iACADEMY

BASICFIN: BASIC FINANCE AND FINANCIAL MANAGEMENT

FINAL REQUIREMENT

A. CAPITAL BUDGETING

I. Mayfields Inc. uses a maximum acceptable payback period of 6 years and currently must choose
between two mutually exclusive projects. Project Copper requires an initial outlay of P22,000.
Project Nickel requires an initial outlay of P35,000.

Using the expected cash inflows given for each project in the following table:

Expected Cash Inflows

Year Copper Nickel
1 6,000 4,000
2 6,000 7,000
3 8,000 8,000
4 4,000 5,000
5 3,500 5,000
6 2,000 4,000

Requirements:
1. Calculate each project’s payback period.
2. Which project should be accepted by Mayfields?

II. Prime Foods is considering acquisition of a new machine. The initial investment is estimated at
P1.4 million and the machine will have a 5-year life with no salvage. The machine is expected to
have an operating cash inflows shown in the following table:

Year Cash Inflow

1 400,000
2 375,000
3 300,000
4 350,000
5 200,000

Using a 6% discount rate, determine the following

3. Determine the net present value (NPV) of the machine given its expected operating cash inflows
4. Based on the project’s NPV, should Prime Foods make this investment?
III. Project T-shirt requires an initial investment of P25,000 and generates cash inflows of P8,000 per
year for 4 years. Project Board Shorts require an initial investment of P32,000 and produces cash
inflows of P12,000 per year for 5 years.

Bench Inc. uses the internal rate of return (IRR) to select projects.

Requirements:
5. Calculate the IRR of each of the following projects and recommend the best project based on
IRR.

B. COST OF CAPITAL AND WEIGHTED AVERAGE COST OF CAPITAL (WACC)

Dynamics Inc. is interested in measuring its over-all cost of capital. The firm’s tax rate is 40%. The firm
has the following data:

Debt:
Dynamics Inc. can raise debt by selling P1,000 par value, 10% coupon interest rate, 10-year bonds on
which annual interest payments will be made. To sell the issue, an average discount of P30 per bond
must be given. The firm must also pay flotation costs of P20 per bond.

Preferred stock:
The firm can sell 11% annual dividend preferred stock at its P100 per share par value. The cost of issuing
and selling the preferred stock is expected to be P4 per share.

Common stock:
The firm’s common stock is currently selling for P80 per share. The firm expects to pay cash dividends of
P6 per share next year. The firm’s dividends have been growing at annual rate of 6% and this rate is
expected to continue in the future. The stock will have to be underpriced by P4 per share, and flotation
costs are expected to amount to P4 per share.

Retained Earnings:
The firm expects to have P225,000 of retained earnings available in the coming year. Once these
retained earnings are exhausted, the firm will use new common stock as the form of common stock
equity financing.

Requirements (Round off final answers up to 2 decimal places):

6. Calculate the cost of debt
7. Calculate the cost of preferred stock
8. Calculate the cost of new issues of common stock
9. Calculate the firm’s weighted average cost of capital using the weights shown in the following
table, which are based on the firm’s target capital structure proportions:

Source of capital Weight

Long-term debt 40%
Preferred stock 15%
Common stock equity 45%
C. INTERPRETING LIQUIDITY AND ACTIVITY RATIOS

The new owners of Sheraton 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.

Ratio Sheraton Industry 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

10. What recommendations relative to the amount and the handling of inventory could you make to
the new owners?
11. What recommendations relative to the amount and the handling of accounts receivables could
you make to the new owners?
12. What recommendations relative to the amount and the handling of accounts payables could you
make to the new owners?
D. FINANCIAL RATIOS
Additional Information:
 The Company did not issue any new common or preferred stock during the year.
 A total of 600,000 shares of common stock were outstanding
 The interest rate on bonds payable is 14%
 Income tax rate is 40%
 Dividend per share of common stock was $ 0.75
 The market value of the common stock on December 31 of the current year was $ 26
 All of the company’s sales are on account.

Requirements: Calculate the following financial ratios:

13. Current ratio
14. Acid-test ratio
15. Accounts receivable turnover
16. Average collection period
17. Inventory turnover
18. Average sale period
19. Gross margin percentage
20. Earnings per share (common stock)
21. Price earnings ratio
22. Dividends pay-out ratio
23. Dividend yield ratio
24. Times interest earned ratio
25. Debt ratio