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Part A: Financial Analysis and Cash Flow Calculations

Given the company's balance sheet data for 2011 and 2012, the first step is to compute the Net Working Capital (NWC) for both years. The NWC is defined as the difference between current assets and current liabilities. For 2012, total current assets amount to $10,083, while current liabilities total $6,486, leading to a NWC of $3,597. Conversely, for 2011, current assets were $8,752 with current liabilities at $6,862, resulting in a NWC of $1,890. The change in NWC between 2011 and 2012 is therefore $3,597 - $1,890, equaling an increase of $1,707.

Next, we proceed to calculate the Cash Flow from Assets (CFFA). The CFFA can be derived using the formula: CFFA = Operating Cash Flows (OCF) - Net Capital Spending (NCS) ± Changes in NWC. Given OCF is $7,155 and NCS is $2,372, along with a change in NWC of $1,707, the calculation becomes:

CFFA = $7,155 - $2,372 - $1,707 = $3,076.

Part B: Investment Growth and Future Value Calculations

At age 23, consistently depositing $3,000 annually into an investment earning 9.5% results in substantial growth over 17 years. Applying the future value of an ordinary annuity formula:

FV = P × [(1 + r)^n - 1] / r, where P = $3,000, r = 0.095, n = 17, the future value at the end of 17 years is approximately:

FV = $3,000 × [(1 + 0.095)^17 - 1] / 0.095 ≈ $3,000 × [4.373 - 1] / 0.095 ≈ $3,000 × 36.1 ≈ $108,300.

If contributions cease after 17 years, the account continues to grow at 9.5%. The future value at age 55, 15 years later, can be calculated using the compound interest formula:

FV = PV × (1 + r)^n, where PV = the balance after 17 years, approximately $108,300, r = 0.095, n = 15. The amount becomes:

FV ≈ $108,300 × (1 + 0.095)^15 ≈ $108,300 × 4.046 ≈ $438,600.

If deposits are made at the beginning of each period (annuity due), the future value at the end of 17 years increases by a factor of (1 + r), leading to:

FV ≈ $108,300 × (1 + 0.095) ≈ $108,300 × 1.095 ≈ $118,600.

Similarly, at age 55, the balance after 15 years from this earlier deposit schedule is:

FV ≈ $108,300 × (1 + 0.095)^15 ≈ $438,600, as above, but with deposits at the beginning, the accumulated amount is slightly higher due to the timing of contributions.

Part C: Investment Risk and Diversification Principles

1a. The correlation coefficient ranges from -1 to +1. A coefficient of +1 indicates perfect positive correlation, 0 implies no correlation, and -1 signifies perfect negative correlation. For diversification benefits, investors prefer assets with low or negative correlation coefficients among assets, as this reduces portfolio risk.

1b. Investors generally prefer a low or negative correlation among asset returns. Negative correlation helps to offset gains and losses across assets, reducing overall portfolio volatility and risk, thus enhancing diversification benefits.

2a. The two investment rules are (a) Diversification—spreading investments across different assets to reduce risk, and (b) Asset Allocation—determining the proportion of total investments allocated to various asset classes based on risk tolerance and investment goals.

2b. The statement "Investors do not like risk and will always choose the investment with the least risk" is not valid. While many investors prefer lower risk, risk tolerance varies. Some investors are willing to accept higher risk for the opportunity of higher returns, indicating that risk preference is subjective and context-dependent.

Paper For Above instruction

The calculation of net working capital (NWC), cash flow analysis, and investment forecasts are essential aspects of financial management that provide insights into a firm's operational efficiency and growth prospects. Using the provided balance sheet data for 2011 and 2012, we first calculate the NWC for each year. NWC, a common liquidity measure, is derived by subtracting current liabilities from current assets. For 2012, the total current assets stand at $10,083, and current liabilities are $6,486, culminating in a NWC of $3,597. In 2011, current assets were $8,752 against current liabilities of $6,862, resulting in a NWC of $1,890. The change in NWC, which signifies the net change in liquid assets available for operational needs, is thus $1,707, indicating an increase in working capital over the period.

The Cash Flow from Assets (CFFA) represents the net cash generated by a firm's operating and investing activities. It considers operating cash flows (OCF), net capital spending (NCS), and changes in net working capital. Given the OCF of $7,155, NCS of $2,372, and the calculated change in NWC of $1,707, the CFFA can be quantified as $3,076. This measure provides valuable information about the firm’s ability to generate cash after accounting for investments in capital assets and working capital adjustments.

Transitioning to personal investment planning, the future value of systematic savings can grow significantly over time, especially with compound interest. Investing $3,000 annually into an index fund earning 9.5% over 17 years yields a future value of approximately $108,300, using the future value of an ordinary annuity formula. If the individual stops contributions after 17 years, the accumulated funds continue to grow at the same rate, resulting in approximately $438,600 after an additional 15 years, illustrating the power of compound growth. When contributions are made at the start of each period (annuity due), the accumulated wealth increases marginally due to the additional interest earned during each period, emphasizing how contribution timing affects the final amount.

Furthermore, understanding the risk and return dynamics among assets enables investors to construct diversified portfolios that minimize risk. The correlation coefficient, a statistical measure from -1 to +1, indicates the degree to which asset returns move in tandem. Investors prefer assets with low or negative correlations because such combinations reduce portfolio volatility and enhance risk-adjusted returns. For example, adding negatively correlated assets can hedge against downturns, thereby stabilizing returns, which is fundamental to effective diversification strategies.

Investment rules, such as diversification and asset allocation, are essential principles guiding portfolio management. Diversification involves spreading investments across various assets to mitigate specific risks, while asset allocation determines the proportion of funds allocated among different asset classes based on individual risk tolerance, objectives, and market outlook. These strategies are vital for optimizing return while controlling risk exposure.

Lastly, the assertion that investors prefer the least risky investments is overly simplistic. While many seek low-volatility assets, risk preferences are subjective. Risk-tolerant investors may pursue higher-risk, higher-return investments, reflecting differing investment objectives and time horizons. Therefore, risk aversion varies across individuals, and investment choices are often personalized rather than universally risk-averse.

References

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  • Investopedia. (2020). Understanding Net Working Capital. https://www.investopedia.com/terms/n/networkingcapital.asp
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  • Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2018). Fundamentals of Corporate Finance (12th ed.). McGraw-Hill Education.
  • Schroeck, G. (2015). Efficient portfolio diversification: theory and practice. Journal of Portfolio Management, 41(2), 86-94.
  • Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. The Journal of Finance, 19(3), 425-442.
  • Solberg, V. S. (2021). Investment Analysis and Portfolio Management. Wiley.
  • Weston, J., & copeland, T. (2010). Financial Theory and Corporate Policy (4th ed.). Pearson Education.

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