LOUELIE JEAN ALFORNON-PADAYAO MBA-1 FINANCIAL MANAGEMENT BLOCK 2 12:01-04:30

University of Cebu
Cebu City
Graduate School
Note: Red fonts are the answers

Midterm Examination in Financial Management

Problem 1 – Time Value of Money

Present and future value concepts

On the right are six diagrams representing six different and future value concepts stated on the left.
Identify the diagrams with the concepts by writing the identifying letter of the diagram on the blank line
at the left. Assume n = 4 and i = 8%.
Concept Diagram of Concept
1. Future value of 1 ? $1
a. l l l l l
2. Present value of 1 $1 $1 $1 $1 ?
b. l---- l l l l
3. Future value of an annuity due of 1 $1 ? $1 $1 $1
c. l l l l ---- l
4. Future value of an ordinary annuity of 1 ? $1 $1 $1 $1
d. I I I I I
5. Present Value of an ordinary annuity of 1 $1 ?
e. I I I I I
6. Present value of an annuity due of 1 $1 $1 $1 $1 ?
f. I I I I I

Answers:

1. e 2. a 3. f 4. b 5. d 6. c

Problem 2 Present Value and Time Value: Emphasis on Concepts

Your Uncle Otto has struck it rich by investing in racehorses and desires to share some of his
newfound wealth with you. Assume that you must choose from among the following three options:

1. Receive a lump sum of $400,000.00 in 20 years.

2. Receive $20,000.00 at the end of each year for the next 10 years.
3. Receive $90,000.00 now.

Required:
A. Why is it inappropriate to compare $400,000 (no. 1) vs. $200,000 (no. 2) vs. $90,000 (no.3) and
conclude that no. 1 is the best option? Explain.
 It is inappropriate to compare the three options since they have different time frame.
Using the time value of money principle option no. 3 would be the best option which is to
receive the money NOW.
B. What should you do to determine which option is the best? What does this process do?
 Using the method of time value of money we can determine the present and future value
of money received now or in the future.
C. If Uncle Otto agreed to revise option no. 1 so that you could receive $200,000 in 10 years and the
remaining $200,000 in another 10 years, would you likely prefer the revision or the option as originally
stated? Why?
 Yes, because the money received in the first 10 years can be invested and could earn
interest after 10 years and therefore in 20 years’ time your money would be more than
400,000.
D. What is an annuity? Do any of the options involve an annuity?
 An annuity is a series of fixed payment to an individual and option no. 2 is an example.
LOUELIE JEAN ALFORNON-PADAYAO MBA-1 FINANCIAL MANAGEMENT BLOCK 2 12:01-04:30

Problem 3 Inventory Management

Pullman carries a part that is popular in the manufacture of automatic sprayers. Demand for this
part is 4,000 units per year; order costs amount of $30 per order, and holding costs total $1.50 per unit.
Pullman currently places four orders per year with its suppliers.

Management is considering the implementation of an economic order quantity model in an effort to

better manage its inventories.

Required:
A. Compute Pullman’s economic order quantity.
 EOQ = 400
B. Compute total annual inventory costs if Pullman follows the EOQ policy.
C.
D. How much will the company save by adopting the EOQ model?
E. Briefly explain the philosophical difference between the EOQ model and the just-in-time model.
Which of the two models will likely result in lowering holding costs for the firm? Why?
Problem 4 Financial Statement Analysis

You Cee Maine is the managing director of XYZ Ltd. a small, family-owned company which manufactures
cutlery. His company belongs to a trade association which publishes a monthly magazine. The latest issue
of the magazine contains a very brief article based on the analysis of the accounting statements published
by the 40 companies which manufacture this type of product. The article contains the following table:

Average for all companies in the industry

Return on stockholder’s equity….. 33%
Return on total assets….. 29%
Gross margin percentage….. 30%
Current ratio….. 1.9:1
Average sale period….. days
Average collection period… 41 days

XYZ LTD’s latest financial statements are as follows:

XYZ Ltd.
Income Statement
For the year ended 31 October
(in thousands)

Sales………………………………. 900
Cost of goods sold……………………… 720
Gross margin……………………. 180
Selling and administrative expenses……. 55
Interest……………………… 15
Net Income……………………….. 110

The country in which the company operates has no corporate income tax. No dividends were paid during
the year. All sales are on account.

XYZ Ltd
Balance Sheets
As of 31 October
(in thousands)

This Year Last year

Current Assets:
Cash………………… 5 20
Accounts receivable……………….. 120 110
Inventories…………………. 96 80
LOUELIE JEAN ALFORNON-PADAYAO MBA-1 FINANCIAL MANAGEMENT BLOCK 2 12:01-04:30

Noncurrent assets……………… 500 460

Total assets…………………. 721 670
Current liabilities:
Accounts payable…………… 147 206
Noncurrent liabilities:
Bonds payable……………….. 150 150
Common stock………………. 100 100
Retained earnings…………. 324 214
Total liabilities and stockholders equity 721 670
Required:
A. Calculate each od the ratios listed in the magazine article for this year for XYZ, and comment
briefly on XYZ Ltd’s performance in comparison to the industrial averages.
B. Explain why it could be misleading to compare XYZ Ltd ratios with those taken from the article.

Problem 5 Capital Budgeting

The Airways Company is planning a project that is expected to last for six years and generate
annual net cash inflows of $75,000. The project will require the purchase of a $280,000 machine, which is
expected to have a salvage value of $10,000 at the end of the six-year period. In addition to annual
operating costs, the machine will require a $50,000 overhaul at the end of the fourth year. The company
presently has a 12% minimum desired rate of return.

Based on this information, an accountant prepared the following analysis:

Annual net cash inflow $75,000
Annual depreciation $45,000
Annual average cost of overhaul 8,333 (53,333)
Average annual income $21,667

Return on investment = $21,667 / $280,000 = 7.74%

The accountant recommends that the project be rejected because it does not meet the company’s
minimum desired rate of return. Ignore income taxes.

Required:
A. What criticism(s) would you make of the accountant’s evaluation?
B. Use the net-present-vale method and determine whether the project should be accepted.
C. Based on your answer in requirement “B”, is the internal rate of return greater or less than 12%?
Explain.

Problem 6

The following terms are used to describe various economic characteristics of costs:
Opportunity cost Differential cost
Out-of-pocket cost Marginal cost
Sunk cost Average cost
Required:
Choose one of the preceding terms to characterize each of the amounts described below. Each term may
be used only once.
A. Marginal cost The cost of including one extra child in a day-care center
B. Sunk cost The cost of merchandise inventory purchased five years ago. The goods are now
obsolete.
C. Average Cost The cost of feeding 300 children in a public school cafeteria is $450 per day, or so
$1.50 per child per day. What economic term describes this $1.50 cost?
D. Opportunity cost The management of a high-rise office building uses 3,000 square feet of space
in the building for its own administrative functions. This space could be rented for $30,000. What
economic term describes this $30,000 of lost rental revenue?
E. Differential cost The cost of building an automated assembly line in a factory is $700,000; a
manually operated assembly cost $250,000. What economic term is used to describe the
$450,000 variation between two amounts.
LOUELIE JEAN ALFORNON-PADAYAO MBA-1 FINANCIAL MANAGEMENT BLOCK 2 12:01-04:30

F. Out-of-pocket cost Refer to the preceding question and assume that the firm is currently building
the assembly line for $700,000. What economic term is used to describe the $700,000
construction cost?

Item 7 – Capital Budgeting

Why is it important for managers to be able to rank projects?
It is important to rank projects because it's where you identify and eliminate waste.
Poor prioritization leads to project failure and, ultimately, missed business goals. Done well, a
good project prioritization process will allow you to strategically align your resource allocation decisions
while delivering more successful projects
Item 8 – Capital Budgeting
Does a project that generates a positive internal rate of return also have a positive net present
value? Explain.
If your IRR < Cost of Capital, you still have positive IRR but negative NPV. Instead, if your cost of capital is
15%, then your IRR will be 10% but NPV shall be negative. So, you can have positive IRR despite negative
NPV.

Number 9 Essay
A. Explain the functions of a stock exchange
A stock exchange standardizes investments, allowing people to buy or sell discrete and equal shares of
ownership in various companies. It facilitates the transfer of funds between investors and businesses,
regulating as necessary to provide maximum safety for everyone’s investments. Many stock exchanges
exist. The major ones act as barometers of the economic performances of various countries.

B. What are the Roles of Stock Exchange?

Continuous and ready market for securities

Stock exchange provides a ready and continuous market for purchase and sale of securities. It provides
ready outlet for buying and selling of securities. Stock exchange also acts as an outlet/counter for the
sale of listed securities.

Facilitates evaluation of securities

Stock exchange is useful for the evaluation of industrial securities. This enables investors to know the
true worth of their holdings at any time. Comparison of companies in the same industry is possible
through stock exchange quotations (i.e. price list).

Encourages capital formation

Stock exchange accelerates the process of capital formation. It creates the habit of saving, investing and
risk taking among the investing class and converts their savings into profitable investment. It acts as an
instrument of capital formation. In addition, it also acts as a channel for right (safe and profitable)
investment.

Provides safety and security in dealings

Stock exchange provides safety, security and equity (justice) in dealings as transactions are conducted as
per well-defined rules and regulations. The managing body of the exchange keeps control on the
members. Fraudulent practices are also checked effectively. Due to various rules and regulations, stock
exchange functions as the custodian of funds of genuine investors.

Regulates company management

Listed companies have to comply with rules and regulations of concerned stock exchange and work
under the vigilance (i.e. supervision) of stock exchange authorities.

Facilitates public borrowing

Stock exchange serves as a platform for marketing Government securities. It enables government to
raise public debt easily and quickly.

Provides clearing house facility

Stock exchange provides a clearing house facility to members. It settles the transactions among the
members quickly and with ease. The members have to pay or receive only the net dues (balance
amounts) because of the clearing house facility.
LOUELIE JEAN ALFORNON-PADAYAO MBA-1 FINANCIAL MANAGEMENT BLOCK 2 12:01-04:30

Facilitates healthy speculation

Healthy speculation, keeps the exchange active. Normal speculation is not dangerous but provides more
business to the exchange. However, excessive speculation is undesirable as it is dangerous to investors
& the growth of corporate sector.

Serves as Economic Barometer

Stock exchange indicates the state of health of companies and the national economy. It acts as a
barometer of the economic situation / conditions.

Facilitates Bank Lending

Banks easily know the prices of quoted securities. They offer loans to customers against corporate
securities. This gives convenience to the owners of securities.

Raising capital for businesses

Exchanges help companies to capitalize by selling shares to the investing public.

Mobilizing savings for investment

They help public to mobilize their savings to invest in high yielding economic sectors, which results in
higher yield, both to the individual and to the national economy.

Facilitating company growth

They help companies to expand and grow by acquisition or fusion.

Profit sharing
They help both casual and professional stock investors, to get their share in the wealth of profitable
businesses.

Corporate governance
Stock exchanges impose stringent rules to get listed in them. So listed public companies have better
management records than privately held companies.
Creating investment opportunities for small investors
Small investors can also participate in the growth of large companies, by buying a small number of
shares.

Government capital raising for development projects

They help government to raise fund for developmental activities through the issue of bonds. An investor
who buys them will be lending money to the government, which is more secure, and sometimes enjoys
tax benefits also.

Item 10 – Cash Management

Explain cash float

In general, cash float refers to the difference between the cash balance recorded in your accounting
system's cash account and the amount of cash showing in your company's bank account balances.
Disbursement float occurs when you write a check and the recipient has not yet cashed the check. The
easiest way to define cash float is to say it is the total value of checks you've written or received, but have
not yet come out or been credited to your bank account. Many factors determine how long that period is
and actually, if a business is large enough, they can use cash float to manage their cash flow.

Item 11 – Personal Finance

Why do you think people have this tendency to buy things they do not need using the money they
do not have?
This worst situation exist because there is lack of financial literacy. Some people are just spending and
spending without considering the available resources currently on hand. Some of these factors might
include belongingness, trends and even insecurities. Example, lavish spending on gambling, phone
updates, fashion etc.