ALLAMA IQBAL OPEN UNIVERSITY ISLAMABAD ALLAMA IQBAL OPEN UNIVERSITY ISLAMABAD
LEVEL
LEVEL MBA MBA SemesterSemester Spring 2003Spring 2003
Paper
Paper Financial Financial ManagementManagementCC. 562/5535CC. 562/5535 Maximum Maximum Marks Marks 100100 Time
Time Allowed Allowed 3 3 Hrs Hrs Pass Pass Marks Marks 4040
NOTE
NOTE ATTEMPT ATTEMPT FIVE FIVE QUESTIONS. QUESTIONS. ALL ALL CARRY CARRY EQUAL EQUAL MARKSMARKS Q. 1
Q. 1
Why do short term creditors, such as bank
Why do short term creditors, such as banks, emphasize balance sheet analysis when s, emphasize balance sheet analysis when considering loanconsidering loan requests? Should they also analyze projected income statements? Why?
requests? Should they also analyze projected income statements? Why?
Q. 1 Q. 1
Answer:-(Refer to chapter 6 f
(Refer to chapter 6 for detailed analysis of Balance sheet and Projected financial
or detailed analysis of Balance sheet and Projected financial
statements)
statements)
Q. 2 Q. 2
Financial statements for Begalla Corporation follow. Begalla Corporation’s comparative balance
Financial statements for Begalla Corporation follow. Begalla Corporation’s comparative balance sheets atsheets at December 31) in millions)
December 31) in millions)
Assets
Assets 20X1 20X1 20X2 20X2 Liabilities Liabilities 20X1 20X1 20X220X2 Cash
Cash and and equipments equipments $4 $4 $5 $5 Accounts Accounts Payable Payable $8 $8 $10$10 Accounts
Accounts Receivable Receivable 7 7 10 10 Notes Notes payable payable 5 5 55 Inventory
Inventory 12 12 15 15 Accrued Accrued wages wages 2 2 33 Accrued
Accrued taxes taxes 3 3 22 Total
Total Current Current assets assets $23 $23 $30 $30 Total Total CurrentCurrent Liabilities
Liabilities $18 $18 $20$20 Net
Net fixed fixed assets assets 40 40 40 40 Long Long term term debt debt 20 20 2020 Common
Common stock stock 10 10 1010 Retained
Retained earnings earnings 15 15 2020 Total
Total $63 $63 $70 $70 Total Total $63 $63 $70$70
Begalla Corporation’s Income statement 20X2 (in millions) Begalla Corporation’s Income statement 20X2 (in millions)
(a) Prepare a cash flow statement using the indirect method for Begallan Corporation. (a) Prepare a cash flow statement using the indirect method for Begallan Corporation.
(b) Comment on cash flow statement. (b) Comment on cash flow statement.
Sales $95
Sales $95
Cost
Cost of of goods goods sold sold $50$50
Selling
Selling general general and and administrative administrative expenses expenses 1515
Depreciation 3
Depreciation 3
Interest
Interest 2 2 7070
Net
Net income income before before taxes taxes $25$25
Taxes 10
Taxes 10
Net
Q. 2 Answer: - Begalla Corporation Cash Flow Statement
For the year ending December 31, 2002.
(Amount in Millions)
Cash Flows from operating Activities:
Net Income $15
Depreciation 5
Increase, Accounts Receivable (3)
Increase, Inventory (3)
Increase, Accounts Payable 2
Increase, Wages 1
Decrease, Accrued Taxes (1)
_____ 16M
Cash Flows from Investing Activities:
Increase, Fixed Assets (5) (5)
Cash Flow from Financing Activities:
Dividends Paid (10) (10)
Increase in cash and cash equivalent $1M
Cash and cash equivalent Dec31, 2001 4M
Cash and cash equivalent Dec31, 2002. $5M
(b)
Refer to chapter 7 for comments
Q. 3 Jerome J. Jerome is considering investing in a security that has the following distribution of possible one- year returns:
(a) What is the expected return and standard deviation associated with the investment?
(b) Is there much “downside” risk? How can you tell?
Q. 3
Answer: -
(Refer to Q.3 of Spring 2001)
Probability of occurrence .10 .20 .30 .30 .10
Q. 4
The Anderson Corporation (an all-equity-financed firm) has a sales level of $280,000 with a 10 percent profit margin before interest and taxes. To generate this sales volume; the firm maintains a fixed asset investment of $100,000. Currently, the firm maintains $50,000 in current assets.
(a) Determine the total asset turnover for the firm and compute the rate of return on total assets before taxes.
(b) Corporate the before tax rate of return on assets at different levels of current assets starting with $10,000 and increasing in $15,000 increments to $100,000.
Q. 4
Answer:-(a) Total Assets Turnover: Net Sales = $280,000 = $1.867 times Average total assets $150,000
Return on Assets: 10% of $280,000 x 100 = 18.67 % $150,000
(b)
Level Current Fixed Total Return on
Assets Assets Assets Assets
1 $10,000 $100,000 $110,000 25.45% 2 25,000 100,000 125,000 22.40% 3 40,000 100,000 140,000 20.00% 4 55,000 100,000 155,000 18.06% 5 70,000 100,000 170,000 16.47% 6 85,000 100,000 185,000 15.14% 7 100,000 100,000 200,000 14.00% Q. 5
The Pawlowski Supply Company needs to increase its working capital by $4.4 million. The following three financing alternatives are available (assume a 365 -days year):
a. Forgo cash discounts (granted on a basis of ‘3/10, net 30’) and pay on the final due date.
b. Borrow $5 million from a bank at 15 percent interest. This alternative would necessitate maintaining a 12 percent compensating balance.
c. Issue $4.7 million of six-month commercial paper to net $4.4 million. Assume that new paper would be issued every six months. (Note: Commercial paper has no stipulated interest rate. It is sold at a discount, and the amount of the discount determines the interest cost to the issuer.)
Assuming that the firm would prefer the flexibility of bank financing, provided the additional cost of this flexibility was no more than 2 percent per annum, which alternative should Pawlowski select? Why? Q. 5 Answer: - (a) 3 x 365 x 100 = 56.44% 100-3 30 -10 (b) $750,000 x 100 = 17.05% $5,000,000 - $600,000 (c) $750,000 x 100 x 2 = 13.64% $4,400,000
The bank financing is approximately 3.4 percent more expensive than the commercial paper; therefore, commercial paper should be issued.
Q. 6
Silicon Wafer Company presently pays a dividend of $1 per share and has a share price of $20.
(a) If this dividend was expected to grow at a 12 percent rate forever, what is the firm’s expected, or required return on equity using a dividend discount model approach?
(b) Instead of the situation in part (a), suppose that the dividend was expected to grow at a 20 percent rate for five years and at 10 percent per year thereafter. Now what is the firm’s expected, or required return on equity?
Q. 6 Answer:- (a) Ke = D1 + g = $1.12 + 0.12 = 0.176 or 17.6%
P0 $20
(b)
End of year Dividend per share PV@18% PV@19%
1 $ 1.20 $ 1.02 $ 1.01 2 1.44 1.03 1.02 3 1.73 1.05 1.03 4 2.07 1.07 1.03 5 2.49 1.09 1.04 $ 5.26 $ 5.13 Year 6 Dividend = $2.74
Market price at the end of year 5 using the constant growth dividend valuation model.
P5 = $2.74 = $34.25
0.18 – 0.10
P5 = $2.74 = $30.44
0.19 – 0.10
Present value at time O for amount received at the end of year 5:
$34.25 @ 18% = $14.97 $30.44 @ 19% = $12.76 Calculated PV: 18% 19% PV of year 1 – 5 $5.26 $5.13 PV of year 6 -00 14.97 12.76 $20.23 $17.89 By interpolating we get = $20.23 - $20.00 x 1% +18% $23.23 -$17.89 18.098 % or 18.10 %
Q.7 Bruce Read Enterprises in attempting to evaluate the feasibility of investing $95,000 in a piece of equipment having a 5-year life. The firm has estimated the cash inflows associated with the
proposal as shown in the following table.
The firm has a 12 percent cost of capital. Year (t) Cash inflows (CFt)
1 $20,000
2 25,000
3 30,000
4 35,000
5 40,000
(a) Calculate the payback period for the proposed investment.
(b) Calculate the net present value (NPV) for the proposed investment.
(c) Calculate the internal rate of return (IRR) rounded to the nearest whole percent for the
proposed v investment.
(d) Evaluate the acceptability of the proposed investment using NPV and IRR. What
recommendation would you make relative to implementation of the project? Why?
Q. 7
Answer:-(a) Payback period = 3.57 years (b) NPV = PV of FCIFS– ICO
= $104,081 - $ 95,000 = $9,081
(c) IRR: 15.37 15% nearest whole percentage
PV @ 15% = $95,919
PV @ 16% = $93.415
$95919 - $95000 x 1% + 15% $95919 - $93415
= 15.37%
(d) Proposed investment is viable because NPV is positive and IRR is greater than firms cost of capital. Profit ability index comes to 1.096 times.
Q. 8
If all companies had an objective of maximizing shareholder wealth, would people overall ten to be better or worse off? How?