THOMPSON RIVERS UNIVERSITY,

OPEN LEARNING

FNCE 2121• FINANCIAL MANAGEMENT

PRACTICE EXAMINATION

TIME ALLOWED: 3 HOURS MATERIALS PERMITTED:

TOTAL PAGES (INCLUDING THIS PAGE): 12 ◼ Non-programmable financial
TOTAL MARKS: 100 calculator
◼ Pencils or Pens
MATERIALS PROVIDED:
◼ One exam booklet for rough work
◼ Formula Sheets
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PRINT CLEARLY. PLEASE COMPLETE THIS SECTION—
PRINT CLEARLY.
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Instructions
◼ Write all your answers directly in this exam form. Use the exam booklet for rough work.
You should clearly show your work for partial credit. If you use your calculator’s
financial functions, then you should indicate the values entered for each key (e.g., n=12).
FNCE 2121 • PRACTICE EXAMINATION 2 of 12

FNCE 2121: Practice Exam

Below are eight long-answer questions worth 100 marks overall. Provide the requested
details and label your work.

Question 1 (5 marks)
Assume that you really want to own a Ferrari and are willing to wait. You think that in
18 years you can buy a used one for $300,000. You currently have $65,000 to invest.
What annual rate of interest must you earn on your investment to have your $300,000?

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FNCE 2121 • PRACTICE EXAMINATION 3 of 12

Question 2 (10 marks)

You want to buy a new BMW for $83,500, and the finance office at the dealership has
quoted you a 6.5% APR loan for 60 months to buy the car.
a. What will your monthly payments be? (5 marks)
b. Assuming the APR is compounded monthly, what is the effective annual rate on
this loan? (5 marks)

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FNCE 2121 • PRACTICE EXAMINATION 4 of 12

Question 3 (10 marks)

Lucky Strike Corp. has outstanding bonds making annual payments, with 9 years to
maturity, and selling for $948. At this price, the bonds yield 5.9%.
a. What is the coupon rate on a $1,000 face value bond? (5 marks)
b. Explain why some bonds sell at a premium over par value while other bonds sell
at a discount. (5 marks)

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FNCE 2121 • PRACTICE EXAMINATION 5 of 12

Question 4 (10 marks)

Yukon Healthcare Corp. is a start-up company. No dividends will be paid on the stock
over the next 9 years because the firm needs to reinvest profits for growth. The
company will pay a $12-per-share dividend in 10 years and will increase the dividend
by 5% per year thereafter. If the required return on this stock is 13.5%, what is the
current share price?

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FNCE 2121 • PRACTICE EXAMINATION 6 of 12

Question 5 (30 marks)

Solar Tech Inc. must choose between two mutually exclusive projects: A and B. Both
have a 10% required rate of return. Consider the following on projected cash flows:

Year A B

0 $ -50,000 $ -100,000

1 9,000 60,000

2 16,000 30,000

3 40,000 30,000

a. If you apply the payback criterion, which investment will you choose? Why? (5
marks)
b. If you apply the NPV criterion, which investment will you choose? Why? (5
marks)
c. If you apply the profitability index criterion, which investment will you choose?
Why? (5 marks)
d. What is the internal rate of return for each project? (5 marks)
e. At what required rate of return would management be indifferent as to which
project to choose? (5 marks)
f. Based on your answers to the questions above, which project will you finally
choose? Why? (5 marks)

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FNCE 2121 • PRACTICE EXAMINATION 7 of 12

Question 6 (15 marks)

NW Power Corp., who has a 35% tax rate, presented you with the following
information:
• Debt: 10,000 of 6.4% coupon bonds outstanding, $1,000 par value, 25 years to
maturity, and selling for 108% of par; the bonds make semi-annual payments.
• Common stock: 495,000 shares outstanding and selling for $63 per share; the beta
is 1.15.
• Preferred stock: 35,000 outstanding shares of $3.50 preferred stock currently
selling for $72 per share.
• Market: 7% market risk premium and 3.2% risk-free rate.
Calculate the weighted average cost of capital.

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FNCE 2121 • PRACTICE EXAMINATION 8 of 12

Question 7 (10 marks)

Rathtrevor Corp. presented you with the following information:
Rathtrevor Corporation
Statement of Financial Position
December 31, Years 5 and 4 ($ thousands)

Assets Year 5 Year 4

Cash $215 $210

Accounts receivable 310 355

Inventory 328 507

Property, plant and equipment, net 6,527 6,085

Total assets $7,380 $7,157

Liabilities and Shareholder’s Equity

Liabilities

Current liabilities

Accounts payable $298 $207

Notes payable 1,427 1,715

Total current liabilities 1,725 1,922

Long term liabilities

Bonds payable 2,308 1,987

Total liabilities 4,033 3,909

Shareholder’s Equity

Common shares 1,000 1,000

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FNCE 2121 • PRACTICE EXAMINATION 9 of 12

Retained earnings 3,347 2,248

Total Shareholder’s Equity 3,347 3,248

Total Liabilities and Shareholder’s Equity $7,380 $7,157

Rathtrevor Corporation
Income Statement
Year Ended December 31, Year 5 ($ thousands)

Sales $4,053

Cost of goods sold 2,780

Gross profit 1,273

Other Expenses:

Depreciation $550

Interest 502 1,052

Income before tax 221

Tax 75

Net income $146

Other information:

Rathtrevor also paid $47,000 in dividends.

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FNCE 2121 • PRACTICE EXAMINATION 10 of 12

Calculate the following ratios for Year 5:

a. Current ratio (1 mark)
b. Quick ratio (1 mark)
c. Inventory turnover (1 mark)
d. Receivables turnover (1 mark)
e. Day’s sales in receivables (1 mark)
f. Debt ratio (1 mark)
g. Times interest earned ratio (1 mark)
h. Net profit margin (1 mark)
i. Return on assets (1 mark)
j. Return on equity (1 mark)

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FNCE 2121 • PRACTICE EXAMINATION 11 of 12

Question 8 (10 marks)

Mazie’s Clothing Inc. is analyzing two machines to determine which one they should
purchase. The company requires a 14% rate of return, each machine belongs in a 30%
CCA class, and the firm’s tax rate is 35%.
Machine A has a cost of $290,000, annual operating costs of $8,000, and a 3-year life.
Machine B costs $180,000, has annual operating costs of $12,000, and has a 3-year life.
Both machines have zero salvage value at the end of their useful lives.
The company will use the accelerated CCA deduction of 1.5 times the rate in Year 1.
Ignore the tax effect of the machines after Year 3.
Which machine should Mazie's Clothing Inc. purchase? Why? Show your calculations.

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FNCE 2121 • PRACTICE EXAMINATION 12 of 12

END OF PRACTICE EXAM

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Assets = Liabilities + Shareholders' equity [2.1]
Revenues − Expenses = Income [2.2]
Cash flow from assets = Cash flow to bondholders + Cash flow to shareholders [2.3]
Current ratio = Current assets/Current liabilities [3.1]

Current assets − Inventory [3.2]

Quick ratio =
Current liabilities

Cash ratio = (Cash + Cash equivalents)/Current liabilities [3.3]

Net working capital to total assets = Net working capital/Total assets [3.4]
Interval measure = Current assets/Average daily operating costs [3.5]
Total debt ratio = [Total assets − Total equity]/Total assets [3.6]
Debt/equity ratio = Total debt/Total equity [3.7]
Equity multiplier = Total assets/Total equity [3.8]

Long-term debt [3.9]

Long-term debt ratio =
Long-term debt + Total equity

Times interest earned ratio = EBIT/Interest [3.10]

Cash coverage ratio = [EBIT + Depreciation]/Interest [3.11]
Inventory turnover = Cost of goods sold/Inventory [3.12]
Days' sales in inventory = 365 days/Inventory turnover [3.13]
Receivables turnover = Sales/Accounts receivable [3.14]
Days' sales in receivables = 365 days/Receivables turnover [3.15]
NWC turnover = Sales/NWC [3.16]
Fixed asset turnover = Sales/Net fixed assets [3.17]
Total asset turnover = Sales/Total assets [3.18]
Profit margin = Net income/Sales [3.19]
Return on assets = Net income/Total assets [3.20]
Return on equity = Net income/Total equity [3.21]
P/E ratio = Price per share/Earnings per share [3.22]
Market-to-book ratio = Market value per share/Book value per share [3.23]
Future value = $1 × (1 + r)t [5.1]
PV = $1 × [1/(1 + r)t] = $1/(1 + r)t [5.2]

PV × (1 + r ) t = FV [5.3]
FVt
PV =
(1 + r )t
1
= FVt × ( )
(1 + r )t

1 − Present value factor [6.1]

Annuity present value = C × ( )
r
1
1−
(1 + r )t
= C ×( )
r

(Future value factor − 1) [6.2]

Annuity FV factor =
r
t
((1 + r ) − 1)
=
r
Annuity due value = Ordinary annuity value × (1 + r) [6.3]

Perpetuity present value × Rate = Cash flow [6.4]

PV × r = C

(1 − Present value factor) [6.5]

Annuity present value factor =
r
1
= ( ) × (1 − Present value factor)
r

C [6.6]
PV=
r−g
C 1+ g t [6.7]
PV= [1 − ( )]
r−g 1+ r

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EAR = [1 + (Quoted rate/m)]m − 1 [6.8]
EAR = eq − 1 [6.9]
[7.1]
Bond value = C × (1 − 1/(1 + r)t)/r + F/(1 + r)t
1 + R = (1 + r) × (1 + h) [7.2]
R=r+h+r×h [7.3]
R≈r+h [7.4]
P0 = (D1 + P1)/(1 + r) [8.1]
P0 = D/r [8.2]
D0 × (1 + g ) D1 [8.3]
P0 = =
r−g r−g

Dt × (1 + g ) Dt +1 [8.4]
Pt = =
r−g r−g

D1 [8.5]
(r − g ) =
P0
D1
r= +g
P0

OCF = EBIT + D − Taxes [10.1]

= ( S − C − D ) + D − ( S − C − D ) × TC

OCF = ( S − C − D) + D − ( S − C − D) × TC [10.2]
= ( S − C − D) × (1 − TC ) + D
= Project net income + Depreciation

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OCF = ( S − C − D) + D − ( S − C − D) × TC [10.3]
= ( S − C ) − ( S − C − D) × TC
= Sales − Costs − Taxes

OCF = ( S − C − D) + D − ( S − C − D) × TC [10.4]
= ( S − C ) × (1 − TC ) + D × TC

[ IdTc ] [1 + .5r ] Sn dTc 1 [10.5]

PV tax shield on CCA = × − ×
d +r 1+ r d + r (1 + r ) n

S − VC = FC + D
P × Q − v + Q = FC + D [11.1]
( P − v) × Q = FC + D
( FC + D)
Q=
( P − v)

OCF = [( P − v) × Q − FC − D ] + D [11.2]
= ( P − v) × Q − FC

Q = (FC + OCF)/(P − v) [11.3]

Total dollar return = Dividend income + Capital gain (or loss) [12.1]
Total cash if stock is sold = Initial investment + Total return [12.2]
[( R1 − R ) 2 + ... + ( Rr − R ) 2 ] [12.3]
Var( R ) =
T −1

1 [12.4]
Geometric average return = [(1 + R1 ) × (1 + R2 ) × ... × (1 + Rr )] r − 1

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Risk premium = Expected return − Risk-free rate [13.1]
= E ( Rv ) − R f

E ( R ) =  R j × Pj
j

where
[13.2]
R j = value of the jth outcome
Pj = associated probability of occurrence
 j
= the sum over all j

σ 2 =  [ R j − E ( R)]2 × Pj [13.3]
j

σ = σ2

E ( RP ) = x1 × E ( R1 ) + x2 × E ( R2 ) + ... + xn × E ( Rn ) [13.4]

σ 2 P = x 2 Lσ 2 L + x 2U σ 2U + 2 xL xU CORR LU σ Lσ U [13.5]

σ P = σ 2P

Total return = Expected return + Unexpected return [13.6]

R = E ( R) + U
Announcement = Expected part + Surprise [13.7]
R = E(R) + Systematic portion + Unsystematic portion [13.8]
Total risk = Systematic risk + Unsystematic risk [13.9]
E ( Rt ) = R f + [ E ( RM ) − R f ] × βt [13.10]

R = E ( R) + β1 F1 + βGNP FGNP + β r Fr + ε [13.11]

E ( R) = RF + E[( R1 ) − RF ]β1 + E[( R2 ) − RF ]β 2 + E[( R3 ) − RF ]β3 + ... + E[( RK ) − RF ]β K [13.12]

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σ 2 P = x 2 Lσ 2 L + x 2U σ 2U + 2 xL xU CORR LU σ Lσ U [13A.1]

[13A.2]

[13A.3]

COV( R2 , RM ) [13A.4]
β2 =
σ 2 ( RM )

RE = (D1/P0) + g [14.1]
RE = Rf + βE × [RM − Rf] [14.2]
RP = D/P0 [14.3]
V=E+D [14.4]
[14.5]
100% = E/V + D/V
E P D [14.6]
WACC = ( ) × RE + ( ) × RP + ( ) × RD × (1 − TC )
V V V

Taxes* = EBIT × TC [14.7]

CFA* = EBIT + Depreciation − Taxes* − Change in NWC − Capital spending [14.8]
= EBIT + Depreciation − EBIT × TC − Change in NWC − Capital spending

CFA* = EBIT × (1 − TC) + Depreciation − Change in NWC − Capital spending [14.9]

[14.10]

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 [14.11]

fA = (E/V) × fE + (D/V) × fD [14.12]

Debt Equity [14A.1]
β Portfolio = β Levered firm = × β Debt + × β Equity
Debt + Equity Debt + Equity

Equity [14A.2]
β Unlevered firm = × β Equity
Debt + Equity

Equity [14A.3]
β Unlevered firm = × β Equity
Equity + (1 − TC ) × Debt

Percentage change in EPS [16.1]

Degree of financial leverage =
Percentage change in EBIT
EBIT [16.2]
DFL =
EBIT − Interest
[16.3]

RE = RA + (RA − RD) × (D/E) [16.4]

βE = βA × (1 + D/E) [16.5]
(TC × RD × D) [16.6]
Value of the interest tax shield =
RD
= TC × D

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VL = VU + TC × D [16.7]
RE = RU + (RU − RD) × (D/E) × (1 − TC) [16.8]
(1 − TC ) × (1 − TS ) [16A.1]
VL = VU + [1 − ]× D
1 − Tb

Net working capital + Fixed assets = Long-term debt + Equity [18.1]

Net working capital = (Cash + Other current assets) − Current liabilities [18.2]

Cash = Long-term debt + Equity + Current liabilities − [18.3]

Current assets (other than cash) − Fixed assets

Operating cycle = Inventory period + Accounts receivable period [18.4]

Cash cycle = Operating cycle − Accounts payable period [18.5]
Cash collections = Beginning accounts receivable + 1/2 × Sales [18.6]

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