Addis Ababa University

College of Business and Economics

Department of Accounting and Finance
Final Exam for the course Financial Management I
Time Allowed: 1:30 hrs
Name I.D.No.
Section programme __________
General Direction:
1. The examination contains two parts: Part one 9 True or False questions, Part two 21 multiple
choice, and part three two workout type questions. You should give all your answers on the
answer sheet provided below.
2. Using your own calculator is allowed but you cannot share it at all
3. Using cell phones for any purpose while the exam is going on is strictly forbidden

Answer sheet for part one

1. 6. 11. 16. 21. 26.
2. 7. 12. 17. 22. 27.
3. 8. 13. 18. 23. 28.
4. 9. 14. 19. 24. 29.
5. 10. 15. 20. 25. 30.
Part I: True or False Type Questions (9 pts)
Instructions: This part contains 9 True or False questions. You are required to right
True if the statement is correct or False if the statement is incorrect and provide the
answer on the answer sheet provided. (1.25 pts each)

1. Capital budgeting is a short range planning. False

2. As long as NPV > Zero accept the project. True
3. Internal rate of return is nothing but the rate of interest, which equates the present value of
future earnings with present investment. True
4. The company cost of capital is the expected rate of return that investors demand from the
company's assets and operations. False
5. Accounting rate of return considers time value of money False
6. Net present value and internal rate of return can give conflicting result in the case of mutually
exclusive projects. True
7. The cost of capital serves as a basic for evaluating the financial performance. True
8. Internal rate of return is nothing but the rate of interest, which equates the present value of
future earnings with present investment. True
9. The cost of preferred stock is more expensive than the cost of debt. True

Part II: Multiple Choice Type Questions (21 pts)

Instructions: This part contains 17 multiple choice questions. You are required to select
the best answer from the alternatives given and provide the answer on the answer sheet
provided. (1.25 pts each)

10. An equal, consecutive periodic stream of cash flow is called a(n):

a. future value.
b. present value.
c. annuity.
d. time value.
11. What is the future value of $1000 in 10 years if the interest is compounded at 6% annually?
a. $1,771.
b. $558.
c. $1,791.
d. $1,000.
12. What is the present value of $1000 received in 8 years if the current opportunity rate of return
is 7%?
a. $1,718.
b. $600.
c. $6,553.
d. $582.
13. What is the future value of $2000 per year for 5 years invested at 10%?
a. $3,221.
b. $12,210.
c. $10,000.
d. $13,480.
14. What is the current value of a security that pays $500 per year for 7 years if similar
investments now earn 12%.
a. $226.
b. $5,044.
c. $3,500.
d. $2,282.
15. What is the effective rate of a deposit account which compounds monthly and has a quoted
nominal or APR of 6%?
a. per cent.
b. 5.73 per cent.
c. 1.062 per cent.
d. 6.16 per cent.
16. An investment of $1000 grows to $2000 in 7 years. What is the annual rate of return on the
investment?
a. 10.4%.
b. 100%.
c. 14.3%.
d. 12.6 per cent.
17. What are the annual payments necessary to pay a $100,000, 12-year loan if the loan rate is 8
%?
a. $8,333.
b. $19,968.
c. $ 8,000.
d. $13,270.
18. Sam wishes to retire in thirty years. He is able to save $10,000 every year, invested at 9 per
cent. What amount will he have at retirement?
a. $300,000.
b. $1,363,075.
c. $1,245,456.
d. $102,737.
19. What is the monthly payment on a $200,000 mortgage loan, payable over 30 years with an
APR of 8 per cent?
a. $555.
b. $17,765.
c. $1,480.
$ 1,468.
20. What is the present value or price of a $150 annual perpetuity if the returns on similar contracts
are now 7%?
a. $10.50.
b. $2,143.
c. $1,050.
d. $1,751.
21. Tom plans to save $2,000 for each of the next ten years, starting tonight when he will write his
financial planner a check for $2,000. If Tom can earn a 10% annual return, what amount of
money will he have at the end of the 10th year?
a. $35,062.
b. $31, 875.
c. $20,000.
d. $32,733.
22. While the concept of compounding is generally associated with ________, discounting is
associated with _________.
a. present value; future value.
b. future value; present value.
c. periodic payments; present value.
d. annuities; dividing.
23. XYZ Corporation is expected to pay an annual dividend of $0.80 a share next year. The market
price of the stock is $22.40 and the growth rate is 5 percent. What is the firm's cost of equity?
a. 7.23Percent
b. 7.91 percent
c. 8.24 percent
d. 8.57 percent
24. ABC Corporation has 8 percent preferred stock outstanding that is currently selling for $49 a
share. The market rate of return is 14 percent and the firm's tax rate is 37 percent. What is the
firm's cost of preferred stock?
a. 14.77 percent
b. 16.33 percent
c. 15.29 percent
d. 15.67 percent
25. The Hibret Bank has a bond issue outstanding that matures in 7 years. The bonds pay interest
semi-annually. Currently, the bonds are quoted at 101.4 percent of face value and carry a 9
percent coupon. What is the firm's aftertax cost of debt if the tax rate is 30 percent?
a. 4.88 percent
b. 6.11 percent
c. 5.36 percent
d. 5.45 percent
26. Enat Bank has a debt-equity ratio of 0.55 and a tax rate of 35 percent. The firm does not issue
preferred stock. The cost of equity is 14.5 percent and the after-tax cost of debt is 4.8 percent.
What is the weighted average cost of capital?
A. 10.46 percent
B. 11.38 percent
C. 10.67 percent
D. 11.06 percent
27. Which one of the following are true about mutually exclusive projects
a. The decision made in one project does not affect the decision made in the other project
b. These types of projects have different tasks
c. The project that has highest payback period should be selected
d. None
28. Which one of the following is true about the accounting rate of return
a. It is used to evaluate a project based on estimated cash flows
b. It considers time value of money
c. It is not consistent with shareholders objective of wealth maximization
d. All
29. All of the following are weaknesses of the payback period EXCEPT
a. A disregard for cash flows after the payback period.
 b. Only an implicit consideration of the timing of cash flows.
c. The difficulty of specifying the appropriate payback period.
d. It uses cash flows, not accounting profits.
30. The firm's overall cost of capital that is a blend of the costs of the different sources of capital is
known as the firm's
a. Weighted average cost of capital.
b. Cost of equity infusion.
c. Cost of debt.
d. Cost of preferred stock.

Part II: Workout Type Questions (20 pts)

Instructions: This part contains one question. You are required to provide neat and clear
answer on the space provided. (NB. Neatness and clear presentations has its own values)

1. Consider the following information

– Invest 60% of your money in Asset A
– State Probability A B
– Boom .4 30% -5%
– Bust .6 -10% 25%

Required:
a. What is the expected return and standard deviation for each asset?

• Asset A: E(RA) = .4(30) + .6(-10) = 6% ….. (1pts)

• Variance(A) = .4(30-6)2 + .6(-10-6)2 = 384
• Std. Dev.(A) = 19.6% ….. (1pts)

• Asset B: E(RB) = .4(-5) + .6(25) = 13%......(1pts)

• Variance(B) = .4(-5-13)2 + .6(25-13)2 = 216
• Std. Dev.(B) = 14.7% ……(1pts)

b. What is the expected return and standard deviation for the portfolio?

• Portfolio return in boom = .6(30) + .4(-5) = 16…. (1.5pts)

• Portfolio return in bust = .6(-10) + .4(25) = 4…..(1.5pts)
• Expected return = .4(16) + .6(4) = 8.8 or…… (1.5pts)
• Expected return = .6(6) + .4(13) = 8.8
• Variance of portfolio = .4(16-8.8)2 + .6(4-8.8)2 = 6.912
• Standard deviation = 2.63%..... (1.5pts)

2. You are a financial analyst for ABC Electronics Company. The director of capital
budgeting has asked you to analyze two proposed capital investments, Projects X and Z. As
 shown below project X has a cost of $50,000 with cost of capital of 14 percent, and project
Z has a cost of $100,000 with cost of capital of 10 percent. The projects’ expected net cash
flows are as follows:
Period CFX CFZ
0 -50,000 -100,000
1 20,000 60,000
2 20,000 25,000
3 20,000 25,000
4 20,000 25,000
Required:
a. Calculate each project’s payback period, net present value (NPV), Profitability
Index (PI) and internal rate of return (IRR).
b. Which project or projects should be accepted if they are independent?
c. Which project should be accepted if they are mutually exclusive?

Payback period:
Project X = 2.5 years (1pts)
Project Y = 2.6 years (1pts)
Independent: no criteria (0.5 pts)
Mutually exclusive: Project X (0.5 pts)

Net Present Value

Project X = 64,023-50,000 = 14,023 (2 pts)
Project Y = 111,065-100,000= 11,065 (2 pts)
Independent: both project are accepted (0.5 pts)
Mutually exclusive: Project X (0.5 pts)

Profitability Index
Project X = 64,023/50,000 = 1.28 (1pts)
Project Y = 111,065/100,000= 1.11 (1pts)
Independent: both project are accepted (0.5pts)
Mutually exclusive: Project X (0.5 pts)