Finance Assignment: Role Of Financial Theory In Business
Question
Task:
The questions to be answered within this finance assignment are;
Week 1
What are the five basis principles of finance? Briefly explain them (no more than 250 words).
Week 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?
Week 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 semiannually, 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?
Week 4
Giant Equipment Ltd. is considering two projects to invest next year. Both projects have the same startup 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?
Week 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 riskfree 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.
Answer
Answer 1
The five basic principles of finance illustrated in this finance assignment are as follows:
Principle 1: Money has its own time value: It simply means money earned today will certainly be having more value than the same money earned in future (Besley & Brigham, 2013). For instance if a person earns $50 today, he can invest the same in any source for some time, say 1 year at the rate of 5%. Therefore at the end of 1st year the value of his money worth $50 would be $52.5 as there will be an inclusion of interest income in his holdings.
Principle 2: RiskReturn Tradeoff: It means in financial investments higher the degree of return the more risky will be the investment. Higher returns come from the projects or investments where there is high risk. Investors would not take investments with high risk if they do not get rewarded for their investments risk.
Principle 3 Cash Flows are source of value: Cash Flows and Profits are two different aspects of a business. A profitable business without the adequate cash flows may find it difficult to run as payment of business expenses are made out of cash and not out of profit. Hence profits have their own relevance in the business and they add to the value of a firm.
Principle 4 Right information is reflected by Market Prices: Markets are called efficient when the prices of such assets that are being traded in that market have the potential to provide all the correct information that is available at a particular point of time. For investors the hike in the prices of share held by them is good news and the declining share prices offers them bad news in context of their investments (Gitman, Juchau & Flanagan, 2015).
Principle 5 Individuals do respond to incentives: This principle is associated with agency problem wherein managers of the company acts as its agents. Such managers do respond to the incentives they receive. If such incentives are not in line with the incentives of their principal i.e. company’s shareholders then the managers might not feel motivated to take decisions in consistence with the motive of maximizing the shareholder’s value causing the problem of agency that involves excessive agency costs (Shapiro & Hanouna, 2019)
Answer 2
1) EPS
Asset Turnover= 
Net Sales 
Average Total Assets 

Net Sales 
Total Assets*Asset T/O 
860000*1.5 

$ 1,290,000.00 

Profit Margin 
Net Profit 
Sales 

Net Profit 
Sales* Profit Margin 
1290000*6.5% 

$ 83,850.00 

EPS 
Net Profit 
Number of Shares 

$ 83,850.00 

$ 75,000.00 

EPS 
$ 1.12 
Market to Book Ratio
Market to Book Ratio 
Market Capitalization 

Book Value 


Market Capitalization 
Market Value Per Share* Number of Shares outstanding 

12*75000 

$ 900,000.00 


Market to Book Ratio 
$ 900,000.00 

$ 750,000.00 


Market to Book Ratio 
1.2 
Answer 3
Part 1
EAR= 
((1+r/m)^m)1 

((1+(0.08/2))^2)1 

8.16% 
Part 2:
Amount in bank today
Amount today= 
((12500*(1+.0816)^10)+20000))*1.065)^5 

$ 64,927.09 
Table:
1 
$ 12,500.00 
$ 500.00 
$ 13,000.00 
2 
$ 13,000.00 
$ 520.00 
$ 13,520.00 
3 
$ 13,520.00 
$ 540.80 
$ 14,060.80 
4 
$ 14,060.80 
$ 562.43 
$ 14,623.23 
5 
$ 14,623.23 
$ 584.93 
$ 15,208.16 
6 
$ 15,208.16 
$ 608.33 
$ 15,816.49 
7 
$ 15,816.49 
$ 632.66 
$ 16,449.15 
8 
$ 16,449.15 
$ 657.97 
$ 17,107.11 
9 
$ 17,107.11 
$ 684.28 
$ 17,791.40 
10 
$ 17,791.40 
$ 711.66 
$ 18,503.05 
11 
$ 18,503.05 
$ 740.12 
$ 19,243.18 
12 
$ 19,243.18 
$ 769.73 
$ 20,012.90 
13 
$ 20,012.90 
$ 800.52 
$ 20,813.42 
14 
$ 20,813.42 
$ 832.54 
$ 21,645.96 
15 
$ 21,645.96 
$ 865.84 
$ 22,511.79 
16 
$ 22,511.79 
$ 900.47 
$ 23,412.27 
17 
$ 23,412.27 
$ 936.49 
$ 24,348.76 
18 
$ 24,348.76 
$ 973.95 
$ 25,322.71 
19 
$ 25,322.71 
$ 1,012.91 
$ 26,335.61 
20 
$ 26,335.61 
$ 1,053.42 
$ 27,389.04 
21 
$ 47,389.04 
$ 3,080.29 
$ 50,469.33 
22 
$ 50,469.33 
$ 3,280.51 
$ 53,749.83 
23 
$ 53,749.83 
$ 3,493.74 
$ 57,243.57 
24 
$ 57,243.57 
$ 3,720.83 
$ 60,964.40 
25 
$ 60,964.40 
$ 3,962.69 
$ 64,927.09 
Part 3
If $ 85000 is required at the end of 15 years, the amount to be invested 15 years ago would be $ 19198.08
85000= 
(((X*(1.0816)^10)+20000))*1.065)^5 
85000= 
(2.19 X + 20000)*1.37 
85000= 
3.0003X + 27400 
X= 
$ 19,198.08 
Table
1 
$ 19,198.08 
$ 767.92 
$ 19,966.00 
2 
$ 19,966.00 
$ 798.64 
$ 20,764.64 
3 
$ 20,764.64 
$ 830.59 
$ 21,595.23 
4 
$ 21,595.23 
$ 863.81 
$ 22,459.04 
5 
$ 22,459.04 
$ 898.36 
$ 23,357.40 
6 
$ 23,357.40 
$ 934.30 
$ 24,291.70 
7 
$ 24,291.70 
$ 971.67 
$ 25,263.36 
8 
$ 25,263.36 
$ 1,010.53 
$ 26,273.90 
9 
$ 26,273.90 
$ 1,050.96 
$ 27,324.85 
10 
$ 27,324.85 
$ 1,092.99 
$ 28,417.85 
11 
$ 28,417.85 
$ 1,136.71 
$ 29,554.56 
12 
$ 29,554.56 
$ 1,182.18 
$ 30,736.74 
13 
$ 30,736.74 
$ 1,229.47 
$ 31,966.21 
14 
$ 31,966.21 
$ 1,278.65 
$ 33,244.86 
15 
$ 33,244.86 
$ 1,329.79 
$ 34,574.66 
16 
$ 34,574.66 
$ 1,382.99 
$ 35,957.64 
17 
$ 35,957.64 
$ 1,438.31 
$ 37,395.95 
18 
$ 37,395.95 
$ 1,495.84 
$ 38,891.79 
19 
$ 38,891.79 
$ 1,555.67 
$ 40,447.46 
20 
$ 40,447.46 
$ 1,617.90 
$ 42,065.36 
21 
$ 62,065.36 
$ 4,034.25 
$ 66,099.61 
22 
$ 66,099.61 
$ 4,296.47 
$ 70,396.08 
23 
$ 70,396.08 
$ 4,575.75 
$ 74,971.83 
24 
$ 74,971.83 
$ 4,873.17 
$ 79,844.99 
25 
$ 79,844.99 
$ 5,189.92 
$ 85,034.92 
Question 4
Part a
Project A’s Cash Flows
Year 
Cash Flows 
12% 
1 
$ 42,000.00 
0.893 
2 
$ 42,000.00 
0.797 
3 
$ 42,000.00 
0.712 
4 
$ 42,000.00 
0.636 
5 
$ 42,000.00 
0.567 
6 
$ 42,000.00 
0.507 
7 
$ 42,000.00 
0.452 
8 
$ 42,000.00 
0.404 
Cumulative DCF 
4.968 

Cumulative DCF when cash flows are incurring at the beginning of the year 
5.564 

Present Value of Project A 
$ 233677.8 
Project B
Year 
Cash Flows 
12% 
1 
$ 48,000.00 
0.893 
2 
$ 48,000.00 
0.797 
3 
$ 48,000.00 
0.712 
4 
$ 48,000.00 
0.636 
5 
$ 48,000.00 
0.567 
6 
$ 48,000.00 
0.507 
7 
$ 48,000.00 
0.452 
Cumulative DCF when cash flows are incurring at the beginning of the year 
4.564 

Present Value of Project B 
$ 219,060.31 
Project A is to be selected as the initial investment of both the project is same still the present value cash inflows of Project A is higher than Project B
Part b
When the rate of interest is 14% and cash flows are occurring at the beginning of the year
Project A
Year 
Cash Flows 
14% 
1 
$ 42,000.00 
0.877 
2 
$ 42,000.00 
0.769 
3 
$ 42,000.00 
0.675 
4 
$ 42,000.00 
0.592 
5 
$ 42,000.00 
0.519 
6 
$ 42,000.00 
0.456 
7 
$ 42,000.00 
0.400 
8 
$ 42,000.00 
0.351 
Cumulative DCF 
4.639 

Cumulative DCF when cash flows are incurring at the beginning of the year 
5.196 

Present Value of Project A 
218,212.158 
Project B
Year 
Cash Flows 
14% 
1 
$ 48,000.00 
0.877 
2 
$ 48,000.00 
0.769 
3 
$ 48,000.00 
0.675 
4 
$ 48,000.00 
0.592 
5 
$ 48,000.00 
0.519 
6 
$ 48,000.00 
0.456 
7 
$ 48,000.00 
0.400 
Cumulative DCF 
4.288 

Cumulative DCF when cash flows are incurring at the beginning of the year 
4.889 

Present Value of Project B 
$ 234,656.04 
In the changed scenario where Project B also has its cash flows occurring at the beginning of the year and the discounting rate will be 14% in both the projects then Project B must be opted for as it has higher present value of all its cash inflows
Question 5
Part a
Portfolio Components 
Number of Shares 
Weights 
Share A 
13500 
0.33 
Share B 
7600 
0.18 
Share C 
14700 
0.36 
Share D 
5500 
0.13 
Total 
41300 
1 
Part b Geometric Average Mean
GAR= 
(((1+0.097)*(1+0.124)*(10.055)*(1+.172))^(1/4))1 
GAR= 
0.081018 
GAR= 
8.10% 
Part c
CAPM 
Ke= 
Rf + Beta( Risk Premium) 
13.6%= 
Rf +1.5(4.8%) 

13.6%= 
Rf + 7.20% 

6.40% 
Rf 

Inflation Adjusted Risk Free Rate 
((1+Rf)/(1+Inflation Rate))1 
((1+0.064)/(1+0.027))1 
3.60% 
Part d
Rate of Return 
Probability 

Mild Recession (A) 
5.00% 
0.35 
Growth (B) 
15.00% 
0.45 
Strong Growth (C) 
30.00% 
0.2 
Rate of Return 
Probability 
Expected Return 
Deviation 
Deviation Squared 
Deviation square probability 

0.35 
1.75% 
(0.16) 
0.0256 
0.0090 
15.00% 
0.45 
6.75% 
0.04 
0.0016 
0.0007 
30.00% 
0.2 
6.00% 
0.19 
0.0361 
0.0072 
11.00% 
0.0169 

Expected Return 
(A1*WA )+ (B* WB) + (C* WC) 

Expected Return 
(0.05*.35) + (0.15*0.45)+(0.30*0.20) 

0.11 

11% 

Standard Deviation 
(wA2?A2+ wB2 ?B2 +wB2 ?B2+ wC2 ?C22wAwBwC?A?B?C?ABC)1/2 

0.085 

0.85% 

Variance 
1.69% 
References:
Besley, S. and Brigham, E.F., 2013. Principles of finance. Cengage Learning.
Gitman, L.J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Finance assignment Pearson Higher Education AU.
Shapiro, A.C. and Hanouna, P., 2019. Multinational financial management. Wiley.