FIN303 Harvard Case Solution & Analysis

FIN303 Case Solution

In order to access the number of equity to be issued, certain assumptions have been taken such as the value of sales, COGS, inventory, payable and receivable has been increased by 20%. Moreover, fixed assets have been increased by 1 million, and depreciation is calculated by considering the both previous value and new value of the newly added asset such as (500,000+(1000,000/4)250,000=750,000).

All other items of the balance sheet and income statement will remain same, therefore adjusting these values and by keeping the dividend payout ratio same, retained profit is calculated. By adjusting the items of the balance sheet, total value of equity and liabilities is calculated which is equal to the value of the total assets. Then using the new value of equity, a number of shares are also calculated. As the company needs to raise the fund of $2,892,000 and the market price of the share is $12. Therefore the value of shares that needs to be issued to raise the funds of $2,892,000 will be 241,000.

Question 2

Analyze how the concepts of the degree of operating leverage and financial leverage are important for management decisions.

It is expected that degree of operating leverage and financial leverage are very important for the management decisions as operating leverage is such a degree which measures the ratio of the fixed cost within the operating structure of the company and it also determines the value of the contribution that will consume in order to cover that fixed cost, therefore lower the leverage will increase the confidence of the management in order to raise funds to cover the fixed cost and greater funds will be available to  increase the net profit level of the company. In that scenario, the value of the operating leverage increase which means greater funds will be required to cover the fixed cost and the profit level will be low as compared to the last year’s profit level.

Similarly, the degree of financial leverage is also very important for the management decision as it determines the value of the debt in the total capital structure of the company and it also determines the chances of bankruptcy as the firms with greater financial leverage have greater chances of firms as compared to the firms with lower degree of financial leverage. In this scenario, the degree of the financial leverage decreases which shows that the firm is at lower level of bankruptcy and have greater ability to borrow further funds in future.

Question 3

Cash Budget
JulAugSep
sales received next month135000150000165000
Add receipts500005500045000
Total receipts185000205000210000
purchases cash70,00080,00060,000
purchases credit30,00040,00030,000
Operating expenses30,00030,00030,000
Interest10,00010,00010,000
beginning cash balance44,00089,000134,000
ending cash balance89,000134,000214,000

In order to identify the cash budget for the month of July, August and September certain assumptions have been taken such as the ratio of the cash sales will be one-quarter and remaining will be received in the next month. Similarly, credit purchases will be paid in the next. By adjusting these values and adding the opening cash balance for the month of July, closing cash balance for the month of July is calculated. By repeating the same procedure, the cash budget for the month of August and September is also calculated.

Question 4

Relevant cash flows
 Initial investment            3,600,000
 inflows          7,000,000         7,000,000         7,000,000         7,000,000         7,000,000
 outflows          4,625,000         4,625,000         4,625,000         4,625,000         4,625,000
 WC expenditure              700,000
 Depreciation              620,000             620,000             620,000             620,000             620,000
 Salvage value              500,000
 WC expense recovery              700,000
 Total cash flows         (3,600,000)         1,055,000         1,755,000         1,755,000         1,755,000         2,955,000
 Present values         (3,600,000)             930,335         1,364,743         1,203,477         1,061,268         1,575,768
NPV2535591

In order to identify the NPV of the project, first of all, relevant cash flows have been calculated, and only the fixed cost is irrelevant as it will incur if the project is also not taken while the other cash flows are relevant. The value of depreciation is calculated by deducting the salvage value from the total asset value and then this value is divided by the total useful life of the asset.....................

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