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Question 2–Financial Statements and Ratio Analysis
Income statement of CQU Auto –
Particulars | Amount | Amount |
Revenue from sales | | $85,000 |
Less - Cost of Goods sold | | $50,000 |
Gross Profit | | $35,000 |
Operating expenses | | |
Depreciation expense | $5,000 | |
Selling expense | $4,000 | |
General and administrative expenses | $7,500 | |
Total Operating Expenses | | $16,500 |
Operating profit | | $18,500 |
Less - Interest expense | | $3,500 |
Net profits before taxes | | $15,000 |
Less - Income tax expense @ 30 % | | $4,500 |
Net profit after taxes | | $10,500 |
(a) Gross profit
The gross profit of a company has derived by subtracting the cost of goods sold by a company or the cost of sales from the total revenues earned from sale proceeds (Afrasinei, Georgescu and Istrate, 2016). The gross profit derived from the revenues and expenses accounts of CQU Auto for the year 2017 amounts to $ 35000. This shows that the company CQU Auto has made a profit of $ 35000 after deducting all the costs associated with the production and sale of goods.
(b) Operating profit
The operating profit refers to the profit a business derives from its operations after deducting all the operational costs, before the deduction of the company’s interests, and taxes. The operating profit of CQU Auto for the year 2017 amounts to $ 18500. This profit has been derived after the deduction of the operational expenses of the company, which are operating expenses, depreciation expense and selling expense.
(c) BSBPMG522
The net profit before taxes is derived from the deduction of the income tax expense of a company from its earnings after the deduction of interest expenses but before the deduction of taxes. The net profit of CQU Auto before taxes amounts to $ 15000.
(d) Net profits after taxes
The net profit after, simply called the net profits of a company refers to the net income earned by the company after the deduction of all the company’s expenses, taxes and interests. The net profit after taxes of CQU Auto amounts to $ 10500.
(e) Cash flows from operations
The cash flow from operations or the operating cash flow refers to the amount of cash a company has generated from the amount of revenues the company has brought in excluding the expenses or costs associated to the investments of the company on capital items (Collins, Hribar and Tian, 2014).
Cash flow from operations |
Particulars | Amount |
Cash from operating activities | |
Net income | $10,500 |
Income tax expense | $4,500 |
Depreciation expense | $5,000 |
Selling expense | $4,000 |
General and administrative expenses | $7,500 |
Interest expense | $3,500 |
| - $ 14,000 |
Cash from investing activities | Nil |
Cash from financing activities | |
Dividend from preference shares | $500 |
Cash flows from operations | ($13,500) |
The cash flows of CQU Auto from operations amounts to - $ 13500. This shows that the company has a negative cash flow from operations, which indicates that the operating expenses of the company have been much greater than its revenues or net income.
(f) Earnings available to ordinary shareholders
The earnings available to ordinary shareholders in a company is derived by the subtraction of the preferred dividends of the company from the net earnings earned by the company. This figure refers to the total amount of earnings available to the common shareholders of a company. However, if the earnings available to the common stockholders of a company are divided into the number of ordinary shares outstanding in the company, the earnings available to ordinary shareholders can be derived.
Net profit | $10,500 |
Less - Preference share dividends | $500 |
Total earnings available to common shareholders | $10,000 |
Number of outstanding ordinary shares | 5000 |
Earnings available to ordinary shareholders | $2 |
The above calculation shows that the earnings available to the ordinary shareholders of the CQU Auto amount to$ 2.
Question 3–Financial Ratio Analysis
(a) Computation of the financial ratios of CQU South Africa Pty Limited
Particulars | | Ratio |
Liquidity ratios– | | |
Current ratio | Current assets / Current liabilities | 1.666666667 |
Quick ratio | Quick asserts / Current liabilities | 0.962318841 |
Activity ratios – | | |
Inventory turnover | Cost of sales / Inventories for the period | 7.008641975 times |
Average collection days | Receivables turnover ratio / 365 days | 41 days |
Total asset turnover | Sales revenue / Sum of total assets | 2.1 times |
Debt ratios – | | |
Debt ratio | Total debt / Sum of all assets | 0.533 |
Times interest earned | (EBIT / Expenses on interest) | 5.533333333 |
Profitability ratios – | | |
Gross profit margin | (GP / Sales revenues) x 100 | 18.9 % |
Operating profit margin | (OP / Sales revenues) x 100 | 5.14 % |
Net profit margin | (NP / Sales revenues) x 100 | 2.53 % |
Return on investment | Capital employed / Operating profit | 0.16 % |
Return on equity | Net income / Shareholders’ equity | 0.11 % |
(b) Analysis of the overall financial situation of CQU South Africa Pty Limited for the most recent year
The overall financial situation of a company can be derived from the financial ratios of the company (Banos-Caballero, Garcia-Teruel, andMartinez-Solano, 2014). The financial ratios of CQU South Africa Pty Limited have been computed for understanding its overall financial situation in the recent year.
The liquidity ratio of the company shows that the company has an optimum current ratio and quick ratio. The activity ratios show that the collection days of the company is higher than the industry average. Similarly, the assets and inventories turnover of the company is also quite poor in comparison to the average of the industry. On the other hand, the debt ratios of the company show that the debt ratio and the times interest earned is quite good and lower than the industrial average, showing good solvency of the company. However, the company is quite ahead of the industry in terms of profitability since the returns on the company’s equity, investment and the net profits are higher than industrial average of 2017.
Hence, it can be said that the company that the company requires improving the liquid position of the company in order to reach a higher liquid position than the industry average. The debt ratios and profitability ratios of the company are quite good and the company should work harder to maintain this financial management position. However, the company should focus on its activities in order to improve its activity ratios and overall financial position.
(c) Analysis of CQU South Africa Pty Limited’s overall financial situation from a cross-sectional and a time-series point of view
The overall financial situation of a company can be analyzed from a time series and cross-sectional viewpoint. The liquidity, profitability, activity and debt ratios of CQU South Africa Pty Limited have been analyzed in order to analyze the company’s overall financial situation.
The liquidity ratios of the company show that the current ratio and the quick ratio of the company have fluctuated during the last three years. The company had low liquidity in 2015, which increased in 2016 and further decreased in 2017. However, since the liquidity is as per the industrial average, the company can be said to have a good liquid position.
The activity ratios also show the same result. The inventory turnover has been fluctuating during the three years and the inventory turnover has remained almost same during the three years. The average collection days have also increased, which is again a negative point. Hence, the company should be focusing on improving its activity ratios.
The profitability ratios of the company show fluctuations and decreases during 2017. However, since the company is quite ahead of the industry in terms of profitability, it can be said the company is having a good profitability. The returns on the company’s equity, investment and the net profits are higher than industrial average of 2017.
The graph of the debt ratios of the company shows that the times interest earned by the company have increased and the debt ratio of the company has decreased, which is a positive sign for the company.
Thus, it can be understood that the company is having a good financial situation overall but should concentrate towards the improvement of its activity ratios for having a sound financial position.
Question 4–Annuity and Single value calculations
(a) Computation of equal annual end of year deposit if compounded annually
Present value of a two bedroom unit in CocoBay Resort in Noosaville = $ 350000
Rate of interest for purchasing the unit = 13 %
Rate of inflation = 5 %
Time frame = 20 %
Since the rate of inflation, prevailing in the country is 5 %, the rate of interest increases by 5 %. Thus, rate of interest = 18 %.
PV of year 1 | 0.947 |
PV of year 2 | 0.049 |
PV of year 3 | 0.002 |
PV of year 4 | 1.381 |
PV of year 5 | 7.269 |
PV of year 6 | 3.826 |
PV of year 7 | 2.013 |
PV of year 8 | 1.059 |
PV of year 9 | 5.578 |
PV of year 10 | 2.935 |
Sum of PV of 10 years | 25.059 |
Thus, the equal year end deposit = Present value of the two-bedroom unit / PV of 10 years cash flows = 350000 / 25.059 = $ 13967.03779.
Hence, if the rate of inflation is 5 % and the rate of interest is 13 %, the equal annual end of year deposit to be made into the accounting will be $ 13967.0.
(b) Computation of equal annual end of year deposit if compounded daily
If the rate of interest falls down to 8 % and the account is compounded daily, the future value of the amount
= Present Value (1 + Rate of Interest / 365) ^ No. of years * 365 (Gennaioli, Martin and Rossi, 2014)
Thus, 350000 (1 + 0.08 / 365) ^ 2 * 365
=350000 (1.0002) ^ 7300
= $ 1506865.846
Thus, if the rate of interest falls down to 8 % and the account is compounded daily, the amount accumulated at the end of 365 days
= $ 1506865.846 / 20 years
= $ 75343.29
(c)Explanation of the theory behind the impact on the annuity of changes in the interest rate from 13 % to 8 % per annum compounded daily
The theory behind the impact on the annuity due to change in the rate of interest from 13 % to 8% is the ways in which they are compounded. Firstly, when the rate of interest was 13 %, the annuity was compounded annually. However, when the rate of interest reduced to 8 %, the annuity was compounded daily. This is the main reason for the impact on the annuity. Another reason behind the difference is that when the rate of interest was 13 %, there was inflation in the rate of interest by 5%. However, when the rate of interest reduced to 8 %, there was no inflation in the rate of interest. This is the theory behind the impact on the annuity of changes in the interest rate from 13 % to 8 % per annum compounded daily.
Question 5 – Bond Calculations
(a)Bonds issues by CQU Packing Company = $ 1000 par value bonds
Outstanding coupon rate of interest = 14 %
Yield = 12 % return of return
Current market price of the bonds = $ 920
The value of a bond can be derived from the following formula –
Value of bonds = (C / 1 + r^1) + (c / 1 + r^2) + (c / 1 + r^3) … + (c / 1 + r^t) + (F / 1 + r ^t)
Where c = coupon price, r = rate of return or yield and t = time to maturity (Kuehn and Schmid, 2014)
Hence, value of the CQU Packing Company bonds
=(140 / 1.12^{1}) + (140 / 1.12^{2}) + (140 / 1.12^{3})+(140 / 1.12^{4}) + (140 / 1.12^{5}) + (140 / 1.12^{6}) + (140 / 1.12^{7}) + (140 / 1.12^{8})
+ (140 / 1.12^{9}) + (140 / 1.12^{10}) + (1000 / 1.12^{10})
= $ 125 + $ 111.6071429 + $ 99.64923469 + $ 88.97253098 + $ 79.4397598 + $ 70.92835696 + $ 63.32889015 + $ 56.54365192 + $ 50.4854035 + $ 45.07625312 + $ 321.9732366
=$ 1113.004461
Thus, the value of the bonds of CQU Packing Company is $ 1113.00.
(b)Incasewhen the bonds of the CQU Packing Company pay no coupon interest, the bonds turn into a zero coupon bond.
The value of a zero coupon bond can be derived by the following formula –
Zero coupon bond value = F / (1 + r) ^t, where F = Face value of the bond, r = rate of return or yield and t = time to maturity (Najafi and Mehrdoust, 2017)
Hence, the value of the zero coupon bonds of the CQU Packing Company
= $ 1000 / (1 + 12 %) ^10
= $ 1000 / (112) ^ 10
= $ 1000 / 3.1058
= $ 321.97
Thus, the value of the bonds of CQU Packing Company if the company does not pay any coupon interest = $ 321.97
(c)However, if the yield of the bonds of the CQU Packing Company falls down to 10 %, the value of the bonds of the company will automatically fall down.
Thus, value of the bonds of CQU Packing Company when yield is 10 %
= (140 / 1.1^{1}) + (140 / 1.1^{2}) + (140 / 1.1^{3}) + (140 / 1.1^{4}) + (140 / 1.1^{5}) + (140 / 1.1^{6}) + (140 / 1.1^{7}) + (140 / 1.1^{8}) + (140 / 1.1^{9}) + (140 / 1.1^{10}) + (1000 / 1.1^{10})
= $ 127.2727273 + $ 115.7024793 + $ 105.1840721 + $ 95.62188375 + $ 86.92898523 + $ 79.02635021 + $ 71.84213655 + $ 65.31103323 + $ 59.37366657 + $ 53.97606052 + $ 385.5432894
= $ 1245.782684
Thus, the value of the bonds of CQU Packing Company when the yield falls to 10 %amounts to $1245.78.
(d)Yield to maturity – Yield to maturity or YTM of a bond refers to the internal rate of return or the overall rate of interest earned by any investor who purchases the bond at market price until the bond matures (Goldstein, Jiang and Ng, 2017).
Par value –Par value is nothing but simply the face value of a bond or the stated value of a bond (Keown, 2013). Par value refers to the amount at which the lender or the investor is issuing a bond to the issuer or the borrower.
Above and below par values –The two terms above and below par values has come from the term par value. Above par value means that the price of a bond is trading above the face value of the bond and below par value means that the price of a bond is trading below the face value of the bond.
Value of bond –The value of a band is the fair price of a bondthat will be received from the bond after it matures (Jordan, 2014). It is the value, which a convertible bond will have if the bond is no longer convertible.
Maturity of the bond –Maturity of the bond refers to the date at which the principal amount of a bond becomes due as well as repaid to the investor of the bond and the payment of interests stop.
Market price –Market price refers to the exact price at which purchasers and investors agree to trade within a bond market during a specific time.
Relationship between yield to maturity and value of a bond –The value of a bond greatly depends on the yield to maturity of a bond (Ismailov and Rossi, 2017). When the value of a bond goes up, the value of the bond goes down and vice versa.
Relationship between maturity and par value –The maturity and par value of a bond are directly related. For example, if the par value of a bond increases, the maturity value of the bond increases and vice versa.
Relationship betweenbond value and market price of a bond –The relationship between the bond value and the market price of a bond is that when bond value goes up, market price of the bond tends to fall and vice versa.
Relationship between par value and market price of a bond –The par value of a bond is different from the market price of a bond. The fluctuations in the market price of a bond affect the par value of a bond because the market price is the price at which buyers are willing to buy the bond.
Relationship between yield and maturity of the bond –The yield and maturity of a bond differ from each other. The yield is the return an investor gets from a bond and maturity is the final amount an investor gets from a bond. Poor yield gives poor maturity value and vice versa.
Relationship betweenbond value and par value –The bond value and par value are interrelated to each other. Higher par value gives higher bond value and vice versa.
Reference list
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8. Keown, A. J. (2013). Personal finance: Turning money into wealth. Pearson.
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10. Najafi, A. R., &Mehrdoust, F. (2017). Bond pricing under mixed generalized CIR model with mixed Wishart volatility process. Journal of Computational and Applied Mathematics, 319, 108-116.