FIN201 Business Finance Assignment Answers

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International Islamic University Faculty of Management Sciences Spring 2020 FIN 201 Business Finance Total Marks: 40 Mid Term Exam Batch: BBA 39

Question No 1:

Assume that you just won state lottery. Your prize can be taken either in the form of $ 40,000 in the end of each of the next 25 years (i.e. $ 1,000,000 over 25 years) or as a lump sum of $500,000 paid immediately.

Required:

(a).  If you expect to be able to earn 5% annually on your investments over the next 25 years ignoring taxes and other considerations, which alternatives should you take? Why?

(b).  Would your decision in (a) be altered if you could earn 7% rather than 5% on your investments over the next 25 years? Why?

(c).  On a strict economic basis, at approximately what earning rate would you be indifferent in choosing between the two plans?

(d).  Differentiate between

(i).  Money Market & Capital Market ii. Market Segmentation Theory & Liquidity preference Theory

Question No 2:

Fitch Industries is in the process of choosing the better of two equal risk, mutually exclusive, capital expenditure projects– A and B. The relevant cash flows to each project are shown in the following table. The firm’s cost of capital is 14%.

Cash flows Project A Project B

Initial Investment $ 28,500 $ 27,000

Year 1 $ 10,000 $ 11,000 2 $ 10,000 $ 10,000 3 $ 10,000 $ 9,000 4 $ 10,000 $ 8,000

Required:

(a).  Use the payback period to assess the acceptability in relative ranking each project. Explain what argument you should make to show that Payback is not appropriate in this case.

(b). Calculate the Discounted payback period (DPP) using 10% as a discount rate. Should you use DPP as the deciding factor? Exlain. c. If management prefers to have a 40% accounting rate of return, which project would be accepted? What is wrong with this decision? d. Assuming equal risk, use the following sophisticated capital budgeting techniques to assess the acceptability and relative ranking of each other.

(i).  NPV

(ii).  IRR e. Summarize the preferences dictated by each measure, and indicate which project youwould recommend. Explain why? f. Calculate the profitability index for each project. Can this measure help to solve the problem? Explain. g. Use your findings in “a” through “f” to indicate on both a (1) theoretical and (2) practical basis which lathe would be preferred. Explain any difference in recommendations.

 

Question No 3:

The financial statements of Mack Industries for the year ended December 31, 2019, follow.

Income Statement Mack Industries For the year ended December 31, 2019 Sales $ 160,000 Less: Cost of goods sold 106,000 Gross Profit $ 54,000 Less: Operating Expenses Selling Expense $ 16,000 General and Administrative Expense 10,000

Lease Expense 1,000 Depreciation Expense 10,000 Total Operating Expense $ 37,000 Operating Profit $ 17,000 Less: Interest Expense 6,100 Net Profit before tax $ 10,900 Less: Taxes 4,360 Net profit after taxes $ 6,540

Balance Sheet Mack Industries December 31, 2019 Assets Cash $ 500 Marketable securities 1,000 Accounts receivables 25,000 Inventories 45,500 Total Current assets $ 72,000 Land $ 26,000 Buildings and Equipments 90,000 Less: Accumulated Depreciation 38,000 Net fixed Assets $ 78,000 Total Assets 150,000

Liabilities and stockholders’ equity Account payable $ 22,000 Notes payable 47,000 Total Current Liabilities $ 69,000 Long term debt $ 22,950 Common Stock $ 31,500 Retained Earnings $ 26,550 Total liabilities and stockholders’ equity $ 150,000 Required:

(a).  Use the preceding the financial statements to complete the following table. Assume that the industry averages given in the table are applicable for both to 2018 and 2019. b. Analyze Mack Industries financial condition as it relates to (1) Liquidity, (2) Activity, (3) Debt, and (4) Profitability. Summarize the company’s overall financial condition. c. Can a firm generate 25% ROA and still be technically insolvent? Explain.

Ratio Industry Average Actual 2018 Actual 2019 Current ratio 1.80 1.84 Quick ratio 0.70 0.78 Inventory Turnover 2.50 2.59 Average collection period 37 days 36 days Debt ratio 65 % 67 % Times Interest earned 3.8 4.0 Gross profit margin 38 % 40 % Net profit margin 3.5 % 3.6 % Return on total assets (ROA)

4.0 % 4.0 %

Return on equity (ROE) 9.5 % 8.0 %

 

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