Financial Analysis and Investment Decisions

This article covers various financial analysis and investment decisions with solved examples. It includes calculations for net profit, dividend payout ratio, growth rate of earnings, AEC, effective annual interest rate, payback period, NPV, IRR, and more. The subject matter is relevant for finance courses in colleges and universities. Get expert solutions for your finance assignments at Desklib.

Solution 1
a)
Net profit of Fisher Ltd for year 2017-18 = $800,000
Dividend payout ratio = 70%
Growth rate of earnings = 20%
Share of Bradley Lane = 12%
Interest rate p.a. = 10%
Estimated profit of Fisher Ltd for year 2018-19 = 800000 x (1 + 20%)
= $960,000
Dividend to be received in late September 2018 = 800000 x 12% x 70%
= $67,200
Dividend to be received in September 2019 = 960000 x 12% x 70%
= $80,640
Amount to be received in late September 2019 from Dividend = $80,640
Amount required in late September 2019 = $95,000
Remaining amount required = $14,360
Amount which can be consumed in late September 2018 by Bradley Lane
= 67200 - (14360/ (1+ 10%))
= $54,145
b)
Discount rate p.a. = 6%
Cost of Van A = $70,000
Useful life = 3 years
Operating cost p.a. = $7,000
Yea Costs PVF PV

r
0 $ 70,000 1.0000 $ 70,000
1 $ 7,000 0.9434 $ 6,604
2 $ 7,000 0.8900 $ 6,230
3 $ 7,000 0.8396 $ 5,877
$ 88,711
PV of costs = $88,711
PV factor for 3 years at 6% = $2.67
AEC = $33,187.69
Cost of Van B = $90,000
Useful life = 4 years
Operating cost p.a. = $9,000
Year Costs PVF PV
0 $ 90,000 1.0000 $ 90,000
1 $ 9,000 0.9434 $ 8,491
2 $ 9,000 0.8900 $ 8,010
3 $ 9,000 0.8396 $ 7,557
4 $ 9,000 0.7921 $ 7,129
$ 121,186
PV of costs = $121,186
PV factor for 4 years at 6% = $3.47
AEC = $34,973.23
AEC for Van A is less than AEC of Van B. Therefore, Van A should be selected.
c)
Coupon rate p.a. = 13%
Required rate of return p.a. = 19%
Face value = $1,000
Interest amount per annum = 1000 x 13%
= $130
Particulars Year
No.
Amount to
be paid
PVF @
19% PV @ 19%

Interest due on Sep-21 paid in Sep-21 3 $ 130 0.5934 $ 77
Interest due on Sep-22 paid in Sep-22 4 $ 130 0.4987 $ 65
Interest due on Sep-23 paid in Sep-23 5 $ 130 0.4190 $ 54
Interest due on Sep-19 paid in Sep-23 5 $ 130 0.4190 $ 54
Interest due on Sep-20 paid in Sep-23 5 $ 130 0.4190 $ 54
Repayment of Notes 5 $ 1,000 0.4190 $ 419
$ 724
Current value of each Farmers Bank unsecured note = $724
Solution 2
a)
i)
Age today = 42 years
Retirement age = 63 years
Period of investment = 21 years
Period of investment (in months) = 21 x 12 months
= 252 months
Rate of interest p.a. compounding monthly= 4.80%
Monthly interest rate = 4.80% / 12
= 0.40%
Contribution each month = $3,700
Targeted sum = $1,600,000
Fund value at retirement = (3700 / 0.40%) ((1 + 0.40%)^(252) - 1)
= $1,604,515.59
= $1,604,516
She will have $1,604,516 at the age of 63 and she will achieve the targeted sum.
Surplus amount = 1604516 - 1600000
= $4,516

ii)
Age today = 63 years
Pension required till = 87 years
Period of pension = 24 years
Period of pension = 24 x 12 months
= 288 months
Rate of interest p.a. compounding monthly= 4.80%
Monthly interest rate = 4.80% / 12
= 0.40%
Suppose the monthly pension amount be P.
(P / 0.40%)(1 - (1 + 0.40%)^(-288)) = $1,604,515.59
P (170.8172) = $1,604,515.59
P = 1604515.59 / 170.8172
P = $9,393
Monthly pension Joan will receive is $9,393.
b)
i)
Rate of interest p.a. compounding monthly= 4.50%
Monthly interest rate = 4.50% / 12
= 0.375%
Effective annual interest rate = (1 + 0.375%)^12 - 1
= 4.594%

ii)
Rate of interest p.a. compounding monthly= 4.50%
Monthly interest rate = 4.50% / 12
= 0.375%
Amount of loan = $750,000
Repayment period = 25 years
Repayment period = 25 x 12 monthly
= 300 monthly
Suppose month instalment size be P.
(P / 0.375%)(1 - (1 + 0.375%)^(-300)) = $750,000
P (179.9103) = $750,000
P = 750000 / 179.9103
P = $4,169
Amount of monthly repayment is $4,169.
iii)
Rate of interest p.a. compounding monthly= 4.50%
Monthly interest rate = 4.50% / 12
= 0.375%
Repayment period = 25 years
Repayment period = 25 x 12 monthly
= 300 monthly
Amount of loan = $750,000

Value of repayment of $3000 per month at the end of year 1
= (3000 / 0.375%)((1 + 0.375%)^(12) - 1)
= $36,751.86
Value of repayment of $3500 per month at the end of year 2
= (3500 / 0.375%)((1 + 0.375%)^(12) - 1)
= $42,877.17
Loan pending at the end of year two
= 750000 (1 + 0.375%)^24 - 36,751.86 (1 + 0.375%)^12 - 42877.17
= $739,175.18
Suppose month instalment size be Y after two years.
(Y / 0.375%)(1 - (1 + 0.375%)^(-23Y12)) = $739,175.18
Y (171.756) = $739,175.18
Y = 739175.18 / 171.756
Y = $4,303.64
Y is $4303.64 per month.
iv)
Monthly loan repayment = $4,400
Suppose loan is repaid in n months.
(4400 / 0.375%) (1 - (1 + 0.375%)^(-n)) = $750,000
(1173333.33) (1 - (1 + 0.375%)^(-n)) = $750,000
(1 - (1 + 0.375%)^(-n)) = 750000 / (1173333.33)
(1 - (1 + 0.375%)^(-n)) = 0.6392

1 - 0.6392 = (1 + 0.375%)^(-n)
0.3608 = (1.00375)^(-n)
Taking log on both sides
log 0.3608 = (-n) log 1.00375
-0.442733471 = (-n) 0.00162555828
0.442733471 = (n) 0.00162555828
0.44273347113 / 0.00162555828 = n
272.3577964 = n
272.36 = n
n = 272.36
Total months taken for loan repayment is 273 months (22 years 9 months).
Solution 3
i)
Yea
r
Investment P ($) Investment Q ($)
Cash flows
Cumulative Cash
Flows Cash flows
Cumulative Cash
Flows
0 -60,000 -60,000 -60,000 -60,000
1 20,000 -40,000 30,000 -30,000
2 30,000 -10,000 30,000 -
3 44,000 34,000 30,000 30,000
34,000 30,000
Investment P = 2 + (10000/ 44000)
= 2.23 years
Investment Q = 2.00 years
Investment Q should be selected as it has lesser payback period.
ii)

Payback period will be different in this case.
Yea
r
Investment P ($) Investment Q ($)
Cash flows
Cumulative Cash
Flows Cash flows
Cumulative Cash
Flows
0 -60,000 -60,000 -60,000 -60,000
1 20,000 -40,000 30,000 -30,000
2 30,000 -10,000 30,000 -
3 44,000 34,000 30,000 30,000
34,000 30,000
Investment P = 3.00 years
Investment Q = 2.00 years
iii)
Required rate of return = 8%
Yea
r PVF Investment P ($) Investment Q ($)
Cash flows PV Cash flows PV
0 1.0000 -60,000 -60,000 -60,000 -60,000
1 0.9259 20,000 18,519 30,000 27,778
2 0.8573 30,000 25,720 30,000 25,720
3 0.7938 44,000 34,929 30,000 23,815
34,000 19,167 30,000 17,313
Investment P = $19,167.30
Investment Q = $17,312.91
Profitability Index = Present value future cash flow / initial investment
Investment P = 1.32
Investment Q = 1.29
iv)
An estimate of IRR can be made using NPV profiling of both the investments.

Investment P
Year Cash flows PVF @ 22% PV @ 22% PVF @ 23% PV @ 23%
0 -60,000 1.0000 -60,000 1.0000 -60,000
1 20,000 0.8197 16,393 0.8130 16,260
2 30,000 0.6719 20,156 0.6610 19,829
3 44,000 0.5507 24,231 0.5374 23,645
34,000 780 -265
IRR of Investment P = 22%+(23%-22%)*(780/(780+265))
= 23%
Investment
Q
Year Cash flows PVF @ 24% PV @ 22% PVF @ 23% PV @ 23%
0 -60,000 1.0000 -60,000 1.0000 -60,000
1 30,000 0.8065 24,194 0.8130 24,390
2 30,000 0.6504 19,511 0.6610 19,829
3 30,000 0.5245 15,735 0.5374 16,122
30,000 -561 341
IRR of Investment Q = 23%+(24%-23%)*(341/(341+561))
= 23.4%
v)
Rate at which NPV of both the projects is equal is called crossover rate. To calculate
crossover rate, we need to calculate the IRR of difference of cash flows.
Year
Cash Flows
Investment P
($)
Investment
Q ($) Differences
0 -60,000 -60,000 -
1 20,000 30,000 -10,000
2 30,000 30,000 -
3 44,000 30,000 14,000
34,000 30,000
IRR of Differences = 18.32%
Crossover rate = 18.32%

vi)
Criteria
Payback
period NPV PI IRR
Investment P 2.23 $19,167.30 1.32 22.75%
Investment Q 2.00 $17,312.91 1.29 23.38%
In case of conflict, decision of NPV is taken as final due to following reasons:
1. NPV considers time value of money which is ignored by payback period. Further,
payback period does not consider cash flows occurring after payback period.
2. IRR assumes that returns will be reinvestment at the rate equal to IRR which does not
hold good in real world.
Therefore, we should select investment P.
Solution 4
a)
Tax rate = 30%
Cost of capital = 11%
Total cost of new hydrofoils = 480000 x 2
= $960,000
Useful life of new hydrofoils = 4
Depreciation for both the hydrofoils = (480000 / 4) x 2
= $240,000
Savings per year in energy and labour costs = $160,000
Working capital requirement = $30,000
Tax deductible expenses for year 2 = $30,000
Tax deductible expenses for year 3 = $40,000

Salvage value for both the hydrofoils = 75000 x 2
= $150,000
Sale value of old 3 hydrofoils = $510,000
WDV of old 3 hydrofoils = 300000 x 3 x (4/6)
= $600,000
Year 0 1 2 3 4
Savings in energy and labour
costs $160,000 $160,000 $160,000 $160,000
Depreciation -$240,000 -$240,000 -$240,000 -$240,000
Overhauling expenses -$30,000 -$40,000
-$80,000 -$110,000 -$120,000 -$80,000
Tax savings $24,000 $33,000 $36,000 $24,000
-$56,000 -$77,000 -$84,000 -$56,000
Depreciation $240,000 $240,000 $240,000 $240,000
Cash flow from operations $184,000 $163,000 $156,000 $184,000
Working capital
requirement -$30,000 $30,000
Initial investment
-
$960,000
Sale value of old hydrofoils $510,000
WDV of old hydrofoils
-
$600,000
Loss on sale -$90,000
Tax savings $27,000
Cash flow from sale of old
hydrofoils $537,000
Sale value of new hydrofoils $150,000
WDV of new hydrofoils $-
Profit on sale $150,000
Tax -$45,000
Terminal cash flow from
new hydrofoils $105,000
Total cash flows
-
$453,000 $184,000 $163,000 $156,000 $319,000
Present value factor 1.0000 0.9009 0.8116 0.7312 0.6587
Present value
-
$453,000 $165,766 $132,294 $114,066 $210,135
Net Present Value = $169,261
b)
Since NPV is positive, company should buy new hydrofoils.