Business Studies Assignment on Financial Management

Instruction : This Assessment is open-book. There is no time limit, and you
may use your textbooks, other supporting material and and
Excel financial formulae for your reference and assistance.
Please answer all questions.
Question 1 (15 marks)
(Working with financial statements) Based on the information for the T. P. Jarmon Company for the
year ended December 31, 2015:
a) How much is the firm’s net working capital, and what is the debt ratio?
b) Complete a statement of cash flows for the period. Interpret your results.
c) Compute the changes in the balance sheets from 2014 to 2015. What do you learn about T.
P. Jarmon from these computations? How do these numbers relate to the statement of cash
2014 2015
Cash $15,000 $14,000
Marketable Securities 6,000 6,200
Accounts receivable 42,000 33,000
Inventory 51,000 84,000
Prepaid rent $1,200 $1,100
Total current assets $ 115,200 $ 138,300
Net plant and equipment 286,000 270,000
Total assets $ 401,200 $ 408,300
Liabilities and Equity
2014 2015
Account payable $ 48,000 $ 57,000
Accruals 6,000 5,000
Notes Payable 15,000 13,000
Total current liabilities $ 69,000 $ 75,000
Long term debt $ 160,000 $ 150,000
Common stockholders’ equity $ 172,200 $ 183,300
Total liabilities and equity $ 401,200 $ 408,300
Table Q1-1. T. P. Jarmon Company Balance Sheet for 12/31/2014 and 12/31/2015
Page 2 of 6
Sales $ 600,000
Less cost of goods sold $ 460,000
Gross profit $ 140,000
Operating and interest expenses
General and administrative ($ 30,000)
Interest (10,000)
Depreciation (30,000)
Total operating and interest expenses ($ 70,000)
Earnings before taxes $ 70,000
Taxes 27,000
Net income available to common stockholders $42,900
Cash dividends 31,800
Change in retained earnings $11,100
Table Q1-2 Jarmon Company Income Statement for the Year Ended 12/31/2015
Question 2 (10 marks)
Your division is considering two projects. Its WACC is 10%, and the projects’ after-tax cash flows (in
millions of dollars) would be as follows:
a) Calculate the projects’ NPVs, IRRs, MIRRs, regular paybacks, and discounted paybacks.
If the two projects are independent, which project(s) should be chosen?
b) If the two projects are mutually exclusive and the WACC is 10%, which project(s) should
be chosen?
c) Plot NPV profiles for the two projects. Identify the projects’ IRRs on the graph.
d) If the WACC was 5%, would this change your recommendation if the projects were
mutually exclusive? If the WACC was 15%, would this change your recommendation?
Explain your answers
e) The crossover rate is 13.5252%. Explain what this rate is and how it affects the choice
between mutually exclusive projects.
f) Define the MIRR. What’s the difference between the IRR and the MIRR, and which
generally gives a better idea of the rate of return on the investment in a project? Explain.
Page 3 of 6
Question 3 (15 marks)
a) Suppose you are considering two possible investment opportunities: a 12-year Treasury
bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 4%; and
inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4%
thereafter. The maturity risk premium is estimated by this formula: MRP = 0.02(t – 1)%.
The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. You may
determine the default risk premium (DRP), given the company’s bond rating, from the
table below. Remember to subtract the bond’s LP from the corporate spread given in the
table to arrive at the bond’s DRP. What yield would you predict for each of these two
Rate Corporate Bond Yield
Spread = DRP + LP
U.S. Treasury 0.83% —
AAA corporate 0.93 0.10%
AA corporate 1.29 0.46
A corporate 1.67 0.84
b) Given the following Treasury bond yield information, construct a graph of the yield curve.
Maturity Yield
1 year 5.37%
2 years 5.47
3 years 5.65
4 years 5.71
5 years 5.64
10 years 5.75
20 years 6.33
30 years 5.94
c) Based on the information about the corporate bond provided in Part a, calculate yields
and then construct a new yield curve graph that shows both the Treasury and the
corporate bonds. Comment which part of the yield curve (the left side or right side) is
likely to be most volatile over time