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FM Assignment

The document contains sample questions and problems from finance chapters 1-3 along with their solutions. Question 1-4 asks about the impact of a technology upgrade investment on a company's earnings per share and stock price. The investment will decrease earnings this year but is expected to increase intrinsic value and stock price by reducing future costs. Problem 2-4 asks about the depreciation and amortization amount for a company with given EBITDA and net income. The charge for depreciation and amortization was $2.5 million. Problem 3-11 involves completing a balance sheet for a company using given financial ratios and calculations. The completed balance sheet includes assets of $300,000 that are

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Duren Jaya
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161 views

FM Assignment

The document contains sample questions and problems from finance chapters 1-3 along with their solutions. Question 1-4 asks about the impact of a technology upgrade investment on a company's earnings per share and stock price. The investment will decrease earnings this year but is expected to increase intrinsic value and stock price by reducing future costs. Problem 2-4 asks about the depreciation and amortization amount for a company with given EBITDA and net income. The charge for depreciation and amortization was $2.5 million. Problem 3-11 involves completing a balance sheet for a company using given financial ratios and calculations. The completed balance sheet includes assets of $300,000 that are

Uploaded by

Duren Jaya
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Questions CH1: 1-3, 1-4; Problems CH2: 2-4,2-9; CH3: 3-9, 3-11.

(1–3)
What is a firm’s fundamental, or intrinsic, value? What might cause a firm’s intrinsic value to be
different than its actual market value?
The Firm’s fundamental/intrinsic value is an estimate of a stock’s “true” value based on accurate
risk and return data. While market value is created by the “perceived” cash flow and risk by the
marginal investors. As a result, there would be differences between firm’s intrinsic value and
actual market value (market price).

(1–4)
Edmund Enterprises recently made a large investment to upgrade its technology. Although
these improvements won’t have much of an impact on performance in the short run, they are
expected to reduce future costs significantly. What impact will this investment have on Edmund
Enterprises’s earnings per share this year? What impact might this investment have on the
company’s intrinsic value and stock price?
Earnings Per Share of the Edmund Enterprises decreases as an impact of the upgrading
technology. It is due to some portion of the company earnings used for this new investment. In
addition, there is high expected growth in earnings by investors in the future because it would
be cost saving for utilizing the new technology. This would add the intrinsic value of the
company then this would increase company’s market value.

(2–4) Income Statement


Pearson Brothers recently reported an EBITDA of $7.5 million and net income of $1.8 million. It
had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge
for depreciation and amortization

Pearson Brothers Income Statement (in dollars)


Earning Before Interest, Tax, Depreciation and Amortization (EBITDA) 7,500,000
Interest Expense 2,000,000
Earning Before Tax, Depreciation and Amortization 5,500,000
Depreciation and Amortization 2,500,000
Taxable Income 3,000,000
Taxes (40%) *calculation using net income 1,200,000
Net Income (60% from Taxable Income) 1,800,000

Depreciation and amortization = $2,5 million

(2–9) Corporate After-Tax Yield


The Shrieves Corporation has $10,000 that it plans to invest in marketable securities. It is
choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 5%
(but are not taxable), and AT&T preferred stock, with a dividend yield of 6%. Shrieves’s
corporate tax rate is 35%, and 70% of the dividends received are tax exempt. Find the after-tax
rates of return on all three securities.
Need To invest $10,000
Corporate tax rate = 35%
AT&T bonds 7.5%
=7,5% x $10,000 = $750
Taxes = 35% x $750 = $262.5
The AT&T bonds yield
=(750-262.5) x 100 % = 4.875%
10,000

State of Florida Muni Bonds 5%


This bond is not taxable so there is no tax deduction. Then, the yield is 5%

AT&T preferred stock 6%


Dividend = 6% x $10,000 = $600
Tax exemption = 70% x $600 = $420
Tax = 35% x (600-420) = $63
AT&T preferred stock yield
= (600 - 63) x 100 % = 5.37%
10,000

(3–9) Current and Quick Ratios


The Nelson Company has $1,312,500 in current assets and $525,000 in current liabilities. Its
initial inventory level is $375,000, and it will raise funds as additional notes payable and use
them to increase inventory. How much can Nelson’s short-term debt (notes payable) increase
without pushing its current ratio below 2.0? What will be the firm’s quick ratio after Nelson has
raised the maximum amount of short-term funds?
Before raising funds
Current Assets $1,312,500
Current Liabilities $525,000
Inventory Level $375,000
Current ratio = CA/CL
=1,312,500 / 525,000 = 2.5

After raising funds (current ratio min 2.0)


Current ratio = 2
= (1,312,500+ x) = 2
(525,000 + x)
1,312,500+x = 2 (525,000 + x)
1,312,500+x = 1,050,000 + 2x
2x - x = 1,312,500 - 1,050,000
X = 262,500
X = additional notes payable
Current Assets = 1,312,500 + 262,500 = $1,575,000
Current Liabilities = 525,000 + 262,500 = $787,500
Inventory Level = 375,000 + 262,500 = $637,500
Quick Ratio = (CA-Inventories) / CL
= (1,575,000 - 637,500) / 787,500 = 1.19

(3–11) Balance Sheet Analysis


Complete the balance sheet and sales information in the table that follows for Hoffmeister
Industries using the following financial data:
Debt ratio: 50%
Quick ratio: 0.80
Total assets turnover: 1.5
Days sales outstanding: 36.5 days
Gross profit margin on sales: (Sales – Cost of goods sold)/Sales = 25%
Inventory turnover ratio: 5.0

Calculation is based on a 365-day year.


Debt Ratio = Total Debt / Total Aset = 50%
= Total Debt / $300,000 = 50%
Total Debt = $300,000 x 50%
= $150,000
Total Debt = Account Payable + Long-term debt
$150,000 = Account Payable + $60,000
Account Payable = $150,000 - $60,000 = $90,000

Total Asset Turnover = Sales/TA = 1.5


= Sales / $300,000 =1.5
Sales = $300,000 x 1.5 = $450,000
Days Sales Outstanding:
Accounts receivable/Daily sales = 36.5
Account receivable/(Sales/365) = 36.5
Account receivable/($450,000/365) = 36.5
Account receivable = 36.5 x ($450,000/365) =$45,000

COGS = 75% x Sales = 75% x $450,000 = $337,500


Inventory turnover ratio = COGS/ Inventories = 5
= $337,500/Inventories = 5
Inventories = $337,500/5 =$67,500
Total liabilities and equity = Total assets = $300,000
Common Stock :
= Total Liabilities and equity - Account Payable - Long-term debt - Retained Earnings
=300,000 - 90,000 - 60,000 - 97,500 = $45,000

Quick Ratio = (CA-Inventories) / CL = 0.80


= (CA - $67,500) / $90,000 = 0.80
= CA - $67,500 = 0.80 x $90,000
= Current Assets = $72,000 + $67,500 = $139,500
Cash = Current Assets - Account receivable - Inventories
= $139,500 - $45,000 - $67,500 = $27,000

Fixed Assets = Total Assets - Current Assets


= $300,000- $139,500 = $160,500
Balance Sheet

Cash $27,000 Account Payable $90,000


Accounts Receivable $45,000 Long-term debt
$60,000
Inventories $67,500 Common Stock $45,000
Fixed Assets $160,500 Retained Earnings $97,500
Total Assets $300,000 Total liabilities and equity $300,000
Sales $450,000 Cost of goods sold $337,500

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