IN-CLASS EXERCISE

DISCUSSION

Q1: What are the four areas of finance? Give an example of a financial
activity that would fall into each area.

Q2: What is the difference between the primary market and the secondary
market?

Q3: What is the goal of the financial manager?

Q4: How does the surrounding community where a business operates fit into
this goal?

Q5: With what players inside and outside an organization does the finance
manager work to ensure proper financial controls are in place?

Q6: Name a natural conflict between a principal and an agent. How could
this conflict be reduced?

PROBLEMS

Problem 1:
Current assets = $4,300
Net fixed assets = $24,000
Current liabilities = $2,900
Long-term debt = $10,700

→ Construct a balance sheet.

 Owners’ equity = ?

 Net working capital = ?

Problem 2:
Sales = $473,000
Costs = $275,000
Depreciation expense = $42,000
Interest expense = $23,000
Tax rate = 21%
Cash dividends = $25,000

Prepare an income statement and calculate:

 Net income = ?
  Dividends = $25,000

 Addition to retained earnings = ?

Problem 3: Balance Sheet

Brady Enterprises has current assets of $300,000 and total assets of
$750,000.
The company also has current liabilities of $125,000, common equity of
$250,000 and retained earnings of $85,000.
→ How much long-term debt and fixed assets does Brady have?

Problem 4: Income Statement

The Butler Corporation had revenues of $925,000 in 2015. Its operating
expenses (excluding depreciation) amounted to $325,000. Depreciation
charges were $125,000 and interest costs totaled $55,000.
If Butler pays a marginal tax rate of 34 percent, calculate the firm’s net
income after taxes.

Problem 5: Retained Earnings

At the beginning of the fiscal year, November 1, 2014, Big Papi, Inc. had
retained earnings of $425,000. During the year ended October 31, 2015, the
company generated after-tax net income of $820,000 and paid out 35% of its
net income as dividends.
→ Construct Big Papi’s statement of retained earnings and compute the year-
end balance of retained earnings.

Problem 6: Working Capital

Gronkowski, Inc. reported the following information at its last annual
meeting:

 Cash and cash equivalents: $1,225,000

 Inventory: $625,000

 Accounts receivable: $3,500,000

 Other current assets: $125,000

 Accounts payable: $3,200,000

 Notes payable: $1,200,000

→ Calculate Gronk’s net working capital.

Problem 7: Cash Flow Statement – Operating Activities
Tuukka & Co. provided the following financial information for the period
ending September 30, 2015:

 Net income: $225,000

 Depreciation and amortization: $75,000

 Increase in receivables: $95,000

 Increase in inventory: $69,000

 Increase in accounts payables: $80,000

 Decrease in marketable securities: $34,000

→ What is the cash flow from operating activities generated by Tuukka during
this period?
(Hint: first, find the operating cash flow and then convert the change in
current assets and current liabilities into the first section of the cash flow
statement.)

Problem 8: Payback Period

1. Consider the following three-year project. The initial after-tax outlay or

after-tax cost is $1,500,000. The future after-tax cash inflows for years
1, 2, 3 and 4 are: $800,000, $800,000, $300,000 and $100,000,
respectively.
→ What is the payback period without discounting cash flows?
A) 1.875 years
B) 2.0 years
C) 3.5 years
D) 4.125 years
E) 4 years

2. Consider the following ten-year project. The initial after-tax outlay or

after-tax cost is $1,500,000. The future after-tax cash inflows each year
for years 1 through 10 are $400,000 per year.
→ What is the payback period without discounting cash flows?
A) 10 years
B) 5 years
C) 3.75 years
D) 1.5 years
E) 3 years
 3. The initial outlay or cost is $1,500,000 for a four-year project. The
respective future cash inflows for years 1, 2, 3 and 4 are: $400,000,
$500,000, $600,000 and $200,000.
→ What is the payback period without discounting cash flows?
A) About 2.50 years
B) About 2.67 years
C) About 3.00 years
D) About 3.50 years
E) About 2.75 years

Problem 9:

Frameworks, Inc. is considering a five-year project that has an initial after-

tax outlay or after-tax cost of $80,000. The respective future cash inflows
from its project for years 1, 2, 3, 4 and 5 are: $15,000, $25,000, $35,000,
$45,000 and $55,000. Frameworks uses the net present value method
and has a discount rate of 9%.
→ Will Frameworks accept the project?
A) Frameworks accepts the project because the NPV is $129,455.25.
B) Frameworks accepts the project because the NPV is $79,455.25.
C) Frameworks accepts the project because the NPV is $49,455.25.
D) Frameworks accepts the project because the NPV is less than zero.
E) Frameworks accepts the project because the NPV is $70,000.

Problem 10:

Sandstone, Inc. is considering a four-year project that has an initial after-tax

outlay or after-tax cost of $80,000. The future cash inflows from its project
are $40,000, $40,000, $30,000 and $30,000 for years 1, 2, 3 and 4,
respectively. Sandstone uses the net present value method and has a
discount rate of 12%.
→ Will Sandstone accept the project?

A) Sandstone accepts the project because the NPV is greater than $30,000.
B) Sandstone rejects the project because the NPV is less than -$4,000.
C) Sandstone rejects the project because the NPV is -$3,021.
D) Sandstone accepts the project because it has a positive NPV of over
$28,000.
E) Sandstone rejects the project because the NPV is $4,000.
Problem 11:

Crossborder, Inc. is considering Project A and Project B, which are two

mutually exclusive projects with unequal lives.

 Project A: eight-year project, initial outlay $140,000, future cash inflows

each year (1–8) = $36,500.

 Project B: six-year project, initial outlay $160,000, future cash inflows

each year (1–6) = $48,000.

Crossborder uses the equivalent annual annuity (EAA) method and has a
discount rate of 13%.
→ Which project(s), if any, will Crossborder accept?

Problem 12. Profitability Index

Which method is designed to give the dollar amount of return for every $1.00
invested in the project in terms of current dollars?
A) Profitability Index Method
B) Internal Rate of Return Method
C) Net Present Value Method
D) Discounted Payback Period Method
E) None is correct

Problem 13. The ________ method of capital budgeting is a ratio of the

present value of cash inflows divided by the initial investment.
A) Payback period
B) Net present value
C) Internal rate of return
D) Profitability index
E) None is correct
Problem 14. B&H, Inc. is currently considering a five-year project that has
an initial outlay or cost of $220,000. The future cash inflows from its project
for years 1 through 5 are the same at $50,000. B&H has a discount rate of
8%. Because of capital rationing, B&H wants to compute the profitability
index (PI) for each project.
→ What is the PI for B&H's current project?
A) About 0.91
B) About 1.00
C) About 1.19
D) About 1.39
E) About 1.50
CHAPTER 5: SHORT TERM FINANCIAL PLANNING AND PRO FORMA
CASE STUDY

Mini-Case
Dennis Clarkson manages several buildings for Midwest Properties, which
owns and manages apartment buildings in university cities such as Madison,
Wisconsin, and Champaign-Urbana, Illinois. Midwest’s tenants are
overwhelmingly students, and the buildings are private, for-profit university
residence halls. As a result of this specialized clientele, Midwest’s revenues
and expenses follow a predictable seasonal pattern.

From September through May, vacancy rates are negligible, but they rise
rapidly in June, July, and August. The summer months require careful cash
flow planning. The company schedules cleaning, painting, repairs, and
renovations when vacancies are highest, so expenses for supplies, materials,
temporary student labor, and outside contractors peak when revenues are at
their low point for the year.

Dennis is preparing his budget for July, August, and September to submit to
headquarters in Chicago. His budgeting forms include adjusted figures for
the preceding quarter.

Cash Inflows
Dennis is responsible for 200 rental units:

 75% are direct rentals at $600 per month ->600*số occupied units

 25% are contracted to Mendota University at $500 each per month ->
luôn phải trả 500*150=$75000 vào cuối quý (June, Sep). Mà bên dưới
nói là tang 5% vào Sep nên Sep sẽ phải trả 525*150=$78750.

Direct rentals pay on the first of the month, and the university makes
quarterly payments at the end of each quarter, regardless of whether the
apartments are occupied.

Rents are scheduled to increase by 5% in September; the increase will affect

both direct rentals and the university’s payment at the end of the month. 
contract rental payment sẽ trả vào tháng 9 với giá $525/ month -> Sep =
525*150=$78750.

By law, rental companies must segregate security and damage deposits from
operating funds and return them to tenants with interest when they vacate
apartments, so these funds are not included in the budget. However, Dennis
nonetheless assumes an average damage assessment of $100 per vacating
tenant. These funds become available in the following month and should
contribute $7,500 to cash flows in June and $2,500 in July, August, and
September.

Cash Outflows

 Salaries are $8,000 per month.

 Labour and outside contractors average $2,000 per month for most of
the year, but $10,000 per month in June, July, and August. -> Sep:
$2000

 Supplies and materials purchases are normally $5,000 per month, but
that number triples in June, July, and August. The company pays for
supplies and materials one month after they purchase them. -> Jun,
Jul, Aug là $15000.

 Utilities average $80 per occupied apartment. Only half of the 50

contracted apartments are actually occupied in June, July, and August.
The company pays utilities in the following month. -> vd: July trả của
June = 80*125 = $10000

 Payments of $210,000 on debt, $31,500 for property taxes, and

$15,500 for insurance are due in the last month of each quarter.  trả
vào June, Sep.

Questions

1. Complete the following table of cash inflows for the months of July,
August, and September.
2. Complete the following table of cash outflows for the months of July,
August, and September.
Question 3
Complete the following monthly cash flow estimate for the months of July,
August, and September.

Monthly Cash Flow Estimate (April – September)

4. Your monthly cash flow estimate should show a small cash shortage at
the end of September. Is this shortage a cause for concern? Based on
Midwest’s collection and payment patterns, would you expect a cash
deficit or surplus by the end of October? No calculations are required,
but briefly explain your prediction.

5. Construct a pro forma income statement for the properties managed

by Dennis for the third quarter (July, August, and September. Show
dollar amounts and percentages of revenues.

 September’s expenses include $5,000 for supplies and materials and

$16,000 for utilities.

 The payment on debt includes $105,000 in interest and $45,000

toward retirement of the principal.

 Midwest’s tax rate is 34%.

 Remember that the income statement is based on accrual rather than

cash flow principles.

6. Does the period July through September fairly represent Midwest’s

profitability?