Solves papers of Financial Management MBA

Attribution Non-Commercial (BY-NC)

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Solves papers of Financial Management MBA

Attribution Non-Commercial (BY-NC)

- Finanical Management
- manual for finance questions
- ch13#6
- Financial Management & Policy by James c. Van Horne 12th edition
- Costing problems
- 11&13Quiz for Exam4
- Assignment 2
- 15-Management.xlsx
- BF
- internal word and mouth recuitment method
- Van Horne Mcqs
- 404 -- WCM Exercise
- HRM Practices in Mobilink
- Chapter 8 Q
- Cost of Capital Solved Problems
- RATIO REVIEWER.docx
- Chapter 5 Solutions
- Capital Budgeting FM2 answers
- 17433245 Manual for Finance Questions
- TVM Practice Problems

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Q.3. The G.M ltd. Has non-callable, perpetual bonds outstanding. When originally issued,

the perpetual bonds sold for Rs.955 per bond while today (January 1) their current

market price is Rs.1, 120 per bond. The company pays a semiannual interest Rs.55 per

bond on June, 30 and

December 31 each year.

As of today (January 1) what is the implied semiannual yield on these bonds?

Using your answer to (a), what is the (minimal annual) yield on these bonds? The effective

annual yield to these bonds.

Current price of bond = 1.120

Since the bond is perpetual bond, the current price is considered as the present value of this

bond.

Therefore,

V=I/k

Where I is the amount paid on bond semi annually and k is the implied semi annually yield on

this bond

1,120 = 55 / k

k = 55 / 1,120 = 0.05 or 5 %

= ( 1 + 0.10 / 2 )2 – 1 = ( 1 + 0.05 )2 – 1 = ( 1 .05 )2 – 1

Q.4. Complete the following balance sheet for the Range Company using the following

information’s.

Debt to asset = 60 %

Quick ratio = 1.1

Asset turnover = 5 times

Fixed asset turnover = 12.037

Current ratio = 2

Average collection period = 16.837 days

Assume that all sales are on credit and a 360 days year.

Cash Current liabilities

Receivables Bonds payables

Inventory Net worth

Total current assets Tot. liabilities and net worth

Plant and equipment

Total assets Rs.325,000

Cash 28,495 J Current liabilities 95,000 E

Total assets 325,000 Liabilities & net worth 325,000 A

Calculation A

Calculation B

Debt to asset = Total debt / Total asset = Bond payable / Total asset = 0.6

Calculation C

Fixed asset turnover = Sales / Fixed assets = Sales / Plant & Equipment =

12.037

Calculation D

Calculation E

Calculation F

Calculation G

Calculation H

Quick ratio = Quick asset / Current liabilities = 1.1

Calculation I

21.38

Calculation J

Rs.400, 000. The estimated salvage value is zero; tax rate is 55 %. The company uses

straight line depreciation method and the proposed project has cash flows before tax as

follows:

Year 1 2 3 4 5

Profitability index at 15 %

End of year 1 2 3 4 5

A CFBT 100,000 100,000 150,000 150,000 250,000

E=A—D Cash flow after tax 89,000 89,000 111,500 111,500 156,500

Payback period

0 (400,000) (400,000)

1 89,000 (311,000)

2 89,000 (222,000)

3 111,500 (110,500)

4 111,500 1,000

Year Cash flow P.V factor Present value

Profitability index at 15 %

Q.6. Stallings paints company has fixed operating costs of Rs.3 million a

year. Variable operating costs are Rs.1.75 per half pint of paint produced and the average

selling price is Rs.2 per half pint.

rupees of sales (SBE)?

If variable cost decline to Rs.1.68 per half pint, what would happen to the

operating break even point (QBE)?

level of 16 million half pints.

If sales are expected to increase by 15 % from the current sales level, what would be the

resulting percentage change in operating profit (EBIT) from current position?

(a)

FC 3,000,000 3,000,000

QBE = ------------- = --------------- = -------------- = 12,000,000 half pint

24,000,000

(b)

VC = 1.68

FC 3,000,000 3,000,000

(c)

Q(P–V)Q

Q ( P – V ) – FC ( Q – QBE )

16,000,000 16,000,000

(d)

EBIT = Q ( SP – VC ) – FC

1,600,000 – 1,000,000

1,000,000

Q.7. Poris Pottery spends Rs.220,000 per annum on its collection

department. The company has 12 million in credit sales, its average collection period of 2.5

months, and the percentage of bad debt losses is 4 %. The company believes that if it were

to double its collection personnel, it could bring down the average collection period to

2 months and bad debt losses to 3 percent.

The added cost is Rs.180,000, bringing total collection expenditure to

Rs.400,000 annually. Is the increased effort worthwhile, if the before tax opportunity cost

of funds is 20 %? If it is 10%?

SO = 12,000,000

SN = 12,000,000

ΔS = 0

K = 10% and 20 %

ACP0 = 75 days

ACPN = 60 days

B0 = 4 %

BN = 3 %

For K = 10 %

ΔP = [ – K (ΔI ) – S0 (BN – B0 )]

For k = 20 %

ΔP = [ – K (ΔI ) – S0 (BN – B0 )]

The incremental profit for the new policy with 10 % opportunity cost is

opportunity cost is Rs.220,000. Since the additional cost incurred for new

credit policy is Rs.180,000, therefore, the company can use new credit policy only with 20 %

opportunity cost and not with 10 % opportunity cost.

1 Prepared by Mohammad Muzammil

Q1(b) How does the notion of risk and reward govern the behavior of

financial manager?

Q2 Tariq Corporation currently pays a dividend of Rs.3 per share and this dividend is

expected to grow at a 10 % annual rate for 5 years, then at 8 % for the next three years.

After which it is

expected to grow at a 5 % rate forever.

(a) What value would you place on the stock if an 18 % rate return were required?

Phase one and two: present value of dividends to be received over first 8 years

At 18 % of dividend

========

– 0.05)

= 6.39095 / 0.13 = 49.16115

(b) Would your valuation change if you expected to hold the stock only for 3 years?

The valuation of stock will be change if we hold the stock for only three years. The calculations

are as under.

At 18 % of dividend

7.83318

======

– 0.10) = 30.397

Q3 Zahid Company’s share price is now Rs.80. Six months hence it will be either Rs.95

with probability of 0.65 or Rs.100 with probability of 0.5. A call option exists on the stock

that can be exercised only at the end of 6 months at an exercise price of Rs.75.

(a) If you wished to establish a perfectly hedged position, what would you do on the basis of the

facts just presented?

(b) Under each of the two possibilities, what will be the value of your hedged position?

(c) What is the expected value of option price at the end of the period?

Period 0 1 2 3 4

A

B

(Rs.25000)

(Rs.25000)

Rs.10000

Rs.10000

Rs.15000

Rs.35000

Rs.60000

(Difference b/w maximum value and initial investment ) / difference between two present

values

28,920

Present value at 25 % = (60,000) (PVIF 0.25, 4 ) = 60,000 (0.410) =

24,600

b. Assume a required rate of return of 10 %, determine the net present value of each project.

c. Which project would you select? What assumptions are inherent ion

your decision.

Q5 For each of the companies described below would you expect it to have a medium/high

or a low dividend pay-out ratio? Explain why?

a. A company with a large proportion of inside ownership, all of whom are high income

individuals.

c. A company experiencing ordinary growth that has high liquidity and much unused borrowing

capacity.

d. A dividend-paying company that experience an unexpected drops in earning from a trend.

d. The risk less rate of return decrease.

Q7 The present ratio of interest on 4 year 0 coupon treasury security is 10% and on 5 year

securities 9.0 %.

a. What is the implied forward rate on 1-year loan 4-years in the future?

c. Suppose interest rates decline so that the 4- year security yields 8% and the 5- year security

8.40%. What happens to forward rate.

What overall relationship prevails between actual rates and forward rate?

Q1 Cheryl’s Menswear feels that its credit costs are too high. By tightening its credit

standards, bad debts will fall from 5 % of sales to 2 %. However, sales will fall from 100,

000 to 90, 000 per year. The variable cost per unit is 50% of the sale price, and the average

investment in

receivables is expected to remain unchanged.

(a) What cost will the firm face in reduced contribution to profit from sales.

SN = New sales = 90, 000

In order to see that firm should tighten its credit standard or not, we have

Reduction of bad debts = (BN SN– B0 S0) = [ (0.02)(90, 000) –

(0.05)(100, 000)]

Because the reduction in bad debts Rs.3, 200 is less than the reduction of contributory margin

which is Rs.5, 000, the firm should not tighten its credit standard.

Q2 Lockbox system can shorten Orient Oil’s Accounts Receivable collection period by 3

days, credit sales are $ 3,240,000 per year, billed on a continuous basis. The firm has other

equally risky investments with a return of 15%. The cost of the lockbox is $ 9,000 per year.

What amount of cash will be made available for other uses under the lockbox system?

Average collection period existing = X1

Existing receivable = Y1

New receivable = Y2

Credit sales

360 ( Y1 )

3, 240, 000

360 ( Y2 )

000 ( X1 – 3 )

3, 240, 000

What net benefit (cost) will the firm receive if it adopts the lockbox

system? Should it adopt the proposed lockbox system?

The cost of using the new system will be Rs.9, 000 per year whereas company can save Rs.27,

000 in investment in receivable. Therefore company can save 27, 000 – 9, 000 = 18, 000 by

using the new system.

Q3 Determine the cost of giving up cash discounts under each of the following terms of

sale.

= -------------------------- X -------------------------------------------

2 365

100 – 2 30 – 10

1 365

100 – 1 30 – 10

2 365

100 – 2 45 – 10

3 365

100 – 3 45 – 10

1 365

100 – 1 60 – 10

3 365

100 – 3 30 – 10

4 365

100 – 4 180 – 10

Q4 Patterson’s Parts Store expects sales of $ 100,000 during each of the next 3 months. It

will make monthly purchases of $ 60,000 during this time. Wages and salaries are $ 10,000

per month plus 5% of sales. Patterson’s expects to make a tax payment of $ 20,000 in the

next

month and a $ 15,000 purchase of fixed assets in the second month and to receive $ 8,000

in cash from the sale of an asset in the third month. All sales and purchases are for cash.

Beginning cash and the minimum cash balance are assumed to be zero.

Construct a cash budget for the next 3 months.

Briefly discuss how the financial manager can use the data in (a) to plan

for Patterson’s financing needs.

They do not need any finance but they have to consider the investment of extra cash

Q5 Firm J has sales of 100,000 units at $ 2.00 per unit, variable operating costs of $ 1.70

per unit, and fixed operating costs of $ 6,000. Interest is $ 10,000 per year. Firm R has

sales of 100,000 units at $ 2.50 per unit, variable operating costs of $ 1.00 per unit, and

fixed operating costs of $

62,500. Interest is $ 17,500 per year. Assume that both firms are in the 40% tax bracket.

Compute the degree of operating, financial and total leverage of firm J.

FIRM J FIRM L

Leverage (DOL)

Q(P–V)

DOL = ----------------------

Q ( P – V ) – FC

= --------------------------------------

= ------------------------------

30,000

= ------------------------------

= 1.25

= --------------------------------------

= ------------------------------

150,000

= ------------------------------

= 2.4

Degree of financial

Leverage (DOF)

Q ( P – V ) – FC

DOF= ------------------------

Q ( P – V ) – FC – I

30, 000

= ---------------------------

= 2.14

150, 000

= ----------------------

= 3.33

Q(P–V)

DOT = ------------------------

Q ( P – V ) – FC – I

100, 000

= ----------------------------

100, 000

= ------------------ = 7.14

14, 000

100, 000

= ----------------------------

100, 000

= ------------------ = 2.22

45, 000

Q6 Easi Chair Company is attempting to select the best of three mutually exclusive

projects. The initial investment and after-tax cash inflows associated with each project are

shown in the following table.

Pay back period for project A = 60, 000 / 20, 000 = 3 years

Pay back period for project B = 100, 000 / 31, 500 = 3.17 years or 4 years

Pay back period for project C = 110, 000 / 32, 500 = 3.38 years or 4 years

Calculate the net present value (NPV) of each project, assuming that

the firm has a cost of capital equal to 13%.

= 20, 000 (3.517) – 60, 000 = 70, 340 – 60, 000 = 10, 340

= 31, 500 (3.517) – 100, 000 = 110, 785.50 – 100, 000 = 10, 785.50

= 32, 500 (3.517) – 110, 000 = 114, 302.50 – 110, 000 = 4, 302.50

PV for project A at 20 % = 20, 000 (2.991) = 59, 820

Summarize the preferences dictated by each measure, and indicate which project you would

recommend. Explain why.

IRR 19.87 % 17.547 % 14.6 %

with project A and B. In selecting between project A and B, project B has more NPV but less

IRR than project A. In order to select, we have to calculate profitability index and we will select

the project which has greater PI.

coupon interest rate outstanding. The issue pays interest annually and has 16 years

remaining to its maturity date.

If bonds of similar risk are currently earning a 10% rate of return, how much should the

Redenour Supply bond sell for today?

value factor for single payment for 16th year at 10 %

Describe the two possible reasons that similar risk bonds are currently earning a return below

the coupon interest rate on the Redenour Supply bond.

If the required return were at 12% instead of 10%, what would the current value of Redenour

Supply’s bond be? Contrast this with your findings in

V = I (present value annuity factor for 16 years at 12 %) + MV (present value factor for single

payment for 16th year at 12 %)

Q8(a) What is a common-size income statement? Which three ratios of profitability are

found on this statement?

Q8(b) Define and differentiate between return on total assets (ROA) and return on equity

(ROE).

Q.1(a) Which firm is more profitable firm A with the total assets turn over 10.0 and a net

profit of 2% or firm B with the total assets turn over 2.0 and a net profit of 10%? Provide

example of both types of firm.

Firm A = 2 x 10 = 20 %

Firm B = 10 x 2 = 20 %

Two firms with different net profit margins and total asset turnover may have the same earning

power (Return on Assets) Firm A, with a net profit margin of only 2 percent and a total asset

turnover of 10 have the same earning power of 20 percent as Firm B, with a net profit margin of

10 percent and total asset turnover of 2. For each firm every dollar invested in assets returns 20

percent.

Q.1(b) Does increasing the firm’s inventory turnover ratio increase its profitability? Why

should this ratio be computed using costs of good sold (rather than sales, as is done by

some compliers of financial statistics)?

Two problems arise in calculating and analyzing the inventory turnover ratio.

First, sales are stated at market price, so if inventories are carried at cost, as generally are, the

calculated turnover overstates the true turnover ratio.

Therefore, it would be more appropriate to use cost of goods sold in place of sales in the

numerator of the formula.

The second problem lies in the fact that the sales occur over the entire year, whereas the

inventory figure is for one point in time. For this reason, it is better to use an average inventory

measure.

Q2 Patterson’s part store expects sales of $100,000 during each of the next 3 months. It

will make monthly purchases of $60,000 during this time. Wages and salaries are $10,000

per month plus 5% of sales.

Patterson’s expects to make a tax payment of $20,000 in the next month and $1,500 purchase of

fixed assets in the second month and to receive $8,000 in cash from the sale of an asset in the

third month. All sales and purchases are for cash. Beginning cash and min.

B. briefly discuss how the financial manager can use the data in (a) to plan for Patterson’s

financing needs.

Sale of asset 8, 000

Ending balance 25, 000 15, 000 48, 000

Briefly discuss how the financial manager can use the data in (a) to plan for Patterson’s

financing needs.

They do not need any finance but they have to consider the investment of extra cash

Q3 Sorbond industries have a beta of 1.45, the risk free rate is 8% and the expected return

on the market portfolio is 13%. The co. presently pays a dividend of $2 a share, and

investors expect it to experience a growth of 10% per annum for many years to come.

0.1525 or 15.25 %

b. What is the stock’s present market price per share, assuming this required rate?

c. What would happen to the required return and to market price per share if the beta were 0.80?

(Assume that all else stay the same)

Q4 ZZZ worst co. presently has total assets of $3.2 million, of which current assets

comprises $0.2 million. Sales are $10 million annually, and the before tax net profit

margin (the firm currently has no interest bearing debt) is 12%. Given renewed fears of

potential cash insolvency and

overly strict credit policy, and imminent stock outs, the company is considering higher

level of current assets as a buffer against adversity. Specifically, levels of $0.5 million and

$.8 million are being considered instead of 0.2 million presently held. Any additions to

current assets would be financed with new equity capital.

Required: Determine the total assets turnover, before tax return on investment, and before tax

profit margin under the three alternative levels of current assets.

Sales 10 M 10 M 10 M

Total asset = 3.2 – 0.2 + new current asset 3.2 M 3.5 M 3.8 M

Q5 The Dud co. purchases raw material on terms of “2/10, net 30”. A review of the co.

record by owner, Mr. Dud, revealed that payments are usually made 15 days after

purchase are received.

When asked why the co. did not take advantage of its discount, the bookkeeper, Mr.

Blunder replied that it cost only 2% for these funds, whereas a bank loan would cost the

firm 12%.

1- He is not taking advantage of discounts offered to the firm as per terms “2/10, net30.”

2- After giving up discounts, he is usually making payments 15 days after purchases are

received.

= (2 / (100 – 2 ) (360 / [(30 – 20 )] = (2 / 98) (360 / 20) = 0.367 or 36.7 %

But as the Dud company usually makes payments 15 days after purchases are received, the real

cost of not taking discounts would be much as worked out below:

= (2 / (100 – 2 ) (360 / [(15 – 10 )] = (2 / 98) (360 / 5) = 1.468 or 156.8 %

(c) If the firm could not borrow from bank and were resort to the trade credit funds, what

suggestion might be made to Mr. Blunder that would reduce the annual interest cost?

If the company could not avail discount it should make its payments on the final due date, i.e.,

30 days after purchase are received. And if possible, these payments can be stretched for a

period of a week or

10 days.

Q6 The Crazy horse hotel has capacity to stable 50 horses. The fee for stabling a horse is $100

per month. Maintenance, depreciation and other fixed operating cost total $1200 per month.

Variable operating cost per horse is $12 per month for hay and bedding

and $8 for grain.

(a) Determine the monthly break even point (in horses stable)

BE in quantity or QBE = Fixed cost / (Unit sales price – Unit variable cost)

(b) Compute the monthly operating profits if an average of 40 horses are stabled.

Q7 Easi chair co. is attempting to select best of three mutually exclusive projects. The

initial investment and after tax inflows associated with each project are shown in following

table.

Pay back period for project A = 60, 000 / 20, 000 = 3 years

Pay back period for project B = 100, 000 / 31, 500 = 3.17 years or 4 years

Pay back period for project C = 110, 000 / 32, 500 = 3.38 years or 4 years

(b) Calculate the net present value (NPV) of each project, assuming that the firm has a cost

of capital equal to 13%.

= 20, 000 (3.517) – 60, 000 = 70, 340 – 60, 000 = 10, 340

= 31, 500 (3.517) – 100, 000 = 110, 785.50 – 100, 000 = 10, 785.50

= 32, 500 (3.517) – 110, 000 = 114, 302.50 – 110, 000 = 4, 302.50

(c) Calculate the internal rate of return (IRR) for each project.

PV for project A at 20 % = 20, 000 (2.991) = 59, 82067, 040 – 59, 820 = 7, 22067, 040 – 60,

000 = 7, 040

(d) Summarize the preferences dictated by each measure, and indicate which project you

would recommend. Explain why.

Project C is out of question as it has less NPV and IRR in comparison with project A and B. In

selecting between project A and B, project B has more NPV but less IRR than project A. In

order to select, we have to calculate profitability index and we will select the project which has

greater PI.

Q8 (a) contrast the objective of maximizing earnings with that of maximizing wealth.

(b) Explain why judging the efficiency of any financial decision require the existence of

goal.

Q.1 You have just opened a new business and expect to generate $250,000 in sales during your

first year of operation. You recently looked the following industry average for the selected

group of financial ratios:

Calculate the following year end totals, assuming you expect your firm’s financial positions to

mirror that of industry:

(d) Current liabilities

(c) Long term debt

Debt Ratio = 0.5 = Total Debt / Total asset = (CL +LTD) / Total assets

= $33,083

Q.2(a) Choctaw Oilfield Services made a $225,000 operating profit last year and paid

$160,000 in interest expense. How much financial leverage does Choctaw have? If

operating profits drop 50 percent this year, what effect does its financial leverage have on

Choctaw’s net profit?

Q.3 GC investment has $ 100,000 in money market fund that it wants to invest. GC has

two alternatives with different after tax cash flows, each costing $100,000.Year 1 2 3 4

The cost of capital is I0 percent. Calculate the following and state for each criterion whether or

not you should invest.

(a) NPV

3 35,000 0.751 26285 75,000 0.751 56325

(b) IRR

For project A

1 0 0.8696 0 0.847 0

2 0 0.7561 0 0.718 0

(Difference b/w maximum value and

(6,493) / 14,668

For project B

(Difference b/w maximum value and initial investment ) / difference between two present

values

(5,455) / 11,305

If the projects are independent, then company should select both projects and if both projects

are mutually exclusive than company should go for

project A who has NPV and IRR greater than B

Q.No.4 The common stocks of ABC co. and XYZ co. are estimated to offer returns over

the next year according to the following table:

ABC XYZ

5 0.1 10 0.5

10 0.3 50 0.2

20 0.5

ABC

R (%) – 20 – 10 5 10 20

XYZ

R (%) – 30 0 10 50

The expected return and standard deviation for stock ABC will be:

0.05 0.1 0.005 0.009 0.000081 0.0000081

Σ 0.12 0.017591

R' = 0.12/5

0.041

The expected return and standard deviation for Stock XYZ will be:

Σ 0.12 0.057169

R' = 0.12 / 4

0.03

Expected return = 0. 03 or 3 %

Standard deviation = √ .057169 = 0.293

Q.5 ACME production has daily sales of $100,000. You may assume a 360 days year.

Currently all accounts are payable within 30 days. Its new financial manager thinks that

by offering a cash discount its sales will increase 25 percent. Acme’s cost of capital is 12

percent and its direct

production expenses are 60 percent of its sales. The financial manager feels that if its

terms were 2/10 net, 20, 50 percent of its customers would take the cash discount. The

collection expenses are not expected to be significant. Should acme follow its financial

manager advice?

SO = 100,000 (360) = 36,000,000

V = 0.6

1 – V = 1 – 0.60 = 0.40

K = 0.12

ACP0 = 30 days

ACPN = 20 days

P0 = 0

PN = 0.5

D0 = 0

DN = 0.02

ΔI = Incremental change in investment in receivable

Since profit is increased because of new policy, AC ME should follow its financial manager’s

advice.

Q.6 Economics unlimited forecast inventory needs for the coming year at 2.5 million

widgets.

Orders have to be placed in multiple of 1,000 widgets and it costs $10 to place an order.

Carrying costs are $.50 per widget. What is EOQ and average inventory level? How many

orders are placed during the year?

Carrying cost = Cc = 0.5

100,000,000 = 10,000

√ Cc √ 0.5 √ 0.5

Q.7 Given the following changes state would you think the impact would be on the optimal

amount of debt in the firm’s capital structure and why?

demanded by other firms.

e. The product market for the firm’s output become much more volatile and more uncertain.

Q.8(a) The share holders required return for slick manufacturing is 20%. The risk free

rate is 12 percent and requires return on the market portfolio is 15 percent. Calculate the

slick’s beta coefficient.

= 8 / 3 = 2.67

Q.8(b) Describe how break even analysis can be useful for a manager finance?

Q.1. Loquat Foods Company is able to borrow at an interest rate of9 percent for one year.

For the year, market participants expect 4 percent inflation.

a. What approximate real rate of return does the lender expect? What is the inflation premium

embodied in the nominal interest rate?

The expected real rate of return is 5 percent, and the inflation premium is 4 percent.

b. If inflation proves to be 2 percent for the year, does the lender suffer? Does the borrower

suffer? Why?

The lender gains in that his real return is 7 percent instead of the 5 percent that was expected. In

contrast, the borrower suffers in having to pay a higher real return than expected. In other

words, the loan is repaid with more expensive dollars than anticipated.

With 6 percent inflation, the real return of the lender is only 3 percent, so he suffers whereas the

borrower gains.

Q.2. Delphi Products Corporation currently pays a dividend of $2 per share, and this

dividend is expected to grow at a 15 percent annual rate for three years, and then at a 10

percent rate for the next three years, after which it is expected to grow at a 5 percent rate

forever. What value

would you place on the stock if an 18 percent rate of return was required?

Phase: one

Phase: two

Phase: 3

= 32.69

Q.3(a) What are the different motives given by Keynes for holding cash?

Q.3(b) What is net float? How might a company play the float in its disbursement?

Q.3(c) What are the various sources of information you might use to analyze a credit

application?

Balance sheet

Inventory 12 15 Accrued wages 2 3

Accrued taxes 3 2

Common stock 10 10

Retained earnings 15 20

Total 63 70 Total 63 70

2 2.00 (1 + 0.15) 2 = 2.65 0.718 1.90

Income statement 20X2

Sales 95

Depreciation 3

interest 2

Taxes 10

Net income 15

(a) Prepare a sources and uses of funds statement for Begalla Corporation.

Begalla Corporation Sources and uses of funds statement For December 31, 20X1 to December

31, 20X2 (in milliond) Funds provided by operations:

Increase accrued wages 1 Increase accounts receivable 3

____ _____

21 21

(b) Prepare a cash flow statement using the indirect method for Begalla Corporation.

Net income 15

Depreciation 3

Cash and cash equivalent, December 31, 20X2 5

Q.5 Mendez Metal Specialties. Inc. has a seasonal pattern to its business. It borrows under

a line of credit from Central Bank at 1% over prime. Its total asset requirements now (at

year end) and estimated requirements for the coming year are (in millions):

Presently, the company has $4.5 million in equity capital and long term debt plus the permanent

component of current liabilities, and

this mount will remain constant throughout the year.

The prime rate presently is 11 % and the company expects no change in this rate for the next

year.

Mendez Metal Specialties is also considering issuing intermediate - term debt at an interest late

of 13.5%. In this regard, three alternative amounts are under consideration: zero, $ 500,000 and

$ 1 million.

All additional funds requirements will be borrowed under the company’s bank line of credit.

(a) Determine the total dollar borrowing costs for short and intermediate-term debt under each

of the three alternatives for the coming year. (Assume. that there are no changes in current

liabilities other than borrowings). Which alternative is lowest in cost’?

Alternative 1: 0 intermediate term debt and all finance is from bank borrowing Bank loan cost =

(11 + 1) / 4 = 3 % per quarter

Q1Q2Q3Q4

by bank borrowing

Q1Q2Q3Q4

Incremental borrowing 0 500,000 900,000 0

Alternative 3: Issuing 1,000,000 intermediate term debt and rest is financed by bank borrowing

Q1Q2Q3Q4

Alternative 1 is lowest in cost because the company borrows at a lower rate, 12 percent versus

13.5 percent, and because it does not pay interest on funds employed when they are not needed.

(b) Is there a consideration other than expected Cost that deserves your attention?

While alternative 1 is cheapest it entails financing the expected build up in permanent funds

requirements ($500,000) on a short-term basis. There is a risk consideration in that if things turn

bad the company is dependent on its bank for continuing support. There is risk of loan renewal

and of

interest rates changing.

term basis. As a result, only the expected seasonal component of total needs would be financed

with shortterm

debt.

Alternative 3, the most conservative financing plan of the three, involves financing on a term

basis more than the expected build-up in permanent funds requirements. In all three cases, there

is the risk that actual total funds requirements will differ from those that are expected.

Q.6 Compare and evaluate the four major capital budgeting techniques.

Q.7 On the basis of an analysis of past returns and of inflationary expectations, Marta

Gomez feels that the expected return on stocks in general is 12 percent The risk-free rate

on short term Treasury securities is now 7 percent. Gomez is particularly interested in the

return prospects for Kessler Electronics Corporation. Based on monthly data for the past

five years, she has fitted a characteristic line to the responsiveness of excess returns of the

stock to excess returns of the S&P 500 Index and has found the slope of the line to be 1.67.

If financial markets are believed to be efficient, what return can she expect from investing

in Kessler Electronics Corporation?

Q.8. Hayleigh Mills Company has a $5 million revolving credit agreement with First State

Bank of Arkansas. Being a favored customer, the rate is set at 1 percent over the bank’s

cost of funds, where the cost of funds is approximated as the rate on negotiable certificates

of deposit (CDs).

In addition, there is a ½ percent commitment fee on the unused portion of the revolving credit.

If the CD rate is expected to average 9 percent for the coming year and if the company expects

to utilize, on average, 60 percent of the total commitment, what is the expected annual dollar

cost of this credit arrangement?

What is the percentage cost when both the interest rate and the commitment fee paid are

considered?

What happens to the percentage cost if, on average, only 20 percent of the total commitment is

utilized?

Total annual dollar cost = 100,000 + 20,000 = $120,000 in annual dollar cost

$120,000 in annual dollar cost / $1,000,000 in useable funds = 12%

Q.1(b) What are the three major functions of finance manager? How are they related?

Q.1(c) If the firm adopts a hedging approach to financing, how would it finance its current

assets.

Q.1(d) Explain how efficient inventory management affects the liquidity and profitability

of the firm.

Q.2 Complete the 2007 balance sheet of Mughal Industries using the information given

below:

Balance sheet

Mughal Industries

December 31, 2007

Inventories

Balance sheet

Mughal Industries

Total current assets 720,000 (c) Total current liabilities 450,000 (d)

Net fixed asset 1,530,000 (g) Long term debt 900,000 (i)

Total assets 2,250,000 (f) Total liabilities and equity 2,250,000 (j)

Calculation A.

Calculation B.

300,000

Calculation C.

+ Inventory

Calculation D.

Calculation E.

=240,000

Calculation F.

Calculation G.

Fixed asset = Total asset – Current asset = 2,250,000 – 720,000 =

1,530,000

Calculation H.

Calculation I.

Long term debt = Total liabilities – Current liabilities = 1,350,000 – 450,000 = 900,000

Calculation J.

Q.3 Superior Cement Company has an 8 % preferred stock issue outstanding with each

share having $100 face value. Currently the yield is 10 %. What is the market price per

share? If the required return becomes 12 %, what will happen to the market price per

share?

Q.4 Using the capital asset pricing model, determine the required return on equity for the

following situations:

1 10 15 1.00

2 14 18 0.70

3 8 15 1.20

4 11 17 0.08

5 10 16 1.90

Case Rf Rm β R = Rf + β (Rm – Rf)

Q.5 You need to have $50,000 at the end of 10 years. To accumulate this sum you have decided

to save a certain amount at the end of each of the next 10 years and deposited it in the bank. The

bank pays 8 % interest compound annual for long term deposits. How much will you have to

save each year?

Q6 Multinational industries have a beta of 1.45, the risk free rate is 10 % and the expected

return on the market portfolio is 16%. The co. presently pays a dividend of $2 a share, and

investors expect it to experience a growth of 10% per annum for many years to come.

or 18.7 %

b. What is the stock’s present market price per share, assuming this required rate?

c. What would happen to the required return and to market price per share if the beta were

0.80? (Assume that all else stay the same)

or 14.8 %

Q.7 ARY Company has total annual sales (all credit) of $500,000 and a gross profit margin of

15 %. Its current asset are 100,000; current liabilities 75,000; inventories 30,000 and cash

10,000.

(a) How much average inventory should be carried if management wants the inventory

turnover to be 4?

(b) How rapidly (in how many days) must accounts receivable be collected, if management

wants to have an average of $50,000 invested in receivable?

Q.8 Briefly explain the following:

(c) Going concern

Financial Management 562 Spring 2000

Q.1 Enumerate the main functions of the financial manager. Also state how does the notion of

risk and reward govern the behavior of financial manager?

Q.2 Suppose you were to receive Rs.1000 at the end of twelve years. If yours opportunity rate is

15%, what is the present value of this amount if interest is compound annually? Quarterly?

Continuously?

FV = 1,000

k = 0.15

Pv = ?

n = 12 years

m=4

0.0375 ) 48

Q.3. The beta of a company is 1.75 and the risk free rate is 8%. The expected return on market

portfolio is 14%. The company presently pays a dividend of Rs.3 per share and investors expect

it to experience a growth in dividends of 5% per years for many years to come. What is the

stocks required rate of return according to CAPM?

K=?

KM = 0.14

RF = 0.08

D0 = Rs.3.00 / share

β = 1.75

g = 0.05

K = RF + β ( KM – RF )

0.185 or 18.5 %

Q.4. What is meant by intrinsic value and how it is determined? Also explain the concept of

incremental analysis.

Q.5. A company presently gives terms of net 30 days. It has Rs.60 million in sales and its

average collection period is 45 days. To stimulate demand, the company may give terms of net

60 days.

After the change, the average collection period to be 75 days. Variable costs are 0.80 for every

Rs.1 on sales and the company required rate of return on investment in receivable is 20%.

Should the company

extend its credit period. Explain.

SO = 60,000,000

ΔS = 9,000,000

V = 0.80

1 – V = 0.20

K = 0.20

ACP0 = 45

ACPN = 75

ΔI = Incremental change in investment in receivable

ΔP = [ΔS ( 1 – V ) – K (ΔI ) ]

The company can extend its credit period and get additional Rs.500,000 profits by extending its

credit period and due to increased sale.

Q.6. What is meant be APT model? Also explain the assumptions to the theory of capital

structure.

Q.7. A company has 2.5 million shares outstanding, stockholders equity of Rs.41.5 million,

earnings of Rs.3.9 million during the last 12 months during which it paid dividend of Rs.0.95

million and a share price of Rs.37. Required.

Given:

Equity = 41,500,000

Earnings = 3,900,000

Dividend = 950,000

(a)

Price earning ratio = Market price per share / Earning per share

2,500,000 = 1.56

(b)

Dividend yield = Dividend per share / Market price per share

2,500,000 = 0.38

(c)

Market to book value per share = Market value per share / Book value per

share

2,500,000 = 16.6

Q.8. How can diversification reduce the risk of investment in marketable securities? Also

explain briefly the active and passive dividend policy approaches.

Financial Management 562 Spring 2001

2. Equity financing

Times/ year

Deposit period

In years

A 25, 000 16 % 2 5

B 50, 000 12 % 6 3

(a) Calculate the future value at the end of the specified period.

FV = PV (FVIF i n )

1.1664 – 1 = 0.1664

1.1262 – 1 = 0.1262

(c) Compare the nominal interest rate, to the effective interest rate. What relationship exists

between compounding frequency and the nominal and effective interest rates?

Q3 Kamran manufacturing co. must choose between two asset purchases. The annual rate of

return and the related probabilities given in the following table summarize the firm’s analysis to

this point.

Project 257

R (%) 10 10 20 30 40 45 50 60 70 80 100

Probability 0.01 0.04 0.05 0.10 0.15 0.30 0.15 0.10 0.05 0.04 0.01

Project 432

R (%) 10 15 20 25 30 35 40 45 50

Probability 0.01 0.04 0.05 0.10 0.15 0.30 0.15 0.10 0.05

• The expected value of return

• The co-efficient of variation

The range for possible return for project 257 is between 10 % to 100 %

The expected return and standard deviation for project 257 will be:

Σ 0.452 0.194467

R' = 0.452/11

0.041

The expected return and standard deviation for project 432 will be:

0.15 0.1 0.015 0.117 0.013689 0.0013689

Σ 0.3 0.082539

R' = 0.3 / 9

0.033

Expected return = 0. 30 or 30 %

Standard deviation = √ .082539 = 0.287

Q4 Financial analysis carried out in Shaheen foundation Ltd. Reflected the following result.

Sales = Rs.2,400,000

Current assets Common stock Rs.

Total asset 1,200,000 (B). Total liability and equity 1,200,000 (G)

Calculations:

800,000

360 = 250,000

= 500,000

(I) Long term debt = Total debt – C. liabilities = 540,000 – 320,000 = 220,000

Since CGS is equal to sales, there is no gross profit and no retained earnings

(K) Equity = Total capital and liability – total debt = 1,200,000 – 540,000

= 660,000

Q5 The cash flows for projects X and Y in Mobil link co. follow. Each project has a cost of

$40000

1 $26000 $14000

2 12000 14000

3 12000 14000

4 4000 14000

Project X Project Y

Year Cash flow Cumulative cash inflow Cash flow Cumulative cash inflow

0 (40,000) (40,000)

2 12,000 38,000 14,000 28,000

4 4,000 14,000

2 0.826 12,000 9912 14,000 11564

Σ 45290 Σ 44366

project X project Y

Present value at 19 %

1 0.84 26,000 21840 14,000 11760

Σ 39424 Σ 36932

project X project Y

IRR for project X will be: 0.10 + (0.19 – 0.10) (45,290 – 40,000) /

(45,290 – 39,424)

IRR for project Y will be: 0.10 + (0.19 – 0.10) (44,366 – 40,000) /

(44,366 – 36,932)

Q6 (a) Explain capital asset pricing model (CAPM) and its various assumptions.

(b) For each of the following cases use the capital asset pricing model to find out the required

return.

A 5 8 1.30

B 8 13 0.90

C 9 12 -0.20

D 10 15 1.00

E 6 10 0.60

Case Rf Rm β R = Rf + β (Rm – Rf)

A 0.05 0.08 1.30 R = 0.05 + 1.30 ( 0.08 – 0.05) = 0.05 + 0.039 = 0.089

B 0.08 0.13 0.09 R = 0.08 + 0.09 (0.13 – 0.08) = 0.08 + 0.0045 = 0.0845

C 0.09 0.12 – 0.20 R = 0.09 – 0.20 (0.12 – 0.09) = 0.09 – 0.006 = 0.084

D 0.10 0.15 1.00 R = 0.10 + 1.00 (0.15 – 0.10) = 0.10 + 0.05 = 0.15

The earning available for common stockholder from this period operation are $1,00,000 which

have been included as partly of $1.9 million retained earnings.

a. what is max dividend per share that the firm can pay (assume that legal capital includes all

paid in capital

b. I the firm have $160,000 in cash. What is the largest per share dividend it can pay without

borrowing?

c. Indicate the accounts and changes, if any, that will result if the firm pays the dividends

indicated in a and b

In case the company is paying stock dividend, than the common stocks will be increased and

retained earnings will be decreased with the corresponding amoung

If the company decided to pay cash dividend, than the cash will be reduced and the retained

earning will also be reduced with the corresponding amount.

Q8 ABC telecom Co. has the following capital structure which is considered optimal

(Rs. In million)

The cost of debt is 10 percent before tax, the cost of preferred stock is

12.5 percent and the cost of equity is 15.4 %. The firm’s marginal tax is 40%. What is cost of

capital of ABC co?

Item Amount of financing Proportion of total finance Cost Weighted cost

Long term debt

0.06

Preferred stock

0.00625

Common stock

0.1001

Cost 0.12435

Financial Management 562 Spring 2002

Q1. Adair industries are considering relaxing its credit standards to increase its currently

sagging sales. As a result of proposed relaxation sales are expected to increase by 10 % from

10,000 to 11,000 units during the coming year. The average collection period is expected to

increase from 45 to 60 days and bad debts are expected to increase from 1 to 3 % of sales. The

sale price per unit is Rs.40 and the variable cost per unit is rs.31. If the firm’s required rate of

return on similar risk investment is 25 %, evaluate the proposed relaxation and make a

recommendation to the firm.

[Investment in receivable

ΔI = [ Change in collection period ] [ Old sales per day ] + [ V ( ACPN )

( New sales per day ) ]

ΔP = [Incremental sales (contributing margin) – (Cost of carrying new receivable) – (Bad debt

losses)]

This indicate that with new proposal, the profit of the company will be increased by

Rs.22,162.36, therefore, company should relax its credit standard.

Q2. Barnstead industries turns its inventory 8 times each year, has an average payment period of

35 days, and ahs an average collection period of 60 days. The firm’s total outlays for operating

cycle investment are 3.5 million. Assuming 360 days a year.

= 60 + 45 = 105 days

(b) Calculate the firm’s daily cash operating expenditure. How much negotiated finance is

required to support its cash conversion policy?

3, 500, 000 (70)

333, 333

105

Q3 Quick Enterprise has obtained a Rs.10, 000, 90 days bank loan at an annual interest rate of

15 %, payable at maturity. Assume 360 days in a year.

(a) How much interest will the firm pay on the 90 day loan?

Amount of interest = 10, 000 (0.15) ( 90 / 360) = 10, 000 ( 0.0375) = Rs.375

(b) Annualize your findings to find the effective annual interest rate for this loan, assuming that

it is rolled over each 90 days throughout the year under the same conditions and circumstances.

Q4 Briefly describe the pro forma income statement preparation process using percent of sale

method. What are the strengths and weaknesses of this approach?

Q5 Winters Design has fixed operating cost of Rs.380, 000, variable cost per unit is Rs.16 and a

selling price of Rs.63.50 per unit.

FC = Rs.380, 000

P = Rs.63.50

V = Rs.16

(b) Calculate the firm’s EBIT at 9, 000, 10, 000 and 11, 000 units respectively.

EBIT = Q ( P – V ) – FC

EBIT = 9, 000 (63.50 – 16.00) – 380, 000 = 9, 000 (47.50) – 380, 000

EBIT = 10, 000 (63.50 – 16.00) – 380, 000 = 10, 000 (47.50) – 380, 000

= 475, 000 – 380, 000 = 95, 000 for 10, 000 units

EBIT = 11, 000 (63.50 – 16.00) – 380, 000 = 11, 000 (47.50) – 380, 000

= 522, 500 – 380, 000 = 142, 500 for 11, 000 units

(c) By using 10, 000 units as a base, what are the % change in units sold and EBIT as sales

shown move from the base to the other levels used in b.

(d) Using the percentage computed in c, calculate the DOL

Rs.95, 000 in a piece of equipment having 5 years life. The firm has estimated the cash flow

associated with the proposal as shown in the following table. The firm has 12 % cost of capital.

Year 1 2 3 4 5

Cash inflow 20, 000 25, 000 30, 000 35, 000 40, 000

0 (95,000) (95,000)

1 20,000 (75,000)

2 25,000 (50,000)

3 30,000 (20,000)

4 35,000 15,000

Total 104081

3 30000 0.6575 19725 0.6407 19221

(d) Evaluate the acceptability of the proposed investment using NPV and IRR.

As IRR is greater than the cost of capital and NPV is positive, we will accept the project.

Q7 Dora wishes to estimate the value of an asset expected to provide cash inflow of Rs.3, 000

per year at the end of the year 1 through 4 and Rs.15, 000 at the end of year 5. Her research

indicates that she must earn 10 % on low risk, 15 % on average risk and 22 % on high risk

asset.

(a) What is the most Dora should pay for the asset if it is classified as low risk, average risk and

high risk?

at 10 % at 15 % at 22 %

She should pay Rs.18, 822.90 or less for low risk asset

She should pay Rs.16, 023 or less for average risk asset

She should pay Rs.13, 032 or less for high risk asset.

(b) All things being the same what effect does increasing risk have on the value of an asset?

Q8 What is the relationship of total risk, non-diversifiable risk and

diversifiable risk? Why is nondiversifiable risk the only relevant risk?

1 Prepared by Mohammad Muzammil

Q.1. Why do short term creditors, such as banks emphasize balance sheet analysis when

considering loan request? Should they also analyze projected income statements? Why?

Begalla Corporation

0Balance Sheet

Accrued taxes 3 2

Common stock 10 10

Retained earnings 15 20

Total 70 70 Total 63 63

Begalla Corporation

Income statement

Sales 95

Depreciation 3

Interest 2 70

Net income before tax 25

Taxes 10

Net income 15

Net income 15

Depreciation 3

==

Q3 Jerome is considering investing in security that has the following distribution of possible

one year return.

What is the expected return and standard deviation associated with the investment?

R P exp. R R-R' (R-R')² (R-R)²P

RxP

0 0.2 0 -0.1 0.01 0.002

R=0

R’ = 0.11

SD = 0.114

R – R’ 0 – 0.11

SD 0.114

or 16.7 %

R – R’ 0.10 – 0.11

SD 0.114

0.297 or 29.7%

For 20 % return

R – R’ 0.20 – 0.11

SD 0.114

From normal distribution table the value for Z=0.7894 is 0.2835

The probability of return between 10 and 20% will be 0.2835 + 0.033 = 0.3165 or 31.65 %

From the above calculations, we can conclude that there is no down side risk.

Q.4. The Anderson corporation (an all equity financed firm) has a sale level of Rs.280, 000 with

a 10% profit margin before interest and taxes.

To generate this sale the firm maintains a fixed asset investment of Rs.100, 000. Currently the

firm has Rs.50, 000 in current asset.

(a) Compute the total asset turnover and compute the rate of return on total asset before taxes.

Total asset turnover = sale / total asset = 280, 000 / 150, 000 = 1.867

Return on total asset before taxes = Net profit margin x total asset turnover

= 10 (1.867) = 18.67 %

(b) Compute the before tax rate of return on assets at different levels of current asset starting

with

capital by 4.4 million. The following three financing alternatives are available. (assume 365 day

year)

(a) Forgo cash discount (granted on the basis of 3/10, net 30 and pay on

the final due date

(b) Borrow 5 millions from a bank at 15%. The alternate would necessitate maintaining a 12%

compensating balance.

(c) Issue 4.7 million of six month commercial paper to net 4.4 million. Assume that new paper

would issue every six months.

Assuming that the firm would prefer the flexibility of bank financing, provided the additional

cost of this flexibility was no more than 2% per annum, which alternative should be selected.

% discount 365

----

2 365 2 365

100 – 2 30 – 10 98 20

Cost of alternative b

Amount of loan actually used = 5, 000, 000 – 600, 000 = 4, 400, 000

Cost of alternative c

14.1 %

The company will choose option C for its working capital financing which has the lower

interest rate.

Q.6. Silicon wafer company presently pays a dividend of Rs.1 per share and has a share price of

Rs.20.

(a) If this dividend was expected to grow at 12% rate forever, what is the firm’s expected or

required return on equity using a dividend discount model approach?

P = -------------

( Ke – g )

%

Ke – 0.12

(b) Suppose that the dividend was expected to grow at a 20% for 5 years and at 10 % per year

thereafter. Now what is the firm’s expected return on equity.

V = 20

D0 = 1

g = 0.10

20 = ------------------------------------

( 1 + Ke)5 ( Ke – 0.1 )

---------

2.76188

= ------------- = 163.909

0.01685

---------

2.8614

= ------------- = 28.8614

0.1

---------

( 1 + Ke)5 ( Ke – 0.1 ) ( 1 + 0.16)5 ( 0.16 – 0.1 ) 2.1 ( 0.06)

2.88628

= ------------- = 22.879

0.126

For Ke = 0.17 the value of R.H.S

2.91116

= ------------- = 18.965

0.1535

By interpolation:

Q.7. Bruce read enterprise is attempting to evaluate the feasibility of investing Rs.95, 000 in a

piece of equipment having a 5 years life. The firm has estimated the cash inflows associated

with the proposal as shown in the following table. The firm has a 12 % cost of capital.

(a) Calculate the pay back period for the proposed project:

The payback period will be 4 years.

(b) NPV of the project:

Sum 104085

NPV at 15 %

Year C.F PV at 15 % PV

Sum 95940

Year (t) 1 2 3 4 5

Cash in flow 20, 000 25, 000 30, 000 35, 000 40, 000

95, 000 20, 000 75, 000

30, 000 20, 000

NPV at 16 %

Year C.F PV at 16 % PV

Sum 93405

8. If all companies had an objective of maximizing shareholder’s wealth, would people overall

tend to be better or worse off? How?

Q.No.1. If a firm earns its interest expanse 15 times and the interest expanse in 17,000, what is

its net income? If it has lease payment of 110,000, what is its fixed financial charge coverage?

(Assume a 40% tax rate)

EBIT

Interest expanses

EBIT + lease payment

Q.No.2. Explain the relationship between break even analysis and operating leverage for a firm

with high fixed costs. What about a firm high variable cost? What are weaknesses of break even

analysis?

Q.No.3. Scifie is attempting to project its year ahead external financing requirements. It projects

a 30 % increase in sales from its current level of 25 million. Its spontaneous assets are estimated

to be 70 % of sales, and its spontaneous liabilities are 48 % of sales. Scifie’s profit margin is 10

% and its dividend pay out ratio is 25 %. Can you help Scifie estimate its external financing

requirement for next year.

Q.No.4 Walter, who is the investment manager for Vista Mutual fund, estimates the following

portfolio returns and risks.

Portfolio 1 2 3 4

Expected return % 11 14 18 21

Standard deviation % 5 12 20 30

Which option should he choose if his cost of borrowing is 10 % and risk free investment earn

10 %?

Portfolio 2 return = ( 14 – 10 ) / 12 = 0.33

Q.No.5. Low enterprises need one of two machines. Machine A costs 18,000 and has a cash

flow of 4,900 a year for six years. Machine B costs 24,000 and has cash flow of 6,500 a year for

six years. Low has 12 % cost of capital. Calculate each machine NPV, IRR and PI and evaluate

the result?

Calculation of NPV

For project A

= (4,900)(4.111) – 18,000

For project B

= (6,500)(4.111) – 18,000

Calculation of IRR

For project A

*2

= 16 + 0.12 = 16.12

For project B

By interpolation IRR = 14 + 47.5 / ( 1278.5 + 47.5 ) = 14 + (47.5 / 1326 )

*2

= 14 + 0.072 = 14.072

Profitability index:

For project A

1.119

For project B

Q.No.6. What are the five characteristics looked by the financial manager in making a credit

decision on a customer? What are some of the drawbacks in using this criterion?

(a) Calculate the length of operating cycle and briefly describe what it shows.

= 360 / 60 = 6 days

over

= 360 / 30 = 12 days

Operating cycle = Inventory turnover in days + Receivable turnover in

days

= 6 + 12 = 18 days

(b) Calculate the length of cash cycle and briefly describe what it shows.

Accounts payable turnover in days = No. of days in a year / Accounts payable turn

= 360 / 45 = 8 days

= 18 – 8 = 10 days

Q.No.8. BB corporation’s stock has a beta of 1.5. You expect dividend of 8 per year for the next

three years. Right now the market rate of return is 16 % and the risk free rate if 12 %.

β = 1.5

or 18 %

(b) To obtain you required return, how much will BB stock have to sell for in three years if

today’s price is 50

D = dividend = 8

P0 = current price = 50

D D D P3

8 8 8 P3

P3 = 53.55

(c) If the stock price goes form 50 to 52 in three years, are you receiving enough return for

the risk taken?

Q.1 Define the characteristics line and its beta. Why is beta a measure of systematic risk? What

is its meaning?

Q.2 Tripex consolidated industries owns $ 1.5 millions in 12 percent bonds of Solow electronics

company. It also owns 100000 shares of preferred stock of Solow, which constitute 10 % of all

outstanding Solow preferred shares. In the past year, Solow paid the stipulated on its bonds and

dividends of $ 3 per share on its preferred stock. The marginal tax rate of Tripex is 34 %. What

taxes must Tripex pay on this interest and dividend?

Note: It is assumed that tripex consolidated Industries has owned the stock for at least 45 days.

Q.3 Presently the risk free rate is 10% and the expected return on the market portfolio is 15%.

Market analyst return expectations for four stocks listed here together with each stock’s

expected beta.

Stock Expected return Expected beta

Union Paint Co. 14.5% 0.8

Undervalued?

R = Rf + β (Rm – Rf)

why is the analysis of trends in financial ratios important?

Q.5 Determine that annual percentage interest rate for each of the following terms of scale

assuming that the firm does not take cash discount but pays on the final day of the net period

(assume a

year)

1 365

(b) = ----------- X ----------- X 1,000 = (2 / 98) (365 / 30 ) (1,000) = 248

100 – 2 10 – 53 365

(d) = ----------- X ----------- X 250 = (3 / 97) (365 / 20 ) (250) = 141

100 – 3 30 – 10

Q.6 Define a stock dividend and a stock split what is the impact of each on share value? What is

dividend reinvestment plan and how might it help the shareholder?

Q.7 What is the difference between a public and private issues of securities? And define a

standby arrangement and over subscription privilege. Why are they used? Which do you think is

used

more often?

Q.8 Explain the concept of synergy. What is the purpose of a two tier tender offer? And what

are the motivations of going private? Do the shareholders who are bought out gain anything?

Q.1 Give the information that follow, prepare a cash budget for the Sitara Group industries for

the first six months of 19X2

c. With respect to credit sales. 60% are collected in the month after the sale, 30% in the second

month, and 10% in the third. Bad-debt losses are insignificant.

e. Payments for purchases of merchandise are 80% of the following month's anticipated sales.

January 30,000 February 40,000 March 50,000

h. Interest of $7,500 is due on the last day of each calendar quarter, and

no quarterly cash dividends are planned.

k. The company has a cash balance $100,000 at December 31, l9Xl, which is the minimum

desired level for cash. Funds can be borrowed in multiples $5,000 (Ignore interest on such

borrowings.)

250,000 200,000

Credit sales (75%) 225,000 262,500 300,000 112,500 150,000 150,000 225,000 187,500

150,000

Collection

Cash 75,000 87,500 100,000 37,500 50,000 50,000 75,000 62,500 50,000

Payments

Net cash inflow 126,750 31,750 (95,750) (80,750) 55,500 (69,500)

Q.2 The Kari Kid Corporation manufactures only product: planks. The single raw material used

in making planks is the dint. For each plank manufactured 12 dints are required. Assume that

the company manufactures 150,000 planks per year, that demand for planks in perfectly steady

throughout the year, that it costs $200 each time dims are ordered and that carrying costs are $8

per dint per year.

Required:

Q.3 The Dud Company has been factoring its accounts receivable for the past five years. The

factor charges a fee of 2% and will lend up to 80 percent of the volume of receivables

purchased for an additional I .5 percent per month. The firm typically has sales of $500,000 per

month, 70 percent of which are on credit. By using the factor, two savings would be affected.

The firm bank has recently offered to lend the firm up to 80 percent of the face value of the

receivables shown on the schedule of accounts. The bank would charge 15 5 percent per annum

interest plus a 2

percent monthly processing charges per dollar of receivables lending. The firm extends term of

net 30 and all customers who pay their bill do so by the 30th day. Should the form discontinue

its factoring arrangement in favor of the bank’s offer if the firm borrows, on the average,

$100,000 per month on its receivables’?

Factoring Fee $7,000

Landing 1,500

$8,500

Interest $1,250

$8,750

Q.4 North Great Timber Company will pay a dividend of $1.50 a share next year. After this

earnings and dividends are expected to grow at a 9 percent annual rate. Indefinitely, Inventory

presently requires a rate of return of 13 percent. The company is considering several business

strategies and wishes to determine the effect of these strategies on the market price per share of

its stock.

a. Continuing the present strategy will result in the expected growth rate and required rate of

return stated above.

b. Expanding timber holdings and sales will increase the expected dividend growth rate 11

percent bull will increase the risk of the company. As a result the rate of return required by

investors will increase to 16 percent.

c. Integrating into retail stores will increase the dividend growth rate to 10 percent and

increase the required rate of return to 14 percent.

(d) From the standpoint of market price per share, which strategy is best?

The present strategy and strategy ‘C’ result in the same market price per share.

Q.5 Discuss the adjustments in capital budgeting process that should be made to compensate for

expected inflation.

Q.6(a) What are the three major functions of the financial manager? How are they related?

Q.6(b) Why are dividends the basis for the valuation of common stock?

Q.7(a) Who is able to issue commercial paper and for what purpose?

Q.7(b) Compare and contrast a line of credit and a revolving credit agreement.

Q.8(b) Explain why a long term creditor should be interested in liquidity ratios.

Financial Management 562 Spring 2007

• Financial Management,

• Progressive taxation

Q.2 Assume that you will be opening a savings account today by depositing S 100000. The

savings account pays 5 percent compound annual interest and this rate is assumed to remain in

effect for all future periods. Four years from today you will withdraw R dollars. You will

continue to make additional annual withdrawals of R dollars for a while longer—making your

last withdrawal at the end of year 9—to achieve the following pattern of cash flows over time.

Note: today is time period zero; one year from today is the end of time period 1; etc.)

0123456789

││││││││││

RRRRRR

How large must R be to leave you with exactly a zero balance after your final R withdrawal is

made at the end of year 9?

123456789123

PVA9 │ │ │ │ │ │ │ │ │ ─ PVA3 │ │ │

RRRRRRRRRRRR

(4.108) – R (2.723)

Q.3(a) A 20-year bond has a coupon rate of 8%, and another bond of the same maturity has a

coupon rate of 15%. If the bonds are alike in all other respects, which will have greater relative

market price decline if interest rates increase sharply? Why?

Q.3(b) Could a security’s intrinsic value to an investor ever differ from the security’s market

value? If so, under what circumstances?

Q.4 Salt Lake City Services, Inc; provides maintenance services for commercial buildings.

Presently, the beta on its common stock is 108. The risk free rate is now 10%, and the expected

return on the market portfolio is 15%. It is January I. and the company is expected to pay a $2

per share dividend at the end of the year, and the dividend is expected to grow a compound

animal rate of 11% for many years to come. Based on the CAPM and other assumptions you

might make what dollar value would you place on one share of this common stock?

15 %

Q.5 The Dud Company purchases raw materials on terms of "2/10, net 30”. A review of the

company’s records by the owner, Ms. Dud, revealed that payments are usually made 15 days

after purchases are received. When asked why the firm did not take advantage of its discounts,

the bookkeeper, Mr. Blunder, replied that it costs only 2 percent for these funds, whereas a bank

loan would cost the firm 12 percent.

“2/10, net30.”

2- After giving up discounts, he is usually making payments 15 days after purchases are

received.

3- Bank loan is more costly than trade credit funds.

But as the Dud company usually makes payments 15 days after purchases are received, the real

cost of not taking discounts would be much as worked out below:

(c) If the firm could not borrow from bank and were resort to the trade credit funds, what

suggestion might be made to Mr. Blunder that would reduce the annual interest cost?

If the company could not avail discount it should make its payments on the final due date, i.e.,

30 days after purchase are received. And if possible, these payments can be stretched for a

period of a week or

10 days.

Q.6 Mendez Metal Specialties. Inc. has a seasonal pattern to its business. It borrows under a line

of credit from Central Bank at 1% over prime. Its total asset requirements now (at year end) and

estimated requirements for the coming year are (in millions):

Presently, the company has $4.5 million in equity capital and long term debt plus the permanent

component of current liabilities, and this mount will remain constant throughout the year.

The prime rate presently is 11 % and the company expects no change in this rate for the next

year.

Mendez Metal Specialties is also considering issuing intermediate - term debt at an interest late

of 13.5 %. In this regard, three alternative amounts are under consideration: zero, $ 500,000 and

$ 1 million.

All additional funds requirements will be borrowed under the company’s bank line of credit.

(a) Determine the total dollar borrowing costs for short and intermediate-term debt under

each of the three alternatives for the coming year.

(Assume. that there are no changes in current liabilities other than borrowings). Which

alternative is lowest in cost’?

Alternative 1: 0 intermediate term debt and all finance is from bank borrowing

Q1Q2Q3Q4

Alternative 2: Issuing 500,000 intermediate term debt and rest is financed by bank borrowing

Q1Q2Q3Q4

Total cost = 67,500 + 15,000 + 27,000 = 109,500

Alternative 3: Issuing 1,000,000 intermediate term debt and rest is financed by bank borrowing

Q1Q2Q3Q4

rate, 12 percent versus 13.5 percent, and because it does not pay interest on funds employed

when they are not needed.

(b) Is there a consideration other than expected Cost that deserves your attention?

While alternative 1 is cheapest it entails financing the expected build up in permanent funds

requirements ($500,000) on a short-term basis. There is a risk consideration in that if things turn

bad the company is dependent on its bank for continuing support. There is risk of loan renewal

and of

interest rates changing.

term basis. As a result, only the expected seasonal component of total needs would be financed

with shortterm

debt.

Alternative 3, the most conservative financing plan of the three, involves financing on a term

basis more than the expected build-up in permanent funds requirements. In all three cases, there

is the risk that actual total funds requirements will differ from those that are expected.

Q.7(a) Marsalis Corporation has an after-tax cost of debt of 8%, a Cost of preferred stock oil 12

% and a cost of equity of 16%. What is the weighted average cost of capital (WACC) for this

company? The capital structure of the company contains 20% debt. 10 % preferred stock, and

70% equity.

Cost 0.14 or 14 %

Q.7(b) HAL's computer Store has operating income of Rs.85,000 and interest expense of

Rs,10,000

DFL = EBIT / (EBIT – I) = 85,000 / (85,000 – 10,000) = 85,000 / 10,000 = 8.5

Q.8 A company has total annual sales (all credit) ol $400,000 and a gross profit margin of 20

percent. Its current assets are $80,000: current liabilities $60,000 inventories. $30,000, and

cash, $10,000.

(a) How much average inventory should be carried if management wants the inventory

turnover to be 4?

(b) How rapidly (in how many days) must accounts receivable be collected, if management

wants to have an average of $50,000 invested in receivable?

Accounts receivable in days = 360 (Receivable) / Credit sales = 360 (50,000) / 400,000 = 45

days

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