Alternative Assessment Management: 2023 Financial Management ✓ Solved
Alternative Assessmentmgmt 2023 Financial Managementsection 1 Comp
Answer all questions in this section.
1. Evaluate the following diagram and explain how the players in the financial market collaborate to acquire funding and ensure economic efficiency. (4 marks)
2. Clarksville Printing Company sold 1,500 books for $85 each in 2019. The books cost $62 each to produce. The company paid $4,600 in marketing expenses, borrowed $50,000 at 10% interest, and paid both interest and principal in December 2019. Depreciation expense was $8,000, and the tax rate is 25%. Verify whether Clarksville made a profit in 2019 by presenting a good-form income statement. (3 marks) Explain the impact of the new loan and depreciation on cash flows. (2 marks) Determine the Operating Cash Flow and explain the difference between net income and operating cash flow. (4 marks)
3. As the Fund Manager, advise your clients based on their financial situations. a. Recommend the best investment option among four options, showing calculations and rationale. (3 marks) Betty Kay has a contract with annual payments over five years and a subsequent annuity; she is offered $30,000 to cancel. Discounted at 14%, should she cancel? Show your workings. (5 marks)
4. As treasurer, given declining earnings and expected falling interest rates, advise on an investment strategy among Treasury Bills, corporate bonds, and zero-coupon Treasury bonds for maximum profit. (4 marks)
5. Rhea owns shares in Riko Corp with current market price $36.34, last dividend $3.25, growth at 6%, required return 16%. Calculate stock value and advise on whether she should sell or hold. (3 marks)
6. Decide whether to invest in Stock 1 (Beta 0.8, Expected Return 7%) and Stock 2 (Beta 1.2, Expected Return 9.5%). Use CAPM, market risk premium 6%, risk-free rate 4%. Show work and advise. (4 marks)
Sample Paper For Above instruction
Introduction
The financial market's efficient functioning and strategic investment decisions are critical for economic stability and growth. This paper evaluates various aspects of financial management, including market collaboration, financial analysis of corporate reports, investment decision-making, bond strategies, stock valuation, and project appraisal, based on scenarios and data provided.
Financial Market Collaboration
The financial market encompasses a network of institutions, investors, governments, and corporations that collaborate to facilitate capital flow. Commercial banks, investment banks, and market intermediaries act as intermediaries, matching savers with borrowers (Mishkin & Eakins, 2018). They provide financing options, such as loans and securities, ensuring liquidity and liquidity provision. Central banks oversee monetary policy to stabilize currency and control inflation, promoting a robust environment for funding (Bernanke, 2020). The securities exchanges and financial innovations facilitate market efficiency and transparent price discovery, ensuring resources are allocated efficiently for economic growth (Brealey, Myers, & Allen, 2019). The collaboration among these players fosters confidence, reduces borrowing costs, and promotes productive investment, which collectively enhance economic efficiency (Bodie, 2019).
Corporate Financial Analysis
Income Statement for Clarksville Printing Company
Sales revenue: 1,500 books × $85 = $127,500
Cost of goods sold: 1,500 books × $62 = $93,000
Gross profit: $127,500 - $93,000 = $34,500
Plus: Other income (interest): $50,000 × 10% = $5,000
Less: Marketing expenses: $4,600
Less: Depreciation expense: $8,000
Interest expense: $50,000 × 10% = $5,000
Pre-tax income: $34,500 + $5,000 - $4,600 - $8,000 - $5,000 = $21,900
Tax (25%): $21,900 × 0.25 = $5,475
Net income: $21,900 - $5,475 = $16,425
Impact of Loan and Depreciation on Cash Flows
The new loan increases cash inflows by $50,000, providing liquidity for operations. The interest expense of $5,000 affects net income but does not impact cash flows directly in cash flow calculations. Depreciation reduces taxable income, lowering tax liability, thus increasing operating cash flows. Therefore, the new loan enhances cash availability, while depreciation provides a non-cash expense that boosts cash flow by reducing taxes.
Operating Cash Flow & Net Income
Operating Cash Flow (OCF) is calculated as: Net income + Depreciation + Interest (if financing cash flows are excluded). Alternatively, adjusting net income by non-cash expenses and working capital changes reflects true cash generated from operations (Khan & Jain, 2017).
Difference: Net income includes non-cash expenses like depreciation and interest, while operating cash flow excludes financing costs, leading to differences. The operating cash flow provides a clearer measure of cash generated from core business operations.
Investment Advice Based on Financial Data
Question 3a: Investment Option Comparison
Option 1: Future Value (FV) = $12,000 × (1+0.06)^5 ≈ $15,186
Option 2: FV = $15,000 × (1+0.09)^2 ≈ $17,633
Option 3: Immediate value: $15,000
Option 4: Annuity PV = $5,000 × [(1 - (1+0.07/2)^(-2×2)) / (0.07/2)] ≈ $9,827
Analysis shows Option 2 yields the highest FV after 2 years, making it preferable for return maximization, given risk equality (Brealey et al., 2019).
Question 3b: Contract Cancellation Valuation
The present value (PV) of payments: PV =∑$ / (1 + 0.14)^t, for t=1 to 5, plus PV of annuity of $8,500 from year 6 to 15. If PV exceeds $30,000, she should retain; otherwise, she should cancel. Calculations show the PV of the remaining payments is around $33,000, marginally above $30,000, so she might prefer retaining based on valuation.
Bond Strategy in Declining Rate Environment
Given decrease in interest rates, long-term zero-coupon Treasury bonds are most sensitive to rate declines, thus providing higher capital gains if rates fall. Zero-coupon bonds are discount instruments with no coupons, so their prices increase significantly when rates decline (Fabozzi, 2019). CDS, Corporate Bonds, and Treasury Bills offer different risk-return profiles. Investing in zero-coupon bonds maximizes capital appreciation, aligning with profitability goals in declining rate scenarios (Bodie et al., 2019). The strategy should involve purchasing long-term zero-coupon bonds, possibly locking in gains, and considering the firm's risk appetite and liquidity needs.
Stock Valuation & Investment Decision
Using the Gordon Growth Model: P = D1 / (r - g)
D1 = $3.25 × (1 + 0.06) = $3.445
Expected stock value: P = $3.445 / (0.16 - 0.06) = $34.45
Current market price: $36.34 > $34.45, indicating the stock may be slightly overvalued. Rhea might consider adding to her holdings if she believes market conditions will favor growth or sell if she expects a decline (Brealey et al., 2019).
CAPM Analysis & Portfolio Selection
Expected Return (CAPM): E(R) = Rf + Beta × Market Risk Premium
Stock 1: E(R) = 4% + 0.8×6% = 4% + 4.8% = 8.8%
Stock 2: E(R) = 4% + 1.2×6% = 4% + 7.2% = 11.2%
Given the expected returns surpass the actual or required returns, Stock 2 offers a higher expected return and better risk-adjusted profile, suggesting investment is favorable.
Conclusion
The comprehensive analyses indicate that efficient financial market collaboration, prudent corporate and investment decisions based on valuation, and strategic bond investments can substantially benefit firms and investors. The decisions should consider market conditions, risk factors, and future growth prospects to optimize returns and maintain financial stability.
References
- Brealey, R. A., Myers, S. C., & Allen, F. (2019). Principles of Corporate Finance. McGraw-Hill Education.
- Bernanke, B. S. (2020). The New Tools of Monetary Policy. American Economic Review, 110(4), 943-983.
- Bodie, Z. (2019). Investments. McGraw-Hill Education.
- Fabozzi, F. J. (2019). Bond Markets, Analysis and Strategies. Pearson.
- Khan, M. Y., & Jain, P. K. (2017). Financial Management. McGraw-Hill Education.
- Mishkin, F. S., & Eakins, S. G. (2018). Financial Markets and Institutions. Pearson.