Question

1. During 2019, a company’s cash flow from assets (CFA) amounted to $50,000.  During that year, the firm paid out $15,000 in dividends and $12,000 in interest.  Also, the firm paid down $30,000 of long-term debt.  In net terms, did this company issue any new common stock, or did it buy back any of their common stock from public?  Provide a dollar figure, making sure to show your calculations.
2. Consider the following ratios for companies A & B:

Company	A	B
Current Ratio	2.50	3.50
Quick Ratio	2.00	1.50

Based on this information, what can you conclude about the relative liquidity of the two companies, and their relative investments in inventory?

3. Consider the following ratios for companies A & B:

Company	A	B
Return on Equity	10.05%	11.67%
Net Profit Margin	2.80%	2.60%
Total Asset Turnover	1.75	1.70
Equity Multiplier	2.05	2.64

What explains Company B’s better performance as measured by return on equity?  Is it (a) the greater use of debt; (b) superior cost control; (c) more efficient use of assets to generate revenue; or (d) higher dividend payout to shareholders?  Or is it some combination of these 4 factors?  Make sure to justify our answer, using only the information provided here.

4. How much would you have to invest today if you want your portfolio to be worth $100,000 at the end of 10 years from now, assuming a rate of return of 4%?  Recalculate your initial required investment assuming a rate of return of 6%.

Answer 1

Q1. Cash Inflow=CFA = 50,000

Cash outflow= dividend+interest+debt paid = 15000+12000+30000 = 57,000

As Cash outflow > Cash inflow, the company paid more than it earned. So, the extra money (57000-50000 = $7000) paid must be borrowed. So this company issued any new common stock worth of $7000 to borrow extra money.

Q2.

Current Ratio=Current Assets / Current Liabilities ​

QuickRatio=Current Assets - Inventory/ Current Liabilities

As the current ratio of 3.5 for B is better than 2.5 of A. we can say company B is more liquid.

As the difference (Current ratio - Quick ratio) gives inventory positions, this difference of 2 (3.5-1.5) for B is greater than 0.5 (2.5-2) for A. So, B has a higher investment in inventory.

Q3. [Dupont model] B's ROI is higher because it has a higher Equity multiplier (among the other 3 ratios than ROI).

Equity multiplier = Total assets/shareholder equity = (debt+ shareholder equity)/shareholder equity.

As B's a higher Equity multiplier, it might be having greater use of debt. So option A is correct.

B's Net Profit Margin is not better. So it does not have superior cost control. So, option B incorrect.

B's total Asset Turnover is not better. So it is not having a more efficient use of assets to generate revenue. So, option C  incorrect.

Paying dividend will reduce cash (i.e. assets), So, option D incorrect.

Q4. PV1 = FV/ (1+r)^t = 100,000/ (1+0.04)^10 = 67,556.42

PV2= FV/ (1+r)^t = 100,000/ (1+0.06)^10 = 55,839.48