Financial Analysis And Tax Calculation Essay.

Question 1: Maddox Corporation Tax Liability Calculation

1). Calculate the Maddox Corporation’s tax liability when the taxable income is $526,800.

                                                              

2). Syntex, Inc. is considering an investment in one of two common stocks. Given the information that follows, which investment is better, based on risk (as measured by the standard deviation) and return?

                                                                    

3). The balance sheet and income statement for the J. P. Robard Mfg. Company are as follows:

                                                                                              Balance Sheet ($000)

Cash	$ 500
Accounts receivable	2,000
Inventories	1,000
Current assets	$3,500
Net fixed assets	4,500
Total assets	$8,000
Accounts payable	$1,100
Accrued expenses	600
Short-term notes payable	300
Current liabilities	$2,000
Long-term debt	2,000
Owners' equity	4,000
Total liabilities and owners' equity	$8,000

                                                                                                           Income Statement ($000)

Net sales (all credit)	$8,000
Cost of goods sold	(3,300)
Gross profit	4,700
Operating expenses
(includes $500 depreciation)	(3,000)
Operating income	1,700
Interest expense	(367)
Earnings before taxes	$1,333
Income taxes (40%)	(533)
Net income	$ 800

                                                         

                                                        

4). CSR Enterprises is evaluating its financing requirements for the coming year. The firm has only been in business for 1 year, but its CFO predicts that the firm's operating expenses, current assets, net fixed assets, and current liabilities will remain at their current proportion of sales. Last year CSR had $12 million in sales with net income of $1.2 million. The firm anticipates that next year's sales will reach $16 million with net income rising to $3 million. Given its present high rate of growth, the firm retains all its earnings to help defray the cost of new investments. The firm's balance sheet for the year just ended is found below:

                                                              

Estimate CSR's total financing requirements (i.e., total assets) for 2001 and its net funding requirements (DFN).

5). CAPITAL BUDGETING

X construction is considering two projects to develop. The estimated net cash flow from each project is as follows:

Year	Project X ($)	Project Y ($)
1	110,000	75,000
2	65,000	150,000
3	100,000	60,000
4	115,000	55,000
5	35,000	60,000
Total	425,000	400,000

Each project requires an initial investment of $ 200,000. A rate of 15% has been selected for the NPV analysis.

Require to

Calculate Payback period, ARR Net Present Value and Profitability Index.

Which Project is to be recommended to develop based on NPV, Profitability Index, Payback period and ARR? Suggest.

FORMULAE

 

Payback Period =   Base Year + (Initial Investment - Cumulative of Base Year)

       Cash Inflow of Next Year

Accounting Rate of Return =         Average Profit            x100

         Average Investment

Net Present Value =   Cumulative Present Value of Cash Inflow - Initial Investment

Profitability Index =   PV of future cash flows

  Initial Investment

1). 

Part A & B
Stock J
ki	p	kp	ki-k	(ki-k)^2*p
-10	0.1	-1	-20.2	40.804
4	0.25	1	-6.2	9.61
12	0.3	3.6	1.8	0.972
20	0.25	5	9.8	24.01
16	0.1	1.6	5.8	3.364
k		10.2	σ2	78.76
σ				8.87
Stock M
ki	p	kp	ki-k	(ki-k)^2*p
-15	0.1	-1.5	-22.75	51.75625
0	0.25	0	-7.75	15.015625
10	0.3	3	2.25	1.51875
15	0.25	3.75	7.25	13.140625
25	0.1	2.5	17.25	29.75625
k		7.75	σ2	111.1875
σ				10.54

Stock J
k	10.2
σ	8.87

Stock M
k	7.75
σ	10.54

2). 

1. Firm liquidity
Current ratio	=	Current assets	=	$642000	=	2.14
		Current liabilities		$300000
Average collection period	=	Accounts Receivable	=	$220000	=	24.85
		Daily Credit Sales		$3231000/365
2. Operating profitability
Operating income Return on Investment	=	Operating Income	=	$ 12,47,500	=	1.32
		Total assets		$ 9,47,500
Operating profit Margin	=	Operating Income	=	$ 12,47,500	=	0.39
		Sales		$ 32,31,000
Total Asset Turnover	=	Sales	=	$ 32,31,000	=	3.41
		Total assets		$ 9,47,500
Inventory turnover	=	Cost of Goods Sold	=	$ 7,17,000	=	4.94
		Inventory		$ 1,45,000
Fixed assets Turnover	=	Sales	=	$ 32,31,000	=	10.59
		Net Fixed assets		$ 3,05,000
3. Financing Decision
Debt Ratio	=	Total Debt	=	$ 66,500	=	0.07
		Total Assets		$ 9,47,500
4. Return on common equity
Return on Common Equity	=	Net Income	=	$ 7,35,000	=	1.27
		Common equity		$ 5,81,000

Analysis of Ratios
Ratio	Industry Norms	The Ferri Furniture Company	Comment
Current ratio	1.5	2.14	Good
Total asset turnover	1	3.41	Good
Inventory turnover	3	4.94	Good
Operating profit margin	18%	39%	Good
Operating income return on investment	18%	132%	Good
Debt ratio	60%	7%	Bad
Average collection period	100 days	24.85 Days	Good
Fixed asset turnover	1.5	10.59	Good
Return on equity	15%	127%	Good

3).

Part (1)	Payback Period
	Project X
Year	Cash Flows ($)	Cumulative Cash flows
1	50,000	50,000
2	40,000	90,000
3	20,000	1,10,000
4	20,000	1,30,000
5	10,000	1,40,000
	Payback period	2.50

	Project Y
Year	Cash Flows ($)	Cumulative Cash flows
1	10,000	10,000
2	20,000	30,000
3	20,000	50,000
4	40,000	90,000
5	70,000	1,60,000
	Payback period	4.14

Formula

Payback Period =   Base Year + (Initial Investment - Cumulative of Base Year)

       Cash Inflow of Next Year

 The payback period of project X is less than project Y. Hence we should select Project X.

Part (2)
Project X
Total cash Inflows	1,40,000
Less: Cash Outflow	100000
Profit	40,000
Avg profit	8,000
Avg Investment	50000
ARR	16%

Project Y
Total cash Inflows	1,60,000
Less: Cash Outflow	100000
Profit	60,000
Avg profit	12,000
Avg Investment	50000
ARR	24%

Formula

Accounting Rate of Return =         Average Profit            x100

   Average Investment

 The ARR of Project Y is higher than Project X. Hence we should select project Y.

Part (3)
Project X
Year	Cash Flows ($)	PVF @ 12%	DCF
1	50,000	0.893	44,643
2	40,000	0.797	31,888
3	20,000	0.712	14,236
4	20,000	0.636	12,710
5	10,000	0.567	5,674
Total present value			1,09,151
Initial investment			1,00,000
NPV			9,151

Project Y
Year	Cash Flows ($)	PVF @ 12%	DCF
1	10,000	0.893	8,929
2	20,000	0.797	15,944
3	20,000	0.712	14,236
4	40,000	0.636	25,421
5	70,000	0.567	39,720
Total present value			1,04,249
Initial investment			1,00,000
NPV			4,249

Formula

Net Present Value =   Cumulative Present Value of Cash Inflow - Initial Investment

 The NPV of project X is higher than project Y. Hence we should select project X.

Part (4)
Profitability Index
PI of X	1.09151
PI of Y	1.04249

Formula

Profitability Index =   PV of future cash flows

       Initial Investment

As we see both the projects have PI greater than 1 we can accept both the projects. But we will accept project X as its PI is greater than project Y.

4). This curve elaborates the risk and return relationship of two investment proposals A and B as the risk of both the investment proposals is same that is σA = σB , but A is more riskier than B because of large probability of losses. In other words we can say that for A there is same risk involved as in B but the returns are smaller in A as compared to B. We can see that A is one the negative side as well. So, we would recommend to invest in B as the risk is same but the returns are higher in A as compared to B.

5). Axioms of Finance:

1. Risk-Return Trade-off:

The risk associated with the return is called risk return trade off as higher risk is related to more probability of higher return and low risk is related to high probability of smaller returns (Ghysels, Santa-Clara  and Valkanov, 2005). Hence, risk return trade off explains the trade-off which an investor faces between the return and risk while making an investment (Campbell and Viceira, 2005).

Question 2: Investment Analysis for Syntex, Inc.

For Example: While making an investment Rohan faces a risk return trade off as if he deposits all money in the saving account of bank then he will earn a low return as compared to the return he will get from investing in the equity say stock market. The risk involved in share market is very high as compared to the risk in keeping money in bank account as the money will get insured in the bank account as well.

2. Time Value of Money:

The concept of time value of money defines that the value of a dollar to be received in future is less than the value of a Dollar in hand today. This means that the money also grows with time. The money received today will be invested in some activity and will worth more if we receive the same amount in future. This is because of the inflation effect as inflation is actually the rise in general level of prices with the passage of time.

Some basic terms are used in the time value of money calculation:

Present Value

Future Value

Discounting Rate

Time period

Time Value of money can be used to compare various investment alternatives and to solve problems of mortgages, loans, leases and savings.

For example:

If we invest $1 today at an interest rate of 6% for one year then the future value will be $1.06 that means the discounting rate is $1, time period is 1 year, future value is $1.06 and present value is $1.

3. Cash is king:

It is an age-old saying that cash is a king as the business and household both require cash in hand. Cash is the life blood as without the proper amount of cash both business and household will be in trouble. It is necessary to have some amount of cash in hand to run the day to day operation of business and the customers as well.

It is very necessary for business to have some amount of cash in hand as they often need to invest the money in some unexpected exposures and for that they need considerable amount of cash in hand or any other uncertainty can come in the way of the business and interrupt their smooth flow of business. The flow of cash is very necessary for long term growth of the company.

Question 3: J. P. Robard Mfg. Company Financial Statements

The same notation is for the customers as well households also as it is very necessary for them to keep the considerable amount of cash handily and not keep all the money for investment purpose as the flow of cash is also necessary.

4. Incremental Cash Flows:

The additional cash flow that an organisation receives from investing in a new project is called incremental cash flows. The increase in cash flow from the acceptance of the project is called positive incremental cash flow and if the cash flows will decrease after the implementation of the new project then it is called non incremental cash flows (Petty, Titman, Keown, Martin, Martin, and Burrow, 2015). If there is a positive incremental cash flow then it is a good indicator for the company. Incremental cash flow is the net cash flow that is inflows minus outflows of the new project over a specified time period and the comparison is to be done between two or more business proposal.

5. The agency problem:

The agency problem is the conflict of interest in any relationship where one party is likely to act in the best interest of another party (Arye Bebchuk and Fried, 2003). In corporate finance there are two primary agency relationships, the agency problem is the conflict of interest between a company’s stockholders and a company’s management and between the company’s creditors and its stakeholders (Chen, Lu, and Sougiannis, 2012).

6. Taxes bias business decisions:

The government taxation incentives directly influence the business and financial decisions of a company. It is very import for the companies to follow the government tax policies as if they will not follow the taxation system then penalties will impose on them (Buss, 2001). So, companies should not ignore the importance of government tax policies as the tax realises is used in most cases for boosting the economic purpose. Therefore it is important for the organisations to keep the awareness with the government taxation policies because they may provide the benefit of cost reduction (Park, Kim and Choi, 2007).

7. All risks are not equal:

Some risk can be diversified and some cannot, as the process of diversification reduces the risk and as a result the risk of any project or asset cannot be measured easily (Papa, 2009). A project’s risk is dependent on whether we measure it alone or we measure it with other projects of the company as well.

8. Ethical Dilemmas is everywhere in finance:

Question 4: Financing Requirements for CSR Enterprises

Ethical Dilemmas is judging between what is right and what is wrong. There are many cases in finance where ethical dilemmas occur as it is hard to make any choice between the right ad right thing and the right and wrong thing (Dobos, Barry and Pogge, 2011). As we take a small example to elaborate this, A firm had a choice to invest in two investment proposal A and B namely one proposal offer a positive NPV and other proposal offers a positive NPV but that too is lower than the first one, as we move forward to IRR project A has lower IRR than project B. Here arises the ethical dilemma as which proposal the company will accept it is hard to make a choice between A and B. As like this there are many cases where ethical dilemmas arises in the course of running the business where it is hard to make any choice.

The statement is absolute correct in its context “Although it is not necessary to understand finance in order to understand these axioms, it is necessary to understand these axioms in order to understand finance”. Finance is all about these axioms it is very necessary to have an in-depth knowledge of these axioms to lean how financial decisions can be made in a company (Lie, 2000). The company need to go through with all these conditions to run the business smoothly and they need to keep in view all these condition on time and very effectively (O’Fallon and Butterfield, 2005).

References:

Arye Bebchuk, L. and Fried, J.M., 2003. Executive compensation as an agency problem. The Journal of Economic Perspectives, 17(3), pp.71-92.

Buss, T.F., 2001. The effect of state tax incentives on economic growth and firm location decisions: An overview of the literature. Economic Development Quarterly, 15(1), pp.90-105.

Campbell, J.Y. and Viceira, L.M., 2005. The term structure of the risk–return trade-off. Financial Analysts Journal, 61(1), pp.34-44.

Chen, C.X., Lu, H. and Sougiannis, T., 2012. The agency problem, corporate governance, and the asymmetrical behavior of selling, general, and administrative costs. Contemporary Accounting Research, 29(1), pp.252-282.

Dobos, N., Barry, C. and Pogge, T. eds., 2011. Global financial crisis: The ethical issues. Springer.

Ghysels, E., Santa-Clara, P. and Valkanov, R., 2005. There is a risk-return trade-off after all. Journal of Financial Economics, 76(3), pp.509-548.

Lie, E., 2000. Excess funds and agency problems: An empirical study of incremental cash disbursements. The Review of Financial Studies, 13(1), pp.219-248.

O’Fallon, M.J. and Butterfield, K.D., 2005. A review of the empirical ethical decision-making literature: 1996–2003. Journal of business ethics, 59(4), pp.375-413.

Papa, V., 2009. Cash Is King. CFA Magazine, 20(6), pp.16-17.

Park, C.S., Kim, G. and Choi, S., 2007. Engineering economics. Pearson Prentice Hall, New Jersey.

Petty, J.W., Titman, S., Keown, A.J., Martin, P., Martin, J.D. and Burrow, M., 2015. Financial management: Principles and applications. Pearson Higher Education AU.