Problem 1-Time Value of Money

Present and future value concepts.

On the right are six diagrams representing six different present and future value concepts stated on the
left. Identify the diagrams with the concepts by writing the identifying letter of the diagram on the
blank line at the left. Assume n = 4 and i = 8%.
Concept Diagram of Concept
__e__ 1. Future value of 1. ? $1
a. | | | | |
__a__ 2. Present value of 1.
?
__f__ 3. Future value of an annuity $1 $1 $1 $1
due of 1. b. |- - - - | | | |

__b__ 4. Future value of an ordinary annuity of 1. ?

$1 $1 $1 $1
__d__ 5. Present value of an ordinary c. | | | |- - - - |
annuity of 1.

__c__ 6. Present value of an annuity ? $1 $1 $1 $1

due of 1. d. | | | | |

$1 ?
e. | | | | |

$1 $1 $1 $1 ?
f. | | | | |

Problem 2 Present Value and Time Value: Emphasis on Concepts

Your Uncle Otto has struck it rich by investing in racehorses and desires to share some of his
newfound wealth with you. Assume that you must choose from among the following three
options:

1. Receive a lump sum of $400,000 in 20 years.

2. Receive $20,000 at the end of each year for the next 10 years.
3. Receive $90,000 now.

Required:
A. Why is it inappropriate to compare $400,000 (no. 1) vs. $200,000 (no. 2) vs. $90,000 (no. 3)
and conclude that no. 1 is the best option? Explain.
B. What should you do to determine which option is the best? What does this process do?
C. If Uncle Otto agreed to revise option no. 1 so that you could receive $200,000 in 10 years
and the remaining $200,000 in another 10 years, would you likely prefer the revision or the
option as originally stated? Why?
D. What is an annuity? Do any of the options involve an annuity?

a. The cash flows do not occur at the same points in time, and such an analysis disregards the time
value of money. Dollars received in earlier years are worth more than dollars received in the
future
b.The cash flows should be discounted, and the option with the highest present value should be
selected. Such a process integrates the time value of money into the decision process
c. The revision should be preferred. Both options involve the same total dollars; however, because
significance inflows occur sooner with the revision, this option would have a higher present
value
d.An annuity is a series of uniform cash inflows or outflows over a period of years. Option no. 2
 involves an annuity

Problem 3 Inventory Management

Pullman carries a part that is popular in the manufacture of automatic sprayers. Demand for this part
is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit.
Pullman currently places four orders per year with its suppliers.

Management is considering the implementation of an economic order quantity model in an effort to

better manage its inventories.

Required:
A. Compute Pullman's economic order quantity.
B. Compute total annual inventory costs if Pullman follows the EOQ policy.
C. How much will the company save by adopting the EOQ model?
D. Briefly explain the philosophical difference between the EOQ model and the just-in-time
model. Which of the two models will likely result in lower holding costs for the firm? Why?

Problem 4 Financial Statement Analysis

You Cee Maine is the managing director of XYZ Ltd. a small, family-owned company which
manufactures cutlery. His company belongs to a trade association which publishes a monthly
magazine. The latest issue of the magazine contains a very brief article based on the analysis of the
accounting statements published by the 40 companies which manufacture this type of product. The
article contains the following table:

Average for all companies in the industry

Return on stockholders' equity ...... 33%
Return on total assets .............. 29%
Gross margin percentage ............. 30%
Current ratio ....................... 1.9:1
Average sale period ................. days
Average collection period ........... 41 days

XYZ Ltd’s latest financial statements are as follows:

XYZ Ltd.
Income Statement
for the year ended 31 October
(in thousands)

Sales ...................................... 900

Cost of goods sold ......................... 720
Gross margin ............................... 180
Selling and administrative expenses ....... 55
Interest ................................... 15
Net income ................................. 110
The country in which the company operates has no corporate income tax. No dividends were paid
during the year. All sales are on account.

XYZ Ltd
Balance Sheets
as of 31 October
 (in thousands)

This Year Last Year

Current assets:
Cash ............................... 5 20
Accounts receivable ................ 120 110
Inventories ........................ 96 80
Noncurrent assets .................... 500 460
Total assets ....................... 721 670
Current liabilities:
Accounts payable ................... 147 206
Noncurrent liabilities:
Bonds payable ...................... 150 150
Common stock ......................... 100 100
Retained earnings .................... 324 214
Total liabilities and
stockholders’ equity ............ 721 670
Required:

A. Calculate each of the ratios listed in the magazine article for this year for XYZ, and comment
briefly on XYZ Ltd’s performance in comparison to the industrial averages.

B. Explain why it could be misleading to compare XYZ Ltd ratios with those taken from the
article.

Problem 5 Capital Budgeting

The Airways Company is planning a project that is expected to last for six years and generate
annual net cash inflows of $75,000. The project will require the purchase of a $280,000 machine,
which is expected to have a salvage value of $10,000 at the end of the six-year period. In addition to
annual operating costs, the machine will require a $50,000 overhaul at the end of the fourth year. The
company presently has a 12% minimum desired rate of return.

Based on this information, an accountant prepared the following analysis:

Annual net cash inflow $ 75,000
Annual depreciation $45,000
Annual average cost of overhaul 8,333 (53,333)
Average annual income $ 21,667

Return on investment = $21,667 ÷ $280,000 = 7.74%

The accountant recommends that the project be rejected because it does not meet the
company's minimum desired rate of return. Ignore income taxes.

Required:
A. What criticism(s) would you make of the accountant's evaluation?
B. Use the net-present-value method and determine whether the project should be accepted.
C. Based on your answer in requirement "B," is the internal rate of return greater or less than
12%? Explain.

Problem 6

The following terms are used to describe various economic characteristics of costs:

Opportunity cost Differential cost

Out-of-pocket cost Marginal cost
Sunk cost Average cost
 Required:
Choose one of the preceding terms to characterize each of the amounts described below. Each
term may be used only once.

A. ________________The cost of including one extra child in a day-care center.

B. ________________The cost of merchandise inventory purchased five years ago. The goods
are now obsolete.
C. ________________The cost of feeding 300 children in a public school cafeteria is $450 per
day, or $1.50 per child per day. What economic term describes this $1.50 cost?
D. ________________The management of a high-rise office building uses 3,000 square feet of
space in the building for its own administrative functions. This space could be rented for
$30,000. What economic term describes this $30,000 of lost rental revenue?
E. ________________The cost of building an automated assembly line in a factory is
$700,000; a manually operated assembly line would cost $250,000. What economic term is
used to describe the $450,000 variation between these two amounts?
F. ________________Refer to the preceding question and assume that the firm is currently
building the assembly line for $700,000. What economic term is used to describe the
$700,000 construction cost?

Item 7-Capital Budgeting

Why is it important for managers to be able to rank projects?

Item 8-Capital Budgeting

Does a project that generates a positive internal rate of return also have a positive net present
value? Explain.

Number 9 Essay A. Explain the functions of a stock exchange

B . What are the Roles of Stock Exchange?

Item 10-Cash Management

Explain cash float

Item 11-Personal Finance

Why do you think people have this tendency to buy things they do not need using the money
they do not have?