TABLE OF CONTENT

Foreword .................................................................................................................................................. ...2

Introduction ............................................................................................................................................. ...3

Instruction Program Outline .............................................................................................................. ...5

MODULE 1 ................................................................................................................................................. ...6

MODULE 2 ................................................................................................................................................. 13

MODULE 3 ................................................................................................................................................. 20

MODULE 4 ................................................................................................................................................. 26

MODULE 5 ................................................................................................................................................. 32

MODULE 6 ................................................................................................................................................. 41

MODULE 7 ................................................................................................................................................. 46

MODULE 8 ................................................................................................................................................. 52

MODULE 9 ................................................................................................................................................. 59

MODULE 10 .............................................................................................................................................. 65

MODULE 11 .............................................................................................................................................. 72

MODULE 12 .............................................................................................................................................. 80

MODULE 13 .............................................................................................................................................. 87

1
 FOREWORD

Principal of Finance is the foundation from the Finance Concentration in the further
year. From this subject, student will learn more about how to apply financial theories
and equations through the business implications. The students will embark on the
journey of knowing why and how the financial worlds are being done with great
examples from the past and current situations.

This class will let the students to find out the basics and insights of how would it be like
to have finance as their concentration in the further year. We will learn on how to read
financial statements, financial growth, financial tools, and many more basics
information to emphasize a greater perspective on this major.

This module has been compiled in a way that these purposes might be achieved. It
contains the key elements of each chapter, followed by specifically chosen exercises to
be solved and discussed in each meeting with the lab assistant.

The aim of this module is to help students understand more about Principle of Finance
in order for the students to be able to move into a more advance finance education. We
will try our best, so each student can apply the knowledge from Principle of Finance for
the cases that will be given and also for more Advanced Finance subjects.

And for the students, I hope that we can learn well together with your own laboratory
assistant and please don’t hesitate to ask and give feedbacks. It is our wish that you can
use these financial techniques for your tools in the future. May God bless all of you and
grant you wisdom throughout the journey.

On behalf of the laboratory assistant team, I wish you good luck and have a great journey.

Metta Kumala Dewi

Lab Assistant Coordinator

2
 INTRODUCTION

A. Description
Laboratory subject is related to the main subject (Theory), which cannot be separated.
The purpose of laboratory subject is to make the student be able to understand the
concept of the subject by exercising their self in problems and cases. All laboratory
subject is 0 credit but the duration of the class is 120 minutes which equivalent to 2
credits.

B. General Purpose Instruction

After involving in this class and doing all of the materials, students are expected to be
able to do identification/explaining/calculating/analyzing the concept about:
1. Corporate Finance and Financial Statements
2. Long-Term Financial Planning
3. Bond and Stock Valuation
4. Interest Rates and Net Present Value
5. Credit and Inventory Management

C. Lecture Activities
The students are directed to involve actively in the class learning process.
1. To facilitate the learning proses, the students must read the chapter on the
reference book that related to the class material. Students are also able to read the
brief theory that provide in each module.
2. The questions that provide in this module are only the materials that partially
have been taught in the theory subject.
3. Students must do the questions on the module individually based on the
instruction of the laboratory assistant, do quizzes that will be held, follow the
laboratory mid-exam and final exam based on the given schedule.

D. Class Rules
1. Attendance
At least attend 85% attendance, which is equivalent to attending 11 out of 12
sessions.

2. Lateness
>10 Minutes regarded as absent
3
 3. Permission Exception
1. Formal permission from university or faculty
2. Hospitalized (maximum 2 weeks)
3. Sudden pass away of core family member (with supported documents).

E. Grading Composition
The final grade is the sum of the student’s theory and lab score with a composition of
80% theory class and 20% lab course.
Below are the components of the lab course grading:

Mid-Test : 35% Quiz 1 : 10%

Final Test : 35% Quiz 2 : 10%
Assignment : 10%

*Note: Quiz 1, Quiz 2, and Assignment will be collected as KAT

F. Grading Scale
Score Grade
90 – 100 A
85 – 89.99 A-
80 – 84.99 B+
75 – 79.99 B
70 – 74.99 B-
65 – 69.99 C+
60 – 64.99 C
55 – 59.99 C-
0 – 54.99 F

4
 INSTRUCTION PROGRAM OUTLINE (SAP)

WEEK MODULE CHAPTER MATERIAL

1 Module 1 Chapter 1,2 Introduction for Finance Corporate
and Financial Statements

2 Module 2 Chapter 3 Calculating Financial Statements

3 Module 3 Chapter 4 Measuring Long-Term Financial
Planning and Growth

4 Module 4 Chapter 5 Learning Valuation

5 Module 5 Chapter 6 Calculating DCF Valuation
6 Module 6 Chapter 7 Calculating Interest Rate and Bonds
7 Module 7 Chapter 8 Calculating Stock Valuation
8 MID-TERM EXAM
9 Module 8 Chapter 9 Calculating NPV and Investment
Capital

10 Module 9 Chapter 10 Learn to Make Capital Investment

Decision

11 Module 10 Chapter 11 Analysis and Evaluate Project

12 Module 11 Chapter 18 Measuring Short-Term Financial
Planning

13 Module 12 Chapter 19 Calculating Cash and Liquidity

Management

14 Module 13 Chapter 20 Calculating Credit and Inventory

Management

15 - - Quiz & Review

16 FINAL EXAM

5
 MODULE 1: INTRODUCTION TO CORPORATE FINANCE & FINANCIAL
STATEMENTS, TAXES AND CASHFLOW

Reviewed by Caroline Hanni Abraham

Introduction to Corporate Finance

Corporate finance is the area of finance dealing with the sources of funding and the capital
structure of corporations and the actions that managers take to increase the value of the
firm to the shareholders, as well as the tools and analysis used to allocate financial
resources.

Three types of Financial Management Decision

a. Capital budgeting is the process of planning and managing a firm’s long-term
investments.
b. Capital structure refers to the specific mixture of long-term debt and equity the
firm uses to finance its operations.
c. Working capital management refers to a firm’s short-term assets, such as inventory,
and its short-term liabilities, such as money owed to suppliers.

Financial Statements, Taxes, and Cash Flow:

1. Balance Sheet
Balance sheet is a “snapshot” of the firm. Balance sheet is a financial statement
showing a firm’s accounting value on a particular date, organizing and summarizing
what a firm owns (its asset), what a firm owes (its liabilities), and the difference
between the two (the firm’s equity) at a given point in time.
Assets are classified as either current or fixed. A fixed asset is one that has a
relatively long life while a current asset has a life of less than one year which means
that the asset will be converted to cash within 12 months.
Liabilities are also classified as either current or long term. Current liabilities have
a life of less than one year which means they must be paid within a year. A debt that
is not due in the coming year is classified as a long-term liability. The difference
between the total value of the assets and the total value of liabilities is the
shareholders’ equity, also called common equity or owners’ equity.

6
 The balance sheet “balances” because the value of the left side always equals the
value of the right side.
Balance Sheet Identity or Equation:
Assets = Liabilities + Shareholder’s Equity

Net Working Capital is defined as the difference between a firm’s current assets

and its current liabilities. Net working capital is usually positive in a health
firm.

Net Working Capital = Current Assets – Current Liabilities

2. The Income Statement

The income statement measures performance over some period of time, usually a
quarter or a year. Income statement is like a “video recording” covering the period
between before and after pictures. Things reported on income statements are
revenue and expenses from the firm’s principal operations, financial expenses, and
taxes which are reported separately. The last item in income statement is net
income.

7
 Income Statement Equation:
Income = Revenues – Expense

Earning per Share:

Net Income / Total Shares

Dividend per Share:

Total Dividends / Total Share

3. Taxes

Average tax rate: Total taxes paid divided by total taxable income

Marginal tax rate: Amount of tax payable on the next dollar earned

8
4. Cash Flow
By cash flow, we simply mean the difference between the number of dollars that
came in and the number that went out. The cash flow from the firm’s assets must
equal the sum of the cash flow to creditors and the cash flow to stockholders (or
owners)
Cash Flow Identity:
Cash Flow from Assets (CFFA) = Cash flow to creditors + Cash flow to Stock holder

Cash flow from assets involves three components:

a. Operating cash flow, refers to the cash flow that results from the firm’s day to
day activities of producing and selling
b. Capital Spending, refers to the net spending on fixed assets (purchases of fixed
assets less sales of fixed assets)
c. Change in net working capital is measured as the net change in current assets
relative to current liabilities for the period being examined and represents the
amount spent on net working capital.

Operating Cash Flow:

OCF = EBIT + Depreciation – Taxes

Net Capital Spending:

NCS = Ending Net Fixed Assets – Beg. Net Fixed Assets + Depreciation

Change in Net Working Capital:

Change in NWC = Ending NWC – Beg. NWC

Conclusion:
Cash Flow From Assets
Operating Cash Flow xxx
(Net Capital Spending) xxx
(Change in NWC) xxx

Cash Flow From Assets xxx

9
Cash flow from assets sometimes called as free cash flow which means cash that
the firm is free to distribute to creditors and stockholders because it is not needed
for working capital or fixed asset investments.

Cash Flow to Creditors (Bondholders):

Cash Flow to Creditors = Interest paid – Net new borrowing

Cash Flow to Stockholders:

Cash Flow to Stockholders = Dividends paid – Net new equity raised

10
REVIEW PROBLEMS
Problem 1.1
Northern India Corporation has sales of $2.100.000. Cost of Goods Sold $850.000,
depreciation expense of $95.000, interest expense of $80.000, and a tax rate of 30%. They
paid out $150.000 in cash dividends. And has 65.000 shares of common stock outstanding.
Answer the following questions:
a. What is the net income of the firm?
b. What is the addition to retained earnings?
c. What is the Earnings Per Share and Dividends Per Share?

Problem 1.2
The CHA corporation has net fixed asset with book value $850 and appraised market
value about $1.500. NWC is $550 on the book but $750 would be realized if all the current
asset were liquidated. AB has $500 short term debt in both book and market value. What
is the book value of equity? Construct two balance sheets, one in book value and one in
market value!

Problem 1.3
Magenta, Inc. has sales of $95.000, COGS of $30.500, depreciation expense of $4.500, and
interest expense of $2.500. If the tax rate is 30%. What is the Operating Cash Flow
(OCF)?

Problem 1.4
Mipan Zuzuzu, Inc. 2017 balance sheet showed net fixed assets of $7.5 million, current
assets $900.000 and current liabilities $395.000 and the 2018 balance sheet showed net
fixed assets of $9 million, current assets $1.100.000 and current liabilities $635.000. The
company’s 2017 income statement showed a depreciation expense of $450.000.
a. What was the net capital spending for 2018?
b. What was the change in Net Working Capital (NWC) of 2018?

Problem 1.5
The 2016-2017 balance sheet of Pororo Inc, showed below.
Balance Sheet Data 2016 2017
Long term debt $ 4.550.000 $ 5.050.000

11
 Common Stock $ 481.000 $ 523.000
Additional Paid-In $ 675.000 $ 725.000
Surplus

The 2017 income statement showed an interest expense of $550.000. The company paid
out $655.000 cash dividend this year.
a. What was the firm’s cash flow to creditors during 2017?
b. What was the firm’s cash flow to stockholders during 2017?

Problem 1.6
Alfred Corp. Shows the following information on its 2018 income statement: sales
$450.000; COGS $155.000; other expenses $9.500; depreciation expense $10.750;
interest expense $25.500; taxes $30.500; dividends $13.500. In additions you told that
the firm issued $6.500 in new equity during 2018 and redeemed $9.600 in outstanding
long-term debt.

a. What is the 2018 Operating cash flow?

b. What is the 2018 cash flow to creditors?
c. What is the 2018 cash flow to stockholders?

Problem 1.7
NyamNyam Industries had the following operating results for 2017:
Sales $25.800; COGS $16.200; Depreciation expense $4.500; interest expense $1.900;
dividends paid $1.500. At the beginning of the year, net fixed assets were $13.800, current
assets were $4.700, and current liabilities were $3.200. At the end of the year, net fixed
assets were $16.900 current assets were $6.300, and current liabilities were $4.250. The
tax rate for 2017 was 34%.
a. What is BCG’s net income for 2017?
b. What is its operating cash flow for 2017?
What is its cash flow from assets for 2017? Is this possible? Explain

12
 MODULE 2 : WORKING WITH FINANCIAL STATEMENT

Reviewed by Caroline Hanni Abraham

Statement of Cash Flow

Summarizes the sources and uses of cash. Divided into three major catagories: Operating
Activity, Investment Activity, and Financing Activity.

Standardized Financial Statement

- Common Size
- Common Base
- Combined

PepsiCo,Inc.
Balance Sheet
December 25, 2010 and December 26, 2009
(dollar amounts are in millions)
Common
Normal Common Size Combined
Base

Assets 2017 2018 2017 2018 2018 2018

Current Assets
9,90
Cash $ 3.943 $ 5.943 8,70% 1,51 0,88
%
Marketable
192 426 0,50 0,60 2,22 1,20
Securities
Accounts Receivable 4.624 6.323 11,60 9,30 1,37 0,80
Merchandise
2.618 3.372 6,60 4,90 1,29 0,74
Inventory
Other Current Assets 1.194 1.505 3,00 2,20 1,26 0,73
Noncurrent Assets
Property, Plant, and
12.671 19.058 31,80 28,00 1,50 0,88
Equipment
Intangible Assets 9.157 28.469 23,00 41,80 3,11 1,82
Other Assets 5.449 3.057 13,70 4,50 0,56 0,33
Total Assets $ 39.848 $ 68.153 100% 100% 1,71 1,00

13
Ratio Analysis
Comparison of line items in the financial statements of a business. Used to evaluate a number
of issues with an entity, such as its liquidity, efficiency of operations, and profitability. Ratios
allow for better comparison through time or between companies.

- Short-term Solvency or Liquidity Ratios

Current Ratio 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕

Current Ratio =
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Quick Ratio 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕−𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚

Quick Ratio =
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

𝒄𝒂𝒔𝒉
Cash Ratio =
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Net Working Capital (NWC) to Total Assets

Other Liquidity
𝑵𝑾𝑪
Ratios =
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔

𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕
Interval Ratio =
𝒂𝒗𝒆𝒓𝒂𝒈𝒆 𝒅𝒂𝒊𝒍𝒚 𝒐𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒄𝒐𝒔𝒕

- Long-term Solvency or Financial Leverage Ratios

𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔−𝒕𝒐𝒕𝒂𝒍 𝒆𝒒𝒖𝒊𝒕𝒚

Total Debt Ratio =
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Total Debt Ratio 𝒕𝒐𝒕𝒂𝒍 𝒅𝒆𝒃𝒕
Debt to Equity Ratio =
𝒕𝒐𝒕𝒂𝒍 𝒆𝒒𝒖𝒊𝒕𝒚

𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Equity Multiplier =
𝒕𝒐𝒕𝒂𝒍 𝒆𝒒𝒖𝒊𝒕𝒚

Total Capitalization 𝒍𝒐𝒏𝒈 𝒕𝒆𝒓𝒎 𝒅𝒆𝒃𝒕

Long Term Debt Ratio =
vs Total Assets 𝒍𝒐𝒏𝒈 𝒕𝒆𝒓𝒎 𝒅𝒆𝒃𝒕+𝒕𝒐𝒕𝒂𝒍 𝒆𝒒𝒖𝒊𝒕𝒚
Times Interest 𝑬𝑩𝑰𝑻
Times Interest Earned Ratio =
Earned 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕
𝑬𝑩𝑰𝑻+𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏
Cash Coverage Cash Coverage Ratio =
𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕

14
- Asset Management or Turnover Ratios

𝑪𝑶𝑮𝑺
Inventory Turnover Inventory Turnover =
𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚
and Days' Sales in
𝟑𝟔𝟓 𝒅𝒂𝒚𝒔
Inventory Days' Sales in Inventory =
𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚 𝒕𝒖𝒓𝒏𝒐𝒗𝒆𝒓

𝒔𝒂𝒍𝒆𝒔
Receivables Turnover Receivables Turnover =
𝒂𝒄𝒄𝒐𝒖𝒏𝒕 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
and Days' Sales in
Receivables 𝟑𝟔𝟓 𝒅𝒂𝒚𝒔
Days' Sales in Receivables =
𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆 𝒕𝒖𝒓𝒏𝒐𝒗𝒆𝒓
𝒔𝒂𝒍𝒆𝒔
NWC Turnover =
𝑵𝑾𝑪

Asset Turnover 𝒔𝒂𝒍𝒆𝒔

Fixed Asset Turnover =
𝒏𝒆𝒕 𝒇𝒊𝒙𝒆𝒅 𝒂𝒔𝒔𝒆𝒕
Ratios
𝒔𝒂𝒍𝒆𝒔
Total Asset Turnover =
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕

- Profitability Ratios

𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆
Profit Margin Profit Margin =
𝒔𝒂𝒍𝒆𝒔
Return On Asset 𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆
ROA =
(ROA) 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈
𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆
ROE =
Return On Equity 𝒕𝒐𝒕𝒂𝒍 𝒆𝒒𝒖𝒊𝒕𝒚
(ROE) 𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆 𝒔𝒂𝒍𝒆𝒔 𝒂𝒔𝒔𝒆𝒕𝒔
ROE = x x
𝒔𝒂𝒍𝒆𝒔 𝒂𝒔𝒔𝒆𝒕𝒔 𝒆𝒒𝒖𝒊𝒕𝒚

- Market Value Ratios

𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆
Earning per Share (EPS) EPS =
𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈 𝒔𝒉𝒂𝒓𝒆𝒔
Price to Earning Ratio 𝒑𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
PER =
(PER) 𝑬𝑷𝑺
𝒑𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
Price to Sales Ratio Price to Sales Ratio =
𝒔𝒂𝒍𝒆𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
𝒎𝒂𝒓𝒌𝒆𝒕 𝒗𝒂𝒍𝒖𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
Market to Book Ratio Market to Book Ratio =
𝒃𝒐𝒐𝒌 𝒗𝒂𝒍𝒖𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆

15
16
REVIEW PROBLEMS

Calculate using financial ratio:

a. Current ratio
b. Quick ratio
c. Cash ratio
d. Inventory turnover
e. Receivables turnover
f. Days’ sales in inventory
g. Days’ sales in receivables
h. Total debt ratio
i. Long term debt ratio
j. Times interest earned ratio
k. Cash coverage ratio

Problem 2.2
Refer to problem 2.1, calculate the 2017
ROE for the ABC Corp. and then break down your answer into its component parts using Du
Point Identity.

Problem 2.3
The Blackponk Company had additions to retained earnings for the year just ended of
$480,000. The firm paid out $190,000 in cash dividends, and it has ending total equity of

17
$6.5 million. If the company currently has 245,000 shares of common stock outstanding,
what are earnings per share (EPS)? Dividend per share? Book value per share? If the stock
currently sells for $60 per share, what is the market-to-book ratio? The price earnings ratio?
If the company had sales of $5 million, what is the price-sales ratio?

( The table below is for Problem 2.4 and Problem 2.5)

Problem 2.4
Prepare the 2017 and 2018 common size and common base balance sheets for the ABC Corp.

Problem 2.5
Prepare the 2018 combined common size, common base year balance sheet for the ABC Corp.

Problem 2.6
P. Torvas Company has a debt to equity ratio of 0.88, Return on Assets (ROA) is 9.2%, and
the total equity is $680,000. What is the quity multiplier? ROE? Net income?

18
 MODULE 3 : LONG TERM FINANCIAL PLANNING AND GROWTH

Reviewed by Metta Kumala Dewi

External Financing Needed (EFN)

In the theory of capital structure, External Financing is the phrase used to describe funds that
firms obtain from outside of the firm. It is contrasted to internal financing which consists
mainly of profits retained by the firm for investment.

EFN = Spontaneous increase in assets - Spontaneous increase in liabilities - Increase in

Retained Earnings

or

EFN = (A*/S) DS – (L*/S) DS – MS1 (1-d)

Details:
A*/S = Assets that increase spontaneously / Original Sales
L*/S = Liabilities that increase spontaneously / Original Sales
S = Original Sales
S1 = Total Sales for the next year (based on projection)
DS = S1 – S
M = Profit Margin
d = Dividend pay-out ratio

EXAMPLES:

CHICKEN COMPANY
FINANCIAL STATEMENT
BALANCE SHEET
INCOME STATEMENT
ASSETS LIABILITIES AND OWNER'S EQUITY
Sales 4250 Current Assets 900 Current Liabilities 500
Costs 3875 Net Fixed Assets 2200 Long-term Debt 1800
Taxable Income 375 Owners' Equity 800
Taxes (35%) 131.25 Total Assets 3100 Total Liabilities and Owners' Equity 3100
Net Income 243.75
Dividends 82.6
Additional to R/E 161.15

What is EFN if sales are predicted to grow by 10%? (use the percentage of sales approach)

19
SOLUTION
CHICKEN COMPANY
FINANCIAL STATEMENT
BALANCE SHEET
INCOME STATEMENT
ASSETS LIABILITIES AND OWNER'S EQUITY
Sales 4675 Current Assets 990 Current Liabilities 550
Costs 4262,7 Net Fixed Assets 2420 Long-term Debt 1800
Taxable Income 412,3 Owners' Equity 977,135
Taxes (35%) 144,305 Total Assets 3410 Total Liabilities and Owners' Equity 3327,135
Net Income 267,995
Dividends 90,86
Additional to R/E 177,135

EFN = Total Asset – Total Debt and Equity

EFN = 3410 – 3327,135
EFN = 82,821

Internal Growth Rate

Maximum growth rate that can be achieved with no external financing of any kind.

Internal Growth Rate = ROA x b

(IGR) 1 - ROA x b
Details:
ROA = Return on Assets = Net Income
Total Assets

b = Retention Ratio = Additional to Retained Earnings

Net Income

Sustainable Growth Rate

The maximum growth rate that can be achieved with no external equity financing while
maintaining a constant debt equity ratio.

Sustainable Growth Rate= ROE x b

(SGR) 1- ROE x b
Details:
ROE = Return on Equity = Net Income
Total Equity

b = Retention Ratio = Additional to Retained Earnings

Net Income

20
EXAMPLE
Connie Inc., had equity of $140,000 at the beginning of the year. At the end of the year, the
company had total assets of $255,000. during the year the company sold no new equity. Net
Income for the year was $18.000 and the dividend were $2,500. What is the Sustainable
Growth Rate for the company? What is the Sustainable Growth Rate if you use the formula
ROE x b and beginning of period equity? What is sustainable growth rate if you use end of
period equity in this formula? And the calculate the Internal Growth Rate for the company.

SOLUTION
R/E = Net Income – Dividend
R/E = $18.000 – 2.500
R/E = 15.500

Ending Equity = Beginning Equity + R/E

Ending Equity = $140.000 + 15.500
Ending Equity = $155.500

ROE based on the end of the period equity is :

ROE = $18.000/$155.500
ROE = 11,58%

Plowback Ratio = Addition to Retained Earnings / Net Income

Plowback Ratio = $15.500 / $18.000
Plowback Ratio = 86,11%

Sustainable Growth Rate = ROE x b

1– ROE x b
Sustainable Growth Rate = 0,1158 x 0,8611 = 0,1108
1 – 0,1158 (0,8611)
ROE based on the beginning of period equity :
ROE = $15.500 / 140.000
ROE = 0,1107

21
Using the shortened equation for the sustainable growth rate and the beginning of period ROE,
we get:
Sustainable Growth Rate = ROE x b
Sustainable Growth Rate = 0,1107 x 0,8611
Sustainable Growth Rate = 9,53%

Using the shortened equation for the sustainable growth rate and the beginning of period ROE,
we get:
Sustainable Growth Rate = ROE x b
Sustainable Growth Rate = 0,1158 x 0,8611
Sustainable Growth Rate = 9,97%

Using the end of period ROE in the shortened sustainable growth rate results in a growth rate
that is too low. This will always occur whenever the equity increases. If equity increases, the
ROE based on end of period equity is lower than the ROE based on the beginning of period
equity. The ROE in the abbreviated equation is based on equity that did not exist when the net
income was earned.
ROA using end of period assets is :
ROA = Net Income / Total Assets
ROA = 18.000 / 255.000
ROA = 0,07058 or 7,058%

The beginning of period assets had to have been the ending assets minus the addition to
retained earnings, so:
Beg. Assets = Ending assets – Addition to R/E
Beg. Assets = 255.000 – 15.500
= 239.500
ROA using beginning of period asset is :
ROA = $18.000/$239.500
ROA = 0,0751 or 7,51%

𝑅𝑂𝐴 𝑋 𝑏 0,0751 𝑥 0,8611

Internal Growth Rate = 1−𝑅𝑂𝐴 𝑥 𝑏 = 1−0,0751 𝑥 0,8611 = 𝟎, 𝟎𝟔𝟗𝟏 𝒐𝒓 𝟔, 𝟗𝟏%

22
REVIEW PROBLEMS

Problem 3.1.
The financial statement for PETRICK Co. are shown below:
INCOME STATEMENT BALANCE SHEET
Sales 400.000 Assets 600.000 Debt 225.000
Cost -347.500 Equity 375.000
Taxable Income 52.500 TOTAL 600.000 TOTAL 600.000
Taxes (35%) -18.375
Net Income 34.125

Assets and costs are proportional to sales. Debt to equity are not. A dividend of $10.000 was
paid, and the company wishes to maintain a constant pay-out ratio. Next year’s sales are
projected to be $600.000. What is the EFN?

Problem 3.2.
The financial statement for HANNI Inc. are shown below:
INCOME STATEMENT BALANCE SHEET
Sales 40.000 Current Assets 5.500 Current Liabilities 6.500
Cost 35.500 Fixed Assets 20.000 Long term Debt 8.500
Taxable Income 4.500 Equity 10.500
Taxes (35%) 1.575 TOTAL 25.500 TOTAL 25.500
Net Income 2.925

Assets, costs, and current liabilities are proportional to sales. Long-term debt and equity are
not. The company maintains a constant 20 percent dividend pay-out ratio. As with every other
firm in its industry, next year’s sales are projected to increase by exactly 15 percent. How
much is the EFN?

Problem 3.3.
Based on the following information, calculate the sustainable growth rate for DEWI Inc. : Profit
Margin = 12,5%, Total Assets Turnover = 2, Total Debt Ratio = 0,5, and Pay-out ratio = 20%.

23
Problem 3.4.

RED CORPORATION
Income Statement A 15% growth rate in sales is projected. Prepare a pro
Sales $28.000 forma income statement assuming cost vary with sales
Cost 9.700
Taxable Income 18.300 and the dividend pay-out ratio is constant. What is the
Taxes (20%) 5.490 projected addition to Retained Earnings?
Net Income 12.810
Dividend $5200
Addition to R/E 7.300

Problem 3.5.
The balance sheet for WYX Corporation follows. Based on this information and the income
statement in the previous problem, supply the missing information using the percentage of
sales approach. Assume that accounts payable vary with sales, whereas notes payable do not.
Put n/a needed.
WYX COMPANY
Balance Sheet
Assets Liabilities and Owners' Equity
$ Percentage of Sales $ Percentage of Sales
Current Assets Current Liabilities
Cash 4000 Account Payable 1400
Account Receivable 7050 Notes Payable 6700
Inventory 7600 TOTAL 8100
TOTAL 18650 Long Term Debt 27000

Fixed Assets Owners' Equity

Net Plant and Equipment 41350 Common Stock and Paid in Surplus 17000
Retained Earnings 7900
TOTAL 24900

TOTAL ASSETS 60000 TOTAL LIABILITES AND OWNER'S EQUITY 60000

Problem 3.6.
From problem number 4) and 5) prepare a pro forma balance sheet showing EFN, assume
there is 15% increase in sales, there is no new external debt or equity financing, and constant
pay-out ratio.

Problem 3.7.

Rona Corporation wishes to maintain an Internal Growth Rate (IGR) of 8 percent and a
dividend pay-out ratio of 30 percent. The current profit margin is 20%, and the corporation
uses no external financing sources. What must total asset turnover be?

24
 MODULE 4: INTRO TO VALUATION (TIME VALUE OF MONEY)
Reviewed by Metta Kumala Dewi

Time Value of Money (5 Years)

CF0 CF1 CF2 CF3 CF4 CF5

In this module, you will learn the necessary concepts needed to understand the rest of the
module in this book. Future value of an investment made today, present value of money that
you will receive in the future, return on an investment and how long it takes for an investment
to reach a desired value. Basic concepts that you need to know for this module are:

Present Value (PV) is cash flow at an earlier period. Unless stated, then PV is always at time
zero (t=0). Translating future cash flow values into PV is called discounting.

Future Value (FV) is cash flow at sometimes in the future. Converting a present value into
future value is called compounding.

Annuity is a finite (numberred) series of equal payments that happens at regular intervals of
time. If the first payment happens at the end of period 1, then its called an ordinary annuity
but if the first payment occurs at the beginning of period 1, then its called an annuity due.

Perpetuity is basically an annuity that lasts forever. So, t= ∞

Principal is the original amount borrowed/invested.
Interest rate is also known as the discount rate, cost of capital, opportunity cost of capital
and required rate of return.

1. Future Value and Compounding

Simple Interest
Suppose you invest $100 in a fixed deposit account with 5% simple interest. How much

money do you have at the end of the 5th year?

Value at end of year 5 = $100 + $100 (5%) + $100 (5%) + $100 (5%) + $100
(5%) + $100 (5%)
= $125, also expressed as FVt = P(1+tr), where r is the interest rate.
25
 Compound Interest
Suppose you invest $100 in a deposit account with 10% compound interest.
How much money would you have at the end of year 5?

𝐹𝑉 = 𝑃𝑉 (1 + 𝑟)x

PV = $100

r = 10%

t=5

FV = $100(1+0,10)5 = $161,051
1.61051 is known as the future value interest/compounding factor for 5
years and Interest rate of 10% in an investment.

2. Present Value and Discounting

1
𝑃𝑉 = 𝐹𝑉
(1 + 𝑟)𝑥
PV = Present Value
FV = Future Value
r = discount rate/ interest rate
t = time period
Otherwise, you could just multiply the FV with the present value interest/discount factor
which is FV x [1/(1+r)t], whereas [1/(1+r)t] is the discount factor. Calculating the
present value of future cash flow to determine its worth today is called discounted cash
flow (DCF) valuation.

EXAMPLE
You want to buy a car, but you wonder whether it’ll be worth it to buy now or wait another
3 years. Currently, the car costs $ 50,000 and you predict that the car will cost about $
62,500. Find the present value of the car price in 3 years and use the information to make
a decision assuming that you earn 8% of interest per year!

SOLUTION
1
= 62500 = $49,614.52
(1 + 0.08)3

26
 It would be better to buy the car in 3 years because it has a lower value and you’ll be
saving

$50,000 - $ 49,614.52 = $ 385.48 in today’s money value.

More about PV and FV valuation

Actually, you only need to memorize one of the formula mentioned above between FV and
PV to find the missing element required (FV, PV, t or r) by rearranging the formula:
𝑭𝑽 = 𝑷𝑽 (𝟏 + 𝒓)𝒕
Can be arranged as:
𝐹𝑉
𝑃𝑉 =
(1 + 𝑟)𝑡
Further rearrangement, we can use it to find r
𝑭𝑽 = 𝑷𝑽 (𝟏 + 𝒓)𝒕
𝐹𝑉
(1 + 𝑟)𝑡 =
𝑃𝑉
𝑡 𝐹𝑉
𝑟=√ −1
𝑃𝑉

Another way of rearrangement, we can use this formula to find t :

𝐹𝑉
(1 + 𝑟)𝑡 =
𝑃𝑉
𝐹𝑉
𝑡 log(1 + 𝑟) = log
𝑃𝑉
𝑭𝑽
𝒍𝒐𝒈 𝑷𝑽
𝒕=
𝒍𝒐𝒈(𝟏 + 𝒓)
Rule of 72

Rule of 72 is a rules of thumb that can estimate how long it takes to double a certain sum of
money, the formula expresses both the time required to double your money in years and
the interest rate it takes to double your money.

72
𝑇𝑖𝑚𝑒 𝑡𝑜 𝐷𝑜𝑢𝑏𝑙𝑒 𝑀𝑜𝑛𝑒𝑦 =
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒
72
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑅𝑎𝑡𝑒 =
𝑇𝑖𝑚𝑒 𝑡𝑜 𝐷𝑜𝑢𝑏𝑙𝑒 𝑀𝑜𝑛𝑒𝑦

27
As you can see, the rule of 72 provides a simple way to determine how long and how much
interest rate is required to double your money. Only applies IF you are doubling your
money.

EXAMPLE
a. Say you want be as rich as Michael Jordan. Currently, Michael Jordan’s net worth is
about $ 1 Billion. Your net worth/wealth right now is about $ 10 million, assuming
that your annual earnings is about 8%, how long would it take for you to be as rich
as Michael Jordan?
$ 1,000,000,000 = $ 10,000,000 (1 + 0.08)𝑡
1,000,000,000
𝑙𝑜𝑔 10,000,000 2
𝑡= = = 59.84 ≈ 60 𝑦𝑒𝑎𝑟𝑠
log (1 + 0.08) 0.03342375549

So, at your current net worth and annual earnings, it would take you 60 years to
have a net worth of 1 billion dollars. Seems realistic right?

b. Assuming that you’re required to have $10 million in your pension account to be
considered as happily retired. If you can earn about 8.5% annually by investing for 40
years right now as a 20 year old, how much money would you need to invest in order to
meet your retirement fund goal?
$ 10,000,000 = PV ( 1 + 0.085 )40
$ 10,000,000
𝑃𝑉 = = $382,657.7139
(1 + 0.085)40

So, you need about $ 383 thousand dollars to retire comfortably with $ 10 million
40 years from now.

c. Right now, you have about $ 100,000 and 10 years to triple the money. How much
must you earn per year to achieve your goal?

$ 300,000 = $ 100,000 ( 1 + r )10

10 300,000
𝑟= √ − 1 = 0.1161
100,000

You have to earn about 11,61% per year to triple your money in 10 years.

28
REVIEW PROBLEMS

Problem 4.1
You’ve just made an initial deposit of $ 20,000 to your retirement account. Assuming that you
can earn a 12% rate of return and make no additional deposit after the initial one, what will
your account be worth when you retire in 40 years? What if you wait 5 years before making
an initial deposit? Compare these two investment strategies and decide which one is better!

Problem 4.2
Suppose you want to buy a Ferari that’s worth about $ 650,000 in 8 years. Assuming that you
can earn a steady 7.5% by depositing your money in a bank account, how much must you
deposit today in order to buy that Ferari in 5 years?

Problem 4.3
Assuming that you need $ 23,000 for a car in 6 years. Currently your parents have about $
16,000 to invest for your car. How much interest rate must be earned in order to cover the
cost of your car in 6 years?

Problem 4.4
At 12% interest rate, how long would it take you to double your money? Triple it?

Problem 4.5
In January 2019, the average house price in Karawaci was $ 450,000. Exactly 8 years later, the
average house price in Karawaci rises to $ 1,100,000. What was the annual increase in the
selling price?

Problem 4.6
You want to buy a rocket that cost $ 5,000,000. You have $750,000 today that you can invest
in your bank at 6% annually. How long until you can afford the rocket?

Problem 4.7

29
A company is projected to have $ 30 Million in debt in 15 years from now. To determine its
profitability, financial analysts want to see how much that debt is worth today using an 17%
discount factor. How much is the debt worth today?

30
 MODULE 5: DISCOUNTED CASHFLOW VALUATION
Reviewed by Xevinkeng

1. Present Value (PV)

The value of a cash flow at an earlier period of a time line. Translating a

future value to a present value referred as discounting.
Formula:

PV = Present Value FV = Future Value

r = period interest rate t = number of periods

EXAMPLE

Suppose you need $1000 to buy the newest mac book next year. You
can earn 5% quarterly interest when put the money in the bank, how
much should you put in your money now?

SOLUTION:

Known:

FV = $1000 r= 0,05 t = 1x4

Discount Rate

1 Usually called discount rate, used to calculate

𝑃𝑉 = 𝐹𝑉 × the present value of future cash flow
( 1 + 𝑟 )𝑡

31
 EXAMPLE

In 4 years, you are going to need $2000. You can earn 10% on your money. How much
do you have to invest today?
Discount factor:
1
(1 + 𝑟 )𝑡
1
= 0.6830
( 1 + 0.1)4

The amount you must invest is: $2000 x 0.6830 = $1366

We can say that $1366 is the present or discounted value of $2000 to be received in 4
years at 10%

2. Future Value (FV)

The value of a cash flow at a specified date. Converting a present value to a future
value is called compounding.

Formula:

FV = PV (1 + r)t

Future value interest factor = (1 + r) t

EXAMPLE

a. Suppose you invest $1000 in a fixed deposit account that pays 5% simple
interest. How much will you have at the end of 3 years?
Year 1 = Original invested amount + Interest earned in year 1
= $1000 + ($1000x 5%) = $ 1050

Year 2 = $1050 + Interest earned year 2

= $1050 + ($1000 x 5%) = $1100

Year 3= $1100 + Interest earned year 3

= $1100 + ($1000x 5%) = $1150

Future value at the end of year 3 = $1150

32
 b. Suppose you deposit your $1000 into savings account that pays 5% compound
interest. What will you have at the end of 2 years?

Year 1 = Original invested amount + Interest earned year 1

= $1000 + ($1000x 5%) = $1050

Year 2 = $1050 + Interest earned year 2

= $1050 + ($1050x5%) = $1102.5

Number of Period FV = PV (1+r) t

𝑭𝑽
𝐥 𝐧( )
𝑷𝑽
𝒕= 𝐥 𝐧( 𝟏+𝒓 )

EXAMPLE

You want to purchase a house for $150,000. If you can invest at 10% per year and
you currently have $100,000, how long will it be before you have enough money
to pay cash for the house?
r = 10%
PV = $100.000
FV = $150.000

𝟏𝟓𝟎, 𝟎𝟎𝟎
𝐥 𝐧 (𝟏𝟎𝟎, 𝟎𝟎𝟎)
𝒕= = 𝟒. 𝟐𝟓 𝒚𝒆𝒂𝒓𝒔
𝐥 𝐧( 𝟏 + 𝟎. 𝟏 )

3. Discounted Cash Flow Valuation

Future and present values of multiple cash flows

• Suppose you deposit $250 today in an account paying 8%. In one year, you
will deposit another $200. How much will you have in 2 years?

The first deposit = $250 x (1+ 0.08)2 = $291.6

The second deposit = $200 x (1.08)1= $216

You will get $291.6 + $216 = $507.6 in two years.

33
Annuities and perpetuities

• Ordinary annuities: Series of constant payment of $200 starting at the end

of the period or time 1.
0 1 2 3

$200 $200 $200

• Annuity due: series of constant payment start at the beginning of the

period 0 0 1 2 3

$200 $200 $200 $200

Formulas:

EXAMPLE

Assume that you have $50,423 in your saving account. You will need to draw upon
this amount for your university education in four equal annual payments. You would
like to have the first payment now. Interest rate is 8% compounded annually. How
large the payment will be?
Annuity due value = Ordinary annuity value x (1+r)

34
4. Growing Annuities ans Perpetuities
1+𝑔
1 − ( 1 + 𝑟 )𝑡
𝐆𝐫𝐨𝐰𝐢𝐧𝐠 𝐀𝐧𝐧𝐮𝐢𝐭𝐲 𝐏𝐫𝐞𝐬𝐞𝐧𝐭 𝐕𝐚𝐥𝐮𝐞 = 𝐶 𝑥 [ ]
𝑟−𝑔

EXAMPLE

Suppose that we are looking at a lottery payout over a 10-year period. The first
payment, made one year from now, will be $200,000. Every year thereafter, the
payment will grow by 5%.

The payment in the second year will be = $200.000 x 1.05 =

$210.000
The payment in the third year will be = $210.000 x 1.05 =
$220.500
What is the present value if the appropriate discount rate is 11%?
1 + 0.05 10
1 − (1 + 0.11)
𝑃𝑉 = 200,000 𝑋 [ ] = $ 1,421,095.32
0.11 − 0.05

1
𝐆𝐫𝐨𝐰𝐢𝐧𝐠 𝐏𝐞𝐫𝐩𝐞𝐭𝐮𝐢𝐭𝐲 𝐏𝐫𝐞𝐬𝐞𝐧𝐭 𝐕𝐚𝐥𝐮𝐞 = 𝐶 𝑋 [ ]
𝑟−𝑔

EXAMPLE
In the previous question. Now suppose the payments start at the end of the period
and continue forever, what is the present value?
1
𝑃𝑉 = 200,000 𝑋 [ ] = $ 3,333,333.33
0.11 − 0.05
5. Effective Annual Rate ( EAR )
The interest rate expressed as if it were compounded once per year.
𝑸𝒖𝒐𝒕𝒆𝒅 𝑹𝒂𝒕𝒆 𝒎
𝐄𝐀𝐑 = [ 𝟏 + ( ) ]−𝟏
𝒎
*Quoted rate = APR ( Annual Percentage Rate)
6. Pure Discount Loans
𝑭𝑽
𝑷𝑽 =
(𝟏 + 𝒓 )𝒕

35
 EXAMPLE
Suppose a borrower was able to repay $25,000 in five years. If we, acting as the lender,
wanted 12% interest rate on the loan, how much would we be willing to lend ? what
value asign today to that $25.000 to be repaid in 5 years ?
25,000
𝑃𝑉 = = $14,185.
( 1 + 0,12)5
7. Interest Only Loans
EXAMPLE

A three year, 10%, interest only loan of $1000, the borrower would only pay
$1000x10% = $100 in interest at the end of the first and second years. At the end of
the third year, the borrower would return the $1000 along with another $100 in
interest for that year.
Principal payment
Interest year 1 Interest year 2 Interest year 3

8. Amortized Loans
a. With fixed principal payments
EXAMPLE

The loan agreement calls for borrower to pay the interest on the loan
balance each year and to reduce the loan balance each year by $1000.
Because the loan amount declines by $1000 each year, it is fully paid in
5 years.
Interest Interest Interest Interest Interest

Principal Principal Principal Principal Principal

payments payments payments payments payments

Year Beginning Total Interest Principal Ending

balance payments paid paid balance
1 5000 1450 450 1000 4000
2 4000 1360 360 1000 3000
3 3000 1270 270 1000 2000
4 2000 1180 180 1000 1000

36
 5 1000 1090 90 1000 0
Totals 6350 1350 5000

b. With fixed equal Payments

EXAMPLE

Suppose our 5 years, 9%, $5000 loan was amortized this way, how would the
amortization schedule look?

9. Balloon Payment
Suppose we have a $100,000 commercial mortgage with a 12% APR and a 20 year
amortization. Further suppose the mortgage has a five year balloon. What will the
monthly payment be? How big will the balloon payment be?

37
REVIEW PROBLEMS

Problem 5.1

Investment A offers to pay $5,000 per year for 15 years, meanwhile investment B
offers to pay you $9,000 per year for seven years. If the discount rate is 8%, which
of these cash flow streams has the higher present value?

Problem 5.2

You decided to deposit $10.000 per year for the next 10 years in an account paying
10% interest:

a. How much money will you have in the account in 10 years?

b. How many years will it take for your account to be worth one million?

c. If you decided to change your account, how much interest do you need to be a
millionaire in the next 10 years?

d. How much money will you have to deposit at the end of each year if you want to
be a millionaire in the next 10 years?

Problem 5.3

What is the future value of $2,300 in 20 years assuming an interest rate of 8.4%
compounded daily?

Problem 5.4

You want to buy a sport car for $23,000. The finance office has quoted you a 15%
APR loan for 5 years to buy the car.

a. What will your monthly payment be?

b. What is the effective annual rate of this loan?

Problem 5.5

38
If the appropriate discount rate for the following cash flow is 5% compounded
monthly, what is the present value of the cash flow? What is the Effective Annual
Rate on this loan?

Period Cash Flow

1 $200

2 $1000

3 $623

4 $0

Problem 5.6

Ritsuka has a $10.000 loan with 2.5% interest that must be fully paid in 5 years with
fixed equal payments. How much will he have to pay each year? If the loan calls
Ritsuka to pay with a fixed principal amount that the loan amount declines by
$2,000 each year, how much is the total payment every year? (Show the
amortization schedule and table for both answer)

Problem 5.7

Jack needs a 50-year, fixed rate mortgage to buy a new home for $500,000. Jack’s
mortgage bank is willing to lend her money at a 6.55% APR for this 600-months
loan. However, jack can afford monthly payments of only $2,250, so Jack offers to
pay off any remaining loan balance at the end of the loan in the form of a single
balloon payment. How large will this balloon payment have to be for jack to keep
her monthly payments at $2,250?

Problem 5.8

Rin is planning to save for retirement over the next 40 years. So, she starts investing
$1,000 a month in stock and $250 a month in a bond account. The return of these
accounts are 12.5% and 6,1% respectively. When she retires, she will combine her

39
money into an account with 10% return. How much can she withdraw each month
from her account assuming a 35-years withdrawal period?

40
 MODULE 6: INTEREST RATE AND BONDS VALUATION

Reviewed by Elnike

Bonds Valuation
1
1− F
(1+r)t
Bond Value = C[
r
] + (1+r)t

Coupon Rate = The annual coupon divided by the face value of the bond
C = Coupon → The stated interest payment made on a bond
C = F x Coupon Rate
F = Face Value → The principal amount of a bond that is repaid at the end of the term
r = YTM (market/discount rate) → The rate required in the market on a bond
t = Maturity → The specified date on which the principal amount of a bond is paid

Bonds can be priced at:

Par value: Bond Value = Face Value
YTM = Coupon Rate
Premium: Bond Value > Face Value
YTM < Coupon Rate
Discount: Bond Value < Face Value
YTM > Coupon Rate

The percentage change in price is calculated as:

Percentage change in price = (New price – Original price) / Original price x 100%

Example:
Suppose PT. LIA were to issue a bond with 10 years to maturity. The PT. LIA has an annual
coupon of $34. Similar bonds have a yield to maturity of 6%. Based on our preceding
discussion, the PT. LIA will pay $1,000 to the owner of the bond. What would this bond sell
for?

41
 1
1− [ ] 1000
(1+0.06)10
Bond Price = 34 * [ ] + (1+0.06)10
0.06

(1−0.558) 1000
= 34 * + 1.7908
0.06

= 34 * 7.37 + 558.41

= 808.99

This bond sells at discount because the bond value < face value.

Finding the YTM: Trial and Error

If the question is asking about the value of YTM (i), and the information regarding the bond
can be put into the formula like below, we cannot solve it explicitly indeed.

1
1− $1,000
(1+𝑟)6
$953.77 = [$70 𝑥 ] + [(1+𝑟)6 ]
𝑟

The only way to find the answer is to use trial and error. We can speed up the trial-and-error
process by using what we know about bond prices and yields.

In this case, the bond has an $70 coupon and is selling at a discount. Therefore, the YTM must
be greater than 7%. If we compute the price at 9% it will result $910.28. The value we
calculate is lower than the actual price, so 9% is too high. The true yield must be somewhere
between 7% and 9%.

At this point, it’s “plug and chug” to find the answer. You would probably want to try 8% next.
If you did, you would see that this is in fact the bond’s yield to maturity (8% will result
$953.7712034).

The Fisher Effect

The relationship between nominal, real, and inflation rate.
1+R=(1+r)x(1+h)
R: nominal rates: Interest rates or rates of return that have not been adjusted for inflation.
r: real rate: Interest rates or rates of return that have been adjusted for inflation.

42
h: inflation rate

Example:
Suppose you know the real rate is 6% and the inflation rate is 7.5%, what the nominal rate
would be?
R = (1 + 0.06)(1 + 0.075) – 1 = .1395 x 100 -> 13.95%

Zero-Coupon Bonds
No periodic interest payment or coupon rate = 0%
𝐹
Zero Coupon Bond Value =
(1+𝑟)𝑡

Example:
A $1,000 bond pays no coupon payment and has 6 years until maturity. It yields at 6.17%.
What will be the appropriate value for this bond?
ZCB Value = $1,000 / (1+0.0617)6 = $698.21

43
REVIEW PROBLEMS
Problem 6.1
PT. Nimo has bonds on the market offering annual payment at 15 years of maturity. It’s
currently selling for $987.3. If the bonds yield at 7.5%, what must be the coupon rate for this
bond?

Problem 6.2
Red Inc. issued a semiannual, 20-year bond at a coupon rate of 9.7%. If the YTM of this bond
is 7.5%, what’s the current bond price? Is it categorized as par value, discount, or premium
bond?

Problem 6.3
Tokyo bond has an 6.5% coupon rate and it currently sells for 125 percent of par value, the
bond paid annually and it matures in 25 years. What is its yield to maturity?

Problem 6.4
If the real rate is 4.25% and the inflation rate is 7.9%, what will be the appropriate nominal
rate correspond to Fisher Effect?

Problem 6.5
Both Bond X and Bond Y have 7,5% coupon rate, make semiannual payments, and are priced
at par value. Bond X has 15 years to maturity while Bond Y has 20 years to maturity. If interest
rates suddenly rise by 2 percents, what is the percentage change in the price of those bonds?
On contrary, if interest rates fall by 2 percents instead, what would happen to both bonds’
prices?

Problem 6.6
Kylie Co. wants to issue new 15-year bonds for its expansion plans. The company currently
has 10% coupon bonds on the market that sell for $1,080, and it makes semiannual payments.
What coupon rate should Galaxy Co. sets on its new bonds if it wants them to sell at par?

Problem 6.7

44
Suppose Kim’s company needs to raise $50 million and she plans to issue 25-year bonds for
this purpose. Assume the required return on these bonds issue will be 9%, and you’re
assigned to evaluate 2 alternatives; a 8% semiannual coupon bond and a zero coupon bond.
Tax rate is 35%.
a. How many of coupon bonds would Jane need to issue to raise $50,000,000? On the
other side, how many zeroes would she need to issue?
b. What will Jane’s company repayment be if she issues coupon bonds? What if she issues
zeroes?

Problem 6.8
Vanilla Co. has 2 different bonds currently outstanding:
Bond A has face value of $50,000 and matures in 15 years. It makes no payments for the first
5 years then pays $1,200 every six months over the subsequent 4 years and finally pays
$1,500 semiannually until the maturity date.
Bond B also has the same face value and maturity period, but it makes no coupon payments
over its life period.

If the YTM of both bonds is 8%, what are the current price of those bonds?

45
 MODULE 7: STOCK VALUATION

Reviewed by Elnike

Cashflow

P0 = current price of the stock

D1 = cash dividend paid in 1 period
D2 = cash dividend paid in 2 periods
R = required return or discount rate or total return

Growth Stock
• Zero growth
The dividend is constant, so the value of the stock:

𝐷
𝑃0 =
𝑅

Example:
PT. Lippo pays a $10 per share dividend annually. Find the value of share of stock
if the required return is 20%.
𝐷 10
𝑃0 = = = $50/𝑠ℎ𝑎𝑟𝑒
𝑅 0,2

• Constant growth
The dividend grows at a steady rate, so the dividend t periods into the future, Dt:

Dt= D0 × (1 + g)t

Dt = dividend in t years
D0 = the dividend just paid or current dividend
g = growth rate

46
 Example:
PT. Lippo just paid a dividend of $10 per share. The dividend grows at a steady
rate of 20% per year. What will the dividend be in 4 years?

Dt = D0 × (1+g)t = $10 × (1+0.2)4 = $20.74

Dividend Growth Model

The model is used when dividend grows at a steady rate. The price of stock as of time t
is:

Nonconstant Growth
If the dividend grows at steady rate, g, then the price is:

𝐷1 𝐷2 𝐷𝑡 𝑃𝑡
𝑃0 = + 2
+⋯+ 𝑡
+
(1 + 𝑅) (1 + 𝑅) (1 + 𝑅) (1 + 𝑅)𝑡

Where Pt can be calculated as below:

Example:
In 6 years, PT. Minion will pay a dividend for the first time. The dividend will be $1 per
share. It will grow at a rate of 11% per year indefinitely. The required return is 21% Find
the price of the stock today.

𝐷5 𝑥(1 + 𝑔) 𝐷6 $1
𝑃5 = = = = $10
(𝑅 − 𝑔) (𝑅 − 𝑔) (0.21 − 0.11)

𝑃𝑡 𝑃5 $10
𝑃0 = = = = $3.86
(1 + 𝑅)𝑡 (1 + 𝑅)5 (1 + 0.21)5

47
Two-Stage Growth
The dividend grow at a rate of g1 for t years (1st stage) and then grow at a rate of g2
thereafter forever (2nd stage). Thus, the value of the stock is:

The second part is the present value of the stock price once the 2nd stage begins at Time
t. Hence, we calculate Pt as follows:

Pt = stock price at time t

Example:
PT. Lippo’s dividend is expected to grow at 23% for the next 7 years. Then, the growth is
expected to be 3% forever. If the required return is 12%. Find the value of the stock if the
dividend just paid is $2.
𝐷0 𝑥(1 + 𝑔)7 𝑥(1 + 𝑔2 ) $2𝑥(1 + 0.23)7 𝑥(1 + 0.03)
𝑃7 = = = $97.49
𝑅 − 𝑔2 0.12 − 0.03
𝐷1 1 + 𝑔1 𝑡 𝑃𝑡
𝑃0 = 𝑥 [1 − ( ) ]+
𝑅 − 𝑔1 1+𝑅 (1 + 𝑅)𝑡

𝐷0 𝑥(1 + 𝑔1 )𝑡 1 + 𝑔1 𝑡 𝑃𝑡
𝑃0 = 𝑥 [1 − ( ) ]+
𝑅 − 𝑔1 1+𝑅 (1 + 𝑅)𝑡

$2𝑥(1 + 0.23)7 1 + 0.23 7 $97.49

𝑃0 = 𝑥 [1 − ( ) ]+ = $115.86
0.12 − 0.03 1 + 0.12 (1 + 0.12)7

48
Components of the Required Return
Earlier we calculate P0 as:
𝐷1
𝑃0 =
(𝑅 − 𝑔)
If we arrange this to get R, then we get:

D1/P0 = dividend yield

g = growth rate or capital gain yield

Example:

PT. Agung sells its stock for $20 per share. The next dividend will be $2 per share. The
dividend will grow by 10% per year more or less indefinitely. What return does this stock
offer if this is correct?

𝐷1
𝑅 =( )+𝑔
𝑃0

=$2/$20 + 0.1 = 20%

Valuing Equity Using Peer Multiples

• PE ratio = Price per share ÷ Earnings per share
• Price to sales ratio = Price per share ÷ Sales per share
• Price to cash flow ratio = Price per share ÷ Cashflow per share
• Earning per share = Net income / Shares

49
REVIEW PROBLEMS
Problem 7.1
The next dividend payment by PT. Nusantara will be $15 per share. The dividends are
anticipated to maintain a 6.25% growth rate forever. The stock currently sells at $100
per share. Find the required return.

Problem 7.2
Every beginning of year, Studio Ghibli pay the dividends for their stockholders. Next year
(2021) they will give 2 for each share, and in the 2022, they will give $2.5 for each share.
The required return for this company is 30%. How much the price of Tabi’s stock value
now (2020)?

Problem 7.3
PT. Red, PT. Blue, and PT. White each will pay a dividend of $10 next year. The growth
rate in dividends for all three companies is 2.5%. The required return for each company’s
stock is 6%, 9%, and 12%, respectively. What is the stock price for each company? What
do you conclude about the relationship between required return and stock price?

Problem 7.4
A startup company, PT. WWCD will not pay any dividends on the stock over the next 5
years, the firm use its earnings to fuel their growth. The company will pay $8 per share
dividend in 6 years and will increase the dividend by 2.5% per year thereafter. Required
return on the stock is 15%. Find the current share price.

Problem 7.5
Netflix just paid a dividend of 2.7 per share. The dividends are expected to grow at 5.5%
for the next 5 years and then 7.5% growth rate for the following years. If the required
return is 15%, find the price of the stock today.

Problem 7.6

50
Below is the stock quote for PT. Nestle from today’s newspaper. What was the closing
price for this stock that appeared in yesterday’s newspaper? If the company currently
have 25 million shares of stock outstanding, what was net income for the most recent
four quarters?

52 Week YIELD VOL NET

STOCK
HI LO (DIV) % PE 100S CLOSE CHANGE

82 58 RJW 2.72 3 18 15678 ? -0.30

51
 MODULE 8 : NPV AND OTHER INVESTMENT CRITERIA

Reviewed by Nadya Komari

1. Net Present Value

The NPV of an investment is show the difference between its market value and its cost. NPV
is estimated by calculating the present value of all future cash flow of a project minus the
investmen cost.

NPV rule: if the NPV is positive, ACCEPT the project. If the NPV is negative, REJECT the
project.

Example:

Omega Corporation is considering an investment that costs $40 million, it will return after-
tax cash flow of$15 million per year for the next four years and another $20 million in year
five. The discount rate is 10%. Should Omega accept or reject the project?
15 15 15 15 20
NPV = + 1.12 + 1.13 + 1.14 + 1.15 - 40
1.1

NPV = $19.97 million (Accept)

2. Payback Period
Payback is the length of time it takes to recover the intial investment.

Example:

Year 0 1 2 3 4

Cash Flow -$10,500 $2,500 2,800 3,000 3,200

After the first three years, the CF total will be $8,300 ($2,500 + 2,800 + 3,000). After fourth
year, the CF total will be $11,500 ($2,500 + 2,800 + 3,000 + $3,200). So, the project pays
back between the end of year 3 and the end of year 4.

Because the accumulated cash flows for the first three years are $8,300, we need to recover
$2,200 in the third year (-$10,500 + $2,500). the fourth year cash flow is $3,200, so the
payback period is: 3 + ($2,200 / $3,200) = 3.69 year.
52
3. Discounted Payback
Discounted payback is the length of time it takes until the sum of an investment’s
discounted cash flows equals to its cost. To calculate the discounted payback is the same
as payback period, but the difference is you should calculate the cash flow in present value
to get the discounted payback.

4. Average Accounting Return

∑ 𝑛𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
• Average net income = 𝑡𝑜𝑡𝑎𝑙 𝑦𝑒𝑎𝑟𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
AAR =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐵𝑜𝑜𝑘 𝑉𝑎𝑙𝑢𝑒 𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑐𝑜𝑠𝑡+0
• Average book value = 2

• If the depreciation use “straight line method”,

then to find the average book value =
𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒
2

5. Internal Rate of Return

The IRR is the discount rate that makes the estimated NPV of an investment equals to zero.
IRR rule: accept the project when the IRR more than the required return (it is when the
NPV > 0).

Example:

a firm evaluates a project by applying IRR rule. If the required return is 20%, should the
firm accept the project?

Year Cash Flow

0 -$1,500
1 $300
2 $450
3 $750
4 $750
5 $900

“use interpolasi”

53
Step 1: Calculate NPV with first trial rate of return

if the rate is 24%, the NPV will be:

$300 $450 $750 $750 $900

NPV = -$1,500 + (1.24) + + + + = 52.19
(1.24)2 (1.24)3 (1.24)4 (1.24)5

Step 2: Calculate NPV second trial rate of return

If the first trial you have positive NPV, so you should increase the second trial rate of return
to make second NPV negative. If the first trial you have negative NPV, so you should
decrease the second trial rate of return to make second NPV positive.

Let’s increase the rate to 28% and the NPV will be:

$300 $450 $750 $750 $900

NPV = -$1,500 + (1.28) + + + + = -92.01
(1.28)2 (1.28)3 (1.28)4 (1.28)5

Step 3: calculate the “interpolasi”

- 52.19 + 92.01 = 144.2

- The range of the rate: 28% - 24% = 4%
52.19
- Interpolasi: x 4 = 1.45%
144.2

Step 4: Calculate the IRR

IRR = 24% + 1.45% = 25.45%

Conclusion:

Since the IRR is more than the required return, the firm should accept the project.

54
Profitability Index

The PI is the ratio of present value to cost

𝑃𝑉 𝑜𝑓 𝑐𝑎𝑠ℎ 𝑖𝑛 𝑓𝑙𝑜𝑤𝑠
PI = , cash outflows is the same as initial cost.
𝑃𝑉 𝑜𝑓 𝑐𝑎𝑠ℎ 𝑜𝑢𝑡 𝑓𝑙𝑜𝑤𝑠

PI rule: accept the project or investment if the PI > 1

55
REVIEW PROBLEM

Problem 8.1

An investment (new project) has annual cash inflow of $5,000, $5,800, $6,200, $7,800, and
$8,300. For the next 5 years, the discount rate is 11%. What is the discounted payback period
for these cash flows if the initial cost is $10,000? What if the initial cost $15,500? What if the
initial cost is $21,000?

Problem 8.2

A new manufacturing plant has an installation cost of $60 million, which will be depreciated
straight-line to zero its5 year. The plant has projected 5 years net income of: $5,550,000,
$5,895,500, $6,765,980, $6,500,000, and $5,940,000. What is the project’s average
accounting return?

Problem 8.3

A firm evaluates the new project and it has the following cash flows:

Year 0 1 2 3 4

Cash Flows -$18,000 $4,230 $6,990 $7,200 $9,330

a. Using IRR, should the firm accept this project if the required return is 10%?
b. What is the NPV at a discount rate of zero percent? What is the NPV at a required return
of 21%? Should the firm accept this project?

Problem 8.4
Val’s Corporation has identified the following two mutually exlusive projects
Year Cash Flow A Cash Flow B

0 -$35,000 -$35,000

1 $16,500 $18,000

2 $25,000 $23,200

56
 3 $22,300 $25,000

4 $19,500 $19,200

a. What is the IRR? Which project should be accept?

b. If the required return is 17%, what is the NPV of each project? Which project will the
company choose is it applies the NPV decision rule?

Problem 8.5

Kim’s Corp. is considering the cash inflows from two mutually exclusive projects

Year Cash Flow A Cash Flow B

0 -$250,000 -$50,000

1 $36,000 $24,000

2 $52,000 $17,000

3 $87000 $15,000

4 $280,000 $14,200

Whichever project you choose, you are require a 12% return on your investment. Using all of
these criterion, which project will you choose? Why?
a. Payback criterion
b. Discounted payback criterion
c. NPV criterion
d. IRR criterion
e. Profitability Index criterion

Problem 8.6

The Black Corporation wants to setup a new business, it will provide a net cash inflows of
$120,000 for the firm during the first year. The cash flows are projected to be grow at a rate
of 8$ per year indefinitely. This new business requires an initial investment of $2,900,000.

57
a. If Kent requires a 14% return on such undertakings, should the business be started?
b. The company is somewhat unsure about the assumption of a 8% growth rate in its
cash flow. At what constant growth rate would the company just break even if it still
required 14% return on investment?

58
 MODULE 9: MAKING CAPITAL INVESTMENT DECISION

Reviewed by Sherly Handoko Roeslie

I. WE SHOULD ACCEPT THE PROJECT IF

NPV > 0 IRR > r

Lower EAC

II. PRO FORMA INCOME STATEMENTS

Sales Price/Unit x Unit

Variable Variable Cost/Unit x
Costs Unit
Fixed Costs Fixed Cost
Depreciation Fixed Asset / Useful
Life
EBIT Sales – VC – FC – Dep
Taxes EBIT x Tax
Net Income EBIT - Taxes

III. OPERATING CASH FLOW (OCF)

Common Approach OCF = EBIT + Depreciation – Taxes

Top Down Approach OCF = Sales – Costs – Taxes
Bottom Up Approach OCF = Net Income + Depreciation
Tax Shield Approach OCF = (Sales – Costs)(1 – Tc) + (Tc x
Depreciation)

IV. NET PRESENT VALUE (NPV)

𝑃𝑉 = −𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐶𝑎𝑠ℎ 𝑂𝑢𝑡𝑙𝑎𝑦 + 6 𝑂𝐶𝐹 𝑥 𝐴𝑛𝑛𝑢𝑖𝑡𝑦 𝐹𝑎𝑐𝑡𝑜𝑟

V. AFTER TAX SALVAGE VALUE

𝐴𝑓𝑡𝑒𝑟𝑡𝑎𝑥 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒 = 𝑆𝑎𝑙𝑣𝑎𝑔𝑒 𝑉𝑎𝑙𝑢𝑒 𝑥 (1 − 𝑇𝑐)

59
 VI. ANNUAL EQUIVALENT COST (AEC)
NPV
EAC =
Annuity Factor

EXAMPLE :
You expect to sell 10.000 units with the selling price $2 each unit. In beginning of the year,
you supposed to proposed a 5 year project with initial cash outlay for fixed asset $25.000
and this assets will be depreciated straight line to zero at the on the project. Cost for this
project are fixed costs will be $5.000 and variable costs $0.75 per unit. The project requires an
initial investment in net working capital of $10.000 which will be recovered in full at the end
of the project’s life. The required return is 15% and taxes is 35%. Should we accept the
project? Why? Use NPV and IRR. (Prepare with pro forma income statement, projected
capital requirements, and projected cash flow)

Step 1: Pro Forma Income Statement

Sales 20,000 (10.000 x $2)
Variable
Costs 7,500 (10.000 x $0.75)
Fixed Costs
5,000 ($25.000 / 5)
Depreciation
5,000 (2.500 x 35%)
EBIT 2,500
Taxes 875
Net Income
1,625

60
Step 2: Projected Capital Requirements

Year

0 1 2 3 4 5

Net Working Capital

10,000 10,000 10,000 10,000 10,000 10,000
Net Fixed Assets 25,000 20,000 15,000 10,000 5,000 0
Total Investments
35,000 30,000 25,000 20,000 15,000 10,000

Step 3: Operating Cash Flow

Because all the 4 methods of determining OCF will result the same. So we used the Common
Approach

OCF = 2,500 + 5,000 − 875 = 6,625

Step 4: Projected Cash Flow

Year

0 1 2 3 4 5

Operating Cash Flow 6,625 6,625 6,625 6,625 6,625

Change in NWC -10,000 10,000
Capital Spending -25,000
Total Project Cash -35,000 6,625 6,625 6,625 6,625 16,625
Flow

61
Step 5: NPV
6625 6625 6625 6625 6625
𝑁𝑃𝑉 = −35,000 + + 2
+ 3
+ 4
+
(1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15) (1 + 0.15)5
= -7820

Step 6: IRR
Using Interpolation approach :
We know that if the required return 15% would result -$7,820 and if the required return 6%
would result $379, So

𝐼𝑅𝑅 = 6% + $379 (6% − 15%) = 0.056 = 5.6%

$379 − (−$7,820)
Conclusion :

• NPV -> We should reject the project because NPV is < 0

• IRR -> We should reject the project because IRR < r

Discounted Cash Flow Analysis

Cost of new computer system is $100,000 with annual savings from improved efficiency:
$23,000 with useful life for 5 years. Initial cost will depreciated straight line to zero but have
salvage value after 5 years for $25,000. The required return is 10% and tax is 35%. Should
we accept or reject the project?

Step 1 : Capital Spending

Capital spending is $100,000 (from cost of new computer system).

Step 2 : After Tax Salvage Value

After Tax Salvage Value = $25,000 × (1 − 0.35) = $16,250
Step 3 : Operating Cash Flow
Depreciation Expense : $100,000 / 5 = $20,000
Because there is savings from improved efficiency, so we can calculate EBIT :
EBIT = $23,000 - $20,000 = $3,000

62
Then, we can calculate Tax : $3,000 x 35% = $1,050 So the OCF is :

OCF = $3,000 + $20,000 - $1,050 = $21,950

Step 4 : Projected Cash Flow

0 1 2 3 4 5

Capital Spending -100,000 16,250

Operating Cash
Flow 21,950 21,950 21,950 21,950 21,950
Total Project Cash Flow -100,000 21,950 21,950 21,950 21,950 38,200

Step 5 : NPV
Step 6 : Conclusions
We should reject the project because the NPV < 0

63
REVIEW PROBLEMS
Problem 9.1
An Investment has expected sales of 50.000 unit with the selling price of $30 each unit. The
Variable cost are 50% of sales and fixed cost are $100.000. The Investment would required
fixed assets cost $100,000 with useful life 4 years. Assuming a tax rate of 30% percent. What
is the projected net income?

Problem 9.2
Calculate the Operating Cash flow using the four different approaches from problem 1

Problem 9.3
If the new OCF is $50.000 with the new required fixed assets cost $100.000, should we accept
or reject the project if the change of net working capital is $70,000 that will be recovered at
the end of the project and the required return is 15%? (t=4 years)

Problem 9.4
PT Jay’s Food want to invest in the expansion of a restaurant in Karawaci. They will need 4
years to finish this project that required initial asset of fixed asset of $5 Million and will be
depreciated straight line to zero in the end of the project. The project will give the restaurant
fo expected sales $ 7,000,000 with costs of $3,850,000 annually. If the tax rate is 35% and
required return is 15%. Would you accept the project?

Problem 9.5
Monster Inc would like to open a new store using machine that would cost $1,200,000 and
will be depreciated straight line to zero over its 5 years useful life. The project will be done
in 3 years and the machine still worth $700,000. The system will save the firm

$500,000 per year in pretax operating cost and it will need initial working capital
$350,000 that will be covered at the end of the project. If the tax rate is 25% and the discount
rate 15%. Should we accept or reject the project?

Problem 9.6

64
Sonia has offered an 5 year project which he should invest to an initial asset for $700,000.
He need net working capital of investment $35,000 and an annual OCF of $75,000. The fixed
asset would be depreciated straight line to zero and has no salvage value. If the return is 18%,
what is the project’s EAC? What does it mean?

65
 MODULE 10: PROJECT ANALYSIS AND EVALUATION

Reviewed by Nadya Komari

SUMMARY OF ALL THE FORMULAS:

NPV Calculation:
= -Initial Investment + ΣPV of all Future Cash Flow
(1+𝑟)𝑛 −1
= -Initial Investment + [𝑂𝐶𝐹 𝑥 ( 𝑟(1+𝑟)𝑛 )]
:

*OCF = EBIT + Depreciation – Tax

Fixed and Variable Cost

Total Variable Cost (VC) = 𝑄 𝑥 𝑉
Fixed Cost (FC) don’t change during
specified period Total Cost = FC + VC

The General Break Even

𝐹𝐶 (1−𝑇)+𝑂𝐶𝐹−𝐷𝑇 𝐹𝐶 + 𝑂𝐶𝐹
Q=( ) Q=( )….. ignoring taxes
(𝑝−𝑣)(1−𝑇) 𝑝−𝑣

Accounting Break Even Point:

𝐹𝐶 (1−𝑇)+𝐷−𝐷𝑇 𝐹𝐶 + 𝐷
Q=( ) Q=( )….. ignoring taxes
(𝑝−𝑣)(1−𝑇) 𝑝−𝑣

OCF = (S – VC – FC – D) + D Net Income = 0

The Cash Break Even Point:

𝐹𝐶 (1−𝑇)+0−𝐷𝑇 𝐹𝐶
Q=( ) Q=( )….. ignoring taxes
(𝑝−𝑣)(1−𝑇) 𝑝−𝑣
𝐹𝐶 (1−𝑇)−𝐷𝑇
Q=( ) OCF = 0
(𝑝−𝑣)(1−𝑇)

66
The Financial Break Even Point:
𝐹𝐶 (1−𝑇)+𝑂𝐶𝐹−𝐷𝑇 𝐹𝐶 + 𝑂𝐶𝐹
Q=( ) Q=( )….. ignoring taxes
(𝑝−𝑣)(1−𝑇) 𝑝−𝑣

NPV of the Project = 0

Degree of Operating Leverage (DOL)

DOL = 1 + FC
OCF
%Change in OCF = DOL x %Change in Q
(𝑄1−𝑄0)
%Change in Q = 𝑄0

Keterangan:
FC =
Fixed
Cost P =
Price

V = Variable Cost
per unit T = Taxes

D = Depreciation
OCF= Operating Cash Flow

Example:
A project under consideration costs $200,000, has a five-year life, and has no
salvage value. Depreciation is straight-line to zero. The required return is 12% and
the tax rate is 34%. Sales are projected at 6000 units per year. Price per unit is
$80, variable cost per unit is $60, and fixed costs are $50,000 per year. What are
the upper and lower bounds for these projections? What is the base-case NPV?
What are the best and worst-case scenario NPVs? The unit sales, price, variable
cost and fixed costs for completing questions are given below.

67
 Base Case Lower Bound Upper Bound

Unit Sales 6,000 5,500 6,500

Price per unit $80 $75 $85

Variable costs per unit $60 $58 $62

Fixed costs per year $50,000 $45,000 $55,000

Step 1: Calculate base-case NPV

We can calculate the base-case NPV by first calculating the net income:

Sales $480,000
Variable costs $360,000
Fixed Costs $50,000
Depreciation $40,000

EBIT $30,000
Taxes (34%) $10,200

Net Income $19,800

The Operating Cash Flow (OCF) is thus $19,800 + 40,000 = $59,800 per year.
At 12%, the five year annuity factor is 3.6048 (Calculated below), so the base
case NPV is:

(1+0.12)5 −1
𝐵𝑎𝑠𝑒 𝐶𝑎𝑠𝑒 𝑁𝑃𝑉 = −$200,000 + $59800 x 0.12 (1+0.12)5

𝐵𝑎𝑠𝑒 𝐶𝑎𝑠𝑒 𝑁𝑃𝑉 = $15,567

Thus, the Project looks good so far.

Step 2: Calculated Best and Worst NPVs

To get the worst case, we assign low values for items like units sold and price
per unit and high values for costs. We do the reverse for the best case. For our
project, these values would be the following:
68
 Worst Case Best Case

Unit
Sales 5,500 6,500

Price per unit $75 $85

Variable costs per unit $62 $58

Fixed costs per year $55,000 $45,000

Worst Case Best Case

Sales $412,500 Sales $552,500

Variable Costs $341,000 Variable Costs $377,000

Fixed Costs $55,000 Fixed Costs $45,000

Depreciation $40,000 Depreciation $40,000

EBIT -$23,500 EBIT $90,500

Taxes (34%) $7,990 Taxes (34%) $30,770

Net Income -$15,510 Net Income $59,730

Worst Case operating Cash Flow is -$15,510 + 40,000 = $24,490 per

year. Best Case operating Cash Flow is $59,730+ 40,000 = $99,730
per year.

(1+0.12)5 −1
Worst Case NPV = - $200,000 + ($24,490 x )=-
0.12 (1+0.12)5

$111,719

(1+0.12)5 −1
Best Case NPV = - $200,000 + ($99,730 x )=-
0.12 (1+0.12)5

$159,504

69
 Scenario Net Income Cash Flow Net Present Value IRR

Base Case $19,800 $59,800 $15,567 15.1%

Worst Case -$15,510 $24,490 -$111,719 -14.4%

Best Case $59,730 $99,730 $159,504 40.9%

Example:
Foxconn Technology Group is a multinational electronics contract manufacturing company.
The company has received an order for 10,000 smartphones to produce. Each smartphone
requires $250 in raw materials and $100 in direct labors. The production facility itself runs
$150,000 per month. If Foxconn usually produces 200,000 smartphones per year, what is
the total cost of productions?

VC = Q x V
= 10,000 x $350
= $3,500,000

FC = $15,000 x 12 month
= $1,800,000

TC = VC + FC
= $3,500,000 + $1,800,000
= $5,300,000

Example:
Philip Morris International is considering a new project that has the following estimated
data: Price of the product is $65 per unit, Variable cost per unit is $33 and the fixed cost is
$4,000. The required return is 16% with an initial investment of $9,000 that has three- year
life. Ignoring the taxes, calculate accounting break-even quantity, cash break-even quantity,
financial break-even quantity and also what is the degree of operating leverage at financial
break-even level of output?

Accounting Break Even Quantity

First, you have to calculate the depreciation
$9000
Depreciation = = $3,000
3

70
QACCBEP = $4,000+$3,000 = 218.75 𝑈𝑛𝑖𝑡𝑠
$65−$33

71
Cash Break Even Quantity

$4,000
QcashBEP = $65−$33 = 125 𝑈𝑛𝑖𝑡𝑠

Financial Break Even Quantity

First, you must have the OCF. Remember that NPV in Financial Break Even quantity is Zero.

(1+𝑟)𝑛 −1
NPV = −𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + (𝑂𝐶𝐹 𝑥 )
𝑟(1+𝑟)𝑛

(1 + 0.16)3 − 1
0 = −$9,000 + (𝑂𝐶𝐹 𝑥 )
0.16(1 + 0.16)3

(1.16)3 − 1
0 = −$9,000 + 𝑂𝐶𝐹 𝑥
0.16(1.16)3

OCF = $ 4,007.32

$4,000+$4,007.32
Qfbep = = 250.22 𝑈𝑛𝑖𝑡𝑠
$65−$33

Degree of Leverage

$4,000
𝐷𝑂𝐿 = 1 + = 1.998
$4,007.32

72
 REVIEW PROBLEMS

Problem 10.1
Nike is one of the largest sportswear manufactures in Europe. To produce shoes, the variable
material cost is $40 per unit and variable labor cost is $5.5 per unit.

a. What is the variable cost per unit?

b. Suppose that Adidas Fixed cost of $80,000 during a year in which total production of 10,000
units. What are the total costs for the year?
c. If the selling price is $90 per unit, what is Adidas quantity break-even on cash basis? If
depreciation is $12,000 per year, what is the quantity accounting break- even point?

Problem 10.2
Project analyzer team in Lippo Group is evaluating a project that costs $525,000, has a four-year life,
and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project.
Sales are projected at 240,000 units per year. Price per unit is

$30.00, variable cost per unit is $15, and fixed costs are $1,050,000 per year. The tax rate is 35 percent,
and we require a 12 percent return on this project.

a. Calculate the Accounting break-even point and NPV. What is the degree of operating leverage at
the accounting break-even point? (ignoring Tax)
b. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in the sales
figure? Explain what your answer tells you about a 300 unit decrease in projected sales.

Problem 10.3

A proposed project has fixed costs of $40,000 per year. The operating cash flow at 18,000 units is $60,000.
Ignoring the effect of taxes, what is the degree of operating leverage? If units sold rises from 18,000 to
18,500, what will be the increase in operating cash flow? What is the new degree of operating leverage?

Problem 10.4
Consider four-year project with the following information: initial fixed asset investment

73
= $400,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $20;
variable costs = $15; fixed costs = $280,000; quantity sold = 150,000 units; tax rate = 34%.

a. How sensitive is OCF to changes in quantity sold?

b. What is the degree of operating leverage at the given level of output? What is the degree of
operating leverage at the accounting break-even level of output?

Problem 10.5

Consider a project with the following data: accounting break even quantity = 16,000 units; cash break
even quantity = 12,500 units; life = three years; fixed costs = $120,000; variable costs = $20 per unit;
required return = 15%. Ignoring the effect of taxes, find the financial break-even quantity.

Problem 10.6
A Project under consideration costs $525,000, has a three-year life, and has no salvage value.
Depreciation is straight line to zero. The required return is 15%, and the tax rate is 34%. Sales are
projected at 400 units per year. Price per unit is $3,500, variable cost per unit is $1,000, and fixed costs
are $130,000 per year.

a. Suppose you think that the unit sales, price, variable cost, and fixed costs projections given here
accurate to 5%. What are the upper and lower bounds for these projections? What is the base
case NPV? What are the best case and worst-case scenarios NPVs?
b. What are the cash, accounting and financial break-even sales level for this project? (ignoring
taxes)
c. What is the degree of operating leverage at the Financial break-even point?

74
 MODULE 11: SHORT-TERM FINANCE & PLANNING

Reviewed by Millie Walia

Net Working Capital

Basic Balance Sheet : Net working capital + Fixed assets = Long-term debt + Equity
Net working capital = (Cash + Other Current Assets – Current Liabilities)
Cash = Long-term debt + Equity + Current Liabilities – Other Current Assets – Fixed Assets

Operating Cycles and Cash Cycles

• Operating Cycle is the time we acquire some inventory to the time we collect the cash
Operating Cycle = Inventory period + Accounts receivable period
• Cash Cycle is the time between cash disbursement and cash collection.
Cash Cycle = Operating cycle – Account Payable period

Other formulas to determine the Operating Cycles and Cash Cycles are:

75
EXAMPLE
You have collected information for Indochat Company :

Item Beginning Ending Average

INVENTORY $ 5.000 $ 7.000 $ 6.000
ACCOUNT 1.600 2.400 2.000
RECEIVABLE
ACCOUNT PAYABLE 2.700 4.800 3.750
If the credit sales for the year just ended were $100,000 and the COGS was $75,000. How long does it
take Indochat to collect on its receivable? How long does merchandise stay around before it is sold?
How long does Indochat take to pay the bills? How about the operating and the cash cycle?

SOLUTION :
𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 100.000
Receivables Turnover =𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 = = 50 𝑡𝑖𝑚𝑒𝑠
2.000

𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 75.000

Inventory Turnover =𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = = 12.5 𝑡𝑖𝑚𝑒𝑠
6.000

𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 75.000

payables Turnover = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 = = 20 𝑡𝑖𝑚𝑒𝑠
3.750

So, from the equation above we know that :

Receivable Period = 365/50 = 7.3 days
Inventory Period = 365/12.5 = 29.2 days
Payable Period = 365/20 = 18.25 days

Operating Cycle = Inventory Period + Receivable Period = 29.2 + 7.3 = 36.5 days Cash Cycle =
Operating Cycle – Payable Period = 36.5 – 18.25 = 18.25 days

Cash Budget
To make it easier, we can use this example to determine the cash collection and the cash disbursement

76
Avaplus Company has estimated sales for the next four quarters as follow :

Q1 Q2 Q3 Q4
SALES $ 25.000 $ 40.000 $ 86.000 $ 72.000

1. Cash Collection

From the Avaplus example, we get information that Account Receivable at the beginning of year are
$10,500 and Avaplus has 36-day collection period.

SOLUTIONS:
This means that 40% (36/90) of the sales will be reflected as ending receivable and will be collected in
the following quarter, and the 60% are collected in the quarter that sales are made.

Q1 Q2 Q3 Q4
END. RECEVIABLES $ 10.000 $ 16.000 $ 34.400 $ 28.800

Q1 Q2 Q3 Q4
BEG. RECEVIABLES $ 10.500 $ 10.000 $ 16.000 $ 34.400

Then, the Cash Collection = Beg. Receivable + 60% of sales in the quarter it is made
Q1 Q2 Q3 Q4
BEG. RECEVIABLES $ 10.500 $ 10.000 $ 16.000 $ 34.400
CASH SALES 15.000 24.000 51.600 43.200
TOTAL COLLECT 25.500 34.000 67.600 77.600

2. Cash Disbursement
From the Avaplus example, we get information that purchases from supplier during a quarter are
equal to 50% of the next quarter’s sales. The average account payable period is 45-days.

SOLUTIONS:

First, we have to determine the purchases of Avaplus which are 50% of the next sales. It
means that half of the sales in Q2 will be the purchase in Q1, and so do on.
Q1 Q2 Q3
PURCHASES $ 20.000 $ 43.000 $ 36.000
Second, because the period is about 45-days. Then, 50% (45/90) will be paid in the quarter
of the purchase (cash payment) and the 50% will be paid in the next quarter.

77
 Q1 Q2 Q3
BEG. PAYABLE $ 6.250* $ 10.000 $ 21.500
CASH PAYMENT 10.000 21.500 18.000
TOTAL PAYMENT 16.250 31.500 39.500

We get 6,250 because the sales of Q1 is 25,000. From this information, Avaplus purchase
12,500 in Q0, so the payable is 50% x 12,500 = 6,250 that should be paid in Q1.

• The next following information are the company has forecast expenditure: wages, taxes and
other cost totaling 15% of sales; interest payment $5,750 every quarter; and major capital
expenditure is $10,500 in the first quarter.

SOLUTIONS:
Total Cash Disbursement = Total Payment + Wages, Taxes, and Other Cost + Interest
Payment + Total Capital Expenditure

Q1 Q2 Q3
TOTAL PAYMENT $ 16.250 $ 31.500 $ 39.500
WAGES, TAXES, OTHER COST 3.750 6.000 12.900
INTEREST PAYMENT 5.750 5.750 5.750
CAPITAL EXPENDITURE 10.500 - -
TOTAL CASH DISBURSEMENT 25.750 43.250 57.950

3. Cash Balance
To make the cash balance, we need these following steps:

• Make the Net Cash Inflow (Outflow)

Q1 Q2 Q3
TOTAL COLLECT $ 25.500 $ 34.000 $ 67.600
TOTAL DISBURSEMENT (25.750) (43.250) (57.950)
NET CASH (250) (9.250) 9.650
INFLOW(OUTFLOW)

• Make the Ending Cash Balance. From the Avaplus, we get information that the Beginning Cash
Balance is $ 25.000.

Q1 Q2 Q3
BEG. CASH BALANCE $ 25.000 $ 24.750 $ 15.500
NET CASH INFLOW(OUTFLOW) (250) (9.250) 9.650

78
 END. CASH BALANCE 24.750 15.500 25.150

• Make the Cumulative Surplus (Deficit). From the Avaplus, we get the information that
the Minimum Cash Balance should be $ 2.500
Q1 Q2 Q3
BEG. CASH BALANCE $ 25.000 $ 24.750 $ 15.500
NET CASH INFLOW(OUTFLOW) (250) (9.250) 9.650
END. CASH BALANCE 24.750 15.500 25.150
MIN. CASH BALANCE (2.500) (2.500) (2.500)
CUMULATIVE SURPLUS (DEFICIT) 22.250 13.000 22.650

79
REVIEW PROBLEMS
Problem 11.1
GRAB Corp. has a long-term debt $3550 Net working capital is $2570. Fixed assets are
$5100. Other current assets are $5250. How much cash does the company have?
(if current liabilities are $3180) by first finding out its equity.

Problem 11.2
Mount Inc. has $3150 of current liabilities, a net working capital, other than cash of
$3360, with a fixed cost of $7100 and equity $6780. With this information, how
much cash does Mount Inc. have?

Problem 11.3
Starbucks Company has projected the following quarterly sales amounts for the
coming year:

Q1 Q2 Q3 Q4
SALES $900 $840 $990 $ 920
a. Accounts receivable at the beginning of the year are $410. Starbucks has a
45- day collection period. Calculate cash collections in each of the four
quarters by completing the following:

Q Q Q Q
1 2 3 4
BEG.
RECEVIABLES
SALES
CASH
COLLECTION
END.
RECEIVABLES

b. Rework (a) assuming a collection period of 60 days

c. Rework (a) assuming a collection period of 30 day
80
Problem 11.4
Consider the following financial statement information for the Alpha Corporation:

Item Beginnin Ending

g
INVENTORY $ 11 400 $12
800
ACCOUNT RECEIVABLE 7850 8370
ACCOUNT PAYABLE 9280 9690
NET SALES 91
210
COST OF GOODS SOLD 62
365
Calculate the operating and cash cycles.

Problem 11.5
PT Lippo has announced a new product, this is the projection of the following sales
for the coming year (in billion):

Q1 Q2 Q3 Q4 Q5
Sales $ 710 $ 760 $740 $79 $88
0 0
a. Calculate payments to suppliers assuming that PT Lippo place orders during
each quarter equal to 30% of projected sales for the next quarter. Assume that
PT Lippo pays immediately. What is the payables period in this case?

Q1 Q2 Q3 Q4
Payment of accounts

b. Rework (a) assuming a 60-day payables period.

c. Rework (a) assuming a 90-day payables period.

81
 Problem 11.6
As seen in Problem 11.4, PT Niaga purchase from suppliers during each quarter
equal to 30 % of projected sales in the next quarter. And the payable period is 45
days. Wages, taxes, and other expenses are 17 % of sales, interest and dividend
are $55 per quarter. No capital expenditure is planned. Projected quarterly sales
are as per problem 11.4.

Problem 11.7

Here are some important figures from the budget of Link Company, for the
second quarter of 2018:

Month April May June

Credit sales $510 000 $464 000 $581 000

Cash Disbursements

Credit purchases 182 100 167 800 209 030

Wages, taxes, and

expenses 71 540 64 320 80 190

Interest 23 000 23 000 23 000

Equipment purchases 81 300 92 500 0

The company predicts that 5 % of its credit sales will never be collected, 45 % of its
sales will be collected in the following month. Credit purchases will be paid in the
month of purchase. In March 2018, the ending cash balance is $290 000, with credit
sales $480 000 and credit purchases $203 600. They have a minimum cash balance
of

$40 000. Using this information, complete the following cash budget:

Month April May June

Beginning cash balance

82
Cash receipts
Cash collections from credit sales
Total cash available
Total cash disbursements
Ending cash balance
Cumulative surplus (deficit)

83
 MODULE 12: CASH AND LIQUIDITY MANAGEMENT

Reviewed by Amanda Fortuna Arum Sekarlaras

The amount of money you have according to your checkbook can be different from the
amount of money in your bank account. The cash balance that a firm shows on its book is
called the firm’s book or ledger. The cash balance shown in its bank account that available
to spend is called its available or collected. The difference between book cash & bank cash,
representing the net effect of checks in the process of clearing, called float.

Float = firm’s available balance – firm’s book balance

Net Float = Disbursment Float + Collection Float

DISBURSMENT FLOAT (Checks Written)

Example :
Suppose COCO corporation’s currently has $50.000 on deposit with its bank. On July 10, they
buy some raw materials and pays with a check for $30.000. The company’s book balance is
immediately reduced from $50.000 to $20.000. Let say, it will presented to COCO
corporation’s bank for payment on July 15.

Float = $50.000 - $50.000 = $0 ( float before July 10 )

Float = $50.000 - $20.000 = $30.000 ( float from July 10 until July 15 )
So, COCO corporation bank will not find out about this check until it presented to the bank
for payment on July 15. Until the check presented, th firm’s available balance is greater than
its book balance. And before July 10, it has 0 float because no purchase.

If the float positive, it is disbursment float.

COLLECTION FLOAT (Checks Received)

Example :
Suppose ABBI.Inc currently has $50.000 on deposit with its bank. Then receives a check from
customer for $100.000 on March 16. It will increase the book balance from $50.000 to
$150.000. Let say, the check will presented & liquidated on March 21

Float =$50.000 - $50.000 = $0 ( float before March 16 )

Float = $50.000 - $150.000 = -$100.000 ( float from March 16 until March 21 )
84
 So, ABBI. Inc’s available balance will not increased until March 21, when the bank will
presented the check, liquidate it and ABBI.Inc will received $100.000. Until the check
presented, the firm’s available balance is lower than its book balance. And before March 16,
it has 0 float because no payment made.

If the float negative, it is collection float.

MEASURING FLOAT
The size of the float depend on both the dollars and the time delay involved.
Example: suppose you mail a check $100 to another state. It takes 5 days in the mail for the
check to reach its destination (the mailing time), 1 day for the recipient to go to the bank
(the processing delay), & 3 days the bank holds out-of-state checks (availability delay). So,
the total delay is 9 days.

Total float
Average Daily Float =
Total days in a month

Average Daily Receipts =

Total days in a month

Receipts 1

Average Daily Float = average daily reciepts x weighted average delay

Example :
XYZ Corp. receives 2 items each month, as follows ( assuming 30 days in a month ) :
Amount Processing & Availability Delay Total Float

Item A : $2.000.000 5 days = $10.000.000

Item B : $4.000.000 8 days = $32.000.000

Total = $6.000.000 Total = $42.000.000

85
LOCKBOXES

When a firm receives its payment by mail, it must decide where the checks will be
mailed and how the checks will be picked up and deposited. Many firms use special post
offices boxes called lockboxes, to intercept payments and speed cash collection.

Using ‘Perpetuity Due’ (payments at the beginning of the month or beginning

of the year)

86
 Example :
BEE. Inc proposed lockbox system. Frou Bank wants a $480 fixed fee in addition to the
$250 per check ( 4000 checks ). It will decrease the collection time by 2 days. Let
say the interest rate is 0,025%. Is the system still a good idea?

From the information above, we know that :

- Daily Interest : 0,025%
- Reduction Days : 2 Days
- Average Number of Daily Payments : 4000 checks
- Average Size of Payments : $250
- Cost of Payments : $480

So :
Average Daily Collections = $250 x 4000 checks = $1.000.000

PV for Lockbox = (2 reduction days) x $1.000.000 = $2.000.000

PV for cost payment = $480 / 0,025% = $1.920.000

Net Present Value = $2.000.000 - $1.920.000 = $80.000

So, yes its still a good idea to use lockbox systems because the NPV is positive

87
REVIEW PROBLEMS
Problem 12.1
Ricciardo currently has $100,000 on deposit. Ricciardo Company writes checks totaling
$40,000 to pay its suppliers. The clearing time is 6 days. Meanwhile, the company is
receiving payments from its customers totaling $50,000. The cash from the payments is
available to the company after 3 days.

a. Calculate the firm’s disbursment float, collection float, and net float.
b. How would you answer part (a) if the collected funds were available after
4 days instead of 3 days?

Problem 12.2
Sebastian Inc. receives an average of $100.000 in checks per day. The delay is typically 5
days.

a. What is the company’s float?

b. Lets say Sebastian Inc. also has to pay to its customer using check for $50,000. The
delay is 2 days. Now, what is the company net float?

Problem 12.3
Miracle. Inc receives 2 checks each month, as follows :

Amount Processing & Availability Total Float

Delay

Item 1 : $600,000 4 days = ..

....

Item 2 : $300,000 5 days = ..

....

Total = ..... Total= ….

( 30 days in a month )
a. Please Complete the table !
b. Calculate the average daily float, average daily receipts, and weighted average daily !

88
Problem 12.4
PT. XYZ has an average receipt size of $500 and receives 10000 checks per day. A bank has
approached PT. XYZ to use lockbox services that will decrease the total collection time by 3
days. If the bank charges a fee for $580 per day. Let say the interest rate is 0,04% per day.
Should PT. XYZ accept the lockbox services?

Problem 12.5
Norris Company has average daily receipts of $8.000.000 (5000 checks, $1600 per check),
with delay time 5 days. Norris Company want to use lockbox system, but they are confused
which bank should they choose. European Bank offer lockbox system, $1000 per day to
decrease 2 days of the collection time. Asian Bank offer $2500 per day, to make the delay
time from 5 days become 2 days only. Both bank have 0,01 percent interest rate daily.
Which Bank should Norris Company choose? Why?

Problem 12.6
It takes 6 days for Verstappen Shop to receive and deposit checks from their customers.
Verstappen Shop is considering to use lockbox system, to reduce the collection period. The
lockbox system will reduce receipt and deposit times by 2 days. The average daily collection
of Verstappen Shop is $300.000 (1000 checks and $400 of the value) and the required rate
of return is 10% per year. Also, the variable lockbox fee (per transaction) is $0,6.

a. What is the reduction in outstanding cash balances as a result of using lockbox system?
b. What is the dollar return that could be earned on these savings?
c. What is the NPV of the transaction?
d. How could your answer change if there were a fixed charge of $60.000 per year in
addition to variable charge?

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 MODULE 13: CREDIT AND INVENTORY MANAGEMENT

Reviewed by Millie Walia

Credit Management
• There are three components of credit policy:
1. Terms of sales
o If the firm does grant credit to customer, the terms of sale will specify the
credit period, cash discount and discount period.
o Example: 2/10, net 30. The customer will get 2% discount on purchase if
the payment is within 10 days. Also, the customer will be given 30 days time
to submit payment.
2. Credit analysis
o The process of determining the probability that customer will not pay
using number of devices and procedures.
3. Collection policy
o The procedures followed by a firm in collecting accounts receivables.

• The Size of Receivables

Account receivables = Average daily sales × Average Collection Period (ACP)

Example: The average collection period (ACP) of Timore Corporation is 40 days. If
credit sales run $2,500 per day, so:

Account receivables = 40 days x $2,500 per day = $100,000

• Cost of Credit

% 𝑫𝒊𝒔𝒄𝒐𝒖𝒏𝒕 𝟑𝟔𝟓 𝒅𝒂𝒚𝒔

𝑹= ×
𝟏𝟎𝟎% − % 𝑫𝒊𝒔𝒄𝒐𝒖𝒏𝒕 𝑪𝒓𝒆𝒅𝒊𝒕 𝑷𝒆𝒓𝒊𝒐𝒅
𝑹 𝒎
𝑬𝑨𝑹 = (𝟏 + ) −𝟏
𝒎

R : Interest rate
m : Number of compounding periods in a year
Example:
The cost when customer not paying early and not getting the sales discount. We need
to find the interest rate that the buyer is effectively paying for the trade credit. Terms

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 of sale is 2/10, net 30. The customer has to choose between paying in 10 days at
$1,470 or paying in another 20 days at $1,500.

Answer:

% 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 365 𝑑𝑎𝑦𝑠

𝑅= 𝑥
100% − % 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑒𝑟𝑖𝑜𝑑

2% 365 𝑑𝑎𝑦𝑠
= 𝑥
100% − 2% (30 𝑑𝑎𝑦𝑠 − 10 𝑑𝑎𝑦𝑠)

= 0.3724 = 𝟑𝟕. 𝟐𝟒%

𝑅 𝑚
EAR = (1 + 𝑚 ) − 1

365
20
37.24%
= (1 + ) −1
365
20

= 44.58%

• Cash Discount and ACP

To extent that a cash discount encourages customers to pay early, it will

shorten the receivables period and reduce the firm’s investment in
receivables.

Example:
The Jellymore Corporation offers terms of 5/10, net 30, probably 60
percent of customer will take the discount based on experience. The
remaining will still take an average of 30 days to pay.

a. What is the average collection period for

the firm? ACP = (0.6 x 10 days) + (0.4 x 30
days) = 18 days So, the ACP thus fall from
30 days to 18 days.
b. If the firm sells $10 million annually, what is the average balance in
account receivables?
Average daily sales = $10 million / 365 days =
S27,397 So, receivables thus fall by $27,397 x 10
days = $273,970
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• Credit Policy Evaluation
The components that we need to evaluate the credit policy are : P: Price per unit

V: Variable cost per unit

Q : Current quantity sold per month Q’ : Quantity sold under new policy R : Monthly
required return Example:

Stanmore Corporation changes its cash payment policy to net one month (30 days).
Price per unit is $68, variable cost per unit $22, current quantity sold per month 90
units and quantity sold by net one month is 105 units. R is 3% per month. Analyze
whether Stanmore should change the policy or not.

Solution :
Monthly sales = P× Q
= $68 × 90 = $6,120
Variable cost per month = v × Q
= $22 × 90 = $1,980
Cash flow with old policy = (P−v) x Q
= ($68−$22) × 90
= $4,140
Cash flow with new policy = (P-v) x Q’
= ($68-$22) x 105
= $4,830
Incremental cash inflow = (P-v) x (Q’-Q)
= ($68-$22) x (105-90)
= $690
Present Value = (P-v)(Q’-Q)/R
= $690/0.03
= $23,000
Cost of switching= PQ + v(Q’-Q)
= $6,120 +$330
= $6,450

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 NPV of switching = (P x v) – cost of switching
= ((p-v)(Q^'-Q ))/R - ( PQ + v (Q’ – Q )
= $23,000 - $6450
= $16,650

Inventory Management
Economic Order Quantity (EOQ) Model :

T: Total unit sales per year

CC : Carrying Cost per unit per
year F : Fixed Cost per unit

Q : Quantity per order

Example:
Glassmore Microwave has 150 units in stock. This stock is depleted each period and
reordered. The carrying cost for each microwave per year is $10, how much the total
carrying cost for the microwave?

Answer:
150
Total Carrying Cost = 𝑥 $10
2

= $750
Glassmore has total sales 3000 units per year. The restocking cost is $25 per order. How
many times per year does Glassmore restock? What are the total restocking cost?

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Answer:
Time Restoking = (3000 units)/(150 units)
= 20 times
Total Restocking Cost = (3000 units)/(150 units) x $25
= 20 orders x $25
= $500
Based on two previous problems, what size orders should Glassmore place to minimize
costs?

Answer:
(2𝑥3000) 𝑥 $25
The Optimal Order Size = √ = 𝟏𝟐𝟐. 𝟒𝟔 𝐮𝐧𝐢𝐭
$ 10

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REVIEW PROBLEMS
Problem 13.1

Christian, Inc., is considering a change in its cash-only sales policy. The new terms of sale
would be net one month. Based on the following information, determine if Christian should
proceed or not. The required return is 2.5% per month.

Current Policy New Policy

Price per unit $ 1350 $ 1550
Cost per unit $ 690 $ 690
Unit sales per month 2170 2340

Problem 13.2

Chamberlyn Corp. has annual sales of 30 000 units notebook. This company always has 500
units in stock. This stock is depleted each period and reordered. The carrying cost for each
unit per year is $7. The restocking cost per order is $16. Determine order frequency and total
cost.

Problem 13.3

Blueline Manufacturing starts each period with 780 tennis rackets in stock and total yearly
sales is 45 000 units. This stock is depleted each month and reordered. If the carrying cost per
racket is $4, and the fixed order cost is $6. Is Blueline following an economically order size
strategy?

Problem 13.4

The JoePolk Corporation has annual sales of $60 million (term of sale 2/10, net 30). The
average collection period is 30 days. What is the average investment in account receivables as
shown on the balance sheet?

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Problem 13.5

Monster, Inc. offers terms of 3/10, net 30, probably 40.5% of customers will take
the discount based on loyalty and experience. The remaining will still take an
average of 30 days to pay. What is the average collection period for the firm?

Problem 13.6

Calculate annual interest and effective annual interest rate for terms of sale
7/10, net 30. To determine whether the customer will pay in 10 days at $1400 or
pay in 30 days more at $1,600.

Problem 13.7

The economic order quantity of RichTech Corp. is 210 units. The carrying cost for
each unit is $8 and fixed cost per order is $12. Find the annual sales per year!

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