FINANCIAL MANAGEMENT

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?
Assets
2014 2015
Cash $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 Equity
2014 2015
Account 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 B
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Sales $ 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 (in
millions 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 B
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Question 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?
Rate Corporate Bond Yield
Spread = 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 year 5.37%
2 years 5.47
3 years 5.65
4 years 5.71
5 years 5.64
10 years 5.75
20 years 6.33
30 years 5.94
c) 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 B
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Question 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 B
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Question 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 longterm 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 B
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Question 6 (Please write between 300-500 words, 15 marks)
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.
Question 7 (Please write between 300-500 words, 15 marks)
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?