BA 2802 – PRINCIPLES OF FINANCE

Graded Homework 1 – Due on April 12, 2022 by 17:00

Rules: Students are allowed to work in groups on this homework assignment

however a single submission for the whole group is not allowed. Each and every
student in the group should turn in his or her own work. If you work in groups,
you need to list the names of people that you worked together on the upper right-
hand corner of the first page of your assignment. Your answers to the
questions should be hand written on PROFESSIONAL LOOKING A4
paper.

1. (38 points) Jane is working for an investment bank as an equity analyst. Her manager gave
her the financial statements of The Box of Chocolate Inc. Jane has to determine if the
company is financially healthy or not. Unfortunately, both the balance sheet and the income
statement of the company are not in the correct format. Furthermore, Jane spilled over
coffee on some numbers, and she cannot read them now. Fortunately, she has some ratios
that she can use to prepare the balance sheet and the income statement for 2021. The Box
of Chocolate Inc. has 5 million shares outstanding and paid $1.54 as dividends to its
shareholders at the end of 2021. The retained earnings at the beginning of 2021 was $12.9
million.
Debt ratio = 0.4
TIE = 10
Current ratio = 1.4
Quick ratio = 1.0
Cash ratio = 0.2
ROA = 0.12
Inventory turnover = 5.0
Days’ Sales in Receivables = 73 days

She listed the numbers she can read from financial statements of the company in the table
below in alphabetical order:
Accounts payable 20
Accounts receivable
Cash
Common Stock
Cost of Goods Sold
Depreciation 20
Equity
Fixed assets, net
Inventories
Long-term Debt
Notes Payable 5
Retained Earnings
Sales
Selling, general, and administrative expenses 10
Total assets 115

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a. (14 points) By using the information provided above, prepare the correctly formatted
balance sheet and income statement of the company for 2021. Please note that the list
given above does not include all the items in the income statement. You should find
these items and prepare the income statement for the company in the correct format.

Balance Sheet
as of December 31, 2021
(in million dollars)

2021 2021
Cash 5 A/P 20
A/R 20 N/P 5
Inventories 10 Total Current Liabilities 25
Total Current Assets 35 Long-term Debt 21
Fixed assets, net 80 Total Liabilities 46
Common Stock 50
Retained Earnings 19
Total Shareholders’ Equity 69
Total Assets 115 Total Liabilities and Shareholders’ Equity 115

Income Statement
January-December 2021
(in million dollars)

2021
Sales 100
CoGS 50
Gross Profit 50
Selling, general and administrative expenses 10
Depreciation 20
Earnings Before Interest and Taxes 20
Interest expense 2
Earnings Before Taxes 18
Tax expense 4.2
Net Income 13.8
Dividends 7.7
Additions to Retained Earnings 6.1

Total Debt
TDR = Total Assets = 0.4, Total Debt = 0.4 × 115 = 46

Total Current Liabilities = A/P + N/P = 20 + 5 = 25

Long − Term Debt = 46 − 25 = 21

Using Total Assets = Total Liabilities and Shareholders ′ Equity

Total Shareholders′ Equity = Total Assets − Total Liabilities = 115 − 46 = 69

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 Current Assets
Current Ratio = = 1.4, Current Assets = 1.4 × 25 = 35
Current Liabilities

(Current Assets−Inventories)
Quick Ratio = = 1.0, Inventories = 35 − 25 = 10
Current Liabilities

Cash
Cash Ratio = Current Liabilties = 0.2, Cash = 0.2 × 25 = 5

Accounts Receivable = Total Current Assets − Cash − Inventories = 35 − 5 − 10

= 20

Fixed Assets, net = Total Assets − Total Currrent Assets = 115 − 35 = 80

365
Days′ Sales in Receivables = A/R = 73, A/R Turnover = 5
Turnover

Sales
A/R Turnover = = 5, Sales = 5 × 20 = 100
A/R

CoGS
Inventory Turnover = Inventories = 5.0, CoGS = 5 × 10 = 50

Gross Profit = Sales − CoGS = 100 − 50 = 50

EBIT = GP − Operating expenses − Depreciation = 50 − 10 − 20 = 20

EBIT 20
TIE = Interest Expense = 10, Interest Expense = 10 = 2

EBT = EBIT − Interest Expense = 20 − 2 = 18

NI
ROA = Total Assets = 0.12, NI = 115 × 0.12 = 13.8

Tax Expense = EBT − NI = 18 − 13.8 = 4.2

Dividends = DPS × Number of Shares outstanding = 1.54 × 5 = 7.7 (in millions)

Additions to Retained Earnings = NI − Dividends = 13.8 − 7.7 = 6.1

Retained Earnings (RE) = RE at 2020 + Additions to RE at 2021

= 12.9 + 6.1 = 19

Common Stock = Total Shareholders′ Equity − Retained EArnings = 69 − 19 = 50

b. (15 points) Her manager asks Jane to analyze the profitability and market value of
the company. Jane realized that she needs some additional information, and she finds
out that the dividend yield for 2021 is 5%. She also gets the industry averages for a set
of ratios listed in the table below. Identify the ratios she needs to look at to analyze the
profitability and market value of the company. Calculate these ratios for The Box of
Chocolates Inc. Analyze the profitability and market value of the company relative to

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 the Industry Average. Conduct the Du Pont Analysis for both the company and the
industry.

Company Ratios for 2021 Industry Average for 2021

Current Ratio 1.4 1.6
Quick Ratio 1.0 1.2
ROA 0.12 0.15
Profit Margin 0.13.8 0.125
Debt Ratio 0.4 0.325
Total Asset Turnover 0.8696 1.20
Inventory turnover 5 5.5
Accounts Receivable Turnover 5 6
P/E 11.1594 13.50
M/B 2.232 3.15

Accounting Profitability Ratios: Profit Margin, ROA, ROE

Net Income 13.8
Profit Margin = = = 0.138 = 13.8%
Sales 100

Net ıncome
ROA = Total Assets = 0.12

Net ıncome 13.8

ROE = Total Equity = = 0.20 = 20%
69

Market Value Ratios: P/E, M/B

DPS=1.54
13.8
EPS = = 2.76
5

DPS 1.54
Dividend Yield = = 0.05, Price/Share = 0.05 = 30.8
PPS

PPS 30.8
Price to Earnings Ratio = = = 11.1594
EPS 2.76
30.8
Market to Book Ratio = = 2.232
69⁄
5
100
Total Assets Turnover = 115 = 0.8696

1 1
Equity Multiplier = 1−TDR = 1−0.4 = 1.667

1 1
Equity Multiplier for the industry = 1−TDR = 1−0.325 = 1.4815

ROEC = PM × TAT × EM = 0.138 × 0.8696 × 1.667 = 0.20

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 ROEI = PM × TAT × EM = 0.125 × 1.20 × 1.4815 = 0.2222

The ROE for the industry is higher. It is because it has higher TAT. The company has
higher profit margin and equity multiplier. The company is better at controlling its costs
and the company has more debt thus have a higher equity multiplier. On the other hand,
the industry is better at managing its assets and has less debt and less risk.

When we look at the market values, we can conclude that price to earnings ratio and
market to book ratio for the company is lower than the industry. Both market ratios are
higher than 1. The stock price for the company is not as high as the average of other
company’s stock prices.

c. (5 points) Jane also calculated how fast The Chocolate Box Inc. can grow by using
only its internal sources. However, her manager does not like the number she sees. She
wants Jane to calculate the dividend payout ratio that will allow the company to grow
at 8% next year by using internal sources only. Calculate the dividend payout ratio
required to achieve this growth rate.

We need to calculate the Internal Growth Rate (IGR) because the company uses its
internally generated funds only. The IGR should be 8%.

0.12 × b
IGR = = 0.08
1 − 0.12 × b

b = 0.6173 = 61.73%

Thus, dividend payout ratio should be 1 - 0.6173 = 0.3827 = 38.27%

d. (4 points) By using the dividend payout ratio you solved for in part (c) of this question,
calculate the maximum growth rate the company can have next year by using internal
sources and borrowing while keeping a constant debt ratio.

Since the company can borrow now, we need to calculate the Sustainable Growth Rate
(SGR).
0.20×0.6173
SGR = 1−0.20×0.6173 = 14.085%

2. (62 points) Last night, you watched “Midnight at the Pera Palace” and learned about time
travel. Your grandfather works at the Pera Palace and has the key for time traveling. Also,
in class, you learned about how a $10 deposited in a bank account becomes $447,189.84 in
200 years. This gives you an idea. With the help of your grandfather, first, you traveled
back to October 29, 1933, and celebrated the 10th anniversary of the Turkish Republic with
your grand grandfather and grand grandmother. After doing this trip couple of times, you
wondered if you could turn these trips into an opportunity by depositing some money into
a bank account under your grand grandfather’s name. You told your grand grandfather
about your plans and asked him not to withdraw any money from this account. Suppose
your grandfather is the only descendant of your grand grandfather. Furthermore, you talked
to Is Bank about this account, and the bank promised a return of 8.4% compounded monthly
per year until April 12, 2023.

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a. (5 points) After returning from your last time travel, you sat down and made some
calculations. First, you try to determine how much money you have in the bank account
on April 12, 2023, your 25th birthday, if you make a single deposit of 100 Liras on April
12, 1933.
0.084
𝐸𝐴𝑅 = (1 + 12 )12×1 − 1 = 8.73%
𝐹𝑉2023 = 100 × (1 + 0.0873)90 = 186,829.27

b. (6 points) Unsatisfied with the amount of money you have in the account on April 12,
2023, under the alternative in part (a), you want to determine the amount of money
you will have in this account on April 12, 2023, if you make 100 lira deposits into the
bank account in every 10 years on April 12. The first deposit will be in 1933, and the
last will be in 2023.

Number of payments=10
0.084
𝐸𝑅 = (1 + 12 )12×10 − 1 = 1.3096 = 130.96%
𝐹𝑉2023 = 100 × 𝐹𝑉𝐼𝐹𝐴(130.96%, 10) = 329,707.23

c. (6 points) Still unsatisfied with the amount of money you have in the account on April
12, 2023, under the alternative in part (b), you want to determine the amount of money
you will have in this account on April 12, 2023, if you make 100 Lira deposits into the
bank account every 2.5 years. The first deposit will be on April 12, 1933, and the last
one will be on April 12, 2023.

Number of payments=4×9+1=37
0.084
𝐸𝑅 = (1 + 12 )12×2.5 − 1 = 0.2328 = 23.28%
𝐹𝑉2023 = 100 × 𝐹𝑉𝐼𝐹𝐴(23.28%, 37) = 990,503.18

d. (2 points) Satisfied with the amount of money you have in the account on April 12,
2023, you made these deposits under the alternative in part (c). Now you and your
brother are making plans on how to spend this money. Since this was your idea, your
brother insists that you should get 60% of the money in the bank account on April 12,
2023. Determine the division of wealth between you and your brother.

𝑌𝑜𝑢𝑟 𝑤𝑒𝑎𝑙𝑡ℎ = 990,503.18 × 0.60 = 594,301.91

𝑌𝑜𝑢𝑟 𝑏𝑟𝑜𝑡ℎ𝑒𝑟 ′ 𝑠 𝑤𝑒𝑎𝑙𝑡ℎ = 990,503.18 × 0.40 = 396,201.27

e. (8 points) Your brother celebrates his 18th birthday on April 12, 2023. He plans to
marry a rich girl on his 35th birthday and has no intention of going to college or working.
He wants to support himself with this money and not live with your parents. He would
like to withdraw money from this account every six months. The first withdrawal will
be on April 12, 2023, and the last one will be 6 months before his 35th birthday. He
plans to leave the money in the account at Is Bank, and the bank promises to pay 15%
compounded monthly on his account until his 35th birthday. Determine the semiannual
withdrawals your brother can make from this account.

Number of payments=34 payments

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 0.15
𝐸𝑅 = (1 + )12×0.5 − 1 = 0.0774 = 7.74%
12
𝑃𝑉2023 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠 × 𝑃𝑉𝐼𝐹𝐴(7.74%, 34) × (1 + 0.0774) = 396,201.27
𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠 = 30,913.91

f. (10 points) Your brother is very disappointed with the semiannual withdrawals you
calculated in part (e) of this question. He wants to be able to withdraw 72,000TL every
six months from this account. He still wants to marry a rich girl on his 35th birthday. He
will continue to live with your parents until he can start making withdrawals from this
account. While he is living with your parents, he will not touch this money. He will
continue to earn 15% with monthly compounding on his account. He will move to his
own place when he can make his first withdrawal from the account and the last
withdrawal will still be 6 months before his 35th birthday. Determine how long your
brother has to live with your parents before moving into his own place.

We can compound the amount your brother has to his 35th birthday.
𝐹𝑉35 = 396,201.27 × (1.0774)34 = 4,997,270.80
𝐹𝑉35 = 72,000 × 𝐹𝑉𝐼𝐹𝐴(7.74%, 𝑇) × (1.0774) = 4,997,270.80
𝐹𝑉𝐼𝐹𝐴(7.74%, 𝑇) = 64.42
(1.0774)𝑇 − 1
= 64.42
0.0774
𝑙𝑛(5.9861)
𝑇 = 𝑙𝑛(1.0774) = 23.99 ≈ 24
He can get this amount for 24 periods, 12 years. There are still 17 years to his 35th
birthday. Therefore, he has to live with his family for another 5 years.

g. (25 points) Being a finance wizard, you would like to use your share of the money to
buy a house on your 36th birthday and finance your retirement. You will keep the money
in an account at Is Bank, earning an interest rate of 12% with monthly compounding
until your 85th birthday. You will start working on your 25th birthday and retire on your
60th birthday.
i. (9 points) You think you need to pay 2.5 million TL for your dream house on your
36th birthday. After careful analysis, you determined that you can make quarterly
deposit of 3,350TL into this account until your 36th birthday. The first deposit will
be 3 months after your 25th birthday and the last one on your 36th birthday. Check
if you have enough money in this bank account on your 36th birthday to buy your
dream house.

APR=12% monthly compounding

On your 25th birthday you have 594,301.91 from the previous investments.
You plan to save 3,350 every quarter until you are 36 to buy the house.
We need a quarterly effective rate.
0.12 12×1
𝐸𝑅 = (1 + ) 4 − 1 = 3.03%
12
We need to find the future value of your current savings. There are 11 years, 44
quarters.𝐹𝑉36 = 594,301.91 × (1.0303)44 = 2,210,089.79
The value of the quarterly savings will be:
𝐹𝑉36 = 3,350 × 𝐹𝑉𝐼𝐹𝐴(3.03%, 44) = 300,593.37

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 Total savings at the age 36 will be:
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑣𝑖𝑛𝑔𝑠 = 2,210,089.79 + 300,593.37 = 2,510,683.16
You will have enough money to buy the house.

ii. (16 points) Any money remaining after you buy your house will be saved to support
you during your retirement. You think you can live till your 85th birthday. You
would like to be able to withdraw 36,000TL from your retirement account every
month during your retirement. The first withdrawal from the account will be on
your 60th birthday, and the last one will be one month before your 85th birthday.
Determine the quarterly deposits you have to make into this account between your
36th and 60th birthdays to satisfy your retirement goal. The first deposit will be 3
months after your 36th birthday and the last one on your 60th birthday.

At the age of 36 you will have 2,510,683.16 – 2,500,000 = 10,683.16

We need to calculate how much you should save at the age of 60 in order to be able
to withdraw 36,0000 every month in your retirement.
We need a monthly effective rate
1
0.12 12×12
.𝐸𝑅 = (1 + ) − 1 = 0.01
12
Number of periods: 25×12-1+1=300
𝑃𝑉60 = 36,000 × 𝑃𝑉𝐼𝐹𝐴(1%, 300) × (1.01) = 3,452,256.60
You already have 10,683.16. We should find its future value at the age of 60
Number of periods = 24 years and 24×12 = 288 months
𝐹𝑉60 = 10,683.16 × (1.01)288 = 187,609.74
You need to save 3,452,256.6 – 187,609.74 = 3,264,646.86
Number of periods= 24×4 = 96
𝐹𝑉60 = 𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠 × 𝐹𝑉𝐼𝐹𝐴(3.03%, 96) = 3,264,646.86
Quarterly payments = 5,973.49