Name:______________________________________ Id.

No:____________________

Birla Institute of Technology and Science, Pilani

Second Semester: 2022-2023
Mid-semester Test (Regular)
Course Name & No.: Financial Management (ECON / FIN F 315)
Maximum Marks: (90 Marks) 30% Weight-age Date: 16 Mar 23
Duration: 90 Minutes Type: Closed Book
Instructions for the students (PART A)
1. Write your name and BITS Id No in the space provided on the top of this page
2. This Part A of the paper consists of 15 MCQs of 2 marks each and 6 questions of 5 marks each. Total 60 marks.
The part B is of remaining 30 marks.
3. There is no negative marking in the question paper.
4. For MCQs, write your answers in the table provided below. Answers written elsewhere or in incorrect order
will not be evaluated. Overwritten/ambiguous answers will not be evaluated.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

1. An investor is considering a portfolio consisting of two stocks, A and B. The expected

return on stock A is 15%, and it has a beta of 1.2. The expected return on stock B is 12%, and
it has a beta of 0.8. The risk-free rate is 3%, and the portfolio beta is 1. What is the expected
return on the portfolio?

a. 12.5% b. 13.5% c. 14.5% d. 15.5% e. NOTA (none of the above)

2. A stock has a beta of 0.9 and has an expected return of 12% as per analyst’s estimates
based on average return for the last five years. The market risk premium is 5%, and the risk-
free rate is 2%. If the stock is fairly priced what is the market's expected return according to
the Capital Asset Pricing Model (CAPM)?

a. 8.5% b. 5% c. 7% d. 9.5% e. NOTA

3. A well-diversified portfolio has a beta of 1.2., and its expected return is 15%. The risk-free
rate is 3%, and the market standard deviation is 15%. What is the portfolio's Sharpe ratio?

a. 0.67 b. 0.53 c. 0.88 d. 0.44 e. NOTA

4. An individual wants to have $1,000,000 in 30 years to fund their retirement. They plan to
invest in a retirement account that offers a 6% annual interest rate. If they make monthly
contributions to the account, how much should they contribute each month to achieve their
goal?
a. $979 b. $997 c. $1,090 d. $1,101 e. NOTA

5. ABC Corp issued a 5-year bond with a face value of $1000, annual coupon rate of 7%, and
a yield to maturity of 8%, with annual compounding. What is the bond's current market
price?
A. $920.93 B. $934.58 C. $960.07 D. $977.47 E. NOTA

6. Which of the following would be the least adequate for analysing the short term liquidity
of a firm for paying current liabilities:
a. inventory turnover ratio b. current ratio c. dividend yield d. cash flows from
operating activities e. NOTA
7. If total current assets is Rs 750, total long term-assets (net) is Rs 150, and total liabilities
and owner’s equity is Rs 780, then the net working capital is equal to:
a. Rs 720 b. (Rs 30) c. Rs 630 d. (Rs 120) e. NOTA

8. When a company takes a financing decision, all of the below accounts are generally
impacted, except:
a. cash account b. pre-paid expense account c. interest expense account d.
notes payable account e. NOTA

9. The floatation cost:

a. increases the cost of capital of a firm b. reduces the face value of the marketable
securities issued c. is a cost incurred by the firm for having its stock listed on a
recognized stock exchange d. is an underwriting expense incurred by the investors e.
NOTA

10. If the market value weights, the book value weights, and the target capital structure
weights are given, then the one that maximizes the WACC is:
a. book value weights b. target capital structure c. market value weights d.
NOTA

11. The cost of capital is best determined using:

a. money left on the table principle b. the dividend policy principle c. the
opportunity cost principle d. the investment principle e. NOTA

12. If, as per the income statement, the interest expense for the most recent year is Rs
120,000, and as per the balance sheet the outstanding book value of debt remains
unchanged from the last year at Rs 1,200,000, then it doesn’t certainly imply that:
a. the coupon rate on the bond is 10% b. the coupon rate on the bond is 12% c.
the company paid Rs 120,000 as interest charge on its debt obligations d. there are more
than one correct answers to this question e. NOTA

13. For the markets to be in equilibrium (i.e. all securities are fairly priced):
a. the historical realized rates of return must be equal to the expected realized rates of
return
b. the required rate of return must be equal to the realized rate of return
c. all companies must be dividend paying stock and must be far from bankruptcy type
situation
d. the expected rate of return must be equal to the required rate of return
e. there are more than one correct answers to this question

14. Compared to past decades, in today’s time, it has become impractical for the financial
manager to use the CAPM in real life because:
a. hurdle rate is a better measure for cost of capital b. stock markets are very volatile
and CAPM estimates may change very rapidly c. it is impossible to hold a fully
diversified portfolio that can be called a market portfolio d. CAPM is a return demanded
by the investors that currently does not fully capture all the risks of investment e. NOTA

15. The slope of CML represents:

a. all set of Markowitz’s efficient frontier b. At least one risky asset that is short-sold c.
reward to risk ratio of an investment portfolio d. beta of stocks that are greater than
the market beta e. There are more than one correct answers to this question

*************
Short-answer type questions (5 marks each): Use the reverse side of the main answer sheet
for carrying out the rough work for this part. The space provided for answering every
question is for only writing the key steps, showing important calculations, and writing the
final answer. No extra sheet will be provided for this part, use the space provided carefully.

1. For each of the following return projections for three assets there is an equal likelihood of occurrence of the
given outcomes:
Asset Outcome 1 (%) Outcome 2 (%) Outcome 3 (%) Expected return Standard
(%) deviation (%)
1 12 0 6 6 8
2 12 6 0 6 8
3 0 6 12 6 8

a. If funds are equally allocated among assets for a two-asset portfolio, then which pair of assets will have the
minimum variance portfolio?
b. Compute the coefficient of variation of the minimum variance portfolio.

Ans: Pair 2 and 3 are perfectly negatively correlated, hence would be suitable for the minimum variance
portfolio.
b. exp return 6%; standard deviation 0%; CV = 0.

2. PQR Corp has an expected dividend growth rate of 8% and a required rate of return of
15%. If the last (most recent, i.e. at t=0) dividend paid was $1.50 and the company has a
constant dividend pay-out ratio from its earnigns, what is the company's return on equity
assuming a most recent market P/E ratio of 12?

Sol: Calculate the price = {1.5*(1+8%)}/(15%-8%) = $23.14; P/E = 12, hence E = $1.93
Company just paid $1.5 out of $1.93; retention ratio = 22%; ROE = g/b = 8%/22% = 36%

3. Compute the after-tax cost of debt using the below data:

Face value = Rs 100; Maturity = 7 years; Number of bonds issued = 57,500; Total cash received
net of floatation cost Rs 54,05,000; floatation cost = 2%; coupon rate 11%; coupon payment
frequency = semiannual; corporate tax rate = 25%

Sol: Price = Rs 96; Floatation cost = Rs 115,000 (included in the cash flow); YTM = (5.5+100-
94)/14)/98 = 6.05% => kd = 9.08% (other close approximations will also be considered).

4. Make ONE Neat and Legible graph (not to scale), keeping the portfolio return on the Y-axis,
portfolio risk on X-axis, intercept as the risk-free rate and including the following (ensure
clarity in the graph):
a. Markowitz efficient frontier, including the minimum variance portfolio, the market portfolio,
the efficient set, and the inefficient set.
b. The Capital Market Line.
c. Risk-return indifference curve map for two individual investors having different degrees of
risk-aversion and showing the different choices for portfolios on the CML for the two
individuals.
d. One portfolio having Sharpe ratio better than the market portfolio.
Appropriately label the graph and highlight (darken) the key points on the graph.

Sol: Refer to pp. 987 of the text-book

5. Compute the portfolio’s standard deviation and expected return using the following data
for a two-asset portfolio:
Stock A: expected return = 15%; risk-to-reward ratio = 1.27; weight in the portfolio = 40%;
correlation with stock B = 0.65
Stock B: expected return = 27%; risk-to-reward ratio = 0.89

Sol: E(rp) = .4*.15+.6*.27 = 22.2%;

Sigma(p) = sqrt(.4^2*.19^2+.6^2*.24^2+ 2*.4*.6*.19*.24*.65 = 20.2%

6. You are provided with the following data from the balance sheet and the income statement
of a firm, calculate the cash generated (provided) by the operating activities for the operating
section of the cash flow statement (all data in Rs):
Change in accounts receivable = 12,500; change in notes payable = -7,000; change in
merchandise inventories = 9,200; net income for the period = 100,000; change in accrued
expense payable = 15,000; change in interest payable = -1,000; depreciation expense for the
period = 4,000; loss on sale of fixed asset = 250; cash dividends paid = 2000; income tax
expense for the period 11,000.

Sol: NI+Depre-DelA/R-DelInv+DelAcc expense payable = 100,000+4,000-12,500-9,200+15,000

=97,300

****************
 Part B - Sol

1. a. Buy price 20.75 CAGR 5 marks

Expected price 29 11.80%
Realised price 30.05 13.14%
Error 1.33%

1. b. Cost of equity at t=-3 12.60%

Required return on market at t=0 5.200%
Market risk premium at t=0 2.20%
Risk free rate 3.000%
Cost of equity at t=0 7.400%
Stock's risk has reduced today 5 marks

1. c. Calculate WACC
wd 25%
we 75%
cost of debt 3.43%
cost of equity 7.40%
WACC (req. return on av. risk projects) 6.41% 5 marks

2 Calculate EMI on original T&C

Calculate PVAF for:
r 0.6000%
t 300
m 12
PVAF at t=0 138.97
EMI, original 19,428.65 6 marks
Prepare amortization schedule for 5 months
EMI Interest Principal Outstanding Principal
August 19,428.65 16,200.00 3,228.65 2,696,771.35
September 19,428.65 16,180.63 3,248.03 2,693,523.32
October 19,428.65 16,161.14 3,267.51 2,690,255.81
November 19,428.65 16,141.53 3,287.12 2,686,968.69
December 19,428.65 16,121.81 3,306.84 2,683,661.85

PFAV at t=5 116.73 at 9.2%

Revised EMI 22,990
Change in EMI 3,561.68 9 Marks