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SOLUTION: -

• Non-payment of dividend fir the last two years.


• Non-utilization of browed funds.

• reflexive investment polices.


Investors consider dividends as a promise, and that signaling is an
important consideration. Because of he possible signaling effects and
investor perception of uncertainty, it is believed that management will
attempt to “ smooth” dividends rather than pay a constant percentage
of earnings. To avoid negative signals, dividends will not be increased
until management is certain that the new level can be maintained. The
residual approach, however, is also seen in the tendency of rapidly
growing firms to have lower payout than more mature firms. Retention
and reinvestment of earnings to postpone taxes is especially apparent
in smaller of closely held corporations. It appears that there is not a
single universal explanation of dividend decisions,but that all of the
aqbove factors and arguments have an impact that varies with the
situation. Clientele effect. The clientele effect indicafes that investors
will tend to hold stocks whose dividend policy fits their needs. That is
investors preferring more certain dividends over uncertain future
earnings or having a preference for current incomes over capital gains,
will tend to hold socks with relatively high dividend pay out and
vicaversa.

2- Management,s perspective:-
Non- payment of dividend was due to poor profitability and
to use the available funds for company operation .
Company was care full in not using borrowed funds an it may
lead to financial distress and ultimately toward bankruptcy.
Large management carry two tiers of leadership that allow
shareholders and management to work together in the best interests
of the firm investors elect a board of directors that is led by the
chairman of the board. The board of directors then hires management
to run the daily operations of the company. The chief executive officer
is the top manager, while the chief financial officer is responsible for
the financial standing of the company management will finance
themselves by issuing debt and selling equity ownership stakes as
shares of stock. There are several considerations that factor in to a
management decision as to whether to issue dividends. The
management must make interest payments to creditors to remain
solvent, but it has deciding whether to return profits to shareholders in
the form of dividends. Interest payments are tax-deductible costs, but
dividends are paid out of net income. Further, preferred stock carries
rights to receive dividend payments prior to Common stock equity.

3. Perspective of shareholders:

The separation perspective suggests that, because managers are


agents of the firm’s owners-the shareholders-managers should always
strive to act in the best interest of the best interest of the firm’s
owners. This view does not cause managers to ignore non – owner
stakeholders, indeed, when taking actions that benefit stakeholders
also benefit owners, the separation perspective would advise
managers to do so. One facet that differentiates this perspective from
the others, however, is the rationale behind such decisions, the reason
managers make decisions and take actions benefiting non-owner
stakeholders is ultimately to reward owners. Clearly, problems arise
when a given decision would maximize the benefit to non-owners at
the expense of owners, but that would serve the greater good of
society in general.

In General:
The ethical perspective is that businesses have an obligation to
conduct themselves in a way that treats each stakeholder group fairly.
This view does not disregard the preferences and claims of
shareholders, but takes shareholder interests in consideration only to
the extent that their interests coincide with the greater good. The
integrated perspective. The third approach, the integrated perspective,
suggests that firms cannot function independently of the stakeholder
environment in which they operate , making the effects of managerial
decisions and actions on non-owner stakeholders part and parcel of
decisions and actions made in the interests of owners. This view holds
that managerial decisions and actions are intertwined with multiple
stakeholder interests in such a way that breaking shareholders apart
from non-owner stakeholders is not possible. Managers who, according
to this approach, make decisions in isolation of the multitude of
stakeholders and focus singly on shareholders overlook important
threats to their own well-being as well as opportunities on which they
might capitalize for example, the national association of securities
dealers (NASD) is a self-regulatory organization that monitors and
disciplines members such as insurance companies and brokerages. By
incorporating NASD regulations into their management decisions and
actions, insurance companies and brokerages, at least to some extent,
preempt outside governmental action that may make compliance more
restrictive or cumbersome.

4- Creditor’s perspective:
Creditor will be happy over these policies because the company has
funds ( due to non- payment of dividend, no more borrowing and
passive investments) which may be used and reply the creditors funds
& interest thereon.
The capital markets:
A) new share issues, for example, by companies acquiring a
stock market listing for the first time
B) rights issues
• Loan stock
• Retained earnings
• Bank borrowing
• Government sources
• Business expansion scheme funds
Borrowings from banks are an important source of finance to
companies. Bank tending is still mainly short term, although
medium- term lending is quite common these days.
Short term lending may be in the form of:
a) overdraft, which a company should keep within a limit set
by the bank. Interest is charged ( at a variable rate) on the
amount by which the company is overdrawn from day
today:
b) a short- term loan, for up to three years.

PARTS.
A) Purpose
B) Amount
C) Repayment
D) Term
E) Security

The purpose of the loan A loan request will be refused if the purpose
0f the loan is not acceptable to the bank.
The amount of the loan . The customer must exactly how much he
wants to borrow. The banker must verify, as he is able to do so, that
the amount required to make the proposed vestments has been
estimated correctly.
How will the loan be repaid? Will the customer be able
to obtain sufficient income to make the necessary repayments ?
What would be the duration of the loan? Traditionally, banks have
offered short-term loans and overdrafts, although medium – term
loans are now quite common.

Does the require security ? If so, is the proposed security adequate?

5: Suggestions
The rewards& Benefits of the management could be liked with the
performance shown by the management and to cheek this
performance some internal control measures & auditing practices
should be made by the company’s shareholders. More shares,
power . It may seem an obvious statement but the greater the
shareholding of an individual, the greater are his/jer rights and the
greater is his/her power within the Company. This is so not only
because the larger the shareholding the more likely it so to
represent a controlling interest, But also because the Companies
Act affords greater rights and power to an individual as the size of
his/her shareholding increases. For example, a shareholder owning
5% of a company has the right to have an item placed on the
agenda for discussion at the annual general meeting and, once the
shareholder’s ownership reaches 10% of the company, he/she has
the right to actually call a general meeting of shareholders.
Controlling Interest in the great majority of limited companies, a
shareholding in excess of 50% of the issued share capital will be
enough to control the company, dictate the makeup of the board of
directors and to do most of the acts necessary to run the company
in its everyday business.

SOLUTION Q#2: -
Return of Assets (ROA): This ratio is used in evaluating whether
management has earned a reasonable return with the assets under
its control. IN this computation returns usually is defined as
operating income, since interest expense and income taxes are
determined by factors other than the manner in assets are used.
The return on assets is computed as follows:
Return On Assets = Operating Income
Average Total Assets

Return On Equity (ROE):The return on assets that we calculated


above measures the efficiency with which management has utilized
the assets under its control, regardless of whether these assets
were financed with debt or equity capital. The return on equity ratio
in contrast, looks only at the return earned but management on the
stockholder’s investment, that . On owner’s equity, The returns to
stockholders is net income which represents the return from all
sources, both, operating and non-operating. Thus return on equity is
computed as follows.
Return On Equity : Net Income
Average Total Stockholders,
Equity Relationship Between The ROA&ROE

ROA is use for management has earned a reasonable return with the
assets under its control, But Roe find by management from the utilization
of the assets. ROA, return usually is defined as operating income,
since interest expenses and income taxes are determined by factors other
than the manner in which assets are used and in ROE return to
stockholders is net income, which represent the return from all sources,
both operating.

Example of ROA:
Lets us now determine the return on assets earned by the management
of computer city in 2006. Operating income, as shown in the income
statement amount to Rs.120.000 Assume that computer city’s asset at
beginning of 2006 totaled Rs.570,000 The balance sheet shows that
assets of Rs.630,000 at year-end. Therefore, the company’s average total
assets during the year amounted to Rs.600,000 (570,000+630,000)/2)

The return on assets in 2006 is 20 percent, determined as.


Return On Assets= Operating Income = 120,000
20% Average Total Assets 600, 000

Example of ROA: Let


us again return to the 2006 financial statement of computer city. The
company earned net income of Rs.72,000. The year-end balance sheet
shows total stockholder’s equity for Rs. 42.000. The enable us
computations. We will assume that the stockholders equity at the
beginning of the year amounted to Rs.380,000. Therefore, the average
stockholders equity for the year amount to Rs. 400,000
(380,000+420,000)/2]. The return on stockholders equity in 2006 is 18
Net Income
percent, computed as follows 72,000
Return On Equity =
= = 18%
Average TotalS. Equity 400,000

Solution Q.2.b) Five Groups Of Ratios

Sr. Groups Detail


I • Gross Profit Ratio
Profitability ratio • Net Profit Ratio
• Operating Profit Ratio
II • Current Ratio
Solvency Ratio • Liquidity Ratio
• Cash Ratio
III • Stock turnover ratio
Activity Ratio • Accounts receivable turnover ratio
• Working capital turnover ratio
Iv • Debt-Equity ratio
Leverage ratio • Debt to total assets ratio
V • Earning per share ratio
Market ratio • Price earning ratio
• Dividend yield ratio

Example of gross profit ratio


Calculated as:

Gross profit margin= Revenue Cogs


____________
Revenue
Where:
COGS= Cost of goods sold
Gross profit margin: For example, suppose that ABC Corp earned 20
million in revenue from producing widgets and incurred 10 million in
COGS-related expense. ABC,s gross profit margin would be 50% This
means that for every Rs that ABC earns on widgets, it really has only
0.50 at the end of the day.

Example of Net profit ratio:


Essentially the net profit ratio tells us about how the company’s profits
relate to their sales Different industries have fundamentally different
net profit ration. The net profit ratio can tell us about the nature of the
industry the industry the company is operating in as well as serving to
compare past performances of a company.
The formula for the net profit ratio is as follows:
Net profit Ratio (%) = profit before Tax/Total revenues)x100.
Example: Calculating the Net profit ratio:
Let us consider an example where a local supermarket, over the period
of 1 year, produces the following results:
 Sales of: 4 million
 Cost of sales: 3.5 million
 Employee costs:$0.2 million
 Other costs: 0.1 million
 Net profit: 0.2 million (4-3.5-0.2-0.1)
In this case we can calculate the net profit ratio to be 5% (0.2/4)*100
Example Of Current Ratio
The current is another test of a company’s financial strength. It
calculates how many Rs in assets are likely to be converted to cash
within one year to pay debts that come due during the same year. You
can find the current ratio by dividing the total current assets by the
total current liabilities . For example, if a company has 10 million in
current assest and 5 million in current liabilities, the current ratio
would be 2 (10/5=2).

Example of Stock Turnover Ratio:


The current ratio is another test of a company’s financial strength. It
calculates Rs in assets are likely to be converted to cash with one year
in order to pay debts that come due during the same year: You can
find the current ratio by dividing the total current assets by the total
current liabilities. For example, if a company has 10 million in current
assets and 5 million in current ratio would be 2 (10/5=2). Example of
Stock Turnover Ratio:
Calculate stock Turnover by dividing the cost of goods sold (COGS) for
the reporting period by average value of inventory on hand during the
period . The reporting period can be anyt time interval you select-
monthly , quarterly, or annually , for example. Stock Turnover
= Cogs/Average Rs value of inventory on – hand if your cost of goods
sold during the period is 100 Rs and your average finished products
inventory during the month is10, then your finished products inventory
turnover ratio is 10 (100/10=10). This implies that you are able to sell
out your inventory ten times during the reporting period.

Example of Working Capital Turnover Ratio:

Following formula is used to calculate working capital turnover ratio


Working Capital Turnover Ratio= COST OF sales / Net working capital .
The two components of the ratio are cost of sales and the net working
capital. If the information about cost of sales is not available the figure
of sales may be taken as the numerator. Net working capital is found
by deduction from the total of the current assets the total of the
current liabilities.
Example
Cash
Bills Receivables
Sundry Debtors
Stock
Sundry Creditors
Cost of sales
Calculate Working Capital Turnover Ratio
Calculation:
Working Capital Turnover Ratio = cost of sales / net working capital
Current Assets = 10,000 + 5,000+ 25,000+ 20,000 = 60,000
Current Liabilities = 30,000
Networking capital = current assets – current liabilities
= 60,000 – 30,000
= 30,000
So the working capital Turnover Ratio = 150,000 / 30,000
= 5 times

DEBT EQUITY RATIO:


A measure of a company’s financial leverage calculated by
dividing its total liabilities by stockholders’ equity. It indicates
what proportion of equity and debt the company is using to
finance its assets.

Total Liabilities
=
Shareholders Equity

Note : sometimes only interest – bearing, long – term debt is used


instead of total liabilities in the calculation. Also known as the personal
Debt / Equity Ratio, the ratio can be applied to personal financial
statements as well as companies. For example, capital – intensive
industries such as auto manufacturing tend to have a debt equity ratio
above 2 , while personal computer companies have a debt / equity of
under 0.5.

PRICE EARNING RATIO


A valuation ratio of a company’s current share price compared to its
per- share earnings.

Calculated as:
Market value per share
=
Earnings per share (EPS)
For example, of a company is currently trading at 43 a share and
earnings over the last 12 months were 1.95 per share, the P/E ratio for
the stock would be 22.05 (43/1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes
it can be taken from the estimates of earnings expected in the next
four quarters (projected or forward P/E). A third variation uses the sum
of the last two actual quarters and the estimates of the next two
quarters.
Also sometimes known as “price multiple” or “earnings multiple”.

EXAMPLE OF DIVIDEND YIELD RATIO


A financial ratio that shows how much a company pays out in dividends
each year relative to its share price. In the absence of any capital
gains, the dividend yield is the return on investment for a stock.
Dividend yield is calculated as follows:

Annual Dividends Per Share


=
Price Per Share
If two companies both pay annual dividends of Rs 1 per share, but ABC
company’s stock is trading at Rs 20 while XYZ company’s stock is
trading at Rs 40, then ABC has a dividend yield of 5% ehile XYZ is only
yielding 2.5% thus, assuming all other factors are equivalent, an
investor looking to supplement his or her income would likely prefer
ABC’s stock over that of XYZ.

Q.5.a) Relationship between Required rate of returns on investment vs


cost of capital with investment return on investment (ROI) is generally
referred to as the cash or profit gained from equity RS invested. It is
also referred to as return of equity (ROE). The return can be expressed
as a dollar amount, or converted to a percentage by dividing the return
by the equity deployed. Typically, returns are calculated on an annual
basis and referred to as annual rate of return.
RS Received / RS Originally invested = rate of return
Return can also be calculated of total capitalization ( debt and equity).
Such a return would be calculated as follows:

RS Received / ( Equity Capital + Debt Capital Invested) = return on


total capitalization

Example: if RS 50 was received in year one as a return of RS200


invested the rate of return would be 25 percent, calculated as 50/200
= .25 or 25 percent

These returns can be calculated after the fact, as above, the formula
can be used to calculate the amount that can be invested and still
yield a required rate of return. For example, if a given investment is
expected to earn RS 50 and the required rate of return is 25 percent,
then the amount that cant be invested is RS200. using basic algebra to
rearrange our original formula for calculated rate of return, we obtain
the following formula to calculate investment amount that will yield the
desired rate of return given the expected amount of income:

RS Received / Required rate of return = RS Originally invested


RS50 /.25 = RS200
Cost of capital is the minimal return that investors intend to earn on
their investments. For shareholders, the cost of capital is the dividend
and capital gains on the share value, while for bondholders it is the
interest rate quoted on a bond.
While investing , it is essential to consider the opportunity cost of the
invested capital, as it represents the return that is foregone by
investors by choosing an alternative investment opportunity has
similar or comparable risk. So, this factor may be considered while
castigating the cost of capital.

Calculating Cost of Capital


There are two ways to calculate cost of capital:
Weighted average cost of capital (WACC)- This is the minimum return
that a company must realize from an existing asset base in order to
fulfill the needs of its creditors, owners and investors. Weighted
average cost of capital (WACC) for the invested capital contains equal
proportions of equity and debt , which is calculated as:
WACC= (E/F) Re+ (D/F Rb (1-tc)
Where total capital invested (F) = D+ E
Re= Expected fate of return on equity or cost of equity (%)
Rb = Expected fate of return on borrowings or cost of debt (%)
tc= Corporate tax rate (%)

D = current value of the firm’s total debt and leases


E= Total market value of equity and equity equivalents
However, if a part of the capital comprises of a preferred stock ir
an asset with a different cost of invested equity , then the formula may
be modified as follows:
WACC= Wd (1-T) Rd= We Re
Wd= Debt portion of value
T = Tax rate
Rd = Cost of debt (rate)
We = Equity portion of the total value of a firm
Re =Rate (Cost) of internal equity
capital asset pricing model (CAPM)-This model
states that investors must be compensated for the risks associated
with an investment and time value of money . So the CAPM calculates
the expected return from a security (Es) as follows:

Es = Rf=Bs (Rm- Rf)


Where :
Rf= Expected risk-free return from the security
Bs= Sensitivity of the security to market risk
Rm= Historical returns from financial
markets ` (Rm-Rf)= Risk premium of market assets
over risk-free assets investors are advised to refrain from investing
when the expected return falls short of the required return.

Answer Q. 2 (c)
Allied Corporation
Incom statement
For the period ended 2008

Sale 100
Less:COGS 68.60
Depreciation 13.60
EBIT 17.80
Interest paid 12.40
Taxable Income 5.45
Tax deduction 1.85

Net Income 3.60

Answer Q. 3 (A)

PV =500
i=12%
n=5%
Fv=Pv (1 + i)n
i. 12% Compounded Semi-Annually for 5 year
Fv = Pv (1 + i %)nx2
n=500 (1.06)10

ii. 12% Compound quarterly for 5 Year


Fv - Pv (1 + i %) nx4

=500 (1.03)20
iii. 12% Compounded Monthly for 5 Year
Fv - Pv (1 + i %)nx12
=500 (1 – 01)60
Answer Q No. 3b
Pv =25000
i= 10
n=5%
PvA = FvA (Fvi x FA10% x ny )
25000= FvA (Fvi x FA10% x 5y )
25000= FvA (3.791)
FvA =25000/ 3.791
FvA =6595

Year Installment Interest Principle Ending


Balance
0 25000
1 6595 2500 4095 20905
2 6595 2090 4505 16400
3 6595 1640 4955 11445
4 6595 1144 5451 5994
5 6595 601 5994 0

Answer Q. 3 (c)
Div =3
g=8%
What will the dividend be in 5 Year

Do =3
D1=3(1.08) =3.24
D2=3.24 (1.08)=3.50
D3=3.50 (1.08)=3.78
D4=3.78 (1.08)=4.08
D5=4.08 (1.08)=4.41

Answer No. 4A
i. Expected Rate of Return
Ki Probability Ki x Pn
0.20 0.30 0.06
0.05 0.40 0.02
.12 0.30 0.036
0.116

ii. Standard Deviation

Ỏ=[sum(Ki-(K/n)xPn)]1/2
Ki K K1 –K (K1 - K)2 Pn (Ki - K) x Pn
.20 .116 0.084 .0071 .30 .00213
.05 .116 -0.066 .0044 .40 .00176
.12 .116 0.004 .000016 .30 .000048
.0038948
Ỏ = 0.0624
Ỏ=

iii. Coefficient of Variance


= S.D x 100
X
= 0.0624 x 100
.116
= 5.40
Answer Q. 4 (b)
Investment=100000
Expected Return=13%
20%
B=1.30
R7=7%
Ki = Rf + B( Rm - Rf )
20%=7%+ 1.30( Rm - 7%)
20%-7%= 1.30( Rm – 9.1% )
13%+9.1% = 1.30 Rm
22-1% = Rm
1.30
20.8% = 20.8% = Rm

RELATIONSHIP
IF ThenCapital Budgeting :
NPV <0 IRR<Cost of Capital Reject the investment from the
cash flow perspective. Other factors could be important. Provides the
minimum return. Probably reject .
NPV =0 IRR = Cost of capital from the cash flow perspective.
Other factors cold be important.
Screen in for further analysis. Other investments May provide
NPV > 0 IRR> Cost of capital rationed, i.e., go to the most
profitable projects. Others factors could be important.
When we pay that the required return an investment so, say,
10% we usually mean that the investment will have a positive NPV only
if return exceeds 10% another way of interpreting the required return
is to observe that the firm must earn 10% an the investment to
compensate its investor for the use of the capital needed to finance
the project. This is why we could also say that 10% is the cost of
capital associated with the investment imagine that we are evaluating
a risk-free project, in this case how to determine that required return is
obvious, we look at the capital markets and 0bserve the current rate
offered by the risk-free investment and we use this rate to discount the
projects cash flows. Then the cost of capital for a risk-free investment
is the risk free rate. If s project is risky, then assuming that all the
other information is unchanged . the required return is obviously
higher. In other words the cost of capital for this project if it risky, in
greater then the risk-free rate and the appropriate discount rate would
exceed the risk-free rate .
Answer 5(b)

i.
Do = 2
Po = 23
g =7

D1 = D ( 1 + g ) Di = 2.147
= 2(1.07) =
Ke = Dividend1 + g
Po
=2.14 + 7%
23
= 9.3% + 7%
= 16.30%
ii.CAPM
Ke = Rf + B ( Rm – Rf )
= 9% + 1.60 ( 13% - 9% )
= 9% + 1.60 ( 4% )
= 9% + 6.4%
=15.4%