DISCUSSION MNF2023 CLASS
MNF2023 DISCUSSION CLASS
September 2010
Ensure that your calculator is cleared before any new
calculation (shift or 2nd Function, clear all/CA.
When you clear the HP10bII it should show a quick message
(1- P-yr). If it does not, press; 1 Shift PMT and clear again until
it indicates (1-P-yr)
If you calculate an annuity due, remember to convert the
calculator to begin mode and always change back to normal
mode after you complete this kind of calculation
In time value for money, interest is always quoted per annum
e.g. 12% pa. Therefore when it is compounded more than once
a year, remember to determine the interest per period and to
increase the periods N (see study unit 5 study guide)
You should ignore the input (CPT) key when using the HP10bII
and just press for the required variable
IMPORTANT INFORMATION (Calculators)
I have provided you the suggested solutions (Memo) for the
May/June 09 exams posted under additional resources on
myUNISA. Please work through the questions and check with
the answers. But please, do not concentrate on this paper
alone as the upcoming exam questions may differ.
I have also provided you with the questions and answers from
last semester(Semester 1),2010 for both assignments 1 & 2.
Although some of the questions are similar to your tutorial, I
advise you to attempt them and compare with the answers I
have provided at the end of these slides.
You have enough questions and pointers for this exam, in this
presentation, your tutorial letters, the May/June, /Oct/Nov 09
exam,
the
study
guide
and
textbook.
So,
just
practice....practice...practice!
IMPORTANT INFORMATION
The examination will consist of section A & B. Section A is 50
multiples choice questions accounting for 1 mark each,
(totalling 50 marks)
Section B will comprise 2 short answer questions (from
chapters 14 &/or 15) totalling 20 marks (show all your working
for this section). The whole paper will be marked out of 70
marks which will be adjusted to 90% to account for the exam
mark.
The exam duration is 2hours so budget your time sparingly so
that you complete the exam on time. We recommend at most, 1
and a half hours to section A and 30 minutes to section B but
you are welcome to follow a pattern which suits you.
Both your assignments 01 and 02 contribute to the year mark of
10%. Each assignment accounts for 5% of the year mark so
you are encouraged to submit both assignments.
EXAMINATION FORMAT
CHAPTER 2 FINANCIAL STATEMENTS
FINANCIAL STATEMENT ANALYSIS
You will need to be familiar with income and balance sheet
will need to be familiar with income and balance sheet
statements since some questions will test your knowledge in
this regard.
Questions 1-4 in your assignment 01 tested your knowledge on
the income statement. Please work through the solutions in
your tutorial and the statements above to become familiar with
your tutorial and the statements above to become familiar with
these calculations
You need to know how to calculate Earnings per share (EPS),
net profit after taxes, Dividends per share given the divided
payout, ROE, etc
You should expect both theory and calculations from this
should expect both theory and calculations from this
section. Below is some illustration of typical questions that
could come from this section. Please work through them and
compare with the provided answers.
FINANCIAL STATEMENT ANALYSIS
Slovo Corporation had pre-tax profits of R 1.2 million, an
average tax rate of 35% and it paid preference share dividends
of R 80 000. There were 80 000 shares outstanding and no
interest expense. What was Slovo Corporations earning per
share? (R8.75) (May/June 2009)
A firm has fixed assets worth R1 000 000 and accounts
payables worth R20 000. The firm owes R440 000 on a
mortgage bond and has R120 000 in current assets. Its owners
equity equals to (R660 000) (May/June 2009)
A firm with sales of R1 000 000, net profits after taxes of
R30 000 total assets of R1 500 000 and total liabilities of
R30 000, total assets of R1 500 000 and total liabilities of
R750 000 has a return on equity of (4%) (May/June 2009)
Similar questions in your guides, tutorial letters and prescribed
questions in your guides, tutorial letters and prescribed
textbook
FINANCIAL STATEMENT ANALYSIS(FSA)
You will need to know how to calculate the statement of
retained earnings. Example format is provided above;
A firm had as at year-end 2004 and 2005 retained earnings
balances of R670 000 and R560 000 respectively. The firm paid
R10 000 in dividends in 2005. The firms net profit after taxes
for 2005 was
R670 000 + Net profit Dividends paid = R560 000
R670 000 + NP 10 000 = R560 000, so NP = - R100 000
(FSA) Statement of Retained Earnings
Liquidity Ratios
Ratios
Current Ratio
Quick Ratio
Activity Ratios
Inventory Turnover
Average Age of Inventory
Average Collection Period
Average Payment Period
Payment Period
Total Asset Turnover
Price Earnings (P/E) Ratio
Market/Book (M/B) Ratio
At the end of 2007, Heaton Industries
the end of 2007 Heaton Industries
reported retained earnings of
R675 000 and it had R172 500 worth
of net income during the year. The
previous year the company had
reported R555 000 in retained
earnings. If the company purchased no
shares during 2007 how much
shares during 2007, how much
dividends did it pay during 2007?
(R52 500)
Financial Leverage Ratios
Financial Leverage Ratios
Debt Ratio
Profitability Ratios
Common-Size Income Statements
Gross Profit Margin
Operating Profit Margin (OPM)
Net Profit Margin (NPM)
Earnings Per Share (EPS)
Return on Total Assets (ROA)
on Total Assets (ROA)
Return on Equity (ROE)
Note: Work through ratio analysis.
(R
(Remember that formulae are not
th
provided in the final exam so you will
have to master them!)
FSA (Financial Ratios)
Which one of the following statements is correct?
th
A reduction in inventories held will have no effect
on the current ratio
on the current ratio.
An increase in inventories will have no effect on the
current ratio
current ratio.
If a firm increases its sales while holding its
inventories constant then its inventory turnover will
inventories constant, then its inventory turnover will
increase if all other factors are held constant.
A reduction in the inventory turnover will generally
reduction in the inventory turnover will generally
lead to an increase in the return on equity (ROE).
EXAMPLES
An organisation with a gross profit margin
that meets the industry standards, but a net
profit margin that is below the industry
fit
th
th
standards, must have excessive ...
cost of goods sold.
dividend payments.
principal payments.
general and administrative expenses
and administrative
Practice questions
A firm with a substandard return on total assets can
improve its return on equity, all else equal, by
increasing its total asset turnover
increasing its debt ratio
decreasing its debt ratio
decreasing its total asset turnover ( Answer
increasing the debt ratio)
The DuPont system of analysis is used to dissect
DuPont system analysis is used to dissect
the firms financial statements and to assess its
financial condition.
It merges the income statement and balance sheet into two
th
summary measures of profitability: ROA and ROE as shown in
the equation below.
Practice questions (The Du Pont)
Practice questions (The Du Pont)
R 500 Preference share
R 126
R 600 Ordinary shares
Account receivable
Interest expense
Total operating expenses
R
1000
40%
18
R 1800
The firms earnings that were available for ordinary
shareholders for 2009 were
-R224.00
R195.00
R302.40
R516.00
outstanding
outstanding
dividends
Tax rate
of goods sold
R 3060 Cost of goods sold
Sales revenue
Practice questions
Please note that Bad debts and depreciation are never included in the
cash budget because they are considered non cash items.
Assignment 01, Questions 15-17
GENERAL FORMAT OF A CASH BUDGET
R136 000
R 98 000
R180 000
R 16 000
R196 000
R 60 000
R
R 64 000
R (20 000)
Purchases
Rent & Salaries
Total Purchases
(b)
Net Sales (a-b)
Opening Balance
End Balance
Minimum
Balance
Surplus
financing
R 44 000
44 000
4 000
R234 000
R256 000
R142 000
000
R (20 000)
R162 000
R 64 000
R 16 000
R120 000
R114 000
R 76 000
Credit
Sales
(38%)
Total Sales (a)
R120 000
R200 000
November
R180 000
R300 000
October
Cash Sales (60%)
Sales
September
(Actual)
R200 000
R202 000
000
R (20 000)
R222 000
R162 000
R 60 000
R106 000
R 16 000
R 90 000
R166 000
R 76 000
R 90 000
R150 000
December
1. Discuss the role of time value in finance
2. The concept of future value and present value, their
calculation for single amounts
3. Find the future value and the present value of both an
ordinary annuity and an annuity due, and the present
value of a perpetuity.
4. Calculate both the future value and the present value
of a mixed stream of cash flows.
5. Understand the effect that compounding interest more
frequently than annually has on future value and the
effective annual rate of interest.
6. Describe the procedures involved in (1) determining
deposits needed to accumulate to a future sum, (2)
loan amortization, (3) finding interest or growth rates,
and (4) finding an unknown number of periods.
TIME VALUE FOR MONEY
TIME VALUE FOR MONEY
FV = R 800 X (1 + 0.06)5
= 800 X 1.338
=R 1 070.40
Jane Farber places R800 in a
savings account paying 6%
interest
compounded
annually. She wants to know
how much money will be in
the account at the end of five
years.
Future Value of a Single Amount
= R 1 700 X PVIF8%, 8
PV = R 1 700/(1 + 0.08)8
= 1 700/1.851 = 918.42
Pam Valenti wishes to find
Valenti wishes to find
the present value of $1,700
that will be received
8 years from now. Pams
opportunity cost is 8%.
Present Value of a Single Amount:
FVA
= $5,751
$5
= $1,000 (5.751)
= $1,000 (FVIFA,7%,5)
$1,000 (FVIFA,7%,5)
Fran Abrams wishes to
determine how much money
she will have at the end of 5
years if he deposits (at the end
of every year) R 1 000 into an
account earning 7% annually.
Annuities (ordinary)
= $6,154
= $1,000 (5.751) (1.07)
FVA =
$1,000(FVIFA,7%,5)(1+.07)
Fran Abrams now wishes to
calculate the future value of an
annuity due if he deposits (at
the beginning of every year) R
1 000 in to an account earning
7% for 5 yrs
Annuities (Due)
PV
PV= 1 000/0.08 = R12 500
A perpetuity is a special kind FV of a Mixed Stream
Mi
St
of annuity.
With a perpetuity, the periodic
annuity or cash flow stream
continues forever.
For example, how much would
I have to deposit today in
order to withdraw R1,000 each
year forever if I can earn 8%
on my deposit?
Calculate the FV of a mixed
stream if the opportunity cost is
stream if the opportunity cost is
PV=Annuity/interest rate
8%?
Present Value of a Perpetuity
FV OF A MIXED STREAM
0
1 yr
2yrs
Fred Moreno has found an
institution that will pay him 8%
annual interest, compounded
quarterly. If he leaves R 100
in the account for 24 months
(2 years), he will be paid 2%
interest compounded over
eight periods.
Compounding Interest
More Frequently Than Annually
= R100 X 2.71830.16
= R100 X 1.1735
= R117.35
FV = R100 X e0.08 X 2
Fred Moreno deposits R100
into an account paying 8%
annual interest compounded
continuously. Find the future
value of this investment after
2 years of this investment?
Continuous Compounding
FVA = PMT X FVIFA
PMT = 30 000/5.637
30 000/5
Hence = PMT = FVA
= 5 321.98
FVIFA
Suppose you want to buy a
house 5 years from now and
you estimate that the down
payment needed will be
R30,000. How much would
you need to deposit at the end
of each year for the next 5
years to accumulate R30,000 if
you can earn 6% on your
deposits?
Calculating payments (PMT)
PVIFi, 5YRS = PV/FV =
1250/1520 = 0.822 = 5%
Find the rate of interest or
the of rate interest or
growth for the following
stream of cashflows?
Interest or Growth Rates
Practice questions 11-15 of
assignment 01, May/June 09,
01
09
October/November 09.
PVIF8%, n = PV/FV =
1000/2500 = 0.400 or 12 Yrs
Mrs Bates wishes to know
the number of years it will
take for her initial R 1 000
earning 8% per annum to
grow to R 2 500
Finding Number of Periods
Game room wishes to
determine the returns of its
video machine Conqueror. It
was purchased 1 year ago
for R20,000 and currently
has a market value of
R21,500. During the year, it
generated R800 worth of
after-tax receipts.
Defining return = Cf+Pt-Pt-1
return Cf+Pt
Pt-1
20 000
Choose
the
better
of
two
investments, A and B.
Each
requires an initial outlay of R10,000
and each has a most likely annual
rate of return of 15%. Management
has made pessimistic and optimistic
estimates of the returns associated
with each.
Risk preferences
Risk preferences
Risk-averse
Risk-indifferent
Risk-seeking
Return = 800 + 21 500 - 20 000
Risk and Return
Risk of a Single Asset
Standard Deviation
Deviation
Expected Return
Review questions 6
(assignment 02,and18
assignment 01. First semester
01 Fi
The coefficient of variation,
CV, is a measure of relative
dispersion that is useful in
comparing risks of assets with
differing expected returns.
Coefficient of Variation
In the same way the beta of a portfolio will be
calculated using this formula. Qn 10 sem 2
In this case you calculate the weight/proportion of
every asset in the portfolio, multiply it by its beta
and find the total beta of that portfolio. You will
also need to know the implication of beta values.
The return of a portfolio is a weighted average of
the returns on the individual assets from which it is
formed and can be calculated as shown in
Equation 5.5.
Portfolio Return
For premium bonds, the current yield > YTM.
discount bonds the current yield YTM
For discount bonds, the current yield < YTM.
Valuation of stocks and bonds is done In a similar manner.
Practice question 13 assignment 01.
Basic Valuation Model
A Par value company bond
pays interest semiannually,
the required stated annual
return is 12% and it has 10
yrs to maturity. Calculate PV
Bond corporation issued
R1000 par value bonds
bearing a coupon rate of
12% and paying coupons
semi annually. The bonds
have 3yrs remaining to
maturity and are priced at
R940 per bond. What is the
annual yield to maturity?
Coupon=12%X1000=120/2
Periods N= 3X2= 6
FV= 1 000
PV= 940 compute I = 7.27X2
= 14.54%
Calculating YTM, PV & FV
E(r) = 1/25 + .07 = 11%
For example, if the firms $1 dividend on a $25 stock is expected
to grow at 7%, the expected return is:
E(r) = D1 /P + g
Stock Returns are derived from both dividends and capital
gains, where the capital gain results from the appreciation of
the stocks market price due to the growth in the firms
earnings. Mathematically, the expected return may be
expressed as follows:
Common Stock Valuation
Basic Stock Valuation Equations
Practice
question
assignment 01.
14
P0 = R1.50/(0.15 0.07) = R18.75
of
Lamar Company, a small Lamar has just paid a dividend
cosmetics company, paid the of R1.50 and expects dividends
following per share dividends: to grow according to the
schedule below. Calculate the
price of Lamars share.
Constant Growth Model
7 = R18.20/share.
For example, Lamar s expected EPS is R2.60/share and the
.
industry average P/E multiple or P/E ratio is 7, then P0 = R2.60 X
Question 4 assignment 01
P0 = (EPSt+1) X (Industry Average P/E)
Some stocks pay no dividendsusing P/E ratios are
one way to evaluate a stock under these circumstances.
The model may be written as:
Other Approaches (P/E) Multiples
Central to short-term financial management is an
understanding of the firms cash conversion cycle.
Net Working Capital is defined as total current assets
less total current liabilities.
It also consists of current liabilities, including accounts
payable (trade credit), notes payable (bank loans),
and accrued liabilities.
Working Capital includes a firms current assets,
Capital
firm current assets
which consist of cash and marketable securities in
addition to accounts receivable and inventories.
Working Capital Management
AAI
or
ACP
the
amount
of
to support operations.
resources the firm must commit
reducing
cash conversion cycle, thus
sales
are
cyclical,
then
investment in operating assets will
vary over time, leading to the need
for seasonal funding requirements
in addition to the permanent
funding
requirements
for
its
minimum investment in operating
assets.
lengthening APP will reduce the If
Reducing
If a firms sales are constant,
then
its
investment
in
operating assets should also
be constant, and the firm will
have only a permanent
or funding requirement.
Permanent vs. Seasonal
Calculating the OC & CCC
Aggressive strategy the firm funds its seasonal
requirement from short term debt while its
permanent requirement from long term funds.
Conservative strategy the firm funds both its
seasonal and permanent requirements from long
term debt.
Apply the concepts and calculate the amount of
financing required under each of the two methods
of financing. Work through;
Illustrations from Gitman chapter 14
and assignment 03 tutorial letter 101.
Aggressive vs. Conservative Strategies
Ignore the $ Signs (example used only for illustration
purposes)
Given this information, should Dodd relax its credit
standards?
Dodd is currently contemplating relaxation of credit standards
Dodd is currently contemplating a relaxation of credit standards that is
is
anticipated to increase sales 5% to 63,000 units. It is also anticipated that the
ACP will increase from 30 to 45 days, and that bad debt expenses will increase
from 1% of sales to 2% of sales The opportunity cost of tying funds up in
from 1% of sales to 2% of sales. The opportunity cost of tying funds up in
receivables is 15%.
Dodd Tool, a manufacturer of lathe tools, is currently selling a product for
$10/unit. Sales (all on credit) for last year were 60,000 units. The variable cost
per unit is $6. The firms total fixed costs are $120,000.
Changing Credit Standards Example
60,000
10.00
$
$
$
Proposed Sales Level (units)
Price/unit ($)
Variable Cost/unit ($)
Contributin Margin/unit ($)
2.0%
15.0%
Opportunity Cost (%)
8.1
Proposed A/R Turnover (365/AR)
A/R Turnover (365/AR)
Proposed Bad Debt Level (% of sales)
12.2
Present A/R Turnover (365/AR)
1.0%
45.0
New Receivables Level (days)
Present Bad Debt Level (% of sales)
30.0
Old Receivables Level (days)
4.00
6.00
63,000
Present Sales Level (units)
Relevant Data
Analysis of Relaxing Credit Standards
Dodd Tool Company
Tool Company
$ 6.00
$ 10000
10.0
3,000 Contribution Margin/Unit $ 4.00
63,000 Variable Cost/Unit
60,000 P
60000 Pririce/Unit
Addi nal Prof Cont
AdditionalProfit Contributionnffrom Sales (salessiincr x cont margin) $ 12000
Sal
crxcontmargi 12,000
Increase in Sales
New Sales Level
Old SalesLevel
Sal s Level
Additional Profit Contribution from Sales
Analysis of Rexaxing Credit Standards
Dodd Tool Company
DoddTool Company
Additional Profit Contribution from
Sales
Changing Credit Standards Example
$
$
$
$
Total VC Under the Proposed Plan
Average Investment Under Present Plan
Average Investment Under Proposed Plan
Marginal Investment in Accounts Receivable
378,000
360,000
$
$
o Marginal Bad Debts
2,574 Cost off Marginal Bad Debts
Cost off Marginal Investment in Accounts Receivable
o Marginal Investment in Accounts Receivable
$
$
15.0% Cost of Bad Debt under Proposed Plan
Opportunity Cost
6,600
12,600
6,000
2.0%
Bad Debt % under Proposed Plan
of Bad Debt under Present Plan
17,158 Cost of Bad Debt under Present Plan
46,667
29,508
630,000
1.0%
Total Sales under Proposed Plan
600,000
Bad Debt % under Present Plan
Debt under Present Plan
$
Total Sales under Present Pllan
P
Cost of Bad Debt = Bad Debt % x Total Sales
$
$
Total VC Under the Present Plan
Total VC = VC/Unit X # of Units
Cost of Marginal Investment in A/R = Total VC/Turnover of A/R
Cost of Marginal Bad Debt
Analysis of Relaxing Credit Standards
Analysis of Rexaxing Credit Standards
Cost of Marginal IInvestment iin Accounts Receivable
of Marginal nvestment n Accounts Receivable
Dodd Tool Company
Dodd Tool Company
Changing Credit Standards Example
Yes they should because they have profit from the plan
Yes they should because they have a profit from the plan.
Kindly note the positive and negative values and why they occur.
When you relax credit standards you will expect to increase your
sales but the marginal investment in accounts receivables will also
increase and so will your bad debts. So you have to reconcile
these effects
these effects.
2,826
Net Profit From Implementation of Proposed Plan
$
(6,600)
Cost of Marginal Bad Debts
12,000
(2,574)
$
Cost of Marginal Investment in Accounts Receivable
Additional Profit Contribution from Sales
Making the Credit Standard Decision
Sta
Analysis of Relaxing Credit Standards
Dodd Tool Company
Changing Credit Standards Example
credit pd - discount pd
Note: If the cost of giving up the cash discount exceeds the required return on
borrowed funds the company should take the cash discount. Attempt practice
questions in your tutorials and study guides.
100% - %discount
Taking the Cash Discount
the Cash Discount
If a firm intends to take a cash discount, it should pay on the
last day of the discount period.
There is no cost associated with taking a
cash discount.
Giving Up the Cash Discount
If a firm chooses to give up the cash discount, it should pay on
the final day of the credit period.
The cost of giving up a cash discount is the implied rate of
interest paid to delay payment of an account payable for an
additional number of days.
Cost =
% discount
x
365________
Analyzing Credit Terms
Interest
Borrowed amount
Once the nominal (stated) rate of interest is
established the method of computing interest
established, the method of computing interest
is determined.
Interest can be paid either when a loan matures or
in advance.
If interest is paid at maturity, the effective (true) rate
of interest
of interestassuming the loan is outstanding for
the loan is outstanding for
exactly one yearmay be computed as follows:
Method of Computing Interest
Sources of Short-Term Loans
Review the practice examples in chapter 15 of your prescribed
textbook.
If the interest is paid in advance, it is deducted from the loan
so that the borrower actually receives less money than
so that the borrower actually receives less money than
requested.
Loans of this type are called discount loans. The effective
rate of interest on a discount loan assuming it is outstanding
for exactly one year may be computed as follows:
Interest paid
paid
Amount borrowed interest paid
Method of Computing Interest
Sources of Short-Term Loans
1
4
4
1
4
4
16.
1.
6.
11.
16.
17.
12.
7.
2.
17.
12.
7.
2.
Qn.
Ans.
3
3
4
3
3
1
3
2
Ans.
1
1
4
2
19.
14.
9.
4.
Qn.
18.
13.
8.
3.
2
4
2
3
19.
14.
9.
4.
Assignment 02 Semester 1
18.
13.
8.
3.
Qn.
*The Zero denoted as an option implies that there was no correct solution for that
question and students should just attempt it.......!
3
11.
4
6.
Ans.
1.
Qn.
Assignment 01 semester 1
Ans.
1
1
3
3
4
3
1
2
20.
15.
10.
5.
20.
15.
10.
5.
Qn.
Ans.
4
2
2
0
1
4
2
3
As part of your preparation we encourage you to attempt
questions from assignments 01 and 02 for the First semester
10. The suggested answers are provided here below:
PRACTICE QUESTIONS
KASOZI STEPHEN JASON
AJH VAN DER WALT BUILDING RM 3-116
TEL: [phone]
27 12 429 4684
EMAIL: [e-mail]
GOOD LUCK WITH THE EXAM!!!