NATIONAL SCHOOL OF BUSINESS MANAGEMENT

02nd Year 2nd Semester Examination

Model Paper
MGT 2306 – Financial Management

Instructions to Candidates
1) This paper consists with six (06) questions. Answer only five (05) questions.

2) Time allocated f o r the examination is three (03) hours.

3) Total number of pages - Six (06)

4) If a page or a part of this question p a p e r is not printed, please inform the Supervisor
immediately.

5) Write your index number p r o p e r l y i n y o u r a n s w e r b o o k l e t .

6) Attach all answer sheets at the end of the examination.

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Question 01

a) Financial market is an organized financial system where lenders of funds provide their excess
funds to the market and borrowers obtain the funds to meet the shortage of funds. Identify
the categories of “Financial Markets” and briefly explain each of it

b) A financial statement is an official document of the firm, which explores the entire financial
information of the firm. Briefly explain the components of financial statements.

c) Discuss the weaknesses of “Dividend Growth Model” as a method of share valuation.

d) “Systematic risk can be diversified”. Do you agree with the statement? Justify your answer.

e) The payback method is useful to compare projects that may be competing for a firm’s limited
capital. But there are some weaknesses in this model. Identify those weaknesses and propose
an adjustment to the method which minimize those weaknesses.

(Total=4x5=20 Marks)

Question 02
a) You are offered a special set of annuities by your pension fund whereby you will receive
Rs. 200,000 a year for the next 10 years and Rs. 300,000 a year for the following 10 years.
How much would you be willing to pay for these annuities, if the discount rate is 9% p.a.
and the annuities paid are at the end of the year? (5 Marks)

b) First City Bank pays 7% simple interest per annum on its savings accounts whereas Second
City Bank pays 7% interest compounded annually. If you made a Rs. 5,000 deposit in each
bank, how much more money would you earn from the Second City at the end of 10
years?
(5 Marks)

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 c) An insurance company is offering a new policy to its customers. Typically the policy is
bought by a parent or grandparent for a child at the child’s birth. The details of the policy
are as follows: The purchaser makes the following payments to the insurance company:

First birthday Rs. 7,500 Fourth birthday Rs. 8,500

Second birthday Rs. 7,500 Fifth birthday Rs. 9,500

Third birthday Rs. 8,500 Sixth birthday Rs. 9,500

After the child’s sixth birthday, no more payments are made. When the child reaches age 65,
he or she receives Rs.2,500,000. If the relevant interest rate is 11% for the first six years and
7% for all subsequent years, is the policy worth buying? (10 Marks)

(Total 20 Marks)

Question 03

a) The distribution of returns for share AAA and the market portfolio is given below;

Returns (%)

Probability Share AAA Market

0.30 25 -10

0.40 30 20

0.30 70 30

You are required to calculate the expected returns, standard deviation and variance of the
returns of share AAA and the market. (10 Marks )

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 b) Two shares, L and M have the following expected returns and standard deviations;

E(rL) = 28% E(rM) = 37%

SDL= 18% SDM = 20%

The correlation of returns of L and M is 0.7. If an investor has invested of 60% of his funds in share
M and rest of the funds in share L. Identify the risk and return associated with the investor's
portfolio. (10 Marks)

(Total 20 Marks)

Question 04

a) Colombo Dockyard just a paid a dividend of Rs.1.40 per share on its stock. The dividends
are expected to grow at a constant rate of 6% per year indefinitely. If investors require a
12% return, what is the price of the share today? (4 Marks)

b) A company is expected to pay a dividend of Rs.1.50 at the end of this year, a Rs.2.00
dividend at the end of year 2, and a Rs.2.30 dividend at the end of year 3. It is estimated
that dividend will grow at a constant rate of 5% per year thereafter. Investor requires a
return of 10%. What is the current market value of this company’s common stock?

(10 Marks)
c) Tutin Company has in issue 5 million Rs.100 par value irredeemable 6% preference shares
.Find the price of the share today if the discount rate is 8%? (3 Marks)

d) Sunny ventures have in issue Rs.1000 par value debentures with a coupon rate of 10%
paid annually and redeemable at 1100. Find the value of the debenture today if the
discount rate is 12% compounded annually? (3 Marks)

(Total 20 Marks)

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Question 05
a) Following dividend payments of Company X common stocks were obtained for the last 5
years.

2013 –Rs. 25.00

2014 –Rs. 26.00

2015 –Rs. 28.00

2016 –Rs. 29.30

2017 –Rs. 32.65

I. Estimate the dividend growth rate. (03 Marks)

II. If the above growth rate persist for the future, determine the cost of equity
assuming currently the stock is trading at Rs. 300. (03 Marks)

b) Determine the cost of debt (after tax) on a debt that has par value of Rs.1,000/=, a rate
of 8%, time to maturity of 10 years and is currently trading at Rs.850/= You can assume
the tax rate to be 25%. ( 03 Marks)

c) Nestle PLC has financed 30% of their assets by debt, 10% from preference shares and
the balance is financed by ordinary shares. Currently the common stocks are traded at
Rs. 140/=. The face value of the share is Rs. 100/=. The company has just paid the
ordinary dividend of 12/= to its shareholders. The dividend is expected to grow at a rate
of 6% per annum indefinitely.

10% preference shares have been issued at a face value of Rs. 1100/=. The shares are
traded at Rs. 1200/= per share.

The 8% corporate bonds have a market value of Rs. 900/=. However the face value of
these shares at Rs. 1,000/=. These bonds will be matured after 16 years at its face value.

The corporate tax rate is 28%.

Compute the weighted average cost of capital of Nestle PLC. (11 Marks)

(Total 20 Marks)

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Question 06
a) Abans PLC is considering to invest in a project. They have 4 options and the respective
cash flows of each of these projects are given below. Given cash flows are in rupees.

Year Project A Project B Project C Project D

0 (1000) (800) (1200) ( 1500)

1 400 500 700 1400

2 600 100 800 1300

3 200 400 100 700

Calculate the payback periods for all four projects and select the best project to invest?
(07 Marks)
b) Calculate the “Internal Rate of Return (IRR) “based on following information. If WACC
for this project is 12%, would you accept this project?

Discounting Factor Project NPV (Rs.)

10% 2000

15% ( 2500)

(04 Marks)
c) Kasun is willing to purchase a machine under a 4 years-lease agreement as he does not
have enough money in his hand. The value of the machine today is 500,000. The annual
interest rate is 14%. A fixed installment should be paid at the end of every year for the
next 4 years.
I. What will be the periodic payment on this lease?
II. Draw the loan amortization schedule. (06 Marks)

(Total 20 Marks)

-End of the paper-

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