Evaluating Returns and Cash Flow Streams- Assessment 4

Evaluating Returns and Cash Flow Streams
Evaluating Returns and Cash Flow Streams

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Evaluating Returns and Cash Flow Streams


Solve nine problems addressing a range of issues related to valuation of stocks, bonds, annuities, and cash flow streams.

The result of a financial manager’s efforts is ultimately reflected in stock price; maximizing shareowner wealth is what finance is all about. This assessment examines the classic financial tradeoff of risk versus reward.

By successfully completing this assessment, you will demonstrate your proficiency in the following course competencies and assessment criteria:

  • Competency 1. Maximize shareholder wealth. 
    • Calculate the required return on a portfolio fund.
    • Calculate the required rate of return.
    • Compute the present values of ordinary annuities.
  • Competency 3. Evaluate capital expenditure investment projects. 
    • Calculate bond evaluation.
    • Apply computations to explain yield to call.
    • Calculate yield to maturity using correct calculations.
    • Compute the after tax cost of debt.
  • Competency 5. Apply evaluation principles of various financial instruments.
    • Explain uneven cash flow streams.

Evaluating Returns and Cash Flow Streams

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Maximizing shareowner wealth is all about increasing the stock price. Risky investments require higher returns, so when financial managers take greater risks, the logical reaction of shareowners is to demand a higher return. How do they accomplish this? If you were a bondholder, you would require a higher interest payment, but as a shareowner, you get higher returns by lowering the stock price.

So it may appear that a business should be averse to risk because it runs counter to the notion of a higher stock price, but in fact, businesses must take risks to get those higher returns. When relatively risky ventures pay off, or when shareowners believe management can pull it off, the stock price can soar.


It is important to examine the main categories of bonds, long-term instruments such as Treasury bonds, corporate bonds, municipal bonds, and foreign bonds. All bonds share certain common features such as face or par value, coupon rate, maturity date, and other provisions. Some bonds are sold at a deep discount and do not provide any coupon interest payments; these are called zero-coupon bonds.

Previously we have talked about the fact that the value of any financial asset should be based on the present value of its future cash flows. This holds true for the valuation of bonds as well. There are different numerical tools used in assessing and comparing different bonds such as yield-to-maturity, current yield, and yield-to-call for callable bonds.

Our analysis of bonds would certainly be incomplete if we did not consider the risks involved in purchasing different types of bonds. Interest rate, reinvestment rate, and default risks are all associated with the investment in bonds. One important observation regarding the bond markets is that they rely on several independent bond rating agencies providing continuous monitoring of the most important bond issuers.

Evaluating Returns and Cash Flow Streams

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Cash Flow

An asset’s value depends on the valuation of the after-tax cash flows this asset is expected to produce.

Questions to consider

To deepen your understanding, you are encouraged to consider the questions below and discuss them with a fellow learner, a work associate, an interested friend, or a member of the business community.

  • Analyze some of the most important elements of the current tax laws, such as the differences between the treatment of dividends and interest paid and interest and dividend income received. How can financial managers increase shareholder value through managing tax obligations?
  • Examine the company you work for (if your company is not publicly held, pick a company you are familiar with), and consider the following.
    • Would you consider this company to be relatively risky? Does the stock rise and fall faster than the market?
    • What things contribute to the riskiness or stability of the stock?
    • What is the CAPM and security market line, and how can they be used in assessing share price?
  • The time value of money is defined as the math of finance for which interest is earned over time by saving or investing money. Why does time value affect almost any financial decision? Under what situations might time value matter less?
  • Examine the importance of bond ratings and some of the criteria used to rate bonds. Differentiate between interest rate risk, reinvestment rate risk, and default risk. How would a financial manager use bond ratings to increase the value of the firm?
  • Examine what is meant by the statement that a preferred stock is a hybrid between a common stock and a bond. What factors determine the value of a share of preferred stock?
  • Identify some of the factors that would cause you to rely more on either NPV or IRR. Does MIRR solve all of IRR’s shortcomings?

Evaluating Returns and Cash Flow Streams

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The following optional resources are provided to support you in completing the assessment or to provide a helpful context. For additional resources, refer to the Research Resources and Supplemental Resources in the left navigation menu of your courseroom.

  • Brigham, E. F., & Houston, J. F. (2016). Fundamentals of financial management (14th ed.). Boston, MA: Cengage.

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Assessment instructions

For this assessment, complete Problems 1–9 to apply the necessary knowledge to assess returns and cash flow streams. You may solve the problems algebraically, or you may use a financial calculator or an Excel spreadsheet. In addition to your solution to each computational problem, you must show the supporting work leading to your solution to receive credit for your answer. Note the following:

  • You may need an HP 10B II business calculator.
  • You may use Word or Excel, but you will find Excel to be most helpful for creating spreadsheets.
  • If you choose to solve the problems algebraically, be sure to show your computations.
  • If you use a financial calculator, show your input values.
  • If you use an Excel spreadsheet, show your input values and formulas.

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The Economic Order Quantity (EOQ)

The Economic Order Quantity (EOQ)
The Economic Order Quantity (EOQ)

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The Economic Order Quantity (EOQ)


The Economic Order Quantity is that quantity that results in minimal costs in terms of holding costs for a particular period. The EOQ provides a good measure for calculating the optimal stock quantity required.

1a).EOQ = √2 (Annual Usage in Units) (Order Costs)/ (Annual Carrying Cost per Unit)

EOQ = √2 (CoD/Ch

Where Co = Cost of Placing Order = £2

D = Annual demand = 20,000

Ch = Cost of holding one item for a year = £1.5

            EOQ = √2 (2×20, 000/1.5

EOQ =230.94

1b). The implications of holding stock occur when stock outs are registered before the delivery of new orders. The shortage experienced causes delay for customer’s orders who eventually search for reliable suppliers. Alternatively excessive stocks lead to dead stock and holding of capital in stock instead of being utilized in other operations that can be more productive for the company. The above implications above compel the company to identify the right Economical Order Quantity to maintain (Doupnik and Perera 2012)

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2. a)

Cash flow Forecast for UniFood 2016
Credit Sales200030003000400040003000200010001000500060004000
Capital Amounting10000           
Total Receipts (A)300002100025000260003000023000120001100028000330003400029000
Cash Pymts to supplier200025003000300030001500150020003000300030002500
Cr pymts to supplier600065007000400060002000100020006000700070006000
Delivery Cost100012001500100120090080010001000150015001200
Rent and rates40000           
Insurance         960  
General expenses303030303030303030303030
Bank Loan100010001000100010001000100010001000100010001000
Vehicle Running200200200200200150100150200200200100
Vehicle Tax250           
Total Payments (B)585401950020800163901949013590124701424019300217602080018880
Net In/Out Flow (A-B)-28540150042009610105109410-470-32408700112401320010120
Opening Balance5000-23540-22040-17840-8230228011690112207980166802792041120
Closing Balance-23540-22040-17840-823022801169011220798016680279204112051240

2b) The months that will experience cash shortage are January, February, March and April.

2c) The cause of the cash shortage is that the business capital is insufficient to pay all the initial costs of operating the business. The credit sales are also contributing to the shortage of cash. The rental charges are also very high (Doupnik, Hoyle and Schaefer 2012).

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2d) To improve the Cash Flow Unifoods should apply for some low cost financing from a convenient bank that can advance a soft loan of £23540 or source for funding from an alternative source to facilitate the business operations during the first four months of the year. Unifoods may also opt to shop for cheaper premises that are within the same locality but which have the same goodwill or advantages as their present premises (Vance 2003).

4a) i.

Project AProject B
Payback period1 year and 6 months.1 year and 7 months

The Payback Period for project A is one year six months while the payback period for Project B one year seven months (Hermanson, Edwards & Invacevich, 2011)

4b) ii.

Unifood Accounting Rate of Return
Project AProject B
0100,000 100,000 
160,000 60,000 
280,000 70,000 
390,000 80,000 
4100,000 90,000 
5100,000 95,000 
Total530,000 495,000 
 Less 100,000430%Less 100,000 395%
ARRAverage annual returns/Initial inv

The ARR for project A is 430% while the ARR for Project 395% (Bodie, Kane & Marcus 2008).

4c)  iii.

Project  A      Project B
YearCash flowCash flow
 Discount Rate 10.00% 10.00%
PV for future cash flows$318,672.97$292,960.61

The NPV for project A is $218672.97 while the NPV for Project B 192960.61 (Brealey, Myers & Allen 2005).


The best project to invest in is project A. The payback period for the first project is shorter. The Accounting rate of return is 430% which is also higher than that of project B. The NPV for Project A is also higher than that of project B. The NPV for project A is £218,672.97 while that of project b is £192,960.61 (McLaney 2003). The other factors which should also be considered are the other extra expenses like the preliminary expenses. It may be costly to commence trading on some projects hence all the total costs should be considered (Harrington 2003).

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The Gross Profit Margin for Unifood is 65.76% while the Net Profit Margin is 15.31%. The total costs for the project would amount to 84.69%. The profitability ratios for Unifood are good and above average. The total costs are a little high but they can be brought down by strategically moving to cheaper premises. The efficiency ratios for Unifood are: Average collection Period Days in a Year/Inventory Turnover. To obtain the turnover the average stocks have to be obtained and which are not available (Helfert 2007).

DateTotals  Analysis   
Credit Sales38000  12.58%    
Capital Amounting10000      
Total Receipts (A)302000 302,000    
Cash Pymts to supplier30000      
Cr pymts to supplier60500      
Delivery Cost12900 103400    
Gross Profit  198,60065.7616(Gross Profit Margin)  
Rent and rates40000      
General expenses360      
Bank Loan12000      
Vehicle Running2100      
Vehicle Tax250      
Total Costs255760 25576084.6887   
Net In/Out Flow (A-B)46240  15.3113(Net Profit Margin)  
Opening Balance52240      
Closing Balance98480      

The credit sales are only 12.6% of the total sales which represent a low rate of credit sales. Unifood needs to provide flexible credit terms to encourage more sales to improve its profitability.

To increase the working capital, Unifood should cut down on its revenue costs. For example, Unifood should look for a way to reduce its rental income which is very high (Fridson 2002).The wages are also very high the company should find a way of reducing the high wages (Samuels et al 1998). Unifood has also to negotiate with the suppliers to provide more favorable credit terms to facilitate increased purchases and trade.\

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To conclude the Economical Order Quantity has provided an accurate way of determining the optimal stock level that a company should maintain having in mind the annual demand of the company and the holding costs that the company incurs in cases of overstocking and the costs of placing an order. The analysis of the company indicates that the financial performance of unifood is good as it is making profits and the suppliers are paid on time while the debtors are also maintained are reasonably low levels.


Bodie, Z., Kane, A., & Marcus, A. J., 2008, Investments (7th International ed) Boston: McGraw-Hill. 303.

Brealey, R.A, Myers, S. C., Allen, F., 2005, .Principles of Corporate Finance Boston: McGraw-Hill/Irwin.

Fridson, M., 2002, Financial Statement Analysis: A Practitioner’s Guide. New York: John Wiley.

Harrington, D, R., 2003, Corporate Financial Analysis: Decisions in a Global Environment. 4th ed. Chicago: Richard D. Irwin, Inc.

Helfert, E, A., 2007, Techniques of Financial Analysis: A Modern Approach. 9th ed. Chicago: Richard D. Irwin, Inc.

Hermanson, R.H., Edwards, J.D., & Invacevich, S.D., 2011, Accounting Principles: A Business Perspective. First Global Text Edition, Volume 2 Managerial Accounting, 37-73.

Vance, D. (2003). Financial analysis and decision making: tools and techniques to solve financial problems and make effective business decisions. New York: McGraw-Hill.

Doupnik, T.S., Hoyle, J.B. and Schaefer, T.F., 2012, Advanced Accounting. Boston: Irwin/McGraw-Hill, Print.

Doupnik, T.S, and Perera, H.B., 2012, International Accounting. New York: McGraw-Hill Irwin, 2012. Print.

McLaney, E. J., 2003, Business Finance: Theory and Practice (5th Ed). London: Pearson Education Ltd.

Samuels, J. M., Wilkes, F. M. and Brayshaw, R. E., 1998, Management of Company Finance (7th Ed). International Thomson Business Press.

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