Financial Management, Capital Budgeting, Variance and Standard Deviation, Loan Amortization, Present Value of Annuity

Financial management as the name suggests, deals with managing the financing
activities of the companies, that involves, analysis of various ratios, determining the
debt and equity mix for the businesses and also deciding on the sources of
financing, keeping in view the cost of each source of funds and effective weighted
average cost of capital for the business as a whole. The objective of financial
management is to maximize the shareholders’ wealth and the decisions taken by
the financial managers are taken, keeping in view this ultimate objective of
shareholders’ wealth maximization.
Financial management can also be used in personal finances, involving
identification of best avenues for investing money and computation of amount that
the individual will receive in future from each source, or vice versa, I.e. in
computing the amount that an individual needs to invest today, in order to get a
specific amount of money in the future.
(Ref: Eugene F. Brigham and Michael C. Ehrhardt, (2013))
SOLUTION: QUESTION 1
The given case study deals with evaluation of a capital budgeting proposal for
National Brewing Inc., who is considering the acquisition of a new still. It involves
computation and analysis of the cash flows from the new still over its useful life and
a comparison of the present value of those cash flows based on the cost of capital
of the company, to determine, whether or not the project is financially viable, based
on the NPV of the project.
From given information,
Purchase price of still (Machine) $600,000
Transportation Cost 60,000
Installation Cost 40,000
Cost of Machine 700,000
Increase in Working Capital 30,000
Initial Investment $730,000
Unrestricted

Machine Life = 10 years, but depreciated over next 5 years
Depreciation Method = Straight Line Method
Salvage value at the end of year 10 = $10,000
So,
Annual Depreciation for year 1-5 = Cost of mac h ine−salvage value
Useful life = 700000−10000
10 =
$69,000
Annual Incremental Revenue = $120,000
Annual Incremental Operating Cost = $20,000
So, Net Annual Incremental Revenue = 120000-20000 = $100,000
Marginal Tax Rate (t) = 30%
Cost of Capital (r) = 10%
Insert a timeline
Calculation of Net Cash Flows:
Year
s
Net
Incremental
Revenue Depreciation
Net Income
before tax
Tax
@
30%
Net
Income
after tax
Add back
depreciation
Net Cash
Flows
1 100,000 69,000 31,000 9300 21700 69,000 90,700
2 100,000 69,000 31,000 9300 21700 69,000 90,700
3 100,000 69,000 31,000 9300 21700 69,000 90,700
4 100,000 69,000 31,000 9300 21700 69,000 90,700
5 100,000 69,000 31,000 9300 21700 69,000 90,700
6 100,000 0 100,000
3000
0 70000 0 70,000
7 100,000 0 100,000
3000
0 70000 0 70,000
8 100,000 0 100,000
3000
0 70000 0 70,000
9 100,000 0 100,000
3000
0 70000 0 70,000
10 140,000 0 140,000
4200
0 98000 0 98,000
For Year 1-5
Annual Net Cash flow = $90,700
Present Value of Annuity = 90,700[PVIFA10%, 5 Years] = 90700*3.791 = 343,843.7
Calculation of NPV
Unrestricted

Year Net cash flow PVIF @ 10% Present Value
0 ($730,000) 1 -730,000.00
1-5 90,700 3.791 343,843.70
6 70,000 0.564 39,480
7 70,000 0.513 35,910
8 70,000 0.467 32,690
9 70,000 0.424 29,680
10 98,000 0.386 37,828
Net Present Value -210,568.30
Conclusion: Since the Net Present Value of the cash flows from the purchase of the equipment
is negative, the equipment should not be purchased.
SOLUTION: QUESTION 2
It deals with computation of variance and standard deviation of returns of Euro
flop’s stock over the period of last 5 years. Variance refers to the expected
deviation that the return might face from the mean return of the security, i.e. Euro
flop’s shares in this case.
Standard deviation is used to measure the amount of variation or dispersion of
values from the mean. A high standard deviation implies that values are spread out
over a wider range, whereas on the other hand, a low standard deviation implies
that the values are closer to the mean value.
Calculation of Variance and Standard Deviation:
Year Price Change (%) (x) (x-x̄)2
1 20 400
2 -10 100
3 -30 900
4 5 25
Unrestricted