UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

ACADEMIC YEAR 2020/ 2021

BACHELOR OF ACCOUNTI NG (HONS)

YEAR 2 TRIMESTER 1

UKFF1023 FINANCIAL MANAGEMENT FUNDAMENTALS

TUTORIAL QUESTIONS

Tutorial 1

• Refer to Course Plan, brief the students on course learning outcomes

(CLOs) of this course.
• Refer to Course Plan, remind students on continuous assessment
(students’ group assignment and mid-term test). Mid-Term Test will be
given in WEEK 7, to monitor students’ progress on the understanding of
the lectures and tutorials from Topic 1 to 5. The duration of the test will be
TWO (2) hours. The attendance for this test is compulsory. The test is
OPENED BOOK and online assessment.
• Students’ group assignment will be given in WEEK 1 which involves an in-
depth ratio analysis and to appraise a listed firm in Bursa Malaysia.
Assignment submission: WEDNESDAY, 12PM, WEEK 9, upload to
WBLE. Each group is required to upload softcopy of their work with the file
name strictly following the format of UKFF1023_TUTORIAL GROUP
NO_COMPANY NAME, e.g. UKFF1023_T2_GENM. Failure to submit
assignment before the due date will be subject to Late Submission Penalty
Clause.
• Inform the students that they need to prepare and answer all the tutorial
questions before they attend tutorial class. Students are required to
present their answers to tutorial questions. Poor presentation and
insufficient efforts in preparation will result in poor performance in
continuous assessment and final assessment.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 2 (Topic 1)
An Overview of Financial Management

Question 1
Identify the primary characteristics of each form of legal organization.
(a) sole proprietor; (b) partnership; (c) corporation

Question 2
Using the following criteria, specify the legal form of business that is favoured:
(a) organizational requirements and costs
(b) liability of the owners
(c) continuity of business
(d) transferability of ownership
(e) management control and regulations
(f) ability to raise capital
(g) income taxes

Question 3
What are some of the problems involved in the use of profit maximization as the
goal of the firm? How does the goal of maximization of shareholder wealth deal with
those problems?

Question 4
Describe the primary role of a Financial Manager within a firm.

Question 5
Firms often involve themselves in projects that do not result directly in profits; for
example, Maxis and Magnum frequently support public television broadcasts. Do
these projects contradict the goal of maximization of shareholder wealth? Why or
why not?

Question 6
What is agency cost? Provide two examples of agency costs.

Question 7
Maximizing share price does not make sense because investors focus on short-term
results rather than long-term consequences. Give your comment.

Question 8
Discuss four (4) stakeholders to a firm, excluding its owners.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 9
The end-of-year parties at Yearling, Inc., are known for their extravagance.
Management provides the best food and entertainment to thank the employees for
their hard work. During the planning for this year’s bash, a disagreement broke
out between the treasurer’s staff and the controller’s staff. The treasurer’s staff
contended that the firm was running low on cash and might have trouble paying its
bills over the coming months; they requested that cuts be made to the budget for the
party. The controller’s staff believed that any cuts were unwarranted, as the firm
continued to be very profitable.
Can both sides be correct? Explain your answer.

Question 10
Recently, some branches of Donut Shop, Inc., have dropped the practice of allowing
employees to accept tips. Customer who once said, “Keep the change,” now have to
get used to waiting for their nickels. Management even instituted a policy of
requiring that the change be thrown out if a customer drives off without it. As a
frequent customer who gets coffee and doughnuts for the office, you notice that the
lines are longer and that more mistakes are being made in your order.
Explain why tips could be viewed as similar to stock options and why the delays and
incorrect orders could represent a case of agency costs. If tips are gone forever, how
could Donut Shop reduce these agency costs?

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 UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 3 (Topic 2)
Financial Statement and Taxes. Ratio Analysis. Financial Planning and Forecasting

Question 1
Using J. B. Chavez Corporation’s financial statements:
(a) Compute the following ratios for both 2018 and 2019.
Industry Norm
Current ratio 5.00
Acid-test (quick ) ratio 3.00
Inventory turnover 2.20
Average collection period 90.00
Debt ratio 0.33
Times interest earned 7.00
Total asset turnover 0.75
Fixed asset turnover 1.00
Operating profit margin 20%
Operating income return on
investment 15%
Return on common equity 13.43%
(b) How liquid is the firm?
(c) Is management generating adequate operating profit on the firm’s assets?
(d) How is the firm financing its assets?
(e) Are the common stockholders receiving a good return on their investment?
J.B. Chavez Corporation, Balance Sheet at 31/12/2018 and 31/12/2019
Liabilities and
Assets 31/12/2018 31/12/2019 owners' equity 31/12/2018 31/12/2019
Cash $225 $175 Accounts payable $250 $115
Notes payable - current
Accounts receivable 450.00 430 (9%) 0 115
Inventory 575.00 625 Current liabilities $250 $230
Current assets $1,250 $1,230 Bonds $600 $600
Plant and equipment $2,200 $2,500 Owners' equity
Less: Accumulated
depreciation (1000) (1200) Common stock $300 $300
Net plant and
equipment $1,200 $1,300 Paid-in-capital 600 600
Total assets $2,450 $2,530 Retained earnings 700 800
Total owners' equity $1,600 $1,700
Total liabilities and
owners' equity $2,450 $2,530

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

J.B. Chavez Corporation, Income Statement for the Years Ending 31/12/2018 and 31/12/2019
2018 2019
Sales $1,250 $1,450
Cost of goods sold 700 875
Gross profit $550 $575
Operating expenses 30 45
Depreciation 220 250 200 245
Net operating income $300 $330
Interest expense 50 60
Net income before taxes $250 $270
Taxes (40%) 100 108
Net income $150 $162

Question 2
The annual sales for Salco Inc., were $4.5 million last year. The firm’s end-of-year
balance sheet appeared as follows:
Current Assets $ 500,000 Liabilities $1,000,000
Net Fixed Assets $1,500,000 Owners’ Equity $1,000,000
$2,000,000 $2,000,000

The firm’s income statement for the year was as follows:

Sales $4,500,000
Less: Cost of goods sold ($3,500,000)
Gross profit $1,000,000
Less: Operating expenses ($ 500,000)
Operating income $ 500,000
Less: Interest expense ($ 100,000)
Earnings before taxes $ 400,000
Less: Taxes (50%) ($ 200,000)
Net Income $ 200,000

(a) Calculate Salco’s total asset turnover, operating profit margin and operating
income return on investment.

(b) Salco plans to renovate one of its plants, which will require an added
investment in plant and equipment of $1 million. The firm will maintain its
present debt ratio of 0.5 when financing the new investment and expects sales
to remain constant, while the operating profit margin will rise to 13 percent.
What will be the new operating income return on investment for Salco after
the plant renovation?

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

(c) Given that the plant renovation in part (b) occurs and Salco’s interest
expense rises by $50,000 per year, what will be the return earned on the
common stockholders’ investment? Compare this rate of return with that
earned before the renovation.

Question 3
The new owners of Bluegrass Natural Foods, Inc., have hired you to help them
diagnose and cure problems that the company has had in maintaining adequate
liquidity. As a first step, you perform a liquidity analysis. You then do an analysis of
the company’s short-term activity ratios. Your calculations and appropriate
industry norms are listed.
Industry
Ratio Bluegrass norm
Current ratio 4.5 4.0
Quick ratio 2.0 3.1
Inventory turnover 6.0 10.4
Average collection period 73 days 52 days
Average payment period 31 days 40 days

(a) What recommendations relative to the amount and the handling of inventory
could you make to the new owner?
(b) What recommendations relative to amount and handling of accounts
receivable could you make to the new owners?
(c) What recommendations relative to amount and handling of accounts
payable could you make to the new owners?
(d) What results, overall, would you hope your recommendations would achieve?
Why might your recommendations not be effective?

Question 4
Robert Arias recently inherited a stock portfolio from his uncle. Wishing to learn
more about the companies that he is now invested in, Robert performs a ratio
analysis on each one and decides to compare them to each other. Some of his ratios
are listed below.
Island Burger Fink Roland
Ratio Electric Utility Heaven Software Motors
Current ratio 1.10 1.30 6.80 4.50
Quick ratio 0.90 0.82 5.20 3.70
Debt ratio 0.68 0.46 0 0.35
Net profit margin 6.2% 14.3% 28.5% 8.4%

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Assuming that his uncle was a wise investor who assembled the portfolio with care,
Robert finds the wide differences in these ratios confusing. Help him out.
(a) What problems might Robert encounter in comparing these companies to
one another on the basis of their ratios?
(b) Why might the current and quick ratios for the electric utility and the fast-
food stock be so much lower than the same ratios for the other companies?
(c) Why might it be all right for the electric utility to carry a large amount of
debt, but not the software company?
(d) Why wouldn’t investors invest all of their money in software companies
instead of in less profitable companies? (Focus on risk and return.)

Question 5
Grenoble Enterprises had sales of $50,000 in March and $60,000 in April. Forecast
sales for May, June, and July are $70,000, $80,000, and $100,000, respectively. The
firm has a cash balance of $5,000 on May 1 and wishes to maintain a minimum cash
balance of $5,000. Given the following data, prepare and interpret a cash budget for
the months of May, June, and July.
(1) The firm makes 20% of sales cash, 60% are collected in the next month, and the
remaining 20% are collected in the second month following sale.
(2) The firm receives other income of $2,000 per month.
(3) The firm’s actual or expected purchases, all made for cash, are $50,000, $70,000,
and $80,000 for the months of May through July, respectively.
(4) Rent is $3,000 per month.
(5) Wages and salaries are 10% of the previous month’s sales.
(6) Cash dividends of $3,000 will be paid in June.
(7) Payment of principal and interest of $4,000 is due in June.
(8) A cash purchase of equipment costing $6,000 is scheduled in July.
(9) Taxes of $6,000 are due in June.

Question 6
Consider the balance sheets and selected data from the income statement of Keith
Corporation.
Keith Corporation
Balance Sheets
December 31
Assets
2019 2018
Cash $ 1,500 $ 1,000
Marketable securities 1,800 1,200
Account receivable 2,000 1,800
Inventories 2,900 2,800
Total current assets $ 8,200 $ 6,800
Gross fixed assets $ 29,500 $ 28,100

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Less: Accumulated depreciation 14,700 13,100

Net fixed assets $ 14,800 $ 15,000
Total assets $ 23,000 $ 21,800
Liabilities and Stockholders’ Equity
Accounts payable $ 1,600 $ 1,500
Notes payable 2,800 2,200
Accruals 200 300
Total current liabilities $ 4,600 $ 4,000
Long-term debt $ 5,000 $ 5,000
Common stock $ 10,000 $ 10,000
Retained earnings 3,400 2,800
Total stockholders’ equity $ 13,400 $ 12,800
Total liabilities and stockholders’ equity $ 23,000 $ 21,800
Income Statement Data (2019)
Depreciation expense $1,600
Earnings before interest and taxes (EBIT) 2,700
Interest expense 367
Net profit after taxes 1,400
Tax rate 40%

(3.1) Cash flow from operations = Net profits after taxes + Depreciation and other
noncash charges
(3.2) Net operating profits after taxes = Earnings before interest and taxes x (1 –
Applicable corporate tax rate)
(3.3) Operating cash flow = Net operating profits after taxes + Depreciation
(3.4) Operating cash flow = [Earnings before interest and taxes x (1 – Applicable
corporate tax rate)] + Depreciation
(3.5) Free cash flow = Operating cash flow – Net fixed asset investment – Net
current asset investment
(3.6) Net fixed asset investment = Change in net fixed assets + Depreciation
(3.7) Net current asset investment = Change in current assets – Change in (accounts
payable + accruals)

(a) Calculate the firm’s accounting cash flow from operations for the year ended
December 31, 2019, using Equation 3.1.
(b) Calculate the firm’s net operating profit after taxes (NOPAT) for the year
ended December 31, 2019, using Equation 3.2.
(c) Calculate the firm’s operating cash flow (OCF) for the year ended December
31, 2019, using Equation 3.3.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

(d) Calculate the firm’s free cash flow (FCF) for the year ended December 31,
2019, using Equation 3.5.
(e) Interpret, compare, and contrast your cash flow estimates in parts a, c, and d.

Question 7
What is net working capital? How is it different from gross working capital? What
is the difference between interest-bearing debt and non-interest-bearing debt?

Question 8
Discuss the reasons why one firm could have positive cash flows and be headed for
financial trouble, and another firm with negative cash flows could actually be in a
good financial position.

Question 9
(a) Current ratio shows the ability of the company to meet its short-term
obligations when due. The higher the current ratio, the better it is. Discuss.
(b) Differentiate between ‘overtrading’ and ‘overcapitalisation’. Which financial
ratios could signal these conditions?

Question 10
Explain five (5) limitations of financial ratio analysis. Give example to illustrate
whenever appropriate.

Question 11
(a) Describe the use of DuPont analysis.
(b) Is it possible for a company to have an increase in operating income return
on investment when its operating profit margin is reducing? Explain.

Question 12
Explain the term ‘free cash flows’. Briefly explain how to calculate free cash flows
from asset perspective.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 4 (Topic 3)
The Financial Environment: Markets, Institutions & Interest Rate. Raising Capital
in the Financial Markets. Sources of Finance

Question 1
(a) Describe the key role of a financial market and how an economy might lose
out when its financial markets are not developed.
(b) Explain and discuss how corporations raise capital in the financial markets.
(c) What is an investment banker, and what major functions does he or she
perform?

Question 2
(a) Differentiate the following terms:
(i) Primary market and Secondary market
(ii) Initial Public Offering and Seasoned Offering
(b) Why might a large corporation want to raise long-term capital through a
private placement rather than a public offering?

Question 3
Briefly explain disadvantages for firms to go public.

Question 4
Name two regulatory bodies that supervise and manage the local securities industry
in Malaysia. Support your answers with their core functions.

Question 5
Briefly describe four money market instruments traded in Malaysia.

Question 6
Identify three distinct ways that savings are ultimately transferred to business firms
in need of cash.

Question 7
Nemo Berhad has 18 million RM0.50 ordinary shares in issue. The current market
value of its shares is RM1.70 per share. The directors have decided to announce a
one for three rights issue at RM1.25 each. Suppose you hold 3,000 shares of this
firm.
(a) What, in theory, will be the ex-rights price of the shares?
(b) If you wish to sell the rights off, how much could you ask for each?
(c) Will it matter to you, if you allow the rights to lapse? Why or why not? Show
with computations.
(d) Explain any two (2) factors considered in respect to rights issues.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 8
Endo Berhad currently has 4 million shares issued and outstanding, valued at
RM2.00 each, and the company has annual earnings equal to 20% of the market
value of the shares. A two for five rights issue is proposed at an issue price of
RM1.65 each. If the market continues to value the shares on a price/earnings ratio
of 5, what would be the value per share if the new funds are expected to earn, as a
percentage of the money raised: (i) 15%, (ii) 20%, and (iii) 25%. How would these
values from (i), (ii) and (iii) compare with the theoretical ex-rights price? Explain
the differences.

Question 9
Distinguish the Equity Crowdfunding (ECF) and Peer-to-Peer (P2P) financing for
small businesses or start-ups. Justify the main difference of both financing
methods.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 5 (Topic 4)
The Time Value of Money

Question 1
(a) What is time value of money? Why is it important?
(b) How would an increase in the interest rate (i) or a decrease in the holding
period (n) affect the future value (FVn) of a sum of money? Explain why.
(c) Given a discount rate, future value of a sum of money rises at an increasing
rate as time period becomes longer, whereas present value of a sum of money
falls at a decreasing rate as time period becomes longer. Explain.
(d) What is an annuity? Give some examples of annuities? Distinguish between
an annuity and perpetuity.

Question 2
As finance manager of Lions Ltd., you are given three investment alternatives to
analyze. The cash flows from these three investments are as follows:

END OF YEAR A B C
1 $10,000 $10,000
2 $10,000
3 $10,000
4 $10,000
5 $10,000 $10,000
6 $10,000 $50,000
7 $10,000
8 $10,000
9 $10,000
10 $10,000 $10,000
Assume a 20 percent discount rate. Find the present value of each investment.

Question 3
You are trying to plan for retirement in 10 years and currently you have $100,000 in
a savings account and $300,000 in stocks. In addition, you plan to add to your
savings by depositing $10,000 per year in your savings account at the end of each of
the next five years and then $20,000 per year at the end of each year for the final
five years until retirement.
(a) Assuming your savings account returns 7 percent compounded annually and
your investment in stocks will return 12 percent compounded annually, how
much will you have at the end of 10 years? (Ignore taxation).
(b) If you expect to live for 20 years after retirement, and at retirement you
deposit all of your savings in a bank account paying 10 percent, how much
can you withdraw each year after retirement (20 equal withdrawals
beginning one year after you retire) to end up with a zero balance at death?

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 4
Find net present value of an investment that yield the following cash flows:
Year 1 to 3: - RM 50,000 per annum
Year 4 until forever: RM 28,000 per annum
Cost of capital for the company is maintained at 12.5% per annum.
Should the investment be undertaken?

Question 5
Hishamuddin wants to buy a house in 2 years, that is expected to cost RM200,000 at
that time. He wants to fund with a housing loan but he can afford payments of only
RM1,000 per month on a 30 years, 9% loan. He currently has RM20,000 in a fixed
deposit account that pay 6% compounded monthly. Calculate how much more cash
he needs to pay as down payment.

Question 6
Upon retirement, your goal is to spend 5 years traveling around the world. To travel
in style will require RM 250,000 per year at the beginning of each year.
If you plan to retire in 30 years from today, what are the equal monthly payments
necessary to achieve this goal? The funds in your retirement account will compound
annually at 10%.

Question 7
For each of the mixed streams of cash flows shown in the following table, determine
the future value at the end of the final year if deposits are made into an account
paying annual interest of 12%, assuming that no withdrawals are made during the
period and that the deposits are made:
(a) At the end of each year.
(b) At the beginning of each year.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 8
You deposit $5,000 today for 6 years into a savings account that pays 16% interest.
(a) How much will you have in your savings account after 6 years if the interest
is compounded: annually; semiannually; quarterly.
(b) Find the effective annual rate (EAR) if the interest is compounded: annually;
semiannually; quarterly.

Question 9
A debt of RM5,000 with interest at 5% compounded semi-annually is amortised by
equal semi-annual payments over the next 3 years.
(a) Calculate the amount of each installment payment.
(b) Construct an amortisation schedule.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 6 (Topic 5)
Risk and Rates of Return

Question 1
Three assets – F, G, and H – are currently being considered by Perth Industries.
The probability distributions of expected returns for these assets are shown in the
following table.

Asset F Asset G Asset H

j Prj Return, kj Prj Return, kj Prj Return, kj
1 0.1 40% 0.4 35% 0.1 40%
2 0.2 10% 0.3 10% 0.2 20%
3 0.4 0% 0.3 -20% 0.4 10%
4 0.2 -5% 0.2 0%
5 0.1 -10% 0.1 -20%
−
(a) Calculate the expected value of return, k , for each of the three assets. Which
provides the largest expected return?
(b) Calculate the standard deviation, σk, for each of the three assets’ returns.
Which appears to have the greatest risk?
(c) Calculate the coefficient of variation, CV, for each of the three assets’
returns. Which appears to have the greatest relative risk?

Question 2
A multinational company is thinking of investing in two overseas locations for a
planned expansion of its production facilities. The future returns from the
investments depend to a large extent on the economic situation of the countries
under consideration. An analysis of the expected rates of return under three
different scenarios is as follows:
Probability Expected return of country A Expected return of country B
0.3 20% 10%
0.3 10% 20%
0.4 15% 20%
(a) Calculate the mean return and the standard deviation of the returns from the
investment in each country.
(b) Comment what would be the expected return and standard deviation of the
portfolio if the available funds were split 20% to country A and 80% to
country B, and the correlation between returns of the two countries are:
(i) 0
(ii) +1
(iii) –1

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 3
Colours Plc. is considering two mutually exclusive investments: Black and White.
The possible net present values for both projects and the associated probabilities are
as follows:
BLACK WHITE
Probability NPV Probability NPV
0.1 RM 10 million 0.6 RM 15 million
0.5 RM 20 million 0.2 RM 20 million
0.4 RM 25 million 0.2 RM 40 million
(a) Determine the levels of risk of each investment project in RM terms.
(b) Assuming, the management is risk averse, justify the investment it should
accept.

Alternatively, the firm has an opportunity to invest in two overseas locations for a
planned expansion of its production facilities. The future returns from the
investments depend to a large extent on the economic situation of the countries
under consideration. An analysis of the expected rates of return under three
different scenarios is as follows:
Probability Expected Return of Region 1 Probability Expected Return of Region 2
0.3 30% 0.2 50%
0.4 25% 0.6 30%
0.3 20% 0.2 10%
*Assume the correlation coefficient between returns from the two countries to be 1.0.
(c) What would be the expected return and standard deviation of the portfolio if
the available funds were split 60% to Region 1 and 40% to Region 2?
(d) Should the firm consider expanding operations in both the regions? Justify.

Question 4
Mr Rich owns a portfolio consisting shares of five public listed firms. The details of
these securities and his asset allocation are provided below:
Security Number of Market Price per Beta Actual
Shares share Coefficient return
RM %
Happiness 11,000 2.00 0.75 13.00
Fit 25,000 1.80 0.90 14.60
Wealth 12,000 2.75 0.60 11.40
Success 16,000 1.50 1.60 20.30
Kind 20,000 2.60 1.20 16.60
The market return is 15% and risk-free investments offer 7%.
(a) Calculate the required rate of return for each security in Mr Rich’s portfolio
using the Capital Asset Pricing Model. Which securities over-performed?
(b) Determine the portfolio beta. Is this portfolio riskier than the market?
Justify.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 5
Jamie Peters invested $100,000 to set up the following portfolio one year ago:
Asset Cost Beta of purchase Yearly income Value today
A $20,000 0.8 $1,600 $20,000
B 35,000 0.95 1,400 36,000
C 30,000 1.5 - 34,500
D 15,000 1.25 375 16,500
(a) Calculate the portfolio beta on the basis of the original cost figures.
(b) Calculate the percentage return of each asset in the portfolio for the year.
(c) Calculate the percentage return of the portfolio on the basis of original cost,
using income and gains during the year.
(d) At the time Jamie made his investments, investors were estimating that the
market return for the coming year would be 10%. The estimate of the risk-
free rate of return averaged 4% for the coming year. Calculate a required
rate of return for each stock on the basis of its beta and the expectations of
market and risk-free returns.
(e) On the basis of the actual results, explain how each stock in the portfolio
performed relative to those CAPM-generated required performance. What
factors could explain these differences?

Question 6
Wolff enterprises must consider several investment project, A through E, using the
capital asset pricing model (CAPM) and its graphical representation, the security
market line (SML). Relevant information is presented in the following table.

Item Rate of return Beta, 

Risk-Free asset 9% 0
Market portfolio 14% 1.00
Project A -- 1.50
Project B -- 0.75
Project C -- 2.00
Project D -- 0
Project E -- -0.5

(a) Calculate (1) the required rate of return and (2) the risk premium for each
project, given its level of non-diversifiable risk.
(b) Use in your finding in part (a), to draw the security market line (required
return relative to non-diversifiable risk).

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

(c) Discuss the relative non diversifiable of projects A through E.

(d) Assume that as a result of recent economic events, investors to become less
risk averse, causing the market returns to decline by 2%, to 12%. Calculate
the new required return for asset A through E, and draw the new security
market line (SML) on the same set of axes that you used in part (b).
(e) Compare your finding in parts (a) and (b) with those in part d. what
conclusion can you draw about the impact of a decline in investor risk
aversion on the required returns of risky assets?

Question 7
How are total risk, non-diversifiable risk, and diversifiable risk related? Why is
non-diversifiable risk the only relevant risk?

Question 8
(a) What risk does beta measure? How can you find the beta of a portfolio?
(b) Define the Security Market Line.

Question 9
Risk and return are linearly related, but do not necessarily move at the same rate.
How then, can different assets be relatively compared?

Question 10
What impact would the following changes have on the security market line and
therefore on the required return for a given level of risk?
(a) an increase in inflationary expectations
(b) investors become less risk-averse

Question 11
Describe any two (2) assumptions of the Capital Asset Pricing Model.

Question 12
(a) What is price efficiency in the context of stock markets?
(b) Elaborate any five implications of market efficiency.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 7 (Topic 6)
Fixed Income Securities: Characteristics and Valuation. Valuation and
Characteristics of Bonds

Question 1
Telink Corporation bonds pay $110 in annual coupon interest, with a $1,000 par
value. The bonds mature in 20 years. Your required rate of return is 9 percent.

(a) Calculate the value of the bond.

(b) How does the value change if
(i) your required rate of return (k) increases to 12 percent, or
(ii) decreses to 6 percent
(c) Interpret your findings in part (a) and (b).

Question 2
Calculate the yield-to-maturity (YTM) and current yield for each of the bonds
below:
Bond Par Value Market Price Coupon rate (%) Years to maturity
A RM1,000 RM820 9% annually 8
B RM100 RM108 2.5% semiannually 5
C RM500 RM560 12% annually 12
(Note: For YTM calculation, use the approximate formula)

Question 3

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FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 4
What is ‘term structure of interest rates’?
What are the term structure theories that explain an upward sloping yield curve?

Question 5
Given the following information on ABC Corporation’s bonds:
Coupon rate = 9%
Current yield = 9.62%
Call premium = 12.25%
Par value = $1,000
Years to call = 6 years
Years to maturity = 11 years
If the bond pays coupons semiannually, compute its yield-to-call (YTC) by using
financial calculator.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 8 (Topic 7)
Common Stocks: Characteristics and Valuation. Stock Valuation

Question 1
Nesta Berhad has a beta of 1.8 and has just paid a dividend of RM0.80 per share. Its
dividend is expected to grow at 5% per annum for the foreseeable future. Return on
Treasury security is 4% and risk premium for market portfolio is 10%. Is it
worthwhile to purchase Nesta Berhad’s ordinary shares at its current market price
of RM5.50 per share?

Question 2
Dhabi Sdn Bhd paid dividend of RM250,000 this year. Current return to
shareholders of companies in the same industry as Dhabi is 12%, although an
additional risk premium of 2% is applicable to Dhabi, being a smaller and non-
listed company. Dhabi has 1,000,000 authorized ordinary shares, but only 800,000
shares are currently issued and outstanding. What is the fair price for Dhabi’s
ordinary shares, if:
(a) the current level of dividend is expected to continue for the foreseeable future
(b) the dividend is expected to grow at a rate of 4% p.a. into the foreseeable
future
(c) the dividend is expected to grow at a rate of 3% p.a. for three years, and 2%
p.a. thereafter

Question 3
Home Place Hotels Inc. is entering into a 3-year remodelling and expansion project.
The construction will have a limiting effect on earnings during that time, but when
it is complete, it should allow the company to enjoy much improved growth in
earnings and dividends. Last year, the company paid a dividend of $3.40. It expects
zero growth in the next year. In years 2 and 3, 5% growth is expected, and in year
4, 15% growth. In year 5 and thereafter, growth should be a constant 10% per
year. What is the maximum price per share that an investor who requires a return
of 14% should pay for Home Place Hotel’s common stock?

Question 4
Using the free cash flow valuation model to price an IPO. Assume that you have an
opportunity to buy the stock of CoolTech, Inc., an IPO being offered for $12.50 per
share. Although you are very much interested in owning the company, you are
concerned about whether it is fairly priced. To determine the value of the shares,
you have decided to apply the free cash flow valuation model to the firm’s financial
data that you’ve developed from a variety of data sources. The key values you have
compiled are summarised in the following table.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Free cash flow

Year(t) FCFt Other data
2016 700,000 Growth rate of FCF, beyond 2019 to infinity = 2%
2017 800,000 Weighted average cost of capital = 8%
2018 950,000 Market value of all debt = $2,700,000
2019 1,100,000 Market value of preferred stock = $1,000,000
No. of shares of common stock outstanding = 1,100,000

(a) Use the free cash flow valuation model to estimate CoolTech’s common stock
value per share.
(b) Judging on the basis of your finding in part (a) and the stock’s offering price,
should you buy the stock?

Question 5
Today is 1st January 2020. PLEP Group expects to generate the following free cash
flows at the end of year (31st December):
2020: $200,000
2021: $250,000
2022: $310,000
2023: $350,000
2024: $390,000
2025 and therefore: grow at 3% per annum for the foreseeable future
PLEP Group has a weighted average cost of capital of 11%. It had issued 225,000
ordinary shares with 25,000 of which being repurchased from open market and kept
in treasury in anticipation of exercising of its employee share option scheme. It also
has $1.5 million redeemable debentures and $400,000 preferred shares in issue.
Estimate PLEP Group ordinary share value using discounted free cash flow
method.

Question 6
State four (4) factors that might cause the market value of an asset to deviate from
its book value.

Question 7
Juve Bhd recently paid a dividend per share of RM1.50. It maintain a constant
payout ratio of 40% of its earnings. Juve Bhd has two major rivals in its industry,
namely Bayern Bhd and Barca Bhd. Bayern Bhd has a PE ratio of 9.6 times while
Barca Bhd has a PE ratio of 9.0 times.
Estimate Juve Bhd fair price per share using PE method.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 8 (Topic 8)
The Cost of Capital

Question 1
Ruffles Incorporated reported net earnings of RM4.2 million last year. It paid a
dividend of RM1.26 per share for the 1 million shares outstanding. The firm’s
capital structure includes 40% debt and 60% common share. The tax rate is 28%.
(a) If Ruffles shares are trading at RM40 and dividends are expected to grow at
6%, determine the cost of financing with retained earnings.
(b) If underwriting and flotation costs are RM7.00 per share, what is the cost of
issuing new shares to the firm?
(c) The firm can issue 10%, 5- year bonds at a premium at RM1,200 each. What
is the cost of debt financing, if floatation cost is RM25 per bond? Face value
of the bond is RM1,000 each.
(d) Calculate Ruffles Inc.’s weighted average cost of capital.

Question 2
As the Finance Director for Ginger Bread Berhad, you have been asked to estimate
the firm’s weighted average cost of capital.
Using the information below, perform the necessary calculations, using market
values.
Capital Structure:
11% bonds (redeemable in 5 years) RM80,000
*Ordinary Shares (RM0.25 par) RM90,000
**9% Preference Shares (RM1 par) RM50,000
Retained Earnings RM145,000
Note: The above are all in book values.
→ Current dividend, to be paid soon is RM0.20 per share. Dividends are
expected to grow at 5% per year.
→ The interest rate on short-term bank borrowings stands at 12.6%.
→ Stock market prices as at 30 June 2017 (all ex-dividend); *RM1.76 and
**RM0.67 respectively.
→ Bond market price as at the 30 June 2017 (all ex-interest); RM950.
Assume a corporate tax of 28%.

Question 3
The capital structure for Nealon, Inc., follows:
Nelaon, Inc., Balance Sheet
Percentage of
Type of financing future financing
Bonds (8%, $1,000 par, 16-year maturity) 38%
Preferred stock (5,000 shares outstanding, $50 par,
$1.50 dividend) 15%

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Common stock 47%

Total 100%

Flotation costs are (a) 15 percent of market value for a new bond issue, (b) $1.21 per
share for common stock, and (c) $2.01 per share for preferred stock. The dividends
for common stock were $2.50 last year and are projected to have an annual growth
rate of 6 percent. The firm is in a 34 percent tax bracket.
Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common
stock. There will be sufficient internal common equity funding (i.e., retained
earnings) available such that the firm does not plan to issue new common stocks.
What is the weighted average cost of capital if the firm financing are in the above
mentioned proportions?

Question 4
Dillon Labs has asked its financial manager to measure the cost of each specific type
of capital as well as the weighted average cost of capital. The weighted average cost
is to be measured by using the following weights: 40% long-term debt, 10%
preferred stock, and 50% common stock equity (retained earnings, new common
stock, or both). The firm’s tax rate is 40%.
Debt
The firm can sell for $980 a 10-year,$1,000-par-value bond paying annual interest at
a 10% coupon rate. A flotation cost of 3% of the par value is required.
Preferred stock
Eight percent (annual dividend) preferred stock having a par value of $100 can be
sold for $65. An additional fee of $2 per share must be paid to the underwriters.
Common stock
The firm’s common stock is currently selling for $50 per share. The dividend
expected to be paid at the end of the coming year (2019) is $4. Its dividend
payments, which have been approximately 60% of earnings per share in each of the
past 5 years, were as shown in the following table.

Year Dividend
2018 $3.75
2017 3.50
2016 3.30
2015 3.15
2014 2.85

It is expected that in order to sell, new common stock must be underpriced $5 per
share, and the firm must also pay $3 per share in flotation costs. Dividend payments
are expected to continue at 60% of earnings.
(a) Calculate the specific cost of each source of financing.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

(b) If earnings available to common shareholders are expected to be $7 million,

what is the break point associated with the exhaustion of retained earnings?
(c) Determine the weighted average cost of capital between zero and the break
point calculated in part b.
(d) Determine the weighted average cost of capital just beyond the break point
calculated in part (b).

Question 5
Using the data for each firm shown in the following table, calculate the cost of
retained earnings and the cost of new common stock using the constant-growth
valuation model.

Current Dividend Projected Under- Floatation

market price growth dividend per pricing cost per
Firm per share rate share next year per share share
A $50.00 8% $2.25 $2.00 $1.00
B 20.00 4 1.00 0.50 1.50
C 42.50 6 2.00 1.00 2.00
D 19.00 2 2.10 1.30 1.70

Question 6
Federico Berhad has the following capital structure:
Book Value Market Value
Debt RM500 RM550
Preferred Stock RM100 RM120
Common Equity RM1,400 RM4,330
New corporate bonds can be issued at par if they have a coupon of 7%. The current
yield on newly-issued preferred stock is 6%. Risk free rate is 3% and market risk
premium is 5%. If Federico Berhad has a stock beta of 2.0 and a corporate tax of
25%, what is the company’s weighted average cost of capital?

Question 7
(a) How does a firm’s tax rate affect its cost of capital? What is the effect of the
floatation costs associated with a new security issue?
(b) Distinguish between internal and external equity. Why is there a cost
associated with internal equity?

Question 8
(a) Why is it crucial for a firm to calculate its cost of capital accurately?
(b) Briefly discuss the Modigliani-Miller Proposition 1.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 9 (Topic 9)
Analysis and Impact of Leverage

Question 1
Famous Caterer Berhad (FCB) has an expected sales of RM20 million. Fixed
operating costs are RM2.5 million, and the variable cost ratio is 65%. It has an
outstanding RM12 million, 8% bank loan and an outstanding shares of 1 million
ordinary shares (RM1 par). Assume corporate tax rate is 28%.
(a) What is FCB’s degree of operating leverage at a sales level of RM20 million?
(b) What is FCB’s current degree of financial leverage?
(c) What is the combined leverage of FCB?
(d) Forecast FCB’s earnings per share if sales drop to RM15 million.
(e) What information does the degree of financial leverage provide in decision
making?

Question 2
Footwear, Inc., manufactures a complete line of men’s and women’s shoes for
independent merchants. The average selling price of its finished product is $85 per
pair. The variable cost for this same pair of shoes is $58. Footwear, Inc., incurs
fixed costs of $170,000 per year.
(a) What is the break-even point in pairs of shoes for the company?
(b) What is the dollar sales volume the firm must achieve to reach the break-
even point?
(c) What would be the firm’s profit or loss at the following units of production
sold: 7,000 pairs of shoes? 9,000 pairs of shoes? 15,000 pairs of shoes?
(d) Find the degree of operating leverage for the production and sales levels
given in the part (c).

Question 3
Northwestern Savings and Loan has a current capital structure consisting of
$250,000 of 16% (annual interest) debt and 2,000 shares of common stock. The firm
pays taxes at the rate of 40%.
(a) Using EBIT values of $80,000 and $120,000, determine the associated
earnings per share (EPS).
(b) Using $80,000 of EBIT as a base, calculate the degree of financial leverage
(DFL).
(c) Rework parts (a) and (b) assuming that the firm has $100,000 of 16%
(annual interest) debt and 3,000 shares of common stock.

Question 4
Discuss factors that influence business risk of a firm.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 5
(a) Distinguish between business risk and financial risk. What gives rise to, or
causes, each type of risk?
(b) What are business risk and financial risk? How does each of them influence
the firm’s capital structure decisions?

Question 6
A manager in your firm decides to employ break-even analysis. Of what
shortcomings should this manager be aware?

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 10 (Topic 10)

The Basic of Capital Budgeting. Cash Flows Analysis

Question 1
(a) Why do we focus on cash flows rather than accounting profits in making our
capital-budgeting decisions? Why are we interested only in incremental cash
flows rather than total cash flows?
(b) How do sunk costs affect the determination of cash flows associated with an
investment proposal?

Question 2
Garcia’s Truckin’ Inc. is considering the purchase of a new production machine for
$200,000. The purchase of this machine will result in an increase in earnings before
interest and taxes of $50,000 per year. To operate this machine properly, workers
would have to go through a brief training session that would cost $5,000 after tax.
In addition, it would cost $5,000 after tax to install this machine properly. Also,
because this machine is extremely efficient, its purchase would necessitate an
increase in inventory of $20,000. This machine has an expected life of 10 years, after
which it will have no salvage value. Finally, to purchase the new machine, it
appears that the firm would have to borrow $100,000 at 8 percent interest from its
local banks, resulting in additional interest payments of $8,000 per year. Assume
simplified straight-line depreciation and that this machine is being depreciated
down to zero, a 34 percent marginal tax, and a required rate of return of 10 percent.
(a) What is the initial outlay associated with this project?
(b) What are the annual after-tax cash flows associated with this project for
years 1 through 9?
(c) What is the terminal cash flow in year 10 (what is the annual after-tax cash
flow in year 10 plus any additional cash flows associated with termination of
the project)?
(d) Should this machine be purchased?

Question 3
A firm is considering the following three separate situations.
Situation A Build either a small office building or a convenience store on a parcel
of land located in a high-traffic area. Adequate funding is available, and both
projects are known to be acceptable. The office building requires an initial
investment of $620,000 and is expected to provide operating cash inflows of $40,000
per year for 20 years. The convenience store is expected to cost $500,000 and to
provide a growing stream of operating cash inflows over its 20-year life. The initial
operating cash inflow is $20,000, and it will increase by 5% each year.
Situation B Replace a machine with a new one that requires a $60,000 initial
investment and will provide operating cash inflows of $10,000 per year for the first 5
years. At the end of year 5, a machine overhaul costing $20,000 will be required.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

After it is completed, expected operating cash inflows will be $10,000 in year 6;

$7,000 in year 7; $4,000 in year 8; and $1,000 in year 9, at the end of which the
machine will be scrapped.
Situation C Invest in any or all of the four machines whose relevant cash flows are
given in the following table. The firm has $500,000 budgeted to fund these machines,
all of which are known to be acceptable. Initial investment for each machine is
$250,000.
Operating cash inflows
Year Machine 1 Machine 2 Machine 3 Machine 4
1 $50,000 $70,000 $65,000 $90,000
2 70,000 70,000 65,000 80,000
3 90,000 70,000 80,000 70,000
4 -30,000 70,000 80,000 60,000
5 100,000 70,000 -20,000 50,000

For each situation, indicate:

(a) Whether the projects involved are independent or mutually exclusive.
(b) Whether the availability of funds is unlimited or capital rationing exists.
(c) Whether accept-reject or ranking decisions are required.
(d) Whether each project’s cash flows are conventional or non-conventional.

Question 4
Covol Industries is developing the relevant cash flows associated with the proposed
replacement of an existing machine tool with a new, technologically advanced one.
Given the following costs related to the proposed project, explain whether each
would be treated as a sunk cost or an opportunity cost in developing the relevant cash
flows associated with the proposed replacement decision.
(a) Covol would be able to use the same tooling, which had a book value of
$40,000, on the new machine toll as it had used on the old one.
(b) Covol would be able to use its existing computer system to develop programs
for operating the new machine tool. The old machine tool did not require
these programs. Although the firm’s computer has excess capacity available,
the capacity could be leased to another firm for an annual fee of $17,000.
(c) Covol would have to obtain additional floor space to accommodate the larger
new machine tool. The space that would be used is currently being leased to
another company for $10,000 per year.
(d) Covol would use a small storage facility to store the increased output of the
new machine tool. The storage facility was built by Covol 3 years earlier at a
cost of $120,000. Because of its unique configuration and location, it is
currently of no use to either Covol or any other firm.
(e) Covol would retain an existing overhead crane, which it had planned to sell
for its $180,000 market value. Although the crane was not needed with the

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

old machine tool, it would be used to position raw materials on the new
machine tool.

Question 5
(a) If depreciation is not a cash flow item, why does it affect the level of cash
flows from a project in any way?
(b) What effect do sunk costs and opportunity costs have on a project’s
incremental cash flows?

Question 6
What are the common reasons for capital rationing? Is capital rationing rational?

Question 7
DuPree Coffee Roasters, Inc., wishes to expand and modernize its facilities. The
installed cost of a proposed computer-controlled automatic-feed roaster will be
$130,000. The firm has a chance to sell its 4-year-old roaster for $35,000. The
existing roaster originally cost $61,000 and was being depreciated using MACRS
table and a 7-year recovery period. DuPree pays taxes at a rate of 40% on ordinary
income and capital gains.

(a) What is the net book value of the existing roaster?

(b) Calculate the after-tax proceeds of the sale of the existing roaster.
(c) Calculate the change in net working capital using the following figures:

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Anticipated Changes in Current

Assets and Current Liabilities

Accruals -$20,000
Inventory 50,000.00
Accounts payable 40,000.00
Accounts receivable 70,000.00
Cash 0
Notes payable 15,000.00
(d) Calculate the initial investment associated with the proposed new roaster.

Question 8
Ultra Berhad (UB) has a proposed contract with Spltra Berhad. The initial
investment in land and equipment will be RM120,000. Of this amount, RM70,000 is
subject to five-year Industrial Building Allowance/Capital Allowance – Purchased
Assets depreciation (Year 1: 20%; Year 2: 32%; Year 3: 19.2%; Year 4: 11.5%;
Year 5: 11.5%; Year 6: 5.8%). The balance is in non-depreciable property. The
contract covers six years; at the end of six years the non-depreciable assets will be
sold for RM50,000. The depreciated assets will have zero resale value.
The contract will require an additional investment of RM55,000 in working capital
at the beginning of the first year and, of this amount, RM25,000 will be returned
after six years.
The investment will produce RM50,000 in income before depreciation and taxes for
each of the six years. The company is in a 40 percent tax bracket and has a 10
percent cost of capital.
Determine the cash flow for this investment. Use the net present value method to
explain whether this investment should be undertaken.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 11 (Topic 11)

Capital Budgeting Techniques and Decision Criteria

Question 1
Clean & Clear Berhad is considering to invest in a developmental research project.
The investment opportunities Project A and Project B, are mutually exclusive and
have the following estimated cash flows
Year Project A Project B
0 -$125,000 -$125,000
1 $62,500 $22,500
2 $62,500 $22,500
3 $25,000 $75,000
4 $25,000 $75,000
(a) Compute the net present value for both the projects using trial and error
approach.
(b) Compute the internal rates of returns of both projects given a 10% cost of
capital for the firm.
(c) If the firm is able to reinvest the cash flows from the projects and earn a 10%
annual rate of return, which project has the highest expected rate of return?
(d) Which project should the firm adopt? Why?

Question 2
Healthy Food Inc. is considering switching its manually operated machine with a
new automated machine. Although the existing unit has 5 more years of service life,
its operating costs are fairly high compared to its revenue.
The new automated machine costs RM2.5 million. An additional RM100,000 is
needed for transportation and installation. The new machine is expected to generate
incremental revenues of RM2 million with an incremental overhead cost of
RM700,000 per year. It will be depreciated on a straight line method over 5 years to
a salvage value of RM200,000.
(a) Define the three basic cash flows involved in a typical capital budget. Is the
above investment a replacement or an expansionary project? Justify.
(b) If the firm’s cost of capital is 12%, calculate the following:
(i) Payback period
(ii) Net Present Value
(iii) Internal Rate of Return
(c) Advise the management on whether it should go ahead with this investment
or not. Justify.

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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 3
Cure Berhad, a leading pharmaceutical firm, is evaluating its capital structure. The
balance sheet of the firm is as follows:

Assets (RM’ million) Liability (RM’ million)

Fixed 4,000 Long-term debt 2,500
Current 1,000 Equity 2,500
Total 5,000 Total 5,000

• The debt is in the form of bonds, with coupon rate of 10%. These bonds are
yielding 12% return. The market value is 80% of the face value.
• The firm currently has 50 million shares outstanding which is trading at RM80 per
share. It pays a dividend of RM4 per share and has a price/earning ratio of 10.
• The firm has a beta of 1.2 and Treasury bill offers 8%. Market risk premium is
5.5%.
• The tax rate is 28%.
(a) What is the debt/equity ratio for this firm in book value terms? Why does it
differ when the ratio is in market value terms?
(b) Determine the firm’s current weighted average cost of capital.

Now assume that Cure Berhad is considering an investment project costing RM100
million that has the following estimated annual income statement:
EBIT RM20.00 million
Interest RM 4.00 million
EBT RM16.00 million
Taxes RM 4.48 million
Net Income RM11.52 million
Depreciation for this project is expected to be RM5 million a year to perpetuity.
Assume cash flow is also for perpetuity.
(c) Evaluate this proposal from the shareholders standpoint.
(d) Evaluate this proposal from the firm’s standpoint.

Question 4
(a) What is the fundamental flaws of using the internal rate of return in making
investment decisions?
(b) Payback period is an appraisal technique that ignores the concept of time
value of money. How can it be adjusted for use as an investment decision-
making tool?

Question 5
When might two mutually exclusive projects having unequal lives be incomparable?
How should managers deal with this problem?

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Question 6
The B.T.Knight Corporation is considering two mutually exclusive pieces of
machinery that perform the same task. The two alternatives available provide the
following set of after-tax net cash flow.
YEAR EQUIPMENT A EQUIPMENT B
0 -$20,000 -$20,000
1 12,590 6,625
2 12,590 6,625
3 12,590 6,625
4 6,625
5 6,625
6 6,625
7 6,625
8 6,625
9 6,625

Equipment A has an expected life of three years, whereas equipment B has an

expected life of nine years. Assume a required rate of return of 15 percent.
(a) Calculate each project’s net present value.
(b) Are these projects comparable?
(c) Compare these projects using replacement chains and EAAs. Which project
should be selected? Support your recommendation.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 12 (Topic 12)

Dividend Policy

Question 1
(a) What is meant by the term dividend payout ratio?
(b) What is the residual dividend theory? Why is this theory operational only in
the long term?

Question 2
(a) Why is stable dollar dividend policy popular from the viewpoint of the
corporation?
(b) Is it also popular with investors? Why?

Question 3
What is the logic behind repurchasing shares of common stock to distribute excess
cash to the firm’s owner?

Question 4
The Howe Company’s stockholders’ equity account is as follows:
Common stock (400,000 shares at $4 par) $1,600,000
Paid-in capital in excess of par $1,000,000
Retained earnings $1,900,000
Total stockholders’ equity $4,500,000
The earnings available for common stockholders from this period’s operations are
$100,000, which have been included as part of the $1.9 million retained earnings.
(a) What is the maximum dividend per share that the firm can pay? (Assume
that legal capital includes all paid-in capital.)
(b) If the firm has $160,000 in cash, what is the largest per-share dividend it can
pay without borrowing?
(c) Indicate the accounts and changes, if any, that will result if the firm pays the
dividends indicated in parts (a) and (b).
(d) Indicate the effects of an $80,000 cash dividend on stockholders’ equity.

Question 5
As president of Young’s of California, a large clothing chain, you have just received
a letter from a major stockholder. The stockholder asks you to estimate the amount
of the dividend that you are likely to pay next year. You have not yet collected all
the information about the expected dividend payment, but you do know the
following:
(1) The company follows a residual dividend policy.
(2) The total capital budget for next year is likely to be one of three amounts,
depending on the results of capital budgeting studies that are currently under

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

way. The capital expenditure amounts are $2million, $3 million, and $4

million.
(3) The forecasted level of potential earnings next year is $2 million.
(4) The target or optimal capital structure is a debt ratio of 40%.

You have decided to respond by sending the stockholder the best information
available to you.
(a) Describe a residual dividend policy.
(b) Compute the amount of the dividend (or the amount of new common stock
needed) and the dividend payout ratio for each of the three capital expenditure
amounts.
(c) Compare, contrast, and discuss the amount of dividends (calculated in part (b)
associated with each of the three capital expenditure amounts.

Question 6
The following four public listed companies have different dividend policies.
• Utara Berhad pays all its earnings in the form of cash annually.
• Selatan Berhad is yet to pay any cash dividends and has no such plans in the
foreseeable future.
• Timur Berhad repurchases shares as an alternative to a dividend payment.
• Barat Berhad offers shareholders the choice of either a small but stable
dividend or a script dividend each year.
Discuss the advantages and disadvantages of each policy clearly and
comprehensively.

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UKFF1023 – FINANCIAL MANAGEMENT FUNDAMENTALS

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT (FAM)

Tutorial 13 (Topic 13)

Working Capital Management

Question 1
If sales are projected to be 10,000 units and the order cost/order is $50 and the
carrying cost/unit is $300, using the EOQ Model:
(a) Calculate the optimal quantity to be ordered.
(b) What is the total inventory cost?

Question 2
Persie Berhad has determined the following inventory information and
relationships:
Orders can be placed only in multiples of 300 units
Annual unit usage is 600,000 units (assume a 50-week/year in calculation)
The carrying cost is 10% of the purchase price of the goods. The purchase price is
RM6 per unit, ordering cost is RM85 per order. The desired safety stock is 6,000
units, excluding the delivery-time stock. Delivery time is 5 weeks
Given these information:
(a) What is the Economic Order Quantity (EOQ) level?
(b) At what inventory level should a reorder be made?

Question 3
Gardner Company currently makes all sales on credit and offers no cash discount.
The firm is considering offering a 2% cash discount for payment within 15 days.
The firm's current average collection period is 60 days, sales are 40,000 units, selling
price is $45 per unit, and variable cost per unit is $36. The firm expects that the
change in credit terms will result in an increase in sales to 42,000 units, that 70% of
the sales will take the discount, and that the average collection period will fall to 30
days. If the firm’s required rate of return on equal risk investments is 25%, should
the proposed discount be offered? (Note: Assume a 365-day year.)

Question 4
(a) Why might a firm choose to factor its receivables (debt factoring)?
(b) What is meant by collection policy? What are typical collection policy
activities?

Question 5
(a) Respond to this statement: It is impossible for a firm to have zero net
working capital; the firm would be bankrupt.
(b) Explain the liquidity/profitability trade off faced by managers in the context
of working capital management.

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