JIMMA UNIVERSITY AGARO CAMPUS

COLLEGE OF BUSINESS AND ECONOMICS

PROGRAM: MA in PROJECT MANAGEMENT and FINANCE

Course: Fundamentals of Project Management and Finance

Course No: MPMF 641
Group One Assignment
Group members
1. Tadele Solomon
2. Eyuel Zewde
3. Kidist Mechalu
4. Melkamu Getachew
5. Tayiro Abbabor
6. Nura Mohammed

Instructor: Ganfure T. (asst prof.,)

Submission Date: August 11/2022

Part I: Briefly discuss the following question and write your final answer that fits the
objective of the question

Q1. Discuss the modern approach scope (functions) of financial management and differentiate
how it differs from the traditional functions of financial management.

Answer. The modern finance function is strategically positioned in the business, with a much
larger scope of work and ecosystem of tools and processes. According to the modern
approach, financial management is concerned with both acquisition of funds and optimum
use of available resources. The arrangement of funds is an important component of the whole
finance function.

In this approach, not only sporadic events are considered but also the long term and short
term financial problems are considered. The main components of financial management
include financial planning, evaluation of alternative use of funds, capital budgeting,
determination of cost of capital, determination of the financial standard for the success of the
business, management of income, etc. Therefore, according to this approach, four important
decisions are taken by the finance manager. The four decisions are: Investment Decision,
Financing Decision, Dividend Decision, and Liquidity Decision.

The modern finance management is differing from traditional function of financial

management in the following futures.

 This approach is more analytic and less descriptive as the right decisions for a business
can be taken only on the base of accounting and statistical data. It gives more emphasis
on financial decisions.

 The modern approach is a constant activity (Continuous Function) where the financial
manager makes different financing decisions unlike the traditional method,

 It gives importance not only to optimum use of finance also about the fund’s
procurement. Similarly, it also incorporates features relating to the cost of capital, capital
budgeting, and financial planning, etc. It has broader view.
  Performance of a firm is also affected by the financial decision taken by the Management
or finance manager. Therefore, to maximize revenue, the modern approach keeps a
balance between liquidity and profitability.

Q2. Why wealth maximization of financial management goal is by far better than profit
maximization of financial management? Discuss it.

Answer. Although Profit and Wealth Maximization sound pretty similar, there are some major
differences between them.

 Profit maximization aims at increasing the profit of a firm, wealth maximization have a
larger role to play and it deals with the wellbeing of the stakeholders as a whole.
 Wealth maximization plays a larger role in business than profit maximization.
 The main focus of profit maximization is on increasing the profit of the company while
wealth maximization deals in raising the value of stakeholders in the company. The profit
maximization theory is centered around the profit motive while wealth maximization
looks at the wellbeing of all stakeholders.
 The risk and its effects on financials of the company are a core part of the wealth
maximization process, while there is no focus on risk in the profit maximization theory.
Therefore, in practice, profit maximization is not a complete theory in itself while wealth
maximization is much more cohesive and inclusive in nature.
 Profit maximization is actually a concept that is basically related to day-to-day business
profits. Wealth maximization is a more complex process of increasing the overall wealth
of the company that is reflected in the increased price of shares in the market.
 Profit maximization does not cover the risk factors associated with finance and
operations but wealth maximization does.
 Profit maximization is an older theory and hence it lacks the modern approaches towards
business and profitability. Wealth maximization is a new concept that deals with a larger
subject area and includes as many factors as possible. Therefore, wealth maximization is
a better approach than profit maximization.
Profit maximization is a theory of the past, while wealth maximization is a modern theory so
wealth maximization is more preferable.
3. Define what working capital management is and discuss the working capital management
techniques of working capital management and factors that determine working capital
management.

Answer; Working capital Management ensures the best utilization of a business current assets
and liabilities for the company’s effective operation The main aim of managing working capital
is to monitor a company’s asset and liabilities to maintain adequate cash flow and meet short-
term business goals Working capital management is a business strategy designed to ensure that
a company operates efficiently by monitoring and using its current assets and liabilities to their
most effective use.

The four main components of working capital are:

1. Trade Receivables form a significant part of the current asset and, therefore, working capital.
It also includes the amount due to the bills of exchange receivable. These are the amounts in
which the business is owned by its customers.

2. Inventory is another significant part of current assets and, without a doubt, forms an integral
component of working capital management. Good Inventory Management is essential since it is
responsible for proper control over inventory from the raw material stage to the finished goods
stage.

3. Cash and Bank Balances are the most liquid current assets found on a business’s balance
sheet. Cash and bank balances are short term commitments with temporarily idle cash and easily
convertible into a known cash amount.

4. Trade Payables forms a significant part of current liabilities. It also includes the amount due
to the bills of exchange payables. These are the amounts the business has to pay for credit
purchases made by it.

Techniques of working capital management are

 Reduce inventory and increase inventory turn over.

 Pay vendors on time and manage debtors effectively.
 Convert to electronic payables and receivables.
 Receive adequate financing.
 Grow your business with well managed working capital.

Factors determining working capital.

 Nature and size of business. The working capital need of a business depends a great deal
on its nature and size.
  Business cycle. Business cycle too has significant impact on the working capital needs of
a business.
 Production cycle
 Seasonal fluctuations
 Operational efficiency

4. Explain the time value of money concept using your own example
Answer; The time value of money is the amount of money that could earn between today and
the time of a future payment.
For example if you were going to loan your sister 5000 birr for five years, you aren’t just
reducing your bank account by 5000 birr until you get the money back.
The one birr today is greater than the tomorrow one birr because today you can invest by that
money or birr.
5. Separately define what capital structure, leverage, differentiate the difference between
operational leverage and capital leverage.
Capital structure is the particular combination of debt and equity used by a company to funds
its ongoing operations and convinces to grow.
Leverage the ratio of company loan capital (debt) to the value of its ordinary share (equity)
gearing.
The difference between operational leverage and capital leverage;
 Operating leverage influences sales and EBIT and EPS. Conversely, the capital structure
of the company is responsible for financial leverage.
 Operating leverage a rises due to the company’s cost structure and it measures the
operating risk of a business. Capital leverage measures financial risk of a business. Costs
whereas financial leverage measures the effect of interest expenses.
 The operating leverage measures the effect of fixed operating

6. Discuss what is the dividend, dividend policy and the factors that affect dividend policy.
 Dividend refers to a reward, cash or other wise, that a company gives to its shareholder.
Dividends can be issued in various forms, such as payment, stocks or any other form. A
company’s dividend is decided by its board of directors and its requires the shareholders’
approval.
 Dividend policy is the policy a company uses to structure its dividend payout to
shareholders some researcher suggest the dividend policy is irrelevant, in theory,
because investors can sell a portion of their shares or portfolio if they need funds.
Factors that affect dividend policy such as;
  After tax earnings
 Availability of cash
 Share holders expectation
 Expected future earnings
 Liquidity leverage
 Return on investment future earnings
 Industry norms as well as
 Future earnings
7. Based on how should the firm pay dividend, discuss the concept and assumptions of residual
dividend policy, constant dividend policy, and residual dividend policy with their advantages for
the firm that pays the dividend.
The dividend payout amount is typically determined through forecasting long–term earnings and
calculating a percentage of earnings to be paid out. Under stable policy companies may create a
target payout ratio. This is percentage of earnings that is to be paid to shareholders in the long
term.

 A residual dividend is a dividend policy used by companies where by the amount of

dividends paid to shareholders amounts to what profits are left over after the company
has paid for its capital expenditures (cap EX).
 Under the constant dividend policy, a company pays a percentage of its earnings as
dividends every year. In this way, investors experience the full volatility of company
earnings. If earnings are up, investors get a larger dividend, if earnings are down,
investors may not receive a dividend.

The Gordon growth model (GGM) assumes that a company exists for ever and that there is
constant growth in dividend when valuing a company stock. The GGM works by taking an
infinite series of dividends per share and discounting them back in to the present using the
required rate of return.

Advantages of residual dividend policy

 Allows a business to focus on development and growth.

 It is more secure policy that focuses on long term stability rather than immediate but
profitability.
 This model allows a company to have a simpler form of accounting because basic
operational expenses are paid out of cash flow.

Advantages of constant dividend policy

 Simplifies the dividend decision, and has the advantage of protecting a company against
over or under payment of dividend.
 It ensures that dividend is paid when profits are earned and avoided when it incurs losses.
8. Compare and contrast the difference between Modigliani and millers (MM) theory, Bird in
hand theory, clientele effect theory, Tax differential theory, and information signaling theory of
dividends.
Modigliani and millers (MM) theory that the market value a company is correctly calculated as
the present value fits future earnings and is independent of its underlying assets, and is
independent of its capital structure.

Their assumptions appear to be unrealistic and unpractical although theoretically it is appealing.

Some of the problems of MM approach are due to imperfect markets, transactions costs,
floatation costs and uncertainty of future capital gains and the preference for current dividends.

 The Bird in Hand is a theory that says investors prefer dividends from stock investing to
potential capital gains because of the inherent uncertainty
 The clientele effect is a theory which states that different policies attract different types of
investors, and changes to the policies will cause a shift in demand for the company's
stock by investors.
 The tax differential of dividend policy is the belief that shareholders prefer equity
appreciation to dividends because capital gains are effectively taxed at lower rates than
dividends when the investment time horizon and other factors are considered.
 Information signaling theory is useful for describing behavior when two parties
(individuals or organizations) have access to different information. Typically, one party,
the sender, must choose whether and how to communicate (or signal) that information,
and the other party, the receiver, must choose how to interpret the signal.
Part Two: show the necessary steps and write the correct answer for each of the following
quantitative questions.

Q1, Fatuma Ahmed deposits 2,500 birrs annually into the Awash ban, earning 7%
compounded semi-annually. Due to a change in employment, these deposits stop
after 10 years, but the account continues to earn interest until Fatuma retires 20 years
after the last deposit is made. How much is in the account when Fatuma retires?

 For the first 10 years the cash flow is in annuity form

Given: periodic deposit (R) =2500 birr, i= 7%, m=2, n=10

( ) ( )
Solution; FVIFAi,n= R* =2500* =70,699.2 birr

 For the last 20 years after depositing is stopped it is in lump sum form with Pv=70699.2
birr

FV n = PV (1+ )nm = 70699.2 (1+ )2*20=279,916.49 birr

Q2,A company issues 10,000 equity shares of $100 each at the premium of 10%. The
company has been paying 25% dividends to equity shareholders for the past five years and
expects to maintain the same in the future also.

Required

A, compute the cost of equity capital

Given D=25, Npd =100

Ke = = *100 =25%

B, will it make any difference if the market price of equity share is $ 175?

Given D=25, Npm =175

Ke = = *100 =14.28%
Q3, Assume that Bekele has a plan of setting up a fund for his son, Borut, to go to
college. Bekele has figured that he will need Birr 80,000 by the time he is old enough
to go to college. He found an account that pays 6% compounded monthly. How much
will Bekele’s monthly payment be to get his son Borut set up for college in 20 years?
How much interest will the account accrue?

Given FVIFA6%,10yrs=80000 birr, i=6%, m=12, n=20

Required R=?

solution

( ) ( )
FVIFAi,n= R* =80000= R*

462.04R=80000

R=br. 173.14 per month

Therefore, total birr payment made by Bekele=173.14 birr*12 months*20 years=br.41,553.6

and interest accrue by account=br.80000-br.41,553.6=br.38,446.4

Q4. Airport Company is considering investing in two new vans that are expected to generate
combined cash inflows of Birr 16,000 per year. The van’s combined purchase price is Birr
52,000. The expected life and salvage value of each is five years and Birr 12,000, respectively.
Airport Plane has an average cost of capital of 14 percent.
Required:
A. Calculate the net present value of the investment opportunity.
B. Indicate whether the investment opportunity is expected to earn a return that is above or
below the cost of capital and
C. Show your decision (accepted or rejected).

Required
A. NPV = CF1 + CF2 + CF3---------- + CFn — ICO

(1+r)1 (1+r)2 (1+r)3----- +(1+r)n

NPV = 16000+16000+16000+16000+16000 — 52000

(1+0.14)1 + (1+0.14)2 +(1+0.14)3 +(1+0.14)4+(1+0.14)5

TPV =54795.3

NPV=54795.3-52000=2795.3

B. Cost of capital =52000 and total present value =54795.3

TPV>ICO

Therefore the investment opportunity earns a greater return than the cost of capital.
C. NPV is greater than zero so, ACCEPTED.

Q5. Frew Manufacturing Company has an opportunity to purchase some technologically

advanced equipment that will reduce the company’s cash outflow for operating expenses by
$1,280,000 per year. The cost of the equipment is $6,186,530.56. Frew expects it to have a 10-
year useful life and a zero-salvage value. The company has established an investment
opportunity hurdle rate of 15 percent and uses the straight-line depreciation method.
Required: Calculate the internal rate of return of the investment opportunity and indicate
whether the investment opportunity should be accepted.

Given IO=6186530.56
R=1280000
n=10

Required; IRR?

Solution Trial 1 assume i=15%

PVOA%, n

PVOA%, n =6424023.84

NPV=PVCF-IO

=6424023.841-6186530.56=237493.28

Trail 2 Assume i=17%

 PVOA%, n

PVOA%, n =5963012.64

NPV=PVCF-Io

=5963012.64-6186530.56=-223517.92

Trail 3 Assume i=16%

PVOA%, n

PVOA%, n = 6186531.17

NPV=PVCF-Io

6186531.17-6186530.56=0.61

1. Determine the NPV of the two closest rates of return

(NPV/16%) = + 0.61

(NPV/17%) = - 223517.92

2. Find the sum of the absolute values of the NPVs obtained in step 1

0.61+223517.92=223518.53

3. Calculate the ratio of the NPV of the smaller discount rate, identified in step 1, to the sum
obtained in step 2

+ 0.61/223518.53=0.00

16+0.00=16%

Therefore IRR=16%

Q6. An annuity of $ 45, 000 is flowing continuously for 10 years. Find its future value if
the rate of interest is 10% compounded continuously.

Given R=45,000, n=10, i=10

Required, FV-OA=?
 ( )
Solution FV-OA=R* = 45000* =$ 717,184.11

Q7. Abush Company plans to issue 10000 new shares of birr 100 each at par. The
floatation costs are expected to be 4% of the share price. The company pays a
dividend of birr. 12 per share initially and growth in dividends is expected to be 5%.

Required:
a) Compute the cost of the new issue of equity shares.
b) If the current market price of an equity share is birr 120. Calculate the cost of
existing equity share capital.

Given for a,

Po =100, g =5%, Do =12

Required = Ke = +g, D1 = Do(1 + g) =12(1 + 0.05) =12.6

Ke = +0.05 =17.6%

Given for b,

Require, cost of existing equity share capital (ks)

Po =120, g =5%, Do =12

D1 = Do (1 + g) =12(1 + 0.05) =12.6

f = 4.8(4%*120)

Solution, ks = +g, = Po – f =120 – 4.8 = 115.2

ks = +0.05 = 15.94%

Q8. Sky Bus Company is considering expanding its territory. The company has the opportunity
to purchase one of two different used Buses. The first Bus is expected to cost Birr 1,800,000; it
will enable the company to increase its annual cash inflow by Birr 600,000 per year. The Bus is
expected to have a useful life of five years and no salvage value. The second plane costs Birr
3,600,000, enabling the company to increase annual cash flow by Birr 900,000 per year. This
Bus has an eight-year useful life and a zero-salvage value.
Required: Determine the payback period for each investment alternative and identify
the alternative Sky should accept if the decision is based on the payback approach.
 The first opportunity (A)
Given
Total investment of the first bus (A) =br. 1,800,000
Annual cash inflow = br. 600,000
Useful life time = 5 years

Solution

PBPA = = = 3 years

 The second opportunity (B)

Given
Total investment of the first bus (B) = br.3,600,000
Annual cash inflow = br. 900,000
Useful life time = 5 years

PBPA = = = 4years

Therefore, according to payback period approach we choose the least PBP which is the
first opportunity (A) with PBPA = 3 years.
Q9. Tujube company issued 10% debentures (debt instrument) of the face value of Birr 100
redeemable at par after 20 years. Assume the floatation cost incurred is 5% and the company
operates in a country where the tax rate is 30%. Accordingly, calculate the cost of debt when;
A. When debentures are issued at par
B. When debentures are issued at 7%
C. When debentures are issued at 12.5%

Given , i=10%, Pn =100, n=20years, f=5%, t=30%

Solution
A, when debentures are issued at par

= Po-f=100-5=95, I= 100*0.1=10

( )
Kd=
 ( )
Kd= =10.51%

Kdt= Kd(1-t) = 10.51(1-0.3) =7.36%

B, when debentures are issued at 7%

( )
I=100*0.07=7, Kd= = 7.44%

Kdt= Kd(1-t) =7.44(1-0.3) = 5.21%

C, when debentures are issued at 12.5%

( )
I=100*0.125=12.5, Kd= = 13.08%

Kdt= Kd(1-t) =13.08(1-0.3) = 9.16%

Q10. Assume that Samsung Corporation is currently paying $2 per share in dividends and
investors expect dividends to grow at the rate of 7 percent a year for the foreseeable future. For
investments at this risk level, if the investors require a return of 12 percent a year, what is the
estimated value of Samsung today?

Given
Do = 2, g = 7%, ks =12%
Required, po =?

Solution po = , D1 = Do (1+g) =2(1+0.07)=2.14

po = =42.8 birr

Q11. Assume ABDO Company has the following capital structure specifications. Based on
the data below calculate the weighted average cost of capital, assuming 50% as the
rate of income-tax, before and after tax.

Particulars Amount ($)

Equity (expected dividend 12%) 1,000,000
10% preference 500,000
8% Debt 1,500,000

WACC = * re + rd(1-t) + * rps

= *0.12 + *0.08(1-0.5) + *0.1

 =0.04+0.02+0.0167

=7.67%

Q12. 12. Assume that you can invest in any of the following three securities today and hold
them for one year. However, there is uncertainty about how well your investment will do over
the ensuing year. Thus, the uncertainty is represented by the three
economic states of nature that can potentially occur with probabilities, and the returns
for each security in the three states of nature are given in the table below;

Probabilities(in%) Stock-C Stock-D Moody’s market return

25% 20 0 5
45% 5 15 10
30% 27 24 15
Required;

A. Calculate the expected returns for Stock-C and Stock-D

B. The variances of Stock-C and Stock-D’s returns
C. The standard deviation of Stock-C and Stock-D’s returns
D. Assume if you invest 60% of your capital in stock C and 40% in stock D,
calculate the portfolio return of your investment
E. Assume if you invest 60% of your capital in stock C and 40% in Moody’s
market; calculate the portfolio return of your investment.
Solution

A, Expected return of C=E(C) ∑ PiCi =0.25*20+0.45*5+0.3*27=15.35

Expected return of C=E(D) ∑ PiDi=0.25*0+0.45*15+0.3*24=13.95

2
σc
B, Variance of stock C= =∑ ( ) =(20-15.35)2 *0.25+(5-15.35)2 *0.45+(27-
15.35)2*0.3=94.33

2
Variance of stock D= σD = ∑ ( ) =(0-13.95)2*0.25+(15-13.95)2*0.45+(24-
13.95)2*0.3 =79.45
C, Standard deviation of C= σc=√ =√ = 9.71
Standard deviation of C= σD=√ D = √ = 8.91
D, given, Wc =60%=0.6, WD =40%-0.4
Expected portfolio =E(P)= Wc + WD =0.6*15.35 +0.4*13.95 = 14.79

E, Expected portfolio =E(P)= Wc + Wm ̂ , Wc=60%=0.6, Wm=40%=0.4

E(M) ̂ ∑ Pi i 0.25*0.05+0.45*0.1+0.3*0.15=0.1

E(P)= Wc + Wm ̂ =0.6*15.35+0.4*0.1=9.25

Q13. That the risk-free rate of interest is 3%, the market risk premium is 5%, and that the Betas
for DURBAN Stock and MUGAR stock are 1.2 and 0.8 respectively. According to the CAPM,
what should be the required rate of return for these two stocks?

Given Kf =3%, β(Durban)=1.2, β(Mugar)=0.8

Market risk premium (Km-Kf) =5%

Required rate of return for Durban=Ked = Kf+(Km-Kf) βD =3% + 5% * 1.2 =9%

Required rate of return for Muger =Kem = Kf+(Km-Kf) βM = 3% + 5% *0.8 =7%

Q14. Assume that the Ethiopian government has recently issued a renaissance Dam bond with
1000-birr face value, 12 years, 7% coupon rate compounded quarterly. If your investment
advisor has told you that the yield-to-maturity on this bond is 6%.What should be the price of
this bond?

Given, M=1000, n = 12*4=48, Coupon rate = = 1.75%, I = 100*1.75% =17.5 and YTM=6%

Required the price of coupon (Bo) =?

( ) ( )
Solution YTM = = 0.06=

By solving for =163.87

Q15, MUHE company’s stock is expected to pay a dividend of birr 4 at the end of one year.
After this, the dividends are expected to grow at the rate of 5% per year forever. The required
return on the stock is 12%. What's the price of the stock according to the dividend discount
model?

Given D1 =4 (which is paid at the end of year one)

g = 5%, Ks =12%

Required price of stock (Po) =?

Po = = =57.14 birr

Q16, Bole company has no debt outstanding and a total market value of birr 150,000. Earnings
before interest and taxes are projected to be Birr 14,000 if economic conditions are normal. If
there is a strong expansion in the economy, then EBIT will be 30% higher. If there is a recession,
then EBIT will be 60% lower. Bole company is considering a Birr 60,000 debt issue with a 5%
interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500
shares outstanding. Assuming that tax issues are ignored for this question and calculate Earnings
per share (EPS) under;
a) Normal economic condition
b) Expansionary economic condition
c) Recession economic condition.

Solution
a. Under normal conditions

EPS= = =5.60 birr

b. Under expansionary conditions

EPS= = = =7.28 birr

c. Under a recession

EPS= = = =2.24 birr

Q17, Dallol Company has a 20-year, 5% coupon bond rated A+ grade in the capital market.
Assume that your broker indicates that the yield-to-maturity of similarly rated 15-year corporate
bonds is 5%. If the coupon payments on this bond are compounded semi-annually, what should
be the price of this bond?

Q18, Ethiopian insurance company makes an original Ocean screen Bolt that wholesales for Birr
8. Each screen Bolt latch has a variable operating cost of 4 birrs. Fixed costs are Birr 80,000 per
year. The firm pays Birr 18,000 interest and preferred dividends of Birr 14,000 per year. At this
point, the firm is selling 38,000 bolts per year and is taxed at a rate of 25%.
A. Calculate the firms’ ocean screen Bolt’s operating breakeven point.
B. On basis of the firm’s current sales of 38,000 units per year and its interest and
preferred dividend costs, calculate its EBIT and earnings available for common.
C. Calculate the firm’s degree of operating leverage (DOL)
D. Calculate the firm’s degree of financial leverage (DFL)
E. Calculate the firm’s degree of total leverage (DTL)

Given: FC=80000 , SP=8 , VC=4 , Q=38000 , I=18000 , t=25%

Solution;

A. BEP

BEP = =20000 units

B.EBIT=Net income+tax+interest
EBIT=192000+48000+18000=258,000
C. DOL=
DOL=
DOL=1.005
D.DFL=
DFL=
DFL=0.77%