FINANCIAL MANAGEMENT – ASSESSMENT BPage 1 of 6ASSESSMENT Instruction : This Assessment is open-book. There is no time limit, and you may use your textbooks, other supporting material and and Excel financial formulae for your reference and assistance. Please answer all questions. Question 1 (15 marks) (Working with financial statements) Based on the information for the T. P. Jarmon Company for the year ended December 31, 2015: a)How much is the firm’s net working capital, and what is the debt ratio? b)Complete a statement of cash flows for the period. Interpret your results. c)Compute the changes in the balance sheets from 2014 to 2015. What do you learn about T. P. Jarmon from these computations? How do these numbers relate to the statement of cash flows? Assets20142015Cash $15,000 $14,000 Marketable Securities 6,000 6,200 Accounts receivable 42,000 33,000 Inventory 51,000 84,000 Prepaid rent $1,200 $1,100 Total current assets $ 115,200 $ 138,300 Net plant and equipment 286,000 270,000 Total assets $ 401,200 $ 408,300 Liabilities and Equity20142015Account payable $ 48,000 $ 57,000 Accruals 6,000 5,000 Notes Payable 15,000 13,000 Total current liabilities $ 69,000 $ 75,000 Long term debt $ 160,000 $ 150,000 Common stockholders’ equity $ 172,200 $ 183,300 Total liabilities and equity $ 401,200 $ 408,300 Table Q1-1. T. P. Jarmon Company Balance Sheet for 12/31/2014 and 12/31/2015
FINANCIAL MANAGEMENT – ASSESSMENT BPage 2 of 6Sales $ 600,000 Less cost of goods sold $ 460,000 Gross profit $ 140,000 Operating and interest expenses General and administrative ($ 30,000) Interest (10,000) Depreciation (30,000) Total operating and interest expenses ($ 70,000) Earnings before taxes $ 70,000 Taxes 27,000 Net income available to common stockholders $42,900 Cash dividends 31,800 Change in retained earnings $11,100 Table Q1-2 Jarmon Company Income Statement for the Year Ended 12/31/2015 Question 2 (10 marks) Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (inmillions of dollars) would be as follows: a)Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks. If the two projects are independent, which project(s) should be chosen? b)If the two projects are mutually exclusive and the WACC is 10%, which project(s) should be chosen? c)Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph. d)If the WACC was 5%, would this change your recommendation if the projects were mutually exclusive? If the WACC was 15%, would this change your recommendation? Explain your answers e)The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice between mutually exclusive projects. f)Define the MIRR. What’s the difference between the IRR and the MIRR, and which generally gives a better idea of the rate of return on the investment in a project? Explain.
FINANCIAL MANAGEMENT – ASSESSMENT BPage 3 of 6Question 3 (15 marks) a)Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 4%; and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0.02(t – 1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. You may determine the default risk premium (DRP), given the company’s bond rating, from the table below. Remember to subtract the bond’s LP from the corporate spread given in the table to arrive at the bond’s DRP. What yield would you predict for each of these two investments? RateCorporate Bond YieldSpread = DRP + LP U.S. Treasury 0.83% — AAA corporate 0.93 0.10% AA corporate 1.29 0.46 A corporate 1.67 0.84 b)Given the following Treasury bond yield information, construct a graph of the yield curve. Maturity Yield 1 year5.37%2 years5.473 years5.654 years5.715 years5.6410 years5.7520 years6.3330 years5.94c)Based on the information about the corporate bond provided in Part a, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. Comment which part of the yield curve (the left side or right side) is likely to be most volatile over time?
FINANCIAL MANAGEMENT – ASSESSMENT BPage 4 of 6Question 4 (15 marks) The Barryman Drilling Company is planning an on-market buyback of $1 million worth of the company’s 500000 shares, which are currently trading at a price of $10. Stan Barryman is the founder of the company and still holds 10000 company shares, which he originally purchased for $8 per share (more than 12 months ago). a)If Stan decides to sell 2000 of his shares for $10 a share, what will be his after-tax proceeds if his personal marginal tax rate is 47%? b)The Barryman Drilling Company is reconsidering its plan to buy back $1 million of its ordinary shares and instead plans to pay a $1 million fully franked cash dividend, which amounts to $2 per ordinary share. If the company tax rate is 30% and Stan Barryman’s personal marginal tax rate is 47%, what tax liability does this create for him? What will be Stan’s after-tax proceeds from the dividend distribution?
FINANCIAL MANAGEMENT – ASSESSMENT BPage 5 of 6Question 5 (15 marks) Helen Bowers, owner of Helen’s Fashion Designs, is planning to request a line of credit from her bank. She has estimated the following sales forecasts for the firm for parts of 2014 and 2015: Estimates regarding payments obtained from the credit department are as follows: collected within themonth of sale, 10%; collected themonth following the sale, 75%; collected the second month following the sale, 15%.Payments for labor and raw materials are made themonth after these services were provided. Here are the estimated costs of labor plus raw materials: May 2014 $180,000 June 180,000 July 360,000 August 540,000 September 720,000 October 360,000 November 360,000 December 90,000 January 2015 180,000 May 2014 $90,000 June 90,000 July 126,000 August 882,000 September 306,000 October 234,000 November 162,000 December 90,000 General and administrative salaries are approximately $27,000 a month. Lease payments under long- term leases are $9,000 a month. Depreciation charges are $36,000 a month. Miscellaneous expenses are $2,700 a month. Income tax payments of $63,000 are due in September and December. A progress payment of $180,000 on a new design studio must be paid in October. Cash on hand on July 1 will be $132,000, and a minimum cash balance of $90,000 should be maintained throughout the cash budget period. a)Prepare a monthly cash budget for the last 6 months of 2014. b)Prepare monthly estimates of the required financing or excess funds—that is, the amount of money Bowers will need to borrow or will have available to invest. c)Now suppose receipts from sales come in uniformly during the month (that is, cash receipts come in at the rate of 1 30 each day), but all outflows must be paid on the 5th. Will this affect the cash budget? That is, will the cash budget you prepared be valid under these assumptions? If not, what could be done to make a valid estimate of the peak financing requirements? No calculations are required, although if you prefer, you can use calculations to illustrate the effects.
FINANCIAL MANAGEMENT – ASSESSMENT BPage 6 of 6Question 6 ) What effect would each of the following events likely have on the level of nominal interest rates? a.Households dramatically increase their savings rate. b.Corporations increase their demand for funds following an increase in investment opportunities. c.The government runs a larger-than-expected budget deficit. d.There is an increase in expected inflation. a)Is it possible for conflicts to exist between the NPV and the IRR when independent projects are being evaluated? Explain your answer. b)If the payback was the only method a firm used to accept or reject projects, what payback should it choose as the cutoff point, that is, reject projects if their paybacks are not below the chosen cutoff? Is your selected cutoff based on some economic criteria, or is it more or less arbitrary? Are the cutoff criteria equally arbitrary when firms use the NPV and/or the IRR as the criteria? Explain. c)Why do most academics and financial executives regard the NPV as being the single best criterion and better than the IRR? Why do companies still calculate IRRs?
