DEPARTMENT OF MANAGEMENT & COMMERCE “T3-Examination, May-2018” Semester:4th Subject: Financial Decision Making (CMA-III) Branch: FAA Course Type:Core Time: 3 Hours Max.Marks: 80
Date of Exam:28/05/2018 Subject Code: MCH237 Session:II Course Nature:Hard Program: BBA Signature: HOD/Associate HOD:
Note: All Questions are compulsory from Part A (2 X 10 = 20 Marks). Attempt any two questions from Part B (15 Marks each). Attempt any two questions from Part C (15 Marks each) PART A 1. a. Define Enterprise Risk Management (ERM). b. Within a financial risk management context, define the term Value at Risk (VAR). c. When compared with the 1992 Internal Control–Integrated Framework issued by COSO, list down the elements that are new to the Enterprise Risk Management (ERM) –Integrated Framework. d. Define the underlying objective of Foreign Corrupt Practices Act of the U.S. law. e. What is sensitivity analysis in relation to capital investment decisions? f. Briefly list down the advantage and disadvantages of the payback method. g. Bell Delivery Co. is financing a new truck with a loan of $30,000, to be repaid in five annual installments of $7,900 at the end of each year. What is the approximate annual interest rate Bell is paying? h. What is Internal Rate of Return (IRR)? i. What is the payback period for a capital budgeting project where the total initial capital investment is $175,000 and the expected annual net after-tax cash flow is $35,000? j. Which is method that recognizes the time value of money by discounting the after-tax cash flows over the life of a project using the company's minimum desired rate of return? *****
Page 1 of 6
PART B 2. Magneto Industries (MI) recently appointed George Parker as CEO following the retirement of the previous CEO. After spending a few weeks reviewing operations and financial results, George is concerned about how MI is doing business. MI reported record earnings over the last several years, with 15% growth per year â€“ unpredictable in the industry. When George interviewed Bob Gartner, the Chief Operating Officer, Bob shared with George that the equipment used in production is in bad shape. Despite the fact that the equipment is only five years old, it has begun to breakdown at unexpected times due to lack of preventive maintenance. Sam Donato, the head of maintenance, explained that the maintenance budget has been reduced by 10-15% every year for the last three years. Despite his pleas to the previous CEO to increase the budget and memos explaining the consequences of not properly maintaining the production equipment, he has had to limit his activities to repairs only. Further, he has had to literally glue some of the equipment back together to keep it running. What should have been a temporary fix became permanent when his purchase requests for replacement parts were returned to him as unapproved. One day while George was walking through the plant, he was astonished to see Tom Haskins, the production supervisor, take the chewing gum out of his mouth and place it in the piece of machinery. When George inquired into what he was doing, Tom calmly explained that there was a piece on the machinery that regularly vibrated loose. Tom has noticed that Samâ€™s staff was getting irritated with having to repeatedly come out and glue it in place so he started to fix it himself to save time. While in the plant, George also spoke to a few production employees. The general message that these staff communicated to George was that they were just earning a pay check while looking for a better job. MI was known for doing as little as possible to maintain its equipment and its workforce. When he reviews the current year financials, George is not surprised to see that revenue and production have slipped substantially on a year-to-date basis as compared to the previous year. Based on the above case study, answer the following questions: i) ii) iii)
What values does this organization believe in and how do they explain what George has witnessed? How has leadership by example impacted the attitude and actions of Tm Haskins? What steps should George take to create more ethical and value-based culture at Magneto industries?
3. Jorelle Company's financial staff has been requested to review a proposed investment in new capital equipment. Applicable financial data is presented below. There will be no salvage value at the end of the investment's life and, due to realistic depreciation practices, it is estimated that the salvage value and net book value are equal at the end of each year. All cash flows are assumed to take place at the end of each year. For investment proposals, Jorelle uses a 12% after-tax target rate of return. Page 2 of 6
Investment Proposal Year 0 1 2 3 4 5
Purchase Cost and Book Value $250,000 $168,000 $100,000 $50,000 $18,000 $0
Annual Net After-tax Cash Flows $0 $120,000 $108,000 $96,000 $84,000 $72,000
Annual Net Income $0 $35,000 $39,000 $43,000 $47,000 $51,000
Calculate the Net Present Value (NPV) for the investment proposal. 4. Maxgo Company is considering replacing its current computer system. The new system would cost Maxgo $60,000 to have it installed and operational. It would have an expected useful life of four years and an estimated salvage value of $12,000. The system would be depreciated on a straight-line basis for financial statement reporting purposes and use an accelerated depreciation method for income tax reporting purposes. Assume that the percentages of depreciation for tax purposes are 25%, 40%, 20%, and 15% for the four-year life of the new computer. Maxgo's current computer system has been fully depreciated for both financial statement and income tax reporting purposes. It could be used for four more years but not as effectively as the new computer system. The old system currently has an estimated salvage value of $8,000 and will have an estimated salvage value of $1,000 in four years. It is estimated that the new system will save $15,000 per year in operating costs. Also, because of features of the new software, working capital could immediately be reduced by $3,000 if the new system is purchased. Maxgo expects to have an effective income tax rate of 30% for the next four years. Determine the net incremental investment (i.e., net cash outflow at time 0) for Maxgo Company, if the new computer system is purchased. PART C 5. Discuss IMA’s four standards of ethical conduct (answer in minimum 250 words). 6.In order to increase production capacity, Gunning Industries is considering replacing an existing production machine with a new technologically improved machine effective January 1. The following information is being considered by Gunning Industries.
The new machine would be purchased for $160,000 in cash. Shipping, installation, and testing would cost an additional $30,000. The new machine is expected to increase annual sales by 20,000 units at a sales price of $40 per unit. Incremental operating costs are comprised of $30 per unit in variable costs and total fixed costs of $40,000 per year. The investment in the new machine will require an immediate increase in working capital of $35,000. Gunning uses straight-line depreciation for financial reporting and tax reporting purposes. The new machine has an estimated useful life of five years and zero salvage value. Page 3 of 6
Gunning is subject to a 40% corporate income tax rate.
Gunning uses the net present value method to analyze investments. Calculate Gunning Industries' discounted annual depreciation tax shield for the first year of operation. 7. Lunar Inc. is considering the purchase of a machine for $500,000 which will last 5 years. A financial analysis is being developed using the following information.
Unit Sales Selling Price per unit Variable Cost per unit Fixed Costs Pre-Tax Cash Flow
Year 1 10,000 $100
Year 2 10,000 $100
Year 3 20,000 $100
Year 4 20,000 $100
Year 5 20,000 $100
The machine will be depreciated over 5 years on a straight-line basis for tax purposes and Lunar is subject to a 40% effective income tax rate. Assuming Lunar will have significant taxable income from other lines of business, and using a 20% discount rate, calculate the net present value of the project.
Page 4 of 6
Page 5 of 6
Page 6 of 6