Scheme Answer SET A

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Final Examination Semester January – June 2011

Answer Scheme / SET A

Subject: Entrepreneurial Finance (FIN2533)

SECTION A

QUESTION 1

PART A

a)

i. Net Initial Outlay of New Machine

Initial Outlay = 0

ii. Net Operating Cash Flow

Year 1RM

Year 2RM

Year 3RM

Year 4RM

Year 5RM

Revenue 300,000.00√ 300,000.00 300,000.00 300,000.00 300,000.00

Operating Cost (50,000.00)√ (52,500.00)√

(55,125.00)√

(57,881.25)√

(60,775.31)√

Labour Cost (30,000.00)√ (30,000.00) (30,000.00) (30,000.00) (30,000.00)

Depreciation (W1) (42,000.00)√ (42,000.00) (42,000.00) (42,000.00) (42,000.00)

Gross Profit 178,000.00 175,500.00 172,875.00 170,118.75 167,224.69

Tax Liability (35%) 62,300.00√ 61,425.00 60,506.25 59,541.56 58,528.64

115,700.00 114,075.00 112,368.75 110,577.19 108,696.05Add back withDepreciation

42,000.00√ 42,000.00 42,000.00 42,000.00 42,000.00

Net Operating CashFlow

157,700.00√156,075.00

√154,368.75

√152,577.19

√150,696.05

√

W1 = [(200,000 + 10,000) / 5 – 0] = RM42,000 a year

iii. Terminal Year Cash Flow (Year 5)

Return on Net Working Capital = RM5,000√

(20√/20 x 12 m = 12

m)

1 FIN2533/FINAL/SETA/MAY11

RM

Plant Machinery Cost

200,000

√

Installation Cost cc10,000√

Increased in Net WorkingCapital

ccc5,000 √

Net Initial Outlay of NewMachine

215,000√



b)

i. The Payback Period for each project:

Project AZRBYear Cash Flows Balance

0 (25,000) (25,000)√

1 10,000 (15,000)√

2 10,000 (5,000)√3 20,000

4 25,000

Payback Period for Project AZRB = 2√ + (5,000√/20,000√) = 2 + 0.25 = 2.25years√

Project PUNS

Year Cash Flows Balance

0 (100,000) (100,000)√

1 30,000 (70,000)√2 50,000 (20,000)√

3 70,000

4 120,000

Payback Period for Project PUNS = 2√ + (20,000√/70,000√) = 2 + 0.29 = 2.29years√

Decision: Choose Project AZRB√ because Payback Period is the shortest√.

ii. Net Present ValueProject AZRB

YearCash Flows

(RM)Discounted (10%)

New CashFlows(RM)

0 (25,000) 1.0000 (25,000)√

1 10,000 0.9091 9,091√

2 10,000 0.8264 8,264√

3 20,000 0.7513 15,026√

4 25,000 0.6830 17,075√

Net Present Value 24,456√




Project PUNS

YearCash Flows

(RM)Discounted (10%)

New CashFlows(RM)

0 (100,000) 1.0000(100,000)

√1 30,000 0.9091 27,273√

2 50,000 0.8264 41,320√

3 70,000 0.7513 52,591√

4 120,000 0.6830 81,960√

Net Present Value103,144

√

Decision: Choose Project PUNS√ because the highest net present value√.

iii. Modified Internal Rate of Return

Project AZRB

Year

CashFlows(RM)

Compounded (10%)New Cash

Flows(RM)

1 10,000 1.331013,310

√

2 10,000 1.210012,100

√

3 20,000 1.100022,000

√

4 25,000 1.000025,000

√

Total72,410

√

MIRR = 4√72,410√/25,000√ -1 = 1.3046 – 1 = 30.46%√ > 10%

Project PUNS

YearCashFlows(RM)

Coumpounded (10%)New Cash

Flows(RM)

1 30,000 1.3310 39,930√

2 50,000 1.210060,500

√

3 70,000 1.100077,000

√

4 120,000 1.0000120,000

√




Total297,430

√

MIRR = 4√297,430√/100,000√ -1 = 1.3132 – 1 = 31.32%√ > 10%

Decision: Choose Project AZRB√ because the highest of MIRR√.

(48√/48 x 8 m = 8

m)

PART B

i. Relevant Ratios:

Current Ratio = Total Current Assets = 3,500,000√ = 1.75 times√

Total Current Liabilities 2,000,000√

Acid Test Ratio = Total Current Assets – Inventories = 3,500,000 – 1,000,000√ = 1.25

times√

Total Current Liabilities 2,000,000√

Inventory Turnover Ratio = Sales = 8,000,000√ = 8 times√

Inventories 1,000,000√

Operating Profit Margin = Earnings before Interest Taxes = 1,700,000√ = 21.25%√

Sales 8,000,000√

Days Sales Outstanding = Accounts Receivable = 2,000,000√ = 90 days√

Annual Sales / 360 days 8,000,000/360√

Profit Margin on Sales = Net Income available to common Shareholders = 980,000√

= 12.25%√

Sales 8,000,000√

Times Interest Earned Ratio = Earnings before Interest Taxes = 1,700,000√ = 5.67

times√

Interest Charged 300,000√

Debt Ratio = Total Debts = 6,000,000√ = 75%√

Total Assets 8,000,000√

(24√/24 x 8 m = 8

m)

ii. Comments:




Comments:

Ratio ResultsIndustryAverage

Comments

Current Ratio1.75times 2.0 times

Bad /Poor√

Acid Test Ratio

1.25

times 1.1 times Good√Inventory Turnover Ratio 8 times 2.4 times Good√

Operating Profit Margin 21.25% 15.50% Good√

Days Sales Outstanding90 days

25 daysBad /Poor√

Profit Margin on Sales 12.25% 4% Good√Times Interest EarnedRatio

5.67times 3.5 times Good√

Debt Ratio75%

48%Bad /Poor√

(8√/8 x 4 m = 4

m)iii. Recommendations:

a) Current ratio: Increase (CR) by doing a lot of promotion. Therefore can

reduce the number of inventory quickly.√

b) Days sales outstanding: Decrease DSO by collect the debt from

debtors quickly.√

c) Debt ratio: Decrease debt ratio by paying the creditors on time.√

(3√/3 x 4 m = 4

m)

iv. Two (2) reasons for conducting ratio analysis:

a) To take a look of company performance.√

b) To analyze the liquidity and profitability of a firm.√

(2√/2 x 2 m = 2

m)

SECTION B

QUESTION 1

PART A

i. EOQ = √2DS / K = √(2√x245,000√x200√)/2√ = 7,000 umbrellas√ (5√/5 x 2 m

= 2 m)

ii. Number of orders = Number of Orders = 245,000√ = 35 orders√ (3√/3 x 2 m

= 2 m)




Q/2 7,000√

iii. Re-order Point = (Usage x Lead Time) + Safety Stock

= (245,000/250√ x 3 days√) + 5,000√

= 7,940 units√ (4√/4 x 2 m = 2

m)

iv. Total Ordering Costs = Number of orders x Ordering Costs = 35√ x RM200√ =

RM7,000√

Total Carrying Costs = (Q/2) + Safety Stock x Carrying Costs

= (7,000/2)√ + 5,000√ x RM2√ = RM17,000√

Total Inventory Costs = Total Ordering Costs + Total Carrying Costs

= RM7,000 + RM17,000

= RM24,000√ (8√/8 x 4 m = 4

m)

PART B

a) Define:

i. Seed Financing – consists of relatively small amounts√ of money provided

to support exploration of a concept before the venture actually begins

operation√. Seed financing may cover such things as the cost of assessing

the size of potential market and preparing the business plan. The principal

risk exposure of seed financing are risk of discovery. For example: during

this phase the entrepreneur may discover that a significant market for the

product does not exist or that an existing competitor already controls

essential technology. For high-technology ventures, seed financing may

provide initial funds for research and development. In cases where research

and development efforts are expensive and protracted. Therefore R&D

financing could be required beyond what is typically regarded as seed

financing. The critical risk exposure at this point is the risk of unsuccessful

product development effort. Sources: self, friends and family.




ii. First Stage Financing – is provided to a company that has initiated

production and is generating revenues but normally has not yet achieved

profitability√. Product development activities are completed to the point

where the firm has a marketable product√, but substantial uncertainty

remains as to achieve sales and profitability. The critical risk at this point is

marketing risk, the question of whether the venture can reach a level of

sales sufficient to attract and compensate investors. Sources: strategic

partner, venture capital, asset-based lender, trade credit.

(4√ x 1 m = 4

m)

b) Differences between entrepreneurial finance and corporate finance:

Differences Corporate Finance Entrepreneurial

FinanceInterdependence between

investment and financial

decision√ 1m

The manager makes the

decision of which assets to

acquire by comparing the

return on the investment

to the market rate of

interest for projects of

equivalent risk. 1/2m

The manager does not

need to consider, how

ownership of the assets

will be financed or

whether the firm’s

shareholders value high-

dividend payouts or prefer

capital gains. 1/2mManagerial involvement of

outside investors√ 1m

In public corporations,

investors are generally

passive and do not

contribute managerialservices. 1/2m

Outside investors in new

ventures frequently do

provide managerial and

other services thatcontribute to the new

venture success. 1/2mHarvesting the

investment√ 1m

In corporate finance,

investment opportunities

are evaluated based on

their ability to generate

free cash flow for the

corporation. Free cash

flow is cash flow beyond

what is needed tomaintain the investment

and provide for growth.

1/2m

Investors in corporations

purchase stock in public

markets. They realize

Investing new venture is

different. New venture

investments normally are

not liquid and often do not

generate any significant

free cash flow for several

years. 1/2m




returns in form of

dividends and from capital

gains realized by re-selling

the shares of stock to

other investors.Value to entrepreneur Maximizing value of

shareholders.

Maximizing value for the

entrepreneur as distinct.(6 m)

QUESTION 2

PART A

a) Expected Rate of Returns

ERR (P) = (0.05√ x 0.75√) + (0.15√ x 1.25√) + (0.60√ x 8.50√) + (0.15√ x 14.75√) +

(0.05√ x 16.25√) = 16√

ERR (Q) = (0.05√ x 1.00√) + (0.15√ x 2.50√) + (0.60√ x 8.00√) + (0.15√ x 13.50√) +

(0.05√ x 15.00√) = 15.2√

Decision: Choose Line P√ because of higher of expected rate of returns means returns

that company will receive higher returns√. (24√/24 x 4

m = 4 m)

b) Standard Deviation

SD (P) = [(0.75 – 16)2 x 0.05]√ + [(1.25 – 16)2 x 0.15]√ + [(8.50 – 16)2 x 0.60]√ +

[14.75 – 16)2 x 0.15]√ + [(16.25 – 16)2 x 0.05]√ = 11.63 + 32.63 + 33.72 +

0.23 + 0.003 = √78.213 = 8.84%√

SD (P) = [(1.00 – 15.2)2 x 0.05]√ + [(2.50 – 15.2)2 x 0.15]√ + [(8.00 – 15.2)2 x 0.60]√ +

[13.50 – 15.2)2 x 0.15]√ + [(15.00 – 15.2)2 x 0.05]√ = 10.08 + 24.19 + 31.10 +

0.43 + 0.002 = √65.802 = 8.11%√

Decision: Choose Line Q√ because of lower of standard deviation means risks that

company face will be low√.

(14√/14 x 4 m = 4 m)




c) Coefficient Variation

Line P = Standard Deviation = 8.84√ = 0.55√

Expected Returns 16√

Line Q = Standard Deviation = 8.11√ = 0.53√

Expected Returns 15.2√

Decision: Choose Line Q√ because of lower of coefficient variation means risks that

company face will be low√.

(8√/8 x 2 m = 2 m)

PART B

a) Three (3) types of risk:

i. Transaction exposure√ – refers to the extent to which the future cash

transactions of the firm may be affected by any changes in the currency

exchange rate√.

ii. Economic exposure√ – measures the impact of changes in exchange rate

on the firm’s cash flows and earning√.

iii. Translation exposure√ – refers to accounting exposure. It measures the

impact of changes in exchange rate on the financial statements of the

group of the company√.

(6√/6 X 6 m = 6

m)

b) i. Direct quotation√ – direct quotations have a dollar sign in their quotation

and state the number of dollars per foreign currency unit, such as dollars per

euro√. Example: Direct U.S dollar quotations for the euro are $1.1542, because

one euro can be bought for 1.1542 dollars.

ii. Indirect quotation√ – the number of units of a foreign currency that can be

purchased for one U.S dollar√.

(4√/4 X 4 m = 4

m)

QUESTION 3




PART A

a) i. The future value of annuity at the end of four years:

FVA4 = 1,000 (FVIFA 10%/2, 4 x 2)

= 1,000√ (FVIFA 5%√, 8√)

= 1,000 x 9.549√

= RM9,549√

ii. The present value of annuity:

PVA4 = 1,000 (FVIFA 10%/2, 4 x 2)

= 1,000√ (FVIFA 5%√, 8√)

= 1,000 x 6.563√

= RM6,463√ (10√/10 x 6 m = 6

m)

b) Acc 1:

FV2 = 3,000√ (FVIF 6%/2√, 1 x 2√)

= 3,000 (FVIF 3%, 2)

= 3,000 x 1.061√

= RM3,183√

Acc 2:

FVA12 = 150√ (FVIFA12%/12√, 1 x 12√)= 150 x 12.682√

= RM1,902.30√

Total withdraw amount = RM3,183√ + RM1,902.30√ = RM5,085.30√

ii. Amount of Loan = RM80,000√ x 0.9√ = RM72,000 √

PVA8 = PMT (PVIFA5%, 8)

72,000√ = PMT (6.463)√

PMT = RM11,140.34 yearly√ (19√/19 x 4 m = 4

m)

PART B

a) $700,000√ x 3.06√ = RM2,142,000√




€400,000√ x 4.01√ = RM1,604,000√ (6√/6 x 4 m = 4

m)

b) i. Letter of Credit√ - a document issued mostly by a financial institution,

used primarily in trade finance, which usually provides an irrevocable

payment undertaking√.

ii. Bank Acceptance√ - a negotiable instrument√ or time draft drawn on and

accepted by a bank. Before acceptance, the draft is not an obligation of

the bank√; it is merely an order by the drawer to the bank to pay a

specified sum of money on a specified date to a named person or to the

bearer of the draft. Upon acceptance, which occurs when an authorized

bank accepts and signs it, the draft becomes a primary and unconditional

liability of the bank.

iii. Shipping Guarantees√ - a written guarantee signed by the bank√ andissued to the importer for picking up the goods from the shipping

company in the case of arrival of cargo prior to the shipping documents√.

Such a kind of trade finance is especially applicable in the case of short

shipping voyage and arrival of cargo prior to the documents.

(6√/6 x 6 m = 6

m)

QUESTION 4

PART A

a) i. A, PVA5 = PMT (FVIFA30%√, 5√)

= 10,000√ (2.436√)

= RM24,360√


http://en.wikipedia.org/wiki/Financial_institution

http://en.wikipedia.org/wiki/Trade_finance

http://en.wikipedia.org/wiki/Negotiable_instrument

http://en.wikipedia.org/wiki/Bankers'_acceptance#Comparison_with_other_drafts

http://en.wikipedia.org/wiki/Bank

http://en.wikipedia.org/wiki/Financial_institution

http://en.wikipedia.org/wiki/Trade_finance

http://en.wikipedia.org/wiki/Negotiable_instrument

http://en.wikipedia.org/wiki/Bankers'_acceptance#Comparison_with_other_drafts

http://en.wikipedia.org/wiki/Bank



(10√/10 x 8 m = 8 m)

ii. Therefore, we should invest in A because of higher returns√. (2√/2 x 2 m

= 2 m)

b) i. Trade credit – arises automatically as part of the purchase transaction

when a firm acquires goods and services but does not pay for them

immediately, since short-term credit is extended by the suppliers.

(2 m)

Advantages of trade credit

• easily available with few restriction

• no formal agreement or contract required

• continuous sources of funds

• flexibility in repayment (any

2 = 2 m)

Disadvantages of trade credit:

• firm may end up paying a higher price when full credit is taken up

• credit receive during the discount period is not free since there may

be opportunity cost incurred by the buyer if he/she foregoes the

chance to pay less for the purchases

(any 2 = 2 m)

ii. advantages of short-term financing:

• flexibility√ (explain)√

• cost of short-term debt is lower√ (explain)√ (4√/4 x 4

m = 4 m)


Calculation B for investment:

Year

CashFlows

FVIF (30%) Amount

3 10,000 0.455 4,550√

4 10,000 0.350 3,500√

5 10,000 0.269 2,690√

6 10,000 0.207 2,070√Total 12,810√

Scheme Answer SET A

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