Financial Management

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Suggested Solution By Prof. F.R. Tariq
For any query please contact at azeez786@hotmail.com, 0333-4233770, 0321-4401660 ALLAMA IQBAL OPEN UNIVERSITY ISLAMABAD
LEVEL MBA Semester Autumn 2002
Paper Financial Management CC. 562/5535 Maximum Marks 100
Time Allowed 3 Hrs Pass Marks 40
NOTE ATTEMPT FIVE QUESTIONS. ALL CARRY EQUAL MARKS
Q. 1 Cheryl’s Menswear feels that its credit costs are too high. By tightening its credit standards, bad debts will fall from 5 percent of sales to 2 percent. However, sales will fall from $100,000to $90,000 per year .The variable cost per unit is 50 percent of the sale price, and the average investment in receivables is expected to remain unchanged.

(a) What cost will the firm face in reduced contribution to profits form sales? (b) Should the firm tighten its credit standards? Explain your answer. Q. 1 Answer:-
Existing Arrangements Proposed Arrangements
Sales $ 100,000 $90,000
Variable cost 50,000 45,000
Bad Debts 5,000 1,800
Net Earnings $45,000 $43,000
The company should not tighten its credit standards because of reduced contribution margin. Q. 2
Lockbox system can shorten Orient Oil’s accounts receivable collection period by 3 days. Credit sales are $3,240,000 per year, billed on a continuous basis. The firm has other equally risky investments with a return of 15 percent. The cost of the lockbox system is $9,000 per year. (a) What amount of cash will be made available for other uses under the lockbox system? (b) What net benefit (cost) will the firm receive if it adopts the lock box system? Should it adopt the proposed lockbox system?

Q. 2 Answer: -
(a) Amount of cash available=$9,000 x 3 =$27,000
($3,240,000/360=$9,000)
(b) Expected earnings of funds related 27,000 x 15/100 = $4,050 The firm should not initiate lockbox system because annual cost of lockbox $9,000 is greater than potential earnings.
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Suggested Solution By Prof. F.R. Tariq
For any query please contact at azeez786@hotmail.com, 0333-4233770, 0321-4401660 Q. 3 Determine the cost of giving up cash discounts under each of the following terms of sale. a) 2/10 net 30 b) 1/10 net 30

c) 2/10 net 45 d) 3/10 net 45
Q. 3 Answer: - (a) 2 x 365 = 37.24%
100-2 30 -10
(b) 1 x 365 = 18.43%
100-1 30 -10
(c) 2 x 365 = 21.28%
100-2 45 -10
Q. 4 Patterson’s Parts store expects sales of $100,000 during each of the next 3 months. It will make monthly purchases of $60,000 during this time. Wages and salaries are $10,000 per month plus 5 percent of sales. Patterson’s expects to make a tax payment of $20,000 in the next month and a $15,000 purchase of fixed assets in the second month and to receive $8,000 in cash from the sale of an asset in the third month. All sales and purchases are for cash. Beginning cash and the minimum cash balance are assumed to be zero.

(a) Calculate a cash budget for the next 3 months.
(b) Briefly discuss how the financial manager can use the data in (a) to plan for Patterson’s financing needs.
Q. 4 Answer:- (Refer to Question 2 of Autumn 2003)
Q. 5 Firm J has sales of 100,000 units at $2.00 per unit, variable operating costs of $1.70 per unit, and fixed operating costs of $6,000. Interest is $10,000 per year. Firm R has sales of 100,000 units at $2.50 per unit, variable operating cists of $1.00 per unit and fixed operating costs of $62,500. Interest is $17,500 per year. Assume that both firms are in the 40 percent tax bracket. (a) Compute the degree of operating, financial, and total leverage for firm J. (b) Compute the degree of operating, financial, and total leverage for firm R. Q. 5 Answer:-

DOL = Q (P –V) or EBIT + FC
Q (P – V) –FC EBIT
Firm J: 100,000 (2-1.70) = 1.25 Times or $24,000 +$6,000 =1.25 Times 100,000 (2-1.70) – $6,000 $24,000
DFL = EBIT = $24,000 = 1.7142 Times
EBIT – Interest $24,000-$10,000
DTL = Q (P –V) = $30,000 = 2.14 x
Q (P-V) - FC – Interest $30,000-$6,000-$10,000
OR
DTL = DOL x DFL 1.25 x 1.714 = 2.14 Times
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