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PROGRAM

MODULE
TUTORIAL
SESSION
TOPIC 8

Outline
BBA, BIM, BHRM, BAC, BEC, BMKT, BTRM, BHM
BBPW3103
FINANCIAL MANAGEMENT I
T4
Cost of Capital
Subtopics:
1. Definition for Cost of Capital
2. Determining the Cost of Capital for Each Component of Capital Resources
3. Weighted Average Cost of Capital (WACC)

TOPIC 9

Financial Planning
Subtopics:
1. Financial Planning
2. Cash Budget
3. Pro Forma Income Statement

TOPIC 10

Working Capital Management


Subtopics:
1. The Importance of Working Capital Management
2. Strategies of Working Capital Management
3. Types of Short-Term Financing
4. Cash Conversion Cycle
5. Management of Accounts Receivable
6. Inventory Management

LEARNING
OUTCOMES

Topic 8:

Calculate the cost of debts, cost of ordinary shares and cost of preference
shares

Determine a companys weighted average cost of capital (WACC)


Topic 9:

Explain the importance of cash budget and pro forma income statement in
financial management

Prepare cash budget and pro forma income statement


Topic 10:

Identify the determinants of net working capital

Explain the types and sources of short-term financing

Evaluate the efficiency of a firms working capital management based on cash


conversion cycle

Assess the factors that influence the management of accounts receivable

Identify costs that are related to inventory and explain how decisions on
inventory management are made

Notes

INSTRUCTIONAL
ACTIVITIES

Topic 8:

Explain the importance of cost of capital to a firm

Demonstrate by using relevant examples on how to calculate cost of debt

Demonstrate by using relevant examples on how to calculate cost of


preference share

Demonstrate by using relevant examples on how to calculate cost of ordinary


share

Explain the determinants of a firms weighted average cost of capital (WACC)

Demonstrate by using relevant examples on how to calculate weighted


average cost of capital (WACC)

Topic 9:

Explain the purpose of preparing a cash budget

Demonstrate by using relevant examples on how to prepare a cash budget

Explain the purpose of preparing a pro forma income statement

Demonstrate by using relevant examples on how to prepare a pro forma


income statement
Topic 10:

Explain the importance of working capital management

Demonstrate by using relevant examples on how to calculate cash conversion


cycle

Discuss the management of accounts receivable

Explain the important aspects of credit policy and credit control

Explain the importance of inventory management

Demonstrate by using relevant examples on how to calculate economic order


quantity (EOQ)

DIAGNOSTIC
EXERCISE
(5-10 minutes to
ensure basic
understanding
of topic)

Topic 8:
1. Why do we calculate a firms cost of capital? In computing the cost of capital,
which sources of capital do we consider?
2. Compare approaches that could be used in computing the cost of ordinary
shares.

Topic 9:
1. What is the purpose of cash budget?
2. What is the purpose of pro forma income statement?

Topic 10:
1. Why is working capital management an important area in financial
management?

Or other
exercises
prepared
by face to
face
tutors

2.
3.
4.
5.

Describe the asset categories that are included in working capital


management.
What is meant by credit term 5/10 net 30?
Explain the five Cs of credit.
What are the assumptions of economic order quantity (EOQ) model?

WORKED EXAMPLES FOR TOPIC 8

Questions & Answers


Extra Notes
Utama Companys preference shares sells for RM90 per share
and pays a RM7.50 annual dividend per share. If the company
were to sell a new preference issue, it would incur a flotation
cost of 5.00% of the price paid by investors.
Calculate the company's cost of preference share?
Method/Solution:

= 90 (5% x 90)
= 90 4.50
= 85.50

= RM7.50
RM85.50
= 0.0877 (8.77%)
2

Lingoland Company hired you to help them estimate their cost


of capital. You were provided with the following data: D1 =
RM1.25; P0 = RM40; g = 6% (constant); and Floatation cost =
5%. Assuming the firm must issue new share, calculate the cost
of equity raised by selling new ordinary share.

Method/Solution:

Kcs=

1.25
+ 6%
40 (5% x 40)

= 1.25 + 0.06
38
= 0.0929 (9.29%)

You were hired as a consultant to Indah Company, and you were


provided with the following data: Target capital structure: 40%
debt, 10% preference shares, and 50% ordinary shares. The
after-tax cost of debt is 4.00%, the cost of preference share is
7.50%, and the cost of retained earnings is 11.50%. The firm will
not be issuing any new share.
Calculate the firms weighted average cost of capital (WACC)?
Method/Solution:

WACC = (40% x 4%) + (10% x 7.50%) + (50% x 11.50%)


= 0.016 + 0.0075 + 0.0575
= 0.081 (8.10%)

WORKED EXAMPLES FOR TOPIC 9

Questions & Answers


Based on the information below, prepare a pro forma income
statement for Sutera Sdn. Bhd. for year 2012.







Sales forecast RM10,000,000


Cost of goods sold 60% of sales
Administration and sales expenses RM100,000
per month
Depreciation expenses RM140,000 per month
Interest expenses RM120,000
Tax rate 28%

Method/Solution:
Sutera Sdn. Bhd.
Pro forma Income Statement
For the year ended 31 December 2012
RM
Sales
Cost of goods sold
Gross profit
Depreciation expenses
Administration and sale
expenses
Operating profit (EBIT)
Interest expenses
Profit before tax
Tax (28%)
Net income

10,000,000
6,000,000
4,000,000
1,680,000
1,200,000
1,120,000
120,000
1,000,000
280,000
720,000

Extra Notes

WORKED EXAMPLES FOR TOPIC 10

Questions & Answers


Extra Notes
Armada Sdn. Bhd. borrows RM150,000 from a bank. A 10%
compensating balance is required.
What is the amount of the compensating balance?
Method/Solution:
What is compensating balance?
Compensating balance is the amount that must be kept in the
bank account and remained as a balance throughout the loan
period. The requirement for this compensating balance
makes the actual amount received by the borrower to be less
by the compensating balance amount. Sometimes banks
require borrowers to maintain an average demand deposit
balance equal to 10% to 20% of the face amount of the loan.
This makes the money unavailable for use and increases the
cost of borrowing.
Compensating balance = RM150,000 x 0.10
= RM15,000

Given the following information:


Average payment period = 30 days
Average collection period = 40 days
Production-sales cycle = 60 days

a) Calculate the cash conversion cycle.


b) If the company review its credit policy and decided to
offer discount on early payments to shorten the
average collection period by 10 days, compute the
new cash conversion cycle.

Method/Solution:
Cash conversion cycle = Age of inventory + Collection period
Payment period
a) Cash cycle = 60 + 40 30 = 70 days
b) Cash cycle = 60 + 30 30 = 60 days

Exercises for Topic 8

Ungu Berhad has been paying an annual dividend of RM3 per


share for 10 years and is expected to continue such payment
in the future. Assume that the firms shares are selling for
RM20 per share.
What is the cost of the ordinary share?
Answer: 15%

Merah Berhad plans to issue bond that have a maturity


period of 10 years with the par value of RM1000 that will pay
an interest of RM55 every 6 months. These bonds are sold at
the net amount of RM840.68 after taking into account the
additional cost involved. Assume that the rate of corporate
tax is 25%.
What is the cost of debt after tax?
Answer: RM10.5%

Exercises for Topic 9

You are given the quarterly sales of Setapak Sdn. Bhd. for the year
2011.

Total sales (RM)

Qtr 1
64,000

Qtr 2
56,000

Qtr 3
72,000

Qtr 4
64,000

Assume that of each quarters sales, 70 percent is collected in the


first quarter of the sale; 28 percent is collected in the following
quarter and 2 percent is uncollectible.
What is the total cash collections for first, second, third and fourth
quarter of 2011?
Answer: RM44,800; RM57,120; RM66,080 and RM64,960
2

The following information is obtained from Wangsa Sdn. Bhd.

(Wangsa) in the preparation of pro forma income statement for


year 2012.
Forecast sales
Cost of goods sold
Administrative expenses
General expenses
Interest expense
Tax rate

RM25,000
45% of sales
RM2,000
RM1,500
RM2,000
28%

What is Wangsas projected 2012 profit after tax?


Answer: RM5,940

Exercises for Topic 10

RBR Sdn. Bhd. borrows RM200,000 from a bank. A 15%


compensating balance is required.
What is the amount of the compensating balance?
Answer: RM30,000

Amanah Sdn. Bhd. sells 50,000 units of Product T each year.


The percentage of storage cost is 20% of inventory value. The
cost of placing an order for stock is estimated at RM1,500 and
the purchase price is RM15.00 per unit.
What is the economic order quantity (EOQ) of the product?
Answer: 7,071 units