INSTITUTE OF BUSINESS MANAGEMENT

Final Exam Semester: Summer 2021

Course Title: Theory & Practice of Financial Management Course Code: PMWE-10882
Faculty: Faraz Naseem Day/Date: Sunday / 29th Aug 2021
Time: 9:30 – 12:30 Total Marks: 40

NOTE: All amounts are in PKR. Student’s Name: ID:

Question # 1 (Short Answers)

a) How are spontaneous & discretionary liabilities utilized as a source of financing while sustaining growth
opportunities?
b) What factors determine management’s decision while investing in real & financial assets?
c) How can the use of operating & financial leverage result in maximization of shareholders wealth?
d) What drawbacks (if any) are associated with using the payback period method of project evaluation?
e) Why is after tax cost of debt, rather than before tax cost of debt used to calculate the weighted average cost
of capital?
(10 marks)
Question # 2
You have been hired as an analyst for a Bank and your team is working on an independent assessment
of a company that specializes in computer hardware & related products. Your assistant has provided you
with the following data (ratios) of the company’s financial performance over the past three years and
the industry averages:
Ratio Analysis 2018 2019 2020 Industry Average 2020
Current 2.3 1.5 2.6 2.7
Quick 0.8 0.5 0.9 1.0
Average Collection Period 37.4 39.5 45.5 32.0
Inventory Turnover 4.0 4.0 3.5 6.1
Fixed Assets Turnover 10.0 6.2 8.4 7.0
Total Assets Turnover 2.3 2.0 2.0 2.5
Debt to Total Assets 54.8% 80.7% 43.8% 50.0%
Interest Coverage 3.3 0.1 6.3 6.2
Net Profit Margin 2.6% -1.6% 3.6% 3.6%
Return on Assets 6.0% -3.3% 7.2% 9.0%
Return on Equity 13.3% -17.1% 12.8% 17.9%
Price/Earnings (P/E) 9.7 -6.3 12.0 16.2

Using the information provided, you are required to analyze the company’s financial condition and performance over
the last three years against the industry averages by answering the following questions:
a) What can you say about the liquidity position of the company and its ability to meet short term obligations?
b) What would be your assessment of the company’s short term asset utilization ratio(s)?
c) What value if any to your assessment of the first two parts can asset turnover ratio(s) bring?
d) Evaluate the company’s overall leverage position?
e) Provide the shareholders with an overall assessment of the firm's profitability/returns?
(10 marks)
Question # 3
A plastic manufacturer is considering a new product line to supplement its existing range. Two mutually
exclusive projects are under consideration and their after tax cash:
PROJECT 0 1 2 3 4 5
A -700,000 150,000 350,000 650,000 1,150,000 1,650,000
B -2,200,000 550,000 650,000 850,000 1,550,000 2,850,000

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Though the product line might be viable after year 05, the company prefers to be conservative and end all
calculations at that time.

Required:
a) Based on the commonly used capital budgeting evaluation techniques, which project in your opinion should
be accepted considering that the management requires a 10% return on investment also keeping in mind
that the management does not consider payback period to be an effective technique?
b) Capital budgeting techniques that do not consider time value of money provide a more practical/justified
evaluation? Would your answer to part a) been any different had the same been considered?
(08 marks)
Question # 4
A Corporation is planning to increase the level of sales from 10 million to 13 million in 2021 i.e. an increase of 30%.
The company considers all of its assets and non financing current liabilities as directly related to the level of sales.
Following is the balance sheet extract as on 31st Dec 2020:
Assets Liabilities & Equity
Current Assets 3,000,000 Accounts payable 700,000
Fixed Assets 5,000,000 Salaries payable 100,000
Rent payable 200,000
Short term loan 1,000,000
Long term loan 2,000,000
Shareholders’ equity 4,000,000
Total Assets 8,000,000 Total liabilities and shareholders’ equity 8,000,000
The expected profit margin on sales is 5% and the company has a dividend payout ratio of 40%.
To achieve the target sales of 13 million, calculate the AFN assuming 100 % utilization of total assets.
(04 marks)
Question # 5
Suppose a company uses both debt and equity to finance its capital budget. The capital structure is:
Assets Liabilities & Equity
Current Assets 5,000 Long Term Debt 3,000
Fixed Assets 5,000 Preferred Stock 1,000
Common Stock 6,000
Total Assets 10,000 Total liabilities and shareholders’ equity 10,000

Considering the following:

 The before tax cost of debt is 10 % and the tax rate is 40%;
 Preferred stock is currently trading at 111 with an expected dividend of 8;
 Market premium is 6% and risk free rate is 2.7% and the returns are twice as volatile with the stock market;
 Common stock is currently trading at 43 with a last paid dividend of 1.72 with an expected growth rate of 5%.
What is the Weighted Average Cost of Capital (WACC) of the company?
(04 marks)
Question # 6
A share of common stock paid a 100 dividend at the end of last year and is expected to pay cash dividend every year
from now to infinity. Each year, the dividends are expected to grow at a rate of 10%. Based on an assessment of the
riskiness of the common stock, the investor’s required rate of return is 15%. What value can the investor place on this
common stock?
(02 marks)
Question # 7
A corporate bond has an 8% coupon rate (with interest paid semi-annually), a maturity value of 1,000, and matures in
5 years. If the bond is priced to yield 6%, what is the bond's current value?
(02 marks)

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