ENGR 111

Mel Bulu-Taciroglu Summer 2017 HOMEWORK 2 SOLUTIONS

1. (8 points) Financial Manager makes various types of decisions related to different

aspects of a company’s operations. Determine whether each of the following decisions is a
Capital Budgeting, Capital Structure or a Net Working Capital management decision. Note
that each case may affect more than one decision.

a) Hiring a fresh-out-of-college engineer as the CEO.

b) Investing the extra cash on a piece of land that is estimated to go up in value
versus keeping it in the cash account.
c) Deciding whether to borrow from a financial institution versus issuing and
selling new stock shares.
d) Deciding whether to acquire a smaller competitor.

a) (2 points) Hiring a fresh-out-of-college engineer as the CEO. This
decision does not concern any of the choices directly. As mentioned in class,
many of the important assets a company has, like human capital, is not
reflected in the numbers provided in the balance sheet.

b) (2 points) Investing the extra cash on a piece of land that is estimated

to go up in value versus keeping it in the cash account. Land is a fixed
asset and can be considered as a capital budgeting decision. Also, since it is
going to be financed by cash, it will affect the Net Working Capital as well.

c) (2 points) Deciding whether to borrow from a financial institution versus

issuing and selling new stock shares. This is a capital structure decision.

d) (2 points) Deciding whether to acquire a smaller competitor. This is a

capital budgeting decision. Depending on how it is financed it can be a Capital
Structure and/or Net Working Capital decision as well.

2. (2 points) Calculate the Dupont Identity for Company X given in question 4 of HW1.
Shareholders demand higher ROE. What can the management do to increase ROE?

ROE = NI/E *Assets/Assets * Sales/Sales = Sales/Assets * NI/Sales *

Assets/Equity
0.455 = 1.0476*0.2068*2.1
Dupont Identity points to three ratios that can be improved for a higher
ROE. 1. Total Asset Turnover can be increased by improving asset
management efficiency.
2. Profit Margin can be improved by increasing operational efficiency.
3. Company can get into more debt and increase its equity multiplier
BUT this may have a negative effect on ROE down the line since it will
mean higher interest payments and possibly lower profit margin.
3. BALANCE SHEET – INCOME STATEMENT - FINANCIAL CASH FLOW STATEMENT

Balance Sheet and Income Statement of Zwitter Inc. are given below as of Dec 31 2014
and Dec 31 2015.

Calculate 2015 Cash Flow to/from:

a) (10 points) Assets

b) (10 points) Creditors
c) (10 points) Stock Holders
d) (5 points) If Zwitter distributes same percentage of its Net Income as dividends
each year, what was the amount of dividends that were distributed in 2014?
e) (5 points) Which accounts would be affected (and by which amount) in the Balance
Sheet if Zwitter were to distribute NO dividends in 2015 but retain all earnings (Net
Income) within the company?

INCOME STATEMENT ZWITTER – in thousands

Cash Flow From Assets:

Operating Cash Flow = EBIT + Depreciation – Taxes = 170+10-19.6 = 160.4

Cash to Net Working Capital = (Ending NWC – Beginning NWC) = (196.8-146.4) – ( 164-
122) = 8.4
Cash to Fixed Assets =(Ending Net Fixed Assets – Beginning Net Fixed Assets +
Depreciation) = 1250-1200+10 = 60

Cash Flow From Assets:

160.4-8.4-60 = 92

Cash Flow to Creditors:

Interest - (Ending Long Term Debt – Beginning Long Term Debt) = 72 - (720-690) = 42

Cash Flow to Stock Holders:

Dividends - (Ending Stock – Beginning Stock) = 50 – (500-500) = 50

Note that Dividends are not given directly. However, one can find the dividends for 2015 by
looking at the difference in accumulated retained earnings change from 2014 to 2015:

80.4 – 52 = 28.4 must be the amount that is retained from 78.4 of Net Income. Then 78.4-
28.4 = 50 must be distributed as dividends in 2015.

If Zwitter distributes the same percentage of its Net Income a dividends each year, it
distributes 50/78.4 = 63.78%

Therefore, in 2014 Zwitter must have distributed 56.8 * 63.78% = 36.22 as dividends.

If Zwitter were to distribute no dividends in 2015, Accumulated Retained Earnings would

have been higher by 50. Then, this money would have been used in the company in some
way. If company decides to keep it in its cash account until it has a use for it, Cash
Account would have been higher by 50. If it decides to buy fixed assets, Fixed Assets
would increase by 50 or pay off debt, Long Term Debt would go down by 50. Or a
combination of these activities would be possible with the extra cash.

4. FINANCIAL PLANNING: Znap Inc. is a young company founded by a UCLA graduate.

Annual Balance Sheet and Income Statement of Znap are provided below (as of Dec 31st
2016).

a) (40 points) Company would like to grow its sales by 25% from 2016 to 2017. Given the
following conditions, produce Znap’s proforma statements for 2017:

1. Sales and Costs(COGS&Adm&Dep) grow at 25%.

2. Interest for 2017 is 10% of 2017 Long Term Debt. (You can check to see that
Interest was 10% of Long Term Debt for 2016 as well.)
3. Tax rate is 20%.
4. Company would like to preserve its dividend policy as in 2016.
5. Company would like to purchase back $50 worth of its own stock in 2017.
6. All accounts on the Assets side grow at the same rate as sales.
7. Accounts Payable grows at the same rate as sales.
8. Company’s short term debt (Notes Payable) stays constant and no new stock will
be issued in 2017.
9. Company meets its external financing need by borrowing long term.
 b) (10 points) Can you use the External Financing Need formula to calculate Znap Inc.’s
EFN without producing its proforma statements? Why or why not?

Company ZNAP, Pro Forma Income Statement

2016 2017
(Projected)
Sales $1,000
Costs (COGS&Adm&Dep) 700
Interest 160
Taxable Income 140
Taxes 28
Net Income 112
Dividends 0
Additions to Retained Earnings 112

Company ZNAP, Pro Forma Balance Sheet

% of 2017 %of 2017
2016 Sales (Projected) 2016 Sales (Projected)
Current Assets Current Liabilities
Cash 160 Accounts Payable 300
Accounts Receivable 440 Notes Payable 100
Inventory 600 Total Current 400
Liabilities
Total Current Assets 1,200 Long-Term Debt 1,600
Net Fixed Assets 1,800 Owners’ Equity
Stock 888
Retained Earnings 112

Total Assets 3,000 Total Liabilities and 3,000
Owners’ Equity

SOLUTION TO QUESTION 4 IS IN A SEPARATE EXCEL FILE.