The University of Poonch, Rawalakot Azad Kashmir

(Faculty of Management Sciences)

Final Term

Date:14-12-2015

M.Com/MBA-II

Financial Management

Marks 50

Time.2hour

Q1 Explain in detail the optimum capital structure of a firm?

Q2 The City of San Jose must replace a number of its concrete mixer trucks with new trucks. It
has received two bids and has evaluated closely the performance characteristics of the various
trucks. The Rockbuilt truck, which costs $74,000, is top-of-the-line equipment. The truck has a
life of eight years, assuming that the engine is rebuilt in the fifth year. Maintenance costs of
$2,000 a year are expected in the first four years, followed by total maintenance and rebuilding
costs of $13,000 in the fifth year. During the last three years, maintenance costs are expected to
be $4,000 a year. At the end of eight years the truck will have an estimated scrap value of $9,000.
A bid from Bulldog Trucks, Inc., is for $59,000 a truck. Maintenance costs for the truck will be
higher. In the first year they are expected to be $3,000, and this amount is expected to increase by
$1,500 a year through the eighth year. In the fourth year the engine will need to be rebuilt, and
this will cost the company $15,000 in addition to maintenance costs in that year. At the end of
eight years the Bulldog truck will have an estimated scrap value of $5,000.
a. If the City of San Joses opportunity cost of funds is 8 percent, which bid should it accept?
Ignore tax considerations, because the city pays no taxes.
b. If its opportunity cost were 15 percent, would your answer change?
Q 3 Bacher Co is considering investing $500,000 in equipment to produce a new type of ball. Sales of the product
are expected to continue for three years, at the end of which the equipment will have a scrap value of $80,000. Sales
revenue of $600,000 pa will be generated at a variable cost of $350,000. Annual fixed costs will increase by
$40,000.
(a) Determine whether, on the basis of the estimates given, the project should be undertaken, assuming that all cash
flows occur at annual intervals and that Bacher Co has a cost of capital of 15%.
(b) Find the percentage changes required in the following estimates for the investment decision to change:
(i) Initial investment
(ii) Scrap value
(iii) Selling price
(iv) Unit variable cost
(v) Annual fixed cost
(vi) Sales volume
(vii) Cost of capital.
Q 4 The City of San Jose must replace a number of its concrete-mixer trucks with new trucks. It has received two
bids and has evaluated closely the performance characteristics of the various trucks. The Rockbuilt truck, which
costs $74,000, is top-of-the-line equipment. The truck has a life of eight years, assuming that the engine is rebuilt in
the fifth year. Maintenance costs of $2,000 a year are expected in the first four years, followed by total maintenance
and rebuilding costs of $13,000 in the fifth year. During the last three years, maintenance costs are expected to be
$4,000 a year. At the end of eight years the truck will have an estimated scrap value of $9,000. A bid from Bulldog

Trucks, Inc., is for $59,000 a truck. Maintenance costs for the truck will be higher. In the first year they are expected
to be $3,000, and this amount is expected to increase by $1,500 a year through the eighth year. In the fourth year the
engine will need to be rebuilt, and this will cost the company $15,000 in addition to maintenance costs in that year.
At the end of eight years the Bulldog truck will have an estimated scrap value of $5,000.
a. What are the relevant cash flows related to the trucks of each bidder? Ignore tax considerations
because the City of San Jose pays no taxes.
b. Using the figures determined in Part (a), what are the cash-flow savings each year that can be
obtained by going with the more expensive truck rather than the less expensive one? (That is,
calculate the periodic cash-flow differences between the two cash-flow streams assume that any
net cost savings are positive benefits.)
Q 5 Using the capital-asset pricing model, determine the required return on equity for the following situations:
EXPECTED RETURN
ON MARKET PORTFOLIO RATE

RISK-FREE

SITUATION

1
2
3
4
5

15%
18
15
17
16

10%
14
8
11
10

BETA

1.00
0.70
1.20
0.80
1.90

What generalizations can you make?

Good Luck