Question

1. Nelson's Landscaping Services just completed a pro forma statement using the percentage of sales approach. The pro forma has a projected external financing need of -GHS 5,500. What are the firm's options in this case?
2. You want your portfolio beta to be 0.95. Currently, your portfolio consists of GHS 4,000 invested in stock A with a beta of 1.47 and GHS 3,000 in stock B with a beta of 0.54. You have another GHS 9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset. How much should you invest in the risk-free asset?
3. Theo's Bar & Grill needs GHS 147,000 a week to pay bills. The standard deviation of the weekly disbursements is GHS 9,600. The firm has established a lower cash balance limit of GHS 40,000. The applicable interest rate is 3.5 percent and the fixed cost of transferring funds is GHS 45. Based on the BAT model, what is the optimal average cash balance?
4. How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?

Answer 1

a)With a negative(-GHS 5,500) external financing need,the firm has a surplus of funds that it can use to reduce current liablities,reduce long term debt,buy back shares of common stock,or increase dividends.If acceptable opportunities exist,the firm might also use the extra funds to purchase fixed assets thereby increasing its maximum capacity level,should that need be anticipated.

b)Portfolio beta=0.95

We know that portfolio beta=Weight of stock*beta of stock

Total Value of portfolio=GHS 4,000+ GHS 3,000+GHS 9,000=GHS 16,000

beta of risk free asset=0

Let the amount to be invested in risk free asset is GHS 9000-X

0.95=(4000/16,000)*1.47+(3000/16000)*0.54+(X/16000)*1.74+(9000-X/16000)*0

0.95=0.3675+0.10125+(X/16000)*1.74+0

X=4425.29

Thus,Investment in risk free asset is;

=GHS 9000-GHS 4425.29

=GHS 4574.71