Assignment Help for Financial Accounting

SECTION 1: SHORT ANSWER PROBLEMS
  1. Vindaloo Corporation reported retained earnings of $400 on its year-end 2002 balance sheet. During 2003, the company reported a loss of $40 in net income, and it paid out a dividend of $60. We will calculate retained earnings for Vindaloo's 2003 year-end balance sheet.


 

Retained earnings for Vindaloo's 2003.










ParticularsAmount
Retained Earning 2002400
Less : Loss during The year40
Less : Divided pay out60
Retained Earning 2003300

 
  1. A firm has an ROA of 8%, sales of $100, and total assets of $75. Lets calculate its profit margin.













Total Assets  $    75.00
 8% ROA  $       6.00
 (Total Assets * ROA = 75*(8/100) = 6) 
 Total Sales  $  100.00
 Profit Margin $       6.00
 (Profit / Total Sales = ) 

 
  1. Given the following information: profit margin = 10%; sales = $100; retention ratio = 40%; assets = $200; equity multiplier = 2.0. If the firm maintains a constant debt-equity ratio and no new equity is used, what is the maximum sustainable growth rate (SGR)?  (Assume a constant profit margin.)



































ParticularsDetails
profit margin10%
Sales100
Total Profit10
Retention4
Total Assets200
Equity Multiplier2
Total equity100
(Total Assets/ equity multiplier) 
Total debt100
Debt Equity ration constant 
  
ROE0.1
Retention Ratio40%
ROE* Retention Retio0.04
1-ROE* Retention Retio0.96
SGR=ROE*R.R/1-ROE*R.R4.17%
Your brother-in-law invests in the stock market and doubles his money in a single year while the market, on average, earned a return of only about 15%, here a discussion is done whether  your brother-in-law’s performance a violation of market efficiency or not.

 

No, brother in law performance is not violation of market efficiency; this indicates that Brother in law has taken much higher risk than the average market. If it suits him so be it (Preda, 2009). 
This could also indicate that the Brother in law had some good market tips and exited at most opportune time without hanging around with the stocks.
  1. Iggie's Used Cars will sell you a 2002 Suzuki Aerio for $3,000 with no money down. You agree to make weekly payments of $40 for two years, beginning one week after you buy the car.  What is the EAR of this loan?

For calculating Ear, formula is

Where EAR=Effective annual rate
K=Nominal interest rate
M=Compounding frequency per year (Randall, 2007)

c

NOMINAL RATE OF INTEREST= (difference in total amount paid per year/total amount paid)/100

[ 4160-3000=1160 For 2 yrs = 580 per yr]

=(580/3000)*100= 19.33%

Putting value in EAR we get

                                52

EAR = (1+19.33/52) – 1

Solving this we get EAR= 21.2812 %
  1. Rebus company is trying to make a decision between two projects. Their calculations are as below.
























   
YearProject IProject II 
Payback (yrs.)2.053 Year1.92 Year 
Discounted Payback (yrs.)2.44 Year1.25 Year 
IRR15.41%28.44% 
NPV39073843 

 
  1. Payback period calculation



















PROJECT APROJECT B
Cash inflowcumulative cash inflowCash inflowcumulative cash inflow
8500850065006500
900017500600012500
950027000700019500
Project A

Payback period = 2 yrs + [18000-17500 / (27000-17500)]

                        = 2.053 years

Project B

Payback period = 1 yrs + [12000-6500/ (12500-6500]

                        = 1.92 years

 

 
  1. Discounted Payback period calculation



































PROJECT APROJECT B
Cash inflowDiscounted fector (11%)cumulative cash inflowCash inflowCash inflowDiscounted fector (11%)cumulative cash inflowcumulative cash inflow
85000.90097657.657657.6565000.90095855.855855.85
90000.81167304.414962.0560000.81164869.610725.45
95000.73116945.4521907.570000.73115117.715843.15
Project A

Discounted Payback period = 2 yrs + [18000-14962 / (21907-14962)]

= 2.44 years

Project B

Payback period = 1 yrs + [12000-10725/ (15843-10725]

= 1.25
  1. Net present value (11%IRR)

Project A

21907-18000=3907

Project 2

15843-12000= 3843

Calculation of internal rate of return (IRR)

 
































































































































PROJECT A 
yearcash inflowdiscounted factor@15%discounted cash inflowdiscounted factor@16%discounted cash inflowdiscounted factor@14%discounted cash inflow 
180000.86969520.8625992.6240.8775255.5 
295000.75671820.7435336.2260.7694103.5 
390000.65759130.643784.320.6742550.6 
  3.351200473.27315113.173.27311909.7 
         
IRR using interpretation formula Project A = 15% - (18000-15113.17/ 20047-15113) = 15% - 0.5851 = 15.415% 
 
PROJECT B 
yearcash inflowdiscounted factor@28%discounted cash inflowdiscounted factor@29%discounted cash inflowdiscounted factor@30%discounted cash inflow 
165000.78135078.450.77525038.80.76924999.8 
260000.61043662.40.60013600.60.59173550.2 
370000.47733390.46583260.60.45513185.7 
  3.35112079.853.27311900 11735.7 
         
IRR using interpretation formula Project A = 29% - (12000-11900/ 12080-11900) = 29% - 0.556 = 28.44% 
 
          
 SECTION 2

Problem 1

 































































































AssetsAmount25%90% capacity of acutal 
Cash5062.545 
Inventory150187.5135 
FA600750540 
Total8001000720 
LiabilityAmount25%  
Accounts payble10012590 
Notes payble100125 90 
long term Debt350434 477 
Equity250250 250 
 8001000  
Reserves and Surplus066 47 
     
ParticularsAmount25% 90% of actual 
Sales8001000720 
Cost600750540 
Profit200250180 
Taxes688561 
 132165119 
a)
  1. External finance if sales increased by 25% :

Effect of increase in 25% sasles is already given in the table above.

As menationed in question, 40% is retained.

So retained profit=165*40/100=66 (add as reserves and surplus to liability)

Now if we balance both sides we get Long Term debt = $ 434

So total external financing need is $434.
  1. Firm is producing at only 90% capacity

In this case, looking at figures in above calculation, external financing will increase from $434 to $477 due to decrease in working capacity. Since amount of profit retained is less, the firm has to maintain more external financing to meet its requirement.
  1. B) Suppose the firm wishes to maintain a constant debt-equity ratio, retains 60% of net income, and raises no new equity. Assets and costs maintain a constant ratio to sales.   What is the maximum increase in sales the firm can achieve.

Lets find debt equity ratio.



Debt-to-Equity Ratio = Total Liabilities
Shareholders' Equity

 

                                    = 800/250 = 3.2

Looking at the calculation above, there can be no change in total liability or equity amount as debt equity ratio is to be maintained. So any change to be made in liability side can be only done through change on long term debt. As plant is already operating on 100% capacity, the maximum possible sale is $800

Problem 2

 The managers of Magma International, Inc.  plan to manufacture engine blocks for classic cars from the 1960s era.  Cetain values are given. We will calculate following things

1) Depreciation tax shield in the third year for this project (Nissim, 2002).

CCA at 30% = Machinery Cost*30%

Depreciation tax shield = Machinery cost- CCA












Machinery costCCA @30%Depreciated Tax shield
800000240000560000
560000168000392000
392000117600274400

 

2) Present value of CCA tax shield






























Machinery costCCA @30%Depreciated Tax shieldDiscounting FactorPresent value of Cca tax shield
8000002400005600000.892857143500000
5600001680003920000.797193878312500
3920001176002744000.711780248195312.5
274400823201920800.635518078122070.3125
192080576241344560.56742685676293.94531

 

Discounted Value @ 12% = 1st year = 1/1.12

                                             = 2nd yr = 1st year discounted rate/ 1.12

 

3)  the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation

 
















price of machine800000
cost for block125000
fixed cost125000
total cost1050000
less salvage value150000
total cost900000
less depreciation @30%630000
add: Tax@35%850500
From above table, the firm has to bid a minimum amount of $850500. It can add industry profit to it and bid accordingly.

4) NPV of this project









































































































Inflow      
YearProfitDepreciationPBTPATDisc Factor @ 8%PV of Cash Profit
215000045000105000367500.89285714332812.50001
315000045000105000367500.79719387829296.87502
415000045000105000367500.71178024826157.92411
515000045000105000367500.63551807823355.28937
615000045000105000367500.56742685620852.93696
      0
    Total PV cash profit 132475.5255
Salvage of plant & machinery   150000  
       
TOTAL INFLOW      
       
Net cash Inflow   -17524.47454  
       
PROBLEM 3
  • cost of equity based on the dividend growth model

Cost of Equity = (Next Year's dividends per share / Current market value of stock) + Growth rate of dividends

                        = (1.8/8)+4% = 6.17%

Cost of equity = 6.17 %
  • cost of equity based on the security market line

Cost of equity = rf + Bs(Emkt - rf)

Where: rf = the risk-free rate
Bs = the beta of the investment
Emkg = the expected return of the market

Here cost of equity = 4+ 1.2 (12-4) = 13.6 %
  • the cost of financing using preferred stock

The cost of preferred stock is equal to the preferred dividend divided by the preferred stock price, plus the expected growth rate.

SO here in this case, Cost of Preferred stock = (1.8/83)+12 = 12.01
  • pre-tax cost of debt financing

lets calculate

1- (Company tax rate/100) = 0.66

            Pre tax costing = (400000*83)/.66 = $50303030

 
  • weight to be given to equity in the weighted average cost of capital computation

In financial decision making, financing of firm’s assets is done by either debt or equity. The weighted average cost of capital (WACC) measures the average riskiness of a firm's assets by calculating the weight of debt and equity to any given situation. In effect, by calculating a weighted average, a firm can estimate the capital discount of debt and equity in dollar terms.

Formula for this is

WACC = Wd x Rd(1-T) + Ws x Rs + Wp x Rp

where:
  • Wd: the weight of debt (percentage of debt allocated to finance the project)
    • Ws: the weight of equity (percentage of equity allocated to finance the project)
    • Wp: the weight of preferred stocks (percentage of preferred stocks allocated to finance the project)

So for this case, percentage of equity allocated to finance the project = (total equity allocated/ total amount of financing)*100
  • the cost of new financing (including the impact of each of 28-year bonds, preferred shares and common shares), assuming that flotation costs would be 5% of the proceeds of the issue

the cost of financing will have effect of floatation cost at 5% will will affect equity.
  • If net income in the next year is expected to be $8,000,000, what would be the common equity breakpoint for new financing, assuming the current capital structure is considered optimal

Current capital structure is optimal

Breakeven ppoint = Available Retained Earnings = 800000/10 = 80000

                            Equity Percentage of Total

REFERENCES:
  • Randall, S. (2007). “FRB Speech: Creating More Effective Consumer Disclosures".

  • Preda, A. (2009). “Framing Finance: The Boundaries of Markets and Modern Capitalism.” University of Chicago Press.

  • Nissim, D. (2002). "Valuation of the Debt Tax Shield". The Journal of Finance 57 (5): 2045–2073.

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