.

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University of the South Pacific

School of Accounting and Finance

Semester 1, 2017

AF208 Financial Management (Print Mode)

FINAL EXAMINATION

Instructions

This test has a total mark of 100 and canies a 50% weighting towards your overall
course grade

There are 19 pages in this test paper, including this cover page

You have 180 minutes to complete this paper and an additional 10 minutes reading
time

Answer ALL questions

This is a closed book examination

You may use a hand-held, non-programmable calculator. This is not supplied.

.'
5. The minimum rate of return that will make a project acceptable is the:

a. lntemal rate of return

b. Weighted average cost of capital (WACC)

c. Hurdle rate

d. Risk-fi'ee rate

6. An engaged couple are evaluating what sort of wedding they should have. Which of the
following is a sunk cost?

a. Cost of bridal gown

b. Cost of engagement ring

c. Cost of catering

d. Cost of venue hire

7. Which of the following is not a means of incorporating risk into project evaluation?

a. Risk-adjusted discount rates (RADRs)

b. Celiainty-equivalent cash flows

c. Accounting rate of return

d. Divisional cost of capital

8. Which ofthe following ignores (i) the time value of money and (ii) future cash flows that
occur beyond a specified point in time?

a. Payback period

b. Net present value

c. Accounting rate of return

d. Internal rate of return

9. Which of the following is not a characteristic of an internally controlled individual?

a. Self-motivation

b. Acceptance of responsibility for own deeds and ontcomes

c. Tendency to blame others when things go wrong

d. Learns from mistakes

Page 3 of15
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14. Which of the following is not classified as pennanent funding?

a. Commercial bills

b. Long-tenn debt

c. Leases

d. Ordinary shares

15. Which ofthe following assets is likely to have the highest loan-to-value ratio (LVR) as
security for short-tenn finance?

a. Vacant land in a non-residential area

b. Inventories of fashion goods

c. Existing trade receivables

d. New inventories

16. A firm purchases on credit. Credit tem1S require settlement by the end of the month following
the month of invoicing, but discount of 2% is offered for a settlement within 7 days of
invoicing. The finn decides to take the prompt settlement discount on all invoices received
after the 20 th day of the month. What is the cost of forgoing the discount on the other invoices
(assuming an average credit period of 50 days)?

a. 14.90%

b. 15.89%

c. 14.60%

d. 15.55%

17. Which of the following is not a trade-off to be considered in the management of working
capital?

a. Cash: cost offorgoing higher retums versus the benefit of avoiding illiquidity

b. Debtors: cost of financing versus benefits of increased sales and customer goodwill

c. Inventory: cost of can'y versus benefit of avoiding stock-outs

d. Office premises: freehold ownership versus leasehold possession.

Page 5 of 15
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23. Given an economic order quantity (EOQ) of 120, demand of 10,000 units and holding costs of
$7, this implies ordeling costs of approximately:

a. $12

b. $18

c. $7

d. $5

24. If demand for cars is 1,300 per year and ordering and holding costs are $3,000 and $4,000
respectively, assuming a constant rate of demand this order would last:

a. 161 days

b. 12 days

c. 29 days

d. 83 days

25. Which of the following is not encompassed within the just-in-time (JIT) philosophy?

a. Reduction in setup times

b. Zero defects

c. Multi-skilled workers

d. Larger inventories

26. When a finn is 'insolvent' this refers to:

a. the illegal diversion of funds from the finn by employees to their own benefit

b. a finn that is unable to pay its bills or meet its financial obligations on time

c. a finn which is funded by a greater proportion of debt than equity

d. when a finn makes a large net loss

27. If demand for chocolate bars is 5,000 per year and ordering and holding costs are $1.25 and
$1.75 respectively, then the economic order quantity (EOQ) is:

a. 95

b. 85

c. 118

d. 93

Page 7 of15
' ..

32. Quiz Company has a 12 year lease, with payments of $250,000 made at the beginning of each
year. If no purchase option exists, and the company is in the 40% tax bracket, what is the
annual after-tax cash outflow on the lease?

a. $3,000,000

b. $250,000

c. $150,000

d. $100,000

33. Given a 2-for-15 rights issue, a current market price of $13.50 and subscription price of $12,
this implies a theoretical rights price of:

a. $1.32

b. $1.50

c. $1.86

d. $1.39

34. A company has 10 million issued ordinary shares and pays a dividend of 12 cents per share. If
the company's after tax profit was $2 million, its retention ratio was:

a. 60%

b. 40%

c. 6%

d. 4%

35. Which of the following factors do not have an impact upon a finn's dividend policy?

a. Transaction costs

b. Taxes

c. The legal system in the finn's home country

d. All of the above have an impact on a finn's dividend policy

Page 9 of15
'" .,

SECTIONB PROBLEM SOLVING QUESTIONS 60 MARKS

Question 41 (20 marks)

In your position of CFO at Fantasy Fabrics Ltd, it is your job to recommend which investments the
company should make. The investment altematives are listed below.

Investment Initial Outlay ($) IRR before IRR after tax

tax (%) (%)

Cutting machine 120,000 9 8

Computer system 50,000 8.5 7
Premises upgrade 750,000 11 10
Automated loom 345,000 16.5 15
Bleaching vats 80,000 15 13
Fantasy Fabrics' cun'ent capItal structure consists of the following:

Source of finance Amount of finance ($)

Debt 900,000
Preference Shares 525,000
Ordinary equity (including retained 900,000
eamings)

The Board have specified this pattem of funding as the target capital mix. To raise additional debt,
Fantasy Fabrics would issue bonds with a face value of $1,000. The coupon rate on the bonds
would be 4% and interest would be paid amlUally. The bonds would mature in ten years' time. Issue
costs are 1.5 per cent of the face value. Use the approximate cost of debt equation to calculate the
cost of debt.

A new offering of preference shares would have issue costs of 3.5 %. The preference shares are
trading at $4.50 and new shares would be issued at this price. Fantasy Fabrics pays fully franked
dividends of 42 cents per share.

The ordinary shares have a market price of $6. The next dividend (45 cents, fully franked) will be
paid at the end of the year. Dividends are expected to grow at an annual rate of 5 per cent thereafter.
Flotation costs for ordinary shares would be 5% of the issue proceeds of$5.80 per share. However,
Fantasy Fabrics has sufficient cash to fund the equity portion for all of the proposed projects.
Therefore, no new issue of ordinary shares is to occur. The corporate tax rate is 30%.

Required:

Calculate the cost of capital if Fantasy's shareholders are domestic residents and can fully utilise
imputation credits. Recommend which projects should be accepted.
Show all relevant worlang

(Total marks: 20 marks)

Page 11 of15
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Question 43 (20 marks)

Bateman Company produces helmets for drivers of motorcycles. Helmets are produced in batches
according to model and size. Although the set up and production time vary for each model, the
smallest lead time is six days. The most popular model, Model HA2, takes two days for set up,
and the production rate is 750 units per day. The expected annual demand for the model is 36,000
units. Demand for the model, however, can reach 45,000 units. The cost of canying one HA2
helmet is $3 per unit. The set up cost is $6,000. Bateman chooses its batch size based on the
economic order quantity criterion. Expected annual demand is used to compute the EOQ.

Recently, Bateman has encountered some stiff competition-especially fi'om foreign sources.
Some of the foreign competitors have been able to produce and deliver the helmets to
retailers in half the time it takes Bateman to produce. For example, a large retailer recently
requested a delivery of 12,000 Model HA2 helmets with the stipulation that the helmets be
delivered within seven working days. Bateman had 3,000 units ofHA2 in stock. Bateman infonned
the potential customer that it could deliver 3,000 units immediately and the other 9,000 units in
about 14 working days-with the possibility of interim partial orders being delivered. The customer
declined the offer indicating that the total order had to be delivered within seven working days so
that its stores could take advantage of some special local conditions. The customer expressed regret
and indicated that it would accept the order fi'om another competitor who could satisfY the time
requirements.

Required:

1. Calculate the optimal batch size for Model HA2 usmg the EOQ model. Was Bateman's
response to the customer right? Explain with supporting computations. (5 marks)

2. Upon learning of the lost order, the marketing manager grumbled about Bateman's inventory
policy. "We lost the order because we didn't have sufficient inventory. We need to cany more
units in inventory to deal with unexpected orders like these." Do you agree or disagree? In the
future, should Bateman cany more inventory? (5 marks)

3. The Inventory Management Accountant suggested implementing JIT approach in an attempt to

increase efficiency and reduce waste. Explain two disadvantages of JIT if Bateman Company is
located in a Pacific Island Country. (6 marks)

4. One reason for inventory management is to prevent shutdowns. How does the JIT approach to
inventory management deal with this potential problem?
(4 marks)

(Total marks: 20 marks)

THE END
Page 13 of15
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Page 15 of 15
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 AF 208 FINAL EXAMINATION

MULTIPLE CHOICE ANSWER SHEET (Total Marks: 40 marks)

Name: ____________________ 10:
------------------
Circle only one answer per question.

I e.g. I A I (0
I c I D II
If you circle more than one answer, you will receive a mark of zero for that question

Ie.g. I A I €)
I c I ([) I X I
If you change your mind, cross out your original answer and circle your new answer.

e.g. I A I N: I c I €) I II

1 A B C D 21 A B C D
2 A B C D 22 A B C D
3 A B C D 23 A B C D
4 A B C D 24 A B C D
5 A B C D 25 A B C D
6 A B C D 26 A B C D
7 A B C D 27 A B C D
8 A B C D 28 A B C D
9 A B C D 29 A B C D
10 A B C D 30 A B C D
11 A B C D 31 A B C D
12 A B C D 32 A B C D
13 A B C D 33 A B C D
14 A B C D 34 A B C D
15 A B C D 35 A B C D
16 A B C D 36 A B C D
17 A B C D 37 A B C D
18 A B C D 38 A B C D
19 A B C D 39 A B C D
20 A B C D 40 A B C D