Final Exam (Take-Home) Summer - 2020

Student Name: Daniyal Qamer Reg. ID: 46188

Program: BBA Instructor: Sundus Waqar &
Sumaira Ashraf
Subject: Principles of Finance Max. Marks: 45

Q. No. 1 2 3 4 Total
Total Marks 12 12 11 10 45

Obtained Marks

Department of Business Administration

Please follow the instructions carefully:

1. Write your answers in a Word file or solve on A4 sheets later take pictures and paste
in the word file, and upload the file before the due date on LMS.
2. Write your name and registration ID on the first page of your Word file.
3. Answer scripts can be uploaded on LMS any time before its deadline. Therefore,
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Therefore, do not submit your document through email or any other medium.
5. Use 12 pt. font size and Times New Roman font style along with 1-inch page
margins.
6. Follow the requirements of the word limit and the marking criteria while writing your
answers.
7. Provide relevant, original and conceptual answers, as this exam aims to test your
ability to examine, explain, modify or develop concepts discussed in class.

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 8. Do not copy answers from the internet or other sources. The plagiarism of your answers
may be checked through Turnitin.
9. Recheck your answers before the submission on LMS to correct any content or
language related errors.
10. Double check your word file before uploading it on LMS to ensure that you have
uploaded the correct file with your answers.

Q1 Mr Ali has an option of investing in one project from the proposed three different projects.
The initial investment and cash flows are given below. (r = 12%)
years Cf – project 1 Cf – project 2 Cf – project 3
0 (10,000) (28,000) (22,000)
1 1000 3000 4000
2 880 7000 1000
3 6000 8000 1000
4 4000 12000 9000
5 2000 7500 11500
6 3650 6400 8900

a. Calculate payback for all three projects [1 marks]

b. Calculate discounted payback for all three projects [1 marks]
c. Calculate NPV for all three projects [2 marks]
d. Calculate profitability index for all three projects [1 marks]
e. Calculate IRR for all three projects [2 marks]
f. Write a detailed comment on which project Mr. Ali must invest on the basis of above
calculated criteria’s and why he must ignore the other projects. [5 marks]

Answer:
A) PAYBACK:
PROJECT: 1

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 Year Cf – Project 1 Payback
0 (10,000)
1 1000 -9000
2 880 -8120
3 6000 -2120
4 4000 1880
5 2000 3880
6 3650 7530

Payback period = Year prior to full recovery + Cash flow to be recovered

Cash flow during full recovery

2120
=3+
4000

= 3 + 0.53

P1 = 3.530 years

years Cf – project 2 PAYBACK

0 (28,000)
1 3000 -25000
2 7000 -18000
3 8000 -10000
4 12000 2000
5 7500 9500
6 6400 15900
Payback period =
Year prior ¿ full recovery +cash flow ¿ be recovered ¿
cash flow during full recovery

10000
=3+
12000

= 3 + 0.83

P2 = 3.833 years

years Cf – project 3 PAYBACK

0 (22,000)
1 4000 -18000
2 1000 -17000

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 3 1000 -16000
4 9000 -7000
5 11500 4500
6 8900 13400

Payback period =
Year prior ¿ full recovery +cash flow ¿ be recovered ¿
cash flow during full recovery

7000
=4+
11500

= 4 + 0.609

P3 = 4.609 years

B) DISCOUNT PAYMENT:

years Cf – project 1 PV DISCOUNT

PAYMENT
0 (10,000)
1 1000 1000 -9107.14
= 892.86
1.12

2 880 880 -8403.14

= 701.75
1.25

3 6000 6000 -4132.74

= 4270.5
1.405

4 4000 4000 -1589.84

= 2542.9
1.573
Discount Payment =
5 2000 2000 -454.74
= 1135.1
1.762

6 3650 3650 1394.3

= 1849
1.974

Year prior ¿ full recovery +cash flow ¿ be recovered ¿

cash flow during full recovery

454.74
=5+
1849

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= 5 + 0.248

D1 = 5.248 years

years Cf – project 2 PV DISCOUNT

PAYMENT
0 (28,000)
1 3000 3000 -25321.4
= 2678.6
1.12
2 7000 7000 -19739.26
= 5582.14
1.254
3 8000 8000 -14029.05
= 5693.95
1.405
4 12000 12000 -6400.35
= 7628.7
1.573
5 7500 7500 -2143.85
= 4256.5
1.762
6 6400 6400 1098.3
= 3242.15
1.974

Discount Payment =
Year prior ¿ full recovery +cash flow ¿ be recovered ¿
cash flow during full recovery

2143.85
=5+
3242.15

= 5 + 0.668

D2 = 5.668 years

years Cf – project 3 PV DISCOUNT

PAYMENT
0 (22,000)

1 4000 4000 -18428.6

= 3571.43
1.12
2 1000 1000 -17631.12
= 797.45
1.254
3 1000 1000 -16919.4
= 711.74
1.405

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 4 9000 9000 -11197.8
= 5721.55
1.573
5 11500 11500 -4671.1
= 6526.68
1.762
6 8900 8900 -162.55
= 4508.6
1.974

We don’t have cash flow during full recovery as there is negative sign till 6 years so, it doesn’t
imply in this formula.

C) NPV:
NPV1 = -10,000+892.86+701.75+4270.5+2542.9+1135.1+1849
= -10,000+11392.11
NPV1 = 1392

NPV2 = -28,000+2678.6+5582.14+5693.95+7628.7+4256.5+3242.15
= -28,000+29082.04
NPV2 = 1082.04

NPV3 = -22,000+3571.43+797.45+711.74+5721.55+6526.68+4508.6
= -22,000+21837.45
NPV3 = -162.5

D) PROFITABILITY INDEX:
892.86+701.75+4270.5+ 2542.9+ 1135.1+1849
PI1 =
10000
11392.11
PI1 =
10000
PI1 = 1.139

2678.6+5582.14+5693.95+7628.7+ 4256.5+3242.15
PI2 =
28000
29082.04
PI2 =
28000
PI2 = 1.039

3571.43+797.45+711.74+ 5721.55+ 6526.68+4508.6

PI3 =
22000
21837.45
PI3 =
22000
PI3 = 0.993.

E) IRR:

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 Assume R as
R1 = 10%
R2 = 15%

R 1+(NPV 1 X ( R 2−R 1 ) )
IRR =
NPV 1−NPV 2

FOR PROJECT 1:

1000 880 6000 4000 2000 3650

NPV1 = -10,000+ + + + + +
(1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5 (1.1)6

1000 880 6000 4000 2000 3650

= -10,000+ + + + + +
1.1 1.21 1.33 1.46 1.61 1.77

= -10,000+11288.4

NPV1 = 1288.4

1000 880 6000 4000 2000 3650

NPV2 = -10,000+ 1
+ 2
+ 3
+ 4
+ 5
+ 6
(1.15) (1.15) (1.15) (1.15) (1.15) (1.15)

1000 880 6000 4000 2000 3650

= -10,000+ + + + + +
1.15 1.32 1.52 1.75 2.01 2.31

= -10,000+10344.5

NPV2 = 344.5

10 %+(1288.36 X (15 %−10 % ) )

IRR =
1288.36−344.48

6441.8
= 10% +
943.88

IRR = 16.06%

FOR PROJECT: 2

3000 7000 8000 12000 7500 6400

NPV1 = -28,000+ + + + + +
(1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5 (1.1)6

3000 7000 8000 12000 7500 6400

= -28,000+ + + + + +
1.1 1.21 1.33 1.46 1.61 1.77

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 = -28,000+31021

NPV1 = 3021

3000 7000 8000 12000 7500 6400

NPV2 = -28,000+ 1
+ 2
+ 3
+ 4
+ 5
+ 6
(1.15) (1.15) (1.15) (1.15) (1.15) (1.15)

3000 7000 8000 12000 7500 6400

= -28,000+ + + + + +
1.15 1.32 1.52 1.75 2.01 2.31

= -28,000+27379.16

NPV2 = -620.84

10 %+(3021 X ( 15 %−10 % ))
IRR =
3021−(−620.84)

15105
= 10% +
3641.84

IRR = 13.41%

FOR PROJECT: 3

4000 1000 1000 9000 11500 8900

NPV1 = -22,000+ + + + + +
(1.1)1 (1.1)2 (1.1)3 (1.1)4 (1.1)5 (1.1)6

4000 1000 1000 9000 11500 8900

= -22,000+ + + + + +
1.1 1.21 1.33 1.46 1.61 1.77

= -22,000+23550.2

NPV1 = 1550.22

4000 1000 1000 9000 11500 8900

NPV2 = -22,000+ 1
+ 2
+ 3
+ 4
+ 5
+ 6
(1.15) (1.15) (1.15) (1.15) (1.15) (1.15)

4000 1000 1000 9000 11500 8900

= -22,000+ + + + + +
1.15 1.32 1.52 1.75 2.01 2.31

= -22,000+19610.78

NPV2 = -2389.22

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 10 %+(1550.22 X ( 15 %−10 % ))
IRR =
1550.22−(−2389.22)

7751.1
= 10% +
3939.44

IRR = 11.79%

Q2 ABC private limited as given the dividend of $5 last year and has promised to increase the
dividend by 8% each year for the next four years.
a. Find out the dividend of each of the next four years. [2 marks]
b. If the stocks are selling at $120 at the end of fourth year, find out the price of stock today,
assuming expected return as 12%. [2 marks]
c. Write a detailed comment on what will happen to the today’s selling price of the stock if
the expected return is increased from 12% to 16%. [3 marks]
d. If the stocks are selling at $90 today, find out the price of stock at the end of fourth year,
assuming expected return as 12%. [2 marks]
e. Write a detailed comment on what will happen to the selling price of the stock at the end of
fourth year if the expected return is decreased from 12% to 8%. [3 marks]

ANSWER:
A) FOR DIVIDEND:

D1 = 5 (1.08) = 5.4
D2 = 5.4 (1.08) = 5.83
D3 = 5.83 (1.08) = 6.29
D4 = 6.29 (1.08) = 6.80

B) FOR PRICE OF STOCK:

D1 D2 D3 D 4+P4
= 1
+ 2
+ 3
+
(1+r ) (1+r ) (1+ r) (1+ r) 4

5.4 5.83 6.29 6.8+120

= + + +
(1+0.12) (1+0.12) (1+0.12) (1+ 0.12)4
1 2 3

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 = 4.82+4.66+4.49+80.76

Stock Price = 94.73

C) If the interest rate increases from 12% to 16% the Present value of dividends and price in
year 4 will decrease. This is because higher is the required rate more is the risk. Hence
lower is the price of bond.

Price today =D1/(1+r)+D2/(1+r)^2+D3/(1+r)^3+D4/(1+r)^4+Price in year 4/(1+r)^4

=5.40/(1+16%)+5.8320/(1+16%)^2+6.2986/(1+16%)^3+6.8024/(1+16%)^4+120/
(1+16%)^4

Po = 83.06

D) P4 = P0 x (1+r )4 – D1 x (1+r )1 – D2 x(1+r )2 – D3 x(1+r )3 – D4

= 90 x (1+0.12)4 – 5.4 (1+0.12)1 -5.83(1+0.12)2 -6.29(1+0.12)3 - 6.80

=141.6 – 6.048 – 1.936 – 8.81 – 6.80

P4 = 112.86

E) P4 = P0 x (1+r )4 – D1 x (1+r )1 – D2 x(1+r )2 – D3 x(1+r )3 – D4

= 9 x (1+0.08)4 – 5.4 (1+0.08)1 -5.83(1+0.08)2 -6.29(1+0.08)3 - 6.80

= 12.24 – 5.832 – 6.80 – 7.923 – 6.80

P4 = 95.23

If required Rate decreases the price in year 4 decreases. Lower the interest rate lower is
the future price of bond.

Q3 Exerpt taken from Engro Corporations press release:

“Engro Corp is one of Pakistan’s largest conglomerates, in operation for over 45 years, and with
businesses ranging from fertilizers to power generation. Currently Engro Corp’s portfolio

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consists of seven businesses which include chemical fertilizers, PVC resin, a bulk liquid
chemical terminal, industrial automation, foods, power generation and commodity trade.

Engro Corporation Limited has announced the launch of the second issue of the Engro Rupiya
Certificates savings option, which provides investors with an unprecedented 14.5% (coupon) rate
of return. This issuance follows the successful launch of the certificates in October 2010.

The second release of Engro Rupiya Certificates also offers profit payments twice in a year for a
minimum amount of PKR 25,000, invested for a period of 3 years. The product offers investors
the option to encash the certificates at any time, with the profit accumulated from the date of
purchase to the date of encashment. Engro has also provided a unique service for the
convenience of its customers, enabling certificate holders to conduct transactions and receive
profit payments at home.”

1. Assuming the yield to maturity on the bond is 11.25%, calculate the price of the bond at
the time of issue [2 marks]

2. Assuming the yield curve is flat and doesn’t shit, calculate the bond price two years after
the issue? [2 marks]

3. Compare your answer to part 1 and justify. [2 marks]

4. Evaluate the relevance of the types of risk for this bond. [5 mark]

ANSWER:

1. Amount invested = Rs.25,000

Semi-annual yield = 11.25% = 0.1125 x 6/12 = 0.056
CR = 14.5 % = 0.145 x 6/12 = 0.0725
Coupon Payment = 0.0725 x 25,000
Coupon Payment = 1812.5

N = 3 x 2 = 6 years

Price of the bond = PMT ¿ + FV

¿¿

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 25000
=1812.5 ¿ +
¿¿

Price of the bond = Rs.27054.

2. Price of the bond = PMT ¿ + FV

¿¿

25000
=1812.5 ¿ +
¿¿

Price of the bond for 2 years = Rs.25754

Yes, the YTM remains flat because the rate of YTM is constant (11.25%)

3. In order to reach to its maturity period, bond price will fall and will reach towards its face
value. It will decrease from 27054 to 25754 and in the end towards face value which is
25000 respectively.

4. Relevance of the types of risk for this bond

1. Interest Rate Risk and Bond Prices
Interest rates and bond prices have an inverse relationship; as interest rates fall, the price
of bonds trading in the marketplace generally rises. Conversely, when interest rates rise,
the price of bonds tends to fall. If the prevailing interest rate were on the rise, investors
would naturally jettison bonds that pay lower interest rates. This would force bond prices
down.
2. Reinvestment Risk and Callable Bonds
Another danger that bond investors face is reinvestment risk, which is the risk of having
to reinvest proceeds at a lower rate than the funds were previously earning. One of the
main ways this risk presents itself is when interest rates fall over time and callable bonds
are exercised by the issuers.

The callable feature allows the issuer to redeem the bond prior to maturity. As a result,
the bondholder receives the principal payment, which is often at a slight premium to the
par value.

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 However, the downside to a bond call is that the investor is then left with a pile of cash
that he or she may not be able to reinvest at a comparable rate. This reinvestment risk can
have a major adverse impact on an individual's investment returns over time.

3. Inflation Risk and Bond Duration

When an investor buys a bond, he or she essentially commits to receiving a rate of return,
either fixed or variable, for the duration of the bond or at least as long as it is held.

But what happens if the cost of living and inflation increase dramatically, and at a faster
rate than income investment? When that happens, investors will see their purchasing
power erode and may actually achieve a negative rate of return (again factoring in
inflation).

4. Credit/Default Risk of Bonds

When an investor purchases a bond, he or she is actually purchasing a certificate of debt.
Simply put, this is borrowed money that must be repaid by the company over time with
interest. Many investors don't realize that corporate bonds aren't guaranteed by the full
faith and credit of the U.S. government, but instead depend on the corporation's ability to
repay that debt. Investors must consider the possibility of default and factor this risk into
their investment decision.

Q4. You are 20 years old and have completed your BBA and want to pursue further education
but you don’t want to take money from your father. Your plan is to start working and earn
enough money so that you can finance your degree on your own and get yourself enrolled in five
years’ time. You estimate that the annual cost of doing an MBA 5 years from today will be PKR
400,000 and the program will be two years long. You will need the money at the beginning your
program so that you are not worried about how to clear your dues during your studies. Luckily
you go for a job interview and they hire you and you start working at a salary of PKR 25,000. So
you decide that 50% you will deposit in a saving account at a 10% rate with monthly

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compounding for your further studies and the remaining amount you will use for your daily
expenses.

1. Will you be able to meet your goal at this current saving rate? [2 marks]

2. What percentage of your salary should you save if you want to have exactly your
university expenses amount? [2 marks]

3. How would your answer to part 1 change if the saving account rate changed to 5%?
Comment on your answer. [2 marks]

4. If you are given an option to invest at the 10% saving rate with monthly compounding or
10.5% semiannual compounding, which would you chose? Explain your answer. [4
marks]

ANSWER:

Annual Cost = 400,000

MBA Program = 2 years 50,

400,000 x 2 = 800,000

1. Monthly salary = 25000 x 6/ 12 = 12500 or 25000 x 50% = 12500

R = 0.01 / 12 = 0.0083

N = 5x 12 = 60

FV = 12500 { ( 1+ 0.0083)^60 – 1} / 0.0083

FV = 12500 (77.355)

FV = $ 966,940

Future saving exceeds from required amount so, Yes will be able to meet the goal at saving rate.

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 2. Percentage of salary = ?

First we have to find PMT (Payment annuity)

FV = PMT {(1+r)^n -1)}/ r

80000 = PMT {(0.0083)^60- 1)}/ 0.0083

PMT = 80000/77.355

PMT = 10341

Now, the % of saving = 10341/25000 x 100 = 41.36%

3. Account Ratio = 5% = 0.05/12 = 0.0042

FV = 12500 {(1.0042)^60- 1)}/0.0042

FV = 12500 (68.075)

FV = $ 850,944

So, yes we will be able to meet the future requirements even though part 1 future value is lower.

4. Account Ratio = 10.5% / 2 = 0.0525

N = 5 x 2 = 10

FVAn = 12500 {(1.0525)^10- 1)}/ 0.0525

FVAn = 12500 (0.668/0.525)

FVAn = $1590704

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