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Question 1 (Capital Budgeting)

ABC Company is considering a new product line to supplement its range line. It is anticipated that the new product line will involve cash investment of $700,000 at time 0 and $1.0 million in year 1. After-tax cash inflows of $250,000 are expected in year 2, $300,000 in year 3, $350,000 in year 4, and $400,000 each year thereafter through year 10. Though the product line might be viable after year 10, the company prefers to be conservative and end all calculations at that time.

a) If the required rate of return is 15 percent, what is the net present value (NPV) of the project? Is it acceptable?

b) What is its profitability index (PI) of the project?

c) What would be the case if the required rate of return was 10 percent?

d) What is the projects payback period? Is it acceptable?

e) Briefly compare and contrast the NPV, PI, and IRR criteria. What are the advantages and disadvantages of using each of these methods?

(5 marks) Question 2 (Cost of capital and capital structure determination)

a) A firm borrows money at 9% interest after taxes and pays 11% for equity. The company raises capital in equal proportions, i.e., 70% debt and 30% equity. Determine the Weighted Average Cost of Capital (WACC) of the Firm.

b) Determine the cost of common equity. The current market price of stock is SR 200, and the stock pays Expected dividend of SR8 with a growth rate of 5%.

c) Determine the cost for a preferred stock that pays annual dividend SR 6, has issue price SR 40, and incurs flotation costs of SR 3 per share.

(4 marks) Question 3 (Working capital)

a) What is the Hedging principle and how can it be used to manage the working capital of the firm?

b) Describe the following term:

I. Permanent asset investments

II. Temporary asset investments

III. Permanent sources of financing

IV. Temporary sources of financing

V. Spontaneous sources of financing