Free Financial Management practice exam

Real and nominal approaches

Fairley Co is appraising a project that costs $370,000 at time 0 and would generate net cash inflows of $80,000 a year in current (time 0) prices for 7 years, at the end of each year.

All of the project's cash flows are expected to rise in line with general inflation of 5% a year. The company's money (nominal) cost of capital is 12.35%. Ignore taxation.

Fairley Co appraises projects of this kind in real terms, and discounts level annual cash flows with the annuity factor from the tables.

What is the project's net present value, to the nearest $? (2 marks)

$

Forward contracts

Arden Co is based in a country whose currency is the dollar ($). It trades with customers and suppliers in Corrand, whose currency is the corin (CR).

Arden Co has sold goods to a customer in Corrand for CR581,000, payable in 3 months' time, and will hedge the receipt with a forward contract.

Spot rate: CR0.8209 to CR0.8233 = $1. At this rate the bank gives $1 for every CR0.8233 a customer sells to it, and charges $1 for every CR0.8209 a customer buys from it.

3-month forward rate: CR0.8475 to CR0.8517 = $1. At this rate the bank gives $1 for every CR0.8517 a customer sells to it, and charges $1 for every CR0.8475 a customer buys from it.

How many dollars will Arden Co receive in 3 months' time, to the nearest $? (2 marks)

$

Managing receivables and payables

Yarrow Co has credit sales of $18,250,000 a year; customers pay in 70 days and bad debts are 0.8% of sales. Receivables are financed by an overdraft at 8% a year. A factor offers a service without recourse for a fee of 1.25% of sales; it would cut collection to 45 days, save administration costs of $90,000 a year, and advance 80% of the receivables at 10% a year, the remaining 20% still being financed by the overdraft. Yarrow Co would take the advance. Assume a 365-day year.

What would be the net effect of factoring on annual profit before tax? Enter a net cost as a negative figure. (2 marks)

$