Business Finance-1 (FIN506)

Weekly Assignment # 2

Instructor: Sana Tauseef

Semester: Fall 2019
Due Date: September 08, 11 p.m.

1. Provide brief explanation for each.

a. When should a company consider issuing debt instead of equity?
b. What is interest tax shield? Why is it important to consider it in decision making?
c. Is it always good for the company to use debt financing?
d. Why is debt financing referred to as financial leverage?
(3-4 lines each)

2. Differentiate between:
a. Free cash flow and operating cash flow
b. Net income and NOPAT
c. Fixed assets and operational fixed assets
(3-4 lines each)

3. Following are comparative balance sheet figures for Pakistan Elecktron Limited (PEL).
Net income for the year ended 2008 was PKR452,425,000, interest expense was
PKR972,618,000 and D&A expense was PKR245,119,000. Assume the effective tax rate
of 35%.
Figures in ‘000
Year end June 2007 2008
Cash & bank balances PKR536,574 PKR434,484
Stores and spares 64,376 81,990
Stock in trade 2,507,679 3,571,168
Trade debts 2,947,646 4,207,741
Other current assets 814,615 1,105,911
Total Current Assets 6,870,890 9,401,294
Net Property, Plant & Equipment 4,675,889 6,993,485
TOTAL ASSETS 11,546,779 16,394,779
Short-term debt 3,256,948 4,089,092
Current portion: LT loans 348,606 431,987
Creditors, accruals, etc. 1,572,732 2,084,351
Total Current Liabilities 5,178,286 6,605,430
Long Term Loans 2,303,878 4,171,593
TOTAL LIABILITIES 7,482,164 10,777,023
TOTAL EQUITY 4,064,615 5,617,756
Compute the operating cash flow and free cash flow for firm for PEL for the year 2008. (Note:
The company follows IFRS and records interest under operating activities)
 4. Comparative financials and horizontal analysis for Pakistan Cables are given in the below
table. Complete the table by filling in the missing figures.

(Rs. Million) FY07 FY08 FY09

Balance Sheet
Total equity 1,402,442
Total non-current liabilities 259,050 378,254 510,026
Total current liabilities 1,568,310 1,629,125
Total liabilities 1,827,360 2,007,379
Total equity and liabilities
Total non-current assets 1,268,174 1,714,085 1,833,749
Total current assets 1,710,947 1,631,815
Total assets
Profit and Loss Account
Net sales 3,794,949 3,352,328
Gross profit 614,211 532,355
Operating profit 390,476 6,959
Profit before tax 293,276 53,607 101,841
Profit after tax 65,397 63,921
Horizontal Analysis
% Change % Change % Change
w.r.t. 2006 w.r.t. 2007 w.r.t. 2008
Balance Sheet
Total equity 114.32% 116.22% 104.78%
Total non-current liabilities 148.56% 146.02% 134.84%
Total current liabilities 102.08% 67.23%
Total liabilities 106.81% 79.97%
Total equity and liabilities 109.60% 112.31% 89.89%
Total non-current assets
Total current assets 101.71% 95.37% 71.94%
Total assets 109.60% 112.31% 89.89%
Profit and Loss Account
Net sales 137.68% 91.03%
Gross profit 124.05% 60.22% 143.93%
Operating profit 118.50% 4775.61%
Profit before tax 112.27% 18.28%
Profit after tax 112.29% 33.66% 97.74%

5. Compute ROE for the two companies for both years. Use DuPont analysis and comment
on the factors causing the change in returns.

SuperCo GearInc
Year 1 Year 2 Year 1 Year 2
Revenue 10,000 10,000 17,500 17,500
Net Income 1,000 1,200 2,100 2,100
Assets 5,000 4,800 8,750 8,750
Equity 2,000 2,000 5,000 3,500
6. Complete the financial statements for Southbay Corporation with given information.

Balance sheet
Current assets:
Cash ?
Accounts receivable, net ?
Inventory ?
Total current assets ?
Non-current assets:
Plant and equipment 580000
Less: Accumulated depreciation 80000
Total non-current assets ?
Total assets ?

Liabilities:
Current liabilities ?
Long-term debt, 8% interest ?
Total liabilities ?
Stockholders’ equity:
Common stock, $5 par value 300000
Retained earnings 100000
Total stockholder’s equity ?
Total liabilities and stockholder’s equity ?

Income Statement
Net Sales ?
Cost of goods sold ?
Gross Margin (25% of net sales) ?
Operating expenses ?
Operating income (10% of net sales) ?
Interest expense 28000
Net income before taxes ?
Less income taxes (40%) ?
Net income 60000

Additional Information:
a. The equity ratio is 40% and the debt ratio is 60%
b. The only interest expense was on long-term debt
c. The beginning inventory was $150000; the inventory turnover was 4.8 times.
d. The current ratio was 2 to 1; the quick ratio was 1 to 1
e. The beginning balance in accounts receivable was $80000; the accounts receivable
turnover for the year was 12.8 times. All sales were made on credit.