Introduction to Financial Management

FIN 254 (Assignment)

Spring 2014 (Due on 24th April 10-11.00 AM)

AT NAC 955

1. You have recently started working with a new company and have been having discussions

with your employers superannuation consultants about providing for your retirement. You plan

to retire 35 years from today, which is 1st October 2008. After discussions with the consultants

you agree that you should plan for an income of $80,000 per year for a period of 20 years. You

plan to retire on 1st October 2043 but will use your accumulated long service and annual leave

payments for the first three years of your retirement and receive the first of the 20 annual

retirement payments of $80,000 on 1st October 2046.

During your term of employment you will make annual contributions into the superannuation

fund with the first contribution occurring on 1st October 2009 and the last on 1

st October 2043. If

the superannuation fund expects to earn 12% per year over the next 60 years what is the size of

the annual contribution that you must make into the fund to provide the annual retirement

payments. (Show all workings).

Answer:

This is just a simple annuity question. What we are given is the future value, FV = $80 000. The

length of time, n = 35 years and the superannuation fund expects to earn 12% per year, i = 12%.

So what we are trying to find is the annual contribution. Now if you had a financial calculator

this would be very simple, if you do not this is the formula:

Hence, FV = C [(1+i) ^n -1] i

We fill in our given values and solve for C.

$80 000 = C [(1.12) ^35 - 1] 0.12

C = $12870.11

Therefore the amount of the annual contribution is $12870.11

2. from the operations of Smart Computer Company (SCC), a business selling personal

computers. The following ratios and information have been extracted from the companys books.

2004 2005 2006 2007 2008

Currents Assets 220 203 198 190 236

Total Assets 1220 1203 1198 1190 1235

Sales 1000 950 855 770 615

Profit after tax 157 146 124 105 67

Ratios 2004 2005 2006 2007 2008

Current Ratio 5.2 4.6 3.9 3.3 2.6

Quick Ratio 3.2 2.6 1.9 1.3 0.6

Inventory

Turnover

7 6.5 5.0 4.0 2.0

Receivables

Turnover

8 9 10 12 15

Debt to equity .47 .45 .43 .41 .43

Return on Assets 12.9 12.12 10.4 8.8 5.4

Return on Equity 19.7 18.3 15.6 13.1 8.4

A) How SCCs has inventory turnover ratio performed over the period 2004 to 2008?

Answer:

Smart Computer Company had performed in actual fact imperfectly. Because SCC had achieved

very fewer inventory ratio over the year. As we know low inventory turnover ratio is a signal of

inefficiency, since inventory usually has a rate of return of zero. A low turnover rate can indicate

poor liquidity, possible overstocking, and obsolescence. A high inventory turnover ratio implies

either strong sales or ineffective buying. It can indicate better liquidity, but it can also indicate a

shortage or inadequate inventory levels, which may lead to a loss in business.

So, for SCC it is pretty bad impact in inventory level.

B) How SCCs has Accounts receivable turnover ratio performed over the period 2004

to 2008?

According to account receivables turnover ratio I see Smart Computer Company accomplished

very fastidious turnover over the year. They did in reality superior in terms of account

receivables turnover. This turnover increased over the year and year with well-bred size.

Because we know, Accounts receivable turnover measures the efficiency of a business in

collecting its credit sales. Generally a high value of accounts receivable turnover is favorable and

lower figure may indicate inefficiency in collecting outstanding sales. Increase in accounts

receivable turnover overtime generally indicates improvement in the process of cash collection

on credit sales.

However, a normal level of receivables turnover is different for different industries. Also, very

high values of this ratio may not be favorable, if achieved by extremely strict credit terms since

such policies may repel potential buyers.

C) From the information and ratios above give some brief comments on SCCs

operations particularly in relation to current asset management?

SCC makes mediocre position what current ratio said.

Over the year and year its really close with poorer figure. Since we know the ratio is mainly

used to give an idea of the company's ability to pay back its short-term liabilities (debt and

payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio,

the more capable the company is of paying its obligations. A ratio under 1 suggests that the

company would be unable to pay off its obligations if they came due at that point. While this

shows the company is not in good financial health, it does not necessarily mean that it will go

bankrupt - as there are many ways to access financing - but it is definitely not a good sign.

Current ratio below 1 shows critical liquidity problems because it means that total current

liabilities exceed total current assets.

Abnormally high value of current ratio may indicate existence of idle or underutilized resources

in the company.

Basically SCC act upon in reality very shocking regard as on overall performance when I see my

eyes on ROA ratio. Over the year and year its going down. Because increased ROA indicates

improved performance. The assets of the company are comprised of both debt and equity. Both

of these types of financing are used to fund the operations of the company. The ROA figure

gives investors an idea of how effectively the company is converting the money it has to invest

into net income. The higher the ROA number, the better, because the company is earning more

money on less investment.

This is an indicator of a companys short-term liquidity. The quick ratio measures a companys

ability to meet its short-term obligations with its most liquid assets. For this reason, the ratio

excludes inventories from current assets. The quick ratio measures the dollar amount of liquid

assets available for each dollar of current liabilities. Thus, a quick ratio (of 1.5) means that a

company has $1.50 of liquid assets available to cover each $1 of current liabilities. The higher

the ratio, the better it (company's liquidity position) is.

So it was really well in beginning year. But year by year its decreasing as results their liquidity

assets going down.

3. The WOKO Company has complied the following data related with its capital structure plus

additional information on its capital structure instruments.

Type of Finance Book value

Debentures $10 million

7%, $10 Preference Shares $5 million

4 million, $2 Ordinary Shares $8 million

1. WOKO issued the debentures 10 years ago. Each debenture has a face value of $100,000 and

they have another 20 years before they mature. Interest is paid yearly at a rate of 13% pa.

Currently a $100,000 debenture is trading in the market at a yield of 9% pa.

2. The preference shares pay a fixed dividend of 7% and are selling in the market at $6.50.

3. WOKOs Ordinary shares have a beta of 1.2. The current return on the market portfolio is

11% and return on Government debt is 4.5%. The ordinary shares are trading at $2.25

a) What is the market value of debentures? (1 mark)

Answer:

$100*100000 debenture=$10 million

b) What is the market value of preference shares? (1/2 mark)

Answer:

$10*5 million=50 million

c) What is the market value of equity? (1/2 mark)

Answer:

$2*4 million=$8 million

d) What is the current market required rate of return on preference shares? (1 mark)

The current market required rate of return on preference shares:

Given, dp =7%

Dp =10*7%=.7

Np=6.50

kp=(Dp/Np)*100

= (.7/6.50)*100

=10.78%

e) What is the current market required rate of return on ordinary shares? (1 mark)

The current market required rate of return on ordinary share:

Given, krf=4.5%,

Km=11%,

Beta= 1.2,

So, Kr= (krf+ (km-krf)*beta) *100

= (.045+ (.11-.045)*1.2)100

=12.3%

f) What is the weighted average cost of capital for WOKO if the company tax rate is

30%? (1 mark)

Cost of debenture

Given, n=20years

M= 100,000

Nd=109000

c= 13%

C= 100000*13%= 13000

Cost of Debenture: kd= C+ (M-Nd)/n

M+Nd

2

=13000+ (100000-109000)/20

= 100,000+109000

2

= 12.00%

Hence, WACC= WD*KD (1-t) +WP*KP (1-t) +WE*KE (1-t)

= 43.48%*12.00% (1-.30) +21.74%*10.78% (1-.30) +34.78%*12.3% (1-.30)

= 43.48%*8.40%+21.74%*7.55%+34.78%*8.61%

= 3.65%+1.64%+2.99%

= 8.28%.

4. One star Productions is looking at two mutually exclusive investment proposals. One star has

been using a payback period of three years for its investment projects and a new Chief Financial

Officer has said that One Star should be using a required rate of return of 14%. The two projects

cash flows are set out below using this information answer the following questions:

Project Year 0 Year 1 Year 2 Year 3 Year 4

Alpha -20,000 Nil 25,000 Nil -5000

Omega -30,000 5,000 5,000 5,000 30,000

a. Using the payback method calculates the payback for each project and which

project would you select using the payback method?

#Payback period for Project Alpha = 1 year+ 20000/25000*12 month

= 1 year 9.6 month

= 1 year 9 month 18 days

#Payback period for Project Omega = 3 year+ 15000/30000*12 month

= 3 year 6 month

However, I am going to invest my money on Project Alpha. Because I will get back my initial

capital swiftly rather investing on Project Omega. But for long time like year four project alpha

will be hammering project rather than project omega. After 3 year project alpha will be appear

some sort of loss amount but project omega wont.

b. Using the NPV method, calculate the NPV of each project and which project would

you select using the NPV method?

Project Year 0 Year 1 Year 2 Year 3 Year 4

Alpha -20,000 Nil 25,000 Nil -5000

Omega -30,000 5,000 5,000 5,000 30,000

Rate of return of 14%

#Net Present Value for Project Alpha

= -20000+0/ (1+.14) ^1+25000 / (1+.14) ^2+ 0/ (1+.14) ^3-5000/ (1+.14) ^4

= -20000+0+16874.29+0-2960.40

= -6086.11

#Net Present Value for Project Omega

= -30000+5000/ (1+.14) ^1+5000/ (1+.14) ^2+5000/ (1+.14) ^3+30000/ (1+.14) ^4

= -30000+4385.96+3847.34+3374.86+17762.41

= -629.43

After using NPV method Project Omega is far better than Project Alpha. Since NPV for Project

Alpha is too high negative return whereas Project Omega has lower negative return.

c. Give one reason why you would not use the payback period as a selection method

for investment decisions.

Answer:

I am never going to invest following payback period method. There are some considerable

predicaments in payback period.

Firstly, Payback ignores the time value of money. Thats why for long time it will show

loss. Ultimately it has.

Secondly, Payback ignores cash flows beyond the payback period, thereby ignoring the

"effectiveness" of a project.

Finally, Pay back period gives high emphasis on liquidity and ignores profitability.