Question 1 What are the five basis principles of finance? Briefly explain them (no more than 250...

Question

Question 1

What are the five basis principles of finance? Briefly explain them (no more than 250 words).

Question 2

Little Book LTD has total assets of $860,000. There are 75,000 shares of stock outstanding, total book value of $750,000 with a market value of $12 a share. The firm has a profit margin of 6.5% and a total asset turnover of 1.5.

Required:

a) Calculate the company’s EPS?

b) What is the market –to- book ratio?

Question 3

Fifteen years ago, you deposited $12,500 into an investment fund. Five years ago, you added an additional $20,000 to that account. You earned 8%, compounded semi-annually, for the first ten years, and 6.5%, compounded annually, for the last five years.

Required:

a) What is the effective annual interest rate (EAR) you would get for your investment in the first 10 years?

b) How much money do you have in your account today?

c) If you wish to have $85,000 now, how much should you have invested 15 years ago?

Question 4

Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same start-up costs. Project A will produce annual cash flows of $42,000 at the beginning of each year for eight years. Project B will produce cash flows of $48,000 at the end of each year for seven years. The company requires a 12% return.

Required:

a) Which project should the company select and why?

b) Which project should the company select if the interest rate is 14% at the cash flows in Project B is also at the beginning of each year?

Question 5

Rachel is a financial investor who actively buys and sells in the securities market. Now she has a portfolio of all blue chips, including: $13,500 of Share A, $7,600 of Share B, $14,700 of Share C, and $5,500 of Share D.

Required:

a) Compute the weights of the assets in Rachel’s portfolio?

b) If Rachel’s portfolio has provided her with returns of 9.7%, 12.4%, -5.5% and 17.2% over the past four years, respectively. Calculate the geometric average return of the portfolio for this period.

c) Assume that expected return of the stock A in Rachel’s portfolio is 13.6% this year. The risk premium on the stocks of the same industry are 4.8%, betas of these stocks is 1.5 and the inflation rate was 2.7%. Calculate the risk-free rate of return using Capital Market Asset Pricing Model (CAPM).

d) Following is forecast for economic situation and Rachel’s portfolio returns next year, calculate the expected return, variance and standard deviation of the portfolio.

State of economy Probability Rate of returns

Mild Recession 0.35 - 5%

Growth 0.45 15%

Strong Growth 0.20 30%

finance-for-business-dxl2e5xm.docx

Siddharth · Accepted Answer

Question 1 
What are the five basis principles of finance? Briefly explain them (no more than 250 words).
Answer- 
The 5 basic principles of finance are as follows-
1- Principle of Risk and Reward- It is very important in finance to generate return for the risk taken by the investor. Investor requires extra return for the amount of risk they are taking. By investing, the investor actually delays his current consumption for which he/she needs to be compensated. Moreover higher the risk, higher the expected return.
2- Time Value of Money- Time is considered to be a very important asset in finance. Money loses its real value over time, therefore everyone wants to have money today rather than tomorrow as it can be invested or used to satisfy demand. Time value of money is hence a very important concept as all the future expected cash flows are discounted at present time and the real effect is estimated.
3- Cash Flow Matters- Cash flows are different from profits. A business can invest the incremental cash flows from business which will help the business generate more cash flows. It is the positive flow of cash that matters actually. 
4- Market Prices are Correct- The market prices in efficient markets reflects all the information about the assets. The markets of stocks and bonds are where the companies raise their capitals and it is very important for the investors to have all the knowledge and information. How the markets absorbs the news is what makes people take decisions including their expectation about the future.
5- Conflicts of interest leads to agency problems- Management and owners are different in business but when their interests differ it starts to create agency problems. Such problems arise when management separates from the ownership of the business.
Question 2
Little Book LTD has total assets of $860,000. There are 75,000 shares of stock outstanding, total book value of $750,000 with a market value of $12 a share. The firm has a profit margin of 6.5% and a total asset turnover of 1.5.
Required: 
a) Calculate the company’s EPS?
b) What is the market –to- book ratio?
Answer 2-
a) Calculation of Company’s EPS
EPS= Net Income/ Total Outstanding Shares
We will have to calculate the net income first.
Assets turnover Ratio= Revenue/ Total Assets
1.5 = Revenue/ 860000
Revenue= $1,290,000
Profit Margin of the firm is 6.5%
Net Income= 1,290,000 * 0.065
	       = $83,850
Outstanding Shares= 75000
EPS= 83850/75000
EPS= $1.118
b) Calculation of market-to-book ratio
Market-to-book ratio= Market Capitalization/ Book Value
Market Capitalization= Outstanding Shares* Market Price of share
		          = 75000*12
		          = $900,000
Market-to-book ratio = 900000/ 750000
		          = 1.2
The market-to-book ratio for the firm is 1.2
Question 3
Fifteen years ago,

Question 1 What are the five basis principles of finance? Briefly explain them (no more than 250 words). Question 2 Little Book LTD has total assets of $860,000. There are 75,000 shares of stock...

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