Question: 1

ANALTOLY CORPORATION
Sales $ 4,500,000
COGS $ 2,000,000
Gross Profit $ 2,500,000
Operating Expenses $ 1,200,000
Interest Expense $ 150,000
Depreciation Expense $ 50,000
Net Income $ 1,100,000
   
Dividend Income $ 60,000
Securities Profit $ 80,000
Total Taxable Income $ 1,240,000
   
Applicable Tax rate 34%
Total Tax Liability $ 421,600
   

Question: 2

1. Nominal Interest Rate = Real Rate Interest + Rate of Inflation

= 0.04 + 0.07
= 0.11 or 11%
2.
Stock A
Probability (Px) Return (x)

0.3 11%

0.4 15%

0.3 19%

Mean Return:
x(Px)

3.30%

6.00%
 5.70%

Mean Return ( μx ) =∑(xi)P(xi)= 15.00%

Standard Deviation:
(x-u)2*px

0.0004800

0.0000000

0.0004800

Standard Deviation ( σx ) =∑(xi−μx)^2P(xi)= 3.0984%

Stock B

Probability (Px) Return (x)

0.2 11%
0.3 6%
0.3 14%
0.2 22%

Mean Return:
x(Px)
2.20%
1.80%
4.20%
4.40%

Mean Return ( μx ) =∑(xi)P(xi)= 12.600%

Standard Deviation:
(x-u)2*px
0.0000512
0.0013068
0.0000588
 0.0017672

Standard Deviation ( σx ) =∑(xi−μx)^2P(xi)= 5.6427%

In order to measure the deviation from the mean or expected value, Standard Deviation is
used. The risk in the making an investment is higher when standard deviation is higher and
vice versa. By considering above calculations, the option A seems better than option B,
because it has lower risk and its return is higher.

3. Valuation of Common Stock =

D 0 = $3.50
g = 5%
I = 20%
Since
Common Stock Valuation = P0 =D 0 (1 + g)/(i - g)
Therefore, putting values in the formula i.e.

P0 = 3.50 (1+0.05)/ (0.20-0.05)

= $24.5

4. Preferred Stock Valuation

Total Preferred Stock = (Par Value per Share × Annual Dividend Rate)

= (0.14 * 100 )

= $ 14

Value of preferred Stock = Total Preferred Stock / Rate of Return

= $14/0.0.12

= $116.67

5. Cost of Trade Credit

i. 2/10, net 30

Formula :-
 Cost of Trade Credit = Discount Percentage ÷ (1-Discount %) x [360/(Full allowed
payment days - Discount days)

= 2% ÷ (1 – 0.02 ) x 360/(30-10)
= 36.73

ii. 3/15, net 30

Formula :-

Cost of Trade Credit = Discount Percentage ÷ (1-Discount %) x [360/(Full allowed

payment days - Discount days)

= 3% ÷ (1 – 0.03 ) x 360/(30-15)

= 74.22

7. Economic Order Quantity

Economic Order Quantity Formula = SQRT (2 * Ordering cost * demand units/carrying cost)
Putting values in formula gives results as under:

= SquareRoot ( 2 * 800 *60000/24)

= (4,000,000) ^ (1/2)
= 2000 units
b) Average Inventory
Average inventory formula = Cycle Inventory +Safety Stock = Q/2 +Is
Putting values in formula gives results as under:

= Q ÷2 + Safety Stock
= 2000 ÷ 2+3000
= 4,000 units
8. Weighted Average Cost of Capital:

Source Cost

Debt 5%

Preferred Stock 8%

Common Stock 14%

 Capital Structure Weights Weights * Costs

20% 1.00%

20% 1.60%

60% 8.40%

Weighted Average Cost of Capital = 11%

Question: 3
Payback Period:
Payback Period = Base Year + (Initial Investment - Cumulative of Base Year) / Cash Inflow
of Next Year
For Project X:

Year (cash flows in millions)

Annual Cumulative
Cash Flow Cash Flow
(CF)
0 (200,000) -
1 110,000 110,000

2 65,000 175,000
3 100,000 275,000
4 115,000 390,000
5 35,000 425,000

Putting Values in Formula:

Payback Period = 2 + (200,000-175,000)/100,000
= 2.25
For Project Y:
 Year (cash flows in millions)
Annual Cumulative
Cash Flow Cash Flow
0 (200,000) -
1 75,000 75,000

2 150,000 225,000
3 60,000 285,000
4 55,000 340,000
5 60,000 400,000

Putting Values in Formula:

Payback Period = 1 + (200,000 – 75,000)/150000

= 1.833

Accounting Rate of Return:

Formula :

Average Total Profit

Accounting Rate of Return = ————————— x100
Average Total Investment
Project X:

Average Profit = The inflow – The outflow 

= $ 425,000 – $200,000
=$ 225,000
Average Investment = $200,000
Putting values in formula :
Accounting Rate of Return = 225,000 ÷ 200,000
= 1.125
Project Y:

Average Profit = The inflow – The outflow 

= $ 400,000 – $200,000
=$ 200,000
Average Investment = $200,000
Accounting Rate of Return = 200,000 ÷ 200,000
=1
NPV:

Net Present Value

Project X:
  Project X CF/(1+i)^n
Year 1 110,000 100,000
Year 2 65,000 53,719
Year 3 100,000 75,131
Year 4 115,000 78,547
Year 5 35,000 21,732

NPV = ∑(CFn / (1 + i)n) – ICO

= $329,129 – $200,000

= $129,129

PROJECT Y :

  Project Y CF/(1+i)^n
Year 1 75,000 68,182
Year 2 150,000 123,967
Year 3 60,000 45,079
Year 4 55,000 37,566
Year 5 60,000 37,255
NPV = ∑(CFn / (1 + i)n) – ICO
 = $312,049– $200,000

= $112,049

PROFITABILITY INDEX:
Formula :
PI = 1 + (NPV/ICO)
Project X:

Profitability Index = 1 + (129,129/200,000)

= 1.645
Project Y:

Profitability Index = 1+ (112,049/200000)

= 1.56

b) Based on Capital Budgeting measures i.e. NPV, PI, Payback Period & ARR, project X is
recommended to undertake.

Question: 4
a) Degree of Operating Leverage

Formula:
Degree of Operating Leverage = Contribution Margin / Operating Income
Putting Values in formula after breaking down further :

= Sales – Variable Cost / Sales – Variable Cost – Fixed Cost

= $50,439,375 - $25,137,000 /$50,439,375 - $25,137,000-$10,143,000

= 1.669

b) Degree of Financial Leverage

 Formula:

Degree of Financial Leverage = EBIT / EBIT-Interest

Putting Values in formula:

= $15,159,375 / $15,159,375-$1,488,375

= 1.1088

c) Degree of Combined Leverage

Formula :

Degree of Combined Leverage = DOL x DOF

Putting Values in formula:

= 1.669 x 1.1088

= 1.8508

d) Break even Point (Dollars)

Formula

= Total Fixed Cost .

Contribution Margin to Sales Ratio

Putting Values in formula:

= $10,143,000
0.502

= $ 20,205,179

e)

Hugo Boss Corporation 30% Increase in

sales
Sales 50,439,375 65,571,188
Variable Cost 25,137,000 32,678,100
Contribution 25,302,375 32,893,088
 Margin
Fixed Cost 10,143,000 10,143,000
EBIT 15,159,375 22,750,088
Interest Expense 1,488,375 1,488,375
EBT 13,671,000 21,261,713
Tax 6,835,500 10,630,856
Net Income 6,835,500 10,630,856

Percentage change in EBT = P1 - P0/P0 x 100

= 0.56 OR 55.52%

Percentage change in Net Income = P1 - P0/P0 x 100

= 0.56 OR 55.52%

Question: 5
Current Ratio
= Current Assets / Current Liabilities
= 156,300/ 73,000
= 2.141
Interpretation:
Current Ratio more than one means that the company has sufficient assets to pay
back short term or current debts. The current ratio in the aforementioned case is more
when we compare it with the industry average. Which means that the company perform
better than the industry which is a good and positive indicator about the organization.

Acid Test Ratio or Quick Ratio

= Current Assets – Inventory / Current Liabilities
= 156,300 – 93,000 / 73,000
= 0.868
Interpretation:
The acid test ratio is also known as a quick ratio. It tells us about the capability of
a company that how the company uses their short-term assets in order to cover their short
term & immediate obligations. If a company’s ratio is less than 1, this means that the
company is not being able to fully pay back its current obligations. However, the result of
the ratio not more not less than the industry average. This means it matches with the
competitors.

Debt Ratio
 = Total Debt / Total Assets
= 223,000 / 446,300
= 0.50 OR 50%
Interpretation:
Debt ratio can be understood as the portion of assets of the company are financed
by debt. Ratio which is less than 100% shows that the company has much more number of assets
to pay back its obligations debt. Industry ratio is not greater than the company ratio result that
means that the company is also matching with the competitors and performing in consistency
with the norms of the operating industry.

Long Term Debt to Total Capitalization Ratio:

Formula:
= Long Term Debt / Total Available Capital
= 150,000 / 373,300
= 0.40

Interpretation:
Long Term Debt to Total Capitalization Ratio is measured by dividing long-term
debt with the total available capital i.e. (long-term debt, preferred stock, & common stock).
Investors do comparison of the financial levered firms to assess and to analyze the related
investment risk. Greater figure of ratios show riskier investments, as debt is the main source of
raising financing and leads to larger amount of risk of bankruptcy. Company’s ratio is fewer than
the industry competitors which shows that the investment is significantly safe in aforementioned
organization.

Times Interest Earned Ratio:

= EBITDA / Interest Expense
= 120,000 + 30,000 / 10,000
= 15
Interpretation:
The ratio is a measure of a company's capability to meet its payables and debt
obligations by relying on its income. The result shows that how the company is going to be
able to payback its interest expense from the earning before tax. If the result of this ratio is a
large number as compared to the industry this will show that the financial position of a company
is good and sound because of the reason that the company is able to cover its interest expense
through its operations before tax.

Average Collection Period:

= Accounts Receivable / Daily Credit Sales
 = 38,000 / (700,000/365)
= 20 days
Interpretation:
Companies can calculate its average collection period to ensure that they have
sufficient cash flow to encounter their financial liabilities. When we do the comparison of
company with that of industry, the company uses almost same number of days to changes its
receivables into cash and cash equivalents as compared to the competitors in the industry.

Inventory Turnover
= COGS / Inventory
= 500,000 / 38,000
= 13.15
Interpretation:
Inventory turnover ratio calculates how well a company can be able to sale its
inventory. A greater turnover ratio shows that the company has good number of sales. The
company has considerably greater turnover ratio as compared to industry which shows
substantial demand for its products.

Return on Total Assets:

= Net Income / Total Assets
= 27,100 / 446,300
= 6.07
Interpretation:
Return on assets is a profitability ratio that delivers how much profit a company is
capable to make from its assets. Return on assets (ROA) calculates that how well-organized
a company's management is in making earnings from their resources. But industry is outdoing
the company in this manner showing that the company has weak use of its assets.

Gross Profit Margin Ratio:

= Net Sales – COGS / Net Sales
= 700,000 – 500,000 / 700,000
= 28.5%
Interpretation:
Gross profit margin is used to measure a company's financial well-being by
calculating the amount of sales after subtracting the cost associated with the production of goods
(COGS). The company’s ratio is upper than the industry which shows that the company has a
strong financial health.

Operating Income Return on Investment:

 = EBITDA / Operating Assets
= 120,000 + 30,000 / 446,300
= 33.6%
Interpretation:
This ratio measures that how a company's core operations are performing. That
can be treasured when the investors are trying to assess a company's real earnings. However,
company has much greater ratio than the industry competitors showing the strong financial
fitness of the company.

Operating Profit Margin:

= Operating Income / Sales
= 120,000 / 700,000
= 0.1714 OR 17.142%
Interpretation:
Operating Profit Margin replicates that how much amount or the percentage of
profit an organization makes from its processes before subtracting the amount of tax and
interest. The company has greater profit margin ratio as matched to industry showing the
company is performing well.

Total Asset Turnover

= Sales / Total Assets
= 700,000 / 446,300
= 1.568
Interpretation:
Total asset turnover ratio indicates that what is the level of efficiency with which
a company utilizes its assets to produce and generates its sales. The company’s ratio is greater
than the industry showing that the company is using its assets more capably than competitors of
industry.

Fixed Asset Turnover:

= Sales / Fixed Assets

= 700,000 / 290,000
= 2.413

Interpretation:
The fixed asset turnover ratio is measures how healthy a company can perform by using
its fixed total assets to produce sales. The ratio of the company is greater than the competitors in
the industry which shows that the company is using its fixed assets more competently than other
firms at the same level of industry.