traded for fixed costs.
► The project should not be undertaken.
► Additional marketing analysis may be beneficial before proceeding.
Question No: 4 ( M - 1 ) .
The employment of fixed costs associated with the actual production of goods or services is known as:
► Financial leverage
► Volume discounting
► Operating leverage
► Covariance
Question No: 5 ( M - 1 ) .
Which one of the following terms refers to the variability of return on stocks or portfolios, associated with changes in return on the market as a whole?
► Unsystematic risk
► Unique risk
► Systematic risk
► Company specific risk
Question No: 6 ( M - 1 ) .
What will be the taxable income of an Un-levered firm, if it has Earning Before Interest and Tax (EBIT) equal to Rs.50,000, and its tax rate is 35%?
► Rs.25,000
► Rs.45,000
► Rs.50,000
► Rs.60,000
because Un-levered firm means a firm have no debts financing
Question No: 7 ( M - 1 ) .
Which of the following statements is TRUE regarding temporary working capital?
► Temporary working capital varies with seasonal requirements.
► Temporary working capital is the constant component of working capital.
► Temporary working capital excludes inventories.
► Temporary working capital should be financed with bonds or common stock
Question No: 8 ( M - 1 ) .
Which of the following describes the hedging approach to financing?
► Maturity dates of financing instruments are spread over a period of time so that they mature in a steady, predictable fashion.
► Each asset is offset with a financing instrument of the same approximate maturity.
► Each asset is offset with a put or call option.
► The firm takes out insurance to protect itself against uneven cash flows.
Question No: 9 ( M - 1 ) .
According to the Miller Model, upper limit for cash balance is equal to which of the following?
► Lower limit + Spread
► Spread – Lower limit
► Optimal limit + Lower limit
► Lower limit – Spread
Question No: 10 ( M - 1 ) .
Suppose that the sale (usage rate) on an item gets doubled. The EOQ (Economic Order Quantity) for that item should be:
► Halved
► Unaffected
► Decreased
► Increased
Question No: 11 ( M - 1 ) .
A firm wants to acquire another firm by purchasing its assets. Which of the following methods firm can use to evaluate the financial aspects of this deal?
► Replacement cost method
► Dividend valuation method
► Present value method
► Price earning ratio method
Question No: 12 ( M - 1 ) .
In which of the following acquisition strategies, a purchaser has complete knowledge of the acquiring firm?
► Management Buy-In
► Management buyout
► Consolidation
► Amalgamation
Question No: 13 ( M - 1 ) .
Which one of the following statements is CORRECT regarding exercise price?
► Exercise price is the price mentioned in the option at which the holder exercises his right
► Exercise price is the price mentioned in the option at which the holder exercises his obligation
► Exercise price is the price mentioned in the option at which the option seller exercises his right
► Exercise price is the price mentioned in the option at which the option writer exercises his right
Question No: 14 ( M - 1 ) .
Which one of the following statements is CORRECT regarding Options Contacts?
► A put option gives the holder a right to sell underlying item at a specified price
► A put option gives its writer the right to sell underlying item at a specified price
► A call option gives its writer a right to sell underlying item
► A call option gives its holder a right to sell underlying item
Question No: 15 ( M - 1 ) .
If market interest rate increases above the agreed rate in an interest rate option, the effective interest rate for the option holder would be:
► Less than the market rate
► Greater than market rate
► Equal to the market rate
► Zero
Question No: 16 ( M - 1 ) .
Which one of the following techniques can reduce the risks and disadvantages of share purchase method in mergers and acquisitions?
► Spin-off
► Hive-down
► Hubris
► Off-shoot
Question No: 17 ( M - 1 ) .
The financial consideration to be paid to target company in mergers can be classified in to the following categories EXCEPT:
► Cash
► Assets
► Share – ordinary or preference
► Debt
Question No: 18 ( M - 1 ) .
Which of the following types of dividend policies results in the most volatile dividend payments and stockholder discomfort?
► Target dividend-payout policy
► Low-regular-and-extra dividend policy
► Regular dividend policy
► Constant payout-ratio dividend policy
Question No: 19 ( M - 1 ) .
Suppose you invested Rs. 8,000 in a savings account paying 5 percent interest a year, compounded annually. How much amount your account will have at the end the end of four years?
► Rs.10,208
► Rs.9,728
► Rs.10,880
► Rs.9,624
FV = PV(1-I)n
= 8000(1-.05)4
= 9728
Question No: 20 ( M - 1 ) .
If you deposit Rs. 12,000 per year for 16 years (each deposit is made at the beginning of each year) in an account that pays an annual interest rate of 15%, what will your account be worth at the end of 16 years?
► Rs. 82,168.44
► Rs. 71,450.82
► Rs. 768,901.12
► Rs. 668,609.67
FVA = PMT[(1+I)n-1/i]
= 12000[(1+.15)16-1/.15]
= 668,609.67
Question No: 21 ( M - 1 ) .
Which of the following statements would be CORRECT regarding nominal interest rate when inflations is expected to occur over the foreseeable future?
► Nonimal interest rate would be equal to real interest rate
► Nonimal interest rate would be more than real interest rate
► Nonimal interest rate would be half of real interest rate
► Nonimal interest rate would be less than the real interest rate
Question No: 22 ( M - 1 ) .
Which of the following is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume?
► Technical analysis
► Fundamental analysis
► Common size analysis
► Ratio analysis
Question No: 23 ( M - 1 ) .
Which of the following statements best describes the term Market Correction?
► Market Correction refers to the situation where equilibrium of supply & demand of shares occurs in the market
► Market correction refers to the situation where shares’ intrinsic values becomes equal to face values
► Market Correction refers to the situation when there is a boom in the economy
► Market Correction refers to the situation where inflation rate is above the market interest rate
Question No: 24 ( M - 1 ) .
Which of the following statements is CORRECT regarding the fundamental analysis?
► Fundamental analysts use only Economic indicators to evaluate a stock
► Fundamental analysts use only financial information to evaluate a company’s stocks
► Fundamental analysts use financial and non-financial information to evaluate a company’s stocks
► Fundamental analysts use only non-financial information to evaluate a company’s stocks
fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for competing products, industry comparisons, analysis of the effects of new regulations or demographic changes, and economy-wide changes
Question No: 25 ( M - 1 ) .
Which of the following could be used to calculate the cost of common equity?
► Interpolation method
► Dividend discount model
► YTM (Yield-to-Maturity) method
► Capital structure valuation
Question No: 26 ( M - 1 ) .
When faced with mutually exclusive options, which project should be accepted under the 'Payback Method'?
► The one with the longest payback period
► The one with the shortest Payback period
► It doesn’t matter because the payback method is not theoretically correct
► None of the given options
Question No: 27 ( M - 1 ) .
Which of the following IAS (International Accounting Standard) deals with cash flow statement?
► IAS 1
► IAS 7
► IAS 16
► IAS 28
Question No: 28 ( M - 1 ) .
Mr. Joseph Steve has changed the working capital policy of his company recently. As a result, the liquidity for the company has decreased but an increase in profitability has been observed alongside. From this information we can conclude that the company must have changed his working capital policy from ________ to ________.
► Conservative; Aggressive
► Aggressive; Moderate
► Aggressive; Conservative
► None of the given options
Question No: 29 ( M - 1 ) .
“The firm has very little net working capital sometimes even negative net working capital that can be very risky.” The above statement belongs to:
► Aggressive working capital policy
► Conservative working capital policy
► Moderate working capital policy
► The statement is not related to any of the working capital policies
Question No: 30 ( M - 1 ) .
The amount of current assets that varies with seasonal requirements is referred to as __________ working capital.
► Permanent
► Net
► Temporary
► Gross
Question No: 31 ( M - 1 ) .
Under which of the following concepts, each asset is offset with a financing instrument of the same maturity?
► M&M proposition
► Clientele effect
► Hedging approach
► Baumol Model
Current Assets Financing – Hedging Approach
Under this approach each asset would be offset with a financing instrument of the same maturity.
Question No: 32 ( M - 1 ) .
Which of the following is NOT one of the common motives of holding cash?
► Personal Motives
► Safety Motives
► Transactions Motives
► Speculative Motives
Motives for Cash holding
Transactions Motive ensures that the firm has enough funds to transact its routine, day-to-day business affairs. Safety Motive protects the firm against being unable to meet unexpected demands for cash. Speculative Motive allows the firm to take advantage of unexpected opportunities that may arise
Question No: 33 ( M - 1 ) .
Which of the following is equal to Stock out cost?
► Carrying cost Safety stock
► Holding cost Carrying cost
► Reordering cost Safety stock
► Carrying cost Reordering cost
Question No: 34 ( M - 1 ) .
Which of the following statement is INCORRECT regarding Just-In-Time (JIT)?
► The inventories are kept near zero level.
► The inventory is acquired in such quantity on daily basis that can support the daily production level.
► The entire inventory acquired move to the production hall.
► Inventory level is necessarily kept at zero level.
JIT does not necessarily mean zero inventory level. The objective is to minimize the inventories but to increase the productivity, quality and flexibility.
Question No: 35 ( M - 1 ) .
Which of the following term refers to the minimum inventory amount needed for an item?
► Stock-out
► Buffer Stock
► Holding Stock
► Safety Stock
Safety stock is the minimum inventory amount needed for an item, based on anticipated usage and expected delivery time of materials.
Question No: 36 ( M - 1 ) .
Which of the following is NOT an objective of Just-In-Time (JIT)?
► To increase the productivity
► To increase the inventories
► To increase the quality
► To increase the flexibility
JIT objective is to minimize the inventories but to increase the productivity, quality and flexibility.
Question No: 37 ( M - 1 ) .
“If the people are not able to work together, the merger will not succeed.” Which of the following cause(s) of failure is(are) being depicted in this statement?
► Lack of planning
► Corporate culture
► Talent departure
► All of the given options
Corporate culture
. It is not enough for two companies to appear to fit well on paper; at the end of the day, if the people are not able to work together, the merger will not succeed.
http://business.yourdictionary.com/shark-repellent
Question No: 39 ( M - 1 ) .
Corporate restructuring involves the restructuring of:
► All of the given options
► The assets and liabilities of the company
► The debt to equity structures of the company
► Cost minimization by the company
CORPORATE Restructuring involves restructuring the assets and liabilities of corporations, including their debt-to-equity structures, in line with their cash flow needs to promote efficiency, restore growth, and minimize the cost to taxpayers.
Question No: 40 ( M - 1 ) .
Which of the following terms refer to the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition?
► Management Buyout
► Management Buy-In
► Leverage Buyout
► None of the given options
A leveraged buyout is accomplished with borrowed money or by issuing
more stock.
Question No: 41 ( M - 1 ) .
Which of the following is NOT among the categories of foreign risk?
► Transaction exposure
► Translation exposure
► Local exposure
► Economic exposure
Question No: 42 ( M - 1 ) .
Which of the following is NOT an external method to reduce the transaction exposure?
► Invoicing in home currency
► Money market hedges
► Currency futures
► Currency swaps
External methods:
- Forward contract
- Money market hedges
- Currency futures
- Currency options
- Currency swaps
Question No: 43 ( M - 1 ) .
Which of the following is the purpose of a Forward Interest Rate Agreement?
► To fix the interest rate
► To estimate the exchange rate
► To estimate the interest rate
► To fix the foreign exchange rate
Question No: 44 ( M - 1 ) .
Which of the following statements is INCORRECT regarding forward contracts?
► Reversing forward contract is difficult.
► Parties have to put an initial margin in forward contracts.
► No size restriction is placed in forward contract.
► Forward contract is made between parties and each party needs to confirm the credit worthiness of each other.
Question No: 45 ( M - 1 ) .
If the exercise price of an option is not favorable than the market price of the underlying item, an option would be termed as:
► In the money
► Out of money
► At the money
► None of the given options
If the strike price is not favorable than the current market price of underlying asset or item, the option is called “out-of-money.”
Question No: 46 ( M - 1 ) .
An investor buys 5 options on shares of at a price of Rs 50 per share. Each option consists of 100 shares and premium paid is Rs. 2 per share. What would be the total option cost for investor if the share price is Rs. 55 at the expiry of option?
► Rs. 1,000
► Rs. 1,500
► Rs. 2,500
► Rs. 25,000
5 option each option have 100 share
total share is 5 *100 =500
total cost of option is 50*500=25,000
Question No: 47 ( M - 1 ) .
An investor buys 5 options on shares at a price of Rs 50 per share. Each option consists of 100 shares and premium paid is Rs. 2 per share. What would be the net gain for investor if the share price is Rs. 55 at the expiry of option?
► Rs. 1,500
► Rs. 2,500
► Rs. 1,000
► Rs. 25,000
Question No: 48 ( M - 1 ) .
Which of the following is the CORRECT statement regarding the Law of One Price?
► The law of one price applies to only tradable goods
► The law of one price applies to all goods
► The law of one price applies to immovable goods
► The law of one price applies to services only
Page 145 : (3) The law of one price only applies to tradable goods;
Question No: 49 ( M - 3 )
Explain the main features of a forward rate agreement.
A. Features of FRAs:
· It is in between bank and client for fixing future interest rate on notional amount of loan. The loan is for an affirmed period starting on a particular time in future.
· The size of the notional loan or deposit is decided between the bank and the client.
· FRAs are cash settled.
· On settlement date buyer and seller must settle the agreement.
· The FRA rate for three months loan/deposit starting in a 6 months’ time is normally expressed as 6v9 FRA.
· The buyer of a FRA agrees to pay fixed interest rate on notional loan. At the same buyer will receive interest on notional loan at standard rate of interest. On the other side, seller of FRA agrees to pay interest on the notional amount at benchmark rate and receives interest at a fixed rate.
Question No: 50 ( M - 3 )
Differentiate between Management Buyout and Management Buy-In.
Management Buyouts
Management buyouts are similar in all major legal aspects to any other acquisition of a company. The particular nature of the MBO lies in the position of the buyers as managers of the company and the practical consequences that follow from that. In particular, the due diligence process is likely to be limited as the buyers already have full knowledge of the company available to them. The seller is also unlikely to give any but the most basic warranties to the management, on the basis that the management knows more about the company than the sellers do and therefore the sellers should not have to warrant the state of the company. In many cases, the company will already be a private company, but if it is public then the management will take it private.
Management Buy In (MBI):
Management Buy in (MBI) occurs when a manager or a management team from outside the company raises the necessary finance buys it and becomes the company's new management. A management buy-in team often competes with other purchasers in the search for a suitable business. Usually, a manager will lead the team with significant experience at managing director level. The difference to a management buy-out is in the position of the purchaser: in the case of a buy-out, they are already working for the company. In the case of a buy-in, however, the manager or management team is from another source.
Question No: 51 ( M - 5 )
Assume that a bookstore uses up cash at a steady rate of Rs.300,000 per year. The interest rate is 3% and each sale of securities costs Rs.20. Determine the optimal cash balance for the bookstore.
ECQ = √ [(2 × Conversion Cost × Demand for Cash) / Opportunity Cost]
= √ [(2 × 20 × 300,000) / 0.0025]
= √ [12000000 / 0.0025]
= √ 4800000000
= Rs. 69282
Question No: 52 ( M - 5 )
Firm A wants to acquire a private limited company operating in the same industry. What procedure would be followed by the Firm A to acquire the target company?
Question No: 53 ( M - 5 )
Why exchange rates of two currencies fluctuate? Explain briefly
Following are some factors for fluctuation:
Relative interest rates: One factor that affects exchange rates is the size of the differential between the real interest rates available to investors in the respective countries. The real interest rate is simply the nominal interest rate available to an investor in a high quality short-term investment subtracted by the country's inflation rate.
Trade imbalances: The size of any trade deficit between two countries will also affect those countries' currency exchange rates. This is because they result in an imbalance of currency reserves among the trading partners.
Political stability: If a country's government becomes unstable due to political gridlock, votes of no confidence, revolution or civil war, confidence can quickly be lost. People become less willing to accept paper currency in exchange for their goods and services, primarily because they're unsure whether they'll be able to pass the paper along to the next person.
Government involvement: The relative value of a country's currency is of great importance to its government. The value of a country's currency affects the wealth of its citizens, the competitiveness of domestically produced goods, the relative cost of the country's labor, and the country's ability to compete. As a result, governments often try to influence the relative value of their country's currencies in a number of different ways, including altering their monetary and fiscal policies, and by directly intervening in the currency markets.
Investors: Perhaps the most powerful factor that can influence exchange rates over short time frames is the role that speculators play. Investors typically have tremendous amounts of capital that they can use to either buy or sell any currency. Consequently, their actions can cause the value of such currency to fluctuate, sometimes quite significantly.