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SUGGESTED SOLUTION COMMON TEST 1

MAF253 FEB 2014

PART A

1. C  2. A  3. B  4. D  5. B 
6. A  7. C  8. B  9. A  10. C 
(10 x 1 = 10 marks)
PART B

QUESTION 1

a. The four principal functions of the financial manager are

1. Forecasting and planning 

2. Making investment and financing decisions 
3. Coordination and control 
4. Dealing with financial markets 
(4 x 1 = 4 marks)

b. Debt financing is borrowed funds that a firm issues through either loans or debt
securities such as bond. 

Equity financing is where funds are obtained in exchange for ownership in the firm
such as by retaining earnings or issuing stocks. 
(2 x 1 = 2 marks)

c. The two basic types of financial markets are money markets and capital markets.

1. Money markets 
Deals with short term securities that have a life of one year or less such as
commercial paper or banker’s acceptances. 

2. Capital markets 
Deals with securities that have a life more than one year such as ordinary
shares or bonds. 
(4 x 1 = 4 marks)
(Total: 10 marks)

QUESTION 2

A
a. Cash conversion cycle

Inventory Average inventory 1,200,000  = 36 days

=
conversion period COGS/360 40% x 30,000,000 / 360

Average Collection
= 36 days x 2 = 72 days
period

CCC = 36 days + 72 days – 40 days = 68 days 

(6 x ½ = 3 marks)
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b. Amount of reduction in accounts receivable.

= Ave. Inv. 1million 

New ICP =
COGS/360 12million/360 
= 30 days

= 30 days x 2 = 60 days
New ACP

New Ave. Receivable Old Ave. Receivable

= 60 x 30 million = 5 million = 72 x 30 million  = 6 million

360 360

Reduction in accounts receivable = 6 million – 5 million 

= 1 million

Working:

Old CCC = 72 days + 36 days – 40 days = 68 days

New CCC = 60 days + 30 days – 40 days = 50 days
Number of days reduced 18 days

(10 x ½ = 5 marks)
(Total: 8 marks)

RM^
Marketable securities
B.a.

STF = 400,000
TA = 1m

PCA = 1m
LTF =4,000,000

PA = 2.4m

Period ^

Conservative approach.
(8 x ½ = 4 marks)

b.
All non-current asset, permenant current assets and half of the temporary assets are
financed by long term financing. The remaining temporary assets is financed using
short term financing. The company will have excess of cash and invested in the
marketable securities.

The risk is lower due to higher liquidity,  but the return will be lower due to
incurrence of higher interest expense. 
(6 x 1 = 6 marks)
(Total: 10 marks)
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QUESTION 3

a. Effective cost of not taking discount

EAR = 0.02 X 360 = 9.18% 

(1 – 0.02) (90 – 10)

(8 x ½ = 4 marks)
b. i. Amount borrowed:

650,000 = B – Interest - CB
650,000 = B (1 – (0.09 x 80/360) – 0.15)
B = 650,000/0.83 = 783,133

ii. Effective annual interest rate:

Interest = 9% x 783,133 X 80/360 = 15,663

EAR = 15,663  X 360/80 = 10.84%

650,000
(12 x ½ = 6 marks)

c. No, the line of credit alternative would not reduce the company’s cost of doing
business.  Given the assumptions that the company’s credit rating or supply
sources would not suffer due to late payment, the cost of trade credit and forgoing the
cash discount is lower than the 10.84% effective cost of the line of credit
arrangement that would be used to take advantage of the 2% discount. 

(4 x ½ = 2 marks)
(Total: 12 marks)