1 Assume you are the financial officer of a major firm. The president of the fir
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1 Assume you are the financial officer of a major firm. The president of the firm has just stated that she wishes to reduce the firm's investment in current assets since those assets provide little, if any, return to the firm. How would you respond to this statement? 2 The managers of a firm wish to expand the firm's operations and are trying to determine the amount of debt financing the firm should obtain versus the amount of equity financing that should be raised. The managers have asked you to explain the effects that both of these forms of financing would have on the cash flows of the firm. Write a short response to this request 3 You are considering two lottery payment options: Option A pays $20,000 today and Option B pays $40,000 at the end of ten years. Assume you can earn 5 percent on your savings. Which option will you choose if you base your decision on present values? Which option will you choose if you base your decision on future values? Explain why your answers are either the same or different. 4 Suppose you have a 1-year old son and you want to provide $75,000 in 17 years towards his college education. You currently have $5,000 to invest. What interest rate must you earn to have the $75,000 when you need it? 5 Suppose you win the Publishers Clearinghouse $10 million sweepstakes. The money is paid in equal annual installments of $333,333.33 over 30 years. If the appropriate discount rate is 5%, how much is the sweepstakes actually worth today? 6 Suppose you want to buy a new house. You currently have $15,000, and you figure you need to have a 10% down payment plus an additional 5% of the loan amount for closing costs. Assume the type of house you want will cost about $150,000 and you can earn 7.5% per year, how long will it be before you have enough money for the down payment and closing costs? 7 Uptown Men's Wear has accounts payable of $2,214, inventory of $7,950, cash of $1,263 fixed assets of $8,400, accounts receivable of $3,907, and long-term debt of $4,200. What is the value of the net working capital to total assets ratio? 8 A firm has total assets of $311,770 and net fixed assets of $167,532. The average daily operating costs are $2,980. What is the value of the interval measure? 9 A firm has a debt-equity ratio of 0.42. What is the total debt ratio? 10 A firm has total debt of $4,620 and a debt-equity ratio of 0.57. What is the value of the total assets?Explanation / Answer
1. I would suggest her to hold the current assets. Since short term assets will be used to meet any unexpected short-term obligations, daily operations of the company, for regular payments etc.,,
2. If a company raises finance through debt it will get tax benefit over the interest payments (Tax Shield) and the lender don't have any rights in the company. If a company uses the equity as the source of finance it ha to share the profits of the company to shareholders. Equit holders eventually owners of the comapny.
Debt is chaper than equity, since debt has tax shield.
3. Option A: $20,000 today
Option B: $40,000 after 10 years
Savings Rate or Interest Rate = 5%
Option A future value after 10 years FV = PV (1+r)^n
= 20,000 (1+0.05)^10
= 32,578
Option A after 10 years 32,578 and Option B after years 40,000
Option B is better in terms of future value
Present value of Option B, PV = FV / (1+r)^n
= 40000 / (1+0.05)^10
= 24,557
Option A in present terms 20,000 and option B is 24,557
Option B is better in present terms as well.
4. Interest Rate i = [(FV/PV)^(1/n)] -1
i = [(75000/5000)^(1/17)]-1
= 17.27%
5. Present Value of an Annuity = Payment [{1-(1+r)^-n}/r]
= 333333.33 [{1-(1+0.05)^-30}/0.05]
= 5,214,150
6. Interest Rate = 7.5%
Cash in Hand = 15,000
Amount needed for down payment and closing costs is 15% (10+5) of the house cost 150,000. i.e., 22,500
No.of years required to accumulate 22,500 with 15,000 cash in hand at 7.5% interest rate
n = ln(FV/PV)/ln(1+r)
= ln(22500/15000)/ln(1.075)
= 5.6 years i., 5 years 7 months approximately
7. Working Capital = Current Assets - Current Liabilities
Accounts Payable = 2214 (Current Liablity)
Inventory = 7950 (Current Asset)
Cash = 1263 (Current Asset)
Fixed Asset = 8400 (Fixed Asset)
Accounts Recievabls = 3907 (Current Asset)
Longterm Debt = 4200 (Longterm Debt)
Current Assets = 7950+1263+3907 = 13120
Total Assets = 13120 + 8400 = 21520
Current Liabilities = 2214
Working Capital = 13120 - 2214 = 19306
Working Capital to Total Assets = 19306/21520 = 89.72%
8. Interval Measure = Defensive Assets/ Average Daily Operating Costs
= (311770-167532)/2980
= 48 days
9. D/E = 0.42
Debt (D)+ Equity (E) = 1
E = 1-D
D/(1-D) = 0.42
D = 0.30 Approximatley
10. D/E = 0.57
4620/E = 0.57
E = 8105
Assets = Liabilities + Equity
Total Assets = 4620+8105 = 12725
Note: Since no other information given, I have assumed debt as total liabilities and equity as equity
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