• April 15th, 2016

Financial Management Tma2

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All answers must be with clear working and equation.

Assignment 2 – Page 2 of 6 Individual Assignment This assignment is worth 25% of the final mark for FIN303 Financial Management. The cut-off date for this assignment is 25 April 2016, 2359hrs. ___________________________________________________________________________ Protect IT is a company that makes protective cases for smart phones such as the iPhone. The company is considering a proposal to expand its product selection to include protective covers for tablet devices like the iPad and so far, the firm has spent $10,000 analysing the potential market for such a product. Management believes that many purchasers of cell phone cases will also buy tablets, and so the company has a built-in clientele for the new product line. If the company decides to undertake this project, it will begin selling new products next month when its new fiscal year begins on January 1, 2016. The company would therefore make the required investment before the end of the current fiscal year, that is, 31 December 2015. The financial statements of Protect IT for the years 2014 and 2015 are given in Table 1 and Table 2. The management would like to understand its financial performance in 2015 relative to the industry. The ratios for the industry are given in Table 3. Table 1 Balance Sheet as at December 31 (Figures in Thousands)    2015 2014 Current Assets        Cash and Cash equivalents 440 213 Marketable Securities 35 28 Accounts receivables 1,619 1203 Inventories 615 530 Prepaid Expenses 170 176 Total Current Assets 2,879 2150 Fixed Assets        Gross Property, Plant and Equipment 9,920 9024 Less: Accumulated Depreciation 3,968 3335 Net Property, Plant and Equipment 5,952 5689 Intangible assets 758 471 Net fixed assets 6,710 6160 Total assets 9,589 8310          Current Liabilities        Accounts Payables 1,697 1304 Notes Payables 477 587 Accrued Expenses 440 379 Total Current Liabilities 2,614 2270 Long‐term Liabilities        Deferred Taxes 907 793 FIN303 Assignment 2 – Page 3 of 6 Long term debt 1,760 1,474 Total long term Liabilities 2,667 2,267 Total Liabilities 5,281 4,537 Stockholder Equity        Preferred Stock 30 30 Common Stock ($1 par) 179 185 Paid in Capital in excess of par 442 386 Retained earnings 4,271 3,670 Less: Treasury Stock 614 498 Total Stockholder Equity 4,308 3,773 Total Liabilities and Stockholder Equity 9,589 8,310 Table 2 Income statement for the year ending 31 December (Figures in Thousands)    2,015 2,014 Sales Revenue 12,843 9,110 Less: Cost of goods sold 8,519 5,633 Gross profit 4,324 3,477 Less: Operating and other expenses 1,544 1,521 Less Selling, General and Administrative Expenses 616 584 Less Depreciation 633 608 Operating Profit 1,531 764 Plus: Other income 140 82 EBIT 1,671 846 Less: Interest Expenses 123 112 Pre‐tax Income 1,548 734 Less: Taxes        Current 367 158 Deferred 232 105 Total Taxes 599 263 Net Income 949 471 Less Preferred dividends 3 3 Earnings available for common stockholders 946 468 Less: Dividends 345 326 To Retained Earnings 601 142 Per share data        EPS 5.29 2.52 DPS 1.93 1.76 Price per share 76.25 71.50 Number of shares 178,719,400 185,433,100 Credit purchases (million$) 6,815 4,506 FIN303 Assignment 2 Assignment 2 – Page 4 of 6 Table 3 Industry Ratios Ratios Industry average Current ratio 1.23 Quick ratio 1.02 Inventory Turnover 16 Average Collection Period 42 Average payment period 100 Fixed Asset turnover 1.6 Total asset turnover 1.42 Debt ratio (Total liabilities/total assets) 38.65% Assets/equity ratio (Equity Multiplier) 1.63 Long‐term debt to stockholder equity 30.00% Times Interest Earned Ratio 16.25 Gross profit margin 40.00% Operating profit margin 12.00% Net profit margin 8.50% Return on total assets 12.10% Return on common equity 19.70% With respect to the new product introduction, the following information is obtained: Up-front costs include $50,000 in computer equipment. This equipment will be depreciated over 5 years on a straight line basis and will have no salvage value at the end of 5 years. The managers believe that the average selling price of the new tablet covers to be at $13.50 and they expect that the price will remain constant indefinitely. Managers expect unit sales volume to start at 4,500. It is also estimated that the sales volume will increase by 10% a year from year 2 to year 5. From year 6 onwards, the sales volume will increase at a constant rate of 4% every year. The cost of goods sold will be 72% of sales revenue with selling, general, and administrative expenses at 10% of sales. No additional fixed asset investment will be necessary to support the increased sales. At the start of the new project, Protect IT needs to provide $ 6,000 worth of working capital. Subsequently, as sales grow, Protect IT will make additional investments in inventory and receivables. Each year, accounts receivables will be equivalent to one-month sales, and inventory balances will be about 12.5% of sales. Protect IT’s suppliers will provide trade credit on terms such that the accounts payable balance will equal about 10% of cost of goods sold each year. By the end of year 5, the sales of the tablet covers will reach a steady state and cash flows will grow at 4% a year indefinitely from year 6 onwards. FIN303 Assignment 2 Assignment 2 – Page 5 of 6 The beta of the company is estimated as 0.8. The risk-free rate is 3% and the market risk premium is 6%. Tax rate will be 20% for the project income The company has a target debt ratio of 40%. It can raise debt at 8%. Question 1 Compute the following ratios for 2015. Ratios 2015 Industry Average   Current ratio     1.23 Quick ratio     1.02 Inventory Turnover     16 Average Collection Period     42 Average payment period     100 Fixed Asset turnover     1.6 Total asset turnover     1.42 Debt ratio (Total liabilities/total assets)     38.65% Assets/equity ratio (Equity Multiplier)     1.63 Long‐term debt to stockholder equity     30.00% Times Interest Earned Ratio     16.25 Gross profit margin     40.00% Net profit margin     8.50% Return on total assets     12.10% Return on common equity     19.70% (15 marks) Question 2 Analyse the difference in the ROE of Protect IT and the ROE of the Industry in 2015 through the relevant ratios. (20 marks) Question 3 Calculate the weighted average cost of capital for the project. (15 marks) FIN303 Assignment Assignment 2 – Page 6 of 6 Question 4 Calculate the initial investment on December 31, 2015. (10 marks) Question 5 Calculate the cash flows for the years 2016 to 2020. (20 marks) Question 6 Calculate the terminal cash flow at the end of year 2020. (10 marks) Question 7 Calculate the net present value of this project and recommend whether the project should be undertaken. (10 marks)

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