Master of Professional Banking

Dept. of Banking and Insurance

July-Dec 20 Semester Final Examination
Course: 404: Financial Management
Marks: 15+15+10

[Prepare doc file and PPT and presentthrough zoom]

1. a) What do you understand by the time value of money? Distinguish between the present value
and the future value. How is the present value of future inflow calculated?

Answer: The time value of money is a basic financial concept that holds that money in the
present is worth more than the same sum of money to be received in the future. This is true
because money that you have right now can be invested and earn a return, thus creating a larger
amount of money in the future. (Also, with future money, there is the additional risk that the
money may never actually be received, for one reason or another.) The time value of money is
sometimes referred to as the net present value (NPV) of money.

How the Time Value of Money Works

A simple example can be used to show the time value of money. Assume that someone offers to
pay you one of two ways for some work you are doing for them: They will either pay you $1,000
now or $1,100 one year from now.

Which pay option should you take? It depends on what kind of investment return you can earn on
the money at the present time. Since $1,100 is 110% of $1,000, then if you believe you can make
more than a 10% return on the money by investing it over the next year, you should opt to take
the $1,000 now. On the other hand, if you don’t think you could earn more than 9% in the next
year by investing the money, then you should take the future payment of $1,100 – as long as you
trust the person to pay you then.

Time Value and Purchasing Power

The time value of money is also related to the concepts of inflation and purchasing power. Both
factors need to be taken into consideration along with whatever rate of return may be realized by
investing the money.

Why is this important? Because inflation constantly erodes the value, and therefore the
purchasing power, of money. It is best exemplified by the prices of commodities such as gas or
food. If, for example, you were given a certificate for $100 of free gasoline in 1990, you could
have bought a lot more gallons of gas than you could have if you were given $100 of free gas a
decade later.
purchasing power of money

Inflation and purchasing power must be factored in when you invest money because to calculate
your real return on an investment, you must subtract the rate of inflation from whatever
percentage return you earn on your money. If the rate of inflation is actually higher than the rate
of your investment return, then even though your investment shows a nominal positive return,
you are actually losing money in terms of purchasing power. For example, if you earn a 10% on
investments, but the rate of inflation is 15%, you’re actually losing 5% in purchasing power each
year (10% – 15% = -5%).

Time Value of Money Formula

The time value of money is an important concept not just for individuals, but also for making
business decisions. Companies consider the time value of money in making decisions about
investing in new product development, acquiring new business equipment or facilities, and
establishing credit terms for the sale of their products or services.

A specific formula can be used for calculating the future value of money so that it can be
compared to the present value:

Time Value of Money Formula

FV = PV x [ 1+ ( i /n)](n x t)

Where:

FV = the future value of money

PV = the present value
i = the interest rate or other return that can be earned on the money
t = the number of years to take into consideration
n = the number of compounding periods of interest per year
Present value is the sum of money that must be invested in order to achieve a
specific future goal. Future value is the dollar amount that will accrue over time when that sum is
invested. The present value is the amount you must invest in order to realize the future value.
There is some extra difference between present & future value are which has been showing in the
following:
 Present value Future value

 Current value of cash flow in future.
 Current value of an asset or an
investment at starting of a particular
time period.
 Inflation is considered.
 Discount rate and interest rate are
considered.
 Helps investors in decision making.
 Discounted process/method is
followed.
 Present value = (cash flow)/ (1 + r)^n.
 Value of future flow after certain future
period.
 Value of an asset or an investment at
the end of a particular time period.
 Inflation is not considered.
 Only interest rates are considered.
 Least considered by investors in
making investment decisions.
 Capitalization process/method is
followed.
 Future value = (present value) or (cash
flow) (1 + r)^n

The formula for finding the present value of future cash flows (PV) = C * [(1 - (1+i)^-n)/i], where
C = the cash flow each period, i = the interest rate, and n = number of payments. This is the short
cut to the long-hand version.

b) IFIC Bank Ltd. has agreed to sanction a short term loan amounting Tk. 2, 00,000 to ABC
company at 16% nominal interest rate for 1 year. Calculate the effective rate of interest if the rate
of interest is calculated on
a. Collect Basis b. Discount Basis and c. Monthly installment Basis

a. Collective Basis:
I 360
EIR = ( X ¿ X 100Hence,
P DM
32,000 360
=( X ¿ X 100I =2,00,000 X 16%=32,000
2,00,000 360
= 0.16 X 1 X 100 P =2,00,000
= 16% DM=Date of Maturity=360 days
M= Month
b. Discount Basis :
I
EIR = X 100
P−I
32,000
=( ¿ X 100
2,00,000−32,000
32,000
=( ¿ X 100
1,68,000
 = 19.04 %

c. Monthly installment Basis:

( mi ) -1} X 100
EIR = { 1+
m

.16
= {( 1+
12 )
12
-1} X 100

= ( 1 .1722-1 ) X 100
= 17.22%

c) Mr.Aslamhas taken a car loan amounting tk. 20,00,000 from National Bank Ltd.at an annual
interest rate of 18%. Amortize the loan if semi-annual payments are made for 4 years. Show the
amortization schedule.

We know that,
1

{ }
1−
r
PVA =
Pmt
( )
1+ mn
m
r
m
1

{ }
1−
.18
20,00,000 =
Pmt
( 1+
2 )
2x 4

.18
2

1
20,00,000 =
Pmt {
1−
} (1+ 0.09 ) 8
0.09

1
20,00,000=
Pmt { }
1−
(1.09 ) 8
0.09

1
20,00,000=
Pmt
2
0.09{ }
1−

20,00,000= Pmt { 1−0.05

0.09 }
 20,00,00= Pmt { 0.05
0.09 }
2,00,000=Pmt x 5.56
20,00,000
Pmt= = 3,59,713
5.56
Loan Amortization Schedule:
1 2 3 4=2 X i/2(.09) 5= 3-4 6= 2-5
Year B. Loan Installment Interest Repayment of Remaining
Principal Balance
0 20,00,000
1 20,00,000 3,59,713 1,80,000 1,79,713 18,20,287
2 17,05,035 3,59,713 1,53,453 2,06,260 14,98,775
3 14,98,775 3,59,713 1,34,890 2,24,823 12,73,952
4 12,73,952 3,59,713 1,14,656 2,45,057 10,28,895
5 10,28,845 3,59,713 92,600 2,67,113 7,61,782
6 76,17,82 3,59,713 68,560 2,91,153 4,70,629
7 4,70,629 3,59,713 42,357 3,17,356 1,53,273
8 1,53,273 3,59,713 13,795 -3,45,918 -

2. Discuss the importance of working capital management for a typical manufacturing firm.
Distinguish between permanent and temporary working capital. Graphically explain the
conservative, aggressive and maturity matching approaches to finance working capital of a firm.

Working capital is the heart of manufacturing organizations in modern business. Proper

management of working capital plays a vital role in the profitability and the success of the
organizations. The main elements of working capital are the average collection period,inventory
conversion period, average payment period, and cash conversion cycle. The average collection
period indicates the fromtrade receivables, which helps the firm to re-invest available funds. The
inventory conversion period suggests the conversion of inventory into cash. The average payment
period indicates the payment for trade creditors. And finally, the cash conversion cycle shows the
combination of cash collection and payment of the firm. All these elements individually and
collectively affect the profitability of the company. Excessive working capital is the cause of the
huge cost of capital. On the other hand, deficiency inworking capital is the reason for the
financial crisis.

Difference between Permanent and Temporary Working Capital-

 Permanent working capital refers to a level of current assets which is to be maintained

and vital for the firm to carry its business regardless of the operation levels. While
Temporary working capital refers to the working capital which is over and above the
 permanent working capital. It is required to meet seasonal needs and temporary
requirements.
 Permanent working capital is also known as fixed or hardcore working capital.
Temporary working capital is also known as fluctuating or variable or seasonal working
capital.
 Permanent capital does not depend upon any factors while temporary working capital
depends upon several factors as it is keep on fluctuating from period to period.
 Permanent working capital is stable while temporary working capital is fluctuating i.e.,
sometimes increasing and sometimes decreasing.

There are three strategies or approaches or methods of working capital financing – Maturity
Matching (Hedging), Conservative and Aggressive. Hedging approach is an ideal method of
financing with moderate risk and profitability. Other two are extreme strategies. Conservative
approach is highly conservative with very low risk and therefore low profitability. An aggressive
approach is highly aggressive having high risk and high profitability.

Graph

3. Describe the sources of long term financing. a. Discussbriefly the framework for financial
analysis. Discuss the characteristics of short term loans. What is cost of trade credit? Explain with
the terms of sale “2 /10, net 40”

Long-term financing sources can be in the form of any of them:

 Share Capital or Equity Shares.
 Preference Capital or Preference Shares.
 Retained Earnings or Internal Accruals.
 Debenture / Bonds.
 Term Loans from Financial Institutes, Government, and Commercial Banks.
 Venture Funding.
 Asset Securitization.

Framework of Financial Analysis

The financial statement analysis framework is a generic term used to describe the process by
which analysts take steps to assess financial statements, supplemental information and other
sources of information in order to draw conclusions and make informed recommendations such as
whether or not to invest in a company.

Short-Term Loan
 Access to Quick Cash. Unlike long-term loans that require a lengthy application and
approval process before funds are transferred, short-term loans are often completed
within short time.
 No Collateral. Improved Credit Score.
 Quick Application Process.
  Wide Range of Uses.
 Money Can Be Deposited Directly to Your Account.

Cost of Trade Credit is called Cost of Not Taking the Discount. For Example: Let's say that
your company is offered terms of trade of 2/10, net 30. This means that the supplier will offer you
a 2 percent discount if you pay your bill in 10 days.

Explanation: Terms 2/10, n/40 means there is a discount of 2% is available on payment of due

amount within discount period of 10 days after sale with net credit period of 40 days. As
$2,190,000 of Gross sales payments are made within discount period, discount will be availed on
this value.

3. a) Discuss the impact of the level of current assets on liquidity, profitability and risk.

Impact on Liquidity
Greater current asset levels generate more liquidity all other factors held constant

Impact on Expected Profitability

As current asset levels decline, total assets will decline and the ROI will rise.
Return on Investment =Net Profit/Total Assets
Let Current Assets = (Cash + Rec. + Inv.)
Return on Investment = Net Profit/Current + Fixed Assets

Impact on Risk
Decreasing cash reduces the firm’s ability to meet its financial obligations.-More risk!
Stricter credit policies reduce receivables and possibly lose sales and customers.-More risk!
Lower inventory levels increase stockouts and lost sales.-More risk!

b) Following is the cost statement of Good-luck Corporation:

Raw materials cost tk. 6,00,000 .00, Direct labor cost tk.2,00,000.00
Overheads cost 2,00,000.00, Profit 2,00,000.00 and Selling PriceTk.12,00,000.00

The following additional information is also available

a. Expectedcash balance is: Tk. 3,00,000.00
b. Raw material conversion period: 20 days
c. Work in process conversion period: 20 days
d. Average age of Stock of Finished goods: 25 days
e. Credit allowed to debtors: 2 months
f. Credit allowed by Creditors: 1 month
g. Time Lag in payment of wages: 15 days
 I. Time lag in Payment of Overhead: 30 days

You are required to prepare statement showing the working capital requirement of Good-
Luck Corporation if the company has a policy of Selling 30% in cash and 70%on credit.

Following is the cost statement of Good-luck Corporation:

Raw materials cost Tk. 6,00,000 .00

Direct labor cost Tk. 2,00,000.00
Overheads cost Tk. 2,00,000.00
Total manufacturing cost= (Raw materials cost +Direct labor cost+Overheads cost)
Total manufacturing cost= (6,00,000 .00+2,00,000.00 +2,00,000.00 ) Tk. 10,00,000.00
Selling Price Tk.12,00,000.00
Profit Tk.2,00,000.00

First we should calculate the investment in all current assets:

A. Investment in Inventory:

(1) Inventory in Raw material:

Consumption of Raw material x R.M. Conversion Period

= Tk. 33,333.00
360 days

Tk. 6,00,000.00 X 20 days

=
360 days

(2) Inventory in work in progress:

Cost of Production x W.I P. Conversion Period

= Tk.41,666.66
360 days

Tk. 10,00,000.00 x 15 days

360 days

(3) Finished Goods Inventory:

Cost of Sales
= X Finished goods conversion period
360 days

Tk. 10,00,000.00
= X 25 days
 360 days Tk. 69,444.44

Total Investment in Inventory: Tk. 1,44,444.10

B. Investment in Debtors:

Credit Sales (at cost)

= X Credit Period allowed to debtors
360 days

Tk. 10,00,000.00 x 0.70

= X 60 days
360 days Tk. 1,16,667

C. Cash Balance: Tk. 3,00,000

D. Total Current Assets (A+B+C) : Tk. 5,61,111.10

E. Current Liabilities
1. Creditors:
Purchase of Raw Materials X Raw Mat.cost per unie
= X Credit Period allowed
360 days

Tk. 6,00,000.00
= X 30 days
360 days Tk. 50,000.00

2. Deferred Wages
Purchase of Raw Materials X Labour cost per unie
= X Time lag in wages
360 days

Tk. 2,00,000.00
= X 15 days
360 days Tk. 8,333

3. Deferred Overhead Expenses

Units of Raw Materials X Overhead cost per unit

= X Time lag in overhead
360 days

Tk. 2,00,000.00
= X 30 days
360 days Tk. 16,6667
F. Total Current Liabilities: (1+2+3) tk. 75,000.00

G. Net Working Capital (D-F) tk.4,86,111.00