SECURITY CLASSIFICATION: Official (Closed), Non-Sensitive

BA2087

PRACTICE PAPER 2

FINANCIAL MANAGEMENT

1. This Practice Paper 1 consists of two sections:

Section A : 10 Multiple Choice Questions - 20 marks

Section B : 4 Structured Questions - 80 marks
100 marks

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 SECURITY CLASSIFICATION: Official (Closed), Non-Sensitive

SECTION A : MULTIPLE CHOICE QUESTIONS (20 MARKS)

1. Spontaneous liabilities is financing that arises from the ________ of business.

(A) extraordinary course

(B) normal course
(C) spontaneous occurrence
(D) sudden event

2. The cost of giving up a cash discount is the implied rate of interest paid in order to delay
payment of a/an _________ for an additional number of days.

(A) accounts payable

(B) accounts receivable
(C) long term asset
(D) long term liability

3. Dividends paid to shareholders are __________

(A) at the discretion of financial managers.

(B) at the discretion of preferred shareholders.
(C) not tax-deductible.
(D) tax-deductible.

4. Which of the following statements about the objective for managing accounts receivable
is correct?

(A) The objective for managing accounts receivable is to delay accounts receivable as
long as possible without losing sales.
(B) The objective for managing accounts receivable is to delay accounts receivable as
long as possible even if it results losing sales.
(C) The objective for managing accounts receivable is to collect accounts receivable as
quickly as possible without losing sales.
(D) The objective for managing accounts receivable is to collect accounts receivable as
quickly as possible even if it results losing sales.

5. The __________ manager’s general disposition towards inventory levels is to keep them
low to ensure that the firm’s money is not being unwisely invested in excess resources.

(A) finance
(B) marketing
(C) manufacturing
(D) purchasing

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 SECURITY CLASSIFICATION: Official (Closed), Non-Sensitive

6. The key input to the short-term financial planning process is the ________

(A) audit report.

(B) proforma balance sheet.
(C) proforma income statement.
(D) sales forecast.

7. The primary purpose in preparing pro forma financial statements is for ________

(A) cash planning.

(B) inventory management.
(C) risk management.
(D) profit planning.

8. _________ is the attitude toward risk in which investors prefer investments with greater
risk.

(A) Risk arbitrage

(B) Risk averse
(C) Risk neutral
(D) Risk seeking

9. The liquidity preference theory suggests that short-term interest rates ________ long-
term interest rates most of the time.

(A) should be the same as

(B) should be lower
(C) should be higher
(D) has no correlation with

10. _________ are the standards of conduct or moral judgment that apply to persons engaged
in commerce.

(A) Business commerce standards

(B) Business ethics
(C) Government regulations
(D) Uniform Commercial Codes

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 SECURITY CLASSIFICATION: Official (Closed), Non-Sensitive

SECTION B : STRUCTURED QUESTIONS (80 MARKS)

11. (A) Explain what present value is and what effect does increasing the required return
have on the present value of the future amount.
(4 marks)

(B) Explain what an ordinary annuity and an annuity due are.

(4 marks)

(C) Consider two fixed annuities, one an ordinary annuity and the other an annuity
due, but otherwise identical, explain which one will have a higher present value.
(2 marks)

(D) You have an opportunity to invest in two investments, Annuity Ten and Cashflow
Six. Each investment cost $50,000 today. Annuity Ten is an ordinary annuity that
makes 6 cash payments of $10,000. Cashflow Six pays $8,000 in the first 4 years
and $25,000 in the final 2 years. Assume you can earn 15% on your investments.

i) Calculate the future value of Annuity Ten.

(2 marks)

ii) Calculate the future value Cashflow Six.

(6 marks)

iii) Explain which investment you will choose.

(2 marks)

(Total: 20 marks)

12. (A) Describe what aggressive and conservative funding strategies are.
(4 marks)

(B) Describe what are permanent and seasonal funding and explain why it is helpful
to divide the funding needs of business into permanent and seasonal funding.
(4 marks)

(C) Explain what credit scoring is and why it is used by lenders.

(4 marks)

(D) If a firm has a 90-day operating cycle. Calculate its average collection period if
its average age of inventory is 35 days.
(4 marks)

(E) Using the information in part (D), calculate its cash conversation cycle if its
average payment period is 30 days.
(4 marks)

(Total: 20 marks)

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13. (A) What is cost of capital and what role does it play in the firm’s long-term
investment decisions?
(4 marks)

(B) Explain what does a firm’s capital structure represents.

(4 marks)

(C) Explain what risk does beta measures and why non-diversifiable risk is the only
relevant risk.
(4 marks)

(D) You have a portfolio of stock Alpha, Beta, Charlie and Delta with equal
weightage. The beta of stock Alpha, Beta, Charlie and Delta are 1.20, 1.05, 0.85
and 0.60 respectively. Calculate the beta of your portfolio.
(4 marks)

(E) Calculate the market return for an asset with required return of 8%, risk-free rate
of 2% and a beta of 1.2 using Capital Asset Pricing Model (CAPM).
(4 marks)

(Total: 20 marks)

14. You are considering if you should invest in a project which requires initial investment of
$150,000. This project is expected to provide a cash inflow of $52,000, $78,000 and
$100,000 in year one, two and three respectively. Your firm has cost of capital of 10%.

(A) Calculate the Net Present Value (NPV) of this project and explain if you should
accept the project.
(4 marks)

(B) Explain what is Payback period and calculate the project’s Payback period.
(4 marks)

(C) If the Internal Rate of Return (IRR) of the investment is 11%, explain the decision
rule that you should follow when you use the IRR method to evaluate and if you
should accept the project.
(4 marks)

(D) Calculation the NPV of this project if your firm’s cost of capital increases to 15%.
(4 marks)

(E) Explain the reinvestment assumptions of NPV an IRR which may cause
conflicting rankings.
(4 marks)

(Total: 20 marks)

~ End of Paper ~
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Formulae list

Present value (Po) of a future value (FN) in N periods:

FN
Po =
( ( (1 (1 + r )N

Future value (FN) of a present value (Po) in N periods:

-
FN = Po x ( 1 + r ) N

Present value (Po) of an ordinary annuity (A) in N periods:

A 1
P
Po = x 1
o r ( 1 + r )N

Future value (FN) of an ordinary annuity (A) in N periods:

A
FN = x ( 1 + r )N – 1
r

Gordon Growth Model

where
P0 = Value today of common stock
D1 = Dividend expected at the end of year 1
r = Required return on common stock
g = Constant growth rate

Capital Asset Pricing Model (CAPM)

rj  RF    j   rm  RF  (8.8)
where
rj = Expected return or required return on asset j
RF = Risk-free rate of return
βj = Beta coefficient or index of nondiversifiable risk for asset j
rm = Market return; expected return on the market portfolio of assets

Cash Conversion Cycle (CCC)

CCC = OC – APP

Operating Cycle (OCC)

OC = AAI +ACP

where:
APP = Average payment period
AAI = Average age of inventory
ACP = Average collection period

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