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Allama Iqbal Open University

Name:Faiqa Mughal Roll No.AD514873

Answer No. 1
Part I:- Policies in hand

• Refusal of dividend payment for the first 2 years


• Total avoid of borrowed funds regarding investment
• Forceless investment polices.

Part II: - Management viewpoint:


Management took this decision of Refusal of dividend payment for two
years
a- due to less profitability because
• Either company is standing on break even point
• Or hardly meeting fixed and partial variable cost
b- Or there is least funds to invest and promote working capital.
c- Company is on initial stage and return of investment is very low.
d- Initial Cost will be covered in two year then dividend will be given.

Part III: - Shareholder’s viewpoint:

Shareholders or stockholders own parts or shares of companies. They act as root for
Running the company properly and efficiently.In large corporations, shareholders are
people and institutions that simply invest money for future dividends

Obviously several investors consider dividends as a promise, and that


signaling is an important consideration. Because of he possible signaling effects and
investor perception of uncertainty.

Shareholders strongly believe and propose managers should always strive to act in
the best interest of the best interest of the firm’s owners. This view does not cause
managers to ignore non – owner stakeholders, indeed, when taking actions that
benefit stakeholders also benefit owners, the separation perspective would advise
managers to do so.
In nut shell, Shareholders want least level of risk while purchasing share and
moderate level of return.

Part IV: - Creditors viewpoint:

Regarding refusal for dividend payment, Creditors will be least effected by


these policies as they are preferably paid before shareholders.
Yes! If company is yielding less profit then there may be an elemant of risk that
where they will be paid properly or not or one day they will be refused like
shareholders.

Secondly, non utilization of borrowed funds can effect the creditors


investment in such way as they will not be encouraged enough to invest in the
company as having no opportunity for investment and its return.

Thirdly, creditors knows that they are being considered preferably so small
issues as leisure set up of companies and handsome salary of manager would not
affect the creditor’s perspective. It would be not noticeable for them.

PART V: - Reasonable Proposal/suggestions for Mustafa’s Company


It may seem an obvious statement but the greater the shareholding of an
individual, the greater are his/jer rights and the greater is his/her power within the
Company. This is so not only because the larger the shareholding the more likely it
so to represent a controlling interest, But also because the Companies Act affords
greater rights and power to an individual as the size of his/her shareholding
increases. For example, a shareholder owning 5% of a company has the right to
have an item placed on the agenda for discussion at the annual general meeting and,
once the shareholder’s ownership reaches 10% of the company, he/she has the right
to actually call a general meeting of shareholders. Controlling Interest in the great
majority of limited companies, a shareholding in excess of 50% of the issued share
capital will be enough to control the company, dictate the makeup of the board of
directors and to do most of the acts necessary to run the company in its everyday
business.
a- Company should try its best to reduce the 2-Year time periods in
order to ensure shareholder’s interest.
b- Managers must distinguish between the interests of shareholders
who have long-term interests in a company's worth and those who
have short-term interests. Then they must strive to implement
growth strategies that will benefit both kinds of investors in so far
as possible,
c- If shareholders points out high salary and leisure life of managers
and undue overhead then these staff should fully show its
commitment to protect the shareholder interest.
d- Manager should keep in touch with the shareholder via reporting
and meeting so that they can see the real picture of less
profitability of the company.

Answer#2A
Return of Assets (ROA):
It estimates that what the company can do with what it possesses,i.e. how many
dollars of earnings they derive from each dollar of assets they control. It's a useful
number for comparing competing companies in the same industry. The number will
vary widely across different industries. Return on assets gives an indication of the
capital intensity of the company, which will depend on the industry; companies that
require large initial investments will generally have lower return on assets.

Return on equity(ROE) measures the rate of return on the ownership interest


(shareholders' equity) of the common stock owners. It measures a firm's efficiency
at generating profits from every unit of shareholders' equity (also known as net
assets or assets minus liabilities). ROE shows how well a company uses investment
funds to generate earnings growth.
*ROE = ROA (Equity Multiplier) in order for ROE to equal ROA the equity
multiplier must be one. In other words, the total assets to total shareholders' equity
ratio must be one. The return on assets (ROA) percentage shows how profitable a
company's assets are in generating revenue.

Answer#2 B

Analysts who use financial ratios extensively might be


characterized as belonging to three main groups. Managers, who use ratios to help
analyze, control, and improve the firm’s operations, credit analysts, who examine
ratios to help ascertain a company’s capability to pay its debts, and securities
analysts, who are concerned with a company’s efficiency and growth prospects. As it
is expected, apiece group of analysts has specific areas of interest, which it wishes to
investigate. Therefore, ratios might be characterized into specific task groupings. The
five group categories are liquidity ratios, quality management ratios, debt
management ratios, profitability ratios and market value ratios.Following are the five
groups of ratios:

1. Gross profit margin


2. Net profit margin
3. Current ratio
4. Inventory turnover
5. Return on owner’s equity

Gross profit margin


It refers average gross profit on each dollar of sales before operating expenses. The
equation is simple:

Your gross profit margin will depend on the industry you’re in, so it’s important to
measure yourself against industry benchmarks.

Net profit margin


Your net profit margin is the percentage profit your business makes for every dollar
of revenue – whether you’re making a profit after covering all of your costs.

For example, run high-volume, low-margin businesses, while others sell a small
number of expensive items with plenty of margin built in.

Current ratio

You’re making profitable sales but are they enough to cover short term liabilities? To
answer that, you need the current ratio. It helps to measure the solvency of your
business by comparing your current assets (like unpaid invoices) to your current
liabilities (unpaid bills and the like):

For example If sales are growing and you have a short operating cycle, a lower
number may be OK. But if you have a long operating cycle, you might want your
current ratio to be higher, to make sure liabilities don’t get out of control.

Inventory turnover
If you have trading stock, then inventory turnover is an incredibly useful number. It
shows you how many times your business’ inventory is sold and replaced over a
particular period:

So, if you’ve spent $200,000 buying stock over the year, and you keep an average of
$20,000 worth of stock on hand, then your inventory turnover is 10 times a year.
Inventory turnover varies by industry but as a rule of thumb the higher it is the
better. A low turnover indicates you have a lot of money tied up in stock for long
periods of time, which is not good for cash flow. Too high a figure could indicate
you’re not keeping enough stock on hand!

Return on owner’s equity

Return on owner’s equity compares your net business income to the equity you’ve
invested in the business. It reveals how much you’re making from your investment:

So if you’ve invested $200,000 of your own money in the business, but it’s
generating a net income of $100,000 a year, then your return on owner’s equity is
50%.
This ratio is a great way to compare what you’ve earned from your business to what
you might have earned from another investment. If you’re just starting up, it might
not be as high as you’d like, but it tends to increase over time as your business
grows, especially if your personal investment remains the same.

Answer#2 C

Allied Corporation
Incom statement
For the period ended 2008

Sale 100
Less:COGS 68.60
Depreciation 13.60
EBIT 17.80
Interest paid 12.40
Taxable Income 5.45
Tax deduction 1.85

Net Income 3.60


Answer#3 A

PV =500
i=12%
n=5%
Fv=Pv (1 + i)n
i. 12% Compounded Semi-Annually for 5 year
Fv - Pv (1 + i %)nx2
n=500 (1.06)10

ii. 12% Compound quarterly for 5 Year


nx4
Fv - Pv (1 + i %)
n
=500 (1.03)20
iii. 12% Compounded Monthly for 5 Year
Fv - Pv (1 + i %)nx12
=500 (1 – 01)60

Answer#3 B

Pv =25000
i= 10
n=5%
PvA = FvA (Fvi x FA10% x ny )
25000= FvA (Fvi x FA10% x 5y )
25000= FvA (3.791)
FvA =25000/ 3.791
FvA =6595

Year Installment Interest Principle Ending Balance


0 25000
1 6595 2500 4095 20905
2 6595 2090 4505 16400
3 6595 1640 4955 11445
4 6595 1144 5451 5994
5 6595 601 5994 0

Answer#3 C

Div =3
g=8%
What will the dividend be in 5 Year

Do =3
D1=3(1.08) =3.24
D2=3.24 (1.08)=3.50
D3=3.50 (1.08)=3.78
D4=3.78 (1.08)=4.08
D5=4.08 (1.08)=4.41

Answer#4 A
i. Expected Rate of Return
Ki Probability Ki x Pn
0.20 0.30 0.06
0.05 0.40 0.02
.12 0.30 0.036
0.116

ii. Standard Deviation

Ỏ= [sum(Ki-(K/n)xPn)]1/2
Ki K K1 –K (K1 - K)2 Pn (Ki - K) x Pn
.20 .116 0.084 .0071 .30 .00213
.05 .116 -0.066 .0044 .40 .00176
.12 .116 0.004 .000016 .30 .000048
.0038948
Ỏ = 0.0624
Ỏ=

iii. Coefficient of Variance


= S.D x 100
X
= 0.0624 x 100
.116
= 5.40
Answer#4 B
Investment=100000
Expected Return=13%
20%
B=1.30
R7=7%
Ki = Rf + B( Rm - Rf )
20%=7%+ 1.30( Rm - 7%)
20%-7%= 1.30( Rm – 9.1% )
13%+9.1% = 1.30 Rm
22-1% = Rm
1.30
20.8% = 20.8% = Rm

Answer#5 A
RELATIONSHIP

IF Then Capital Budgeting NPV <0 IRR<Cost of Capital Reject the investment
from the cash flow perspective. Other factors could be important. Provides the
minimum return. Probably reject .
NPV =0 IRR = Cost of capital from the cash flow perspective. Other factors cold
be important.
Screen in for further analysis. Other investments May provide NPV > 0 IRR> Cost of
capital rationed, i.e., go to the most profitable projects. Others factors could be
important.
When we pay that the required return an investment so, say, 10% we usually
mean that the investment will have a positive NPV only if return exceeds 10%
another way of interpreting the required return is to observe that the firm must earn
10% an the investment to compensate its investor for the use of the capital needed
to finance the project. This is why we could also say that 10% is the cost of capital
associated with the investment imagine that we are evaluating a risk-free project, in
this case how to determine that required return is obvious, we look at the capital
markets and 0bserve the current rate offered by the risk-free investment and we use
this rate to discount the projects cash flows. Then the cost of capital for a risk-free
investment is the risk free rate. If s project is risky, then assuming that all the other
information is unchanged . the required return is obviously higher. In other words
the cost of capital for this project if it risky, in greater then the risk-free rate and the
appropriate discount rate would exceed the risk-free rate .

Answer#5 B
i. Do = 2
Po = 23
g =7

D1 = D ( 1 + g ) Di = 2.147
= 2(1.07) =
Ke = Dividend1 + g
Po
=2.14 + 7%
23
= 9.3% + 7%
= 16.30%

ii. CAPM
Ke = Rf + B ( Rm – Rf )
= 9% + 1.60 ( 13% - 9% )
= 9% + 1.60 ( 4% )
= 9% + 6.4%
=15.4%