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The University of the South Pacific


Serving the Cook Islands, Fiji, Kiribati, Marshall Islands, Nauru, Niue, Samoa, Solomon Islands, Tokelau, Tonga, Tuvalu, and Vanuatu.
School of Accounting and Finance
FM202 SMALL BUSINESS FINANCE
FINAL EXAM SEMESTER 2, 2013
Face to Face Mode
Time Allowed: 3 hours plus 10 minutes reading
100 marks (60% of final grade)

INSTRUCTIONS
1. Read all instructions carefully before you begin.
2. Candidates should answer ALL questions as follows:
SECTION I: Multiple Choice Questions 20 Marks
SECTION II: Application-based Questions 80 Marks
3. Present all answers in the space provided. Please write legibly. Unclear answers and
writings may cost you marks.
4. The minimum mark required for this exam is 40% (24/60).
5. Round only the final answer to two decimal places, where applicable.
6. You can use silent non-programmable calculators. No restriction on the model of
calculator that may be used, but no device with communication capability shall be
accepted as a calculator.

Question 1 2 3 4 5 6 MCQ TOTAL

Marks


STUDENT SURNAME: ____________________ FIRST NAME: ____________________
STUDENT ID NUMBER: __________________
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SECTION I: MULTIPLE CHOICE QUESTIONS (2 marks each. Total 20 marks.)
ANSWER ALL QUESTIONS. Choose one best answer for each question. All answers
to this section should be presented on the ANSWER SHEET. The following pages of this
Section will NOT be marked.

1. A customer is given a terms of sale of 1/10, net 30. What is the annualised implicit interest
rate?
A. 13.01%
B. 20.13%
C. 120.13%
D. 45.40%

2. When a small business goes for initial public offering, an underpricing of an issue most likely
will generate the following signal to the public:
A. Lack of confidence of the owner
B. A high planned level of investment expenditure
C. Reflection of the owners expectation of the ability to recover the loss from the
enterprises future success
D. Greater faith placed on a more reputable adviser

3. Should a project be accepted if it offers an annual after-tax cash flow of $1,250,000
indefinitely, costs $10 million, is riskier than the firm's average projects, and the firm uses a
12.5% WACC?

A. Yes, since NPV is positive.
B. Yes, since a zero NPV indicates marginal acceptability.
C. No, since NPV is zero.
D. No, since NPV is negative.
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4. What appears to be the targeted debt ratio of a firm that issues $15 million in bonds and $35
million in equity to finance its new capital projects?

A. 15.00%
B. 30.00%
C. 35.00%
D. 60.00%

5. If the opportunity cost of capital for a project exceeds the project's IRR, then the project has
a(n):

A. positive NPV.
B. negative NPV.
C. acceptable payback period.
D. positive profitability index.

6. A project being considered for investment has a cost of capital of 15% and an internal rate of
return of 12%. Should the project be accepted?
A. Yes, the project should be accepted.
B. No, the project should be rejected.
C. It depends on whether the two rates are mutually exclusive.
D. The project should be accepted only if the two rates are independent.

7. What is the expected return on a portfolio that will decline in value by 13% in a recession, will
increase by 16% in normal times, and will increase by 23% during boom times if each scenario
has equal likelihood?

A. 8.67%
B. 13.00%
C. 13.43%
D. 17.33%

8. The capital asset pricing model (CAPM) attempts to:
A. establish a relationship between unsystematic risk and return.
B. establish a relationship between systematic risk and return.
C. establish a value for beta.
D. establish a value for the risk free rate.

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9. Which of the following is a disadvantage of a payback method:
A. It takes into account of all future cash flows, which makes it difficult to forecast all future
cash flows accurately.
B. It is difficult to forecast the discount rate used in a traditional payback method.
C. It takes into account of only a limited period of cash flows and ignores all other future
cash flows.
D. Both B and C.

10. Your small business in Fiji has an existing foreign currency account payable of A$10,000 (in
Australian dollar) which is due in two months. The current exchange rate is F$1.74 per one
Australian dollar. The forecasted exchange rate in two months is F$1.62 per one Australian
dollar. If you believe that the forecast is accurate, which of the following payment strategy
would you adopt?
A. Adopt a lead instead of lag strategy since your business can save F$1,200 under this
payment strategy.
B. Adopt a lag instead of lead strategy since your business can save F$1,200 under this
payment strategy.
C. Adopt a lead instead of lag strategy since your business can save F$1,000 under this
payment strategy.
D. Adopt a lag instead of lead strategy since your business can save F$1,000 under this
payment strategy.







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SECTION II. APPLICATION-BASED QUESTIONS (Total 80 Marks)
ANSWER ALL QUESTIONS. Read each question carefully before
answering. Present your answers in the allocated space for each question.
Please write legibly. Round only the final answer to two decimal places,
where applicable. Penalty applies to unclear answers and rounding errors.

QUESTION ONE (10 Marks)
A company has 50% debt and 50% equity. The company pays 10% interest on its debt. Interest expense
is tax-deductible. The companys beta is estimated to be 1.2, the expected market return is 14% and the
90-day Treasury bill rate is 4%. The company faces a tax rate of 20%. You have been asked to calculate
the appropriate cost of capital for this company. Show all calculations clearly. Briefly explain your
answers.

















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QUESTION TWO (12 Marks)
Discuss the three major valuation methods: Market valuation, Asset-based valuation and
Earnings and cash-flow based valuations. Present a suggested model to measure each approach.
(i) Market valuation (3 marks)









(ii) Asset-based valuation (3 marks)











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QUESTION TWO (continued)
(iii) Earnings and cash-flow based valuations (6 marks)

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QUESTION THREE (12 Marks)
A new owner-manager has approached you to discuss about some financial concepts for small
business. Clearly explain the following matters to him.
a. Why might it be difficult to distinguish between debt and equity for a small enterprise?
Give two different examples to clearly illustrate the cases where there can be unclear
distinctions between equity and debt of a small business. Keep your answers concise and
clear. (6 marks)







b. In addition to using surrogate and accounting beta, previous research has suggested using
various modified Capital Asset Pricing Model (CAPM) to measure the expected returns
of a small business. Discuss two of these suggested modified CAPMs. Illustrate the
concepts in an equation for each modified model. Keep your answers concise and clear.
(6 marks)








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QUESTION FOUR (10 Marks)
Your small business is looking into buying or leasing a truck. Your business can lease a
truck for 4 years at a cost of $2,500 monthly. Alternatively, your business can buy a truck
using cash at a cost of $80,000, with annual maintenance expenses of $10,000. The truck
will be sold at the end of 4 years for $20,000 after tax. The discount rate is 10%. Should the
company lease or buy? Which is the better option?





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QUESTION FIVE (18 Marks)
A fancy frozen yogurt cafe will cost $65,000 to open. Assuming annual sales of $100,000, variable costs
of 35% of sales, fixed costs of $30,000, depreciation of $10,000, and a tax rate of 20%, calculate the NPV
of the project over a 10-year horizon (no inflation or salvage value assumed) with a 12% cost of capital.
Is this a profitable investment? Conduct a sensitivity/scenario analysis by allowing sales to vary by
plus/minus 10% from the original estimate. Under each scenario, allow the variable cost to change
accordingly, that is, 35% of the corresponding new sales level. Is this a profitable investment under each
scenario? In less than 100 words, explain the purpose of conducting this sensitivity/scenario analysis.
Present a concluding remark on your estimates and determine their reliability in making an investment
decision.



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QUESTION SIX (18 Marks)
Green Environment Ltd. has obtained a one-year loan of $25,000 at an interest rate of 9.5% per
annum. The loan calls for equal quarterly payments over the life of the loan. Construct an
amortization table that shows: (i) quarterly payment to the bank, (ii) a breakdown of this
payment that pays for the interest, (iii) a breakdown of the payment that pays off the principal
and (iv) the quarterly balance. Label all headings and clearly show all calculations for all
relevant quarterly figures for the entire life of the loan. Explain how your answers under each
column of the table are related with one another. Also, comment on the trends of the amounts
for each component over time and the ending balance in one year.



















~THE END~
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FORMULAE
TIME VALUE OF MONEY:
Present Value:
t
r
FV
) 1 ( +
Future Value: PV * (1+r)
t

Present Value of Annuity:
(

t
r r r
C
) 1 (
1 1
* or
(

+

r
r
C
t
) 1 ( 1
*

Future Value of Annuity: ( )
t
t
r
r r r
C +
(

+
1 *
) 1 (
1 1
* or
(

+
r
r
C
t
1 ) 1 (
*
Present Value of Annuity Due: ( ) r
r r r
C
t
+
(

+
1 *
) 1 (
1 1
* or ) 1 ( *
) 1 ( 1
* r
r
r
C
t
+
(

+


Present Value of Annuity Due (PVA Due): PVA * (1+r)
Future Value of Annuity Due (FVA Due): FVA * (1+r)
Capital Asset Pricing Model
) (
f m f
r r r r + = |

Cash conversion cycle
inventory period + receivables period - accounts payable period

Ending accounts receivable
Beginning accounts receivable + sales - collections



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