1. cf review class

7/29/2019 1. CF Review Class

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Corporate Finance Review - 1


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Chapter 30: Working Capital

Management

Question 2.

(a) 98*(1+i)^(30/365) = 100

(1+i) = (100/98)^(365/30)

(1+i) = (1.0204)^(12.1667) I = 27.86% p.a

(b) 98*(1+i)^(25/365) = 100

(1+i) = (100/98)^(365/25)

(1+i) = (1.0204)^(14.6)

I = 34.29% p.a


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Chapter 30: Working Capital

Management

3.Original case: Sales = $ 100; Cost = $ 95; Profit = Sales Cost = $ 5.

By offering the credit, the new sales would go up by 4%.The new sales = 100*(1+0.04) = $ 104.

Alternative 1: Assume that customers take the cashdiscount offered under the new terms. So, new sales willbe 0.98*104 = $ 101.92 at the end of 10th day.

FV of sales = $ 101.92; i =0.06; n = 10/365; PV of sales = ?

PV = FV/(1+i)^n;

The present value of sales = $ 101.757

Profit = 101.757 95 = $ 6.757


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Cont..d

Alternative 2: Assume that the customers will pay

on 30th day.

FV of sales = $ 104; i =0.06; n = 30/365;

PV of sales = ?

Profit = $ 103.503 - $95 = $8.503

In either case, granting credit increases profits.


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Question 4, 5 & 7


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Question 11

a. An increase in interest rates should decrease cash

balances, because an increased interest rate implies a

higher opportunity cost of holding cash.

b. A decrease in volatility of daily cash flow means

stability of cash flows. This should decrease cash

balances.

c. An increase in transaction costs should increase cash

balances and decrease the number of transactions.


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Challenge Question 1:

Selling price (in $) = 10

Sales (in units) = 30,000

Sales (in $) = 300,000

Profit (in $) = 47,000

Cost of goods sold = ($300,000 - $47,000)/30,000

= $8.43 per unit.


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Cont..d

Assume that, if Plumpton pays, it does so on the duedate. Then, at a 10 percent interest rate, the netpresent value of profit per unit is:

NPV per unit = PV(Sales price)

Cost of goods NPV per unit = [$10/(1.10)(60 /365)] $8.43 = $1.41

If Plumpton pays 30 days slow, i.e., in 90 days, thenthe NPV per unit = [$10/(1.10)(90 /365)] $8.43 = $

1.34.


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Cont..d

Reliant has to assess the Plumpton credit worthiness andcompare with it with the industry.

Credit information includes a fair Dun and Bradstreetrating, but some indication of current trouble (i.e., other

suppliers report Plumpton paying 30 days slow) andindications of future trouble (a pending re-negotiation ofa term loan).

Financial ratios can be calculated and compared withthose for the industry (i.e., Debt Equity ratio, Current

ratio, Quick ratio, Net profit ratio, Total Assets turnoverratio, Inventory turnover ratio, Return on total assetsratio and Return on Equity ratio).


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Cont..d

Some things the credit manager should consider are:

What does the stock market seem to be saying aboutPlumpton?

How critical is the term loan renewal? Can we get more

information about this from the bank or delay the creditdecision until after renewal?

Is there any way to make the debt more secure, e.g., use apromissory note, time draft, or conditional sale?

Should Reliant seek to reduce risk, e.g., by a lower initial orderor credit insurance? How painful would default be to Reliant?

What alternatives are available? Are there better ways toenter the Nevada market? What is the competition?


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Chapter 34: Governance and

Corporate Control Around the World

Question 1. a. Managers have a fiduciary duty to

shareholders, it is human nature for managers to put

their own interests ahead of those of the

stockholders when there is a conflict in objectives. It is impossible for stockholders to monitor the

actions of all managers at all times, so agency

problems are inevitable.


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Cont..d

b. The types of mechanisms used to keep agency

problems under control generally involve:

- monitoring of management

- contracts that relate management compensation tofirm performance


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Question 2

Other financial intermediaries include insurancecompanies, mutual funds and pension funds.

- In Japan, banks provide relatively more financing than doother financial intermediaries.

- In U.K, other financial intermediaries providesubstantially more financing than banks.

- In U.S, banks are less important sources of financingcompared to financial intermediaries.

- In Europe, financing provided by banks and financingprovided by other financial intermediaries areapproximately equal.


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Question 3

Transparency is essential in a market-based system, but

is not necessarily a requirement for a bank-based system.

In a bank-based system, banks have long-standing

working relationships with the companies seekingfinancing, and banks have on-going access to information

about the firm.

In a market-based system, creditors and equity-holders

require that financial information about companiesseeking financing be available, sufficiently detailed and

accurate if they are to participate in the market.


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Question 4

A company with dual-class equity has two classes of

common stock with different voting rights. One of

the best known examples of a company with dual-

class equity is Ford Motor Company; the Ford familyowns a class of common stock with extra voting

rights, which allows the family to control the

company.


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Question 5

New industries seem to develop in market-basedfinancial systems such as the U.S., while bank-basedsystems, such as Japan and Germany, seem to besuccessful in sustaining established industries.

A bank-based system is not likely to provide thisearly-stage financing because of the uncertaintyinvolved, but a market-based system providesfinancing from numerous investors with differentviews regarding prospects for development. Market-based systems also seem to be more effective ineliminating declining firms and industries.


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Chapter 29: Financial Analysis and

Planning

Question 7: The effect on the current ratio of the

following transactions:

Inventory is sold no effect

The firm takes out a bank loan to pay its suppliers no effect

A customer pays its overdue bills no effect

The firm uses cash to purchase additional inventories no effect


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Question 9

DPS = $2

Dividend yield = 4%

Stock price = 2/0.04 = $50

Market to book ratio = 1.5

Book value to market price per share = 1/1.5 = 2/3

Book value per share = 2/3*$ 50 = $33.33

Book value of equity = $333.3 million.


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Internal growth rate

Meaning of internal growth: The growth rate that a

company can achieve without external funds is

known as the internal growth rate.


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Contd

Fixed assets, net working capital and other assets= Rs

3255.54 crores.

The company plans to plow back = Rs 320.74 crores.

Internal growth rate = retained earnings/net assets

Internal growth rate = 320.74/3255.54 = 9.85%.


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Decomposition of Internal growth rate

Internal growth rate = (Retained Earnings/Profit After

Tax) * (Profit After Tax/Equity)*(Equity/Net assets)

Internal growth rate = Retention ratio * ROE*

(Equity/Net Assets). Sustainable growth rate = ROE * Retention ratio.


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Meaning of Leverage

Leverage refers to the employment of funds for

which the company pays fixed cost or fixed return.


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Types of Leverages

There are three commonly used measures of

leverage in financial analysis.

Operating Leverage

Financial Leverage

Combined Leverage


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Operating Leverage

Operating Leverage is defined as the tendency of

operating profit to vary disproportionately with that

of sales.

A change in sales will lead to a change in EBIT.However, variable costs will change in proportion to

sales while fixed cost will remain constant.


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Measurement of Degree of Operating

Leverage

The degree of operating leverage is measured as

follows:

DOL = Percentage of change in EBIT / Percentage of

change in Sales


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Financial Leverage

Financial leverage is defined as the tendency of

Earnings per share to vary disproportionately with

that of Operating profit (EBIT).


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Measurement of Degree of Financial

Leverage

The Degree of Financial Leverage is measured as

follows:

DFL = Percentage of change in EPS / Percentage of

change in EBIT


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Combined Leverage

Meaning: Combined Leverage is defined as the

tendency of Earnings per share to vary

disproportionately with that of Sales.

Effect of fixed operating costs is measured byoperating leverage. Effect of fixed interest charges is

measured by financial leverage. The combined effect

of these is measured by combined leverage.


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Measurement of Degree of Combined

Leverage

The degree of combined leverage is measured as

follows:

Degree of Combined Leverage = Percentage of

change in EPS / Percentage of change in Sales.


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Thank You

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