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Assignment - Managerial Finance

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You are on page 1of 20

by

LEONG KHAI SIANG

(CGS00661701)

Open University Malaysia

No. 55-57, Persiaran Greenhill

30450 Ipoh

Perak Darul Ridzuan

QUESTION 1

a. A corporation has a current ratio of 5.65 when the industry average is 1.42. What could

be the reason for this disparity?

Answer:

Formula at current rate = Current Asset

Current Liability

The disparity can be due to higher current assets such as cash, debtors etc.

Besides, it is also done to lower current liability such as creditors, payables etc.

b. Determine the sales of a firm with the following financial information:

Current ratio: 2.40

Quick ratio: 1.50

Current liabilities: RM600,000

Inventory turnover: 6 times

Answer:

Current ratio = CA

CL

2.4 = CA

60, 000

CA = 2.4 x 60,000

= 1,440,000

Q ratio = CA Inventory

CL

1.5 = 1,440,000 Inventory

60, 000

Inventory = 1,440,000 ( 1.5 x 60,000 )

= 540,000

Cost of good sold = Sales (1 gross margin )

= 0.75 sales

Cost = Inventory turnover

Inventory

0.75 sales = 6

540,000

Sales = 6 x 540,000

0.75

= 4,322,000

c. Complete the balance sheet and sales information for Edelle Corporation using the

following financial data:

Debt / equity 50.0%

Quick ratio 1.40

Total asset turnover 1.60

Days outstanding - accounts receivable 30.00

Gross profit margin 25.0%

Inventory turnover 4.00 times

Cash Accounts payable

Accounts receivable Common stock 25,000

Inventory Retained earnings 26,000

Plant and equipment Total liabilities & equity

Total assets

Sales Cost of sales

Answer:

Debt = 50%

Equity

Debt = 50%

25K + 26K

Account payable = Debt = 50% x 51K

= 25,500

Total liability = Total asset

= 25,500 + 25K + 26K

= 76,500

Q

r

= Cash + Receivable = 1.4

CL

Cash + Receivable = 1.4 x 25,500

= 35,700

Asset turnover = Sales = 1.6

Assets

Sales = 1.6

76,500

Sales = 1.6 x 76,500

= 122,400

Day sales outstanding = Receivable

Sales/365

30 = Receivable

122,400/365

Account Receivable = 30 x 335.342

= 10,060

Cash + Receivable = 35,700

Cash = 35,700 10,060

= 25,640

Cost of good sales = Sales (1 gross margin )

(COGS) = 122,400 (1 25%)

= 91,800

Inventory turnover = COGS = 4

Inventory

Inventory = 91,800

4

= 22,950

Plant & equipment = Total Asset Inventory Cash Account Receivable

= 76,500 - 22,950 -25,640 10,060

= 17,850

QUESTION 2

a. Dynamo Pyro Bhd. (DPB) earned RM6.50 of cash flow per share last year.

(i) If DPB expects its cash flow to grow by 6% per year forever, what is the current value of

a share of DPB stock? Assume that the required rate of return is 14.5%.

Answer:

Share value = DIV ( 1 + g )

Req rate of return g

= 6.5 (1 + 6% )

14.5% - 6%

= 6.89

8.5%

= RM 81.06

(ii) If the current stock price is RM59.66, what is the markets expected growth rate

underlying the stock price. Assume the same discount rate and expected cash flow.

Share value = DIV (1 + g )

Req - g

59.66 = 6.5 ( 1 + g )

14.5% - g

59.66 (0.145 g ) = 6.5 + 6.5g

8.6507 59.66g = 66.16g

2.507 = 66.16g

g = 3.25%

b. The risk-free rate is 5.45%, and the market risk premium is 5.00%. Under consideration

for investment outlays are Projects Alpha, Beta, and Chi, with estimated betas of 0.6, 1.1,

and 1.8, respectively. What will be the required rates of return on these projects based on

the Security Market Line approach?

Answer:

Req rate of return = R

f

(risk free rate) + (market base premium)

= 5.45 % + 0.6 (5%)

= 8.45%

= 5.45% + 1.1 (5%)

= 10.95%

Chi = 5.45% + 1.8 (5%)

= 14.45%

c. A 12 year corporate bond with RM1,000 maturity value carries a 7.5% coupon rate. It

pays its interest payments semi-annually.

(i) If the bond is currently selling for RM961.88, what is the rate of return on this bond?

Answer:

Yield of maturity = annual interest income + par value CMP

Years

Par value + CMP

2

= (7.5% x 1,000) + 1000 961.88

12

1000 + 961.88

2

= 7.96%

(ii) If the bond sold for RM1,030.32, what is the rate of return on this bond?

Answer:

Return of rate = 75 + 1,000 1,030.32

12

1,000 + 1,030.32

2

= 7.14%

QUESTION 3

a. Your sister is celebrating her 28th birthday. She wants to start saving for retirement at age

58. She tells you that ideally she would like to withdraw RM50,000 on an annual basis

for at least 25 years starting the year after she retires. She says that she is comfortable

putting aside some money each year in an annuity and believes that she should be able to

earn an 8% rate of return.

(i) If your sister starts making annuity payments to her savings account at the end of this

year and makes her last deposit at age 58, how much must she deposit each year?

Answer:

Total money to withdraw = 50,000 x PVIFA

25,8

= 50,000 x 10.675 (from PVIF table)

= 533,750

533,750 = PMT x (1 + i )

n

1

i

533,750 = PMT x (1 + 0.08)

30

1

0.08

= PMT x (9.06 / 0.08)

PMT = 4,711.64

(ii) Your sister mentions that she already has a savings account of RM10,000, if she used that

money to start the account, how much must she deposit each year until she reaches age

58?

FV = Principle (1 + i )

n

= 10,000 (1 + 0.08)

30

= 100,626.57

New value = 533,750 100,626.57

= 433,123.43

433,123.43 = PMT x (1 + i )

n

1

i

433,123.43 = PMT x (1 + 0.08)

30

1

0.08

= PMT x ( 9.06/0.08)

Deposit = 3,823.37

(iii) She suddenly remembers that her parents had bought her a life insurance policy that

matures on her 50th birthday for an amount of RM75,000. If she added that to the

retirement fund, along with her RM10,000 (year 0) savings account, how much must she

deposit each year until she reaches age 58.

Answer:

Insurance value = 75,000 x PVIFA

88.5%

(30 years) = 75,000 x 1.8509

= 138,817

Total money = 533,750 100,626.57 138,817

= 294,305.93

294,305.93 = PMT x (1 + i )

n

1

i

294,305.93 = PMT x (1 + 0.08)

30

1

0.08

= PMT x (9.06 / 0.08)

PMT = 4,711.64

b. Prepare the first three months of a loan amortization schedule for a RM200,000 thirty

year mortgage. The loan has a 6% APR interest rate and is compounded monthly. What

are the monthly payments?

Answer:

Monthly payment = Total loan i + i

(1 + ii)

n

1

i = 6%

12

= 0.5% (monthly)

n = 30 x 12

= 360

Month payment = 200,000 0.005 + 0.005

(150,005)

360

1

= 200,000 0.005 + 0.005

5.023

= 200,000 (0.005 + 9.9542 )

= 1,199.08

Month

Beginning

Balance

Installment Interest Principle

Year Ending

Balance

1 200,000.00 11,199.10 1,000.00 199.10 199,800.90

2 199,800.90 1,199.10 999.00 200.10 199,600.80

3 199,600.80 1,199.10 998.00 201.10 199,399.70

c. Assume that you are negotiating financing for a new automobile. You have been given

the choice between (1) a RM2,000 rebate and 9% (compounded monthly) financing or (2) no

rebate and 0.0% (compounded monthly) financing. Either loan would require monthly

payments for a two-year period; the cost of the vehicle is RM25,000. The RM2,000

rebate would immediately reduce the price of the vehicle. Calculate your monthly

payment under both alternatives. With which choice are you better off?

Answer:

Option I 2,000 rebate with 9% compounded monthly

New price = 25,000 2,000

= 23,000

Monthly payment = loan i + i

(1 + i)

n

1

i = 9%

12

= 0.75%

n = 2 x 12

= 24

MP = 23,000 0.0075 + 0.0075

(1 + 0.075)

24

1

= 23K 0.0075 + 0.0075

0.1964

= 23K ( 0.046 )

= 1,050.75

Option 2 0% Interest installment & 0 rebate

Installment = 25,000

24

= 1,041.67

Hence, option 2 is preferably due to its lower installment.

QUESTION 4

a. Nickson bought 100 shares ofPristonBhd stock for RM24 per share on January 1, 2009. He

received a dividend of RM2 per share at the end of 2009 and RM3 per share at the end of 2010.

At the end of 2011, Nickson collected a dividend of RM4 per share and sold his stock for RM18

per share. What was Nicksons realized return during the three year holding period?

Answer:

Capital gain = 18 24

= 6

Dividend income = 2 + 3 + 4

= 9

Total return = -6 + 9

= 3

Realized return = 3 x (100/24)

= 12.5%

a. Given an expected return for the market of 12 percent, with a standard deviation of 20

percent, and a risk-free rate of 8 percent, consider the following data:

Stock Beta Ri(%)

1 0.8 12

2 1.2 13

3 0.6 11

(i) Calculate the required rate of return for each stock using the SML.

Stock Beta R

i

(%) Req rate of return (Rs)

1 0.8 12 8 + (0.8) (12-8) = 11.2

2 1.2 13 8 + (1.2) (12-8) = 12.8

3 0.6 11 8 + (0.6) (12-8) = 10.4

(ii) Assume that an analyst, using fundamental analysis, develops the estimates labeled Ri for

these stocks. Which stock would be recommended for purchase?

Answer: It would be Stock 1 recommended to purchase. (highest between Rs and Ri)

b. Why is market risk sometimes said to be the relevant risk for a portfolio manager?

What is the measure of market risk?

Answer:

Market Risk cant diversify and cant be removed or eliminated. For example: market risk = interest

rate, government policy, war.

specific risk

market risk

c. Suppose the Security Market Line (SML) has a risk-free rate of 5 percent and an

expected market return of 15 percent. Now suppose that the SML shifts, changing slope,

so that kRF is still 5 percent but kM is now 16 percent. What does this shift suggest about

investors risk aversion? If the slope were to change downward, what would that suggest?

Answer:

This shift is suggest to increase in risk premium. For instance, 16% to 5 % = 11% before 15% -

5% = 10% higher risk premium indicates higher risk so investor need to be more risk averse.

Apart from that, downward slope indicate to risk.

QUESTION 5

a. Discuss the different forms of market efficiency under the Efficient Market Hypothesis

(EMH)? Are market anomalies consistent with the concept of EMH?

Answer:

The efficient Market Hypothesis (EMH) gives rise to forecasting tests that mirror those

adopted when testing the optimality of a forecast in the context of given information set.

However, there are also important differences arising from the fact that market efficiency

tests rely on establishing profitable trading opportunities in real time. Forecasters constantly

search for predictable patterns and affect prices when they attempt to exploit trading

opportunities. Stable forecasting patterns are therefore unlikely to persist for long periods of

time and will self-destruct when discovered by a large number of investors. This gives rise to

non-stationarities in the time series of financial returns and complicates both formal tests of

market efficiency and the search for successful forecasting approaches.

Market efficiency can be defined as a securities market is efficient if security prices fully

reflect the information available. Besides, it is also understandable that the market is efficient

with respect to some specified information system, if and only if security prices act as if

everyone observes the information. The importance of market efficiency includes

encouraging share buying, whereby the investors need to know that they are paying a fair

price and that they will be able to sell at a fair price. Besides, it provides signals to Company

Managers in pursuit of maximizing shareholders wealth, need to get feedback on their

decisions. Furthermore, it can help in allocating resources. For instance: Allocation

Efficiency requires both operating and pricing efficiency.

Basically, there are three forms of market efficiency as below:

(i) Weak Form Efficient Market

- Market prices reflect all historical information.

- RandomWalk.

(ii) Semi-strong Form Efficient Market

- Market Prices reflect publicly available information.

(iii)Strong Form Efficient Market

- Market prices reflect all information, both public and private.

b. Conventional wisdom has long held that diversification of a stock portfolio should be

across industries. Does the correlation coefficient indirectly recommend the same thing?

Answer:

No, because different industry and minral correlation coefficient. As example

a. What are the assumptions in the CAPM? Can these be relaxed without destroying the

conclusions of the model?

Answer:

The Capital Asset Pricing Model (CAPM) is a theory based upon the above theory of portfolio

selection. The basic premise is that in capital markets people are rewarded for bearing risk. Any

asset is priced in equilibrium so that if the asset is risky people receive a higher rate of return

than they would receive if they held a risk free asset. This higher rate of return is called a risk

premium. But the market does not reward people for bearing unnecessary risk, risk that can be

avoided by diversification. The risk premium on an asset is thus not related to its standalone risk,

but rather to its contribution to an efficiently diversified portfolio. Any efficiently diversified

portfolio can be constructed by mixing a risk free asset and a tangency portfolio of risky assets.

The CAPM model is based upon two assumptions:

Assumption 1: Investors agree on their forecasts of the expected rates of return, risks and

correlations for every asset. They therefore hold risky assets in the same proportions. (Note:

different investors may have differing levels of risk aversion so they may mix the optimal

portfolio of risky assets with the risk free asset in differing proportions.)

Assumptions 2: Investors generally behave rationally. In equilibrium, the prices of all assets have

adjusted so that the market clears. It follows that in equilibrium because all investors hold risky

assets in their portfolios in the same optimal proportions that for the market to clear the market

values of those assets must adjust so that the total market value of each asset is the same

CP O&G

proportion of the total value of all the risky assets as its proportion in the optimal portfolio. A

portfolio which holds assets in the same proportions as they are held in the market is called a

market portfolio. The implication of the CAPM model is that the Market portfolio is the optimal

portfolio.

QUESTION 6

Write a short essay (minimum 250 words) to discuss the importance of good corporate

governance and its effects on firms value. The essay has to be original (evidence of plagiarism,

i.e. cut-and-paste, etc., will result in zero mark). Your arguments must be supported by factual

evidence and, if necessary,sources of reference must be listed down.

Answer:

The essence of good corporate governance is to ensure trustworthy relations between the

corporation and its stakeholders. Therefore, good governance involves a lot more than

compliance. Nevertheless, good corporate governance is a culture and a climate of

accountability, consistency, effectiveness, fairness, responsibility and transparency that is

deployed throughout the organization.

In an organization, good corporate governance could support in effective decision making. This

effective decision making in a well-governed organization is based on a well balanced

accountability framework that is clear communication and understanding across the organization

and understanding across the organization of roles and responsibilities. Apart of that, it also

robust performance, financial, risk and information management systems as well as the high

standards of conduct.

Organizations with good corporate governance have the capacity to maintain high-quality

services and to deliver improvement. Poor governance arrangements set the framework within

which the organizational systems and processes fail to detect or anticipate serious service and

financial failures. Good governance in organizations, based on openness, clarity and honest

accountability enhances public trust and civic engagement.

As conclusion, good corporate governance is a must for complex and dynamic business

environment to ensure long-term sustainability nowadays. So, it should be cultivated and

practiced regularly within the current structure of the business. Undoubtedly, corporations that

genuinely recognize and embrace the principles of good governance will derive enormous

benefits, the availability and lower cost of capital, the ability to attract talent clients and business

partners, improved competitiveness and financial performance, and truly sustainable long-term

growth. With that, good corporate governance is also very important for sustainable

development, not only for the individual company, but also for the economy as a whole.

Therefore, the quality of governance should be continuously improved and good governance

should be promoted.

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