ADMS 3530, FINANCE, SUMMER 2016

Review Class for Final Exam

Dr. Sirajum M Sarwar, with solution

1. Exam date: Friday, August 19 from 7pm to 10pm.- Room # ACW 109.
2. Exam time: 2.5 hours (or whatever is mentioned on the exam). No extra time will be allowed.
3. Topics covered: Chapters 1-13.
4. Question Pattern: All MCQ: Quantitative and qualitative: true/false and fill in the blanks.
5. Exam Format- The format has been posted on the Moodle, please check.
6. Exam room environment- NO talking or getting support/ aid of any type from other students.
7. Equation sheet- You will be provided an equation sheet.
8. Electronic devices- Financial calculator is allowed.
9. Accessories-Bring all your required accessories, e.g. pencil, pen, eraser, water bottle, etc.

You are advised to treat this document as a sample guideline. The followings are suggestions only.
Make sure that you are comfortable with all types of maths and conceptual problems from the text
book and from all the materials provided during the term.
This review booklet focuses on chapters 9-13. However the final exam covers chapters 1-13. So for
the pre-midterm chapters follow the text book and all materials provided for the midterm exam.
In addition to this review booklet you MUST also review:
o The text book
o End of chapter exercises ( 25% of the questions will be from the end of chapters)
o Final exam and midterm tutorial solution ( posted on the Moodle)
o The practice exercises posted on the Moodle and
o The class notes and class exercises.
Chapter Topic
9 1. Relevant cashflow- examples and maths
2. Calculate the CCA for open and closed pool- maths
3. Calculate the CFFA and then NPV- all maths
4. Calculating the PV of each item on the CFFA calculation, e.g. PVCCATS, PV of
salvage.
5. Calculate OCF
6. EOCE 1, 3, 5, 6, 9, 11(a), 17, 20, 21, 22, 24

10 1. How firms organize the investment process

2. Some what-if questions
3. sensitivity analysis
scenario analysis
4. Break-even analysis
accounting break-even analysis
economic value added and break-even analysis
operating leverage
5. Real options and the value of flexibility
the option to expand
a second real option: the option to abandon
a third real option: the timing option

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 a fourth real option: flexible production facilities
6. EOCE- 5, 9, 14, 16, 21, 24

1. Calculating returns- dollar return, percentage return, total percentage return,

11 2. Market efficiency- 3 forms, examples, anomalies and lessons
1. Section 7.6-Market efficiencies. There are No Free Lunches on Wall Street or Bay
Street
2. Market Anomalies and Behavioural Finance
3. EOCE- 2, 3, 7, 14,16,18,20,23,24

12 1. Expected risk and return calculations for individual stock and for portfolio
2. Beta calculation
3. Risk to reward ratio
4. CAPM and SML
5. Overvaluation and overprices securities
6. Application of the CAPM in capital budgeting
7. EOCE-1,3,4,5,6,11,24.
13 1. Calculating Market Values for Securities
2. Calculating Required Rates of Return
3. Calculating WACC
4. Miscellaneous Issues
5. EOCE-3,4,5,6,7,8,9,11,14,19.

20,21 and Chapters 20 (20.1, 20.2, 20.6, 20.7), 21 (21.4 only) and 22 (22.1, 22.3, 22.4)
22 1. Chapter 20
Links between Long Term and Short Term Financing
Working Capital
Sources of Short Term Financing
The Cost of Bank Loans
2. Chapter 21
Managing inventory , EOQ
Managing cash balances, Boumol model, Miller Orr model
3. Chapter 22
Terms of Sale
Credit Analysis
The Credit Decision

4. EOCE- Chapter 20- 4,6

Chapter 21- 13,20 and 21
Chapter 22: 3,5,7 and 8

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 Some useful notes and sample maths from each chapter
Chapter 9---

1. Relevant cashflow: Must include all incremental cashflow and must be after tax. (check LN for
examples of incremental cash flows).

2. In evaluating a capital budgeting project the factors that are important:

a. Salvage value: The salvage value of a depreciable asset will impact projects NPV. This
will also impact the PV of the capital cost allowance tax shield.

b. Depreciation tax shield ( CCA tax shield): If you use a straight line method then there is
no need to calculate the PV of CCA tax shield ( the big equation). But if you use the
declining balance then you have to use the PVCCATS method to calculate the tax shield.

c. Half year rule for depreciation: Careful that if you use half year rule then the depreciation
tax shield will be the same in each year of the project (if there is no salvage value). In case
of declining method you have to follow the percentage of the asset, which will be given to
you in the exam.

d. Net working capital : The NWC will be back to its normal at the end of the operating
cycle. So whatever the cashinflows and outflows are at year -0, you have to have the
opposite signs at year-n to show that the NWC is back to normal. (we have solved similar
maths in the class, please check).

3. Tax effect on cashflows:

a. Cashflows has to be after tax
b. The higher the tax, the higher is the tax shield
c. There is a difference between depreciation tax shield and PV of depreciation tax shield.
Depreciation tax shield = Depreciation*Tax. and PV of of depreciation tax shield is the BIG
equation that we learned in the class.

4. Cashflows that will NOT be relevant are sunk cost, interest expense and overhead cost.
5. All maths related to the CFFA.

Math 1: Relevant cash flow . Also check the erosion cost in the practice exercise
You are considering a project and the cashflows for the initial start up are as follows: What is your cost in
year zero.

Cost Amount Cost Amount

Equipment 100000 Overhead cost 15000
Installation 10000 Renovation 20000
Land, bought 5 years back 5000000 Loss of profit 40000
Land royalty fee to lawyer, 8 years 5000
back
Market value of land today 4000000

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In this question the assumption is that we are using the land and the equipment for the project. If
the project is only equipment and it is said that the land has nothing to do with it then we will NOT
add the market value of land. So, it depends on the question.

Answer: 100000+10000+4000000+20000+40000 = 4170000

Land cost is sunk cost +royalty fee is a sunk +overhead cost are irrelevant to the project

Math 2: Nofrills purchased a Van for 2 million with a CCA rate of 10% and an economic life of 7 years
How much will be the CCA tax shield in year 3 if the corporate tax rate is 40%? What is the book value
of the asset after year three.

End
CCA CCA
y1 100000 1900000
y2 190000 1710000
y3 171000 1539000

CCA tax shield = dep in year 3 * tax rate = 171000*0.4 = 68400

The Book value of the asset at the end of third year is = Ending CCA.
So $1539000.

Math 3: Calculating PVCCATS: In example 2, the salvage if 800000, required rate of return is 10%,
calculate the PV of CCA tax shield?

Answer: Use the following equation

1 0.5k S n dTc
IdTc 1
PV tax shield on CCA
dk 1 k d k (1 k ) n

Math 4: NPV and NWC:

How does net working capital affect the NPV of a five-year project if working capital is expected
to increase by $25,000 and the firm has a 15% cost of capital?

T=0: - $ 25,000 outflow

T-5: + $ 25,000 the PV of the $25,000 is (25000/(1.15^5) = 12,429.42

So, NPV is decreased by the difference of (25000-12429.42) = 12570.58

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Chapter 10: NPV and Capital Budgeting

1. Always make decision based on NPV. This is the best. The higher and positive the NPV of the
project the better it is. It shows how much value will be added to the shareholders if the
company takes the project.

2. Second best is IRR, but doesnt work for mutually exclusive project and non-conventional cash
flow. IRR may produce multiple rate when non-conventional cash flow is there and may
produce incorrect decision when the project is mutually exclusive.

3. The other issues are, investment timing, borrowing and lending decisions and project with
unequal lives.
4. Best techniques for short term, or biased towards short term : Payback, AAR
5. Best techniques for long term, or biased towards long term : NPV, IRR and PI
6. Relevant cashflow: Must include all incremental cashflow and must be after tax.
7. Tax effect on cashflows:
a. Cashflows has to be after tax
b. The higher the tax, the higher is the tax shield
c. There is a difference between depreciation tax shield and PV of depreciation tax shield.
Depreciation tax shield = Depreciation*Tax. and PV of of depreciation tax shield is the
BIG equation that we learned in the class.

8. Accounting breakeven is always less meaningful and provides lower number than NPV
breakeven. NPV breakeven is more meaningful as it considers the time value of money and also
provides a higher number than the Accounting BE.
9. The what-if questions? Scenario analysis and sensitivity analysis are examples of what-if
questions. They are more useful in evaluating a capital budgeting project. Because they ask the
what if questions before the project starts. These techniques help to judge the feasibility of the
project.
10. For uneven lives of the project use Equivalent Annual cost (EAC approach).
11. Operating leverage: Shows how investment in fixed assets has an impact on the profitability of
the firm.
12. Examples: See chapter practice exercise e.g. erosion cost, sunk cost, opportunity cost, etc.
13. Cashflows that will NOT be relevant are sunk cost, interest expense and overhead cost.
14. Practice all maths related to the CFFA.

Math 1: Break-even Units: Dell computers can produce laptop cases that can be sold for $ 80 Non-
depreciated fixed costs are $1000, per year and variable costs are $60 per unit. If the initial investment is
$ 30000 and last for 5 years the is the accounting and NPV breakeven level of sales? Use straight line
method for depreciation and a discount rate of 10% and tax = 40%.

Variable cost = 75% of revenue. Additional profit per $1 of additional sales in therefore $0.25.
Depreciation oer year = $3000/5 = $ 600
BE sales = Fixed cost / profit per $ of extra sales = (1000+600) / 0.25 = $6400 per year.
This sales level corresponds to a production level of $6400/80 = 80 per unit.

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Accounting : tax is zero when profit is zero.

To find NPV break-even, recalculate cashflow,

CF= (1-T) (Revenue-Cash expenses) + T*dep
= 0.6(0.25*sales 1000) +0.4*600
= 0.15*sales -360

The annuity factor is 3.7908, so we find NPV as follows:

3.7908 (0.15*sales-360)-3000= 0
SALES = $7676.
which corresponds to = 7676/80 = 96 units.

Maths 2 (a): Senario analysis

Practice maths solved in the tutorial session (Final exam tutorial solution).

Math 2(b) : Operating leverage: If Dell computers have no fixed cost then what is the minimum DOL
for the firm?

Fixed costs including depreciation

DOL = 1 +
Profit

If profits are positive, DOL cannot be less than 1.0.

At sales = $8000, profits for Dell Computers (if fixed costs and depreciation were zero) would be: $
8000 .25 = $2000

At sales of $10,000, profits would be = $10,000 .25 = $2500

Profit is one-quarter of sales regardless of the level of sales.

If sales increase by 1%, so will profits. Thus DOL = 1.

Math 3: Timing issue: The NPV of an investment made today is $12,000. The project has a total life of
six years. If postponed for three years, the NPV at that time will increase to $16,000 and opportunity cost
=12%. What should you do?

= 16000* (1.12^3) = $11,389.

So invest now at time =0, since the NPV of the project is higher today, i.e. it is $12000 today.

Chapter 11-12:

1. The higher the risk the higher is the return

2. Therefore in terms of risk and return the most riskiest and the highest return securities are as
follows:

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 Venture company,> small stocks> common stocks> Long term bond or notes> T-bill

3. Returns are calculated by using dollar, percentage, total return, , expected return of a security
and expected return of a portfolio.

4. Financial markets are usually semi-strong or weak form of efficient. It is POSSIBLE to make
fair return by trading but not abnormal return on a continuous basis. You CANNOT beat the
market.

5. If market is strong form of efficient then it is NOT possible to make profit by having both
public and private (inside) information. In the real world we do not see any strong form of
efficiency, we only see either semi-strong or weak form of efficiency.

6. If it is semi-strong then it is not possible to make profit by having public information, but
possible to make profit by using inside information. Here, price will reflect all publicly available
information and as soon as they hit the market.

7. In a weak form, it is possible to make profit by using public and private (inside) information, but
not possible to make profit by using past information.

8. Technical analysis and fundamental analysis : Definition and example. See class lectures and
the text book.

9. Examples of systematic and unsystematic risk: Systematic risk cannot be diversified away, e.g.
inflation, interest rates, war, etc. Unsystematic risk can be diversified away, e.g., low dividend,
poor performance of the company, etc. are unsystematic risk.

10. The portfolio weights are always equal to 1 (one). The weights are mostly positive. In such case
the return of a portfolio CANNOT be less than the smallest return on an individual security in
the portfolio but the risk of the portfolio CAN be less than the smallest variance of an individual
security in the portfolio.

11. The relationship between CAPM and IRR

a. If CAPM or required rate of return > IRR = reject, the project
b. If CAPM or required rate of return < IRR = accept the project

12. Beta of t-bill = 0, beta of a market security or portfolio = 1,

13. Beta >1, beta <1 and beta = 1 means your asset is more risky, less risky or equal risky,
respectively, compared to a market security.

14. A portfolio of two securities e.g. T-bill and a common stock means there is zero (0)
correlation between the securities in the portfolio.

15. The CAPM = Rf+B(Rm-Rf) . BE CAREFUL about the words, market risk and market risk
premium. Market risk is Rm and market risk premium is (Rm-Rf) and securities risk
premium [ beta* (Rm-Rf)] .

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 16. Security market line: is a graphical presentation of the CAPM and shows the relationship
between risk and return. The slope of the security market line is equal to the market risk premium
, e.g. (Rm-Rf).

17. If the price of the security is not equal to the CAPM price given all parameters then the stock is
mispriced.

18. In equilibrium the risk to reward ratio of all the securities has to be the same.

19. If the R-to-R ratio of one security is below the SML line (equilibrium) then it means that the
security is overpriced and has a low return to risk ratio. Therefore the investors will continue to
sell the security until the R-to-R ratio is reached.

20. If the R-to-R ratio of one security is above the SML line (equilibrium) then it means that the
security is underpriced and has a higher return to risk ratio. Therefore the investors will continue
to buy the security until the R-to-R ratio is reached.

Math 1: Portfolio with correl

You invest in two in a portfolio with two securities. Security N and M. Security N has a beta equal to the
T-bill. You invest 40% is N, if the portfolio beta is equal to the market beta then what is the beta of M?

Answer: Portfolio beta = W1B1 + w2B2

1.0 = 0.4*0 +0.6*B2
so B2 = 0.6 So Beta of M is = 0.6

Math 2: Mispricing

You wanted to invest in the stock of Dell Inc. The T-bill rate is 3%, market risk premium is 8.25% and
the beta of the stock of Dell Inc. is 1.25. The market is showing an expected rate of return on the stock of
Dell to be 13.55%. Comment on your investment.

By Using CAPM the expected return of Dell is

= Rf + B ( Rm-Rf)
= 0.03+ 1.25( 0.0825) = 13.31% [ Note: the word risk premium]

So, it should be 13.31% ,but it is selling for 13.55%. So it is underpriced and is a good investment.
So buy it.

Math 3: Application of CAPM

Poor Dog Inc. has an investment CTZ that expects to generate net cash flows of $10,000 a year forever
starting next year. The firm has a beta of 0.8, the risk-free rate of return is 4% and the securitys risk
premium of 5.6%. What is the value of investment CTZ today?

The expected cash flows are in the form of a perpetuity,

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The expected return using the CAPM is = Rf + B ( Rm-Rf)
So, = Rf + B ( Rm-Rf) = 0.04+ 0.056 = 9.6% [ Note: the word security risk premium.]
The value f the firm would be
PV = Cashflow/ E ( r) = 10,000 / 0.096 = $104167.

Chapter 13 Cost of Capital:

1. Weight is always equal to 1.

2. Always use the market value of the instruments to calculate the WACC. If Book values are given
DO NOT use it, unless there is no other option to get the market value.

3. If tax is given then apply after tax rate (1-Tc) where applicable. (see example below)

4. Check for more than one bond or prefs in the CS. Calculate the weighted average of these when
calculating the WACC.

5. Be aware of par values. Prefs has a par value of 100 (by default) and bond has a par value of 1000
(by default).

6. If they are selling for par then for pref the dividend rate is the cost of pref, and for bond the coupon
rate is the YTM. If they are not selling at par then YOU MUST CALCULATE the cost of pref and
the cost of debt by using the equations. DO NOT GUESS OR ASSUME. For the YTM it is similar
to finding i, in the TVM, for the cost of pref use the perpetuity equation.

7. If bond is selling for 98% then the CMP = 98% of 1000 = $980. So this bond is NOT selling at a par.
So calculate the cost of debt separately.

8. Bond coupon if paid semiannual then we need to multiply the YTM by 2 to get Rd,

9. Dividend just paid is D0. We need D1 for the DGM model, so D1 = D0*(1+g) has to be used. But if
the dividend is EXPECTED TO PAY, then that is D1.(see example below)

10. Check for risk premium and market return in the CAPM equation, dividend paid quarterly or
annually.

11. Check for D/E ratio. Do not mix and match with Debt ratio or percentage of debt

12. The appropriate use of WACC is to use it as a discount rate for evaluating projects which has the
same risk as the firms existing assets and operations.

13. Careful about D/E ratio and debt ratio. ( See example from class lectures and given here). When
D/E ratio increases then it means that the company has now more debt in the capital structure. That
means the company is using more borrowed funds. It also means that now the equity holder will
demand a higher required rate of return as the firm is more risky now.

Math 1: D/E ratio and Re

Exley's Farms has a debt-equity ratio of .75. The cost of equity is 15% and the after-tax cost of debt is
5.4%. What will the firm's cost of equity be if the debt-equity ratio is revised to .60?

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WACC = WeRe + WdRd(1-Tc)
= [(1.0 / 1.75)*0.15] + [ (0.75/1.75)* 0.054]
= 0.108857

Now using this WACC we het the Re

WACC = WeRe + WdRd(1-Tc)

0.0108857 = [(1.0 / 1.60)*Re] + [ (0.6/1.6)* 0.054]
Solving for Re = 14.18%

If the firm has a D/E of 0.8 then what is the percentage of equity financing?
So, D/E = 0.8
D = 0.8, E = 1.
Total value of the firm = D+E = 0.8+1 = 1.8
So percentage of equity financing is = 1/1.8 = 55.56%

Use the following information for the next 7 questions.

You have collected the following information on Moose Pastures Inc. (MPI), a publicly traded company.

Debt There are two bond issues. The first issue is a 10% coupon bond, selling at par.
This bond issue pays semi-annual coupons and has 12 years to maturity. Book
value is $3,000,000.
The second bond has exactly the same risk profile. It is identical in all respects
except for the coupon. The semi-annual coupon is 7% and this bond also has 12
years to maturity. The second bond has 5,000 bonds outstanding.
Common Stock 1,000,000 shares outstanding with a book value of $8,000,000. The shares are paid
a dividend of $0.75 per share and the growth rate of dividends is 4.2%.
Preferred Stock There are two preferred stocks:
Preferred stock I is 50,000 shares of 12% preferred, ($100 par value) selling for
$98
Preferred stock II is of 100,000 shares yield 2.25% per quarter, selling at 5% less
than the par value.
Market Tax rate is 40%; risk free rate is 3%; market risk premium is 8%; equity beta is
1.40

ADMS 3530, Review Class for Final Exam, S-2016, Dr. Sirajum Sarwar.
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 Market values of each security Note

Debt-1 3,000,000.00
Price*# of share outstanding = 1000*5000= 5000000
Debt- 2 5,000,000.00

Weighted average of Debt 8,000,000.00

Price*# of share outstanding = 7.815*1000000= 5000000
Common Stock 7,815,000.00 (see note below)

Preferred stock-I 4,900,000.00

Preferred stock-II 9,500,000.00

Weighted average of Pref 14,400,000.00

Total value of the firm 30215000.00

Note: Calculating the cost of equity (Re) and price of equity (Po):

Information given:
1,000,000 shares outstanding with a book value of $8,000,000. The shares are paid a
dividend of $0.75 per share and the growth rate of dividends is 4.2%.

Tax rate is 40%; risk free rate is 3%; market risk premium is 8%; equity beta is 1.40

So, Po = D1/ (r-g)

D1 = Do (1+g) = 0.75*(1.042) = 0.7815
r= CAPM = Rf + B ( Rm-Rf) = 0.03+(1.4*0.08) = 0.142 { CAPM = r= Re= cost of equity}
Po = 0.7815/(0.142-0.042) = $ 7.815

Weights of each security ( rounded)

= 8,000,000/ 30215000
Weight of total debt 0.26
=7,815,000/30,215,000
Weight of Common stock 0.26
= 14400000/30,215,000
Weight of preferred stock 0.48

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Weighted average cost of debt

Weighted average cost of

debt Rd Note
Debt-1 3000000
Debt- 2 5000000
Weighted average of Debt 8000000 cost of debt Rd or YTM Weighted average
Debt-1 0.375 0.1 =0.375*0.1 = 0.0375
debt -2 0.625 0.07 =0.625*0.07 = 0.04375
Sum of ( 0.0375+0.04375 )
WACD (before tax) = 0.08125
WACD ( after tax)= = 0.08125*0.6 = 0.04875

Weighted average cost of preferred stoc

Weighted average cost of

Pref Note

Preferred stock-I 4,900,000.00

Preferred stock-II 9,500,000.00

Weighted average of Pref 14400000 Rp Weighted average
=0.34*0.122
Weight 1= Wp1 0.34 = 12/98 = 0.12244898 = 0.04
= 9/95= 0.09473684
(note the dividend is paid quarterly = 0.66*0.0947
Weight 2- Wp2 0.66 so2.25%*4 = 9% = 0.06
Weighted average cost of = 0.04+0.06
preferred stock = 0.10

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Market values
Debt-1 3000000.00
Debt- 2 5000000.00
Weighted average of Debt 8000000.00
Common Stock 7815000.00
Preferred stock-I 4900000.00
Preferred stock-II 9500000.00
Weighted average of Pref 14400000.00
Total value 30215000.00
Weight of total debt 0.26
Weight of Common stock 0.26
Weight of preferred stock 0.48
Cost of Equity (CAPM) 0.142
Cost of pref 0.10
Cost of debt ( net of tax) 0.49
WdRd ( net of tax) 0.129074963
WeRe 0.036727784
WpRp 0.047658448
WACC 0.213461195

Try to answer the following questions:

1. What is the weighted average cost of debt (before and after tax)?
2. What is the weighted average cost of preferred stock? { note since both debt and preferred stock are
more than one , you have to calculate the weighted average cost of those securities}.
3. What is the market value of equity?
4. What is the percentage of equity financing, We?
5. What is the WACC?

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Chapter 20, 21 and 22

C. The relaxed strategy is a conservative, mostly long-term financing with few payoff
requirements in the short run. This strategy has considerable cash assets at times and
emphasizes liquidity. The current ratio and level of net working capital would be very
high, but the return on assets will likely be lower, because this strategy favours liquidity
over profitability.

D. The middle-of-the-road policy recognizes that a certain minimum level of current asset
investment is always present or is permanent. Using the matching policy, the firm would
finance the permanent portion of current asset investment with long-term financing and
the short-term current asset needs with short-term financing. There are times in the
seasonal cycle when the firm will borrow short-term, and there are times when idle funds
will be invested in marketable securities waiting for the next seasonal cycle. In this case
the firm will use the liquidity from both marketable securities and short-term financing.

E. The restrictive strategy uses the matched maturity approach and finances long-term
assets with long-term financing and short-term assets with short-term financing. At times
there will be a high level of short-term financing providing funds for a seasonal increase
in inventory and accounts receivable. The current ratio will fluctuate considerably with
the seasonal fluctuation in current assets and current liabilities, as will profitability as
interest financing rates move up and down. This strategy is more profitability focused,
but also more risky. Short-term financing may not always be affordable or available.

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 Cash Conversion Cycle: Period between firms payment for materials and collection on its sales
= (inventory period + trade receivables period) accounts payable period
OR = Operating cycle Accounts payable period
Carrying Costs: Costs of maintaining current assets, including opportunity cost of capital
Eg. storage cost for inventory, forgone interest when waiting to collect receivables
Shortage Costs: Costs incurred from shortages in current assets
Eg. shutting down production because you run out of inventory

Cost of loans: EA and Interest with Compensating Balances: Note that compensating balande and
discount will make the cost (of loan) higher.

EOQ and meaning the inventory:

Order costs: Administrative and delivery charges associated with ordering inventory
Carrying Cost: Costs associated with holding and storing inventory:
As the firm increases its order size, the number of orders falls and therefore the order costs
decline
However, larger orders means an increased inventory size and higher carrying costs. The trick is
to strike a balance between these two costs and EOQ does that .

The terms of sale and the EAR. EOCE # 3, is a good one for conceptual question
Credit policy
Credit rating: Agencies does it and use financial statements and ratios to determine the rating of a
company. Also use the following numerical scoring
Numerical Credit Scoring
Credit management involves making a judgment about the five Cs of credit:
Customers character
Customers capacity to pay
Customers capital
Collateral provided by the customer
Condition of the customers business
Math 1: Operating and cash conversion cycle

The financials of M&M are as follows:

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Income statement Balance sheet
Beg of year End of year
Sales 5000 Cash 5000 7900
COGS 4200 Inventory 500 600
A/R 100 120
A/P 250 290
Calculate A/R period, A/P period, inventory period, operating cycle and cash conversion cycle

Trade receivables payable = [(100+120) / 2 ] / [5000/365 ] = 8.0 days

Inventory period =[ (500+600)/ 2 ] / (4200/365) = 47.8 days
Trade payables period = { ( 250+290)/2] / [(4200/365) ] = 23.5 days
Operating cycle = 8.0+ 47.8 = 55.8 days
Cash conversion cycle = 8.0+47.8-23.5 = 32.3 days.

Math2: EOQ: XYX company requires 100000 tons of wheat the order cost of which is $20 per order ,
holding cost is 1.25. The days in production period is 370 days and 2 days requires for delivery.
Calculate EOQ, number of orders, average inventory, usage rate and order point for the company.

EOQ = SQRT(2*100000*20) / 1.25 = 1789

Number of orders = T/Q = 100000/1789 = 56
Average inventory = Q/2 = EOQ/2 = 1789/2 = 895
Usage rate, period = T/D = 100000/370 = 270
Reorder point = (T/D)* delivery time = 270*2 working days = 540

Math 3: Cash balance: MPI has a weekly cash expenses of $ 80. Everytime the company withdraws
money from bank , the bank charges $0.15, however the bank pays interest of 3%.

a) How often should the company withdraw fund from the account?
b) What is the optimal size of the withdraw
c) What is the average amount of cash balance on hand?
Annual cash disbursements = $80 52 = $4160
Cost per transaction = $.15
Interest rate = .03

2 4160 .15
Q= = 204
.03

a. You should go to the bank about once every 2 1/2 weeks (204/80 = 2.55).
b. You should withdraw $204 at a time
c. Your average cash on hand will be $204/2 = $102.

Math 4: Trade credit rates: Currently the credit term is 3/20, n 40. The company wants to change that to
3/30, n 40? what is the implicit rate

The implicit rate increases because the extra days of credit bought by forfeiting the discount fall
to 40-30 = 10 days.
3/30, net 40: (1+3/97) ^365/10 1 = 2.040=204.0%

ADMS 3530, Review Class for Final Exam, S-2016, Dr. Sirajum Sarwar.
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Math 5: Credit decision/repeat sale: Staples sales computer training packages for $ 101. The cost of
production is 5% less ( round up) the selling price in present value term. The credit term is net 30 and
estimates a charge of 7% of all orders that are uncollectible. Per order cones in for 20 units and the
interest rate is 1% per month.

a) Should the firm extend credit?

b) What is the break-even probability of collection?

PV (Cost )= 95
PV (Rev) = 101/1.01 = 100
a. The expected profit from sale is :
0.93(100-95) -0.07*95 = -2
The firm should not extend the credit.

b. At the break even probability, the expected profit equals zero:

p(100-95) ( 1-p) (95) = 0
which implies that p = 0.95.

Math 6: Baumol model: A company has a certain disbursements of $1 million per year. The brokerage
charges are $65 each time money is passed from securities to cash disbursement accounts. S-T interest
rate is 7% , what is the average cash balance? How many transfers should be made in a year?

Z= ((2*65*1000000)/0.07)^1/2 = 43095
So average cash balance = 43095/2 = 21548
Number of transfers is(TCN/Z ) = 1000000/43095 = 23 transfers

Math 7: Miller Orr model: In the previous example if the variance is $1M, minimum balance is $5000.
then calculate the optimal transfer amount, the returning point, cash balance and UCL.

1. Z* = [(3*65*1M)/ 4*0.0001918]^1/3 = 6334. [note: 7%/365 = 0.0001918]

2. Z*+LCL = 6334+5000 = 11334
3. UCL = 3*6334 +5000 = 24002
4. The average cash balance = (4/3) *6334+5000 = 13445.

Good luck!

ADMS 3530, Review Class for Final Exam, S-2016, Dr. Sirajum Sarwar.
Page 17