Wolaita Sodo University

School of Graduate Studies

MBA Program

Individual Assignment (Instruction: Do not copy from others!!)

1. Say for example, if one action would probably increase the firm’s stock price from a
current level of $20 to $25 in 6 months and then to $30 in 5 years but another action
would probably keep the stock at $20 for several years but then increase it to $40 in
5 years, which action would be better? Based on such an issue, should stockholder
wealth maximization be thought of as a long-term or a short-term goal? Can you
think of some specific corporate actions that might have these general tendencies?
Answer
Stockholder wealth maximization is a long-run goal. Stockholder wealth maximization
should be a long-term goal since it is assumed that shareholders invest in a company to
meet their long-term financial goal, may it be for a new house, retirement or education of
children. Companies, and consequently the stockholders, prosper by management making
decisions that will produce long-term earnings increases. Actions that are continually
shortsighted often "catch up" with a firm and, as a result, it may find itself unable to
compete effectively against its competitors. There has been much criticism in recent
years that U.S. firms are too short-run profit-oriented. A prime example is the U.S. auto
industry, which has been accused of continuing to build large "gas guzzler" automobiles
because they had higher profit margins rather than retooling for smaller, more fuel-
efficient models.
2. Complete the balance sheet and sales information in the table that follows for XYZ
Plc. using the following financial data:

Debt ratio: 50%; Quick ratio: 0.80X; Total assets turnover: 1.5X; Days sales
outstanding: 36.5 days (considering 365 days in a year); Gross profit margin on
sales: (Sales - Cost of goods sold)/Sales = 25%; Inventory turnover ratio: 5X

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 BALANCE SHEET
Cash ___________________ Accounts payable _____________
Accounts receivable ___________________ Long-term debt 60,000
Inventories ___________________ Common stock _____________
Fixed assets ___________________ Retained earnings 97,500
Total assets Birr 300,000 Total liabilities and equity _____________
Sales ___________________ Cost of goods sold _____________
Solution
Total Assets = Total Liabilities & Equity = 300,000
Sales = 300,000 x 1.5 = 450,000.
Sales = 100% CGS = 75% GPM = 25%
Cost of goods sold = 450,000 x .75 = 337,500
Accounts payable = ( x + 60,000) / 300,000 x 100 = 50%
X = ( 300,000 x .50 ) - 60,000 = 90,000.
Common Stock = 300,000 - 97,500 - 90,000 - 60,000 = 52,500.
Inventory = 337,500 / 5 = 67,500.
Account receivable turnover = 360 / 36.5 = 10
Accounts receivable = 450,000 / 10 = 45,000.
Total current assets except inventory = 90,000 x .8 = 139,500
Cash = 139,500 - 45,000 = 94,500.
Fixed Assets = 300,000 - 94,500 - 45,000 - 67,500 = 93,000.
Balance Sheet
Assets Birr Liabilities & Equity Birr
Cash 94,500 Accounts payable 90,000
Accounts receivable 45,000 Long-term debt 60,000
Inventory 67,500 Common stock 52,500
Fixed assets 93,000 Retained earnings 97,500
Total Assets 300,000 Total Liabilities & 300,000
Equity
Sales 450,000 Cost of Goods Sold 337,500

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3. By consider the following relationships calculate profit margin and debt ratio:
Sales/total assets 1.5X
Return on assets (ROA) 3%
Return on equity (ROE) 5%
Solution
We are given ROA = 3% and Sales/Total assets = 1.5x
From Du Pont equation: ROA = profit margin x total assets turnover
3% = profit margin x 1.5
profit margin = 3%/1.5 = 2%
We can also calculate the company’s debt ratio in a similar manner, given the facts of the
problem. We are given ROA (NI/A) and ROE (NI/E); if we use the reciprocal of ROE we
have the following equation:
E/A = NI/A x E/NI and D/A = 1 - E/A, so
E/A = 3% x 1/.05 = 60%
D/A = 1 - .60 = .40 = 40%
Alternatively,
ROE = ROA x EM
5% = 3% x EM
EM = 5%/3% = TA/E
Take the reciprocal:
E/TA = 3/5 = 60%
therefore, D/A = 1 - .60 = .40 = 40%
Thus, the firm’s profit margin = 2% and its debt ratio = 40%

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4. At the end of year 2014, total assets for Tagay Plc. were birr1.2 million and accounts
payable were Birr375, 000. Sales, which in 2014 were Birr2.5 million, are expected
to increase by 25 percent in 2015. Total assets and accounts payable are
proportional to sales, and that relationship will be maintained. Tagay Plc. typically
uses no current liabilities other than accounts payable. Common stock amounted to
Birr425, 000 in 2014, and retained earnings were Birr295, 000. Tagay plans to sell
new common stock in the amount of Birr75,000. The firm’s profit margin on sales is
6%; 60% of earnings will be retained.
a. What was Tagay’s total debt in 2014?
b. How much new, long-term debt financing will be needed in 2015?
Answer
(a) Total Assets=1,200,000
Common Stock=425,000
Retained Earnings= 295,000
Total Debt (2014)=480,000
(b)Total Assets=1,200,000
 Account Payable= 375,000
 Sales (2014)=2,500,000
 Expected Growth in Sales= 25%
 Increase in Sales= 625,000
 Expected Sales (2015)= 3,125,000
 Profit Margin on Sales= 6%
 Retention Ratio=60%
 Additional Financing Needed = (((Assets/Sales)*Change in Sales) -
((Accounts Payable/Sales)*Chang
 Additional Fund Needed (AFN)=93,750
 New Stock=75,000
 Long-term Debt Needed (2015)= 18,750 which is an additional Funds
Needed - New Stock

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 5. Getway Computers makes bulk purchases of small computers, stocks them in
conveniently located warehouses, and ships them to its chain of retail stores.
Tozer’s balance sheet as of December 31, 2001, is shown here (in millions of
dollars):

Cash $ 3.5 Accounts payable $ 9.0

Receivables 26.0 Notes payable 18.0
Inventories 58.0 Accruals 8.5
Total current assets $ 87.5 Total current liabilities $ 35.5
Net fixed assets 35.0 Mortgage loan 6.0
Total assets $122.5 Common stock 15.0
Retained earnings 66.0
Total liabilities and equity $122.5

Sales for 2001 were $350 million, while net income for the year was $10.5 million. Getway paid
dividends of $4.2 million to common stockholders. The firm is operating at full capacity.
Assume that all ratios remain constant.
A) If sales are projected to increase by $70 million, or 20 percent, during 2002, use the AFN
equation to determine Getway’s projected external capital requirements.
Answer
a. If sales are projected to increase by $70 million, or 20%, during 2002, use the
AFN equation to determine Upton’s projected external capital requirements.
The AFN for 2002 would be $13.44 million as shown below:
AFN = (122.5 / 350)(70) - (17.5 / 350) (70) - 420(0.03)(1 - 0.4)
= (0.35) (70) - (0.05) (70) - (12.6)(0.6)
= 24.5 - 3.5 - 7.56
= 13.44 million
The self-supporting growth rate would be 7.8% as shown below: 𝑔 = 0.03
(1 − 0.4)(350)122.5 − 35.5 − (0.03(1 − 0.4)(350)) = 6.387 − 6.3
= 6.380.7

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= 0.078 or 7.8%
B) Construct Getway’s pro forma balance sheet for December 31, 2002. Assume that all
external capital requirements are met by bank loans and are reflected in notes payable.

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C) Now calculate the following ratios, based on your projected December 31, 2002, balance
sheet. Getway’s 2001 ratios and industry average ratios are shown here for comparison:
TOZER COMPUTERS INDUSTRY AVERAGE
12/31/02 12/31/01 12/31/01
Current ratio _________ 2.5X 3X
Debt/total assets __________ 33.9% 30%
Rate of return on equity __________ 13.0% 12%
Suppose that in 2005 sales increase by 10 percent over 2004 sales and that 2005divide's will
increase to $112,000. Construct the prove forma financial statement using the percent of sales
method. Assume the firm operated at full capacity in 2004.Use an interest rate of 13 percent
on the dept plans at the beginning of the year. Assume divide's will grow 3 percent and that
the AFN will be in the form of notes payable

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 D) Now assume that Getway grows by the same $70 million but that the growth is spread
over 5 years—that is, that sales grow by $14 million each year.
i) Calculate total additional financial requirements over the 5-year period.
ii) Construct a pro forma balance sheet as of December 31, 2006, using notes payable as
the balancing item.
iii) Calculate the current ratio, total debt/total assets ratio, and rate of return on equity as
of December 31, 2006.
iv) Do the plans outlined in parts b and/or d seem feasible to you? That is, do you think
Getway could borrow the required capital, and would the company be raising the
odds on its bankruptcy to an excessive level in the event of some temporary
misfortune?
Explanation:
1) Additional Funds Needed or AFN can be calculated as below=

AFN = (Total Assets / Previous year sales) x Change in Sale -( Liabilities affected by
sales / Previous year sales) x Change in Sale - (Projected net income x Retention ratio )
-----
(a)According to given data in question
Total Assets= 122.5 million
Change in Sales = 70
Liabilities affected by sales = 17.5
Previous year sales = 375
Projected net income = 445
Putting the above values in equation (a)
AFN = (122.5 / 375) x 70 -( 17.5 / 375) x 70 - 445 x 0.030 x 0.60
AFN = 11.59 million

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3) Proforma Balance Sheet for Upton Computer is :

Cash 4.15 Million

Accounts Receivable 30.85 Million
Inventories 68.83 Million
Total Current Assets 103.84 Million
Net Fixed Assets 41.53 Million
Total Assets 145.37 Million
Line of Credit-AFN 11.59 Million
Accounts Payable 18 Million
Accruals 10.09 Million
Total Current Liabilities 50.36
Mortgage Loan 6 Million
Common Stock 15 Million
Retained Earning 74.01 Million
Total Current Liabilities & Equity --- 145.37 Million
3) Growth rate : Growth rate formula is given below,
Growth rate = (Total Assets x g) - (Liabilities affected by sales x g ) - Previous year sales
( 1 +g) x 0.3 x 0.60 = 6.87 %
Rr=8.86% as of December 31, 2006
4) Do the plans outlined in parts b and/or d seem feasible to you? That is, do you think Getway
could borrow the required capital, and would the company be raising the odds on its bankruptcy
to an excessive level in the event of some temporary misfortune?

The answer is definitely not

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 6. Given the following observations on the returns over time:
YEAR STOCK X STOCK Y MARKET
2011 14% 13% 12%
2012 19 7 10
2013 -16 -5 -12
2014 3 1 1
2015 20 11 15
Assume that the risk-free rate is 6% and the market risk premium is 5%.
a. What are the betas of Stocks X and Y?
b. What are the required rates of return for Stocks X and Y?
c. What is the required rate of return for a portfolio consisting of 80 percent of
Stock X and 20 percent of Stock Y?

a. Computation of betas of stock X and Y

Marke Yx
Year Stock X Stock Y XxM M^2
t M
2011 14 13 12 168 156 144
2012 19 7 10 190 70 100
2013 -16 -5 -12 192 60 144
2014 3 1 1 3 1 1
2015 20 11 15 300 165 225

17 -16 -5 -12 192 60

18 3 1 1 3 1
19 20 11 15 300 165
10
sum 40 27 26 853 452
avg
return 8 5.4 5.2 170.6 90.4
Year
X - Average return of X * M
-
Average return of M
X - Average return of
X * M - Average
return of M (X-8)^2 (Y-
5.4)^2
15 40.8 51.68 36 57.76
16 52.8 7.68 121 2.56
17 412.8 178.88 576
108.16
18 21 18.48 25 19.36
11
19 117.6 54.88 144 31.36
sum 645 311.6 902 219.2
Beta = COV(x,y) /
Var(x,y)
 COV(x) = 645/4 =
161.25
 COV(y) = 311/5/4 =
77.9
 Var(x) = 902/5 = 225.5
 Var(y) = 219.2/5 =
54.8
 Beta X = 161.25/225.5
= .72
 Beta Y = 77.9/54.8 =
1.42
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b. What are the required
rates of return on Stocks
X and Y?
 Required rate of return
X = 6 + .72(5) = 9.6%
 Required rate of return
Y = 6 + 1.42(5) = 13.1%
c. What is the required
rate of return on a
portfolio consisting of
80% of Stock
X and 20% of Stock Y?
Bp = (.8)(.72) + (.2)
(1.42) = 0.86

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Required rate of return
Portfolio = 6 + .86(5) =
10.3%

17 -16 -5 -12 192 60

18 3 1 1 3 1
19 20 11 15 300 165
sum 40 27 26 853 452
avg
return 8 5.4 5.2 170.6 90.4
Year
X - Average return of X * M
-
Average return of M
X - Average return of
14
X * M - Average
return of M (X-8)^2 (Y-
5.4)^2
15 40.8 51.68 36 57.76
16 52.8 7.68 121 2.56
17 412.8 178.88 576
108.16
18 21 18.48 25 19.36
19 117.6 54.88 144 31.36
sum 645 311.6 902 219.2
Beta = COV(x,y) /
Var(x,y)
 COV(x) = 645/4 =
161.25
 COV(y) = 311/5/4 =
77.9
15
 Var(x) = 902/5 = 225.5
 Var(y) = 219.2/5 =
54.8
 Beta X = 161.25/225.5
= .72
 Beta Y = 77.9/54.8 =
1.42
b. What are the required
rates of return on Stocks
X and Y?
 Required rate of return
X = 6 + .72(5) = 9.6%
 Required rate of return
Y = 6 + 1.42(5) = 13.1%

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c. What is the required
rate of return on a
portfolio consisting of
80% of Stock
X and 20% of Stock Y?
Bp = (.8)(.72) + (.2)
(1.42) = 0.86
Required rate of return
Portfolio = 6 + .86(5) =
10.3

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17 -16 -5 -12 192 60
18 3 1 1 3 1
19 20 11 15 300 165
sum 40 27 26 853 452
avg
return 8 5.4 5.2 170.6 90.4
Year
X - Average return of X * M
-
Average return of M
X - Average return of
X * M - Average
return of M (X-8)^2 (Y-
5.4)^2
15 40.8 51.68 36 57.76
16 52.8 7.68 121 2.56
18
17 412.8 178.88 576
108.16
18 21 18.48 25 19.36
19 117.6 54.88 144 31.36
sum 645 311.6 902 219.2
Beta = COV(x,y) /
Var(x,y)
 COV(x) = 645/4 =
161.25
 COV(y) = 311/5/4 =
77.9
 Var(x) = 902/5 = 225.5
 Var(y) = 219.2/5 =
54.8

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 Beta X = 161.25/225.5
= .72
 Beta Y = 77.9/54.8 =
1.42
b. What are the required
rates of return on Stocks
X and Y?
 Required rate of return
X = 6 + .72(5) = 9.6%
 Required rate of return
Y = 6 + 1.42(5) = 13.1%
c. What is the required
rate of return on a
portfolio consisting of
80% of Stock
20
X and 20% of Stock Y?
Bp = (.8)(.72) + (.2)
(1.42) = 0.86
Required rate of return
Portfolio = 6 + .86(5) =
10.3%

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7. Say stock P has an expected return of 10%, a beta coefficient of 0.9, and a standard
deviation of expected returns of 35 percent. Stock Q has an expected return of 12.5
percent, a beta coefficient of 1.2, and a standard deviation of expected returns of 25
percent. The risk-free rate is 6 percent, and the market risk premium is 5%.
a) Calculate each stock’s coefficient of variation.
b) Which stock is riskier for diversified investors?
c) Calculate each stock’s required rate of return.
d) On the basis of the two stocks’ expected and required returns, which stock would be most
attractive to a diversified investor?
e) Calculate the required return of a portfolio that has Birr7, 500,000 invested in Stock P
and Birr2, 500,000 invested in Stock Q.
f) If the market risk premium increased to 6%, which of the two stocks would have the
largest increase in their required return?
1. Calculate each stock's coefficient of variation.
Ans: CVx = 3.5 , CVy =2

Particulars Stock-X Stock-Y

Standard Deviation 35% 25%

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 Divide by: Expected
10% 12.5%
return

2. Which stock is riskier for a diversified investor?

 For diversified investors the relevant risk is measured by beta. Therefore, the stock with
the lower beta is more risky. Stock P has the lower beta so it is more risky than Stock Q.
 For diversified investors the relevant risk is measured by standard deviation of expected
returns. Therefore, the stock with the lower standard deviation of expected returns is
more risky. Stock Q has the lower standard deviation so it is more risky than Stock P.
 For diversified investors the relevant risk is measured by beta. Therefore, the stock with
the higher beta is less risky. Stock Q has the higher beta so it is less risky than Stock P.
 For diversified investors the relevant risk is measured by beta. Therefore, the stock with
the higher beta is more risky. Stock Q has the higher beta so it is more risky than Stock P.
 For diversified investors the relevant risk is measured by standard deviation of expected
returns. Therefore, the stock with the higher standard deviation of expected returns is
more risky. Stock P has the higher standard deviation so it is more risky than Stock Q.
3. Calculate each stock's required rate of return.
Ans: rP = 10.5% ，rQ = 12.50%
4. On the basis of the two stocks' expected and required returns, which stock would
be more attractive to a diversified investor?
Ans: Stock Q
5. Calculate the required return of a portfolio that has Birr7, 500,000 invested in
Stock P and Birr2, 500,000 invested in Stock Q.
Ans: rP =33.33%
6. If the market risk premium increased to 6%, which of the two stocks would have
the larger increase in its required return?
Ans: Stock Q

8. Tesfaye is planning a savings program to put his daughter through college. His
daughter is now 13 years old. She plans to enroll at the university in 5 years, and it
should take her 4 years to complete her education. Currently, the cost per year (for

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 everything— food, clothing, tuition, books, transportation, and so forth) is Birr12,
500, but a 5 percent annual inflation rate in these costs is forecasted. The daughter
recently received Birr7, 500 from her grandfather’s estate; this money, which is
invested in a bank account paying 8 percent interest, compounded annually, will be
used to help meet the costs of the daughter’s education. The remaining costs will be
met by money the father will deposit in the savings account. He will make 6 equal
deposits to the account, one deposit in each year from now until his daughter starts
college. These deposits will begin today and will also earn 8 percent interest,
compounded annually.
a) What will be the present value of the cost of 4 years of education at the time the
daughter becomes 18?
b) What will be the value of the Birr7,500 that the daughter received from her
grandfather’s estate when she starts college at age 18?
c) If the father is planning to make the first of 6 deposits today, how large must each deposit
be for him to be able to put his daughter through college?
A. For each year of her education, discount three of these costs back (at8%) to the year
in which she turns 18, then sum the four costs, which include the cost of the 1styear

B. For the estate, compounded at 8%:

FV5, estate = PV0, estate * 1.08^5 = 7500 * 1.08^5 = 11019

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 C. first we must find out the daughter's total university expenses: college expenses in 5
years = $12,500 x (1 + 5%)⁵ = $15,953.92
we must find the present value of the college costs:
PV = $15,953.92 + [$15,953.92 x 2.7232 (PV annuity factor, 5%, 3 periods)] =
$59,399.63
since the daughter already has $7,500, she will deposit that money and will have $7,500 x
(1 + 8%)⁵ = $11,019.96 in 5 years, that means that she is $48,379.67
we now have our future value, the interest rate and the number of periods, we are missing
the annuity due contributions:
FV = annual contribution x FV annuity due factor
$48,379.67 = annual contribution x 7.9228 (FV annuity due factor, 8%, 6 periods)
annual contribution = $48,379.67 / 7.9228 = $6,106.39

9. TTT Company common stock currently sells for Br. 46 per share. The company’s
most recent dividends were Br. 4, and it expects a dividend of Br. 4.28 to be paid at
the end of the current year. The firm also expects to incur a flotation cost of Br. 5 to
sell each share of common stock issue. Based on the information calculate the cost of
new common stock issue and retained earnings.
Solution

Po=Br. 46
D1=Br 4
P1=4.28

46(1+r)=4+4.28=8.28
1+r=0.18

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 R=0.82 or 82% decrement (negative)
The cost of new common stock issue=(5/1.82)+(4/1.82)+(4.28/1.82)=2.75+2.2+2.35=Birr
7.3
10. A manufacturing Company is currently selling its common stock at Br. 108. the firm’s
last earnings per share was Br. 18 and its dividend payout ratio was 60%. The required rate of
return on the stock is 12%. Its dividends are expected to grow at a constant rate. Determine:
a) The expected dividends growth rate (g)
b) The expected stock price of the company after 3 years

A. The expected dividends growth rate (g)

Po=108
rs=12%=0.12
D0=18
108=18(1+g)/(0.12-g)
108*(0.12-g)= 18(1+g)
12.96-108g=18+18g
G=5.04/126=0.04 or 4% (decrement)
B. The expected stock price of the company after 3 years

3
18(1+0.04)
Po= =¿ 1.124864)/ 1.404928=Birr 14.41
(1+0.12)3

11. A firm pays Br. 2.45 dividend per share at the end of next year on a common stock
that has a selling price of Br. 35. The dividends of the firm are expected to grow at a
constant rate of 6%. Compute the required rate of return on the stock (ks).

26
 Birr 2.45
=Birr 35
R
Birr 2.45
R= =0.07∨7 %
Birr 35
12. XYZ Corporation issued bonds with a 20-year maturity, a Br. 1,000 par value, a
10% coupon rate, and semiannual interest payments. Two years after the bonds
were issued, the market interest rate dropped to 6%. Determine the value of each
bond:
A. at the time the bonds were sold
B. two years after issuance

A. B1 = PV of annuity + PV of lump sum

B 1= 100[1 – 1/(1.06)20] / .06 + 1000 / (1.06)20
B1 = 1147+ 311.81= 1458.81
B. B2 = PV of annuity + PV of lump sum
B 2= 100[1 – 1/(1.06)20] / .08 + 1458.81 / (1.06)20
B 2= 1147+ 454.86= 1601.86

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