CB 3410 Assignment 1

Due: 13 October 2024 (updated), 11:50 pm.

Note that in the background information for Questions 2 to 3,
“Cerium currently has cash of about $4.0 m and its assets (fixed) are worth about $16.1 m in
the form of a building to house its employees.”

Notes:
i. Students will input their answers on the Canvas website. Please ask in class if you
have questions.

ii. Show your work. This exercise is also designed to guide you on writing the answers
appropriately. Do not write irrelevant answers and do not go beyond the scope of
the questions. For written-type questions in exams, you will be asked to show your
work.

1.
Mr. Alex Li is the CEO of Ascent Eminent Bank Ltd, a licensed bank in Hong Kong. Alex said that
the bank has to bear risks to earn the return required by the firm’s shareholders. There is no
point for Ascent to invest in only US Treasury bills as its shareholders could do this by
themselves.

The bank must implement prudent risk management controls for its banking business.

On Ascent’s lending business activities, what must Ascent essentially do to make money in
terms of interest rates paid on sources of funds and interest rates Ascent charges for lending to
its customers? Give your answer in one sentence. Discuss the cost of the bank’s source of funds
relative to the rate at which it lends to Ascent’s borrowers.

Questions 2 to 3:
Cerium Co. Ltd currently has bonds outstanding of about $20 m in principal. The $20 m of
the principal is due in five years’ time. The interest amounts to $1.6 m for the first year, i.e.
at 8% interest rate.

Cerium currently has cash of about $4.0 m and its assets (fixed) are worth about $16.1 m in
the form of a building to house its employees. There is no income from the building. The
company is funded by debt (details as stated above) and the rest by equity.

Cerium is currently considering two possible projects for investments, A and B. The
investment size is $4 m for both projects and Cerium will use the cash of about $4 m in its
bank account to buy the machines, etc., for the projects. The projects will be for a duration
of 5 years.

The future cash flows to the firm from the investments A and B are before payments of
interest and principal repayments to Cerium’s debtholders, i.e., Cash Flow to the firm = EBIT
+ Depreciation – increase in Accounts receivables – increase in inventory + increase in
accounts payables + increase in accruals – Increase in Investment. The cash flows to the firm

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can be used to pay interest and principal repayments to the firm’s debtholders and to pay
the firm’s shareholders (if there is any residual cash flow remaining).

Assume that the senior management team members are acting in the interests of the
Cerium’s shareholders.

Project A
Probability Cash Flows to the firm annually for 5 years ($)
0.8 5m
0.2 5.5 m

Project B
Probability Cash Flows to the firm annually for 5 years ($)
0.9 0.01m
0.1 22 m

2. If you were one of the firm’s bondholders, explain in about 60 words which project you
would want the firm to avoid and which project you would want the firm to invest in.

3. Explain in less than 60 words why there is a possibility that senior management acting in
the interests of the firm’s shareholders may want to invest in Project B instead of project
A.

Questions 4 to 6:
On 31 Dec 2022, ABC Co. Ltd.’s shareholders contributed $500,000 in equity funding to start
the company.
In 2023, the following activities took place:
On 1 Jan 2023, ABC borrowed $1 m from a bank at 2% interest rate. The loan matures 5
years later.
On 1 Jan 2023, ABC bought a machine for $300,000, all paid in cash. The machine’s useful
life is 10 years. Salvage value is $0 (assume $0 unless otherwise stated).
On 1 Jan 2023, ABC bought inventory worth $600,000, out of which $520,000 has already
been paid in cash to the suppliers.
The company recorded sale revenue of $710,000 for the $480,000 worth of inventory that
was sold. Assume no other expenses. As of 31 Dec 2023, ABC Co. has collected $500,000 in
cash from its customers for the goods sold.
Interest is all paid in cash (items assumed received/paid in cash unless otherwise stated).
Taxes are all paid in cash. Tax rate is 30%.
On 20 December, 2023, ABC paid $26,000 in dividend to the company’s shareholders.
For the financial year 2023, i.e., from 1 January 2023 till 31 Dec 2023:

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4. Calculate the cash flow from operations based on the indirect method that includes the
net income.
5. What is the cash flow from financing activities?
6. What is the cash flow from investing activities?
Questions 7 to 10:
Francis Chan and his friends founded Iridium Co. Ltd. that specializes in making batteries for
electric vehicles on 31 Dec, 2020. Shareholders contributed $1,200 m as equity capital. All
shareholders have paid in cash.
The financial year for Iridium for 2021 is from 1 Jan 2021 to 31 Dec 2021.
On 1 Jan 2021, the following activities took place:

• Iridium borrowed $200 m at annual interest rate of 8%. The company will pay off the
whole principal of $200 m at the end of year 5.
• Iridium bought machines A and B. Machine A costs $300 m and Machine B costs
$600 m, all paid in cash. Both have useful life of 10 years.
• The company bought raw materials to make the batteries that cost $600 m but $100
m has not been paid to the suppliers.
For the financial year 2021, the revenue recorded for Iridium was $1200 m.
Expenses related to wages and utilities are $250 m and $80 m respectively. As of Dec 31,
2021, $20 m of wages are outstanding (i.e., not paid in cash yet) but utilities are all paid in
cash.
On Dec 31 2021,

• $200 m has not been collected in cash from its customers.

• Of the raw materials that were bought on 1 Jan 2021, $200 m was not used for the
production of batteries in the 2021 financial year. The rest was all used in the form
of expenses to produce the batteries.
• Iridium decided to sell Machine A and buy a better one. Iridium sold Machine A for
$270 m.
• Cash dividend of $100 m was paid to shareholders.
• Iridium bought Machine C with useful life of ten years for $280 m, all paid in cash.
Depreciation expense for Machine C will begin on 1 Jan 2022.
Tax rate is 20%.
7. Calculate the net income for 2021.

8. As of Dec 31, 2021, calculate the ending cash balance.

9. Calculate the total stockholders’ equity as of Dec 31, 2021.

10. Draw up the balance sheet of Iridium as of Dec 31, 2021.