Financial Management Exam Questions and Solutions

This assignment provides a comprehensive set of financial management exam questions and solutions. It includes three separate questions: (1) whether to buy a note or leave money in the bank; (2) finding the component costs of debt, preferred stock, and common stock for Eternalife Company; and (3) analyzing two investment projects A and B with different payback periods, NPV results, and IRR calculations. The assignment is suitable for MBA students studying financial management.

Great Land College
Department of Management
MBA Program
Individual Home-takeExam on Financial Management
Instruction:
 Attempt all the questions and give your answer on the separate sheet.
 Do not copy from your friends
 Do not forget to write your name on answer sheet
 Submit on the date of final exam
Q1) Suppose someone offered to sell you a note calling for the payment of $1,000 in
15months. They offer to sell it to you for $850. You have $850 in a bank time depositthat
pays a 6.76649% nominal rate with daily compounding, which is a 7% effectiveannual
interest rate, and you plan to leave the money in the bank unless you buythe note. The note is
not risky—you are sure it will be paid on schedule. Shouldyou buy the note? Check the
decision in three ways:
(1) by comparing your futurevalue if you buy the note versus leaving your money in the
bank;
(2) by comparingthe PV of the note with your current bank account; and
Q2) Assume Eternalife Company has the following capital structure, which it considers to be
optimal: debt 30%, preferred stock 20%, and common stock 50%. The company’s tax rate is
30%. Investors expect earnings and dividends to grow at a constant rate of 10% in the future.
Eternalife Company paid a dividend of Br. 4.50 per share last year and its stock currently
sells at a price of Br. 50 per share. Five-year treasury bonds yield 5%, the market risk
premium is 4%, and Eternalife beta is 1.2. The following terms would apply to new security
offerings.
Common Stock: New common equity will be raised only by retaining earnings.
Preferred stock: New preferred stock could be sold to the public at a price of Br.100 per
share, with a dividend of Br.10, and floatation costs of Br.5 would be incurred.
Debt (bond): Debt could be sold at an interest rate of 10%.
Required:
i) Find the component costs of debt, preferred stock and common stock
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ii) Determine the Weighted average cost of capital (WACC) of the company.
Q3) Assume your organization is considering two investment projects, each of which requires
an upfront expenditure of $25 million. You estimate that the cost of capital is 10% and that
the investments will produce the following after-tax cash flows (in millions of dollars):
Year Project A Project B
1 5 20
2 10 10
3 15 8
4 20 6
Required:
a) What is the regular payback period for each project?
b) What is the discounted payback period for each project?
c) According to net present value (NPV) results:
I. If the two projects are independent and the cost of capital is 10%, which project or
projects should the firm undertake?
II. If the two projects are mutually exclusive and the cost of capital is 5%, which project
should the firm undertake?
III. If the two projects are mutually exclusive and the cost of capital is 15%, which project
should the firm undertake?
d) According to internal rate of return (IRR) which project should be accepted if they are
independent?
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