Financial Management

Final Examination Practice

1. Brown Inc. earnings are expected to grow by 9.5% per year. It has 189 million shares
outstanding and expects earnings at the end of this year of $780 million. Brown plans to pay
out 50% of its earnings in total, paying 30% as a dividend and using 20% to repurchase shares.
If Brown’s payout rates remain constant, determine Brown’s share price assuming an equity
cost of capital of 15%.

2. Joe owns a small piece of commercial land near a university. Joe’s considering what to do with
it. Joe has been approached recently with an offer to buy it for $400,000. Joe’s also considering
three alternative uses of the land for yourself: a cafe, a barber shop, and an accessories store.
Assume that Joe would operate your choice indefinitely, eventually leaving the business to his
children. He collected the following information about the uses. What should Joe do?

Initial Cash Flow in Growth Rate Cost of Capital

Investment the First Year
Cafe $500,000 $95,000 4.5% 13.5%
Barber Shop $350,000 $65,000 5.0% 14.0%
Accessories $700,000 $100,000 5.5% 14.5%
store

3.
a. Smile Co. issued 14-year bonds a year ago at a coupon rate of 7.8 percent. The bonds make
semiannual payments. If the YTM on these bonds is 5.9 percent, what is the current bond price?
b. Coco Inc., has 9.1 percent coupon bonds on the market that have 8 years left to maturity. The
bonds make annual payments. If the YTM on these bonds is 6.8 percent, what is the current
bond price?

4. Comparing Investment Criteria Consider the following two mutually exclusive projects:

Year Cash Flow A Cash Flow B

0 -$250,000 -$75,000

1 35,000 29,000

2 40,000 22,000

3 100,000 28,000

4 200,000 20,500

Whichever project you choose, if any, you require a 10 percent return on your investment.

a) If you apply the payback method, which investment will you choose? Why?
b) If you apply the discounted payback method, which investment will you choose? Why?
c) If you apply the NPV method, which investment will you choose? Why?
d) If you apply the profitability index criterion, which investment will you choose? Why?
e) Based on your answers in (a) through (e), which project will you finally choose? Why?