BAHRIA UNIVERSITY (KARACHI CAMPUS)

Final Assessment Assignment Spring 2020

Course Code / Title: FIN 320/ Financial Management
Class: BBA-5 (A-G)
Course Instructor: Akbar Saeed, Dr. Mubashir, Dr. Isma & S. Zakir Abbas Marks: 50
Assignment Upload Date and Time by the Teacher: Wednesday, 08th July 2020 @ 8am
Assignment Completion / Upload Date and Time by the Student: Wednesday, 08th July 2020 by 4pm.
Student’s Name: ____________________ Reg. No: _________

Assignment Guidelines by the Teacher

▪ Assignment Submission: MS Word/PDF file with snapshots of handwritten response.
▪ Caution: Plagiarism and sharing-similarity comes under use of unfair means, if found in response
assignment by the students, it shall be dealt with in accordance with BU examination rules.
▪ Answer only be considered correct if calculation of each step and working is shown vividly.
▪ Attempt all questions.

Question # 01 [10 marks]

ABC Company is considering adding a new line to its product mix, and the capital budgeting analysis
is being conducted by Jameel, a recently graduated MBA. The production line would be set up in
unused space in the main plant. The machinery’s invoice price would be approximately Rs 5,000,000,
another Rs 250,000 in shipping charges would be required, and it would cost an additional Rs 750,000
to install the equipment. The machinery has an economic life of 4 years, and ABC Company
applicable depreciation rate are 33.33% for year 1, 44.45% for year 2, 14.81% for year 3, 7.41% for
year 4. The machinery is expected to have a salvage value of Rs 625,000 after 4 years of use. The
new line would generate incremental sales of 1,250 units per year for 4 years at an incremental cost
of Rs 2500 per unit in the first year, excluding depreciation. Each unit can be sold for Rs 5,000 in
the first year. The sales price and cost are both expected to increase by 3% per year due to inflation.
Further, to handle the new line, the firm’s net working capital would have to increase by an amount
equal to 12% of sales revenues. The firm’s tax rate is 40%, and its overall weighted average cost of
capital, which is the risk-adjusted cost of capital for an average project (r), is 10%.
Required:
i. What are the annual depreciation expenses?
ii. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to
include inflation when estimating cash flows?
iii. Construct annual incremental operating cash flow statements.
iv. Estimate the required net working capital for each year and the cash flow due to investments
in net working capital.
v. Calculate the after-tax salvage cash flow.
vi. Calculate the net cash flows for each year. Based on these cash flows and the average project
cost of capital, what are the project’s NPV

Question # 02 [05 marks]

Assume that the Financial manager of a firm calculated three NPVs’ mentioned below based on
different sales forecast. Moreover, he believes there is a 25% chance of worst acceptance to occur, a
25% chance of excellent performance to occur, and a 50% chance of average acceptance to occur.
Use the worst-, base-, and best-case NPVs and probabilities of occurrence to find the project’s
expected NPV, as well as the NPV’s standard deviation and coefficient of variation.
Base Worst Best
NPV $2,200,243 -$1,213,189 $6,973,498

Question # 03 [05 marks]

Suppose a firm makes purchases of Rs 10.95 million per year under terms of 2/10, net 30, and takes
discounts.
i. What is the average amount of accounts payable net of discounts? (Assume the Rs 10.95
million of purchases is net of discounts—that is, gross purchases are Rs 11,173,469.40,
discounts are Rs 223,469.40, and net purchases are Rs 10.95 million.)
ii. Is there a cost of the trade credit the firm uses?
iii. If the firm did not take discounts but did pay on the due date, what would be its average
payables and the cost of this nonfree trade credit?
iv. What would be the firm’s cost of not taking discounts if it could stretch its payments to
40 days?

Question # 04 [05 marks]

Strickler Technology is considering changes in its working capital policies to improve its cash flow
cycle. Strickler’s sales last year were Rs 3,250,000 (all on credit), and its net profit margin was 7%.
Its inventory turnover was 6.0 times during the year, and its DSO was 41 days. Its annual cost of
goods sold was Rs1,800,000. The firm had fixed assets totalling Rs 535,000. Strickler’s payables
deferral period is 45 days.
i. Calculate Strickler’s cash conversion cycle.
ii. Assuming Strickler holds negligible amounts of cash and marketable securities, calculate
its total assets turnover and ROA.
iii. Suppose Strickler’s managers believe the annual inventory turnover can be raised to 9 times
without affecting sale or profit margins. What would Strickler’s cash conversion cycle, total
assets turnover, and ROA have been if the inventory turnover had been 9 for the year?

Question # 05 [05 marks]

You are analysing Jilani’s Jewellery (JJ) stock for a possible purchase. JJ just paid a dividend of
Rs.8.25 yesterday. You expect the dividend to grow at the rate of 6% per year for the next 3 years; if
you buy the stock, you plan to hold it for 3 years and then sell it.
i. What dividends do you expect for JJ stock over the next 3 years? In other words, calculate
D1, D2, and D3. Note that D0 Rs.8.25.
ii. JJ stock has a required return of 13%, the rate you will use to discount dividends. Find the
present value of the dividend stream; that is, calculate the PV of D 1, D2, and D3, and then
sum these PVs.
̂3 Rs.148.78).
iii. JJ stock should trade for Rs.148.78 3 years from now (i.e., you expect 𝑃
Discounted at a 13% rate, what is the present value of this expected future stock price? In
other words, calculate the PV of Rs.148.78.
iv. If you plan to buy the stock, hold it for 3 years, and then sell it for Rs.148.78, what is the
most you should pay for it?
v. Use the constant growth model to calculate the present value of this stock. Assume that g L
6% and is constant.
vi. Is the value of this stock dependent on how long you plan to hold it? In other words, if
your planned holding period were 2 years or 5 years rather than 3 years, would this affect
̂0? Explain your answer.
the value of the stock today, 𝑃

Question # 06 [10 marks]

Roberts Company, a small machine shop, is contemplating acquiring a new machine that costs
$24,000. Arrangements can be made to lease or purchase the machine. The firm is in the 40% tax
bracket. The firm would obtain a 5-year lease requiring annual end-of-year lease payments of
$6,000. All maintenance costs would be paid by the lessor, and insurance and other costs would
be borne by the lessee. The lessee would exercise its option to purchase the machine for $1,200 at
termination of the lease.
The firm would finance the purchase of the machine with a 9%, 5-year loan requiring end-of-year
installment payments of $6,170. The machine would be depreciated by 20% in year 1, 32% in
year 2, 19% in year 3, and 12% in years 4 and 5. The firm would pay $1,500 per year for a service
contract that covers all maintenance costs; insurance and other costs would be borne by the firm.
The firm plans to keep the machine and use it beyond its 5-year recovery period.

i. Find the after-tax cash outflows for each year under the lease alternative.
ii. Find the after-tax cash outflows for each year under the purchase alternative.
iii. Calculate the present value of the cash outflows associated with the lease and purchase
alternatives using the after-tax cost of debt as the discount rate.
iv. Choose the alternative with the lower present value of cash outflows from Step 3. It will be
the least-cost financing alternative.

Question # 07 [10 marks]

Hatfield Medical Supply’s stock price had been lagging its industry averages, so its board of
directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a finance MBA
who had been working for a consulting company, to replace the old CFO, and Lee asked Ashley
to develop the financial planning section of the strategic plan. In her previous job, Novak’s
primary task had been to help clients develop financial forecasts, and that was one reason Lee
hired her.
Novak began as she always did, by comparing Hatfield’s financial ratios to the industry averages.
If any ratio was substandard, she discussed it with the responsible manager to see what could be
done to improve the situation. The following data shows Hatfield’s latest financial statements plus
some ratios and other data that Novak plans to use in her analysis.
Selected Ratios, Calculations, and Other Data, 2018

Cash 90 Sales 9,001

Accts. rec. 1,260 Op. costs (excl. depr.) 8,101
Inventories 1,440 Depreciation 360
Total CA 2,790 EBIT 540
Net fixed assets 3,600 Interest 144
Total assets 6,390 Pretax earnings 396
Taxes (25%) 99
Accts. pay. & accruals 1,620 Net income 297
Line of credit -
Total CL 1,620 Dividends 100
Long-term debt 1,800 Add. to RE 197
Total liabilities 3,420 Common shares 50
Common stock 2,100 EPS 6
Retained earnings 870 DPS 2
Total common equity 2,970 Ending stock price 41
Total liab. & equity 6,390
Other Ratios Hatfield Industry
 Profit margin (M) 3% 6%
Return on assets (ROA) 5% 10%
Return on equity (ROE) 10% 15%
Sales/Assets 1.41 1.69
Asset/Equity 2.15 1.59
Debt/TA 28% 17%
(Total liabilities)/(Total assets) 54% 37%
Times interest earned 3.80 11.70
P/E ratio 6.90 16.00
OP ratio: NOPAT/Sales 5% 6%

a. Forecast the balance sheet and income statements for 2019 using the following preliminary
financial policy. Hatfield’s sales growth rate is 11.1% for 2019.
i. Regular dividends will grow by 10%.
ii. No additional long-term debt or common stock will be issued.
iii. The interest rate on all debt is 8%.
iv. Interest expense for long-term debt is based on the average balance during the year.
v. If the operating results and the preliminary financing plan cause a financing deficit, eliminate
the deficit by drawing on a line of credit. The line of credit would be tapped on the last day
of the year, so it would create no additional interest expenses for that year.
b. If there is a financing surplus, eliminate it by paying a special dividend. After forecasting the
2019 financial statements, answer the following questions.
i. How much will Hatfield need to draw on the line of credit?
ii. What are some alternative ways than those in the preliminary financial policy that Hatfield
might choose to eliminate the financing deficit?