Q/A Session!

Question 1: The question says purchased gasoline for $100 on account. I assume it will go to accounts payable and expenses but not in supplies. And as i pay it later in cash then i should count it in my income statement's expenses. Am i right?

Answer: Yes, this would increase both liabilities and expenses. And it would be shown in the income statement because it is an expense, not because they paid for it! Even if you pay for an expense later, you need to show it in the income statement. Paying or not paying for an expense would have different consequences in terms of cash flows.

Question 2: Part-1: In June 2, purchased a Van for $12000, by paying $2000 cash and signing a N/P for the remaining balance. Then in June 23, made a cash payment of 500 on N/P. Paying this 500 cash payment decreases N/P. So where i can write this $500 cash payment in Cash flow statement... (operating/investing activities?) and what will be the title of this transaction (decreasing N/P or delivery van)?
 Part-2: Similarly in June 17, purchase of gasoline for 150 on account, then in June 29, paid for the gasoline purpose. This transaction also decreases A/P. So in cash flow statement where i can write this transaction... in which section and under what title (decreasing A/P or expense)?

Answer: Part-1: Under investing activities, 'purchase of van' would show a negative $2,500 as total of that much cash went out from the business to purchase it.
Part-2: It would be included in cash payments for expenses under operating activities section.

Q/A Session!

Hello Sir, I have some queries and confusions,
1. I was wondering if equipments, utilities and supplies are the same thing... I mean if I create a category named 'Supplies' in the tabular summary and there's a transaction of equipments/utilities, can I put that transaction under that 'Supplies' category?
2. Where will 'purchase of Gasoline' go?
3. Delivery van is supposed to be an asset and I know the rule how to make adjustments when an asset is purchased in cash, but where will be the adjustments if the transaction is 'purchasing an asset/del.van on account?

Answers: Following are answers to the questions.
1. If whatever you create benefits you more than the current period, it will be an asset, otherwise an expense. So, equipments and supplies are assets as they usually benefit the company for multiple periods. As utility bill (eg. electricity bill) is paid every period and the benefit gets exhausted within the period, this is treated as an expense. All asset items should have separate columns. But all expenses should be recorded in the same expense column in Tabular Summary.
2. With the same logic mentioned above, purchase of gasonline for the delivery van would be an expense.
3. Increase in asset and on the other hand increase in liability (usually accounts payable if any other type is not mentioned, for example, a note payable).

Q/A Session!

Question: Sir, change of tires of a truck. is it capital or revenue expenditure? and in the ratio of return on common stock holder equity (if there is preferred dividends) we need to minus it from net income.but do we need to minus the price of those shares (preferred ones) from total common stock holders"equity to identify avg common stock holders equity??? and borrowing loans from bank .is it under the investing activity on cash flow statement??

Answer: Following are the answers to your questions.
1. Change of tires is a revenue expenditure as it will not change the original feature of the truck.
2. There is no preferred shares within "total common stock holders' equity". So, there is no need for any such deductions.
3. Borrowing money from banks or anyone else for long term is financing activity in cash flow statement.

Q/A Session!

Question 1: Good Morning sir! Aftertax salvage value = s+( bv-s) tax% ... is this formula right?

Answer: According to the book, Aftertax Salvage Value = S.V. - (S.V. - B.V.)*Tax%. But your formula would also work as that is a derived form of the same formula.

Question 2: Can you please clarify us about the final exam syllabus again?

Answer: According to the decisions made centrally by the FIN254 coordination committee, final exam must be comprehensive covering the whole syllabus.

Multiple Choice Questions may be from anywhere, not necessarily from our book as different faculty members use different books in their sections. But as everyone follows same set of topics, you don't need to worry if you cover the things discussed in the class.

As far as problems are concerned I will prepare them considering all the chapters we covered in class. For convenience I am making it simplified - for 100% final exam portion, no problems beyond chapter-10, there will definitely be a large problem from chapter-10, one problem from chapter-8 on stocks, some problems covering time value of money concept and financial statement analysis.

Question 3: Sir, you mentioned about Pretax OCF in the class. If I want to calculate OCF, then I have to deduct taxes from the pretax OCF. Is my concept right, sir? Is pretax OCF same as pretax cost savings?

Answer: You are right! Tax is applied on earnings, not on cash flows. Since we disregard interest expense when evaluating a project, OCF = Net Income + Dep. Exp. = (EBIT - Taxes) + Dep. Exp. So, OCF + Taxes (which is Pretax OCF) = EBIT + Dep. Exp. Now you calculate taxes on EBIT, then deduct taxes from pretax OCF to get OCF.

Yes, in the text books, "pretax OCF", "pretax cost savings", and "savings in pretax operating costs" all have same equivalent meanings. That means, pretax OCF = pretax cost savings = savings in pretax operating costs = OCF + Tax = EBIT + Dep. Exp. = Sales - Costs (excluding non-cash exp). So, whatever following formula you apply, you would end up with the same OCF.
Formula 1 => OCF = EBIT + Dep. Exp. - Taxes
Formula 2 => OCF = NI + Dep. Exp. [Disregarding financing expenses]
Formula 3 => OCF = Sales - Costs - Taxes [Costs exclude all non-cash expenses]
Formula 4 => OCF = (Sales - Costs)(1-T%) + Depreciation*T% [ " ]

FIN254: Math Solution!

Following is a solution to problem 22 of chapter 7.

Q/A Session

Q1: ASSALAMUALYKUM, THIS IS .... FROM FIN254 COURSE. SIR I NEED SOME CLARIFICATION ABOUT THE FINAL SYLLABUS. SIR FOR MCQ THE SYLLABUS WILL BE COMPREHENSIVE AND FOR MATH PART THE SYLLABUS WILL BE CHAPTER 8 TO 13 IS IT RIGHT.......SIR KINDLY HELP ME BY GIVING THIS INFORMATION I WILL BE REALLY GRATEFUL.

Ans: For problems, please cover chapters 2,3,5, and 6 to 10. Thanks.

Q2: Hi sir, I am one of your student from FIN254. I have a question related to share market, I would be glad if you could kindly help me out with it.

I saw a software which takes two parameter/input; your purchase price and number of shares bought. The software does some calculation and reply whether you will make profit or loss. for eg. Your purchase price: 1000, Number of shares: 10, reply: you will make a loss amount -8050! Now I have the following questions for you...
=> Is this forecasting/prediction? Is it using any technical analysis?
=> You have taught me one of the technical analysis "Moving Average". What is the approximate accuracy of this method?

I will be happy if you can write few words. Thanks.

Ans: I am sorry, I have never used or seen such a software. So, no idea about it. Sounds like a technical analysis to me though. It is of course a forecast/prediction, as it is telling you about the future!

Technical analysis is a collection of techniques or tools to help you predict future movements of instruments by taking into consideration historical price and volume action. Moving Average is one such technique that uses only historical price. Different instruments may follow different sets of moving average values at different times. So, it is not possible to tell you exact accuracy of it. To be able to get signals (both buy and sell) MACD (Moving Average Convergence Divergence) is commonly used.

More later. Take care.

FIN254: Q/A Session

Q: Can you please clarify us about the final exam syllabus again?

Ans: According to the decisions made centrally by the FIN254 coordination committee, final exam must be comprehensive covering the whole syllabus.

MCQs are made centrally, so I don't have any control over it. Questions may be from anywhere, not necessarily from our book as different faculty members use different books in their sections. But as everyone follows same set of topics, you don't need to worry if you cover the things discussed in the class.

As far as problems are concerned I will prepare them considering all the chapters we covered in class. For convenience I am making it simplified - no problems beyond chapter-10, there will definitely be a large problem from chapter-10, one problem from chapter-8 on stocks, some problems covering time value of money concept and financial statement analysis.

Q: Sir, my project files are huge in size and I am having genuine problem sending them to you with slow internet connection. What should I do?

Ans: I don't know what to say. The file size should not be that large. I have received many project files so far and the file size ranged from 100+ KB (kilobytes and not megabytes!) to 300+ KB. There is something wrong either in your operating system or the software itself.

Try "Save As" option to save them again in previous excel version, that is, xls (Excel 2003) format and check your file contents and the size. If that works, send them to me. If same problem remains, you may bring the files with you in a flash-drive/pen-drive during exam time and give it to me.

A Q/A Session

Sir, in chapter-10 problem-13 it is said "the sausage system will save the firm $130,000 in pretax operating costs". Is this the EBIT? In problem-14 it is said "you will save $330,000 before taxes per year in order processing costs and you will be able to reduce working capital by $125,000 (this is a one time reduction)". Is the $330,000 the EBIT? Is the $125,000 the change in NWC at the end of the project?

For problem 13, we may use the “Tax Shield Approach” to calculate OCF. In that case, the given pretax OCF is just “Sales – Costs” part of the equation. We may also use the basic approach, OCF = EBIT + Depreciation - Taxes. In this case, given pre-tax OCF is actually “OCF + Taxes” leaving “EBIT + Depreciation” on the other side of the equation.

For problem 14, ‘saving $330,000 before taxes per year’ is actually referring to the pretax OCF, not EBIT. So, we solve this problem using similar approach as discussed above for problem 13. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project.

Sir, sometimes the correct IRR is something like 19.78% , and its very difficult to find out the correct figure as it is too time consuming by using trial and error method . Can we just give the approximate figure , would you deduct any marks for that . like suppose the correct IRR is 19.78% and if i write "IRR is 19.7% could be little higher than that."

Rounding 19.78% to 19.8% (instead of 19.7%) will do.

Sir, how do we calculate capital gains yield?

Capital gains yield is simply percentage change in price. For a stock, the capital gains yield will be the change in price divided by the original (purchase) price expressed in percentage. For example, suppose you purchased a share of ABC Corporation for $200 and later sold the share for $220. The capital gains yield for that investment would be = [(220-200)/200]x100 = 10%. Similarly, if you sell at a lower price (less than the purchase price), your capital gains yield would be negative.

Sir, in chapter-6 for problem 24 we use the periodic rate right? but for problem 25 should we use APR or EAR? unless it is stated in the question that we are comparing between two investments, we are supposed to use APR. is my concept correct?

Please see the answer to the following question. For all types of TVM calculations, we need APR to find out periodic interest rate. So, for both problems you need APR.

Sir, when we calculate the future or present value of an annuity and we need the annual rate of return, which rate do we have to use? APR or EAR?

For Time Value of Money (TVM) calculations we need to use periodic interest rate (not necessarily annual rate, it may be a monthly rate, or a quarterly rate depending on the situation). That means for annual periods (annual compounding) we need to use APR, for monthly periods (monthly compounding) we need to divide APR by 12 (if monthly rate is not given in the problem) to get monthly rate, and so on.

However, we need EAR to compare different investment alternatives.

Sir, I am having great difficulty understanding the rates of return. When it is said "with monthly compounding" or "compounded monthly" it is the APR right? We divide it by 12 to get the actual rate per month right? When it is said say 14% per month it is the actual monthly rate right? In the selected lecture notes that you have given us, on page 39, why is it FV sir? Should'nt it be PV?

Yes, you are right. The phrases “with monthly compounding” and “compounded monthly” mean the same thing. If an annual rate is given and it is not mentioned that it’s an effective rate, it’s always the annual percentage rate (APR). So, you devide that rate by the number of such periods in a year to get the periodic rate, just like you said. If a periodic rate is mentioned that’s the actual rate for that period.

In the daily compounding problem you are referring to, please notice that the amount $15,000 will be needed after 3 years (FUTURE VALUE) to buy a car and you want to calculate the amount of money you need to deposit today (PRESENT VALUE), so that at 5.5% APR based on a daily compounding it (today's deposit) would grow to your desired amount after 3 years.

A Q/A Session

Sir, I am having great difficulty in understanding where shall issuance of loans be written in Cash Flow Statement. In the book it mentions that collection and issuance of loans should be written in the Investing section but then it says that issuance and redemption of long term debts should be written in the Financing section.Arent loans long term debts?

=> I understand your concern. It's easy to misunderstand these concepts. So, read the following carefully. In general, if an activity affects income statement, it is an operating activity; if it affects the long-term assets of a company, it is an investing activity, and if it affects long-term  liabilities and equity, then it is a financing activity.  

Simplistically, the activities related to generation of funds for running a company are financing activities. Once a company has the funds, it may use the funds in investing activities. Read more...

Investing Activity:
1. Purchase and sale of long-term assets.
2. Purchase and sale of instruments (stocks, bonds, etc.) of other companies.
2. Making loans (lending money to an individual or a company) and getting back the principal (NOT the interest, as it is accounted for in the operating activity section) of a loan made earlier.

Financing Activity:
1. Receiving money from owners (by issuing shares) or creditors (by borrowing in form of bonds/notes etc.).
2. Making payments to the owners (in form of dividends) or the creditors (returning the borrowed money e.g. redemption of bonds).
3. Purchase or sale of own shares (also called treasury stock or capital stock).

Sir, I have a question related to chapter 10, FIN254. I am not clear with the question of problem 13. How should I proceed in problem 13? What should be the steps?

=> First you need to calculate annual depreciation expense, then the after tax salvage (as book value at the end of the project would be zero, total salvage value would be the gain and you would need to deduct tax from the gain to get to after tax salvage). Yearly savings of 130,000 is equivalent to pretax earnings [Sales – Costs(without dep. exp)]. You may use the “Tax Shield Approach” to find OCF.

Sir, I am having a confusion in Problem: 14 of Chapter 10.What do we mean by 'reduce working capital by $ 125,000 (this is a one time reduction)'?Where do we place this NWC figure in the calculations?Is it recovered at the end of the project life?

=> This is very much similar to the earlier question (Problem 13). Accepting this project means that we will reduce overall NWC of the firm by $125,000 (remember, incremental cash flow?). This reduction in NWC is a cash inflow for this project at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC for the firm again. So, at the end of the project, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project. 

Sir, you said about Pretax OCF in the class. If I want to calculate OCF, then I have to deduct taxes from the pretax ocf. Is my concept is right sir?

=> You are right! Tax is applied on earnings, not on cash flows. Since we disregard interest expense when evaluating a project, OCF = Net Income + Dep. Exp. = (EBIT - Taxes) + Dep. Exp. So, OCF + Taxes (which is Pretax OCF) = EBIT + Dep. Exp. Now you calculate taxes on EBIT, then deduct taxes from pretax OCF to get OCF.

A Q/A Session

I am a student of FIN 254. Section 10. I am having a problem with question no 9, chapter 8. How should I compute the last dividend that has 11% rate of return thereafter. Should I use the formula of zero growth rate? Then what is the amount in D (in the formula). Please help me out sir.

=> As mentioned in the problem, D0 is $3.50. You would need to use D6 to apply 11% rate of return. It is also mentioned that, dividends would grow by 5% forever. That means, D6=D0(1+g)^6.

A Session of Q/A

Mushtahir Aziz wrote: 

Sir what is 'Porishodhito' capital in share market. Suppose a new brokerage house has to pay 7.5 mil tk for its 1st 3 branches and 5 mil for each of the next ones as 'porishodhito' capital.what does it mean?

Dear Mushtahir:

The synonymous English phrase for 'Porishodhito Capital' is 'Paid-up Capital'. It is the amount that the owner(s) contribute(s) in the firm. In other words, it is the amount of capital that has been paid by the owner(s) of a firm or the shareholders of a corporation.

According to your example, the owner(s) must contribute (invest in the firm as equity capital)  7.5 mil tk to establish 1st 3 branches of a brokerage house and additional 5 mil for each additional branch.

Thanks.

A Session of Q/A

আশফাকুর রহমান said... 
Sir, I know our exam is finished. But i wanted to know why don't we take time value of money into account while depreciating? If we took time value of money into account then we could show more money as depreciated and cut down our tax-able income in other words our tax lower. Is it because depreciation is a non-cash expense?

Dear Ashfaqur:

You have rightly pointed that out! Depreciation is a non-cash expense. It's a process of cost allocation, not a valuation. Depreciation is determined based on the historical cost of a depreciable asset. It does not change, unless you revalue. Another thing is that when we apply time value of money concept/model, we apply that on the cash flows. When we determine cash flows we do add all types of non-cash expenses including depreciation. In other words, depreciation is considered for time value of money indirectly.

Hope this has been helpful.

A Session of Q/A

Mushtahir wrote:

In today's FIN254 Final exam, in problem 1, you mentioned 'pretax operating cash flow $400000'. While solving the problem i assumed that the term 'pretax' is just a trick to create confusion. Because we get OCF after deducting dep. expense and tax from EBIT. But once we get OCF we don't tax it like we do for salvage. 

OCF is alway 'pretax'.Therefore i kept 400000 as it was. Still i am pretty confused. Was my logic correct?

Dear Mushtahir:

Please recall the formula for determining OCF from Income Statement, it's OCF = EBIT + Depreciation - Taxes. Therefore, pretax OCF is just EBIT + Depreciation. Thus, if you deduct depreciation from pretax OCF you will get EBIT. After deducting taxes from EBIT, you will get the Net Income. Since there is no interest expense in the problem, OCF is just Net Income + Depreciation.

Hope this has clarified your confusion.

Thanks.

A Session of Q/A

rumi said... 
sir,we face some problem about the financing activities and operating activities in cash flow. Please give us some example and some entry that will help us in the exam. At last pray for us.

Dear Rumi:

Broadly speaking, if an activity affects the Income Statement, then it's an operating activity; if an activity affects equity or long-term liability items of the Balance Sheet, it's a financing activity. Please try to do chapter-end problems for practice.

Thanks.

A Session of Q/A

Mushtahir Aziz (Anondo) said... 

While I was evaluating two mutually exclusive projects using IRR, i found two discount rates. One of them was negative and it still brought positive NPV. How can you explain that? Is it totally absurd? Because in this case we are having cash surplus while there is negative return.

Dear Mushtahir:

Please recall the class lecture on different decision rules, including IRR. I talked about two situations when IRR is unreliable as a decision rule - when a project has non-conventional cash flows and when projects are mutually exclusive. For projects with non-conventional cash flows, number of possible IRRs can be as high as the number of sign changes in the cash flows. In some cases, there may be no IRR (meaning NPV is negative at every discount rate) at all (see example 9.5)! For mutually exclusive projects, IRR may be misleading as well.

The problem you are talking about may be explained in a more specific way if I have the numbers. In a nominal sense (disregarding time value of money, in other words, with a discount rate of '0') if cash outflows of a project are more than cash inflows, it may give you a negative IRR, for obvious reason - to turn negative NPV to zero. If you start reducing the discount rate even more (higher on absolute term) you will find higher positive NPVs! 

Thank you for raising this point here. Hope this answers your query.