Financial Management: Tax Liability, Risk and Returns, Financing Requirements

This document covers topics in financial management including tax liability calculation for a company, evaluating investment feasibility based on risk and returns, and estimating financing requirements for a business. It provides detailed explanations and calculations for each topic.

FINANCIAL
MANAGEMENT

Table of Contents
QUESTION 1...................................................................................................................................1
a. Computing Tax Liability of Sanderson, Inc............................................................................1
b. Evidencing the Importance of Taxation and its socio-economic purposes.............................2
QUESTION 2...................................................................................................................................3
a. Evaluating feasibility of investment based on risk and returns...............................................3
b. Concept of Risk and Diversification.......................................................................................5
QUESTION 3...................................................................................................................................5
a. Estimating Holycross' Total Financing and Net Funding Requirements................................5
b. Forecasting to ascertain discretionary financing needed (DFN).............................................6
QUESTION 4...................................................................................................................................7
a. Calculation of Ratios...............................................................................................................7
b. Advantages and limitations of Ratio Analysis........................................................................9
QUESTION 5.................................................................................................................................10
a. Recommending a Project using Investment Appraisal Techniques......................................10
b. Distinctive Features of Capital Budgeting Decisions...........................................................11
QUESTION 6.................................................................................................................................11
a. Financial Statements of Winners Industry............................................................................11
b. Role of Finance Department ................................................................................................13
REFERENCES..............................................................................................................................14

QUESTION 1
a. Computing Tax Liability of Sanderson, Inc.
Corporate Tax Liability is the net annual charge on profits of a business entity that it is
legally obligated to pay to a regulating authority (Means, 2017). As per the Corporate tax
regulations, a certain amount of corporate tax rates are applicable for certain tax limits. On the
basis of this the tax charges due from a firm are calculated. This has been illustrated in the case
of Sanderson, Inc. as under:
Corporate Tax Rates
Between $0 and $50,000 15%
Between $50,001 and $75,000 25%
Between $75,001 and $10,000,000 34%
Between $10,000,000 35%
Additional Surtax:
Between $100,000 and $335,000 5%
Between $15,000,000 and $18,333,333 3%
In the given table, Surtax is that tax which is levied on already tax income. This is mainly
done in order to fund a specific government program. Using this table, the taxes due from the
firm are as follows:
[Sanderson, Inc.] Corporate Tax Liability
Particulars $
Between $0 and $50,000 7,500
Between $50,001 and $75,000 6,250
Between $75,001 and $10,000,000 391,000
Additional Surtax:
Between $100,000 and $335,000 11,750
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Working Notes:
Computation of tax liability
$50000 X 0.15 = 7500
$25000 X 0.25 = 6250
$1150000 X 0.34 = 391000
SUR TAX:
$235000 X 0.05 = 11750
Total Taxes Due = $416500
As per the calculations and working notes provided above, the taxes have been calculated
on corporation's tax liability of $1,225,000. This have been further bifurcated on the basis of tax
limit differences. Hence, firstly a 15% tax rate has been levied on the amount up to $50,000
(=$50,00-$0). The remaining amount is $1,175,000 (=$1,225,000−$50,000). Out of this 25% tax
rate has been levied up to $25,000 (=$75,000-$50,001). It is worthy to note that the firm's annual
taxable income is also eligible for a additional surtax worth $11,750 (=$235,000*0.05).
b. Evidencing the Importance of Taxation and its socio-economic purposes
Taxation is an integral part of any economy that is charged by governments in return of
the public expenditure incurred by them for the welfare of people belonging to that state, region
or economy. Hence, taxes are of paramount importance. The aim of taxation is mainly twofold
viz. Generation of Revenue and Welfare of Public Interest (Schmalbeck, Zelenak and Lawsky,
2015). These are important in order to further development in the economy through improvement
in infrastructures such as buildings, roads, bridges and many more services. This results in not
only infrastructural development but also in socio-economic development of the nation as a
whole. One can say that different tax levy serve different purposes. Thus, they can be classified
in two main categorizes viz. Direct Taxes and Indirect Taxes. It is important to note that these
revenues are unrequited in nature. Originally, federal government's sole purpose was to
generate financing to meet government expenditures. However, as the consumer is assumed to be
knowledgable about the quality and safety and the environment is highly dynamic, this purpose
cannot solely define the government's intentions. Just like a business entity, the government
needs to be socially responsible so as to gain trust and act transparently while concerning
themselves with consumer affairs. For instance, federal government tends to contribute 8 percent
to the elementary as well as secondary education of the children (Federal Government and
2

Education, 2019). As the government is responsible for overall development of an economy it is
important for taxes collected to not only fulfil monetary or investment objectives but also ensure
economic security of its people.
This is evidenced in the ILO Report which showed how different governments belonging
to diverse nations aided taxation to accomplish broad social goals. These included job, income,
work , representation, skill reproduction, employment and labour market security. As far as
federal government is concerned one of the socio-economic objective accomplished through
taxation is relieving citizens from poverty by providing basic social services such as wages to
fulfil living expenses through the assignment of social security numbers to the citizens. Another
socio-economic element that is addressed through taxation is that of prevention of concentration
of wealth among to people belonging to a certain class of income. This is achieved through
economic equality and variability in tax levels that lead to a higher tax slab for a higher income
earning bracket (Social Benefits and Costs of Taxation, 2019). Through this, the tax collected
from such taxable classes lead to a better and equitable distribution of wealth among all the tax
brackets.
Hence, one can say that, in recent times, the purpose of federal government to collect
taxes has shifted from generating financing for public expenditure purposes to that of social and
economic centric role.
QUESTION 2
a. Evaluating feasibility of investment based on risk and returns
Risk and Returns are two opposing forces based on which an individual tends to make
important investment decisions (Brigham and Houston, 2012). From a financial perspective, a
risk is considered to be a chance that is taken by the decision-maker, such as investor, with an
expectation that the investment in question will be different from others. Generally, it is observed
that high risk investments give much more fruitful returns. This means that by investing in a high
risk return In order to measure or assess degree of risk related to an investment, measures of
variability and dispersion are taken into consideration. These include variance and standard
deviation respectively.
In the given case scenario, Fair INC. is considering an investment decision in one of two
common stocks viz. Stock A and Stock B. Based on risk and return assessment, it is determined
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which investment option is better suited to the needs of the firm and which is not. Here, the
technique of Weighted Standard Deviation is adopted which helps in ascertaining how
significant each value of return is for a particular common stock (Wan and et.al., 2014). These
are then compared with the other investment option and a definite conclusion or investment
decision is drawn from them. The following formula is used:
Weighted Standard Deviation (6) = [(ki-∑Kˉ)² *P(ki)], where,
ki = Returns;
∑Kˉ = Mean or Average of Expected Returns;
P(ki) = Probability of returns of Common Stock
(ki-∑Kˉ)² = Sum of Squared Deviation Scores
The calculations regarding the same have been provided below with the help of Weighted
Deviation:
Stock A:
(A) (B) (A) X (B) (C) (A) X (C)
Probability Return
Expected
Return
Sum of Squared
Deviation Scores Weighted Deviation
P(ki) (ki) (ki-∑Kˉ)² [(ki-∑Kˉ)² *P(ki)]
0.3 12% 3.60% 10.89 [(=12%-15.3%)2] 3.267 [=10.89*0.3]
0.4 15% 6% 0.09 [(=15%-15.3%)2] 0.036 [=0.09*0.4]
0.3 19% 5.70% 13.69 [(=19%-15.3%)2] 4.107 [=13.69*0.3]
∑Kˉ 15.3 7.41
Б2=7.41%
6=2.72%
Stock B:
(A) (B) (A) X (B) (C) (A) X (C)
Probability Return
Expected
Return
Sum of Squared
Deviation Scores Weighted Deviation
4

P(ki) (ki) (ki-∑Kˉ)² [(ki-∑Kˉ)²*P(ki)]
0.2 15% 3.00% 2.56 [(=15%-13.4%)2] 0.512 [=2.56*0.2]
0.3 6% 1.80% 54.76 [(=6%-13.4%)2] 16.428 [=54.76*0.3]
0.3 14% 4.20% 0.36 [(=14%-13.4%)2] 0.108 [=0.36*0.3]
0.2 22% 4.40% 73.96 [(=22%-13.4%)2] 14.792 [=73.96*0.2]
∑Kˉ 13.4 31.84
б2=31.84%
6=5.64%
On comparing the two stocks based on the weighted deviation results, investment in
common stock option-A should be accepted as it is less risky compared to stock-B.
b. Concept of Risk and Diversification
From a financial perspective, a risk is considered to be a unplanned opportunity that is
taken by the investor with an expectation that the such an opportunity will be different from
others (Clarke, De Silva and Thorley, 2013). Typically, higher returns are associated with
heavily risky investment options. However, an individual may be conservative and would not
want to invest at all with such high risk attached options. Conversely, an investor may also
choose to diversify their portfolio by adding various investments that have different risks and
returns attached to it. Through this, an investor is able to hedge their risk and gain higher returns,
both at the same time. This phenomenon is known as 'Diversification of Portfolio'. It helps in
reducing the probability of a loss occurrence and increasing the profit derived eventually leading
to wealth maximization for the investor.
QUESTION 3
a. Estimating Holycross' Total Financing and Net Funding Requirements
FINANCIAL FORECASTING FOR HOLYCROSS ENTERPRISES
DATE 12/31/2000 12/31/2001
Sales 12000000 15000000
Net Income 1200000 2000000
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Balance Sheet 12/31/2000 % Of sales 12/31/2001
Assets
Current assets
300000Wan, X.,
Wang, W., Liu, J.
and Tong, T., 2014.
Estimating the
sample mean and
standard deviation
from the sample
size, median, range
and/or interquartile
range. BMC
medical research
methodology,
14(1), p.135. 25% 3750000
Net Fixed assets 6000000 50% 7500000
Total Assets 9000000 11250000
Liabilities & Owners Equity
Liabilities:
Accounts payable 3000000 25% 375000
Long-Term Debt 2000000 2000000
Total Liabilities 5000000 5750000
Owner's Equity:
Common Stock 1000000 1000000
Paid-in capital 1800000 1800000
Retained Earnings 1200000 3800000
Common Equity 4000000 6600000
Total Equity and Liabilities 9000000 12350000
Financing Needs -110000
6

From above financial statements it can be ascertained that the total financing
requirements are an adverse of $110,000. Hence, the company is in surplus and does not need
any funding as of yet.
b. Forecasting to ascertain discretionary financing needed (DFN)
Discretionary Financing Needed (DFN) is the difference between total assets and
liabilities including owner's equity (Williams and Dobelman, 2017). It is financial tool that helps
in determining the amount that is expected by the firm to be raised in the next financial period.
Hence, it includes previous as well as current financial information on the basis of which
forecasted or budgeted figures are ascertained. Any variance identified is easily provisioned for
in order to have an adequate pool of working capital for future operational activities. Hence,
Financial Forecasting is an important element to ascertain discretionary financing needed by an
organisation or business.
QUESTION 4
a. Calculation of Ratios
 Current Ratio: Current ratio is also known as liquidity ratio which is used to measure
the ability of company to pay off his short term liabilities. It check a company's current
assets to set off its current liabilities and any other short term debts. To calculate current
ratio following formula is used:
Current Ratio= Current Assets / Current Liabilities
Current Ratio for McDonald = 1143/2985 = 0.38
As per industry norms current ratio is 0.70 but from above calculation it is been
established that current ratio of McDonald's is 0.38 which is very low as compared to industry
norms company has to work to improve its current assets or it should reduce its current liabilities
(Brigham and Houston, 2012).
 Inventory Turnover Ratio: It is a ratio which is used by mangers to see that how
many times a company replace its inventory. It provide a clear picture of Wan, X.,
Wang, W., Liu, J. and Tong, T., 2014. Estimating the sample mean and standard
deviation from the sample size, median, range and/or interquartile range. BMC
medical research methodology, 14(1), p.135.company's efficiency in managing its
cost. It can be calculated by using following formula:
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Inventory turnover = Cost of goods sold / Average inventory
or
Sales / Inventory = 6537 / 71 = 92.07
Inventory turnover of McDonald's is 92.07 which is almost equal to industry norms
which is 90 it indicates that company is working efficiently an effectively. The higher inventory
means that company is doing good in market as its stock of finished goods are filled regularly.
 Average Collection Period: Average collection period is a time which is given to
debtor for collection of payments which is mentioned in terms of accounts
receivables. With the help of following formula average collection period is
calculated:
Average collection Period = Accounts receivables / Total sales * 360
Average collection period of McDonald's = 484 / 11508 * 360 = 15.14
Average collection period of McDonald's is 15 days where as per the industry norm
average collection period should be 6.5 days, this states that company is too much to its debtors
to pay amount owed to them.
 Debt Ratio: Debt ratio is a ratio which measures its total debts to assets, it shows
company's debts which are financed through different debts. To calculate debt
ratio following formula is used:
Debt ratio = Total debts / Total Assets * 100
=6325/18242 * 100 = 34.67%
As per the industry norms debt ratio is 50% but in case of McDonald's it its found to be
34.67% which indicates that only 35% of its assets are financed through debts.
 Total Asset Turnover Ratio: Total assets turnover ratio is a ratio which
measures a value of a company's revenue which is related to value of various
assets acquired by a company. The formula used to calculate this is as given
below:
Assets turnover ratio = total sales / average total assets
Average turnover ratio of McDonald's = 11508 / 18242 = 0.63
The above calculation shows that average turnover ratio of its assets is 0.63 where as the
average assets turnover ratio given as per industry norms is 1.5, which indicates that company is
not working efficiently and need to focus more on its assets to achieve higher growth.
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 Fixed Asset Turnover Ratio: This ratio is used by analysts to identify operating
performance of a company (Babalola and Abiola, 2013). Fixed assets turnover
ratio compares company's total sales with its fixed assets to measure its ability to
generate income through its fixed assets. To calculate following formula is used:
Fixed assets turnover (FAT) ratio = Net sales / Average fixed assets
FAT ratio of McDonald's= 11508 / 14961 = 0.77
Total fixed assets turnover ratio as per company norms is 2 where as in case of
McDonald's it is stated at 0.77 which indicates that capacity of its fixed assets to convert raw
material into finished goods in order to generate revenue is not working up to its optimum
utilization.
 Operating Profit Margin: Operating profit margin is used by company to
measure its performance. This margin shows the percentage of a profit which is
earned by a company from its oWan, X., Wang, W., Liu, J. and Tong, T., 2014.
Estimating the sample mean and standard deviation from the sample size, median,
range and/or interquartile range. BMC medical research methodology, 14(1),
p.135.perations. Following formula is used to calculate it:
Operating profit margin = operating profit / total revenue * 100
Operating profit margin for McDonald's = 2794 / 11508 * 100 = 24.27%
From the above calculation it is stated that operating profit margin of McDonald's is
24.27% which is more than industry norms which is at 21% which shows currently company is
working at a good profit margin from its operation it indicates that current performance of this
company is good.
 Return on Common Equity: Return on Equity is used to measure a company
financial performance which show the amount of return which will be earned by
equity share holders. Following formula is used to calculate ROE:
ROE = Net Income / Average shareholder's equity * 100
ROE of McDonald's = 1617 / 8932 * 100 = 18.10%
From the above calculation it is stated that return on its common equity is currently at
18.10% which is better as compared to industry norms which is at 15% it indicates that company
is giving a higher returns on its equity.
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b. Advantages and limitations of Ratio Analysis
Ratio analysis is a financial tool which is used to analyse the financial reports prepared at
the end of an accounting period (Gotze, Northcott and Schuster, 2016) . It gives an advantage to
shareholders to properly interpret this data more accurately following are some advantages and
limitations of it:
 Advantages:
It help mangers to check authenticity of validating or disproving financing, operating and
investment decision of a company. It also help investors to take decisions which helps them in
investing as it simplifies a complex accounting systems and financial data in to easy ratio which
are easy to interpret.
 Limitations:
Some ratios are calculated on historical cost basis which ignores changes in price due to
inflation and does not reflect correct picture. Firms can make some changes in their financial
statement during year end which does not reflect a correct image of a company and ends up
being Window dressing.
QUESTION 5
a. Recommending a Project using Investment Appraisal Techniques
Payback period:
 Average Cash Inflows = Total Cash Inflows / Project Life
Project A = ($10,000+$15,000+$20,000+$25,000+$30,000) / 5 = $20,000
Project B = ($25,000+$25,000+$25,000+$25,000+$25,000) / 5 = $25,000
 Payback Period = Initial Outlay / Average Cash flows
Project A = $50,000/$20,000 = 2.5 years
Project B = $100,000/$25,000 = 4 years
Interpretation:
As Project A recovers the cost invested in a shorter time duration as compared to Project
B, it should be selected for investment (Kalyebara and Islam, 2013).
Accounting rate of return (ARR):
 Average annual profits= Total net cash flows/ Number of years
Project A = $100,000/5 =$20,000
10

Project B = $125,000/5 = $25,000
 Accounting rate of return= (Average annual profits / Initial investment)*100
Project A = ( $20000/ $50000)*100 = 40%
Project B = ( $25000/ $100000)*100 = 25%
Interpretation:
As Project A renders higher returns with lower initial investment it is much more
profitable as compared to Project B. Hence, it shWan, X., Wang, W., Liu, J. and Tong, T., 2014.
Estimating the sample mean and standard deviation from the sample size, median, range and/or
interquartile range. BMC medical research methodology, 14(1), p.135.ould be selected.
Net present value:
Project A Project B
Years
Present value
factor of 10%
Cash
Inflows ($)
Present Value of
Cash Inflows ($)
Cash Inflows
($)
Present Value of
Cash Inflows ($)
1 0.909 10,000 9,090 25,000 22,725
2 0.826 15,000 12,396.694 25,000 20,661.157
3 0.751 20,000 15,026.296 25,000 18,782.870
4 0.683 25,000 17,075.336 25,000 17,075.336
5 0.621 30,000 18,627.640 25,000 11,566.299
Total Cash Inflows ($) 72,215.966 90,810.662
NPV of Project A= 72215.96- 50000 = $22215.96
NPV of Project B= 90810.66-100000 = ($9189.34)
Interpretation:
Project A renders a positive NPV in terms of outlay incurred initially, it is much more
profitable as compared to Project B, which is negative. Hence, Project A should be selected.
Profitability Index:
Profitability Index= Present value of cash inflows/ Present value of cash outflows
Project A= 72215.96 / 50000 =1.45
Project B= 90810.66 /100000=0.908
Interpretation:
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A Project is only attractive as long as the PI Value is more than one. Based on this
criteria, Project A must be selected.
b. Distinctive Features of Capital Budgeting Decisions
Capital Budgeting Decisions are those that relate to the overall growth of the company
from a long-term perspective by evaluating potential costs and returns gained on them (Bierman
Jr. and Smidt, S., 2012). The distinctive features of such decisions are as follows:
 Permanent: Such Decisions are permanent in nature and hence cannot be easily
changed. Hence, they require heavy investments which are beneficial for a business in the
long-run, usually during the course of its life.
 Long-term Implications: Capital Budgeting Decisions, if executed incorrectly, have a
long-term effect on the operations of the business. This is due to the large amount of
funds locked in such projects that can result in heavy losses for the business.
QUESTION 6
a. Financial Statements of Winners Industry
Provided below are the two financial statements of Winners Industry at the end of
financial accounting period:
Income Statement of Winners Industry for the year ending 31st December 2016
Particulars Gross Amount ($) Net Amount ($)
Net sales revenue 12800
Less: Cost of goods sold 5750
Gross profits 7050
Expenses:
General and administration expenses 850
Operating expenses 1350
Brigham, E.F. and Houston, J.F., 2012. Fundamentals of
financial management. Cengage Learning.Interest
expense 900
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Desperation expense 500
Total Expense 3600
Income before tax 3450
Less: Tax expense 1440
Net profit 2010
Balance Sheet of Winners Industry for the year ending 31st December 2016
($) ($)
Equity and liabilities:
Equity:
Common stock 45,000
Retained earning Wan, X., Wang, W., Liu, J. and Tong,
T., 2014. Estimating the sample mean
and standard deviation from the
sample size, median, range and/or
interquartile range. BMC medical
research methodology, 14(1), p.135.
15,250
Current years profits 2,010
Liabilities
Non-current liabilities 55,000
Current Liabilities 5,400
Total Equity and Liabilities 122,660
Assets
Non current assets:
13

Building and equipment 122,000
Less: Accumulated depreciation (34,000) 88,000
Current assets:
Inventory 6,500
Cash 18,560
Accounts receivable 9,600
Total assets 122,660
b. Role of Finance Department
In any organisation, Finance department is concerned with accumulation and application
of funds in an orderly manner (Kadiri, 2012). In order to achieve business objectives, the finance
department:
 Plans and forecasts the budget;
 Makes important investment decisions on behalf of the business;
 Assists in making key strategic decisions such as marketing projects;
 Contributes to the development of future organizational goals and objectives through
assessment of risks using financial tools and techniques;
 Helps in making crucial expansion related decisions such as valuation of firms while
considering a possible merger or acquisition of other businesses.
 Analyses costs and benefits regarding products and assets important for the successful
implementation of a strategy and generating revenue through sales.
14

REFERENCES
Books and Journal:
Means, G., 2017. The modern corporation and private property. Routledge.
Schmalbeck, R., Zelenak, L. and Lawsky, S. B., 2015. Federal Income Taxation. Wolters
Kluwer Law & Business.
Brigham, E. F. and Houston, J. F., 2012. Fundamentals of financial management. Cengage
Learning.
Wan, X. and et.al., 2014. Estimating the sample mean and standard deviation from the sample
size, median, range and/or interquartile range. BMC medical research
methodology. 14(1). p.135.
Clarke, R., De Silva, H. and Thorley, S., 2013. Risk parity, maximum diversification, and
minimum variance: An analytic perspective. The Journal of Portfolio
Management. 39(3). pp.39-53.
Williams, E. E. and Dobelman, J. A., 2017. Financial statement analysis. World Scientific Book
Chapters. pp.109-169.
Brigham, E. F. and Houston, J. F., 2012. Fundamentals of financial management. Cengage
Learning.
Babalola, Y. A. and Abiola, F. R., 2013. Financial ratio analysis of firms: A tool for decision
making. International journal of management sciences. 1(4). pp.132-137.
Gotze, U., Northcott, D. and Schuster, P., 2016. INVESTMENT APPRAISAL. SPRINGER-
VERLAG BERLIN AN.
Kalyebara, B. and Islam, S.M., 2013. Corporate governance, capital markets, and capital
budgeting. Springer.
Bierman Jr, H. and Smidt, S., 2012. The capital budgeting decision: economic analysis of
investment projects. Routledge.
Kadiri, I. B., 2012. Small and medium scale enterprises and employment generation in Nigeria:
the role of finance. Kuwait Chapter of Arabian Journal of Business and Management
Review. 33(845). pp.1-15.
Online:
Federal Government and Education. 2019. [Online]. Available through:
<https://www2.ed.gov/about/overview/fed/role.html>
Social Benefits and Costs of Taxation. 2019. [Online]. Available through:
<https://www.taxjustice.net/cms/upload/pdf/Benefits_and_Costs_of_Taxation>
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