Question 1

(a) Calculate the market price per share using dividend growth model.

P0 = D1/ (k g)
Earnings per share = 601600/ 1,000,000
= 0.60
Required Rate of Return = Risk-Free Rate + (Beta of Stock)(Market Risk Premium)
= 4% + 1.2 * 7%
= 12.4%
P0 = D1/ (k g)
=0.6/ (12.4% - 6%)
= 9.375
Therefore, market price per share is 9.375

(b) Compute the market value of bonds.

B0 = I/ (1+ry ) + I/(1+ry)2 + (I+M)/(1+ry)T

B0 = current market price of bond or debt security ($)
M = par (face, maturity) value of security ($)
T = term to maturity (years)
r = coupon (interest) rate (%)
I = rM = annual interest ($)
ry = yield to maturity (YTM, %)
B0 = 120,000(1 + 8%) + (1 + 8%) 2 + (1 + 1,000,000)/ (1 + 8%) 10
= 592,795
Question 2
(a) Explain how line of credit will work for Modern Furnitures, indicating the amount of
line of credit that will be taken from the bank.
The amount that will be taken from the bank is
410,000 * 8/200
= 16,400
(b) Calculate the amount of interest that the company will pay if line of credit is taken up.
410,000 x 8/200 = 16,400
Interest is 16,400
(c) Calculate the amount of interest that the company will pay if term loan is taken up.
410,000 x 6/200 = 12,300

(d) Compare the two (2) financing methods and discuss which of these alternatives will
be good for the company.
Line of credit costs 8% per annum is cheaper compared to the term loan while the
term loan is expensive. This means that the line of credit should be taken.
Question 3
Analyse the change in credit policy.
Sales decrease by 10% = 6,000,000 (10%*6,000,000)
=5,400,000
Bad debts decrease by 1% = 150,000 (1% *150,000)
 =148,500
Debtors increase by 20% = 150,000 + (150,000*20%)
=180,000
Accounts receivables
Current policy
Average collection period = 150,000/6,000,000 *360
= 9 days

Proposed policy
5,400,000/360 *(12 +9)
= 315,000
The company should not change its credit terms as this will lead to increased cost.
Question 4
Cash conversion cycle is an important concept in working capital management. Analyse the
importance of cash conversion cycle and explain the strategies to manage the cash conversion
cycle.
i. The Cash conversion cycle measures the length of time that is between the
company's purchase of the inventory and the receipts of the same cash from its
accounts receivable. It is used by the management so as to relate how long the
cash from the company remains tied up in its day to day operations.

ii. A longer Cash conversion cycle means that it takes a longer time to generate cash,
to a small firm, this may mean insolvency. On the other hand, a shorter Cash
conversion cycle may translate to a company being healthier. This means that the
available money can then be used to make extra purchases or be used to pay down
the outstanding debt.
Strategies that are used to manage cash conversion cycle include:

1. Reducing the average age of the inventory so as to improve their inventory conversion
period by making the goods and selling them faster through a more efficient process.
2. By reducing the average collection period so as speed up collections on accounts
those are receivable.
3. By increasing the payables deferral period.
4. By making use of the technology, the strategic partnerships and other leverages
effectively.
QUESTION 5

The formula for the DuPont identity is:

ROE = profit margin x asset turnover x equity multiplier

= 33.33% *1.96 * 2.03
= 1.326