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ACC-501
Final Term Subjective
Maturity Hedging
Try to match financing maturities with asset maturities
2
Finance temporary current assets with short-term debt
Finance permanent current assets and fixed assets with long-term debt and equity
Interest Rates
Short-term rates are normally lower than long-term rates, so it may be cheaper to finance with short-
term debt
Firms can get into trouble if rates increase quickly or if it begins to have difficulty making payments –
May not be able to refinance the short-term loans
With a compromise policy, the firm keeps a reserve of liquidity which it uses to initially finance seasonal
variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.
Define systematic risk and unsystematic risk and also define which risk is eliminated by diversification
5 marks
Systematic risk
A risk that influences a large number of assets. It is also called market risk
Unsystematic Risk
A risk that affects a single or at most a small number of assets. Because these risks are unique to individual
companies or assets, they are also called unique or asset specific risks.
“Unsystematic risk is essentially eliminated by diversification, so a relatively large portfolio has
almost no unsystematic risk.”
Systematic risk can not be eliminated by diversification, as it affects almost all assets to some degree.
What Does Long-Term Solvency Ratio Intend to Address? Name Commonly Ratios? (Marks 3)
These ratios are intended to address the firm’s long-run ability to meet its obligations, or its financial leverage.
Total Debt Ratio
Interest Coverage Ratio
Cash Coverage Ratio
The bonds with lower coupon have greater interest rate risk. …….Explain (3)
If two bonds with different coupon rates have same maturity, the value of the one with the lower coupon is
proportionately more dependent on the face amount to be received. So its value will fluctuate more as interest
rate changes
In other words, bond with higher coupon has a larger cash flow early in its life, so its value is less sensitive to
changes in discount rate
What is net working capital? What are current assets and order of their liquidity?
Net working capital (NWC) is the difference between the current assets and the current liabilities. Often the
short-term financing is called net working capital management.
The difference between short- and long- term financing is the timing of the cash flows.
Current assets
•Cash and other assets that are expected to convert to cash within one year. Presented on balance sheet in
order of their liquidity
Effective annual interest rate calculation in which bank A offer 16.50% rate quarterly, and Bank B
offers 16.75% rate semi annually, so we have to decide which one is better to invest.
BANK A, as it offers 17.55% effective rate and bank B offers 17.45%
Definition of bankruptcy
Unpaid debt is a liability of the firm. If it is not paid, the creditors can legally claim the assets of the firm,
resulting in bankruptcy or financial failure. This possibility does not arise when equity is issued.
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Question No: 47 ( Marks: 5 )
Match the capital budgeting techniques are given in Column A to the criteria in Column B. Provide the correct
answer in Column C.
Column A Column B Column C
Net Present Value Discounted Cash Flow Criteria
Average Accounting Return Payback Criteria
Payback Period Discounted Cash Flow Criteria
Internal Rate of Return Accounting Criteria
Profitability Index Discounted Cash Flow Criteria
What is the reason of tax deduction on the difference between book value and market value.
Sales 50,000/year@5.50/unit
Variable cost 4.50/unit. Fixed cost Rs.8000
Project has no salvage value. Project life is 3 years.
Project cost is 24,000. Depreciation is 8000/year
Investment in net working capital is 10,000
the firm required rate of return is 20%
the tax rate is 34%
Required: calculate the projected net income (5)