FM Assignment Meeting 1

Meeting 1
Ch 1: 1-2, 1-5
1-2
What are the three principal forms of business organization? What are the advantages and disadvantages
of each?
Answer:
Proprietorship
Advantages:
a. Easily and inexpensively formed.
b. Subject to a few governments’ regulations.
c. Its income is not subject to corporate taxation but is taxed as part of the proprietor’s personal
income.
Disadvantages:
a. It may be difficult to obtain the capital needed for growth.
b. Has unlimited personal liability for the business’s debts.
c. The life of a proprietorship is limited to the life of its founder
A partnership
Advantages
a. Bridging the gap in expertise and knowledge
b. More cash
c. More businesses opportunities
Disadvantages
a. The liability of the partners for the debts of the business is unlimited. each partner is ‘jointly
and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of
the partnership debts as well as being liable for all the debts
Corporation
Advantages
a. Unlimited life
b. Easy transferability of ownership
c. Limited liability
Disadvantages
a. Double taxation
b. Time consuming and complex to create one
1-5
Describe the ways in which capital can be transferred from suppliers of capital to those who are
demanding capital.
Answer:

Direct transfers
Direct transfer of money and securities, occur when a business (or government) sells its securities to
savers, who in turn provide the firm with money in need. For example, a firm sells bonds or stocks to
investor directly
Indirect transfers through investment bankers
Capital is transferred through a third party like banks which underwrites (oversees or facilitates) the
transfer. For example, a firm sells its bonds and stock to bank which then sells the same to investors.
Because new securities are involved and the corporation receives the proceeds of the sale, this is a
“primary transaction”.
Indirect transfer through financial intermediaries.
The capital is not exactly transferred but simply exchanged with a newly created form of capital. Here
the intermediary obtains funds from savers in exchange for its own securities. The intermediary then
uses this money to purchase and then hold businesses’ securities. For example, a saver might give
dollars to a bank and receive a certificate of deposit, and then the bank might lend the money to a small
business, receiving in exchange a signed loan.

Ch 2: 2-14, 2-15
2-14
The Berndt Corporation expects to have sales of $12 million. Costs other than depreciation are expected
to be 75% of sales, and depreciation is expected to be $1.5 million. All sales revenues will be collected
in cash, and costs other than depreciation must be paid for during the year. The federal tax rate is 21%
(ignore any possible state corporate taxes). Berndt has no debt.
a. Set up an income statement. What is Berndt’s expected net income? Its expected net cash flow?
Answer:

Net cash flow = Net income + Depreciation

= 1.185 + 1.5
= $ 2.685 million
b. Suppose Congress changed the tax laws so that Berndt’s depreciation expenses doubled. No
changes in operations occurred. What would happen to reported profit and to net cash flow?
Answer:

If depreciation doubled to $3 million, Net income goes to zero and would be net cash flow
3million (NI + Dep = 0 + 3mil).
 c. Now suppose that Congress changed the tax laws such that, instead of doubling Berndt’s
depreciation, it was reduced by 50%. How would profit and net cash flow be affected?
Answer:

if depreciation reduced by 50% to $750,000, the NI would be $1,778,000 and net cash flow
would be $2,528,000. The firm would lose $157,000 ($2.685mil – $2.528mil) compared to the
original plan.
d. If this were your company, would you prefer Congress to cause your depreciation expense to
be doubled or halved? Why?
Answer:
I would prefer to have high depreciation, thus higher the cash flow. Because net cash flow is
cash that the company's owner can take out of the company, it can be used to help the company
improve its revenue and net income in the future.
2-15
Use the following income statement of Elliott Game Theory Consulting to determine its net operating
profit after taxes (NOPAT). Use 25% as the tax rate.

Answer:
NOPAT = EBIT (1 - Tax rate)
= $80,000 (1 – 0.25)
= $60,000

Meeting 2
Ch 3: 3-8, 3-11
3-8
Assume you are given the following relationships for the Haslam Corporation:
Sales/total assets 1.2
Return on assets (ROA) 4%
Return on equity (ROE) 7%
Calculate Haslam’s profit margin and liabilities-to-assets ratio. Suppose half its liabilities are in the
form of debt. Calculate the debt-to-assets ratio.
Answer:
ROA = profit margin * total assets turnover
Profit margin = ROA/ (sales/ total assets)
= 4%/ 1.2
= 3.33%

Liabilities-to-assets ratio = 1 – ROA/ROE

= 1 – 4/7
= 0.429 = 42.9%

Suppose half of Haslam’s liabilities are in the form of debt, the debt-to-ratio would be
Debt-to-ratio = Haslam’s liabilities-to-assets ratio /2
= 0.429 /2
= 0.214 = 21.4%

3-11
Complete the balance sheet and sales information in the table that follows for J. White Industries, using
the following financial data:
Total assets turnover: 1.5
Gross profit margin on sales: (Sales – Cost of goods sold)/Sales = 25%
Total liabilities-to-assets ratio: 40%
Quick ratio: 0.80
Days sales outstanding (based on 365-day year): 36.5 days
Inventory turnover ratio: 3.75
Partial income statement information
Sales 600,000
Cost of goods sold 450,000

Balance sheet information

Cash 28,000 Accounts payable 110,000
Accounts receivable 60,000 Long-term debt 50,000
Inventories 120,000 Common stock 140,000
Fixed assets 192,000 Retained earnings 100,000
Total assets 400,000 Total liabilities and equity 400,000
Answer:
Sales
Total assets turnover = sales/ total assets
Sales = 1.5/ 400,000
= 600,000
Cost of goods sold
Gross profit margin on sales = (Sales – Cost of goods sold)/Sales
COGS = 600,000 – (0.25 * 600,000)
= 450,000
Accounts receivables
DSO = receivables / (avg sales/day)
Receivables = 36.5 * (600,000/365)
= 60,000
Inventories
Inventory turnover ratio = COGS/ inventories
Inventories = 450,000/ 3.75
= 120,000
Accounts payable
Total liabilities-to-assets ratio = total liabilities/ total assets
Total liabilities = 0.4 * 400,000
= 160,000
Total liabilities = accounts payable – long-term debt
Accounts payable = 160,000 – 50,000
= 110,000
Common stock
Total assets = liabilities + equity
Equity = 400,000 – (110,000 + 50,000)
= 240,000
Total equity = common stock + retained earnings
Common stock = 240,000 – 100,000
= 140,000
Total liabilities and equity
Total liabilities and equity = accounts payable + long-term debt + common stock + retained
earnings
= 110,000 + 50,000 + 140,000 + 100,000
= 400,000
Cash
Quick ratio = (current assets – inventories) / current liabilities
Current assets = (0.8*110,000) + 120,000
= 208,000
Current assets = cash + accounts receivable + inventories
Cash = 208,000 – 60,000 – 120,000
= 28,000
Fixed assets
Total assets = cash + accounts receivable + inventories + fixed assets
Fixed assets = 400,000 – 28,000 + 60,000 + 120,000)
= 192,000

Ch 4: 4-24, 4,31
4-24
To complete your last year in business school and then go through law school, you will need $10,000
per year for 4 years, starting next year (that is, you will need to withdraw the first $10,000 one year
from today). Your uncle offers to put you through school, and he will deposit in a bank paying 7%
interest a sum of money that is sufficient to provide the four payments of $10,000 each. His deposit will
be made today.
a. How large must the deposit be?
Answer:
PMT = $10,000
N =4
I/YR = 7%
The deposit would be $33,872.11

b. How much will be in the account immediately after you make the first withdrawal? After the
last withdrawal?
Answer:
Deposit ($33,872.11) =PV(B3,B2,B4,0,0)
Years 4
Rate 7%
PMT 10000
Year Opening Balance Interest earned Withdrawal Closing Balance
1 33,872.11 2,371.05 10,000.00 26,243.16
2 26,243.16 1,837.02 10,000.00 18,080.18
3 18,080.18 1,265.61 10,000.00 9,345.79
4 9,345.79 654.21 10,000.00 0.00
The amount remaining after first withdrawal is $ 26,243.16 and the amount after the last withdrawal is
$0
4-31
It is now January 1. You plan to make a total of 5 deposits of $100 each, one every 6 months, with the
first payment being made today. The bank pays a nominal interest rate of 12% but uses semiannual
compounding. You plan to leave the money in the bank for 10 years.
a. How much will be in your account after 10 years?
Answer:
PMT = $100
INOM = 12
IPER = 12/2 = 6
*Annuities due
6% 6% 6% 6% … 6%
Periods 0 1 2 3 4 5 6 … 20
Deposits $0 100 100 100 100 100 0 0 0

Time 0-5
PV 0
I/YR 6
PMT 100
N 5
FV $597.53 =FV(B9%,B11,-B10,B8,1)

Time 6-20
PV $597.53
PMT 0
I 6
N 15
FV $1,432.02 =FV(B17%,B18,B16,-B15,1)
The amount of money on my account after 10 years is $1,432.02

b. You must make a payment of $1,432.02 in 10 years. To get the money for this payment, you
will make five equal deposits, beginning today and for the following 4 quarters, in a bank that
pays a nominal interest rate of 12% with quarterly compounding. How large must each of the
five payments be?
Answer:

IPER 3% 3% 3% 3% 3%
Period 1 2 3 4 5 6 7 … 39 40
PMT PMT PMT PMT PMT … FV = $1432.02

The timeline depicting the problem is shown above. Because the payments only occur for 5
periods throughout 40 quarters (10years * 4), the problem can be solved in two steps:

1. Discount the $1,432.02 back to period 5 to obtain PV of that FV at period 5

IPER 3% 3% 3% 3% 3%
Period 1 2 3 4 5 6 7 … 39 40
($508.92) … $1,432.02

Using excel or accounting calculator,

N = 35
IPER = 3%
 PMT = 0
FV = 1432.02
The PV would be $ 508.92

2. Then solve for PMT using the PV as the FV of the 5th period annuity due

IPER 3% 3% 3% 3% 3%
Period 1 2 3 4 5 6 7 … 39 40
PMT PMT PMT PMT FV1-5 / PV5-40 FV
$93.06 ($508.92) … $1,432.02

N =5
I = 3%
PV =0
FV = 508.92

And the PMT would be $ 93.06