Stephanie D.

Saunderson
ECON255 Problem Set No.1
TA: Oscar
1. Cash flow, which is defined as cash generated by the firm and paid to creditors and shareholders, is
important because it factors into how much a firm is worth. Buying value-creating assets and selling
bonds & stocks that raise more cash than they cost creates value. Net income, however, is the difference
between the revenue generated by the firm and its expenses. Because businesses often pay 30 days after
an expense is generated, although the net income for a month may be positive, the cash flows can be
negative because the other firms wont pay until the next month.
2. E
a. Working capital management describes short-term financial management. According to a balance
sheet, accounts payable (I), accounts receivable (II), and inventory (IV) are considered shortterm liabilities and assets. This is expected given that inventory changes quickly, and accounts
receivable/payable are resolved in the short-term.
3. Option One
a. The CEOs decision to use the cash surplus to award himself a raise is an example of an agency
problem, where management interests conflict with shareholders interests. Specifically, this is a
direct agency cost, in which the money the CEO uses for himself could have been used to pay
the shareholders or grow the company. A higher salary solely benefits the CEO, whereas the
other options would create more value for the firm, and by extension, benefit the shareholders.
4. See attached Table.
a. Current Ratio: Current Assets Current Liabilities
i. $68,531 $63,448 = 1.08
b. Quickness Ratio: (Current Assets - Inventory) Current Liabilities
i. ($68, 531 - $2111) $63,448 = 1.04
ii. The current ratio indicates short-term liquidity, whereas the quickness ratio does not
consider inventory to determine short-term solvency. The benefit of the quickness ratio is
that not all inventory is liquid, and high inventory is not always an asset, so the quickness
ratio is a more accurate indicator of short-term solvency. Each of these is an important
measure to assess the short-term value and success of a firm.
c. Financial Leverage Ratio (2014 Debt to Equity):
i. $120,292 $111,547 = 1.0784
d. Asset Utilization Ratio (COGS/Inventory)
i. 112,258 2,111 = 53.12
1. This ratio indicates that Apple sold off the entire inventory 53.12 times during the
year. This is a high number, reflecting an efficiently managed inventory.
e. Profitability Ratio (Profit Margin, ROA, ROE)
i. Profit Margin = Net Income/Sales
1. $39,510 $182,795 = .2161
ii. ROA = Net Income/Total Assets
1. $39,510 $231,839 = .1704
iii. ROE = Net Income/Total Equity

5.
6.

1. $39,510 $111,547 = .3542

f. Growth Rate Analysis
i. Internal: (ROA * b) / (1-ROA*b)
11126
=0.718
1. b=1
39510
2. (.1704*.718)(1-.1704*.718) = .1394
ii. Sustainable: (ROE * b) / (1 - ROE*b)
1. (.3542*.718)(1-.3542*.718) = .341
iii. Interpretation:
1. Internal: Apple can grow a maximum of 13.94% without using any kind of EFN.
2. Sustainable: Apple can grow a maximum of 34.1% without external equity
financing and at its current debt-equity ratio.
m
74
r
.10
C0 1+
3500 1+
=$ 6987.73
m
4

( )

( 1+r )T 1
( 1+.08 )101
FV =C
5000
= $ 72432.81
r
.08

7.
a. Option A:
b. Option B:

PV =

C
5000
83333.33
=
=$ 83,333.33
=$ 56715.26
rg .08.02
( 1+. 08 )5

PV =C

1( 1+r )
10000
r

1(

1
)
( 1+ 0.1 )5
= $ 37907.87
. 10

c. I would choose Option A because it has a higher Present Value.

8. See attached
.07 ( 120000 )
=$ 17085.30
9.
10
1( 1+ .07 )
.12 ( 1,200,000 )
=$ 150,000
10.
x
1( 1+.12 )
a. x = 28.403 years ~ 28 years 4.5 months
11. D
12. See Attached
13. See Attached
14. See Attached
15. Both the PI and NPV consider the initial investment of the project, the present of value of all cash
flows, as well as the interest rate. The profitability index, however, is a ratio that compares the cost to
the PV of future cash flows, whereas NPV simply shows the net return on the project in present value
terms. PI does not reflect the scale of the investment, but is a better indicator of the better project if both
are mutually exclusive. However, in most cases NPV is a better tool because it uses all of the cash flows
of the project and discounts them properly.