Question

Question1

You are the new CFO of Risk Surfing Ltd, which has current assets of $7,920, net fixed assets of $17,700, current liabilities of $4,580 and long-term debts of $5,890.

Required:

a.   What are the three important questions of corporate finance you will need to address? Please briefly explain them and indicate how they are related to the areas in the balance sheet of a company. (1 mark)
b.   Calculate owners’ equity and build a balance sheet for the company?
c.   How much is net working capital of the company? (1 mark)
d.   Calculate the return on assets of the company given that Return on Equity is 30%? (1 mark)
e.   What is the PE of the company total number of ordinary share outstanding of the companies is 2,000 and market price of each share is $12? (1 mark)

Answer 1

a) What are the three important questions to be answered in finance -

i) Capital Structure - Capital structure is an important item for a CFO with respect to Corporate Finance. Capital structure means the combination of Debt and equity in a company. In other words, it shows how the company has financed its growth. It also shows the mix of debt and equity for a company. As a CFO, this mix of debt and equity is very important as it shows the funding structure of the company and also shows the long term stability and borrowing power of the organisation. It also shows the riskiness of the management of the company to borrow.

ii) Capital Budgeting - Capital Budgeting is another important area of focus of a CFO. As against a regular budget, capital budgeting deals with the budgeting or planning for long term investments. The long term investments could vary from organisation to organisation but all organisations (be it small or big) at some point in time needs to budget for a longer period of time. These budgets could be for varied situations like buying a new machinery, venturing into a new business/projects, replacing an existing machine, buying vs. leasing, etc. Captial budgeting is utmost important while taking decisions because an error could impact not just near term but for a longer term.

iii) Working Capital management - Whilst the Capital budgeting is for a longer term, working capital management deals with shorter term and is one of the important area of concern in corporate finance for a CFO. Working capital management is focused on managing the Current assets and Current liabilities. Working capital management ensures that the company has sufficient liquidity to meet its short term and near term obligations. If working capital is not managed properly, it might lead to severe stress on the liquidity, which might even lead to closure of business or operation.

b) Calculate the Owner's equity and build a Balance sheet

i) Owners' Equity

Owners' Equity = Total Assets - Total Liabilities

The following table shows the Owners' Equity

Particulars	$
Curret Asset	7,920
Fixed Asset	17,700
Total Asset - A	25,620
Current Liabilities	4,580
Long term debt	5,890
Total Liabilities - B	10,470
Owners Equity A - B	15,150

ii) Balance sheet of Risk Surf Limited

Risk Surfing Ltd
Assets	$	Liabilities	$
Current Asset	7,920	Current Liabilities	4,580
Non-Current Asset		Non-Current Liabilities
Fixed Asset	17,700	Long term Debt	5,890
		Total Liabilities	10,470
		Owner's Equity	15,150
Total Asset	25,620	Total Liabilities & Owners' equity	25,620

c) What is the Net working capital

Net Working Capital = Current Assets - Current Liabilities.

Net Working Capital = 7,920 - 4,580

Net Working Capital = $3,340.

d) Calculate Return on Asset, if Return on Equity - 30%

Return on Equity = Net Income/ Owner's equity

30% = Net Income/15,150.

Net Income = 15,150*30%

Net Income = $ 4,545.

Return on Asset = Net Income/Total asset

Return on Asset = 4,545/25,620.

Return on Asset = 17.74%.

e) What is the P/E of the company

Price - Earnings (P/E) ratio = Market Price per share/ Earnings per share.

Market price per share (given) = $12

Earnings per share (EPS) = Net Income/No. of shares outstanding.

EPS = 4,545/2,000

EPS = $2.27.

P/E ratio = $12/$2.27

Price Earnings ratio = 5.29.