FINANCIAL MANAGEMENT AND APPLICATION PAPER

VIEW SOLVED AT: https://www.answerslab.online/2021/04/financial-management-and-

application_5.html

Question 1 [4-Marks]

The Alpha Beta Company is attempting to establish a current assets policy. Fixed assets are $700,000,
and the firm plans to maintain a 40% debt-to-assets ratio. Alpha Beta has no operating current liabilities.
The interest rate is 12% on all debt. Three alternative current asset policies are under consideration:
30%, 40%, and 70% of projected sales. The company expects to earn 18% before interest and taxes on
sales of $5 million. Alpha Beta’s effective federal-plus-state tax rate is 30%. What is the expected return
on equity under each asset policy?

Question 2 [4-Marks]

a) Kareem & Sons last year reported sales of 12 million and an inventory turnover ratio of 4. The
company is now adopting a new inventory system. If the new system is able to reduce the firm’s
inventory level and increase the firm’s inventory turnover ratio to 8 while maintaining the same
level of sales, how much cash will be freed up?

b) Medwing Corporation has a DSO of 19 days. The company averages 5,500 in credit sales each
day. What is the company’s average accounts receivable?

c) McDowell Industries sells on terms of 4/10, net 40. Total sales for the year are $825,500. Thirty
percent of customers pay on the 15th day and take discounts; the other 70% pay, on average, 60
days after their purchases.
a. What is the days sales outstanding?
b. What is the average amount of receivables?
c. What would happen to average receivables if McDowell toughened its collection policy with
the result that all non-discount customers paid on the 40th day?

d) International Industries sells on terms of 3/10, net 50. Gross sales last year were 5,662,500 and
accounts receivable averaged 547,500. Half of International’s customers paid on the 15th day
and took discounts. What are the nominal and effective costs of trade credit to International’s
non-discount customers? (Hint: Calculate sales/day based on a 360-day year, then calculate
average receivables of discount customers and then find the DSO for the non-discount
customers.

e) The D.J. Masson Corporation needs to raise 500,000 for 1 year to supply working capital to a
new store. Masson buys from its suppliers on terms of 3/10, net90, and it currently pays on the
 10th day and takes discounts. However, it could forgo the discounts, pay on the 90th day, and
thereby obtain the needed$500,000 in the form of costly trade credit. What is the effective
annual interest rate of this trade credit?

Question 3 [4-Marks]

Python Machine Company is considering the acquisition of a large equipment to set up its factory in a
backward region for Rs. 1,900,000. The equipment is expected to have an economic useful life of 10
years. The equipment can be financed either with an eight year term loan at 16% interest, repayable in
equal instalments of Rs 393,112 per year, or by an equivalent amount of lease rent per year. In both
cases, payments are due at the end of the year. The equipment is subject to the straight line method of
depreciation. Assuming no salvage value, and 30% corporate tax rate. Which of the financing
alternatives should it select?

Question 4 [3-Marks]

Emaar Builders need to acquire the use of a crane for construction business, and are considering buying
or leasing a crane. The crane costs Rs. 2,500,000, and is subject to the straight-line method of
depreciation to a zero salvage value at the end of 5 years. In contrast, the lease rent is Rs 550,000 per
year to be paid in advance each year for 5 years. Emaar Builders can raise debt at 18% payable in equal
annual instalments, each instalment due at the beginning of the year. The company is in the 30% tax
bracket. Should it lease or buy the crane?