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UNIVERSITY OF THE WEST INDIES
DEPARTMENT OF MANAGEMENT STUDIES

SOLUTION GUIDE FOR FINAL EXAM
FINANCIAL MANAGEMENT I – MGMT2023 (MS28D)
SEMESTER 1 - 2010/11

Page 1

SEMESTER 1 - 2010/2011
SEM

2
Question 1
...
10,20) = $25,000(8
...
10,25) = PMT(98
...
11,5 ) = PMT(3
...
11,2) = $2,706 (1
...
12
Quarterly compounding (m = 4)
FV4 = $10,000 (1 + 0
...
03,16 ) = $10,000 (1
...
12)1x4
= $10,000 (FVIF0
...
5735) = $15,735
Difference = $16,047 - $15,735 = $312

(4 marks)

(iv)

(b)

N = 5; PV = -$200,000; PMT = $48,271
PV = PMT x PVIFA(r%,5) => $200,000 = $48,271 x PVIFA(r%,5)
PVIFA(r%,5) = $200,000 / $48,271 = 4
...
The
effective interest rate is affected by the frequency of compounding
...

(3 marks)

(ii)

A perpetuity is a financial instrument that promises to pay an equal cash flow per
period forever
...
Some bonds and
some preferred stocks take the form of a perpetuity because they never mature there is no redemption of these investments at their face value anytime in the
future
...

(3 marks)

Page 2

SEMESTER 1 - 2010/2011

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Question 2
...
An efficient portfolio maximizes return
for a given level of risk, or minimizes risk for a given rate of return
...
These events include:
war
political events
international incidents

inflation
interest rate changes
changes in expectations about the overall economy
(3 marks)

(iii)

(b)

The standard deviation can be used to measure the variability of return from an
investment
...

The larger the standard deviation, the more variable an investment’s return and
thus the riskier the investment
(3 marks)

(i)

ke = 0
...
5(0
...
09) = 0
...
70(1+g) / (0
...
04646 or 4
...
95) + (400 / 520)(1
...
14

(3 marks)

(ii)

(iii)

kold= 0
...
1(0
...
1446
P0 = $1
...
11) / (0
...
11) = $41
...
05 + 1
...
086) = 0
...
30(1
...
1618 - 0
...
98
Yes, stock price increases by about $26
...
(20 Marks)
(a)

(i)

Advantages:
1
...

2
...

3
...

Disadvantages:
1
...

2
...


(4 marks)

(ii)

(iii)

(b)

The value of any asset is based on the expected future benefits that the owner will
receive over the life of the asset
...
The value of a financial asset is based on the expected cash flows the asset
will generate for the owner during the holding period
...
If interest rates decrease, the price of
the bond will increase
...
Thus, the price of
the bond increases
...
This is because the value of the bond will be
determined by its conversion value if the conversion value is greater than the
present value of all coupon and principal payments
...
6499) =$649
...
0625($75) = $4
...
69/0
...
37
...
4699) + $1000(0
...
30

(3 marks)

(ii)

(iii)

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SEMESTER 1 - 2010/2011

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Question 4
...
Cash flows should be measured on an incremental basis
...
Cash flows should be measured on an after-tax basis
...
All the indirect effects of a project should be included in the cash flow
calculations
...
Sunk costs should not be considered when evaluating a project
...
The value of resources used in a project should be measured in terms of their
opportunity costs
...

The future cash flows are discounted back to the present at a required rate of
return that reflects the perceived risk of the investment
...

(2 marks)

(iii)

(b)

(i)

The internal rate of return method is more popular because some people feel more
comfortable dealing with the concept of a project’s percentage rate of return than
with its dollar amount of net present value
...
In spite of this, it is
possible to have multiple internal rates of return
...
The reinvestment rate of the internal rate of
return method is less realistic
...
40)}
+ ($61,000 - $45,000) = $78,400
(3 marks)
NPV = [PVIFA(12%,7) x $78,400] - $338,000 = [4
...
089 x $78,400] = $790,978
7

So: $338,000 x (1 + k) = $790,978, (where k = MIRR)
7
(1 + k) = $790,978 / $338,000 = 2
...
34017 - 1 = 0
...
9%
...
(1 marks)

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SEMESTER 1 - 2010/2011

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Question 5
...
25(13% - 9%) = 14%

(3 marks)

kp = $3
...
09 = 9%

(2 marks)

($ 1, 000

− $ 871
...
10 = 10%
kd(pre-tax) = YTM = $ 70 +
6
[$ 1, 000 + (2 × $ 871
...
60 X 14%) + (0
...
6 X 0
...
1%
(b)

(4 marks)

(3 marks)

(i)

1
...

2
...
0
...
The beta of the corporation: Beta is normally estimated by using historic
values reflecting the relationship between a security’s returns and the market
returns
...
External equity has issuance costs associated with new shares
...

2
...

When funds are generated through the earnings of the firm, either managers can
pay out funds as dividends to common stockholders, or the funds can be retained
and reinvested in the firm
...
If managers decide to retain earnings and reinvest them in the firm,
there must be investment opportunities in a firm offering a return equivalent to the
returns available to stockholders in alternative investments on a risk-adjusted
basis
(3 marks)

Page 6

SEMESTER 1 - 2010/2011



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