• August 7, 2018
• David Marks
• 0

Accounting Help

Accounting Help Vindaloo Corporation reported retained earnings of \$400 on its year-end 2002 balance sheet. During 2003, the company reported a loss of \$40 in net income, and it paid out a dividend of \$60. We will calculate retained earnings for Vindaloo’s 2003 year-end balance sheet.

Retained earnings for Vindaloo’s 2003.

 Particulars Amount Retained Earning 2002 400 Less : Loss during The year 40 Less : Divided pay out 60 Retained Earning 2003 300
1. A firm has an ROA of 8%, sales of \$100, and total assets of \$75. Lets calculate its profit margin.
 Total Assets \$    75.00 8% ROA \$       6.00 (Total Assets * ROA = 75*(8/100) = 6) Total Sales \$  100.00 Profit Margin \$       6.00 (Profit / Total Sales = )

1. Given the following information: profit margin = 10%; sales = \$100; retention ratio = 40%; assets = \$200; equity multiplier = 2.0. If the firm maintains a constant debt-equity ratio and no new equity is used, what is the maximum sustainable growth rate (SGR)?  (Assume a constant profit margin.)
 Particulars Details profit margin 10% Sales 100 Total Profit 10 Retention 4 Total Assets 200 Equity Multiplier 2 Total equity 100 (Total Assets/ equity multiplier) Total debt 100 Debt Equity ration constant ROE 0.1 Retention Ratio 40% ROE* Retention Retio 0.04 1-ROE* Retention Retio 0.96 SGR=ROE*R.R/1-ROE*R.R 4.17%

1. Your brother-in-law invests in the stock market and doubles his money in a single year while the market, on average, earned a return of only about 15%, here a discussion is done whether  your brother-in-law’s performance a violation of market efficiency or not.

No, brother in law performance is not violation of market efficiency; this indicates that Brother in law has taken much higher risk than the average market. If it suits him so be it (Preda, 2009).
This could also indicate that the Brother in law had some good market tips and exited at most opportune time without hanging around with the stocks.

1. Iggie’s Used Cars will sell you a 2002 Suzuki Aerio for \$3,000 with no money down. You agree to make weekly payments of \$40 for two years, beginning one week after you buy the car.  What is the EAR of this loan?

For calculating Ear, formula is

Where EAR=Effective annual rate
K=Nominal interest rate
M=Compounding frequency per year (Randall, 2007)

Lets calculate Nominal rate of interest.

NOMINAL RATE OF INTEREST= (difference in total amount paid per year/total amount paid)/100

[ 4160-3000=1160 For 2 yrs = 580 per yr]

=(580/3000)*100= 19.33%

Putting value in EAR we get

52

EAR = (1+19.33/52) – 1

Solving this we get EAR= 21.2812 %

1. Rebus company is trying to make a decision between two projects. Their calculations are as below.
 Year Project I Project II Payback (yrs.) 2.053 Year 1.92 Year Discounted Payback (yrs.) 2.44 Year 1.25 Year IRR 15.41% 28.44% NPV 3907 3843

Accounting Help

1. Payback period calculation
 PROJECT A PROJECT B Cash inflow cumulative cash inflow Cash inflow cumulative cash inflow 8500 8500 6500 6500 9000 17500 6000 12500 9500 27000 7000 19500

Project A

Payback period = 2 yrs + [18000-17500 / (27000-17500)]

= 2.053 years

Project B

Payback period = 1 yrs + [12000-6500/ (12500-6500]

= 1.92 years

1. Discounted Payback period calculation
 PROJECT A PROJECT B Cash inflow Discounted fector (11%) cumulative cash inflow Cash inflow Cash inflow Discounted fector (11%) cumulative cash inflow cumulative cash inflow 8500 0.9009 7657.65 7657.65 6500 0.9009 5855.85 5855.85 9000 0.8116 7304.4 14962.05 6000 0.8116 4869.6 10725.45 9500 0.7311 6945.45 21907.5 7000 0.7311 5117.7 15843.15

Project A

Discounted Payback period = 2 yrs + [18000-14962 / (21907-14962)]

= 2.44 years

Project B

Payback period = 1 yrs + [12000-10725/ (15843-10725]

= 1.25

1. Net present value (11%IRR)

Project A

21907-18000=3907

Project 2

15843-12000= 3843

1. Calculation of internal rate of return (IRR)
 PROJECT A year cash inflow discounted factor@15% discounted cash inflow discounted factor@16% discounted cash inflow discounted factor@14% discounted cash inflow 1 8000 0.869 6952 0.862 5992.624 0.877 5255.5 2 9500 0.756 7182 0.743 5336.226 0.769 4103.5 3 9000 0.657 5913 0.64 3784.32 0.674 2550.6 3.351 20047 3.273 15113.17 3.273 11909.7 IRR using interpretation formula Project A = 15% – (18000-15113.17/ 20047-15113) = 15% – 0.5851 = 15.415% PROJECT B year cash inflow discounted factor@28% discounted cash inflow discounted factor@29% discounted cash inflow discounted factor@30% discounted cash inflow 1 6500 0.7813 5078.45 0.7752 5038.8 0.7692 4999.8 2 6000 0.6104 3662.4 0.6001 3600.6 0.5917 3550.2 3 7000 0.477 3339 0.4658 3260.6 0.4551 3185.7 3.351 12079.85 3.273 11900 11735.7 IRR using interpretation formula Project A = 29% – (12000-11900/ 12080-11900) = 29% – 0.556 = 28.44%

SECTION 2

Problem 1

 Assets Amount 25% 90% capacity of acutal Cash 50 62.5 45 Inventory 150 187.5 135 FA 600 750 540 Total 800 1000 720 Liability Amount 25% Accounts payble 100 125 90 Notes payble 100 125 90 long term Debt 350 434 477 Equity 250 250 250 800 1000 Reserves and Surplus 0 66 47 Particulars Amount 25% 90% of actual Sales 800 1000 720 Cost 600 750 540 Profit 200 250 180 Taxes 68 85 61 132 165 119

a)

1. External finance if sales increased by 25% :

Effect of increase in 25% sasles is already given in the table above.

As menationed in question, 40% is retained.

So retained profit=165*40/100=66 (add as reserves and surplus to liability)

Now if we balance both sides we get Long Term debt = \$ 434

So total external financing need is \$434.

1. Firm is producing at only 90% capacity

In this case, looking at figures in above calculation, external financing will increase from \$434 to \$477 due to decrease in working capacity. Since amount of profit retained is less, the firm has to maintain more external financing to meet its requirement.

1. B) Suppose the firm wishes to maintain a constant debt-equity ratio, retains 60% of net income, and raises no new equity. Assets and costs maintain a constant ratio to sales.   What is the maximum increase in sales the firm can achieve.

Lets find debt equity ratio.

 Debt-to-Equity Ratio = Total Liabilities Shareholders’ Equity

Accounting Help

= 800/250 = 3.2

Looking at the calculation above, there can be no change in total liability or equity amount as debt equity ratio is to be maintained. So any change to be made in liability side can be only done through change on long term debt. As plant is already operating on 100% capacity, the maximum possible sale is \$800

Problem 2

The managers of Magma International, Inc.  plan to manufacture engine blocks for classic cars from the 1960s era.  Cetain values are given. We will calculate following things

1) Depreciation tax shield in the third year for this project (Nissim, 2002).

CCA at 30% = Machinery Cost*30%

Depreciation tax shield = Machinery cost- CCA

 Machinery cost CCA @30% Depreciated Tax shield 800000 240000 560000 560000 168000 392000 392000 117600 274400

2) Present value of CCA tax shield

 Machinery cost CCA @30% Depreciated Tax shield Discounting Factor Present value of Cca tax shield 800000 240000 560000 0.892857143 500000 560000 168000 392000 0.797193878 312500 392000 117600 274400 0.711780248 195312.5 274400 82320 192080 0.635518078 122070.3125 192080 57624 134456 0.567426856 76293.94531

Discounted Value @ 12% = 1st year = 1/1.12

= 2nd yr = 1st year discounted rate/ 1.12

3)  the minimum bid price the firm should set as a sale price for the blocks if the firm were in a bidding situation

 price of machine 800000 cost for block 125000 fixed cost 125000 total cost 1050000 less salvage value 150000 total cost 900000 less depreciation @30% 630000 add: Tax@35% 850500

From above table, the firm has to bid a minimum amount of \$850500. It can add industry profit to it and bid accordingly.

4) NPV of this project

 Inflow Year Profit Depreciation PBT PAT Disc Factor @ 8% PV of Cash Profit 2 150000 45000 105000 36750 0.892857143 32812.50001 3 150000 45000 105000 36750 0.797193878 29296.87502 4 150000 45000 105000 36750 0.711780248 26157.92411 5 150000 45000 105000 36750 0.635518078 23355.28937 6 150000 45000 105000 36750 0.567426856 20852.93696 0 Total PV cash profit 132475.5255 Salvage of plant & machinery 150000 TOTAL INFLOW Net cash Inflow -17524.47454

PROBLEM 3

• cost of equity based on the dividend growth model

Cost of Equity = (Next Year’s dividends per share / Current market value of stock) + Growth rate of dividends

= (1.8/8)+4% = 6.17%

Cost of equity = 6.17 %

• cost of equity based on the security market line

Cost of equity = rf + Bs(Emkt – rf)

Where: rf = the risk-free rate
Bs = the beta of the investment
Emkg = the expected return of the market

Here cost of equity = 4+ 1.2 (12-4) = 13.6 %

• the cost of financing using preferred stock

The cost of preferred stock is equal to the preferred dividend divided by the preferred stock price, plus the expected growth rate.

SO here in this case, Cost of Preferred stock = (1.8/83)+12 = 12.01

• pre-tax cost of debt financing

lets calculate

1- (Company tax rate/100) = 0.66

Pre tax costing = (400000*83)/.66 = \$50303030

• weight to be given to equity in the weighted average cost of capital computation

In financial decision making, financing of firm’s assets is done by either debt or equity. The weighted average cost of capital (WACC) measures the average riskiness of a firm’s assets by calculating the weight of debt and equity to any given situation. In effect, by calculating a weighted average, a firm can estimate the capital discount of debt and equity in dollar terms.

Formula for this is

WACC = Wd x Rd(1-T) + Ws x Rs + Wp x Rp

where:

• Wd: the weight of debt (percentage of debt allocated to finance the project)
• Ws: the weight of equity (percentage of equity allocated to finance the project)
• Wp: the weight of preferred stocks (percentage of preferred stocks allocated to finance the project)

So for this case, percentage of equity allocated to finance the project = (total equity allocated/ total amount of financing)*100

• the cost of new financing (including the impact of each of 28-year bonds, preferred shares and common shares), assuming that flotation costs would be 5% of the proceeds of the issue

the cost of financing will have effect of floatation cost at 5% will will affect equity.

• If net income in the next year is expected to be \$8,000,000, what would be the common equity breakpoint for new financing, assuming the current capital structure is considered optimal

Current capital structure is optimal

Breakeven ppoint = Available Retained Earnings = 800000/10 = 80000

Equity Percentage of Total

REFERENCES:

• Randall, S. (2007). “FRB Speech: Creating More Effective Consumer Disclosures”.
• Preda, A. (2009). Framing Finance: The Boundaries of Markets and Modern Capitalism.” University of Chicago Press.
• Nissim, D. (2002). “Valuation of the Debt Tax Shield”. The Journal of Finance 57 (5): 2045–2073.

David Marks

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