TIME VALUE OF MONEY

QUESTION 1

Mr Joe is trying to plan for retirement in 10 years, and currently he has RM150,000 in a savings account and RM250,000 in common stocks. In addition, Mr Joe plans to add to his savings by depositing RM8,000 per year in his savings account at the end of each of the next 5 years and then RM10,000 per year at the end of each year for the last 5 years until retirement.

Assuming his savings account offers returns 8 percent compounded annually while his investments in stocks will give out returns 12 percent compounded annually, how much will Mr Joe have at the end of 10 years? (Ignore taxes.)

(5 marks)

If Mr Joe expect to live for 20 years after his retirement, and at his retirement age, he deposits all of his savings in a bank account paying 11 percent, how much can he withdraw each year after retirement (20 equal withdrawals beginning one year after Mr Joe retires) to end up with a zero balance at death?

(5 marks)

SHORT TERM FINANCING

QUESTION 2

• Temasek Air Inc. has average inventory of $1,000,000. Its estimated annual sales are $12 million and the firm estimates its receivables conversion period to be twice as long as its inventory conversion period. The firm pays its trade credit on time; its terms are net 30. The firm wants to decrease its cash conversion cycle by 10 days. It believes that it can reduce its average inventory to $900,000. Assume a 360-day year and that sales will not change. By how much must the firm also reduce its accounts receivable to meet its goal of a 10-day reduction?

(10 marks)

• Rainbow Company currently uses maximum trade credit by not taking discounts on its purchases. Rainbow is considering borrowing from its bank, using notes payable, in order to take trade discounts. The firm wants to determine the effect of this policy change on its net income. The standard industry credit terms offered by all its suppliers are 2/10, net 30 days, and Rainbow pays in 30 days. Its net purchases are $11,760 per day, using a 360-day year. The interest rate on the notes payable is 10 percent and the firm's tax rate is 40 percent. If the firm implements the plan, what is the expected change in Rainbow's net income? (assume EBIT equals to $140,000)

(10 marks)

• The Hallmark Corporation's projected sales for the first eight months of 2014 are as follows:

January February March April

$90,000 120,000 135,000 240,000

May June July August

$300,000 270,000 225,000 150,000

Of Hallmark's sales, 10 percent is for cash, another 60 percent is collected in the month following sale, and 30 percent is collected in the second month following sale. November and December sales for 2013 were $220,000 and $175,000, respectively.

Hallmark purchases its raw materials two months in advance of its sales equal to 60 percent of their final sales price. The supplier is paid one month after it makes delivery. For example, purchases for April sales are made in February and payment is made in March.

In addition, Hallmark pays $10,000 per month for rent and $20,000 each month for other expenditures. Tax prepayments of $22,500 are made each quarter, beginning in March.

The company's cash balance at December 31, 2013, was $22,000; a minimum balance of $15,000 must be maintained at all times. Assume that any short term financing needed to maintain the cash balance is paid off in the month following the month of financing if sufficient funds are available. Interest on short term loans (12 percent) is paid monthly. Borrowing to meet estimated monthly cash needs takes place at the beginning of the month. Thus, if in the month of April the firm expects to have a need for an additional $60,500, these funds would be borrowed at the beginning of April with interest of $605 (0.12 x 1/12 x $60,500) owed for April and paid at the beginning of May.

Prepare a cash budget for Hallmark covering the first seven months of 2014.

(9 marks)

Hallmark has $200,000 in notes payable due in July that must be repaid or renegotiated for an extension. Will the firm have ample cash to repay the notes?

(1 mark)