SAMPLE PROBLEMS

16 FEBRUARY 2013

FINANCING BY DEBT OR BY COMMON STOCKS

• HOSPITAL XYZ WOULD LIKE TO EXPAND AND THE EXPANSION IS ESTIMATED TO COST PHP100 MILLION.

• CURRENTLY, THE HOSPITAL HAS A PAID UP CAPITALIZATION OF PHP500,000,000 DIVIDED INTO 500,000 COMMON SHARES.

• THE HOSPITAL IS PROJECTED TO HAVE A NET INCOME BEFORE TAXES OF PHP100,000,000.

• THE EXPANSION IS ESTIMATED TO GIVE THE HOSPITAL AN ADDITIONAL PHP50 MILLION IN NET INCOME

• THE EXISTING OWNERS ARE PRESENTED WITH TWO ALTERNATIVES:– FINANCING IT WITH THE ISSUANCE WITH 100,000 OF

ADDITIONAL SHARES WITH PAR VALUE OF PHP1000 EACH.– A 5 YEAR TERM LOAN OF PHP100,000,000 WITH AN ANNUAL

INTEREST RATE OF 6.5%

• USE OF STOCKS USE OF LOAN

• EBIT 150,000,000 150,000,000

• INT NONE 9,750,000

• EBIT 150,000,000 140,250,000

• CS 600,000 500,000

• EPS PHP250 PHP280• TAXES NOT YET CONSIDERED.

DILUTED EPS COMPUTATION

• AS OF JANUARY 1, A COMPANY HAD 22,500 PHP10 PAR VALUE COMMON SHARES. ON JULY 1, THE COMPANY REPURCHASED 5,000 SHARES. THE COMPANY HAS ALSO HAS11,000, 10%, PHP100 PAR VALUE OF PREFERRED SHARES. IF THE COMPANY’S NET INCOME IS PHP210,000, WHAT IS IT’S DILUTED EPS?

DILUTED EPS COMPUTATION

• SINCE THE COMPANY HAS A SIMPLE CAPITAL STUCTURE, BASIC AND DILUTED EPS ARE EQUAL. THE NUMERATOR EQUALS NI-PREFERRED DIVIDENDS=210,000-(11,000 SHARES X.10 DIVIDENDX100(PAR)=210,000-110,000=100,000=100,000. THE WEIGHTED AVERAGE SHARES OUTSTANDING-22,500-(5,000 SHARES REPURCHASED X.5MIDYEAR)=22,500-2,500=20,000. BASIC EPS=DILUTED EPS=100,000/20,000=PHP5 PER SHARE.

NPV ANALYSIS

• USING THE PROJECT AFTER TAX CASH FLOWS, COMPUTE THE NPV OF EACH PROJECT’S CASH FLOWS AND DETERMINE WHICH SHOULD BE ACCEPTED. ASSUME THE COST OF CAPITAL TO BE 10%.

• YEAR A B

• 0 -2,000 -2,000

• 1 1,000 200

• 2 800 600

• 3 600 800

• 4 200 1,200

NPV ANALYSIS

• NPVA= -2000 + 1,000/(1.1)1 + 800/(1.1)2 + 600/(1.1)3+200/(1.1)4=PHP157.64

• NPVB= -2,000 + 200/(1.1)1 + 600/(1.1)2 + 800/(1.1)3+1,200/(1.1)4=PHP98.36

COST OF DEBT

• XYZ HOSPITAL IS PLANNING TO ISSUE NEW DEBT AT AN INTEREST RATE OF 8%. XYZ HAS A 35% TAX RATE. WHAT IS ITS COST OF DEBT CAPITAL?

COST OF DEBT

KD(1-T)=8%(1-0.35)=5.20%

COST OF PREFERRED STOCK

• IF XYZ HAS PREFERRED SHARES THAT PAY AN PHP8 DIVIDEND PER SHARE AND SELL FOR PHP100 PER SHARE, WHAT IS ITS COST OF PREFERRED STOCK?

COST OF PREFERRED STOCK

• KPS=DPS/P

• KPS=8/100=.08=8%

COST OF COMMON EQUITY

• XYZ STOCK SELLS AT PHP21, NEXT YEAR’S DIVIDEND IS EXPECTED TO BE PHP1. XYZ’S EXPECTED ROE IS 12% AND IS EXPECTED TO PAY OUT 40% OF ITS EARNINGS. WHAT IS THE COST OF EQUITY?

COST OF COMMON EQUITY

• G=(ROE)(RETENTION RATE)

• G=(0.12)(1-0.4) = 0.072=7.2%

• KCE=(1/21)+.072=.12 OR

• 12%

DILUTED EPS

XYZ HOSPITAL HAS:

ON 1 JANUARY 2010, 100,000 COMMON SHARES OUTSTANDING.

ON 1 APRIL 2010 IT ISSUES 50,000 NEW COMMON SHARES.

ON JULY 2010 IT DECLARES A 50% STOCK DIVIDEND.

ALSO ON 1 JULY, 10,000 CONVERTIBLE CUMMULATIVE PREFERRED SHARES ARE ISSUED. EACH PREFERRED SHARE CAN BE CONVERTED INTO FIVE COMMON SHARES. WHAT IS THE DILUTED EPS AS OF 31 DECEMBER 2010?

DILUTED EPS

• (100,000 X 12/12 + 50,000 X 9/12)1.5 = 206,250

• DILUTED EPS = 5,000,000/(206,250 + 25,000) = 21.62.

COST OF GOODS SOLD

• COMPANY X BEGAN OPERATIONS IN 2008 AND USES THE FIFO INVENTORY METHOD. DURING 2008, IT PURCHASED 100,000 UNITS OF INVENTORY AT PHP25 PER UNIT AND SOLD 90,000 UNITS. DURING 2009, IT PURCHASED 75,000 OF INVENTORY FOR PHP30 PER UNIT AND SOLD 70,000 UNITS. IN ITS 2009 INCOME STATEMENT, WHAT COGS WILL IT REPORT?

COST OF GOODS SOLD

• 2008 ENDING INVTY = (100,000 UNITS PURCHASED – 90,000 UNITS SOLD) X PHP 25 = PHP 250,000. THIS BECOMES THE BEG INVTY IN 2009.

• 10,000 UNITS FROM BEG INVTY PHP 250,000

• 60,000 UNITS PURCHASED @30

• PER UNIT 1,800,000

• COGS 2009 PHP2,050,000

• LIFO COGS = 70,000X 30 = 2,100,000

INVENTORY

• THE HEAD OF THE PHARMACY DEPARTMENT OF A HOSPITAL HAS CALCULATED AN INVENTORY TURNOVER OF 10X FOR 2011. THIS IS LOWER THAN LAST YEAR’S AND IS LOWER THAN THE INDUSTRY AVERAGE. WHAT DOES THIS INDICATE?

INVENTORY

• A LOWER INVENTORY TURNOVER RATIO INDICATES THAT THE COMPANY IS HOLDING TOO MUCH INVENTORY, RESULTING IN HIGHER CARRYING COSTS. TURNOVER IS LESS FREQUENT. YHE FOLLOWING IS THE INVENTORY TURNOVER FORMULA:

• INVENTORY TURNOVER = COST OF GOODS SOLD/AVERAGE TURNOVER

FINANCIAL RATIO ANALYSIS

• BASED ON THESE , WHICH COMPANY USES ITS ASSETS MORE EFFICIENTLY?

• A B• FIXED ASSET TO 2.8X 2.0X

• INVTY TO 5.0X 4.5X

• CURRENT RATIO 1.4X 1.3X

• QUICK RATIO .30X 0.12X

• DEBT TO EQUITY 46.6% 28.1%

• INTEREST COVERAGE 24.7X 33.5X

• NET PROFIT MARGIN 6.3% 6. 6%

• RETURN ON EQUITY 17.4% 13.8%

• RETURN ON ASSETS 11.9% 10.8%

FINANCIAL RATIO ANALYSIS

• COMPANY A, SINCE IT HAS A HIGHER FIXED ASSET AND INVENTORY TURNOVERS THAN B.