Assignment No 1 - POF

Topics: Financial Statement Analysis & Time Value of Money

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Name: Ayesha Maroof

Reg No: 47887

Q No 1: The Balance Sheet of LZC Ltd at the end of the year as under:-

EQUITIES AMOUNTS ASSETS AMOUNTS

Equity Share Capital(Rs.100 par) Rs.1,000,000 Plant & Equipment Rs.640,000

Retained Earnings 368,000 Land & Building 80,000

Sundry Creditors 104,000 Cash/Bank 260,000

Bills P/A 200,000 Marketable Securities 150,000

Other Current Liabilities 20,000 Notes Receivable 200,000

Long Term Loans 200,000 Sundry Debtors 440,000

(40,000)
Bonds P/A 300,000 Less:-Allow for B/D

80,000 Account Receivable 400,000

Inventory 530,000

Prepaid Insurance 12,000

2,272,000 TOTAL 22,72,000

Statement of Profit & Loss for the year ended:-

Sales (All on Credit) Rs.4,000,000

Less: Cost of Goods Sold (3,080,000)

Gross Profit 920,000

Less:- Operating Expenses (680,000)

Net Profit 240,000

Less 30% Income Tax (72,000)

Net Profit After Tax 168,000

Sundry Debtors, Sundry Creditors and Stock at the beginning of the year were Rs.300,000, 500,000 and
400,000 respectively. Credit Purchases during the year were Rs.3, 000,000.

REQUIRED: -a) use vertical analysis and interpret light Zone financial strength

b) Calculate and interpret the following ratios.

1) Debtors Turnover in Times ii) Average collection period/Debtors Turnover (in days)
(iii) Stock turn over in times V) Current Ratio vii) Quick Ratio

vii) Gross Profit Percentage viii) Net Profit Percentage ix) Return on Equity
xii) Total Assets Turnover x) Du Pont Ratio

Solution:

(a) vertical analysis is done by calculating each balance sheet item as percentage of total assets

The vertical analysis for the company is shown below

Paint and Equipment. 640,000. 28.17%

Land & Building. 80,000. 3.32%

Cash/Bank. 260,000. 11.44%

Marketable securities. 150,000. 6.60%

Notes receivable. 200,000. 8.80%

Account receivable. 400,000 17.61%

Inventory. 530,000. 23.33%

Prepaid insurance. 12,000. 0.53%

Total. 2,272,000. 100%

Equity share capital. 1,000,000. 44.1%

Retained earnings. 368,000. 16.20%

Sundry creditors. 104,000. 4.58%

Bills P/A. 200,000. 8.80%

Other current liabilities. 20,000. 0.88%

Long term loans. 200,000. 8.80%

BondsP/A. 300,000. 13.20%

Total. 2,272,000. 100.00%

From the vertical analysis, we draw the following conclusions:

1. The company's fixed asset constitute 28.17% +3.52% 31.69% of total assets and hence the current
assets of the company is 68.31% of total assets. The company's current liabilities constitute 4, 58%-
8.80%+0.88% 14.26% of total assets. Hence, we can conclude that the net working capital of the
company is very high and the company has higher proportion of cash balance than the proportion of
sundry creditors. This considerably reduces the liquidity risk of the company

2. The company's long term liability constitute 8.80 % -13.20%-3.52% 25.53% of total assets and this

Proportion of long-term liabilities is well covered by the proportion of fixed assets which stands at
31.69%

3. The proportion of total equity is 44.01% -16.20% 60 21% and is higher than the proportion of long-
term Hence the company has financial liabilities of 25.53% Hence the company has low financial
leverage.

4. Overall the company's financial position is strong with high proportion of net working capital and low
financial leverage the high net working capital can also indicate that the company is paying its supplier
much faster than the time taken to generate cash from sale of inventory

b) The ratios are calculated below:

1 Debtor turnover in times Credit sales/Average debtors

Credit sales = 4000000

Average debtors= (Beginning debtors Ending debtors)/2= (300000-4000001/2=350000

Therefore, debtor turnover in times 4000000/350000=1143

So in a year, the company collects its receivables from customers 11.43 times

2. Average collection period/Debtors Turnover (in days) = Number of days in 1 year/debtor turnover in
times

Assuming 1 year = 365 days, average collection period/Debtors Turnover (in days) = 366/1143-32 days
(rounded to nearest integer)

The company takes 32 days on average in a year to collect cash for its credit sales 3. Stock turnover in
times= Cost of goods sold/Average inventory

Cost of goods sold 3000000 Average inventory = (Beginning inventory-Ending Inventory)/2 = (400000-
530000)/2=465000

Therefore, stock turnover in times=3080000/465000 = 6.62

The company sells its inventory at an average rate of 6.62 times in a year

4 Current Ratio Total current assets/Total current abilities Total current assets=Cash-marketable
securities-Notes receivable-Accounts

Receivable-Inventory-prepaid Insurance 260000-150000-200000-400000-530000-12000=1552000 Total

current liabilities Sundry cerditors+Bilis P/A-Other current liabilities=104000+200000-20000 =

324000

Therefore, current ratio 1552000/324000 4.79

The current ratio indicates the liquidity position of the company. A current ratio of 479 times means that
the

Current assets of the company are more than 4 times its short term obligations

5. Quick ratio= (Cash-marketable securities-Notes receivable-Accounts receivable/Total current liabilities

= (260000-150000-200000-400000/324000=312

The quick ratio indicates the position of liquid assets of a company and a artio of 3.12 shows that its
short term obligations are completely covered by its liquid assets

6. Gross Profit Percentage Gross profit/Sales=920000/4000000 - 23.00%

This is a measure of the company's efficiency in generating gross profit from sales. A higher gross profit
percentage impels the company's efficiency in managing its cost is better.

7. Net Profit Percentage Net profit after tax/Sales=168000/4000000 = 4, 20% this is a measure of the
company's performance and efficiency in generating net profit from sales

8. Return on equity Net profit after tax/Total equity=168000/1000000-368000) = 12.28% this is a

measure of the company's profitability and indicates the company's management's performance A

Higher return on equity means the company is generating more profit from its equity Investment

9. Total Assets Turnover Sales/Total assets=4000000/2272000 1.76 this is a measure of the company's
efficiency and indicates the company's asset performance. A higher

Asset turner means the company is generating more sales from its assets 10. Du Pont Ratio Net Profit
Percentage Total Assets Turn over Equity multiplier
Net Profit Percentage and Total Assets Turnover are already calculated above Equity multiplier Total
assets/Total equity=2272000/000000-368000)-166

Therefore, Du Pont Ratio 420% 1.76 1.66 12.28%

Du Pont ratio segregates the return on equity into three components, which are net profit percentage,
total assets turnover and equity multiplier. As each of these components, improves the company's
profitability becomes better

Q No 2: Define each of the following terms:

a. Simple interest; compound interest
b. Compounding; discounting
c. Opportunity cost
d. Annuity; ordinary (deferred) annuity; annuity due; perpetuity

Answer:

(a). Simple interest is based on the principal amount of a loan or deposit. In

contrast, compound interest is based on the principal amount and the interest
that accumulates on it in every period.

(b). Compounding and Discounting are simply opposite to each other.

Compounding converts the present value into future value and discounting
converts the future value into present value. ... The factor is directly multiplied
by the amount to arrive the present or future value.

(c). Opportunity cost is the value of the next-best alternative when a decision is
made; it's what is given up,” explains Andrea Caceres-Santamaria, senior
economic education specialist at the St. Louis Fed, in a recent Page One
Economics: Money and Missed Opportunities

(d). an ordinary annuity is a series of regular payments made at the end of each period, such as
monthly or quarterly. In an annuity due, by contrast, payments are made at the beginning of each
period. Consistent quarterly stock dividends are one example of an ordinary annuity; monthly
rent is an example of an annuity due.

Q No 3: a). What is the present value of a security that will pay $5,000 in 20 years if securities
of equal risk pay 7% annually?
b). your parents will retire in 18 years. They currently have $250,000, and they think they will
need $1,000,000 at retirement. What annual interest rate must they earn to reach their goal,
assuming they don’t save any additional funds?
c). what’s the future value of a 7%, 5-year ordinary annuity that pays $300 each year? If this was
an annuity due, what would its future value be?

Answer: (a) Present value = Future value / (1+r) ^n

Present value = 5000/ (1+0.07)^20

Present value = 5000/3.869684

Present value = $1,292.10

(b)

Q No 4. a). An investment will pay $100 at the end of each of the next 3 years, $200 at the end
of Year 4, $300 at the end of Year 5, and $500 at the end of Year 6. If other investments of equal
risk earn 8% annually, what is its present value? Its future value?
b). you want to buy a car, and a local bank will lend you $20,000. The loan will be fully
amortized over 5 years (60 months), and the nominal interest rate will be 12% with interest paid
monthly. What will be the monthly loan payment? What will be the loan’s EAR?

Answer: (a) Here's the Present Value Calculation:

Year 1 $100/(1.0+.08) = $ 92.59

Year 2 $100/(1.0+.08)^2 = $ 85.73 Year 3 $100/(1.0+.08)^3 = $ 79.38

Year 4 $200/(1.0+.08)^4 = $147.01

Year 5 $300 / (1.0+.08)^5 = $204.17

Year 6 $500/(1.0+.08)^6= $315.08

Total PV = $923.98

Here's the Future Value calculation:

(Note: since the payment is at the end of each year, the payment for year 1 will compound for
only payment for year 2 will compound for 4 years, and so on)
Year 1 $100 X (1.0+.08)^5 = $146.93

Year 2 $100 X (1.0+08)^4 = $136.05

Year 3 $100 X (1.0.08)^3= $125.97

Year 4 $200 X (1.0+08)^2 = $233.28 Year 5 $300 X (1.0+.08)^1 = $324.00

Year 6 $500 X (1.0+.08)0 = $500.00

Total FV = $1,466.23

Q No 5. A). Find the future values of these ordinary annuities. Compounding occurs once a year.
a. $400 per year for 10 years at 10%
b. $200 per year for 5 years at 5%
c. Rework Parts a, and b assuming they are annuities due.
B). what is the present value of a $100 perpetuity if the interest rate is 7%? If interest rates
doubled to 14%, what would its present value be?

Answer: 14. The future value of an annuity is five by the following formula:
FVA=A [(1+-11/r

a $ 400 per year for 10 years at 10%

A = $400, n = 10, r= 10% or 0.10

FVA= S 400 [(110)¹0-11/0.10 = $ 400 x 15.9374 = $ 6,374.96

FVA due = Ordinary annuity value x (1+r)=$6,374.96 x 110 = $7,012 46

b. $ 200 per year for 5 years at 5%: FVAS 200 x 5.5256 = $1,105.12

FVA due = $1,105.12 x 1.05= $1,160.38

CS400 per year for 5 years at 0% FVA= $ 400 x 5= $2,000

FVA due = $2,000

15. The present value of an ordinary annuity is expressed as:

PVA = A[(1-(1/(1+)/r]
Present value of an annulty due = present value of an ordinary annulty x (1+r)

a. $ 400 per year for 10 years at 10% PVA = $400 x 6.1446 = $2,457.84

PVA of annuity due = $2,457,84 x 110 = $2,703.62

b. $ 200 per year for 5 years at 5%

PVA of ordinary annuity = $200 x 4.3295 = $ 865.90

PVA of annuity due = $ 865.90 x 1.05 = $909.20

c. $ 400 per year for 5 years at 0 %

PVA of ordinary annulty = $ 400 x 5 = $2,000

PVA of annuity due = $2,000 x1= $2,000

Q No 6 A). Find the present values of the following cash flow streams at 8% compounded
annually.

Q No 6. B) Your client is 40 years old; and she wants to begin saving for retirement, with the
first payment to come one year from now. She can save $5,000 per year; and you advise her to
invest it in the stock market, which you expect to provide
an average return of 9% in the future.
a. If she follows your advice, how much money will she have at 65?

b. She expects to live for 20 years if she retires at 65 and for 15 years if she retires at 70.
If her investments continue to earn the same rate, how much will she be able to withdraw at the
end of each year after retirement at each retirement age?

Answer: a) Calculating the future value of annuity using excel sheet:

Step1: Go to excel sheet and click "insert" to insert the function.

Step2: Select the "FV" function as we are finding the future value of annuity in this case.

Step3: Enter the values as Rate = 9%; Nper = 25; PMT = -5000 Step4: Click "OK" to get the
desired value.

The value comes to "$423,504"

b) Calculating the future value of annuity using excel sheet:

Step1: Go to excel sheet and click "insert" to insert the function. Step2: Select the "FV" function
as we are finding the future value of annuity in this case.

Step3: Enter the values as Rate = 9% ; Nper = 30; PMT= -5000 Step4: Click "OK" to get the
desired value.

The value comes to "$681,537"

c) To calculate the withdrawal amount, we need to find out the future value till her retirement.

As we calculated above, the future value is $423,504. This value becomes the present value for
the coming 20yrs.

Now, calculating the withdrawal amount at each retirement age:

Step1: Go to excel sheet and click "insert" to insert the function. Step2: Select the "PMT"
function as we are finding the Annuity withdrawal amount in this case.

Step3: Enter the values as Rate = 9%; Nper = 20; PV = -423504 Step4: Click "OK" to get the
desired value.
The value comes to "$46,393"

The amount that can be withdrawed at each retirement age is $46,393.