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Afaq Ahmed_10495 IUAC
Question 1 8 Marks
Company wants to prepare a cash budget for May, June, and July. At the end of every month the cash
balance will be Rs. 20,000. Determine whether borrowing will be necessary during the period, and if it is,
when and for how much.
50% of total sales are for cash. The remaining will be collected equally during the following
two months.
Cost of purchases are 70% of sales, 90% of this cost is paid during the first month after
incurrence and the remaining 10% is paid in the following month.
Dividend of Rs. 10,000 declared on June will be paid in the month of July.
Company plans to sell machinery costing Rs. 10,000 at an expected gain of Rs. 5,000 in June.
Purchase plant and machinery in June for Rs. 40,000.
Income tax payment of Rs. 1,000 will be made in July.
Solution:
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Afaq Ahmed_10495 IUAC
Collection of receivable
Particulars May June July
Cash Sales @50% 35000 40000 50000
Cash collected (from credit sales of)
March 15000
April 15000 15000
May 17500 17500
June 20000
Total cash receipts from customer 65000 72500 87500
Payment of creditors
Particulars May June July
3780 4410 5040
Credit Purchases (Paid in following month @ 90%) 0 0 0
Credit Purchases (Paid in two month @ 10%) 4200 4200 4900
4200 4830 5530
Total Payment for credit purchases 0 0 0
Cash Budget
May, June and July 2015
Particulars May June July
Beginning cash balance 20000 43000 42200
Cash receipt from customer 65000 72500 87500
Sale of machinery (10000+5000) 0 15000 0
Total cash available 85000 130500 129700
Cash disbursements: May June July
Payment to creditors 42000 48300 55300
Payment of dividend 0 0 10000
Purchase of plant and machinery 0 40000 0
Payment of income tax 0 0 1000
Total Cash Disbursement 42000 88300 66300
Surplus/(Deficit) 43000 42200 63400
Borrowing Required 0 0 0
Ending Cash balance 43000 42200 63400
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Afaq Ahmed_10495 IUAC
Question 2 9 Marks
Atlas Corporation wants to determine the optimal level of current assets that should be kept in the next year.
The company is currently undergoing expansion, after which sales are expected to increase approximately
by PKR 1 million. The company wants to maintain a 40% equity ratio and its total fixed assets are of PKR 1
million. Atlas’s interest rate is currently 8% on both short-term and longer-term debt (which the firm uses in
its permanent structure). The company must choose between three strategies and decide which one is better.
(1) a lean and mean policy where current assets would be only 35% of projected sales, (2) a moderate
policy where current assets would be 40% of sales, and (3) a lenient policy where current assets would be
50% of sales. Earnings before interest and taxes should be 10% of total sales, and the federal-plus-state tax
rate is 35%.
a. What is the expected return on equity under each current asset level?
b. In this problem, we assume that expected sales are independent of the current asset policy. Is
this a valid assumption? Why or why not?
c. How would the firm’s risk be affected by the different policies?
d. A good current and quick ratio are a guarantee of excellent working capital management
strategies. Is this a valid assumption? Why or why not?
Solution
(A)
Moderate Policy
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Afaq Ahmed_10495 IUAC
Lenient Policy
Current Asset at 50% of Sale
Sale 1,000,000.00
CA @50% 500,000.00
FA 1,000,000.00
Total Assets 1,500,000.00
Debt(60% of TA) 900,000.00
Equity(40% 0f TA) 600,000.00
EBIT(10% of sale) 100,000.00
Less: interest (@ 8%) 72,000.00
EBT 28,000.00
Less: Tax (@35%) 9,800.00
NI 18,200.00
ROE 3.03%
B)
Expected sales is not independent of CA because the sales is most likely on the CA of the firm as it
includes of inventory which can be sold or used for production. At the period of topmost where the
volume of sales is high, then the inventory necessity will be higher too. If sales are high and most
of the sale on credit that’s increase account receivable amount in current asset. So, that’s why
expected sale is dependent on or lead to increase current assets.
C)
When a firm have higher current assets that means the firm facing an inventory liquidation risk and its lead
to higher cash involve in current assets. In this scenario company might be sell its inventory at lower level
to get back the fund or cash. As a result of this, there would be lesser profit thereby lesser return on equity.
D)
A good current and quick ratio is not always a guarantee of excellent working capital management
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Afaq Ahmed_10495 IUAC
strategies because these ratios can be used for gauge the liquidity of the firm and don’t show how well firm
manage its working capital. Liquidity ratio shows how well firm can meet their current liabilities with the
available current assets that’s why this assumption is invalid.
Question 3 8 Marks
Excerpt taken and modified from Government of Pakistan Investment bond’s Auction result:
Auction for 3, 5, 10- and 20-year Pakistan Investment Bonds was held on March 20, 2019 with settlement
date on March 21, 2019. The coupon rates for 3, 5, 10- and 20-year bonds are 7.25%, 8.00%, 8.75%, and
10.75% respectively. The accepted bid summary and result is as under:
Solution:
Part A
a). the 2-year rate 3 years from now
1.27807- 1 = X
X = 27.80%
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Afaq Ahmed_10495 IUAC
X = 24.8%
Part B
According to following information the shape of Pakistan investment bond yield curve is upward trend. But
the yield curve also validates these expectations, as after showing a steep upward trend at the beginning of
this year, it flattened by end of FY 19. Importantly, the spread b/w 10 year and 3 year paper also turned
negative in 2019.
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