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HOLMES INSTITUTE

FACULTY OF
HIGHER EDUCATION

HI5002 Finance for Business


Trimester 2 / 2018

TUTORIAL ACTIVITES

Tutorial Activities
Week Topics scheduled Chap(s)
(Questions)
Chap 3&4: SQ: 3.1, 3.3, 4.1, 4.3
3 Firm Financial Performance Evaluation 3&4 SP: 4.6, 4.8, 4.20, and 4.23

Chap 3

Solutions to Study Questions

3–1 The balance sheet represents an enumeration of a firm’s resources (assets)


along with its liabilities and owners’ equity at a given date. The income
statement summarises the net results of the operation of a firm over a
specified time interval.

The primary distinction between these two statements is that the balance
sheet shows the financial condition of a firm at a given date, whereas the
income statement deals with the revenue and expenses of the firm incurred
during a specified period of time.

3–3 Interest expense is the cost of borrowing money from a banker or another
lender. There is typically a fixed interest rate so that the interest expense is
computed as the interest rate times the amount borrowed. If we borrow
$500,000 at an interest rate of 12% per annum (p.a.), then our interest
expense will be $60,000 p.a.

While interest is paid for the use of debt capital, dividends are paid to the
firm’s shareholders. Preference shares typically have a fixed dividend rate, so
that the preference shareholder gets a constant dividend each year. Ordinary
shareholders, on the other hand, usually receive dividends only if
management decides to pay a dividend instead of reinvesting the firm’s
profits. However, typically once a dividend has been paid to ordinary
shareholders, management is reluctant to decrease it or cease paying a
dividend.

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Solutions to Study Problems
The income statement (page 42)
3–1 (Working with the income statement) To find the net profit, we must
subtract all of the relevant expenses from the revenues: cost of goods sold,
operating expenses, interest and taxes Following the template from
Checkpoint 3.1, we find the following for Sandifer Manufacturing Company:

notes
Sales $4 500 given
000
Cost of goods sold (3 375 000) given
Gross profit 1 125 000
Operating expenses
Depreciation expenses (150 given
000)
Other operating (300
expenses 000)
Total operating expenses (450 000) given
Operating profit (EBIT) 675 000

Interest expense $0 (none mentioned)


Earnings before tax (EBIT) 675 000
Tax (@ 30%) (202 500) =$675 000*0.30
Net profit $472 500

3–3 (Working with the income statement) Marifield Steel Fabrication earned a
net profit of $500 000, then paid out a dividend of $300 000. This left $500
000 – $300 000 = $200 000 to be retained by the firm to finance growth.

However, earnings per share is based on net profit, not reinvested earnings.
Thus, the firm’s EPS is:

Net profit $500,000


EPS = = = $5 per share
No. of ordinary shares 100,000

Chap 4
Solutions to Study Questions

4-1 Financial statements of firms are analysed both within the firm and by the
firm’s external constituents. Internal financial analysis is performed by a
firm’s own employees, while external financial analysis is performed by
bankers and investors outside the firm.
Internal financial analyses are done for one or more of the following reasons:

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 to evaluate the performance of employees and determine their pay
raises and bonuses
 to compare the financial performance of the firm’s different divisions
 to prepare financial projections, such as those associated with the
launch of a new product
 to evaluate the financial performance of the firm’s competitors and
determine how the firm might improve its own operations
 to evaluate the financial well-being of an important supplier so that if
the supplier is facing the risk of failure the firm can move quickly to
line up alternative sources of supply
 to determine the credit worthiness of new customers.

External financial analyses are undertaken by a variety of firms and


individuals who have an economic interest in the firm’s financial performance.
These include:

 banks and other lenders who are trying to decide whether to lend
money to the company
 suppliers trying to decide whether to grant credit to the company
 credit-rating agencies who are trying to determine the firm’s
creditworthiness
 professional analysts who work for investment companies that may be
considering investing in the firm or advising others about investing
 individual investors trying to decide whether to invest in the company.

4-3 Five basic questions used to discuss financial statement analysis are:

 How liquid is the firm? (Will it be able to pay its bills as they come
due?)
 How has the firm financed the purchase of its assets?
 How efficient has the firm’s management been in utilizing its assets to
generate sales?
 Has the firm earned adequate returns on its investments?
 Are the firm’s managers creating value for shareholders?

Solutions to Study Problems

4-6 Capital structure analysis

Total liabilities $750,000 + $1,200,000


(a) Debt ratio = = = 28.1%
Total assets $6,950,000

(b)

Total liabilities ( including new debt )


Debt ratio =
Total assets ( including the new warehouse )
$750,000 + ( $1,200,000 + $1,000,000 )
= = 37.1%
$6,950,000 + $1,000,000

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4-8 Profitability analysis

(a Operating profit = Operating profit margin �Sales


)
= 12% �$65 million = $7.8 million

Pro-forma Income Statement ($ millions)


Operating profit $7.80
Interest expense (1.20)
Profit before tax 6.60
Tax (30%) (1.98)
Net profit $4.62

(b Operating profit $7.8 million


) ROA = = = 18.6%
Total assets $42 million

Net profit $4.62 million


ROE = = = 21.0%
Shareholders' equity $42 million - $20 million

4-20 Market value analysis

Market price per share = Price-earnings ratio �Earnings per share


= 12.25 �$3 = $36.75

Total book value of equity $750,500


Book value per share = = = $15.01
No. of ordinary shares 50,000

Market price per share $36.75


Market-to-book ratio = = = $2.45
Book value per share $15.01

4-25 Calculating financial ratios


Current assets $3500
Current ratio = = = 1.75
Current liabilities $2000

Operating profit or EBIT $1700


Interest coverage ratio = = = 4.63 times
Interest expense $367

Cost of goods sold $3300


Inventory turnover = = = 3.30 times
Inventory $1000

Sales $8000
Total asset turnover = = = 1.00
Total assets $8000

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Operating profit or EBIT $1700
Operating profit margin = = = 21.3%
Sales $8000

Operating profit or EBIT $1700


Return on assets = = = 21.3%
Total assets $8000

Total debt $4000


Debt ratio = = = 50.0%
Total assets $8000

Accounts receivable
Average collection period =
Annual credit sales/365 days
$2000
= = 91.3 days
$8000 / 365

Sales $8000
Fixed assed turnover = = = 1.78 times
Net plant and equipment $4500

Net profit $933


Return on equity = = = 23.3%
Equity $4000