Mid-Term Exam (Take-Home) Fall - 2020

NAME
STUDENT ID
SUBJECT
FINANCIAL STRATEGY AND POLICY

Q No. 1
Given data
Debt 20%
RPM 6%
Rrf 5%
Equity 80%
Tax 40%
BetaL 1.5
CAPM (PREVIOUS)
CAPM = RF + RPM(BETA)
CAPM = 5% + 60% (1.5)
COST OF EQUITY (PREVIOUS) = 14%
Solution
Un levered Beta
BU = BL / 1+(1-Tax) (D/E)
BU = 1.5 / 1+ (1- 40%) (20% / 80%)
BU = 1.303

LEVERED BETA
BL = BU (1+ (1 – TAX) D/E
BL = 1.303 (1 + (1 – 40%) 40% / 60%
BL = 1.8

CAPM (NEW)
CAPM = RF + RPM(BETA)
CAPM = 5% + 6% (1.8)
CAPM = 16 %

RESULTS
COST OF EQUITY (PREVIOUS) = 14%
COST OF EQUITY (NEW) = 16%

Q No.2
a. A firm should select the capital structure that is fully levered
Disagree, because a firm should select a capital structure which is fully unlevered or at optimal
level with mix of both debt and equity. Fully levered capital structure means 100% dept capital
which can maximize the fixed cost of the firm that will lead the highest chances for bankruptcy.
So, it will decrease the value of a firm.
B. Leveraged beta represents fundamental operating risk.
Disagree, because unleveraged beta represents the operational risk, and leveraged beta represents
financial risk.
c. MM Proposition I with no tax supports the argument that a firm should borrow money
to the point where the tax benefit from debt is equal to the cost of the increased probability
of financial distress.
Disagree, because this statement is related to MM proposition I with taxes. Where value of
unlevered in equal to value of levered plus taxes.

Q No. 3
Contract 1
Year
 1 4000000/ (1+14%) 3508771.98
2 4000000/ (1+14%)2 3077870.114
3 4000000/ (1+14%)3 2699886.065
4 4000000/ (1+14%)4 2368321.101
Present value= 11654849.26

Contract 2
Year
1 7000000/ (1+14%) 6140350.877
2 1000000/ (1+14%)2 769467.5285
3 1000000/ (1+14%)3 674971.5162
4 1000000/ (1+14%)4 592080.2774
Present value= 8176870.2

Contract 3
Year
1 9000000/ (1+14%) 7894736.842
2 500000/ (1+14%)2 384733.7642
3 500000/ (1+14%)3 337485.7581
4 500000/ (1+14%)4 296040.1387
Present value= 8912996.5

As a financial advisor, I will suggest contract number 1 because it has highest present value.

Q No. 4 (1)
Pro forma Income Statement (upcoming year)
 Income statement 2020 2021
4536
Sale 4,200
(4082.4)
Operating costs (3,780)
453.6
EBIT 420
(120)
Interest (120)
333.6
EBT 300
(136.64)
Taxes (40%) (120)
200
Net Income 180
0
Dividends 0
200
Addition to retrained earnings 180

Pro forma Balance Sheet (upcoming year)

Balance sheet 2020 2021

Cash and marketable securities 42 45.36

Accounts receivable 336 362.88
Inventories (no change) 441 441
Current Assets 819 849.24
Net fixed assets 2,562 2767
Total Assets 3,381 3616.2
Accounts payable and accruals 168 181.44
Notes payable (25%*21.7) +250 250 255.42
Current liabilities 418 436.86
Long term debt (25%*21.7) +700 700 705.42
Common stock (50%*21.7) +400 400 410.85
Retained earnings (200 + 1863) 1863 2063
Total liabilities and equity 3,381 3616.2

Q No. 4 (2)
Current year Upcoming year
2020 2021
 Return on equity 180/ (400+1863) 200/ Increased
Net income/total equity =0.0795/ 7.95% (410.85+2063)
=0.0808/ 8.08%

Inventory turnover 3780/441 4082.4/ 441 increased

Ratio=COGS/Inventory =8.57 =9.25

Profit Margin 180/4200 200/4536 Increased

Net income/ Sales 0.04/4.28% 0.044/ 4.40%

Above table shows that return on equity is increased from 0.13%. Inventory turnover in increases
from 0.68 and profit margin has also been increased from 0.12%.

Q No. 5 Cash budget

January February March

Opening balance 30,000 24,000 17,250
Receipts added
Cash collection 79500 77250 78000
Insurance claim 25000
March
Total cash 109500 101250 120,250
payments
Supplier payments 55,500 46,000 54,000

Payment for wages 15,000 15,000 15,000

Overhead payments 15,000 15,000 15,000
Tax payment 8000
Total payments (85,500) (84,000) (84,000)

Closing balance 24,000 17,250 36,250

Collection from debtors
November December January February march
Sales 80,000 90,000 75,000 75,000 80,000
Collection from debtors
60% sales of current month 45000 45,000 48,000
25% sales in previous 22500 18,750 18,750
month
15% sales from previous of 12000 13,500 11,250
previous month
Total 79500 77,250 78,000
Creditors payments
December January February March
Purchases budget 60,000 55,000 45,000 55,000
payments
90% purchases for current 49,500 40,500 49,500
month
10% in previous month 6,000 5,500 4,500
Total payments 55,500 46,000 54,000