Financial Management: Taxable Income, Risk-Return Tradeoff, Capital Budgeting, and More

This text covers various topics in financial management, including taxable income, risk-return tradeoff, capital budgeting, and more. It explains the factors that affect capital budgeting decisions and the importance of cash flow in business.

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FINANCIAL
MANAGEMENT

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Answer 1:
Part a:
The following table shows the taxable income:
Taxable income
12,25,000.0
0
Less:
50,000.0
0
7,500.0
0
11,75,000.0
0
Less:
25,000.0
0
6,250.0
0
11,50,000.0
0
3,91,000.0
0
Total tax
4,04,750.0
0
Add: surtax
12,142.5
0
total tax
liability
4,16,892.5
0
Part b:

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The given statement is true since the government requires money to build the infrastructure
for the country in order to run the country. These include roads, railways etc. taxes are levied
also to maintain these structure. It is the sole responsibility of the government to maintain the
public security department which include the police, fire men and the army. The revenue is
generated by the way of levying taxes on the citizens of the country. The government is also
responsible for the maintaining of the general services such as the Municipal and the council
services. There has to be an inflow of the money from the taxes that have been imposed
which helps in maintain the essential services. Another major responsibility of the
government is to provide quality health services. The medical service government also
requires medical insurances for the citizens. All of these services requires money to be spent
and this is the sole reason for the government to levy taxes on the citizens of the country
(Finance investments, 2018).
Answer 2:
Part a:
The following table shows the relevant calculations:
Common Stock A Common Stock
B
Probability Retu
rn
Retu
rn
(X-
Mea
Squa
re
Probabilit
y
Ret
urn
Ret
urn
(X-
Mean
Squa
re0.2 12% 2% -17% 3% 0.1 4% 0.4
0%
-2% 0.05
%
0.5 18% 9% 9% 1% 0.3 6% 1.8
0%
6% 0.36
%
0.3 27% 8% 8% 1% 0.4 10
%
4.0
0%
10% 1.00
%
0.2 15
%
3.0
0%
15% 2.25
%
Total return 20% 4% 6%
0.036
584
Number of
observations 3 4

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0.014
634
0.009
146
Standard
deviation
0.119
8
0.095
63
Conclusion: on the basis of return, stock A should be chosen since it has a higher rate of
return but on the basis of risk or standard deviation, stock B must be chosen
Part b:
Risk is the likelihood of something could go wrong. Under the normal market conditions,
diversification serves to an effective tool for the purposes of reducing risk. If an investor
holds just 1 investment and it goes bad, then he could end up losing all the money invested.
But if a diversified portfolio is held, then it much likely that the investments would perform
badly at the same time. The profits that are earned on the investments would set off the losses
that have been incurred from the loss security. In order to illustrate, bonds and the stock
generally move in opposite directions. When an investor expects an economy to go down and
the corporate profits to go down, then the prices of the shares are more inclined to go down.
When something like this happens, then the central bank will have to cut down the rate of
interest for the purposes of reducing the borrowing costs and also encourage spending. This
leads to an increase in the prices of the bonds. In case, the portfolio includes both the stock
and the bonds, then the increase in the value of the bonds would lead to a decrease in the
value of the shares. The main reason for including both in the portfolio is not to increase the

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amount of the return but to reduce the amount of the risk (Ontario Securities commission,
2018).
Answer 3:
Part a:
The following table shows the desired calculations:
Particulars
Curren
t
Estimated for
next year
Increase
on the
basis of
next
years
estimate
d sales
Current assets 6 7.2 1.2
Net fixed
assets 9 10.8 1.8
Accounts
payable 3.75 4.5 0.75
Net Working
2.25

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Capital
Curren
t
Estimate
d for
next year
Increase
on the
basis of
next
years
estimate
d sales
Sales 15 18 0.2
Profit 1.5 3 1
The estimated funding requirement for the company for the next year is $2.25 million or
$2250, 000.
This has been calculated by using the following formula:
Increase in current assets + increase in fixed assets-increase in accounts payable.
Part b:
Any company would like to expand its business operations in the near future so that it can
earn profits. If it thinks that it would be able to land more sales and also, wants to expand its

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business operations, then it would be prudent for it to estimate the amount of the funds that it
requires in the sales to carry on its day to day business operations. It is for such reasons is the
fact that the company needs to estimate the funds that it needs and then decide accordingly
for the amount that should be borrowed.
Answer 4:
Part a:
The following table shows the relevant calculations:
Particulars Ratio
Industry
Average
Current ratio: 0.382914573 0.7
Current assets
1,143.0
0
Current liabilities
2,985.0
0
Inventory turnover: 92.07042254 90
Cost of sales
6,537.0
0
Inventory
71.0
0

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Average collection period 3.964356739 6.5
365 365
Inventory turnover 92.07042254
Debt ratio 104.23% 50%
Debt
9,310.0
0
Equity
8,932.0
0
Total asset turnover 0.09001206 1.5
Net profit
1,642.0
0
Total assets
18,242.0
0
Fixed asset turnover 0.109752022 2
Net profit
1,642.0
0
Fixed assets
14,961.0
0

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Operating profit margin 14.27% 21%
Net profit
1,642.0
0
Sales
11,508.0
0
Return on common
equity 18.38% 15%
Net profit
1,642.0
0
Equity
8,932.0
0
Part b:
The company not much liquid. This can be seen from the current ratio of the company, the
calculated ratio is 0.38 whereas the industry average is 0.7. This shows that the company
would face cash crunch or may not be able to meet its short term liabilities in the near future.
Part c:
No, the management is not able to generate good sales from the assets of the company. This
could be seen from the total asset turnover and the total fixed assets turnover ratio of the

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company. Both of these ratios are low when compared with their respective industry average.
The low ratio who’s inability of the management to effectively use the assets of the company
to generate profits.
Part d:
This fact could be ascertained by the dent equity ratio of the company. It seems that the
company is financing its assets from debt. This is not good for the company.
Answer 5:
Part a:
The following table shows the relevant calculations:
Project A Project B
Projec
t A
Projec
t B
Initial
outlay
-50,000 -1,00,000
Cash
inflows
Year 1 10,000 25,000 -40000 -75000
Year 2 15,000 25,000
-
25,000
-
50,000
Year 3 20,000 25,000
-5,000
-
25,000
Year 4 25,000 25,000 20,000 0
Year 5 30,000 25,000
NPV $ 20,197.16 $ -

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4,754.85
Payback
period about 3.25 years 3 years
Accountin
g rate of
return Average annual profit/average investment
0.04 0.01
Profitabilit
y index 1.4039432 1.0475785
Part b:
Capital budgeting is the process by which the company is able to evaluate the expenditure
that it would be required to incur for expansion in future.
The following are the factors that affect it:
 Changes that takes place in technology due to which old equipment becomes obsolete
 Analysis of the demand for the future
 The competitive strategy
 The cash flows
 The type of the management
 Other factors such as the fiscal policy etc. (Edupristine, 2018).
Answer 6:

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When there is an inflation in the economy, then the prices could rise and the company may
buy larger quantities of inventory and hold the same off till the prices rise. But this is
practically not possible due to the reasons of increase in the stockholding costs like the
interest on the capital which is blocked etc, availability of cheaper substitutes at the future
date, new supply of the sources at the competitive rate, fall in the prices. Hence, even when
there is an inflation in the economy, it is prudent to hold the inventory so that the company is
able to operate its business without incurring any additional costs. Hence, the given statement
is true since inflation solely does not decide the need for holding greater inventory levels
(Kopykitab, 2018).
Answer 7:
Risk - return trade-off:
Higher risk gives a greater probability of greater return and vice versa. Hence wherein an
investor faces the risk and return keeping in mind the investment decision is termed as risk-
return trade off (Economic times, 2018).
Time value of money
This is the worth of money at a future date (PSU infrastructure, 2018).
Cash is king:
This refers to the importance of cash flow in the overall business.
Incremental cash flows:

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This is the additional amount of the cash which is generated by the company by the way of
undertaking additional projects (Accounting explained, 2018).
The agency problem:
This is the problem of conflict of interest wherein one party is expected to act in the best
interest of another party (Economic times, 2018).
Taxes bias business decisions:
This is the biggest mistake of finance managers wherein the managers make decisions
without considering taxes.
All risk is not equal:
This means that all investment must never be made only in one project.
Ethical dilemmas are everywhere in finance:
This involves the use of bets judgment wherein decision has to be taken.
The Curse of Competitive Markets:

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The markets that are competitive would always be cursed since each and every one can enter
this market.
Efficient Capital Markets:
This is the way of increasing the wealth of the company. This forms the backbone of the
financial sector (Kumar, 2018).

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References
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https://accountingexplained.com/managerial/capital-budgeting/incremental-cash-flows
[Accessed 24 Nov. 2018].
EduPristine. (2018). Capital Budgeting: Features, Process, Factors affecting & Decisions.
[online] Available at: https://www.edupristine.com/blog/capital-budgeting [Accessed 24 Nov.
2018].
Kopykitab.com. (2018). Advanced Management Accounting. [online] Available at:
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Nov. 2018].
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Nov. 2018].
Ontario Securities commission. (2018). Diversification | Understanding risk |
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https://www.getsmarteraboutmoney.ca/invest/investing-basics/understanding-risk/
diversification/ [Accessed 24 Nov. 2018].
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https://psu.instructure.com/courses/1806581/pages/introduction-what-is-time-value-of-money
[Accessed 24 Nov. 2018].
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The Economic Times. (2018). Risk Return Trade Off - What is Risk Return Trade Off ? Risk
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