AD 632s A1
Financial Concepts
Final Examination
Wednesday, June 30, 2021
Question #1 to #14 are worth 7 points each
Please answer all the Questions
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TABLE 3.5
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Question #1 – Calculating Ratios – 7 points
The following are a sample of accounts for the Fictitious Company:
Required:
Calculate the following financial ratios for the Fictitious Company:
A. Current ratio
B. Receivable turnover
C. Days’ Sales in Inventory
D. Working Capital
E. Debt-Equity ratio
F. Profit margin
G. Times Interest Earned
Note: Carry your answers out 3 decimal places and round to 2 decimal places
A. Current ratio: current asset/current liabilities=56,675/7,304=7.759~7.76
B. Receivable turnover=sales/ar=375600/28892=13.00
C. Days’ Sales in Inventory:365/IT=365/(COGS/I)=365/
(245300/21956)=365/11.17=32.68
D. Working Capital: C. asset-C. liabilities=56675-7304=$49,371
E. Debt-Equity ratio: TD/TE=(CL+longterm D)/(CS+RE)=23304/92189=0.2528~0.25
times
F. Profit margin: NI/Sales=15800/375600=0.042=4.2 times
G. Times Interest Earned: EBIT/I=81300/61300=1.33 times
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Answer for Question #1
Question #2: - Internal Rate of Return – 7 points
The Blue Egg Company is considering starting two Mutually Exclusive Projects. The new
Treasurer (your boss) wants to use the Internal Rate of Return method. The Company projects
the cash flow for the two projects as indicated below:
Required:
A. If appropriate, calculate the Internal Rate of Return for Project J
B. If appropriate, calculate the Internal Rate of Return for Project K
C. If the Internal Rate of Return is not appropriate, explain why
D. If the Internal Rate of Return is not appropriate, what would you recommend to the new
Treasurer?
Question #3: Financial Instrument – 7 points
A. This is an unconventional cash flows and this project have multiple outlays of cash over a
project's life and as a result, this project is not appropriate to use IRR method.
B. Same as above, this is an unconventional cash flows and this project have multiple outlays of
cash over a project's life and as a result this project also not appropriate to use IRR method.
C. The cash flows for the project are unconventional. Since both projects have multiple positive
and negative cash flows initially and in between the projects, the decision rule for IRR is
invalid in these cases.
D. I will recommend the MIRR methods.
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In Non-CONNECT assignment #4, you were required to define several financial instruments.
Required:
A. Define or describe United States Treasury Note.
A US Treasury note is a marketable U.S. government debt security, backed by the full faith and credit
of the US Government with a fixed interest rate and a maturity between one and 10 years.
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Question #4: Bond Paying Interest Semi-Annually – 7 points
The Fire Free Company issued a 15-year bond 2 years ago. The coupon rate is 5.4%. Interest
payments are made every June 30th and December 31st. The bonds currently sell for 106% of
par value.
Required:
A. What is the current Yield-to-Yield?
N=13*2=26
PMT=54/2=27
FV=1000
PV=-1060
I=2.39 semiannually, so YTM=4.78%
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Question #5 – Payback Period – 7 points
The Red Flower Company is considering 2 independent projects. The Chief Financial Officer
wants to use the Payback Period method. The cut-off decision point she is requiring is 5 years.
The cash flows on the 2 projects are as follows:
Required:
A. Should the Red Flower Company accept Project N? Why or why not?
B. Should the Red Flower Company accept Project P? Why or why not?
A. The payback period is 5.47 yrs, so Project N is not acceptable.
B. The payback period is 4.51 yrs, so project P is acceptable.
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Question #6: - Ratios – 7 points
You are now reporting to the new Treasurer of the New England Pizza and Ice Cream Company.
The Treasurer is very concerned that the Company’s Current Ratio has increased each of the
past 3 years – specifically, from 1.15 to 2.72 to 4.98.
Required:
A. What SPECIFIC actions would you take to understand and be able to explain to the Treasurer
the reasons for the increase in the Current Ratio?
The Current Ratio is the Current Asset divided by Current Liabilities. An increase in the
Current Ratio could mean a company is growing bigger in its capacity or expanding its
business. This ratio is important because it measures the liquidity stand of a firm.
Normally, it is assumed that the higher the ratio, the higher is the liquidity and vice
versa. It would be wrong if the liquidity is concluded just based on the ratio. It can be
understood with the following situations:
1. Did the firm Pay off Note payable? The current ratio depends on current assets,
but it is also equally dependent on the current liability. It would decrease the
level of current liabilities and improve the current ratio.
2. Did the firm Sell-off Unproductive and bad Assets? Cash level can be increased
by selling extra current assets and bad assets. Otherwise, the money is
unnecessarily blocked into them, and this kind of money cost interest.
3. Did the firm collect from the current Account receivable? Collect the payment
from the clients to the firm as early as possible will increase the current assets.
4. Did the firm delay the Account payable? Delay the Account payable in a
reasonable way will increase the firm's cash flow, so eventually, it will increase
the current ratio.
5. Did the inventory increase? The size and the growth of the firm's inventory
(normally below one year's lifetime’s inventory) also will increase the firm's
current asset, which leads to the increase of the current ratio.
6. Did the firm cut off unnecessary other short-term liabilities?
However, it is important to recognize that major purchases that prepare for upcoming
growth – or the sale of unnecessary assets – will somehow artificially and suddenly
change a company's current ratio.
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Question #7 – Future Value: Multiple Cash Flows – 7 points
To begin your retirement plan, you plan on making the following deposits into an account
beginning 1 year from today:
Required:
A. If you will earn the annual rate of 6.74% on the amounts deposited, and no other
deposits are made, how much will be in the account after 28 years?
The NPV of the cash flow is: $54,054.99, consider this as the PV,
Then:
1. Calculate the FV of end of year 5, N=5, I=6.74%, 0 PMT, PV=-54054.99, we got
FV=74898.27.
2. Then from year 6, until year 28, there is no payment, so this FV will be considered as the
PV of the 28-5=23 years. We got $335,735.56(±1).
Another way to calculate this: NPV of the cash flow is: $54,054.99, as today’s PV, N=28, I=6.74, 0
PMT, we also got FV=$335,735.56(±1)
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Question #8 – Calculating Rate of Return – 7 points
In 1908, my grandfather purchased one of the first Ford Model T cars made (not really, but I had
to prepare another question). He paid $850 for the car. Today, if the car is in perfect condition,
the car would be worth $24,200.
Required:
A. What is the annual percentage increase in the value of the car?
N=2021-1908=113
PV=-850
FV=24200
0 PMT
I=3.008%
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Question #9 – Net Present Value versus Internal Rate of Return – 7 points
Shop, Shop, and Shop Some More is considering the following two strategic projects. The
projects are independent and will require a return of 15.0%. The cash flows are projected to be:
Required:
A. If it is appropriate to use the Net Present Value method, what is the NPV on both projects?
B. If it is appropriate to use the Internal Rate of Return method, what is the IRR on both
projects?
C. Which project or projects, if any, should Shop, Shop, and Shop Some More accept?
A. The NPV for CBA is $36,912.07; the NPV for PON is $71,761.40.
B. The IRR for CBA is: 28.18%, the IRR for PON is: 25.11%.
C. NPV is the prime decision factor, so the project PON shall be accepted.
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Question #10 - Annuity – 7 points
You plan to deposit $5,000 at the end of each year for the next 20 years into an account paying
10.1% interest annually.
Required:
A. How much will you have if you make deposits for 20 years?
B. How much will you have if you make deposits for 40 years?
A. $289,647.54
B. $2,273,988.16
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Question #11 – Bond Terms and Features – 7 points
Bonds have several unique terms and features.
Required:
BRIEFLY describe or provide example(s) of the following bond terms and features:
A. Put bonds
B. Protective covenants
C. Sinking fund
A. A put bond is a debt instrument that allows the bondholder to force the issuer to repurchase
the security at specified dates before the maturity date. The repurchase price is set at the
time of issue and is usually at par value. The holder of the put bond has the right, but not the
obligation, to demand early repayment of the principal. The put option is exercisable on one
or more specified dates.
B. Bond covenants can either be positive or negative. Positive bonds are called protective bonds
because they require the bond issuer to take certain actions, usually with the aim of
protecting the investors. These actions may include carrying insurance, maintaining certain
financial performance standards, or providing financial statements.
C. A sinking fund is the amount of money the bond issuer set aside or saved to pay off the
bond. A company that issues bond will need to pay off that bond’s par value and coupon in
the future, and the sinking fund helps to soften the difficulty of a large expenditure of
revenue. A sinking fund is established to contribute to the fund in the years leading up to the
bond's maturity.
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Question #12 – Times Interest Earned – 7 points
One of the long-term solvency ratios is Times Interest Earned.
Required:
A. To the lender, why is Times Interest Earned an important ratio?
B. Does the lender want the Times Interest Earned calculation to be a low number or a high
number? Why?
Question #13 – Interest Rate – 7 points
A. Times Interest Earned is important to lender because a company's TIE indicates its ability to
pay its debts. A good TIE number means a company has enough cash after paying its debts to
continue to invest in the business. It is an indicator to tell if a company is running into
financial trouble. A high ratio normally means that a company can meet its interest
obligations because earnings are significantly greater than annual interest obligations.
B. Normally, the lender wants a higher TIE number, because it indicates that the company has
lower risk of financial trouble. However, sometimes, if the company has a high TIE ratio, it can
also sometimes indicate that the company has an undesirably low level of leverage or pays
down too much debt with earnings that could be used for other investment opportunities to
get a higher rate of return.
14
One of my grandchildren is 3 years old and will be off to college in 15 years. I want to help her
financially so that she does not have to work while she is studying. I plan to invest $1,500 every
6 months in a mutual fund. There is already $56,000 in the mutual fund account. My goal is to
hand her a check for $80,000 on her first day in college.
Required:
A. What annual interest rate do I need to earn to achieve my goal?
N=15*2=30
PMT=-1500
FV=80000-56000=24,000
PV=0
I=4.84*2=9.6766%~9.68%
Question #14 – Present Value: Multiple Cash Flows – 7 points
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Your Financial Advisor calls you with an investment opportunity. The investment will pay you
the following amounts in the next 7 years:
Required:
A. What is the maximum you would be willing to pay for this investment, if you determine
the risk of the investment requires you to earn an 8.6% return?
A. Lets calculate the NPV for this investment: $9,620.62 so $9,620.62 will be the max I will be
willing to pay for this investment.
Intentionally Left Blank
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Grade on the Final Examination:
Question #1 ____________________of 7
Question #2 ____________________of 7
Question #3 ____________________of 7
Question #4 ____________________of 7
Question #5 ____________________of 7
Question #6 ____________________of 7
Question #7 ____________________of 7
Question #8 ____________________of 7
Question #9 ____________________of 7
Question #10 ___________________of 7
Question #11 ___________________of 7
Question #12 ___________________of 7
Question #13___________________of 7
Question #14___________________of 7
TOTAL Score _______of 100
LETTER GRADE __________
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