Accountancy Department

Semi-final Examination in MANACO2

Name of student: ____________________________________ Score: _______________
Class Schedule: ____________________________________ Date: _______________

INSTRUCTION: Write the letter of your choice.

1. The objective of _________ is to select the group of projects that provides the highest
overall net present value and does not require more dollars than are budgeted.
A. capital rationing
B. scenario analysis
C. certainty equivalents
D. sensitivity analysis
2. Which of the following combinations is possible?

Profitability Index NPV IRR

A. greater than 1 positive equals cost of capital
B. greater than 1 negative less than cost of capital
C. less than 1 negative less than cost of capital*
D. less than 1 positive less than cost of capital

3. A company holds the following stock portfolio:

Stock % of Total Portfolio Beta Coefficient
W 20% .8
X 40% .6
Y 30% 1.0
Z 10% 2.0
The beta of the portfolio is (M)
A. .8 C. 1.1
B. .9 D. 2.0

4. Catherine & Co. has extra cash at the end of the year and is analyzing the best way to
invest the funds. The company should invest in a project only if

A. The expected return on the project exceeds the return on investments of comparable
risk.
B. The return on investments of comparable risk exceeds the expected return on the
project.
C. The expected return on the project is equal to the return on investments of comparable
risk.
D. The return on investments of comparable risk equals the expected return on the
project.

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5. Business risk is the risk inherent in a firm's operations that excludes financial risk. It
depends on all of the following factors except (E)
A. Amount of financial leverage. C. Demand variability.

B. Sales price variability. D. Input price variability.

6. Cost of capital is

A. The interest rate an entity must pay to borrow money.

B. The return an entity’s stockholders expect on their investment .
C. The rate of return the entity can earn from investing available cash.
D. A concept of managerial finance incorporating all of the above.

7. In referring to the graph of a firm's cost of capital, if e is the current position, which one of
the following statements best explains the saucer or U-shaped curve?

Cost of

Capital

Debt-to-Equity Ratio

A. The composition of debt and equity does not affect the firm's cost of capital.

B. The cost of capital is almost always favorably influenced by increases in financial

leverage.

C. The financial markets will penalize firms that borrow even in moderate amounts.

D. Use of at least some debt financing will enhance the value of the firm.

8. The interest rate on the bonds is greater for the second alternative consisting of pure debt
than it is for the first alternative consisting of both debt and equity because

A. The diversity of the combination alternative creates greater risk for the investor.

B. The pure debt alternative would flood the market and be more difficult to sell.

C. The pure debt alternative carries the risk of increasing the probability of default.

D. The combination alternative carries the risk of increasing dividend payments.

9. If a $1,000 bond sells for $1,125, which of the following statements are correct?

I. The market rate of interest is greater than the coupon rate on the bond.

II. The coupon rate on the bond is greater than the market rate of interest.

III. The coupon rate and the market rate are equal.

IV. The bond sells at a premium.

V. The bond sells at a discount.

A. I and IV. B. I and V. C. II and IV. D. II and V

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10. To approximate annual cash inflow, depreciation is

A. Added back to net income because it is an inflow of cash.

B. Subtracted from net income because it is an outflow of cash.

C. Subtracted from net income because it is an expense.

D. Added back to net income because it is not an outflow of cash.

11. In capital expenditures decisions, the following are relevant in estimating operating costs
except

A. Future costs. B. Cash costs. C. Differential costs. D. Historical costs.

12. The following statements refer to the accounting rate of return (ARR)

1. The ARR is based on the accrual basis, not cash basis.

2. The ARR does not consider the time value of money.

3. The profitability of the project is considered.

From the above statements, which are considered limitations of the ARR concept?
A. Statements 2 and 3 only. C. All the 3 statements.

B. Statements 3 and 1 only. D. Statements 1 and 2 only.

13. As a capital budgeting technique, the payback period considers depreciation expenses
(DE) and time value of money (TVM) as follows:

A. B. C. D.

DE relevant irrelevant Irrelevant relevant

TVM relevant irrelevant Relevant irrelevant

14. The bailout payback period is

A. The payback period used by firms with government insured loans.

B. The length of time for payback using cash flows plus the salvage value to recover the
original investment

C. (a) and (b)

D. None of the above.

15. You have determined the profitability of a planned project by finding the present value of
all the cash flows from that project. Which of the following would cause the project to look
less appealing, that is, have a lower present value?

A. The discount rate increases.

B. The cash flows are extended over a longer period of time.

C. The investment cost decreases without affecting the expected income and life of the
project.
D. The cash flows are accelerated and the project life is correspondingly shortened.

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16. A company has analyzed seven new projects, each of which has its own internal rate of
return. It should consider each project whose internal rate of return is _____ its marginal
cost of capital and accept those projects in _____ order of their internal rate of return.

A. Below; decreasing. C. Above; increasing.

B. Above; decreasing. D. Below; increasing.

17. Capital budgeting methods are often divided into two classifications: project screening
and project ranking. Which one of the following is considered a ranking method rather
than a screening method?

A. Net present value. C. Profitability index.

B. Time-adjusted rate of return. D. Accounting rate of return.

18. When ranking two mutually exclusive investments with different initial amounts,
management should give first priority to the project

A. That generates cash flows for the longer period of time.

B. Whose net after-tax flows equal the initial investment.

C. That has the greater accounting rate of return.

D. That has the greater profitability index.

Questions 19 through 22 will be based on the following data:

The management of Arleen Corporation is considering the purchase of a new machine
costing P400,000. The company’s desired rate of return is 10%. The present value of P1 at
compound interest of 10% for 1 through 5 years are 0.909, 0.826, 0.751, 0.683, and 0.621,
respectively, and the present value of annuity of 1 for 5 periods at 10 percent is 3.79. In
addition to the foregoing information, use the following data in determining the acceptability in
this situation:

Year Income from Operations Net Cash Flow

1 P100,000 P180,000

2 40,000 120,000

3 20,000 100,000

4 10,000 90,000

5 10,000 90,000

19. The average rate of return for this investment is:

A. 6 percent C. 18 percent
B. 10 percent D. 58 percent

20. The net present value for this investment is:

A. Positive P 36,400 C. Negative P 99,600
B. Positive P 55,200 D. Negative P126,800

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21. The present value index for this investment is:
A. 0.70 C. 1.14
B. 0.88 D. 1.45

.22. The cash payback period for this investment is:

A. 3 years C. 5 years
B. 4 years D. 20 years

Question Nos. 23 through 28 are based on the following (Write the final figures):
Franzen Company manufactures three different models of paper shredders including
the waste container, which serves as the base. While the shredder heads are different for all
three models, the waste container is the same. The number of waste containers that
Franzen will need during the next five years is estimated as follows:
2007 50,000
2008 50,000
2009 52,000
2010 55,000
2011 55,000
The equipment used to manufacture the waste container must be replaced because it
is broken and cannot be repaired. The new equipment would have a purchase price of
P945,000 with terms 2/10, n/30; the company’s policy is to take all purchase discounts. The
freight on the equipment would be P11,000, and installation costs would total P22,900. The
equipment would be purchased in December 2006 and placed into service on January 1,
2007. It would have a five-year economic life and would have the following depreciation.
The equipment is expected to have a salvage value of P12,000 at the end of its economic life
in 2011. The new equipment would be more efficient than the old equipment, resulting in a
25 percent reduction in both direct material and variable overhead. The savings in direct
material would result in an additional one-time decrease in working capital requirements of
P2,500, resulting from a reduction in direct material inventories. This working capital
reduction would be recognized at the time of equipment acquisition.
The old equipment is fully depreciated and is not included in the fixed overhead. The
old equipment from the plant can be sold for a salvage amount of P1,500. Rather than
replace the equipment, one of Franzen’s production managers has suggested that the waste
containers be purchased. One supplier has quoted a price of P27 per container. This price
is P8 less than Franzen’s current manufacturing cost, which is presented below.

Direct materials P10

Direct labor 8
Variable overhead 6
Fixed overhead:
Supervision P2
Facilities 5
General 4 11
Total unit cost P35

Franzen uses a plantwide fixed overhead rate in its operations. If the waste containers
are purchase outside, the salary and benfits of one supervisor, included in fixed overhead of
P45,000 would be eliminated. There would be no other changes in the other cash and
noncash items included in fixed overhead except depreciation on the new equipment.

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 The new equipment will be depreciated according to the following declining amounts:
Year Depreciation
2007 P319,968
2008 426,720
2009 142,176
2010 71,136
2011 0

Franzen is subject to a 40 percent tax rate. Management assumes that all cash flows
occur at the end of the year and uses a 12 percent after-tax discount rate.

23. The initial net cash outflows if the company decides to continue making the waste
containers is:

24. The total after-tax cash outflows, excluding the initial cash outflows, if the new
equipment is purchased are:

25. The present value of the total depreciation shield is:

26. The total relevant after-tax costs to buy the waste containers are:

27. What is the net present value of the purchase alternative?

28. What is the net present value of the make alternative?

29.Raylam Corporation has sold $50 million of $1,000 par value, 12% coupon bonds. The
bonds were sold at a discount and the corporation received $985 per bond. If the
corporate tax rate is 40%, the after-tax cost of these bonds for the first year (rounded to
the nearest hundredth percent) is

A. 7.31%. B. 4.87%. C. 12.00%. D. 7.09%.

30. A firm has determined its cost of each source of capital and optimal capital structure,
which is composed of the following sources and target market value proportions:

Target Market
Source of Capital Proportions After-Tax
Cost
Long-term debt 40% 6%
Preferred stock 10 11
Common stock equity 50 15
The weighted average cost of capital is

A. 6 percent. C. 11 percent
B. 10.7 percent. D. 15 percent.

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