Please complete problems posted on word document provided. Thank you.
Chapter 5:
A5. (Yield to maturity) Marstel Industries has a 9.2% bond maturing in 15 years. What is the yield to maturity if the current market price of the bond is a. $1,120 b. $1000 c. $785?
B13. (Expected dividend growth rate) Suppose MTA is expected to pay $4.00 in cash dividends next year are the rate of $1.00 per quarter and that the required return on MTA Stock is 14%. If MTA is currently selling for $37.50 per share, what is the expected growth rate in dividends for MTA based on the constant growth model?
Chapter 6:
A3. (Expected return and standard deviation)An investment has four possible returns, each with its won probability given here.
a. What is the expected return
b. What are the variance and the standard deviation of returns?
Return -12% -2% 8% 30%
Probability 0.20 0.25 0.35 0.20
B12. (Portfolio return and standard deviation) Seventy percent of a portfolio is invested in a stock that has a 15% expected return and a 15% standard deviation. The other 30% is invested in a stock that has a 21% expected return and a 25% standard deviation. The correlation between the two stocks returns is 0.45. What are the expected return and standard deviation of the portfolio?
Chapter 7:
B9. (CAPM) Stock A has a beta of 2.0 and a required return of 15%. The market return is 10%. What will be the required return of stock B which has a beta of 1.4?
Question 1
Sorenson Stores is considering a project that has the following cash flows:
Year Cash Flows
1 $2,000
2 $3,000
3 $3,000
4 $1,500
The project has a payback of 2.5 years, and the firm’s cost of capital is 12%. What is the project’s NPV?
Question 2
You work for Smith Company as a consultant. Kroncke target capital structure is 30%debt, 20% preferred, and 50% common equity. The after-tax cost of debt is 8%, the cost of preferred is 6.5%, and the cost of retained earnings is 13.25%. The firm will not be issuing any new stock. What is its WACC?
a. 10.07%
b. 10.37%
c. 9.48%
d. 10.68%
e. 10.325%
Question 3
If Do = $2.75, g (which is constant) = 3% and Po – $36, what is the expected total return for the coming year?
a. 9.82%
b. 10.07%
c. 10.33%
d. 10.60%
e. 10.87%
Question 4
Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your expectations are that you will not receive a dividend at the end of year 1, but you will receive a dividend of $9.25 at the end of year 2. In addition, you expect to sell the stock for $150 at the end of year 2.
If your expected rate of return is 16 percent, how much should you be willing to pay for this stock today?
Please see attached file for problems.
Week 3 Problem Set Solutions
5-1: Bond Valuation with Annual Payments.
Jackson Corporations bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $ 1,000 par value, and the coupon interest rate is 8%. The bonds have a yield to maturity of 9%. What is the current market price of these bonds?
5-2: Yield to Maturity for Annual Payments.
Wilson Wonders bonds have 12 years remaining to maturity. Interest is paid annually, the bonds have a $ 1,000 par value, and the coupon interest rate is 10%. The bonds sell at a price of $ 850. What is their yield to maturity?
5-3: Current Yield for Annual Payments.
Heath Foods bonds have 7 years remaining to maturity. The bonds have a face value of $ 1,000 and a yield to maturity of 8%. They pay interest annually and have a 9% coupon rate. What is their current yield?
5-7: Bond Valuation with Semiannual Payments.
Renfro Rentals has issued bonds that have a 10% coupon rate, payable semiannually. The bonds mature in 8 years, have a face value of $ 1,000, and a yield to maturity of 8.5%. What is the price of the bonds?
5-8: Yield to Maturity and Call with Semiannual Payments.
Thatcher Corporations bonds will mature in 10 years. The bonds have a face value of $ 1,000 and an 8% coupon rate, paid semiannually. The price of the bonds is $ 1,100. The bonds are callable in 5 years at a call price of $ 1,050. What is their yield to maturity? What is their yield to call?
6-1: Portfolio Beta.
An individual has $ 35,000 invested in a stock which has a beta of 0.8 and $ 40,000 invested in a stock with a beta of 1.4. If these are the only two investments in her portfolio, what is her portfolios beta?
6-3: Expected and Required Rates of Return.
Assume that the risk- free rate is 5% and the market risk premium is 6%. What is the expected return for the overall stock market? What is the required rate of return on a stock that has a beta of 1.2?
6-4: Expected Return Discrete Distribution.
A stocks return has the following distribution:
Calculate the stocks expected return, standard deviation, and coefficient of variation.
6-9: Portfolio Required Return
Suppose you are the money manager of a $ 4 million investment fund. The fund consists of four stocks with the following investments and betas:
6-10: Portfolio Beta
You have a $ 2 million portfolio consisting of a $ 100,000 investment in each of 20 different stocks. The portfolio has a beta equal to 1.1. You are considering selling $ 100,000 worth of one stock which has a beta equal to 0.9 and using the proceeds to purchase another stock which has a beta equal to 1.4. What will be the new beta of your portfolio following this transaction?
6-11 Required Rate of Return
Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk- free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?
Time to Reflect
Assume that the U.S. financial market consists of two firms, Food Mart and Tech Mart. Use the following stock return data which include U.S. T-Bills to calculate the expected return, beta of market for each security, and the required rate of return of all securities in the market including the market itself.
8-1: DPS Calculation
Thress Industries just paid a dividend of $ 1.50 a share ( i. e., D0 $ 1.50). The dividend is expected to grow 5% a year for the next 3 years, and then 10% a year thereafter. What is the expected dividend per share for each of the next 5 years?
8-2: Constant Growth Valuation
Boehm Incorporated is expected to pay a $ 1.50 per share dividend at the end of the year ( i. e., D1 =$ 1.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs, is 15%. What is the value per share of the company’s stock?
8-3: Constant Growth Valuation
Woidtke Manufacturings stock currently sells for $ 20 a share. The stock just paid a dividend of $ 1.00 a share ( i. e., D0 =$ 1.00). The dividend is expected to grow at a constant rate of 10% a year. What stock price is expected 1 year from now? What is the required rate of return on the company’s stock?
8-4: Preferred Stock Valuation
Basil Pet Products has preferred stock outstanding which pays a dividend of $ 5 at the end of each year. The preferred stock sells for $ 50 a share. What is the preferred stocks required rate of return?
8-11: Nonconstant Growth Stock Valuation
Assume that the average firm in your companys industry is expected to grow at a constant rate of 6% and its dividend yield is 7%. Your company is about as risky as the average firm in the industry, but it has just successfully completed some R& D work that leads you to expect that its earnings and dividends will grow at a rate of 50% [ D1= D0( 1 g) D0=( 1.50)] this year and 25% the following year, after which growth should match the 6% industry average rate. The last dividend paid ( D0) was $ 1. What is the value per share of your firms stock?
8-12: Nonconstant Growth Stock Valuation
Simpkins Corporation is expanding rapidly, and it currently needs to retain all of its earnings; hence it does not pay any dividends. However, investors expect Simpkins to begin paying dividends, with the first dividend of $ 1.00 coming 3 years from today. The dividend should grow rapidly at a rate of 50% per year during Years 4 and 5. After Year 5, the company should grow at a constant rate of 8% per year. If the required return on the stock is 15%, what is the value of the stock today?
8-13: Preferred Stock Valuation
Rolen Riders issued preferred stock with a stated dividend of 10% of par. Preferred stock of this type currently yields 8%, and the par value is $ 100. Assume dividends are paid annually. a. What is the value of Rolens preferred stock? b. Suppose interest rate levels rise to the point where the preferred stock now yields 12%. What would be the value of Rolens preferred stock?
8-14: Return on Common Stock
You buy a share of The Ludwig Corporation stock for $ 21.40. You expect it to pay dividends of $ 1.07, $ 1.1449, and $ 1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $ 26.22 at the end of 3 years.
a. Calculate the growth rate in dividends.
b. Calculate the expected dividend yield.
c. Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to get the expected total rate of return. What is this stocks expected total rate of return?
8-17: Constant Growth Stock Valuation
Suppose a firms common stock paid a dividend of $ 2 yesterday. You expect the dividend to grow at the rate of 5% per year for the next 3 years, and, if you buy the stock, you plan to hold it for 3 years and then sell it.
a. Find the expected dividend for each of the next 3 years; that is, calculate D1, D2, and D3. Note that D0 $ 2.
b. Given that the appropriate discount rate is 12% and that the first of these dividend payments will occur 1 year from now, find the present value of the dividend stream; that is, calculate the PV of D1, D2, and D3, and then sum these PVs.
c. You expect the price of the stock 3 years from now to be $ 34.73; that is, you expect P 3 to equal $ 34.73. Discounted at a 12% rate, what is the present value of this expected future stock price? In other words, calculate the PV of $ 34.73.
d. If you plan to buy the stock, hold it for 3 years, and then sell it for $ 34.73, what is the most you should pay for it?
e. Use Equation 8- 2 to calculate the present value of this stock. Assume that g 5%, and it is constant.
f. Is the value of this stock dependent on how long you plan to hold it? In other words, if your planned holding period were 2 years or 5 years rather than 3 years, would this affect the value of the stock today, P 0? Reizenstein Trucking (RT) has just developed a solar
Loan Repayment, NPV Profile, Required Rate of Return and other Finance problems. See attached file for full problem description.
Need help answering question cannot figure out where to start.
Cost of debt and preferred stock
1. Franklin Mining has 15 yr, 8% annual coupon bond outstanding. Bond has a current market price of $885.54 and a face value of $1,000. If Franklin’s marginal tax rate is 35% what is its relevant after-tax component cost of debt, rd (1-T)?
6.15%
9.46%
6.76%
6.40%
5.60%
They are considering issuing shares of perpetual preferred stock. The preferred stock would have a face value of $100 per share and pay a fixed annual dividend of $7.20 per share. The floatation cost associated with issuing this preferred stock is 10% of each shares face value. What is Franklin’s cost of preferred stock (rp)?
8.00%
7.83%
7.50%
9.00%
8.67%
Costs of debt and prefered stock
Fletcher Publishing stock currently trades at $45.50 per share. At the end of the year, they expect to pay an annual dividend of $4.65 per share (d1=$4.65) and the dividend is expected to grow at a constant rate of 4% per year. What is the firms cost of retained earnings? (rs)
13.67%
12.79%
14.22%
12.02%
12.24%
If Fletcher was to issue new common stock, the new shares could be sold at the current market price, but floatation cost would account for 10% of the proceeds. What is Fletcher’s cost of new common stock (re)?
12.68%
13.52%
15.52%
14.99%
14.41%
Fletcher has forecasted net income of $500 million and a capital budget of $800 million for next year. Fletcher’s target capital structure consists of 65% debt and 35% equity. The firm also plans to keep its dividend payout ratio fixed at 45% what is the relevant cost of common equity to be used in calculating Fletcher’s weighted average cost of capital (WACC) on the last dollar it raises?
12.24%
14.22%
13.25%
13.34%
15.36%
CAPM and the optimal capital budget
2. Ballack Inc. is a 100% equity-financed company (no debt or preferred stock). Its WACC equals its costs of common equity, their retained earnings will be sufficient to fund its capital budget in the foreseeable future. Their beta of 1.6 the risk-free rate of 6.0% and the market premium is 5.0%. What is their WACC?
13.65%
13.25%
13.70%
14.00%
13.55%
They are considering the following projects for next year:
Project Requires investment Expected rate of return
W $1,000 14.10%
X $2,000 13.65%
Y $3,000 14.60%
Z $4,000 13.10%
Each project has average risk, they accept any project whose expected rate of return exceed its cost of capital. How large should next years capital budget be?
$7,000
$3,000
$8,000
$4,000
$5,000
Weighted average cost of capital WACC
3. Howard Industries has a target capital structure consisting of 30% debt, 10% preferred stock, and 60% common equity. The-tax YTM on Howard’s long term bonds is 9.5% it cost of preferred stock is 8% and its cost of retained earnings is 12.5%. If the firm’s 40% what is Howard’s WACC if it doesn’t have to issue new common stock?
9.11%
10.24%
10.01%
9.67%
8.99%
If they undertake a variety of projects with different levels of risk. Howard adds 2 percentage points to its WACC for high-risk projects and subtracts 2 percentage points from its WACC for low-risk projects.
Which projects should Howard Industries accept check all that should be accepted?
Project Expected rate of return risk accept project
A 10.7% High
B 10.4% Average
C 12.7% High
D 8.5% Low
E 8.6% Average
F 6.7 % Low
G 9.1% Low
H 10.8% Average
Capital Structure weights
Frank Inc has the following abridge balance sheet:
Current Assets $3,600 Debt $5,200
Preferred stock $ 600
Fixed assets $6,400 Common Equity $ 4,200
Total assets $10,000 Total liabilities and equity $10,000
The market value of Franks’ debt preferred stock and common equity its book value. Frank’s cost of debt is 10% cost of preferred stock is 7.7% and its costs of common equity are 15%. If Frank’s tax rate is 30% what is the firm’s WACC?
9.65%
10.43%
9.89%
10.49%
9.97%
I needed some tutoring on these questions, I want to make sure that I have correct answers before I turn in my assignment. Thanks.
Please note the attachment and complete problems in Excel.
Thank you!
Suppose the expected returns and standard deviations of stocks A and B are E(RA) = 0.17,
E(RB) = 0.27, StdDevA = 0.12, and StdDevB = 0.21, respectively.
a. Calculate the expected return and standard deviation of a portfolio that is composed of
35 percent A and 65 percent B when the correlation between the returns on A and B is 0.6.
b. Calculate the standard deviation of a portfolio that is composed of 35 percent A and
65 percent B when the correlation coefficient between the returns on A and B is -0.6.
c. How does the correlation between the returns on A and B affect the standard deviation
of the portfolio?
Suppose the expected return on the market portfolio is 14.7 percent
and the risk-free rate is 4.9 percent.
Morrow Inc.stock has a beta of 1.3 Assume the capital-asset-pricing model holds.
a. What is the expected return on Morrow’s stock?
b. If the risk-free rate decreases to 3.7 percent, what is the expected return on Morrow’s
stock?
A portfolio that combines the risk-free asset and the market portfolio has an expected return
of 22 percent and a standard deviation of 5 percent. The risk-free rate is 4.9 percent, and
the expected return on the market portfolio is 19 percent. Assume the capital-asset-pricing
model holds.
What expected rate of return would a security earn if it had a 0.6 correlation
with the market portfolio and a standard deviation of 3 percent?
Suppose you have invested $50,000 in the following four stocks:
Security Amount Invested Beta
Stock A $10,000 0.7
Stock B 15,000 1.2
Stock C 12,000 1.4
Stock D 13,000 1.9
The risk-free rate is 5 percent and the expected return on the
market portfolio is 18 percent.
Based on the capital-asset-pricing model, what is the expected return on the above
portfolio?
You enter into a forward contract to buy a 10 -year, zero-coupon bond that will be issued in
one year.The face value of the bond is $1,000 , and the 1 -year and 11 -year spot interest rates
are 4 percent per annum and 9 percent per annum, respectively. Both of these interest rates
are expressed as effective annual yields (EAYs).
a. What is the forward price of your contract?
b. Suppose both the spot rates unexpectedly shift downward by 1 percent.
What is the price of a forward contract otherwise identical to yours?
1. Pierre Imports is evaluating the proposed acquisition of new equipment at a cost of $95,000. In addition the equipment would require modifications at a cost of $10,000 plus shipping costs of $2,000. The equipment falls into the MACRS 3-year class, and will be sold after 3 years for $35,000. The equipment would require an increased inventory of 3,000. The equipment is expected to save the company $35,000 per year in before-tax operating costs. The company’s marginal tax rate is 30 percent and its cost of capital is 10 percent.
a. What is the terminal year cash flow?
b. Calculate net present value. Should the machine be purchased?
2. Andrews Corporation plans a $6 million expansion. The firm wants to maintain a 35 percent debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 30 percent of last year’s net income. Last year, net income was $4 million.
a. If the company changed to a residual dividend policy, how much external equity will it need?
b. Is the company likely to change to a residual policy? Why or why not?
3. Kern Corporation entered into an agreement with its investment banker to sell 10 million shares of the company’s stock with Kern netting $210 million dollars from the offering. The expected price to the public was $25 per share.
The out-of-pocket expenses incurred by the investment banker were $2,000,000.
a. Is the agreement between the company and its investment banker an example of a negotiated or a best-efforts deal? Why? Which is riskier to the company? Why?
4. The Marcus Corporation’s financial statements are shown below. Figures are in millions. The firm is in the 30% tax bracket.
Balance Sheet
2008 2007
Cash and equivalents 40 30
Marketable securities 10 15
Accounts receivable 60 50
Inventory 80 70
Total Current Assets 190 165
Net plant and equipment 230 190
Total Assets 420 355
2008 2007
Accounts payable 60 50
Notes payable 80 90
Accruals 20 15
Total current liabilities 160 155
Long-term debt 60 50
Common stock 200 150
Total liabilities and equity 420 355
Income Statement
2008 2007
Net sales 550 490
Costs other than depreciation 390 350
Depreciation 100 97
Total operating costs 490 447
Earnings before interest and taxes 60 43
Less interest 10 7
Earnings before taxes 50 36
Taxes 15 11
Net income 35 25
a. Calculate net operating income after taxes
b. Calculate net operating working capital for 2007 and 2008
c. Calculate total operating capital for 2007 and 2008?
d. Calculate free cash flow for 2008
e. Why is free cash flow important? Is it critical that the company always maintain positive free cash flow? Explain
15-1
RESIDUAL DIVIDEND MODEL Axel Telecommunications has a target capital structure that Problems consists of 70% debt and 30% equity. The company anticipates that its capital budget for the 13 upcoming year will be $3,000,000. If Axel reports net income of $2,000,000 and it follows a residual dividend payout policy, what will be its dividend payout ratio?
15-2
STOCK SPLIT Gamma Medical’s stock trades at $90 a share. The company is contemplating a 3-for-2 stock split. Assuming that the stock split will have no effect on the market value of its equity, what will be the company’s stock price following the stock split?
15-5
EXTERNAL EQUITY FINANCING Northern Pacific Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 40% with a $10 million investment in plant and machinery. The firm wants to maintain a 40% debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 45% of last year’s net income. In 2008, net income was $5 million. How much external equity must Northern Pacific seek at the beginning of 2009 to expand capacity as desired? Assume that the firm uses only debt and common equity in its capital structure.
15-7
DIVIDENDS Bowles Sporting Inc. is prepared to report the following income statement (shown in thousands of dollars) for the year 2009.
Sales $15,200
Operating costs including depreciation 11,900
EBIT $ 3,300
Interest 300
EBT $ 3,000
Taxes (40%) 1,200
Net income $ 1,800
Prior to reporting this income statement, the company wants to determine its annual dividend. The company has 500,000 shares of stock outstanding, and its stock trades at $48 per share.
a. The company had a 40% dividend payout ratio in 2008. If Bowles wants to maintain this payout ratio in 2009, what will be its per-share dividend in 2009?
b. If the company maintains this 40% payout ratio, what will be the current dividend yield on the company’s stock?
c. The company reported net income of $1.5 million in 2008. Assume that the number of shares outstanding has remained constant. What was the company’s per-share dividend in 2008?
d. As an alternative to maintaining the same dividend payout ratio, Bowles is considering maintaining the same per-share dividend in 2009 that it paid in 2008. If it chooses this policy, what will be the company’s dividend payout ratio in 2009?
e. Assume that the company is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital. The company would like to avoid transactions costs involved in issuing new equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same per-share dividend?
16-1
CASH CONVERSION CYCLE Primrose Corp has $15 million of sales, $2 million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. What is Primrose’s cash conversion cycle (CCC)? If Primrose could lower its inventories and receivables by 10% each and increase its payables by 10%, all without affecting sales or cost of goods sold, what would be the new CCC, how much cash would be freed up, and how would that affect pretax profits?
16-2
RECEIVABLES INVESTMENT Lamar Lumber Company has sales of $10 million per year, all on credit terms calling for payment within 30 days; and its accounts receivable are $2 million. What is Lamar’s DSO, what would it be if all customers paid on time, and how much capital would be released if Lamar could take action that led to on-time payments?
16-4
CASH CONVERSION CYCLE Zocco Corporation has an inventory conversion period of 75 days, an average collection period of 38 days, and a payables deferral period of 30 days.
a. What is the length of the cash conversion cycle?
b. If Zocco’s annual sales are $3,421,875 and all sales are on credit, what is the investment in accounts receivable?
c. How many times per year does Zocco turn over its inventory?
16-6
WORKING CAPITAL INVESTMENT Prestopino Corporation produces motorcycle batteries. Prestopino turns out 1,500 batteries a day at a cost of $6 per battery for materials and labor. It takes the firm 22 days to convert raw materials into a battery. Prestopino allows its customers 40 days in which to pay for the batteries, and the firm generally pays its suppliers
in 30 days.
a. What is the length of Prestopino’s cash conversion cycle?
b. At a steady state in which Prestopino produces 1,500 batteries a day, what amount of working capital must it finance?
c. By what amount could Prestopino reduce its working capital financing needs if it was able to stretch its payables deferral period to 35 days?
d. Prestopino’s management is trying to analyze the effect of a proposed new production process on its working capital investment. The new production process would allow Prestopino to decrease its inventory conversion period to 20 days and to increase its daily production to 1,800 batteries. However, the new process would cause the cost of materials and labor to increase to $7. Assuming the change does not affect the average collection period (40 days) or the payables deferral period (30 days), what will be the length of its cash conversion cycle and its working capital financing requirement if the new production process is implemented?
7. It costs Smith Widget Company $20 to place an order to its supplier. It also costs the company $2 per widget to store the unsold inventory in its warehouse. If the company sells 30,000 widgets each year, what quantity should the company purchase when it places an order to its supplier? ________________
8. A forecast of sales by Fred Smith Hardware Company for the first 4 months of 2005 are (in thousand dollars):
Month 1 2 3 4
Cash sales 180 210 180 220
Credit sales 240 280 300 340
Expected cash collections: ______ ______ ______ ______
On average, 40 percent of credit sales are paid in the current month, 50 percent in the next month, and the remainder in the month after that. What are expected cash collections for each month?
9. If the balance sheet of a firm indicates that total assets exceed current liabilities plus shareholder’s equity, then the firm has: (circle one)
a. no retained earnings
b. long-term debt
c. no accumulated depreciation
d. no long-term debt
10. Quickstart Battery Company produces car batteries. The company has an inventory conversion period of 75 days, a receivables collection period of 38 days, and a payables deferral period of 30 days. Assuming 360 days per year, what is the length of the company’s cash conversion cycle? _____________ days
11. The December 31, 1999, balance sheet of Serena’s Tennis Shop, Inc. showed current assets of $900 and current liabilities of $325. The December 31, 2000, balance sheet showed current assets of $925 and current liabilities of $475. What was the company’s change in net working capital? (circle one)
a. plus $125
b. minus $125
c. plus $450
d. minus $450
12. Kaleb’s Karate Supply had a profit margin of 7 percent, sales of $10 million, and total assets of $6 million. What was total asset turnover? If management set a goal of increasing total asset turnover to 2.25 times, what would the new sales figure need to be, assuming no increase in total assets?
1. Suppose the following relationships for the Dawn Corporation:
Sales/total assets= 10x
Return on assets= 15%
Return on equity= 25%
What is the real risk free rate for 3-month if the inflation for 3 months is estimated as 4%?
What is Dawn’s debt ratio?
2. Suppose the following data on yields from holds:
3-month T-Bill=5.0%
30-year T-Bond=6.5%
30-year AAA Corporate=7.3%
30-year Municipal=5.475%
What is the maturity risk premium on 30-year Treasury bonds? Assume the expected inflation for 3-month T-Bills and 30-year T-Bonds is the same.
What is the real risk free rate for 3-month if the inflation for 3 months is estimated as 4%?
What is the default risk premium on 30-year AAA corporate bonds? Assume there exist liquid markets for AAA corporate bonds.
3. To finish college, you need $18,000 per year for 4 years, starting next year (that is, you will need to withdraw $18,000 one year from today). A relative offers to pay the expense by depositing in a bank time deposit paying 5 percent interest a sum of money that is sufficient to provide the four payments of $18,000 each. His deposit will be made today. How large must the deposit be?
1) The Joe company is experiencing financial difficulties. Its dividends and earnings are falling at a constant rate of 7% per year. It’s stock just paid an annual common stock dividend of $1.50 per share; the stock has a beta of o:45; three-month U.S Treasury Bill rate is 4.8%, and the market risk premium is 7%. What’s the value of the Joe Company’s Stock.
2) A firm’s stock presently sells for $71 per share. The stock just paid a dividend of $2.12. The dividend is anticipated to increase at a constant rate of 5.5% a year. What stock price is anticipated one year from now?
3) A firm has a target capital structure of 30% equity and 70% debt. The firm’s tax rate is 35% and the yield to maturity on the firm’s outstanding bonds is 8.2%. The firm’s weighted average cost of capital is 8.76%. What’s the firm’s cost of equity capital?
4) A firm has an equity multiplier of 3.71. The firm’s assets are financed with some combination of common equity and long-term debt. What’s the firm’s debt ratio?
5) A company’s project has expected net cash inflows of $4,000 per year for seven years. The project has a cost of $12,200 and the cost of capital is 17% What’s the project’s modified internal rate of return?
6) A project has an upfront cost of $21,300,000. It’s estimated that the project will produce the following net cash flows:
Year Project Net Cash Flows
1 $13,000,000
2 $3,000,000
3 $7,200,000
a) What’s the project’s net present value when the cost of capital is 4%?
b) What’s the project’s net present value when the cost of capital is 11%
1. If a company’s inventory turnover ratio is 24, how long is the firm’s inventory conversion period if you use a 360-day year?
2. To finish college, you need $18,000 per year for 4 years, starting next year (that is, you will need to withdraw $18,000 one year from today). A relative offers to pay the expense by depositing in a bank time deposit paying 5 percent interest a sum of money that is sufficient to provide the four payments of $18,000 each. How much money do you have in the account after the first withdrawal?
3. A credit union offers a savings account with the interest rate of 10% compounded daily. What is the effective interest rate if you use 360-day year?
4. As a lottery winner you are going to receive $10,000 every year forever, starting one year from today. If the appropriate discount rate is 10%, what is the present value of the award cash flows?
1. What is the present value of $1,250 due in 10 years at a 7% discount rate?
2. Suppose an index of small firm stocks started in 1946 at 10, and the index level was 1890.59 in 2001. What is the capital gains yield of the small firm stocks for the period?
3. Suppose the following relationships for the Dawn Corporation:
Sales/total assets= 10x
Return on assets= 15%
Return on equity= 25%
What is their profit margin?
4. Suppose the following data on yields from holds:
3-month T-Bill=5.0%
30-year T-Bond=6.5%
30-year AAA Corporate=7.3%
30-year Municipal=5.475%
Assume the same risk for 30-year AAA Corporate bonds and 30-year Municipal Bonds. If you are indifferent between the two bonds what is your implied marginal tax rate?
Corporate Financial Management Problems
Ch. 17 B4
B4. (Coverage ratios) Mi Furst, Inc., has $100 million of earnings before interest and taxes and
$40 million of interest expense.
a. Calculate Mi Furst’s interest coverage ratio.
b. Calculate the pro forma interest coverage ratio assuming the issuance of $100 million of
10% debt with the issue proceeds to be invested fully in a plant under construction.
c. Calculate the pro forma interest coverage ratio assuming the issuance of $100 million
of 10% debt with the proceeds to be invested temporarily in commercial paper that
yields 8%.
Ch. 18 B5
B5. (Share repurchase) A firm’s common stock is trading at a P/E of 20. Its projected earnings
per share are $2.00, and its share price is $40. All its shareholders are tax exempt. An
open market purchase would result in projected earnings per share of $2.70. How would
you expect the announcement of the share repurchase program to affect the firm’s share
price?
Ch. 20 B9
B9. (Duration) A bond pays interest semiannually at a 10% APR. The bond has a sinking fund
that makes equal payments at the end of years 8, 9, and 10. The bond’s price is 105% of its
face amount.
a. Calculate the bond’s yield to maturity.
b. Calculate the bond’s average life.
c. Calculate the bond’s duration.
Ch. 21 B4
B4. (Net advantage to leasing) Brown Toyota is considering leasing $120,000 worth of computer
equipment. A four-year lease would require payments in advance of $33,000 per
year. Brown does not currently pay income taxes and does not expect to have to pay income
taxes in the foreseeable future. If Brown purchased the computer equipment, it would
depreciate the equipment on a straight-line basis down to an estimated salvage value of
$30,000 at the end of the fourth year. Brown’s cost of secured debt is 14%, and its cost of
capital is 20%. Calculate the net advantage to leasing.
I have solutions that I am not sure if it is correct because it lacks the explanation to arrive at this answer can you please assist me with this I am attaching the question doc. and the answers .xls thanks in advance for your help you are a great tutor!
See attached file for full problem description.
See the attached file.
The textbook is called Financial Management Theory and Practice, 12th edition by Brigham and Ehrhardt.
Problem 5 – 4. Determinant of interest Rates. The real risk free rate is 2 %. Inflation is expected to be 3 % this year and 4% during the next 2 years. Assume that the maturity risk premium is zero.
a. What is the yield on 2 year Treasury securities? Round the answer to the nearest hundredth. ______%.
b. What is the yield on 3 year Treasury securities? Round the answer to the nearest hundredth.
Problem 5 – 11. Yield to Call and Realized Rates of Return. Nine years ago, Goodwyn and Wolf incorporated sold a 16 year bond with a 11% annual coupon rate and a 10% call premium. Today, G& W called the bonds. The bonds originally were sold at their face value of $1000. Compute the realize rate of return for investors who purchased the bonds when they were issued and who surrender them today in exchange for the call price. __%.
Problem 11-7 NPV Your division is considering two investment projects, each of which requires an up front expenditure of $23 million. You estimate that the investments will produce the following net cash flows:
Year Project A Project B
1 45000000 $20000000
2 10000000 10000000
3 20000000 6000000
What are the two projects net present value assuming the cost of capital is 10%.
a. Project A $____________ b. Project B $ ___________
What are the two projects net present values assuming the cost of capital is 5%.
c. Project A $ _____________________ d. Project B $ _______________
What are the two projects net present values, assuming the cost of capital is 15%
e Project A $ ________ f. Project B $ __________________________–
Problem 11 8 NPVs, IRRs and MIRRs for independent Projects Wdelman Engineering is considering including two pieces of equipment a truck and an overhead pulley system in this year’s capital budget. The projects are independent. The cash outlay for the truck is $17100 and that for the pulley system is $22430. Project A is the truck and Project B is the pulley. The firms cost of capital is 14%. After tax cash flows including depreciation are as follows:
Year Truck Pulley
1 $5100 $7500
2 5100 7500
3 5100 7500
4 5100 7500
5 5100 7500
Calculate IRR for each project.
a. Project A _____%
b. Project B___%
Calculate NPV for each project.
c. Project A ____%
d. Project B _____%
Calculate MRR for each project
e. Project A ____%
f. Project B ___%
Problem 11-2 NPV and IRR Analysis. After discovering a new gold vein in the Colorado Mountains, CTC Mining Corporation must decide whether to mine the deposit. The most cost effective method o mining gold is sulfuric acid extraction a process that results in environmental damage. To go ahead with the extraction CTC must spend $9000 for new mining equipment and pay $165000 for its installation. The gold mined will net the firm an estimated $350000 each year over the 5 year life of the vein. CTC’s cost of capital is 17%. For the purposes of this problem assume that the cash inflows occur at the end of the year.
Prepare responses to the following Problems from Foundations of Financial Management, 11th ed.:
Chapter 5: Problems 3, 4, 6, 7, 10 (a through c only), and 20
To complete Problem 7, use the hyperlink below to access the text book student website for the Excel® worksheet:
http://highered.mcgraw-hill.com/sites/dl/free/0072842296/120455/chapter_5.xls
ALL ANSWERS MUST BE IN EXCEL FORMAT
Problems attached.
3. Break-even analysis
Ensco Lighting Company has fixed costs of $100,000, sells its units for $28, and has variable costs of $15.50 per unit.
a. Compute the break-even point.
b. Ms. Watts comes up with a new plan to cut fixed costs to $75,000. However, more labor will now be required, which will increase variable costs per unit to $17. The sales price will remain at $28. What is the new break-even point?
c. Under the new plan, what is likely to happen to profitability at very high volume levels (compared to the old plan)?
4. Break-even analysis
Air Filter, Inc., sells its products for $6 per unit. It has the following costs:
Rent $100,000
Factory labor $1.20 per unit
Executive salaries $89,000
Raw material $.60 per unit
Separate the expenses between fixed and variable cost per unit. Using this information and the sales price per unit of $6, compute the break-even point.
6. Cash break-even analysis
Gibson & Sons, an appliance manufacturer, computes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $1,200,000, but 25 percent of this value is represented by depreciation. Its contribution margin (price minus variable cost) for each unit is $2.40. How many units does the firm need to sell to reach the cash break-even point?
7. Graphic break-even analysis
Draw two break-even graphs?one for a conservative firm using labor-intensive production and another for a capital-intensive firm. Assuming these companies compete within the same industry and have identical sales, explain the impact of changes in sales volume on both firms’ profits.
10. Break-even point and degree of leverage
University Catering sells 50-pound bags of popcorn to university dormitories for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the popcorn are $.10 per pound.
a. What is the break-even point in bags?
b. Calculate the profit or loss on 12,000 bags and on 25,000 bags.
c. What is the degree of operating leverage at 20,000 bags and at 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases?
20. Operating leverage and ratios
Mr. Katz is in the widget business. He currently sells 2 million widgets a year at $4 each. His variable cost to produce the widgets is $3 per unit, and he has $1,500,000 in fixed costs. His sales-to-assets ratio is four times, and 40 percent of his assets are financed with 9 percent debt, with the balance financed by common stock at $10 per share. The tax rate is 30 percent.
His brother-in-law, Mr. Doberman, says Mr. Katz is doing it all wrong. By reducing his price to $3.75 a widget, he could increase his volume of units sold by 40 percent. Fixed costs would remain constant, and variable costs would remain $3 per unit. His sales-to-assets ratio would be 5 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant.
a. Compute earnings per share under the Katz plan.
b. Compute earnings per share under the Doberman plan.
c. Mr. Katz’s wife does not think that fixed costs would remain constant under the Doberman plan but that they would go up by 20 percent. If this is the case, should Mr. Katz shift to the Doberman plan, based on earnings per share?
There is an attachment with 15 short problems attached.
Please review the problems and assist with solutions as described.
Must use Excel financial functions when possible.
There is more than 1 tab.
Thanks
Each answer should be between 200-300 words.
1. What is the concept of marginal cost of capital?
2. Would you expect the cost of capital to be different for an e-business versus a “brick and mortar” business? Why?
3. How would you modify your capital budgeting decision analysis to account for periods of inflation?
See attached file.
At the end of 2005, Uma Corporation was considering undertaking a major long-term project in an effort to remain competitive in its industry. The production
and sales departments determined the potential annual cash flow savings that could accrue to he firm if it acts soon. Specifically, they estimate that a mixed stream of future
cash flow savings will occur at the end of the years 2006 through 2011. The years 2012 through 2016 will see consecutive and equal cash flow savings at the end
of each year. The firm estimates that its discount rate over the first 6 years will be 7%. The expected discount rate over the years 2012 through 2016 will be 11%
The project managers will find the project acceptable if it results in present cash flow savings of at least $860,000. The following data is available to assist you:
a) Determine the value – at the beginning of 2006 – of the future cash flow savings expected to be generated by this project.
b) Should the firm undertake this project? Why or why not?
5 points Chapter 4
Uma Corp.
Present Value of Expected Future Savings
Period: 2006 through 2016
Note: This is a compound TVM problem
Discount rate for years 2006 – 2011 7%
Discount rate for years 2012 – 2016 11%
You are interested in purchasing the common stock of Azure Corporation. The firm recently paid a dividend of $3 per share. It expects its earngins – and hence its dividends – to grow at a rate
of 7% for the foreseeable future. Currently, similar risk stocks have required returns of 10%. (a) Given the data, calculate the present value of this security usign the constant-growth model in Ch. 7
to find the stock value. One year later your broker offers to sell you additional shares of Azure at $73. The most recent dividend paid was $3.21, and the expected growth rate for
earnings remains at 7%. To determine the required rate of return you must use the capital asset pricing model (CAPM). The risk-free rate is currently 5.25%, the market return is 11.55% and the
stock’s beta is 1.07. Substittue the appropriate values into the CAPM to determine the firm’s current required rate of return. (b) Once this required rate of return is found determine the value
of the stock.
Given Data:
Most Recently Paid Dividend
Growth Rate in Earnings
Required rate of return
Leverage and Capital Structure – chapter 12
Calculation of Share Value
Estimates Associated with
Alternative capital Structures
Capital Structure Expected Estimated
Debt Ratio EPS Required Return
0% $1.75 11.40%
10 1.90 11.80%
20 2.25 12.50%
30 2.55 13.25%
40 3.18 18.00%
50 3.06 19.00%
60 3.10 25.00%
Given the above estimates of EPS and required rates of return based on increasing levels of debt for this organization, calculate the estimated share price value for each level
using a common stock valuation model from chapter 11.
Assuming the organization makes decisions considering how best to maximize shareholder wealth, at what debt ratio will this objective be realized? 5 points
See the attached file.
P4-2 Future value calculation Without referring to tables or to the preprogrammed function on your financial calculator, use the basic formula for future value along with the given interest rate, i, and the number of periods, n, to calculate the future value interest factor in each of the cases shown in the following table.
Compare the calculated value to the value in Appendix Table A-1.
Appendix Table A-1
Future Value Interest Factors for One Dollar Compounded at i Percent for n Periods:
n
FVIFi,n = (1 + i )
Case Interest rate, I Number of periods, n
A 12% 2
B 6 3
C 9 2
D 3 4
P4-3 Future value tables Use the future value interest factors in Appendix Table A-1 in each of the cases shown in the table on the facing page to estimate, to the nearest year, how long it would take an initial deposit, assuming no withdrawals,
a. To double.
b. To quadruple.
Case Interest rate
A 7%
B 40
C 20
D 10
Appendix Table A-1
Future Value Interest Factors for One Dollar Compounded at i Percent for n Periods:
n
FVIFi,n = (1 + i )
P12-4 Breakeven analysis Barry Carter is considering opening a music store. He wants to estimate the number of CDs he must sell to break even. The CDs will be sold for $13.98 each, variable operating costs are $10.48 per CD, and annual fixed operating costs are $73,500.
a. Find the operating breakeven point in number of CDs.
b. Calculate the total operating costs at the breakeven volume found in part a.
c. If Barry estimates that at a minimum he can sell 2,000 CDs per month, should he go into the music business?
d. How much EBIT will Barry realize if he sells the minimum 2,000 CDs per month noted in part c?
P12-19 EBIT-EPS and capital structure Data-Check is considering two capital structures. The key information is shown in the following table. Assume a 40% tax rate.
Source of capital Structure A Structure B
Long-term debt $100,000 at 16% coupon rate $200,000 at 17% coupon rate
Common stock 4,000 shares 2,000 shares
a. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values.
b. Plot the two capital structures on a set of EBIT-EPS axes.
c. Indicate over what EBIT range, if any, each structure is preferred.
d. Discuss the leverage and risk aspects of each structure.
I am looking for a detailed explanation of the problems and the work detailed so as to help me to achieve better understanding of the material.
1. You invest a single amount of $10,000 for 5 years at 10 percent. At the end of 5 years you take the proceeds and invest them for 12 years at 15 percent. How much will you have after 17 years?
2. Your uncle offers you a choice of $30,000 in 50 years or $95 today. If money is discounted at 12 percent, which should you choose?
3. Burns Fire and Casualty Company has $1,000 par value bonds outstanding at 11 percent interest. The bonds will mature in 20 years. Compute the current price of the bonds if the present yield to maturity is:
a. 6 percent.
b. 8 percent.
c. 12 percent.
4. Assume a firm has earnings before depreciation and taxes of $200,000 and no depreciation. It is in a 40 percent tax bracket.
a. Compute its cash flow.
b. Assume it has $200,000 in depreciation. Recompute its cash flow.
c. How large a cash flow benefit did the depreciation provide?
d. Would the president of a firm on the New York Stock Exchange likely be satisfied with the earnings after taxes results in part c?
5. You are called in as a financial analyst to appraise the bonds of the Holtz Corporation. The $1,000 par value bonds have a quoted annual interest rate of 14 percent, which is paid semiannually. The yield to maturity on the bonds is 12 percent annual interest. There are 15 years to maturity.
a. Compute the price of the bonds based on semiannual analysis.
b. With 12 years to maturity, if yield to maturity goes down substantially to 8 percent, what will be the new price of the bonds?
6. Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 12 percent discount rate. Method two (explosion) is less expensive to perform but more dangerous and will call for a higher discount rate of 16 percent. Either method will require an initial capital outlay of $75,000. The inflows from projected business over the next five years are given below. Which method should be selected using net present value analysis?
Year Method 1 Method 2
1 $18,000 $20,000
2 24,000 25,000
3 34,000 35,000
4 26,000 28,000
5 14,000 15,000
7. Larry’s Athletic Lounge is planning an expansion program to increase the sophistication of its exercise equipment. Larry is considering some new equipment priced at $20,000 with an estimated life of five years. Larry is not sure how many members the new equipment will attract, but he estimates his increased yearly cash flows for each of the next five years will have the following probability distribution. Larry’s cost of capital is 14 percent.
P
(Probability) Cash Flow
.2 $2,400
.4 4,800
.3 6,000
.1 7,200
a. What is the expected value of the cash flow? The value you compute will apply to each of the five years.
b. What is the expected net present value?
c. Should Larry buy the new equipment?
8. Assume a $40,000 investment and the following cash flows for two alternatives.
Year Investment X Investment Y
1 $ 6,000 $15,000
2 8,000 20,000
3 9,000 10,000
4 17,000
5 20,000
Which of the alternatives would you select under the payback method?
9. Aerospace Dynamics will invest $110,000 in a project that will produce the following cash flows. The cost of capital is 11 percent. Should the project be undertaken? (Note that the fourth year’s cash flow is negative.)
Year Cash Flow
1 $36,000
2 44,000
3 38,000
4 (44,000)
5 81,000
10. The stock of Pills Berry Company is selling at $60 per share. The firm pays a dividend of $1.80 per share.
a. What is the annual dividend yield?
b. If the firm has a payout rate of 50 percent, what is the firm’s P/E ratio?
See attached file for full problem description.
1- In Davis Company , there are 2,000 units in beginning work in process, 11,000 units started into
production, and 1000 units in ending work in process 55% complete. How many physical units are
to be accounted for?
2- Orzel Corporation began October with 350 units in beginning work in process, 10,300 units started
into production, and 250 units in ending work in process that are 40% completed. How many physical
units are to be accounted for?
3- On of Dimaio company’s activity cost pools is machine setups, with estimated overhead of $115,000.
Dimaio produces product X (200 Setups) and Y product (400 setups). How much of the machine
setup cost pool should be assigned to X product?
4- Blinkone Corporation fields $16 of variable costs and $6 of allocated fixed costs to produce an
industrial trash can that sells for 25. A buyer from Seattle offers to purchase 1,500 units at $15 each.
Blinkone has excesss capacity and can handle the additional production. What effect will acceptance
of the offer have on net income.
See the attached practice problems.
1. P5-3 Risk preferences Sharon Smith, the financial manager for Barnett Corporation,
wishes to evaluate three prospective investments: X, Y, and Z. Currently, the firm earns 12% on its investments, which have a risk index of 6%. The expected return and expected risk of the investments are as follows:
Expected Expected
Investment return risk index
X 14% 7%
Y 12 8
Z 10 9
a. If Sharon were risk-indifferent, which investments would she select?
Explain why.
b. If she were risk-averse, which investments would she select? Why?
c. If she were risk-seeking, which investments would she select? Why?
d. Given the traditional risk preference behavior exhibited by financial managers,
which investment would be preferred? Why?
2. P5-4 Risk analysis Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates shown in the following table:
Expansion A Expansion B
Initial investment $12,000 $12,000
Annual rate of return
Pessimistic 16% 10%
Most Likely 20% 20%
Optimistic 24% 30%
a. Determine the range of the rates of return for each of the two projects.
b. Which project is less risky? Why?
c. If you were making the investment decision, which one would you choose?
Why? What does this imply about your feelings toward risk?
d. Assume that expansion B’s most likely outcome is 21% per year and that all
other facts remain the same. Does this change your answer to part c? Why?
3. P5-13 Portfolio analysis You have been given the return data shown in the first table on three assets?F, G, and H?over the period 2007-2010.
Expected return
Year Asset F Asset G Asset H
2007 16% 17% 14%
2008 17 16 15
2009 18 15 16
2010 19 14 17
Using these assets, you have isolated the three investment alternatives shown in the following table:
Alternative Investment
1 100% of asset F
2 50% of asset F and 50% of asset G
3 50% of asset F and 50% of asset H
a. Calculate the expected return over the 4-year period for each of the three alternatives.
b. Calculate the standard deviation of returns over the 4-year period for each of the three alternatives.
c. Use your findings in parts a and b to calculate the coefficient of variation for each of the three alternatives.
d. On the basis of your findings, which of the three investment alternatives do you recommend? Why?
4. Ch. 10 P10-4 Basic sensitivity analysis Murdock Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm’s financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table.
Project A Project B
Initial investment (CFo) $8000 $8000
Outcome Annual cash inflows (CF)
Pessimistic $ 200 $ 900
Most Likely 1000 1000
Optimistic 1800 1100
a. Determine the range of annual cash inflows for each of the two projects.
b. Assume that the firm’ s cost of capital is 10% and that both projects have 20-year lives. Construct a table similar to this for the NPVs for each project. Include the range of NPVs for each project.
c. Do parts a and b provide consistent views of the two projects? Explain.
d. Which project do you recommend? Why?
I need help with the answers.
True/False . Please indicate if the statement is True or False in the space provided below.
1. The break-even model expresses the volume of output as a unit quantity.
2. According to the DuPont Analysis, an increase in net profit margin will decrease
return on assets.
3. A new issue of common stock is considered a primary market transaction in the
money market.
4. When forecasting statements, assets always increase proportionately to sales
regardless of capacity.
5 If we invest money for 10 years at 8% interest, compounded semi-annually, we are
really investing money for 20 six-month periods, during which we receive 4% interest each period.
6. The same basic formula is used for computing both the computation of future value and of present value.
7 The goal of the firm should be the maximization of profit.
8. Both the IRR rule and the accounting rate of return rule take into consideration the time value of money.
9. The IRR assumes that cash flows are reinvested at the cost of capital.
10. The largest cash receipts for a firm come from accounts payable.
11. There are no disadvantages to the Net Present Value method.
12. Corporate profits play a part in the choice firms make between using internal versus external capital.
13. Because the 2% discount is so small, terms of credit such as 2/10 net 30 do not have much affect on accounts receivable management.
14. The capital budgeting decision-making process involves measuring the
incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the project’s cost.
15. Projects are said to be mutually exclusive when undertaking one prevents doing
the other(s).
16. The weighted average cost of capital is the minimum required return that must be earned on additional investment if firm value is to remain unchanged.
17. An increase in financial leverage will increase earnings before income and taxes
(EBIT).
18. Economies of scale are created when sharing of resources increases a firm’s productivity.
19. Leading and lagging are financial techniques used to eliminate risk.
20. Financial ratios comprise the principal tool of financial analysis since they can be
used to answer a variety of questions regarding a firm’s financial condition.
Multiple Choice.
1. Which of the following statements about the percent-of-sales method of financial
forecasting is true?
a. It is the least commonly used method of financial forecasting.
b. It is a much more precise method of financial forecasting than a cash budget would be.
c. It involves estimating the level of an expense, asset, or liability for a future period as a percent of the forecast for sales revenues.
d. It projects all liabilities as a fixed percentage of sales.
2. At 8% compounded annually, how long will it take $750 to double?
a. 6.5 years
b. 48 months
c. 9 years
d. 12 years
3. Which costs should be included when calculating the degree of operating leverage?
a. Depreciation
b. Administrative expenses
c. Real estate taxes
d. Both b and c
e. All of the above
4. What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?
a. 3 1/2
b. 4 1/2
c. 4 2/3
d. 5
5. An increase in ___________________ would increase a firm’s liquidity.
a. notes payable
b. inventories
c. cash
d. both b and c
e. all of the above
6. A company is technically insolvent when:
a. cash outflows in a given period are greater than cash inflows.
b. earnings before interest payments are less than the interest payments.
c. it lacks the necessary liquidity to promptly pay its current debt obligations.
d. the current ratio is less than 1.0.
7. Dieyard Battery Recyclers is considering a project with the following cash flows:
Initial outlay = $13,000
Cash flows: Year 1 = $5,000
Year 2 = $3,000
Year 3 = $9,000
If the appropriate discount rate is 15%, compute the NPV of this project.
a. $4,000
b. -$466
c. $27,534
d. $8,891
8. In the basic model, the optimal inventory level is the point at which:
a. total cost is minimized.
b. total revenue is maximized.
c. carrying costs are minimized.
d. ordering costs are minimized.
9. Which of the following techniques may not consider ALL cash flows of a project?
a. Net present value
b. Internal rate of return
c. Payback period
d. Modified internal rate of return
10. Cost of capital is:
a. the coupon rate of debt.
b. a hurdle rate set by the board of directors.
c. the rate of return that must be earned on additional investment if firm value is to remain unchanged.
d. the average cost of the firm’s assets.
11. Verigreen Lawn Care products just paid a dividend of $1.85. This dividend is expected to grow at a constant rate of 3% per year, so the next expected dividend is $1.90. The stock price is currently $12.50. New stock can be sold at this price subject to flotation costs of 15%. The company’s marginal tax rate is 40%. Compute the cost of internal (retained) earnings and the cost of external equity (new common stock).
a. 0, 17.8%
b. 15.2%, 17.8%
c. 18.2%, 20.9%
d. 18.2%, 16.21%
12. The Independence Hypothesis states that the use of a greater degree of leverage might result in greater:
a. earnings.
b. dividends.
c. firm cost of common equity.
d. both a & c.
e. all of the above.
13. Which of the following does not affect earnings per share (EPS) when a merger is concluded?
a. The exchange ratio for the shares of the acquired firm
b. The relative total asset/equity ratios of the firms
c. The premium paid above market value for the acquired firm
d. The relative earnings growth rates of the firms
14. Elimination of all foreign exchange risk:
a. should be the objective of a prudent financial manager.
b. should be analyzed on a cost benefit basis.
c. is possible through diversification.
d. both a and c.
e. all of the above.
15. Consider cash flows for Projects X and Y such as:
Project X Project Y
Year 1 $3000 $ 0
Year 2 $ 0 $3000
A rational person would prefer receiving cash flows sooner because:
a. the money can be reinvested.
b. the money is nice to have around.
c. the investor may be tired of a particular investment.
d. the investor is indifferent to either proposal.
16. Corporations receive money from investors with:
a. initial public offerings.
b. seasoned new issues.
c. primary market transactions.
d. a and b.
e. all of the above.
17. The debt ratio is a measure of a firm’s:
a. leverage.
b. profitability.
c. liquidity.
d. efficiency.
18. Capital market instruments include:
a. negotiable certificates of deposit.
b. corporate equities.
c. preferred stock.
d. both b and c.
e. all of the above.
19. What is the most important ingredient in developing a firm’s financial plan?
a. A forecast of sales revenues
b. Determining the amount of dividends to pay shareholders
c. Projecting the rate of interest on proposed new debt
d. Deciding upon which method of depreciation a firm should utilize
20. Which of the following best illustrates the hedging principle as it applies to the management of working capital?
a. Don’t place all your eggs in one basket.
b. Temporary current assets of the firm should be financed with short-term sources of funds.
c. Permanent current assets of the firm should be financed with short-term sources of funds.
d. All current assets should be financed with short-term sources of funds.
1. For a typical business, what are some external variables that influence the reversion rate?
2. What action can management take to exploit an overpriced share price of the corporation?
3. What action can management take to exploit an under-priced share price of the corporation?
4. What is one red flag indicator that may indicate deterioration or even distressed on the part of the firm?
See Attachment.
You are given the following long-run annual rates of return for alternative investments:
U.S. Gov’t T-bills 2.25%
Large-cap common stock 7.50%
Long-term corporate bonds 4.85%
Long-term Gov’t bonds 4.35%
Small-capitalization common stock 9.50%
The annual rate of inflation is 1.25%. What is the real rate of return (hint: use formula on page 17)
The following are the monthly rates of return for ABC Corporation and XYZ Corporation (show work for partial credit):
Note: depending on your statistical approach (i.e. Excel formulas or table) I will provide credit assuming I can tell which approach was used.
Month ABC XYZ
1 0.03 0.01
2 0.05 0.025
3 0.01 0.03
4 -0.005 0.015
5 -0.025 -0.02
6 0.35 -0.01
a) what is the geometric mean monthly return for each stock (recall, the returns will need to be converted to non-negative numbers)
b) what is the standard deviation of returns for both (please note: if not using Excel’s formula to arrive at Standard Deviation use n-1 in denominator)?
ABC
XYZ
c) what is the covariance between the rates of return (remember to use n-1 if deriving through a table)?
COV
d) what is the correlation coefficient between the rates of return?
e) would these two stock offer a good chance for diversification? Why or why not?
Compute the beta coefficient for General Electric
The following are the historic returns for Monte Company:
Year Monte Market index
1 23 9
2 5 9
3 -9 6
4 3 -5
5 12 12
6 9 13
a) what is the correlation coefficient between Monte and the Market Index?
b) what is the standard deviation for the company and the index?
c) what is the beta for Monte Company?
Question 1
Assume that you wish to purchase a 25-year bond that has maturity value of $1,000 and makes semiannual interest payments of $45. If you require a 7 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
Question 2
Mark Corporation’s budgeted monthly sales are $3,000. Forty percent of its customers pay in the first month and take the 2 percent discount. The remaining 60 percent pay in the month following the sale and don’t receive discount. Mark’s bad debts are very small and are excluded from this analysis. Purchases for next month’s sales are constant each month at $1,500. Other payments for wages, rent, and taxes are constant at $700 per month. Construct a single month’s cash budget with the information given. What is the average cash gain or (loss) during a typical month for Mark Corporation?
Question 3
ABC Corporation is determining whether to support $125,000 of its permanent current assets with a bank note or a short-term bond. The firm’s bank offers a two-year note where the firm will receive $125,000 and repay $150,000 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, ABC can sell 9.5 percent coupon bonds with a 2-year maturity and $1,000 par value at a price of $950.00. How many percentage points lower is the interest rate on the less expensive debt instrument?
Question 4
On its 1999 Balance Sheet, Sherman Books showed a balance of retained earnings equal to $510 million. On its 2000 Balance Sheet, the balance of retained earnings was also equal to $510 million. Which of the following statements is most correct? Show calculations.
a. The company must have had net income equal to zero in 2000
b. The company had a profit in 2000 but did not pay a dividend in 2000
c. The company’s net income in 2000 was $200 million
d. If the company lost money in 2000, they must have paid a dividend
e. None of the statements above are correct
See attachment
1 (chapter 5) Co. A is about to pay a dividend of $3.15 per share. Its future EPS and dividends are expected to grow with inflation, which is forecasted at 3% per year. What is the company’s stock price? The nominal cost of capital is 10%. (Problem 17 page110)
2. (chapter 6) Calculate the IRR for the following project
C0 = -4,000
C1 = 5,000
C2= 6,000
C3= -3,000
(q 10 page 139)
3. (chapter 7) You are the treasurer of Co. A. The company has just ordered a piece of machinery for $800,000. Of this sum, $100,000 is described by the supplier an an installation cost. You do not know whether the IRS will permit the company to treat this cost as a tax-deductible current expense or as a capital investment. In the latter case, the company will depreciate the installation expense using the MACRS tax depreciation schedule. How will the IRS decision affect the after-tax cost of the machinery? The tax rate is 40% and the opportunity cost of capital is 10%.
(page 163 #13).
4. (chapter 8) Co A has a standard deviation of 42% per year and a beta of +.10. Co. B has a standard deviation of 31% a year and a beat of +.66. Which investment is safer for a diversified investor?
(page 202 #14)
See attached file for 7 finance problems.
Please answer in xlsx and be sure to show how you do all calculations.
Question 1. a) NORREL Corporation’s stock is selling for $35 per share. An investor is considering buying a call option with an exercise price of $40. The investor is willing to pay the premium of 50 cents per option.
b) Why is an investor willing to pay 50 cents an option when the stock is going for $35?
c) Calculate the exercise value if the price of the stock increases to $42 per share.
d) What is the difference between a put option and a call option?
Question 2. Your company is evaluating new equipment that will cost $1,000,000. The equipment is in the MACRS 3-year class and will be sold after 3 years for $100,000. Use of the equipment will increae net working capital by 100,000. The equipment will save $450,000 per year in operating costs. The company’s tax rate is 30 percent and its cost of capital is 10%.
Part a. Calculate the cash flow in Year 0.
Part b. Calculate the incremental operational cash flows .
Reference: MACRS Depreciation Percentages for three-year class life assets:
33% 45% 15% 7% 100%
Part c. Calculate the non-operating terminal year cash flow.
Part d. Calculate the project’s payback period.
Part e. Calculate the project’s NPV.
Part f. Calculate the project’s IRR.
Part g. Calculate the project’s MIRR.
Part h. Investment Decision: Should the project be accepted or rejected? Why or why not?
Question 3. A company generated free cash flow of $1 million last year and expects it to grow at a constant rate of 8 percent indefinitely. The company’s weighted average cost of capital is 10 percent.
a. Calculate the company’s free cash flow for next year.
b. Calculate the value of the company’s operations.
c. How much would the value of operations change if expected growth is 5 percent?
Question 4. Reynolds company is evaluating its dividend policy. Selected data for the company are shown below.
Capital budget: $10,000,000
Desired capital structure: 40% Debt, 60% Equity
Expected net income $7,000,000
Outstanding shares 5,000,000
Last annual dividend per share $0.50
a. If the company follows a residual policy, how much will it pay out in dividends?
b. If the company decides to maintain last year’s dividend, how much will it pay out in dividends this year?
c. What are the company’s options for raising the equity needed for the capital budget?
d. Should the company follow the residual dividend policy? Why or why not?
e. Which is better for the stockholder–cash dividends or stock repurchases? Why?
Question 5. The exchange rate between the Japanese yen and the U.S. dollar is 105 yen = 1U.S$. A U.S. company agrees to purchase goods for 40 million yen, with payment due in 6 months.
a. How many U.S. dollars would the company need to purchase the goods and pay for them today?
b. Has the yen appreciated or depreciated against the dollar If the exchange rate is 100 yen to 1$US in 6 months? Why?
c. How many U.S. dollars will be needed to pay for the goods if the exchange rate is 110 yen to 1$US?
d. Does the Japanese exporter or the U.S. importer bear the risk if payment is due in yen? Why?
e. How can a company protect itself against exchange rate risk?
Question 6. Kemp Corporation is evaluating whether to lease or purchase equipment. The equipment will cost $500,000 if purchased, and the entire amount will be financed by a bank loan at an annual interest rate of 10 percent. At the end of 4 years, the company expects to sell the equipment for $60,000. The equipment falls in the MACRS 3-year class. The firm’s tax rate is 30 percent. The lease terms call for payments of $100,000 for 4 years, payable at the beginning of the year.
a. Calculate the cost of purchasing the equipment.
b. Calculate the cost of leasing the equipment.
c. Calculate the NAL. Should the firm purchase or lease the equipment? Why?
Question 7. ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to increase total assets by $1,400,000. The bank loan bears an interest rate of 10 percent. The company’s president owns 57.5% percent of the 1,000,000 shares of common stock and wishes to maintain control of the company. The company’s tax rate is 30 percent. Balance sheet information is shown below.
The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share.
Current Balance Sheet
Current Liabilities $900,000
Common Stock, Par $1 1,000,000
Retained earnings 700,000
Total Assets $2,600,000 Total claims $2,600,000
a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants.
b. Calculate the president’s ownership position for both alternatives. He doesn’t buy any of the additional shares.
c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets.
d. Calculate the debt ratio under both alternatives
e. Which alternative do you recommend and why?
Attached is a document with 7 finance questions.
What is an opportunity cost? How is this concept used in TVM analysis, and where is it shown on a time line? Is a single number used in all situations? Explain.
Explain whether the following statement is true or false: $100 a year for 10 years is an annuity; but $100 in Year 1, $200 in Year 2, and $400 in Years 3 through 10 does not constitute an annuity. However, the second series contains an annuity.
To find the present value of an uneven series of cash flows, you must find the PVs of the individual cash flows and then sum them. Annuity procedures can never be of use, even when some of the cash flows constitute an annuity because the entire series is not an annuity. True or false? Explain.
Banks and other lenders are required to disclose a rate called the APR. What is this rate? Why did Congress require that it be disclosed? Is it the same as the effective annual rate? If you were comparing the costs of loans from different lenders, could you use their APRs to determine the loan with the lowest effective interest rate? Explain.
Suppose you believe that the economy is just entering a recession. Your firm must raise capital immediately, and debt will be used. Should you borrow on a long-term or a short-term basis? Why?
EXPECTED INTEREST RATE The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?
DEFAULT RISK PREMIUM The real risk-free rate, r*, is 2.5%. Inflation is expected to average 2.8% a year for the next 4 years, after which time inflation is expected to average 3.75% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 8.3%,
YA
I have completed this assignment, but I wish to make sure I did everything correctly. The grade I will receive for this assignment is very important, because it will make me either pass this class with a good grade, or it will make me fail the class. Please help.
Key Financial Data
Dreamscape, Inc. Industry Average
Ratio For the Year Ended For the Year Ended
(% of Sales) December 31, 2004 December 31, 2005
Cost of goods sold 74.5% 70.0%
Gross profits 25.5 30.0
Selling expense 8.0 7.0
Gen. & admin. expense 5.1 4.9
Depreciation expense 2.4 2.0
Total operating expense 15.5 13.9
Operating profits 10.0 16.1
Interest expense 1.4 1.0
Net profits before taxes 8.6 15.1
Taxes 2.4 6.0
Net profits after taxes 5.2 9.1
Income Statement, Dreamscape, Inc.
For the Year Ended December 31, 2005
Sales revenue $1,000,000
Less: Cost of goods sold 750,000
Gross profits $ 250,000
Less: Operating expenses
Selling Expense $70,000
Gen. & admin. expense 48,000
Depreciation expense 20,000
Total operating expense $ 138,000
Operating profits $ 112,000
Less: Interest expense $ 20,000
Net profits before taxes $ 92,000
Less: Taxes $ 36,800
Net profits after taxes $ 55,200
Prepare a common size income statement for Dreamscape, Inc. for the year ended December 31, 2005. Evaluate the company’s performance against industry average ratios and against last year’s results.
2.
In an effort to analyze Clockwork Company finances, Jim realized that he was missing the company’s net profits after taxes for the current year. Find the company’s net profits after taxes using the following information.
Return on total assets  2%
Total Asset Turnover  0.5
Cost of Goods Sold  $105,000
Gross Profit Margin  0.30
3.
Minny Fishing Products is analyzing the performance of its cash management. On the average, the firm holds inventory 65 days, pays its suppliers in 35 days, and collects its receivables in 15 days. The firm has a current annual outlay of $1,960,000 on operating cycle investments. Minny currently pays 10 percent for its negotiated financing. (Assume a 360 day year.)
(a) Calculate the firm’s cash conversion cycle.
(b) Calculate the firm’s operating cycle.
(c) Calculate the daily expenditure and the firm’s annual savings if the operating cycle is reduced by 15 days.
4.
A firm has arranged for a lockbox system to reduce collection time of accounts receivable. Currently the firm has an average collection period of 43 days, an average age of inventory of 50 days, and an average payment period of 10 days. The lockbox system will reduce the average collection period by three days by reducing processing, mail, and clearing float. The firm has total annual outlays of $15,000,000 and currently pays 9 percent for its negotiated financing.
(a) Calculate the cash conversion cycle before and after the lockbox system.
(b) Calculate the savings in financing costs from the lockbox system.
5.
You are considering the purchase of new equipment for your company and you have narrowed down the possibilities to two models which perform equally well. However, the method of paying for the two models is different. Model A requires $5,000 per year payment for the next five years. Model B requires the following payment schedule. Which model should you buy if your opportunity cost is
8 percent?
Year Payment (Model B)
1 $7,000
2 6,000
3 5,000
4 4,000
5 3,000
6. (2 points)
Congratulations! You have just won the lottery! However, the lottery bureau has just informed you that you can take your winnings in one of two ways. Choice X pays $1,000,000. Choice Y pays $1,750,000 at the end of five years from now. Using a discount rate of 5 percent, based on present values, which would you choose? Using the same discount rate of 5 percent, based on future values, which would you choose? What do your results suggest as a general rule for approaching such problems? (Make your choices based purely on the time value of money.)
7. (2 points)
Table 8.1
Plan 1 Plan 2
Interest Expense $25,000 $50,000
Preferred Dividend $3,000 $1,500
Common Shares Outstanding 200,000 100,000
What is the degree of financial leverage at a base level EBIT of $120,000 for both financing plans? The firm has a 40 percent tax rate. (See Table 8.1.)
Finance Questions – Retained Earnings, K, Warrants. See attached file for full problem description.
1. A company’s ability to pay its suppliers on time is best measured by its
a. Current ratio
b. Operating margin
c. Asset turnover ratio
2. A company’s profitability on shareholders’ investment is measured by its
a. Quick ratio
b. Return on equity
c. Debt/equity ratio
d. Asset turnover ratio
3. For the year 2002, a corporation earns $20,000 in revenues, incurs $8,000 in operating costs excluding depreciation, has $3,000 in depreciation, and invests $5,000 in a new factory. The corporate income tax rate is 35%. What is after-tax income for 2002?
4. Monsters and Mazes Comic Books, Inc. had net income after taxes of $256,000. The company had $32,000 in depreciation expenses and $35,000 in interest expenses. Assuming a tax rate of 37%, what was the operating cash flow for Monsters and Mazes?
5. Food Inc. had an outstanding year. Their year-end total capital was $60,000,000; they earned a net income of $5,100,000, paid $2,400,000 in taxes, and $900,000 in interest expense. Assuming an after-tax cost of capital of 8%, calculate Food Inc.’s EVA.
6. Help Rutgers Pride Corporation find their cash flow from assets using the data below:
OCF= $230,000
Depreciation expense= $20,000 Assets: 1/1/2004 12/31/2004
Quick Assets $80,000 $95,000
Inventory $120,000 $145,000
Fixed Assets $200,000 $250,000
Total Assets $400,000 $490,000
Current Liabilities $180,000 $210,000
(Question 7-8) In 2004, Sundance Inc. had 2,000,000 in sales, 600,000 cost of goods sold, and the following current assets information.(to get a denominator of financial ratios please use average of two ending balance)
Current Assets
December 31, 2004 December 31, 2003
Cash 800000 600000
Accounts Receivables 180000 160000
Inventory 100000 80000
Total Current Assets 1,080,000 840,000
7. Find the accounts receivables turnover and average collection period for 2004. What do these ratios tell us about Sundance Inc?
8. Find the inventory turnover and days in inventory for 2004. What do these ratios tell us about Sundance Inc?
(Question 9-12) Given below is financial information for Rutgers Ice Cream
Rutgers Ice Cream
2008 Income Statement
Sales $11,000
Cost of goods sold 5,800
Depreciation 900
EBIT 4,300
Interest paid 800
Taxable income 3,500
Taxes (34%) 1,190
Net income $ 2,310
Addition to retained earnings $ 1,700
Dividends 610
Rutgers Ice Cream
Balance Sheets ending December 31, 2007 and 2008
2007 2008 2007 2008
Asset Liabilities and Owners Equity
Current Assets Current Liabilities
Cash $500 $315 Accounts payable $800 $710
Receivables 905 1,827 Notes payable 250 410
Inventory 3,015 4,718 Other 310 318
Total 1,360 1,438
Fixed Assets Long-term debt 4,325 4,000
Net Plant & Equip. 9318 8998 Owner’s equity
TOTAL
13738
15858 Common Stock
Capital Surplus
Retained Earnings
TOTAL 800
1100
6153
13738 1467
1100
7853
15858
9. What is the ROE for 2008 (to get a denominator please do not use average but use the number at the end of year)?
10. What is the average collection period for 2008 (to get a denominator please do not use average but use the number at the end of year)?
11. What is the debt ratio for 2007 (to get a denominator please do not use average but use the number at the end of year)?
12. What was the cash flow to creditors for 2008?
(Question 13-16) Given below is financial information for Sullivan’s Slushie Incorporated.
Sullivan’s Slushy Incorporated
Income Statement For the Years Ended December 31, 2005 and 2004
. 2005 2004
Sales $3,550,000 $3,340,000
Cost of Goods Sold 1,750,000 1,662,000
Other Expenses 276,500 220,000
Depreciation 80,000 66,000
EBIT $1,443,500 $1,392,000
Interest Expense 243,000 306,500
EBT $1,200,500 $1,085,500
Taxes (35%) 420,175 379,925
Net Income $780,325 $705,575
Dividends $108,000 $74,000
Calculate the following using the information given in Sullivan’s Slushies Incorporated’s financial statements. Also, give a brief 1 to 2-sentence explanation of what each value tells us about the company. Remember to show all work.
13. Operating Cash flow for the year 2005:
14. Net Capital Spending (Change in Fixed Assets) for the year 2005:
15. Change in NWC for the year 2005:
16. Cash flow from assets for the year 2005:
(Question 17-18) Joe Scavone’s brewery had operating revenue of $150,000,000 this year. Their total expenses were 73% of sales, and they are in the 35% tax-bracket. Scavone brewery had $342,000,000 in total assets at year-end last year but increased this amount 14% throughout this current year. To finance the purchase of these assets, Scavone brewery issued $50,000,000 in debt and pays 10% interest on that debt each year. They expect to maintain a debt-to-equity ratio of .32.
17. Construct an income statement for Scavone breweries.
18. What is Joe Scavone’s ROE?
1) Morgan Entertainment has a levered beta of 1.20. The firm’s capital structure consists of 40% debt and 60% equity and it has a corporate tax rate of 40%. What is Morgan’s unlevered beta?
2) Rhino Inc. hired you as a consultant to help them estimate their cost of capital. You have been provided with the following data: D1  $1.30; P0  $40.00; and g  7% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?
3) Edison Electric Systems is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected.
WACC  10%
Year: 0 1 2 3
Cash flows: -$1,000 $450 $460 $470
4) A company is considering a project with the following cash flows:
Project
Year Cash Flow
0 -$100,000
1 50,000
2 50,000
3 50,000
4 -10,000
The project’s WACC is estimated to be 10%. What is the MIRR?
5) The Jones Company plans to issue preferred stock with a perpetual annual dividend of $5 per share and a par value of $30. If the required return on this stock is currently 20%, what should be the stock’s market value?
6) The real risk-free rate is 2.50%, investors expect a 3.50% future inflation rate, the market risk premium is 5.50%, and Krogh Enterprises has a beta of 1.40. What is the required rate of return on Krogh’s stock? (Hint: First find the market risk premium.)
7) Blumberg Inc. has an unlevered beta of 1.10. The firm currently has no debt, but is considering changing its capital structure to be 40% debt and 60% equity. Its corporate tax rate is 40%, rRF = 5% and the market risk premium is 4%. What is Blumberg’s cost of equity?
8) Which of the following statements is CORRECT?
In general, a firm with low operating leverage has a small proportion of its total costs in the form of fixed costs.
An increase in the personal tax rate would not affect firms’ capital structure decisions.
A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
If the after-tax cost of equity financing exceeds the after-tax cost of debt financing, firms are always able to reduce their WACC by increasing the amount of debt in their capital structure.
Increasing the amount of debt in a firm’s capital structure, so that it reaches its optimal capital structure, will decrease the costs of both debt and equity financing.
9) Which of the following statements best describes what would be expected to happen as you randomly select stocks and add them to your portfolio?
Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
Adding more such stocks will reduce the portfolio’s beta.
Adding more such stocks will increase the portfolio’s expected return.
Adding more such stocks will reduce the portfolio’s market risk.
Adding more such stocks will have no effect on the portfolio’s risk.
1.What would be the probable effect on a firm’s cash position of the following events?
a. Rapidly rising sales
b. The payment of payables
c. A more liberal credit policy on sales (to the firm’s customers)
d. Holding larger inventories
2. ( Cash budgeting) The Sharpe Corporation’s projected sales for the first 8 months of 2006 are as followed:
January $90,000 May $300,000
February 120,000 June 270,000
March 135,000 July 225,000
April 240,000 August 150,000
Of Sharpe’s sales 10% is for cash, another 60 percent is collected in the month following sales, and 30% is collected in the second month following sales. November and December sales for 2005 were $220,000 and $175,000, respectively.
Sharpe purchases its raw materials 2 month in advance of its sales equal to 60 percent of their final sales price . The supplier is paid 1 month after it makes delivery. For example, purchases for April sales are made in February, and payments made in March.
In addition, Sharpe pays $10,000 per month for rent and $20,000 each month for other expenditures. Tax repayment of $22,500 are made each quarter, beginning in March.
The company’s cash balance on December 31, 2005, was $ 22,000. This is the minimum balance the firm wants to maintain. Any borrowing that is needed to maintain this minimum is paid off in the subsequent month if there is sufficient cash. Interest on short term loans(12 %) is paid monthly. Borrowing to meet estimated monthly cash needs takes place at the beginning of the month. Thus if in the month of April the firm expects to have a need for an additional $60,500, these funds would be borrowed at the beginning of April with interest of $605 (.12 x1/12 x$60,500) owed for April and paid at the beginning of May.
A. Prepare a cash budget for Sharpe covering the first 7 months of 2006.
B. Sharpe has $200,000 in notes payable due in July that must be repaid or negotiated for an extension. Will the firm have ample cash to repay the notes?
3.(Percent of Sales forecasting) Which of the following accounts would most likely vary directly with the level of firm sales? Discuss each briefly.
Yes No Yes No
Cash Notes Payable
Marketable securities Plant and Equipment
Accounts Payable Inventories
4. (Cost of Service) As CFO of Portobello Scuba Diving, Inc. you are asked to look into the possibility of adopting a lockbox system to expedite cash receipts from clients. Portobello receives remittance totaling $24 million by check in a year. The firm records and processes 10,000 checks in the same period. The National bank of brazil had informed you that it could provide the service of expending checks and associated documents through the lockbox system for a unit cost of $0.25 per check. After conducting an analysis, you project that cash freed up by the adoption of the system can be invested in a portfolio of near cash assets that will yield an annual before tax return of 8%. The company usually usues a 365 day year in its producers.
A. What reduction in check collection time is necessary for Portabello to be neither better nor worse off for having adopted the lockbox system?
B. How would your solution to part a be affected if Portobello could invest the freed-up balances at an expected annual return of only 4%?
C. What is the logical explanation for the differences in your answersto part a and b?
Hello,
I need some assistance with the attached questions regarding my financial accounting studies.
James Corp is worried about managing cash efficiently. On the average, inventories have an age of 90 days, and accounts receivable are collected in 60 days. Accounts payable are paid approximately 30 days after they arise. The firm has annual sales of about $30 million. Assume there is no difference in the investment per dollar of sales in inventory, receivables, and payables; and, a 365-day year.
a. Calculate the firm’s operating cycle.
b. Calculate the firm’s cash conversion cycle.
c. Calculate the amount of resources needed to support the firm’s cash conversion cycle.
d. Discuss how management might be able to reduce the cash conversion cycle (be brief).
Cash conversion cycle
Answer the following “true or false” questions :
1. Because firms are unable to match cash inflows to outflows with certainty, most of them need current liabilities that more than cover outflows for current assets.
2. As the ratio of current assets to total assets increases, the firm’s risk increases.
3. Business risk is the risk of being unable to make the scheduled fixed financing payments on debt and preferred stock.
4. Net working capital can be defined as the portion of the firm’s current assets financed with long-term funds.
5. The cash conversion cycle is the total number of days in the operating cycle less the average payment period for inputs to production.
6. A negative cash conversion cycle (CCC) means the average payment period (APP) exceeds the operating cycle (OC).
7. The ability to purchase production inputs on credit allows the firm to partially (or may be even totally) offset the length of time resources are tied up in the operating cycle.
8. The cash conversion cycle is the difference between the number of days resources are tied up in the operating cycle and the average number of days the firm can delay making payment on the production inputs purchased on credit.
9. When a firm’s cash conversion cycle is negative, the firm should benefit by being able to use the financing provided by the suppliers of its production inputs to help support aspects of the business other than just the operating cycle.
10. The aggressive financing strategy is risky due to its minimum level of net working capital, high dependency on short-term sources of funds, and the changing short-term interest.
11. The conservative strategy is less profitable than the aggressive approach because it requires the firm to pay interest on unneeded funds.
12. In the EOQ model, the total cost is minimized at the point where the order costs and carrying costs are equal.
13. In the ABC system of inventory management, the red-line method or system could be utilized to control C items.
14. In the EOQ model, if carrying costs increase while all other costs remain unchanged, the number of orders placed would be expected to increase.
15. If the level of bad debt attributable to credit policy is relatively constant, increasing collection expenditures can be expected to reduce bad debts.
16. If the cash discount period is increased, the firm’s investment in accounts receivable due to discount takers still getting cash discounts but paying later is expected to increase.
17. Increased collection expenditures should reduce the investment in accounts receivable and bad debt expenses, increasing profits.
18. Assuming that the firm has done all it can to stimulate customers to pay promptly and to select vendors offering the most attractive and flexible credit terms, it can further speed collections and slow disbursements by taking advantage of the “float” existing in the collection and payment systems.
19. A lockbox system is used to reduce collection float by shortening all three basic float components (i.e., mail, processing, and clearing).
20. Federal agency issues are low-risk securities issued by government agencies but not guaranteed by the U.S. Treasury.
Compute accounts receivable and situational accounting questions. See attached file for full problem description.
1. Text Problems, Exercises, and Case
Prepare answers to the following problems from the text, Fundamentals of Corporate Finance, (Brealey):
a. Chapter 19: Quiz Problem 1
Working Capital Management. Indicate how each of the following six different transactions that a company might make would affect (i) cash and (ii) net working capital:
a. Paying out a $2 million cash dividend.
b. A customer paying a $2,500 bill resulting from a previous sale.
c. Paying $5,000 previously owed to one of its suppliers.
d. Borrowing $1 million long-term and investing the proceeds in inventory.
e. Borrowing $1 million short-term and investing the proceeds in inventory.
f. Selling $5 million of marketable securities for cash.
b. Chapter 19: Practice Problem 14
Forecasting Collections. Here is a forecast of sales by National Bromide for the first 4 months of 2004 (figures in thousands of dollars):
Month: 1 2 3 4
Cash sales
15
24
18
14
Sales on credit
100
120
90
70
14. Forecasting Payments. If a firm pays its bills with a 30-day delay, what fraction of its purchases will be paid for in the current quarter? In the following quarter? What if its payment delay is 60 days?
c. Chapter 20: Quiz Problem 4
4. Lock Boxes. Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 400 payments a day will be made to lock boxes with an average payment size of $2,000. The bank’s charge for operating the lock boxes is $.40 a check. The interest rate is .015 percent per day.
a. If the lock box saves 2 days in collection float, is it worthwhile to adopt the system?
b. What minimum reduction in the time to collect and process each check is needed to justify use of the lock-box system?
Prepare answers to the following problems, exercise, and case from the text, Accounting: Concepts & Applications, (Albrecht):
Exercise 7-17 Assessing How Well Companies Manage Their Receivables
Assume that Hickory Company has the following data related to its accounts receivable:
2005
2006
Net sales
$1,425,000
$1,650,000
Net receivables:
Beginning of year
375,000
333,500
End of year
420,000
375,000
Chapter 7: Exercise 7-.17
Use these data to compute accounts receivable turnover ratios and average collection periods for 2005 and 2006. Based on your analysis, is Hickory Company managing its receivables better or worse in 2006 than it did in 2005?
a. Chapter 7: Case 7-3
The president, vice president, and sales manager of Moorer Corporation were discussing the company’s present credit policy. The sales manager suggested that potential sales were being lost to competitors because of Moorer Corporation’s tight restrictions on granting credit to consumers. He stated that if credit policies were loosened, the current year’s estimated credit sales of $3,000,000 could be increased by at least 20% next year with an increase in uncollectible accounts receivable of only $10,000 over this year’s amount of $37,500. He argued that because the company’s cost of sales is only 25% of revenues, the company would certainly come out ahead.
The vice president, however, suggested that a better alternative to easier credit terms would be to accept consumer credit cards such as VISA or MASTERCARD. She argued that this alternative could increase sales by 40%. The credit card finance charges to Moorer Corporation would be 4% of the additional sales.
At this point, the president interrupted by saying that he wasn’t at all sure that increasing credit sales of any kind was a good thing. In fact, he suggested that the $37,500 of uncollectible accounts receivable was altogether too high. He wondered whether the company should discontinue offering sales on account.
With the information given, determine whether Moorer Corporation would be better off under the sales manager’s proposal or the vice president’s proposal. Also, address the president’s suggestion that credit sales of all types be abolished.
b. Chapter 21: Problem 21-5
Problem 21-5 JIT Inventory
The president of Penman Corporation, John Burton, has asked you, the company’s controller, to advise him on whether Penman should develop a just-in-time (JIT) inventory system. Your research concludes that there is a high cost associated with inventory storage facilities; that inventories use a large portion of the company’s cash flow; and that because of the nature of the inventory, there is a significant amount of shrinkage. Research also shows that neither of Penman’s two competitors uses a JIT inventory system. Most of Penman’s employees are trained to do only one job and belong to a local union. The union is strong and, in the past, has opposed major production changes. The union believes major changes will result in the loss of union employees’ jobs. Your research indicates that Penman’s major production item (a fairly new product in the market) should continue to have strong sales growth.
Required:
1. Using the information provided, advise John Burton to either continue the present system or work to develop a JIT inventory system.
2. Assume John decides to develop an inventory management system. He plans to evaluate the system after one year. List at least four possible performance measures John could use to evaluate the effectiveness of the system. Describe what information these measures would provide John.
Problems:
1. A company is analyzing two mutually exclusive projects, A and B, whose cash
flows are shown below:
Years o r= 10% 1
I
A -3,200 1,500
B -3,200 700
2 3
1700 1,500
o 4,700
The company’s cost of capital is 10 percent, and it can get an unlimited amount of
capital at that cost. What is the IRR of the better project, i.e., the project which
the company should choose if it wants to maximize its stock price?
Project _ ~—————–
2. You have been asked by the president of your company to evaluate the proposed
acquisition of a new special-purpose truck. The truck’s basic price is $320,000,
and it will cost another $30,000 to modify it for special use by your firm. The
truck falls into the MACRS. three-year class, and it will be sold after three years
for $40,000. Use of the truck will require an increase in net operating working
capital (spare parts inventory) of $25,000. The truck will have no effect on
revenues, but it is expected to save the firm $130,000 per year in before-tax
operating costs, mainly labor. The firm’s cost of capital is 9% and the marginal
tax rate is 40 percent. Should the company accept/reject the project?
NPV IRR MIRR Decision _
3. ABC Bottling’s December 31st balance sheet is given below:
Cash
Accounts receivable
Inventory
Net fixed assets
$20
25
60
75
Accounts payable
Notes payable
Accrued wages and taxes
Long-term debt
Common equity
Total liabilities
and equity
$40
20
15
35
70
Total assets
Sales during the past year were $360, and they are expected to rise by 50 percent
to $540 during next year. Also, during last year fixed assets were being utilized
to only 65 percent of capacity, so ABC could have supported $360 of sales with
fixed assets that were only 65 percent of last year’s actual fixed assets. Assume
that ABC’s profit margin will remain constant at 6 percent and that the company
will continue to payout 40 percent of its earnings as dividends. To the nearest
whole dollar, what amount of non-spontaneous, additional funds (AFN) will be
needed during the next year (use pro-forma method)?
..—-~—————————————
Additional Funds Needed: ——-
4. A group of graduate students has decided to form a small Internet Service
Company in Brevard County. The company will service Brevard County home
users and need $200 million to start the company. Two financing plans have
been proposed by the investment banking firms. Plan A is an all commonequity
alternative. Under this agreement, 2 million common shares will be
sold to net the firm $100 per share. Plan B involves the use of financial
leverage (debt and equity). A debt issue with a 20-year maturity period will
be privately placed. The debt issue will carry an interest rate of 10 percent,
and the principal borrowed will amount to $80 million. The corporate tax
rate is 40 percent. If the detailed financial analysis projects that there is a
30% chance that EBITwill be $6.0 million, 40% chance that it will be $8.0
million, and 30% chance that it will be $10 million annually, which plan will
maximize the wealth ofthe stockholders? (note: the problem is based on the
understanding of financial statement and financial leverage)
Plan _
5. ABC is considering a leasing arrangement to finance some special
manufacturing tools that is needed for production during the next four years.
A planned change in the firm’s production technology will make the tool
obsolete after 4 years. The firm will depreciate the cost of the tools on a
straight-line basis. The firm can borrow $4,000,000, the purchase price, at
10% to buy the tools or make four equal end of the year lease payments of
$1,200,000. The firm’s tax rate is 34% and the firm’s before-tax cost of debt
is 10%. Annual maintenance costs associated with ownership are estimated
at $200,000. Should the firm lease or buy?
Decision: _
Need some help in answering these questions:
1. Identify the importance of off balance sheet financing with respect to tax and accounting issues?
2. How does EBIT/EPS analysis allow financial managers to determine the capital structure of the firm?
3. What benefits accrue to a company by going public? What are some of the principal reasons a firm may want to remain privately held?
Hi,
** Please help with the attached problems. **
Thank you so much.
James Hardy recently rejected a $14,000,000, five-year contract with the Vancouver Seals.
The contract offer called for an immediate signing bonus of $4,000,000 and annual
payments of $2,000,000. To sweeten the deal, the president of player personnel for the
Seals has now offered a $16,000,000, five-year contract. This contract calls for annual
increases and a balloon payment at the end of five years.
Year 1 $2,000,000
Year 2 2,100,000
Year 3 2,200,000
Year 4 2,300,000
YearS 2,400,000
Year 5 balloon pymt 5,000,000
Total $16,000,000
Quality Shoe Company is considering investing in one of two machines that attach heels to shoes.
Machine A costs $60,000 and is expected to save the company $18,000 per year for six
years. Machine B costs $85,000 and is expected to save the company $23,000 per year
for six years. Determine the net present value for each machine and decide which machine
should be purchased if the required rate of return is 10 percent. Ignore taxes.
National Cruise Line, Inc. is considering the acquisition of a new ship that will cost $180,325,005. In this regard, the president of the company asked the CFO to analyze cash flows associated with operating the ship under two alternative itineraries: Itinerary 1, Caribbean Winter/Alaska Summer and Itinerary 2, Caribbean Winter/Eastern Canada Summer. The CFO estimated the following cash flows, which are expected to apply to each of the next 15 years: $180,325,005
In this regard, the president of the company asked the CFO to analyze cash flows associated with operating the
ship under two alternative itineraries: Itinerary 1, Caribbean Winter/Alaska Summer and Itinerary 2, Caribbean
Winter/Eastern Canada Summer. The CFO estimated the following cash flows, which are expected to apply to
each of the next 15 years:
Caribbean/Alaska Caribbean/Eastern Canada
Net revenue $119,789,010 $103,904,336
Less:
Direct program expenses (24,091,051) (22,812,140)
Indirect program expenses (19,437,162) (19,437,162)
Non-operating expenses (20,186,695) (20,186,401)
Add back depreciation 12,021,667 12,021,667
Cash flow per year $68,095,769 $53,490,300
Associated Penguin Productions is evaluating a film project. The president of Associated
Penguin estimates that the film will Gost $18,000,000 to produce. In its first year, the film
is expected to generate $14,500,000 in net revenue, after which the film will be released to
video. Video is expected to generate $7,000,000 in net revenue in its first year, $1,500,000
in its second year, and $500,000 in its third year. For tax purposes, amortization of the
cost of the film will be $14,000,000 in year 1 and $4,000,000 in year 2. The company’s
tax rate is 40 percent, and the company requires a 12 percent rate of return on its films.
The Boston Culinary Institute is evaluating a classroom remodeling project. The cost of the remodel
will be $200,000 and will be depreciated over 5 years using the straight-line
method. The remodeled room will accommodate 5 extra students per year. Each
student pays annual tuition of $15,000 The before-tax incremental cost of a student (e.g., the cost
of food prepared and consumed by a student) is $1,360 per year. The company’s tax rate
is 40% and the company requires a 12% rate of return on the remodeling
project.
Required:
Assuming a 5 -year time horizon, what is the internal rate of return of the remodeling
project? Should the company invest in the remodel?
Van Doren Corporation is considering producing a new product, Autodial. Marketing data
indicate that the company will be able to sell 35,000 units per year at $35. The product
will be produced in a section of an existing factory that is cun-ently not in use.
To produce Autodial, Van Doren must buy a machine that costs $410,000. The
machine has an expected life of five years and will have an ending residual value of
$12,000. Van Doren will depreciate the machine over five years using the straight-line
method for both tax and financial reporting purposes.
In addition to the cost of the machine, the company will incur incremental manufacturing
costs of $350,000 for component parts, $400,000 for direct labor, and
$185,000 of miscellaneous costs. Also, the company plans to spend $135,000 annually
for advertising Autodial. Van Doren has a tax rate of 40 percent, and the company’s required
rate of return is 12 percent.
The results of operations for the Preston Manufacturing Company for the fourth
quarter of 2007 were as follows (in thousands):
Sales $500,000
Less variable cost of sales 300,000
Contribution margin 200,000
Less fixed production costs $100,000
Less fixed selling and administrative expenses 50,000 150,000
Income before taxes 50,000
Less taxes on income 20,000
Net income $30,000
Note: Preston Manufacturing uses the variable costing method. Thus, only variable
production costs are included in inventory and cost of goods sold. Fixed production
costs are charged to expense in the. period incurred.
The company’s balance sheet as of the end of the fourth quarter of 2007 was as
Bowser Products operates a small plant in New Mexico that produces dog food in
batches of 1,000 pounds. The product sells for $3 per pound. Standard costs for 2009 are:
Standard direct labor cost = $15 per hour
Standard direct labor hours per batch = 8 hours
Standard cost of material A = $0.20 per pound
Standard pounds of material Aper batch = 800 pounds·
Standard cost of material B = $0.40 per pound
Standard pounds of material B per batch = 200 pounds
Fixed overhead cost per batch = $400
At the start of 2009, the company estimated monthly production and sales of 40
batches. The company estimated that all overhead costs were fixed and amounted to
$16,000 per month. During the month of June, 2009 (typically a somewhat slow
month) 30 batches were produced (not an unusual level of production for this month).
The following costs were incurred:
Direct labor costs were $4,800 for 300 hours
24,500 pounds of material Acosting $4,655 were purchased and used
5,900 pounds of material B costing $2,419 were purchased and used
Fixed overhead of $15,500 was incurred
Question 6: Which of the following statements is CORRECT?
A When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
B When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
C Because of tax effects, an increase in the risk-free rate will have no effect on the after-tax cost of debt than on the cost of common stock.
D If a company’s beta increases, this will decrease the cost of equity used to calculate the WACC.
E Higher flotation costs reduce investor returns, and that leads to a reduction in a company’s WACC.
Question 7: Which of the following statements is CORRECT?
A A change in a company’s target capital structure cannot affect its WACC.
B WACC calculations should be based on the before-tax costs of all the individual capital components.
C Flotation costs associated with issuing new common stock normally reduce the WACC.
D If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decline.
E An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.
Question 8: Suppose the September CBOT Treasury bond futures contract has a quoted price of 89-09. The T-bond is a 20-year 6% coupon bond and the interest is paid semi-annually. What is the implied annual interest rate inherent in this futures contract?
A 6.32%
B 6.65%
C 7.00%
D 7.35%
E 7.72%
Question 9: Which of the following statements is CORRECT?
A In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.
B There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.
C A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
D If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.
E Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing.
Question 10: Roxie Epoxy’s balance sheet shows a total of $50 million long-term debt with a coupon rate of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of $55 million. The balance sheet also shows that that the company has 20 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $8.25 per share; stockholders’ required return, rs, is 10.00%; and the firm’s tax rate is 40%. Based on market value weights, and assuming the firm is currently at its target capital structure, what WACC should Roxie use to evaluate capital budgeting projects?
A 7.26%
B 7.56%
C 7.88%
D 8.21%
E 8.55%
Question 11: The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income (EBIT)?
A 5,000 decks
B 10,000 decks
C 15,000 decks
D 20,000 decks
E 25,000 decks
1. How is valuation of any financial asset related to future cash flows?
2. Why might investors demand a lower rate of return for an investment in ExxonMobil as compared to United Airlines?
3. What are the three factors that influence the required rate of return by investors?
4. If inflationary expectations increase, what is likely to happen to yield to maturity on bonds in the marketplace? What is also likely to happen to the price of the bonds?
5. Why is the remaining time to maturity an important factor in evaluating the impact of a change in yield to maturity on bond prices?
6. What are the three adjustments that have to be made in going from manual to semiannual bond analysis?
7. Why is a change in required yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds?
8. What type of dividend pattern for common stock is similar to the dividend payment for preferred stock?
9. What two components make up the required rate of return on common stock?
10. What factors might influence a firm’s price-earnings ratio?
11. How is the supernormal growth pattern likely to vary from the normal, constant growth pattern?
12. What approaches can be taken in valuing a form’s stock when there is no cash dividend payment?
Dear OTA, Please help me in finding with 3 highlighted problems in the attached file.
I need you help with the attached problem sets.
Week 2 Problem Set Problems
Suppose that you observe the following term structure for Treasury securities:
Term to Maturity (Year) Interest Rates (%)
1 12.00%
2 11.75
3 11.25
4 10.00
5 9.25
a. Calculate the forward rates for year 1,2,3,4, and 5.
b. Use this information to create a Yield curve graph.
c. Discuss the shape of the yield curve using the Expectation hypothesis.
d. If the real rate of interest (K*) in the economy is 3% what is the market expected inflation rate for year 1-5?
“Time to Reflect” problem complete practice problems 2-9 through 2-23 on pages 76 and 78 of your course textbook.
2-8. Annuity Payment and EAR
You want to buy a car, and a local bank will lend you $ 20,000. The loan would be fully amortized over 5 years (60 months), and the nominal interest rate would be 12%, with interest paid monthly. What would be the monthly loan payment? What would be the loans EAR?
2-9. Present and Future Values of Single Cash Flows for Different Periods
Find the following values, using the equations, and then work the problems using a financial calculator to check your answers. Disregard rounding differences. (Hint: If you are using a financial calculator, you can enter the known values and then press the appropriate key to find the unknown variable. Then, without clearing the TVM register, you can override the variable that changes by simply entering a new value for it and then pressing the key for the unknown variable to obtain the second answer. This procedure can be used in parts b and d, and in many other situations, to see how changes in input variables affect the output variable.)
a. An initial $ 500 compounded for 1 year at 6%.
b. An initial $ 500 compounded for 2 years at 6%.
c. The present value of $ 500 due in 1 year at a discount rate of 6%.
d. The present value of $ 500 due in 2 years at a discount rate of 6%.
2-10. Present and Future Values of Single Cash Flows for Different Interest Rates
Use equations and a financial calculator to find the following values. See the hint for Problem 2-9.
a. An initial $ 500 compounded for 10 years at 6%..
b. An initial $ 500 compounded for 10 years at 12%.
c. The present value of $ 500 due in 10 years at a 6% discount rate.
d. The present value of $ 500 due in 10 years at a 12% discount rate.
2- 11. Time for a Lump Sum to Double
To the closest year, how long will it take $ 200 to double if it is deposited and earns the following rates? [Notes: ( 1) See the hint for Problem 2- 9. ( 2) This problem can-not be solved exactly with some financial calculators. For example, if you enter PV 200, PMT 0, FV 400, and I 7 in an HP- 12C, and then press the N key, you will get 11 years for part a. The correct answer is 10.2448 years, which rounds to 10, but the calculator rounds up. However, the HP- 10B gives the correct answer.
a. 7%.
b. 10%.
c. 18%.
d. 100%.
2- 12. Future Value of an Annuity
Find the future value of the following annuities. The first payment in these annuities is made at the end of Year 1; that is, they are ordinary annuities. (Notes: See the hint to Problem 2- 9. Also, note that you can leave values in the TVM register, switch to BEG, press FV, and find the FV of the annuity due.)
a. $ 400 per year for 10 years at 10%.
b. $ 200 per year for 5 years at 5%.
c. $ 400 per year for 5 years at 0%.
d. Now rework parts a, b, and c assuming that payments are made at the beginning of each year; that is, they are annuities due.
2- 13. Present Value of an Annuity
Find the present value of the following ordinary annuities ( see note to Problem 2- 9):
a. $ 400 per year for 10 years at 10%.
b. $ 200 per year for 5 years at 5%.
c. $ 400 per year for 5 years at 0%.
d. Now rework parts a, b, and c assuming that payments are made at the begin-ning of each year; that is, they are annuities due.
2- 14. Uneven Cash Flow Stream
a. Find the present values of the following cash flow streams. The appropriate interest rate is 8%. (Hint: It is fairly easy to work this problem dealing with the individual cash flows. However, if you have a financial calculator, read the section of the manual that describes how to enter cash flows such as the ones in this problem. This will take a little time, but the investment will pay huge dividends throughout the course. Note, if you do work with the cash flow register, then you must enter CF0 0.)
b. What is the value of each cash flow stream at a 0% interest rate?
2- 22. Expected Rate of Return
Washington- Pacific invests $ 4 million to clear a tract of land and to set out some young pine trees. The trees will mature in 10 years, at which time Washington- Pacific plans to sell the forest at an expected price of $ 8 million. What is Washington- Pacific’s expected rate of return?
2- 23. Effective Rate of Interest
A mortgage company offers to lend you $ 85,000; the loan calls for payments of $ 8,273.59 per year for 30 years. What interest rate is the mortgage company charging you?
Assume that you are nearing graduation and that you have applied for a job with a local bank. As part of the banks evaluation process, you have been asked to take an examination that covers several financial analysis techniques. The first section of the test addresses discounted cash flow analysis. See how you would do by answering the following questions.
a. Draw time lines for ( 1) a $ 100 lump sum cash flow at the end of Year 2, ( 2) an ordinary annuity of $ 100 per year for 3 years, and ( 3) an uneven cash flow stream of $ 50, $ 100, $ 75, and $ 50 at the end of Years 0 through 3.
b. ( 1) What is the future value of an initial $ 100 after 3 years if it is invested in an account paying 10% annual interest? ( 2) What is the present value of $ 100 to be received in 3 years if the appropri-ate interest rate is 10%?
c. We sometimes need to find how long it will take a sum of money ( or anything else) to grow to some specified amount. For example, if a companys sales are growing at a rate of 20% per year, how long will it take sales to double?
d. If you want an investment to double in 3 years, what interest rate must it earn? e. What is the difference between an ordinary annuity and an annuity due? What type of annuity is shown below? How would you change it to the other type of annuity?
f. ( 1) What is the future value of a 3- year ordinary annuity of $ 100 if the appro-priate interest rate is 10%? ( 2) What is the present value of the annuity? ( 3) What would the future and present values be if the annuity were an annu-ity due?
g. What is the present value of the following uneven cash flow stream? The appropriate interest rate is 10%, compounded annually.
h. (1) Define ( a) the stated, or quoted, or nominal rate ( INOM) and ( b) the peri-odic rate ( IPER).
(2) Will the future value be larger or smaller if we compound an initial amount more often than annually, for example, every 6 months, or semi-annually, holding the stated interest rate constant? Why?
(3) What is the future value of $ 100 after 5 years under 12% annual com-pounding? Semiannual compounding? Quarterly compounding? Monthly compounding? Daily compounding?
(4) What is the effective annual rate ( EFF%)? What is the EFF% for a nominal rate of 12%, compounded semiannually? Compounded quarterly? Compounded monthly? Compounded daily?
i. Will the effective annual rate ever be equal to the nominal ( quoted) rate?
j. (1) Construct an amortization schedule for a $ 1,000, 10% annual rate loan with 3 equal installments. (2) What is the annual interest expense for the borrower, and the annual interest income for the lender, during Year 2?
k. Suppose on January 1 you deposit $ 100 in an account that pays a nominal, or quoted, interest rate of 11.33463%, with interest added (compounded) daily. How much will you have in your account on October 1, or after 9 months?
l. (1) What is the value at the end of Year 3 of the following cash flow stream if the quoted interest rate is 10%, compounded semiannually?
(2) What is the PV of the same stream?
(3) Is the stream an annuity?
(4) An important rule is that you should never show a nominal rate on a time line or use it in calculations unless what condition holds? (Hint: Think of annual compounding, when INOM EFF% IPER.) What would be wrong with your answer to Questions l-(1) and l-(2) if you used the nominal rate ( 10%) rather than the periodic rate ( INOM/ 2 10%/ 2 5%)?
m. Suppose someone offered to sell you a note calling for the payment of $ 1,000 fifteen months from today. They offer to sell it to you for $ 850. You have $ 850 in a bank time deposit that pays a 6.76649% nominal rate with daily compounding, which is a 7% effective annual interest rate, and you plan to leave the money in the bank unless you buy the note. The note is not risky you are sure it will be paid on schedule. Should you buy the note? Check the decision in three ways: (1) by comparing your future value if you buy the note versus leaving your money in the bank, (2) by comparing the PV of the note with your current bank account, and (3) by comparing the EFF% on the note versus that of the bank account.
4. You have found three investment choices for a one year deposit: 10% APR compound monthly, 10% APR compounded annually, and 9% APR compounded daily. Compute the EAR for each investment choice. (Assume there are 365 days in the year).
10. Oppenheimer Bank is offering a 30-year mortgage with an EAR of 5 3/8%,. If you plan to borrow $150,000, what will your monthly payment be?
1. Getrag expects its sales to increase 20% next year from its current level of $4.7 million. Getrag has current assets of $660,000, net fixed assets of $1.5 million, and current liabilities of $462,000. All assets are expected to grow proportionately with sales. If Getrag has a net profit margin of 10%, what additional financing will be needed to support the increase in sales? Getrag does not pay dividends.
a. $283,200
b. No financing needed, surplus of $224,400
c. No financing needed, surplus of $524,400
d. $339,600
2. Last year Curative Technologies Inc. reported earnings after-tax of $23 million. Included in the expenses were depreciation of $3.7 million and interest expenses of $2.9 million. The year-end balance sheets shows an increase in deferred taxes of $2.6 million to a total of $14.2 million. What is Curative Technologies’ after-tax cash flow for last year? Assume a marginal tax rate of 40%.
a. $32.2 million
b. $20.1 million
c. $26.4 million
d. $29.3 million
3. Greg is interested in investing in a small company, and he thinks Good Buy Co. might be a good investment. He has been given the following information and would like to know the return on stockholder’s equity. Assume Good Buy’s marginal tax rate is 40%.
Earning before taxes$3 million
Net profit margin3.6%
Total liabilities$15.0 million
Total stockholder’s equity$10.0 million
a. 20%
b. 12%
c. 18%
d. 15%
4. ECG Monitors is forecasting that sales next year will be $8,640,000, a 20 percent increase over current sales. ECG has total assets of $3,840,000 and all assets will increase proportionately with sales. Of the current liabilities, only accounts payable (now $740,000) will increase with sales. What total financing will be needed by ECG to support the expected sales increase?
a. $465,600
b. $620,000
c. $840,400
d. $317,600
5.What is the return on investment for a firm that has a debt ratio of 0.65, a net profit margin of 6.5%, sales of $740,000, and a total asset turnover of 4?
a. 4.6%
b. 16.9%
c. 26.0%
d. 6.5%
6. Flash In The Pan Cooking School is considering the issuance of additional long-term debt to finance expansion. At the present time the company has $160 million of 10% debentures outstanding. Its after-tax net income is $48 million, and the company’s (marginal) income tax rate is 40%. The company is required by the debenture holders to maintain its coverage ratio at 4.0 or greater. Determine Flash’s present coverage ratio.
a. 5.00
b. 6.00
c. 2.78
d. 3.33
7.If the spot rate for Swiss francs is $0.6658/franc and the 180-day forward rate is $0.6637, the market is indicating that the Swiss franc is expected to
a. weaken relative to the ECU
b. lose value relative to the dollar over the next 6 months
c. strengthen relative to the dollar
d. gain value relative to the dollar over the next 6 months
1- Annuity Due. A store offers two payment plans. Under the installment plan, you pay 25 percent down and 25 percent of the purchase price in each of the next 3 years. If you pay the entire bill immediately, you can take a 10 percent discount from the purchase price. Which is a better deal if you can borrow or lend funds at a 5 percent interest rate?
3- Bond Returns. You buy an 8 percent coupon, 20-year maturity bond when its yield to maturity is 9 percent. A year later, the yield to maturity is 10 percent. What is your rate of return over the year?
4- Rate of Return. A bond that pays coupons annually is issued with a coupon rate of 4 percent, maturity of 30 years, and a yield to maturity of 7 percent. What rate of return will be earned by an investor who purchases the bond and holds it for 1 year if the bond’s yield to maturity at the end of the year is 8 percent.
5- Constant-Growth Model. Eastern Electric currently pays a dividend of about $1.64 per share and sells for $27 a share.
a. If investors believe the growth rate of dividends is 3 percent per year, what rate of return do they expect to earn on the stock?
b. If investors’ required rate of return is 10 percent, what must be the growth rate they expect of the firm?
c. If the sustainable growth rate is 5 percent, and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments?
See attached problems.
Need help with attached problems.
FIN 450 Week 7
Chapter 21 Questions
11. What do 12b-1 fees pay and what is the maximum amount that these fees can be?
15. What regulatory changes have been adopted or are being considered to deal with abuses in the mutual fund industry?
Quantitative Problems
On January 1, a mutual fund has the following assets and prices at 4:00 pm.
Stock Shares Owed Price
1 1,000 $1.97
2 5,000 $48.26
3 1,000 $26.44
4 10,000 $67.49
5 3,000 $2.59
An investor sends the fund a check for $50,000. If there is no front-end load, calculate the new number of shares and price per share. Assume the manager purchases 1,800 shares of stock 3, and the rest is held as cash
Chapter 22 Questions
8. How are insurance companies able to predict their losses from claims accurately enough to let them price their policies such that they will make a profit?
12. Distinguish between defined-benefit and defined-contribution pension plans.
Quantitative Problems
3. Your rich uncle dies. Leaving you a life insurance policy worth $100,000. The insurance company also offers you an option to receive $8,225 per year for 20 years, with the first payment due today. Which option should you use?
Chapter 23 Questions
3. What does it mean to say that investment bankers underwrite a security offering? How is this different from a best-efforts offering?
8. Why would an investment banker advise a firm to issue a security using best efforts rather than under-writing?
Dear OTA,
Please solve Problems 9-2 ,9-3 , 9-4 and 13-1.
Thanks
Question 1: (Cost of Capital)
You are provided the following information on a company. The total market value is $40 million. The capital structure, shown here, is considered to be optimal.
Accounting Value Market Value
Bonds, $1000 par, 7% coupon, 7% YTM $10,000,000 $10,000,000
Preferred Stock, 7%, $100 par, 100,000 shares $10,000,000 $8,000,000
Common Stock, $1 par, 100,000 shares $100,000
Capital in excess of par $400,000 $22,000,000 *
Retained Earnings $13,500,000
* Total market value of common equity
a. What is the after-tax cost of debt? (assume the company’s effective tax rate = 40%)
b. Assuming a $7 dividend paid annually, what is the required return for preferred shareholders (i.e. component cost of preferred stock)? (assume floatation costs = $0.00)
c. Assuming the risk-free rate is 3%, the expected return on the stock market is 12%, and the company’s beta is 1.0, what is the required return for common stockholders (i.e., component cost of common stock)?
d. What is the company’s weighted average cost of capital (WACC)?
Question 2: (Capital Budgeting)
The Seattle Corporation has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 10 percent.
a. What are the Payback Period, Discounted Payback Period, NPV, IRR, and MIRR for this investment?
b. Should the project be accepted or rejected?
Question 3: (Capital Structure)
You have the following data on Joe’s Corporation:
EBIT: $1,000,000
Tax rate: 40%
Cost of Equity: 10% (before borrowing) 12% (after borrowing)
Joe’s is a zero growth firm, and is currently financed entirely with equity (in other words, it currently has no debt).
One of the corporate officers has suggested that since interest rates are so low, Joe might be better off if he borrowed some money and used it to buy back stock, thereby making use of debt financing in the firm. He presents the following data in his analysis:
Amount of debt proposed: $1,000,000
Interest rate: 6%
Cost of equity after the proposal is adopted: 12%
Joe has come to you for advice. Prepare an analysis for him that indicates whether or not the proposal should be accepted.
(Hint: Compare the value of the firm with no debt and at the proposed debt level similar to the way you did it in homework problem 16-9, but note the amount to borrow is given.)
Question 4: (Forecasting)
A firm has the following balance sheet:
Cash $ 20 Accounts payable $ 20
Accounts receivable 20 Notes payable 40
Inventory 20 Long-term debt 80
Fixed assets 180 Common stock 80
Retained earnings 20
Total assets $240 Total liabilities & Equity $240
Sales for the year just ended were $400, and fixed assets were used at 80 percent of capacity. Current assets and accounts payable vary directly with sales. Sales are expected to grow by 5 percent next year, the expected net profit margin is 5 percent, and the dividend payout ratio is 60 percent.
How much additional funds (AFN) will be needed next year, if any?
Question 5: Working Capital Management
The Hamlin Corporation has an inventory conversion period of 57 days, a receivables collection period of 35 days, and a payables deferral period of 25 days. Its annual credit sales are $5,000,000, and its annual credit purchases are $3,500,000.
a. What is the length of the firm’s cash conversion cycle?
b. What is the firm’s investment in accounts receivable?
c. What is the firm’s level of accounts payable?
d. Calculate how many times a year the company’s inventory is turned over.
e. Identify three ways in which the company could reduce its cash conversion cycle? What are possible risks in reducing it?
See attachment.
10. Sustainable Growth Rate The Steiben Company has a ROE of 8.50 percent and a payout ratio of 35 percent.
a. What is the company’s sustainable growth rate?
b. Can the company’s actual growth rate be different from its sustainable growth rate? Why or why not?
c. How can the company change its sustainable growth rate?
11. Return on Equity Firm A and Firm B have debt/total asset ratios of 60 percent and 40 percent and returns on total assets of 20 percent and 30 percent, respectively. Which firm has a greater return on equity?
13. External Funds Needed The Optical Scam Company has forecast a 20 percent sales growth rate for next year. The current financial statements are shown below.
INCOME STATEMENT
SALES $ 38,000,000.00
COSTS $ 33,400,000.00
TAXABLE INCOME $ 4,600,000.00
TAXES $ 1,610,000.00
NET INCOME $ 2,990,000.00
DIVIDENDS $ 1,196,000.00
ADDITIONS TO RETAINED EARNINGS $ 1,794,000.00
BALANCE SHEET
ASSETS LIABILITIES AND EQUITY
Current assets $ 9,000,000.00 Short-term debt $ 8,000,000.00
Fixed assets $ 22,000,000.00 Long-term debt $ 6,000,000.00
Common stock $ 4,000,000.00
Accumulated retained earnings $13,000,000.00
Total equity $17,000,000.00
Total assets $ 31,000,000.00 Total liabilities and equity $31,000,000.00
a. Using the equation from the chapter, calculate the external funds needed for next year.
b. Construct the firm’s pro forma balance sheet for next year and confirm the external funds needed you calculated in part (a).
c. Calculate the sustainable growth rate for the company.
d. Can Optical Scam eliminate the need for external funds by changing its dividend policy?
What other options are available to the company to meet its growth objectives?
15. Ratios and Fixed Assets The Le Bleu Company has a ratio of long-term debt to total assets of 0.70 and a current ratio of 1.20. Current liabilities are $850, sales are $4,310, profit margin is9.5 percent, and ROE is 21.5 percent. What is the amount of the firm’s net fixed assets?
16. Identify the major financial reporting requirements for a U.S. public corporation. What are the interactions among these statements and what information is provided in each statement?
1. Published financial statements are historical. If so, how can they be used to forecast the future?
2. Discuss the interlocking connections among the three primary financial statements and explain why conventional reporting of financial information does not provide complete information upon which financial decisions can be made.
3. The cash flow summary tells the financial manager about the differences between the cash inflows, cash outflows, and the reasons these flows have happened.
a. What does the cash flow report not tell the financial managers, investors, lenders, and other stakeholders?
b. How could this information affect these stakeholders and their participation in the financing of the organization?
c. What do you think a dot.com cash flow statement would have shown or indicated to potential investors?
See attached file.
1. A firm’s balance sheet shows current assets of $95, net fixed assets of $250, long term debt of $40, and owners equity of $200. What is the value of the firm’s current liabilities if that is the only remaining balance sheet item?
2. What is the present value of your trust fund if it promises to pay you $50,000 on your 40th birthday (7 years from today) and earns 10% compounded annually (rounded down to the nearest 100th dollar)?
3. How much can be accumulated for retirement if $2,000 is deposited annually, beginning one year from today, and the account earns 9% interest compounded annually for 40 years (rounded up to the nearest 100th dollar)?
4. Find the interest rate implied by the following combinations of present and future values:
PV = $900; FV = $1,680; time period = 4 years (rounded to the nearest whole percent)
2-3 Assume that a risk-free rate is 6% and the market risk premium is
6%. What is the expected return for the overall stock market?
What is the required rate of return on a stock that has a beta of 1.2?
2-4 Assume that the risk-free rate is 6% and the expected rate of return
on the market is 13%. What is the required rate of return on a
stock that has a beta of 0.7?
2-7 Suppose rRF =14%, and b1 = 1.3.
a. What is the ri, the required rate of return on Stock i?
b. Now suppose rRF (1) increases to 10 per cent or (2) decreases to 8
percent. The slope of the SML remains constant How would this
affect rM and ri??
c. Now assume rRF remains at 9 percent but rM (1) increases to 16
percent or (2) falls to 13 percent. The slope of the SML does not
remain constant. How would these affect ri?
2-9 Suppose you are the money manager of a $4 million investment
fund. The fund consists of 4 stocks with the following investments
and betas:
Stock Investments Beta
_______________________________________________
A S 400,000 1.5
B 600,000 (0.50)
C 1,000,000 1.25
D 2,000,000 0.75
If the market required rate of return is 14 percent and the risk-free
rate is 6%, what is the fund’s required rate of return?
I would really like to know the solutions to these problems to make sure that I am doing them correctly.
Problems:
1. You intend to purchase a 20-year, $1,000 face value bond that pays interest of $35
every 6 months. If your nominal annual required rate of return is 9.5 percent with
semiannual compounding, how much should you be willing to pay for this bond?
(7 points)
Bond value: _________
2. ABC Corporation has outstanding bonds with an annual 8.0 percent coupon.
Interest is paid semiannually. The bonds have a par value of $1,000 and a price of
$1,150. The bonds will mature in 15 years. What is the yield to maturity on the
bonds? (8 points)
Yield to maturity: __________
3. The common stock of ABC Corporation is selling for $35. The stock recently paid
dividends of $2.70 per share and has a projected constant growth rate of 5.50%. If
you purchase the stock at the market price, what is your expected rate of return?
(7 points)
Expected rate of return: __________
4. ABC Corporation recently paid a dividend of $2.50 per share, and the company
will experience a non-constant growth of 25% for the next three years and the
constant growth rate of 6% will start at the end of the third year. The company’s
beta equal is 1.35, the required rate of return on the market is 10%, and the riskfree
rate is 3.5%. What should be the fair price of the ABC’s stock? (8 points)
Stock price: $__________
5. An analyst is interested in using the Black-Scholes model to value call options on
the stock of ABC Inc. The analyst has accumulated the following information:
The price of the stock is $28.
The strike price is $32.
The option matures in 3 months (t = 0.25).
The standard deviation of the stock’s returns is 0.40 and the variance is 0.16.
The risk-free rate is 5 percent.
Given this information, calculate the fair value of the call option using the Black-
Scholes model. (10 points)
Call Option Value: $_____________
6. ABC Corporation plans to maintain its debt structure in the future. The firm has
35 percent debt, 10 percent preferred stock, and 55 percent equity in their capital
structure. ABC has outstanding bonds with an annual 9 percent coupon and pays
interest on a semiannual basis. The bonds have a par value of $1,000, market
price of $1,100, and maturing in 20 years. The firm has a preferred stock with a
par value of $30, a dividend rate of 10%, a floatation cost of $1.75, and a market
price of 50. The market price of the company’s common stock is $35, common
dividends are $3.50, constant growth is 5.0 percent, and the stock’s beta is 1.20.
The risk-free rate is 5.0%, the market returns are 13.0 percent, and the risk
premium is 8.0 percent. What is the company’s weighted average cost of capital
if the marginal tax rate is 35 percent? (10 points)
Weighted Average Cost of Capital: _____________
7. ABC Corporation is considering the purchase of a new machine which will reduce
manufacturing costs by $75,000 annually (cash inflows). ABC expects to sell the
machine at the end of its four year operating life for $35,000. ABC’s marginal tax
rate is 35%, and it uses a 10 percent cost of capital to evaluate projects of this
nature. If the machine costs $195,000, should the project be accepted? (10 points)
PBP: _________NPV: $_____________ IRR ________ %
Decision:_______________________
8. The project being considered by the firm are mutually exclusive and have the
following projected cash flows: (10 points)
Year Project X Project Y
0 ($350,000) ($350,000)
1 175,000 150,000
2 175,000 0
3 175,000 375,000
Based on the information given, which of the two projects would be preferred,
and why?
Project:___________________________________________________________
4. You want to purchase a Car that costs $40,000. You want to finance as much of the purchase as possible with a 5-year bank loan at 12% compounded monthly, but can only afford loan payments of $750 per month. How much will you need as a down payment to buy the boat? (Round to the nearest dollar)
a. $3,523
b. $4,637
c. $5,147
d. $6,284
5. One year ago a $1,000 face value 6% coupon bond was selling for $918.93. Since then, the market return decreased by two percentage points. The bond pays interest semiannually and now has four years to maturity. The bond’s price today is:
a. $1,035.46
b. $1,053.27
c. $1,000.00
d. $932.67
6. Financial leverage is a direct function of the ratio of:
a. EAT to sales.
b. EBIT to sales.
c. interest expense to EBIT.
d. EAT to the number of shares of common stock.
I understand that many of these problems can be done in excel, I need the formulas and calculations that would be used on a calculator to help me understand how to solve the problem myself.
1. The market value of your firm’s equity is $500 million, which is also the value of your total debt. Your cost of debt (rd) is 6% and your cost of equity is (re) is 10%. What is your weighted average cost of capital (WACC) if your tax rate is 40%?
2. Crone Industries is planning its operations for next year, and Ronnie Crone, the CEO, wants you to forecast the firm’s additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.
Last year’s sales = S0
$350
Last year’s accounts payable
$40
Sales growth rate = g
30%
Last year’s notes payable (to bank)
$50
Last year’s total assets = A0
$500
Last year’s accruals
$30
Last year’s profit margin = M
5%
Target payout ratio
60%
3. You invest $50,000 in George’s House Painting, Inc, borrowing $30,000 of the money at 9%. If you expect to earn a 20% return on your investment under this arrangement, what would you expect to earn on a % basis, if you put up the entire $50,000 from your own money? Assume no taxes.
Please see attached questions. Please explain how you got the answers that you provide.
1. The future value of an annuity due is greater than the future value of an otherwise identical ordinary annuity.
a . True
b. False
2. If we invest money for 10 years at 8 percent interest, compounded semi-annually, we are really investing money for 20 six-month periods, and receiving 4 percent interest each period.
a. True
b. False
3. What is the expected rate of return on a bond that matures in 7 years, has a par value of $1,000, a coupon rate of 14%, and is currently selling for $911? Round your answer to the nearest whole percent, and assume annual coupon payments.
a. 15%
b. 14%
c. 2%
d. 16%
4. How can investors reduce the risk associated with an investment portfolio without having to accept a lower expected return?
a. Wait until the stock market rises.
b. Increase the amount of money invested in the portfolio.
c. Purchase a variety of securities; i.e., diversify
d. Purchase stocks that have exceptionally high standard deviations.
5. Bartiromo, Inc. bonds have a 6% coupon rate with semi-annual coupon payments and a $1,000 par value. The bonds have 14 years until maturity, and sell for $950. What is the current yield for Bartiromo’s bonds?
a. 3.28%
b. 6.32%
c. 6.55%
d. 7.52%
6. Preferred stock is similar to a bond in the following way:
a. preferred stock always contains a maturity date
b. both investments provide a stated income stream
c. both contain a growth factor similar to common stock
d. both provide interest payments
7. By investing in different securities, an investor can lower his exposure to risk
a. True
b. False
8. The value of a bond investment, which provides fixed interest payments, will increase when discounted at a 12% rate rather than at a 7% rate.
a. True
b. False
9. How much would you be willing to pay for a 10-year ordinary annuity if the payments are $500 per year and the rate of return is 6.25% annually?
a. $3,423
b. $3,637
c. $3,864
d. $4,132
10. A common protective provision in a bond indenture is the limitation of dividends on the issuing firm’s common stock.
a. True
b. False
11. How much money must be put into a bank account yielding 3.5% (compounded annually) in order to have $1,250 at the end of 10 years (round to nearest $1)?
a. $921
b. $886
c. $843
d. $798
12. In general, the required rate of return is a function of (1) the time value of money, (2) the risk of an asset, and (3) the investor’s attitude toward risk.
a. True
b. False
13. If you put $10 in a savings account at the beginning of each year for 11 years, how much money will be in the account at the end of the 11th year? Assume that the account earns 11% and round to the nearest $10.
a. $220
b. $200
c. $190
d. $180
14. Assume that you have $100,000 invested in a stock whose beta is .85, $200,000 invested in a stock whose beta is 1.05, and $300,000 invested in a stock whose beta is 1.25. What is the beta of your portfolio?
a. 0.97
b. 1.02
c. 1.21
d. 1.12
15. N. Ron Corp. preferred stock pays a $.15 annual dividend. What is the value of the stock if your required rate of return is 25%.
a. $.06
b. $.60
c. $6.00
d. $60.00
16. If you have $20,000 in an account earning 8 percent annually, what constant amount could you withdraw each year and have nothing remaining at the end of 5 years?
a. $5,009
b. $4,755
c. $3,409
d. $2,466
11. A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A’s standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
Answer
Either A or B, i.e., the investor should be indifferent between the two.
Stock A.
Stock B.
Neither A nor B, as neither has a return sufficient to compensate for risk.
Add A, since its beta must be lower.
12. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
Answer
The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
The yen-dollar exhange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market.
The relationship between spot and forward interest rates cannot be inferred.
13. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 6.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.
14. Bill Dukes has $100,000 invested in a 2-stock portfolio. $75,000 is invested in Stock X and the remainder is invested in Stock Y. X’s beta is 1.50 and Y’s beta is 0.70. What is the portfolio’s beta?
15. as a member of UA Corporation’s financial staff, you must estimate the Year 1 cash flow for a proposed project with the following data. What is the Year 1 cash flow?
Sales revenues, each year $40,500
Depreciation $10,000
Other operating costs $17,000
Interest expense $4,000
Tax rate 35.0%
16. To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% annual coupon, paid semiannually, sells at a price of $875, and has a par value of $1,000. If the firm’s tax rate is 40%, what is the component cost of debt for use in the WACC calculation?
17. Your company, CSUS Inc., is considering a new project whose data are shown below. The required equipment has a 3-year tax life, and the accelerated rates for such property are 33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected to be constant over the project’s 10-year expected operating life. What is the project’s Year 4 cash flow?
Equipment cost (depreciable basis) $70,000
Sales revenues, each year $41,000
Operating costs (excl. depr.) $25,000
Tax rate 35.0%
18. Confu Inc. expects to have the following data during the coming year. What is the firm’s expected ROE?
Assets $165,000 Interest rate 8%
Debt/Assets, book value 65% Tax rate 40%
EBIT $25,000
19. Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that a project’s projected NPV can be negative, in which case it will be rejected.
WACC: 10.00%
Year 0 1 2 3
Cash flows -$825 $500 $400 $300
20. Harry’s Inc. is considering a project that has the following cash flow and WACC data. What is the project’s NPV? Note that if a project’s projected NPV is negative, it should be rejected.
WACC: 14.75%
Year 0 1 2 3 4 5
Cash flows -$1,000 $300 $300 $300 $300 $300
A1. (Bond valuation) A $1,000 face value bond has a remaining maturity of 10 years and a
required return of 9%. The bond’s coupon rate is 7.4%. What is the fair value of this bond?
A5. (Yield to maturity) New Jersey Lighting has a 7% coupon bond maturing in 17 years. The
current market price of the bond is $975. What is the bond’s yield to maturity?
B19. (Constant growth model)
a. The current dividend for Birmingham Electric is $2.40 and is growing at 5% annually.
If the required return is 13%, what is the value of one share of stock?
A1. (Realized return) Tie Su bought $5,000 worth of stock 22 months ago. The firm has paid
no dividends since he bought the stock. The stock is currently worth $5,680. What is Tie’s
realized APY?
A5. (Required return) According to the CAPM, what would be the required return on an asset
that has a beta of 1.35 when the expected return on the market portfolio is 12% and the
riskless return is 7%?
(See attached file for full problem description)
10.33 The risk-free rate is 7.6 percent. Potpourri Inc. stock has a beta of 1.7 and an expected return of 16.7 percent. Assume the capital-asset-pricing model holds.
1. What is the expected market risk premium?
2. Magnolia Industries stock has a beta of 0.8. What is the expected return on the Magnolia stock?
3. Suppose you have invested $10,000 in a combination of Potpourri and Magnolia stock. The beta of the portfolio is 1.07. How much did you invest in each stock? What is the expected return of the portfolio?
39) The Tuft Company is generating cash flow of $333,000 per year. If they invest in a new press, they expect to increase their cash flow to $400,000 per year. The cash outflow for the new press is $250,000; to accept or reject the investment they have to consider the
A) press cost of $250,000 and total cash flow of $400,000 per year.
B) press cost of $250,000 and incremental cash flow of $67,000 per year.
C) current cash flow of $333,000 and the cost of $250,000
40) What is the nominal rate of interest given a real rate of interest of 5.0% and an inflation rate of 7.0%? (express your answer with one significant figure)
Ans. _______%
41) You have been asked to evaluate two pollution control devices. The wet scrub costs $100 to set up and $50 per year to operate. It must be completely replaced every 3 years, and it has no salvage value. The dry scrub device costs $200 to set up and $30 per year to operate. It lasts for 5 years and has no salvage value. Assuming pollution control equipment is replaced as it wears out, which method do you recommend if the cost of capital is 10%? Determine the equivalent annuity cost (EAC) and show your decision by marking your choice. All revenues are assumed to be the same.
43) ABC Inc. is considering the purchase of a $500,000 computer with an economic life of five years. The computer will be depreciated fully over five years using the straight line method. The market value of the computer is $100K in five years. The computer will replace five office employees whose combined annual salaries are $120K. The machine will also lower
the firms required net working capital (NWC) by $100K. This amount of NWC will need to be replaced once the machine is sold. Tc = 34%, discount rate is 12%. Determine the NPV to see if it is worth it?
Yr-0 Yr-1 Yr-2 Yr-3 Yr-4 Yr-5
Annual salary savings 120,000
Depreciation 100,000
Pre-tax income
Taxes 6,800
Operating C/F 113,200
ΔNWC -100,000
Investment -500,000 66,000
Total C/F 113,200
Elaborate in your own words with detailed responses to the questions.
Why do options sell at prices higher than their exercise values?
Describe between beta (or market) risk, within-company (or corporate) risk, and stand-alone risk for a potential project. Of these three measures, which is theoretically the most relevant, and why?
Brigit Hall has decided to establish a university endowment fund at T.T. Penguin’s former university, using an $8 million donation from Penguin. The fund will be used to construct a new building in five years, which is expected to cost $10 million at that time. In the interim, Penguin would like to generate end-of-year scholarship payments from the fund. Assume that the invested funds will earn an effective annual return of 6%.
a. How much can be paid in scholarships in each of the next five years, still leaving $10 million in the fund after five years?
b. The endowment fund will be set up so that $3 million is invested in 20-year semi-annually paying bonds with a coupon rate of 5% that are currently selling at 89.3843% of par value. What is the yield to maturity on these bonds? What is their expected effective annual return?
c. The other $5 million will be invested in an equity fund that is expected to pay dividends of $4 per $100 of net asset value at the end of this year. The dividends are expected to grow at an annual rate of 4% thereafter. What is the expected return on this equity fund?
d. Assume that the expected standard deviation of the bond is 8%, the expected equity fund standard deviation is 20%, and the correlation of their returns is 0.55. Estimate the portfolio standard deviation.
e. Estimate the beta of this portfolio and determine the required return according to the security market line (SML), given the following information:
? Expected return on the market is 11%.
? Standard deviation of the market is 18%.
? Risk-free rate is 5%.
? Correlation coefficient between the fund’s bond returns and the market returns is 0.40.
? Correlation coefficient between the equity fund and the market returns is 0.85.
f. Ignore your answer for part (b) and assume instead that the expected effective annual return equals 6.5%. Similarly, ignore your answer for part (c) and assume instead that the expected return in that part equals 11%. Also assume a capital structure of 37.5% of debt and 62.50% of equity. Does the portfolio lie above or below the SML?
g. Independent of parts (a) to (f) above, Hall is considering investing in a relatively new company whose profitability has been growing at a compound rate of 20% per year. Using the constant growth DDM (dividend discount model), Hall calculates that the share price should be $60; this is substantially more than the actual market price of the shares [$40]. What is the most likely reason for the wide disparity between the observed price and that which Hall estimates?
1) Elizabeth has $35,000 in an investment account, but she wants the account to grow to $100,000 in 10 years without making any additional contributions to the account. What effective annual rate of interest does she need to earn on the account to meet her goal?
2) McGwire Company’s pension fund projects that most of its employees will take advantage of an early retirement program the company plans to offer in five years. Anticipating the need to fund these pensions, the firm bought zero coupon U.S. Treasury Trust Certificates maturing in five years. When these instruments were originally issued, they were 12% coupon, 30-year U.S. Treasury bonds. The stripped Treasuries are currently priced to yield 10%. Their total maturity value is $6,000,000. What is their total cost (price) to McGwire today?
$ 553,776
$5,142,600
$3,404,561
$4,042,040
$3,725,528
3) A stock that currently trades for $40 per share is expected to pay a year-end dividend of $2 per share. The dividend is expected to grow at a constant rate over time. The stock has a beta of 1.2, the risk-free rate is 5%, and the market risk premium is 5%. What is the stock’s expected price seven years from today?
1. A company has collection centers across the country to speed up collections. The company also makes its disbursements from remote disbursement centers. The collection time has been reduced by two days and disbursement time increased by one day because of these policies. Excess funds are being invested in short-term instruments yielding 12 percent per annum.
(a) If the company has $5 million per day in collections and $3 million per day in disbursements, how many dollars has the cash management system freed up?
(b) How much can the company earn in dollars per year on short-term investments made possible by the freed-up cash?
2. Swartz and Sons pays a 12 percent coupon rate on debentures that are due in 20 years. The current yield to maturity on bonds of similar risk is 10 percent. The bonds are currently callable at $1,060. The theoretical value of the bonds will be equal to the present value of the expected cash flow from the bonds. This is the normal definition we use.
(a) Find the theoretical market value of the bonds using semiannual analysis.
(b) Do you think the bonds will sell for the price you arrived at in part (a)? Why?
3. Larry Smith calls his broker to inquire about purchasing a bond. His broker quotes a price of $1,180. Larry is concerned that the bond might be overpriced based on the facts involved. The $1,000 par value bond pays 14 percent interest, and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is 12 percent. Compute the new price of the bond and comment on whether you think it is overpriced in the marketplace.
4. Audrey Wright has just retired after 25 years after teaching high school. Her total pension funds have an accumulated value of $180,000, and her life expectancy is 15 more years. Her pension fund manager assumes she can earn a 9 percent return on her assets. What will be her yearly annuity for the next 15 years?
1. How is a stock’s beta computed?
2. Does a bond’s time to maturity ever equal its duration? Please explain.
3. Are the valuation models for common stock with constant, zero growth dividend payments and for preferred stock very similar? Please explain.
4. How do mutually exclusive and independent investment projects differ?
5. What are some of the disadvantages of the payback rule in capital budgeting?
6. Will the net present value (NPV) and internal rate of return (IRR) capital budgeting rules ever not give the same accept/reject decision for an investment project? Please explain.
7. How is the cost of stock adjusted for flotation costs? Please explain.
8. How can a company reduce its cash conversion cycle?
9. Would you expect that a technology firm or a utility firm would have a higher Price/Earnings ratio? Please explain.
10. How does an annuity due differ from an ordinary annuity?
1. Calculate the current price per share for Cali Corporation given the following projections for the coming year:
Sales=10,000 units
Sales price per unit= $10
Variable cost per unit= $5
Fixed costs= $10,000
Bonds outstanding= $15,000
Interest rate on outstanding bonds= 8%
Tax rate= 40%
Dividend payout ratio= 60%
Expected long term growth rate= 8%
Shares of common stock outstanding= 10,000 shares
Beta= 1.4
Current rate on government T- Bonds= 5%
Expected return on the stock market= 9%
2. According to www.bondpage.com, on Feb 22, 2006, dealers were offering the US government’s 10.625% 2015 Treasury Bond for “145.958.” Answerthe following about the bond:
a. What is the price in dollars of the bond?
b. What is the amount of the coupon interest payment you would receive each year if you bought the bond? (assume annual payments)
c. How many payments would you receive if you bought the bond and held it to maturity? (how many years does the bond have to go before it matures)
d. What is the bonds yield to maturity, assuming you purchased it for the current offering price?
3. Assume you are planning how to finance your child’s college education. The child is 3 yrs old now so there are 15 years to go before your child enters college at age 18. According to your estimates you will need $80,000 in the bank at that time.
a. If you believe you can earn 9% a year, on average, between now and the time your child starts college, how much will you have to invest between now and then inorder to reach your target?
b. It appears the annual payment required to reach your target is more than you can afford. If the most you can afford to invest each year is $12,000, what average annual rate of return must you earn in order to reach your target?
1. Explain what a yield curve is, and the three different types of curves.
Explain Expectations Theory, and give an example.
2. Explain Liquidity Preference Theory, and give an example.
3.Explain Market Segmentation Theory, and give an example.
4. What is the I-Bond and why was it offered by the USD of Treasury?
5. Why do financial managers prefer to calculate values of projects or investments in present values?
6. What is meant by “the present value of a future amount”?
7. How would you calculate that?
8. What is the difference between simple and compound interest?
9. What is the difference between simple and compound interest?
10. What is the difference between an annuity and an annuity due, and which always has the greater future value, and why?
11. What is the impact of international assets on a portfolio?
Is there more or less risk?
12. Explain the term Beta in determining risks in a portfolio or security.
13. What is an IPO? Give an example.
14. What does a firm have to do, legally before “going public”?
15. What are the differences between debt and equity capital?
16. What are the differences between common and preferred stock? Which would you prefer and why?
17. What risks do common stockholders take that other suppliers of long-term capital do not?
1. Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given below:
Possible Sales
Market Reaction in Units Probabilities
Low response . . . . . . . . . . . . . 20 .10
Moderate response . . . . . . . . . 40 .30
High response . . . . . . . . . . . . . 55 .40
Very high response . . . . . . . . . 70 .20
a. What is the expected value of unit sales for the new product?
b. What is the standard deviation of unit sales?
5. Five investment alternatives have the following returns and standard deviations of returns.
Returns? Standard
Alternative Expected Value Deviation
A. . . . . . . . . . . $ 5,000 $1,200
B. . . . . . . . . . . 4,000 600
C. . . . . . . . . . . 4,000 800
D. . . . . . . . . . . 8,000 3,200
E. . . . . . . . . . . 10,000 900
Using the coefficient of variation, rank the five alternatives from lowest risk to highest risk.
7. X-treme Vitamin Company is considering two investments, both of which cost
$10,000. The cash flows are as follows:
Year Project A Project B
1 . . . . . . . . . . $12,000 $10,000
2 . . . . . . . . . . 8,000 6,000
3 . . . . . . . . . . 6,000 16,000
a. Which of the two projects should be chosen based on the payback method?
b. Which of the two projects should be chosen based on the net present value
method? Assume a cost of capital of 10 percent.
c. Should a firm normally have more confidence in answer a or answer b?
Net present value and internal rate of return methods
15. The Danforth Tire Company is considering the purchase of a new machine that wuld increase the speed of manufacturing and save money. The net cost of this machine is $66,000. The annual cash flows have the following projections.
Year Cash Flow
1. $21,000
2. 29,000
3. 36,000
4. 16,000
5. 8,000
a. If the cost of capital is 10 percent, what is the net present value?
b. What is the internal rate of return?
c. Should the project be accepted? Why?
Net present value profile
20. Miller Electronics is considering two new investments. Project C calls for the purchase of a coolant recovery system. Project H represents an investment in a heat recovery system. The firm wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:
Project C ($25,000 investment) Project H ($25,000 investment
Year Cash Flow Year Cash Flow
1. $6,000 1 $20,000
2. 7,000 2 6,000
3. 9,000 3 5,000
4. 13,000
a. Determine the net present value of the projects based on a zero discount rate.
b. Determine the net present value of the projects based on a 9 percent discount rate.
c. The internal rate of return on Project C is 13.01 percent, and the internal rate of return on project H is 15.68 percent. Graph a net present value profile for the two investments. ( Use a scale up to $10,000 on the vertical axis, with $2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)
d. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if he cost of capital (discount rate) is 8 percent. (Use the net present value profile for your decision; no actual numbers are necessary.)
e. If the two projects are mutually exclusive ( the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 5 percent, (2) 13 percent, (3) 19 percent? Use the net present value profile for your answer.
Coefficient of variation and investment decision
14. Mr. Monty Terry, a real estate investor, is trying to decide between two potential small shopping center purchases. His choices are the Wrigley Village and Crosley Square. The anticipated annual cash inflows from each are as follows:
Wrigley Village Crosley Square
Yearly Aftertax Cash Inflow Yearly Aftertax Cash Inflow
(in thousands) Probability (in thousands) Probability
$10 .1 $20 .1
30 .2 30 .3
40 .3 35 .4
50 .3 50 .2
60 .1
a. Find the expected value of the cash flow from each shopping center
b. What is the coefficient of variation for each shopping center?
c. Which shopping center has more risk?
1. Your hospital has the following revenue for the month of July-September:
July $2, 000,000
Aug $ 2, 500,000
Sep $ 3,000,000
If 30% of the month’s revenue is collected in the same month, 40% is collected in the second month and 30% is collected in the third month, how much of July’s revenue is collected in August? and How much is collected in September?
2. An imaging center has the following information:
Revenue per test: $225
Variable cost per test: 150
Total fixed costs: $ 225.000
Calculate the total revenue dollars need to break-even.
3. A newly purchased piece of equipment shows the following:
initial cost $1,000,000
Estimated yearly cash flow 25% of the initial cost
Calculate the payback (in Years)
1. Is a single dollar worth more today or a year from now? Why?
2. I have two available projects in which I can invest. Project A has
three possible (equally likely returns on investment (10%), 15%, and
55%. Project B similarly has three returns (also equally likely) of
15%, 20%, and 25%. The average return on these investments is 20%.
Therefore, wouldn’t I be indifferent between the two as investment
opportunities?
3. Congratulations! You just won a $1 million lottery. You have the
choice of taking 20 annual payments of $50,000 per year or a lump sum of
$400,000 right now. What considerations do you need to take into
account when deciding which option to accept? Assume that there are no
taxes.
4. Why are changes that the Federal Reserve makes to the discount rate
so important to business investment?
5. Can a series of highly risky investments be combined into a low risk
portfolio?
6. Why is shelf registration important?
7. What role does the underwriter play in a new issue?
Return on Financial Assets
Solve the following problems:
1. Consider the following four debt securities, which are identical in every characteristic except as noted:
W: A corporate bond rated AAA
X: A corporate bond rate BBB
Y: A corporate bond rated AAA with a shorter time to maturity than bonds W and X
Z: A corporate bond rated AAA with the same time to maturity as bond Y that trades in a more liquid market than bonds W, X, or Y
List the bonds in the most likely order of the interest rates (yields to maturity) of the bonds from highest to lowest. Explain your work.
2. Explain how an economist could use the slope of the yield curve to analyze the probability that a recession will occur and why the spread may matter.
3. One year ago, you bought a bond for $10,000. You received interest of $400 at the end of the year, as well as your $10,000 principal. If the inflation rate over the last year was five percent, calculate the real return. Show your work.
4. Suppose that the price of a stock is $50 at the beginning of a year and $53 at the end of the year, and it pays a dividend of $2 during the year. Calculate the stock’s current yield, capital-gains yield, and the return. Show your work for three separate calculations.
5. Use the capital-asset pricing model to predict the returns next year of the following stocks, if you expect the return to holding stocks to be 12 percent on average, and the interest rate on three-month T-bills will be two percent. Calculate a stock with a beta of -0.3, 0.7, and 1.6. Show your work for three separate calculations.
The format should be as follows:
o Typed, double-spaced, Times New Roman font (size 12), one-inch margins on all sides, APA format.
o Type the question followed by your solution.
Please provide the workings, formulas and calculations.
Question 1:
a) You want to quit your job and return to school for an MBA degree 3 years from now. The current tuition fee for the MBA degree is $20,000. You expect the fees to increase at an annual compounded rate of 3%. (To simplify your calculation, assume that you have to pay the entire fee during enrollment, which is supposed to be made at the beginning of year 4). You plan to start savings today and will make 3 equal deposits in a low risk investment account that pays an annual dividend of 6.00% per annum. Under these assumptions, how much you would need to deposit yearly in order to have sufficient amount to enroll for the programme? [Use 3 decimal places in your calculation and round up your answer to the nearest dollar].
b) Your aunt is about to retire, and she wants to sell some of her stocks and buy an annuity that will provide her with an income of $40,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.00%. How much would it cost her to buy such an annuity today? [Assume annual compounding. Use 3 decimal places in your calculation and round up your answer to the nearest dollar].
Question 2:
a) A 25-year, $1,000 par value bond has an 8.5% annual payment coupon. The bond currently sells for $950.88. If the yield to maturity remains at its current rate, what will the price be 5 years from now? [Use 3 decimal places in your calculation and round up your answer to the nearest dollar].
b) Indrapura Industries Limited has a bond outstanding with 15 years to maturity, an 8.25% nominal coupon, semiannual payments, and a $1,000 par value. The bond has a 6.5612% nominal yield to maturity, but it can be called in 6 years at a price of $1,150. What is the bond’s nominal yield to call?
Question 3:
a) Agarwal Technologies was founded 10 years ago. It has been profitable fthe last 5
years, but it has needed all of its earnings to support growth and thus ha never paid a dividend. Management has indicated that it plans to pay a $0.25 dividend 3 years from today, then to increase to a rapid pace for the following 2 years:
Year 4 $0.40
Year 5 $0.55
Thereafter, earnings and dividends are expected to grow at a long-term constant growth rate of 8.00%. Assume a required rate of return of 11%. [Use 3 decimal places in your calculation and round up your answer to the nearest dollar]
i) What is your estimate of the stock’s current value?
ii) If the stock is currently selling for $12.00 per share, is it a good buy? Why or why not?
iii) If assumptions made holds, what is your estimate of the stock price one year from now?
b) You must estimate the intrinsic value of Noe Technologies’ stock. The end-of-year free cash flow (FCF ) is expected to be $24.00 million, and it is expected to grow at a constant rate of 7.0% a year thereafter. The company’s WACC is 10.0%, it has $125.0 million of long-term debt plus preferred stock outstanding, and there are 15.0 million shares of common stock outstanding. What is the firm’s estimated intrinsic value per share of common stock? [Use 3 decimal places in your calculation and round up your answer to the nearest dollar].
Question 4:
a) Doklan Inc.’s management estimates that it has a 25% chance of producing an EBIT of 17m, a 50% chance of producing an EBIT of $12m, and a 25% chance of producing an EBIT of -$8m. What is the firm’s expected EBIT?
b) Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio’s beta is 1.25. Now suppose you decided to sell one of your stocks that have a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 0.80. What would the portfolio’s new beta be?
Question 5:
Fronterra Engineering Corporation (FEC) has the following capital structure which it considers to be optimal:
Debt 25%
Preferred stock 15%
Common equity 60%
FEC tax rate is 30%; and investors expect future earnings and dividends to grow at a constant rate of 9%. FEC paid a dividend of $3.60 per share last year and its stock currently sells for $54.00 per share.
FEC can obtain new capital in the following ways:
 Preferred: New preferred stock with a dividend of $11.00 can be sold to the public at aprice of $95.00 per share.
 Debts: Debt can be sold at par with a coupon interest rate of 12%.
i) Determine the cost of each capital component.
ii) Calculate the weighted average cost of capital [WACC].
iii) FEC has the following investment opportunities that are average-risk projects:
Project Cost at t = 0
($) IRR (%)
A 10,000 17.4
B 20,000 16.0
C 10,000 14.2
D 20,000 13.7
E 10,000 12.0
Which projects should FFB accept? Why?
iv) Suppose FEC is evaluating a new venture in the consumer product industry. The IRR on the new venture is 15.5%. WACCs of firms in the consumer product industry tend to average around 16%. Should this new project be pursued? Will FEC make the correct decision if its discounts cash flows on this proposed venture at its WACC found in part
(b) above? Explain.
Question 1
The Houston Corp. needs to raise money for an addition to its plant. It will issue 300,000 shares of new common stock. The new shares will be priced at $60 per share with an 8.5% spread on the offer price. Registration costs will be $150,000. Presently Houston Corp has earnings of $3 million and 750,000 shares outstanding.
(a) Compute the potential dilution from this new stock issue.
(b) Compute the net proceeds to Houston Corp.
(c) What rate of return must be earned on the net proceeds so that no dilution of earnings per share occurs?
Question 2
Gray House is issuing bonds paying $105 annually that will mature fifteen years from today. The bond is currently selling for $980.
Calculate:
(a) Coupon Rate
(b) Current Yield
(c) Yield To Maturity
Question 3
The Haavelmo Widget Corporation has just signed an 84-month lease on an asset with an 8-year life. The lessor will retain the property at the end of the lease, and the present value of the minimum lease payments is $250,000. The estimated fair value of the property is $300,000. Is this an operating lease?
a.no
b.yes
c.if the company elects to treat the lease as an operating lease
d.more information is required
Question 4
Private placement of corporate bonds
a.has increased in use as new bond issues increased.
b.are the most popular method of raising debt capital.
c.are more expensive to issue than publicly placed bonds.
d.have lower interest rates than mortgage-backed securities.
Question 5
All of the following are disadvantages of going public except
a.the firm may now become active in mergers and acquisitions.
b.the company must make all information available to the public through filings to the SEC and the state.
c.an erosion in value may take place after the initial offering.
d.there is a high cost associated with going public.
Question 6
Which of the following bonds offers the most security to the bondholder?
a.Junior mortgage bonds
b.Senior mortgage bonds
c.Debenture bond
d.Income bond
Question 7
A “subordinated debenture”
a.must be transferred with the bond to which it is attached.
b.is used mainly by railroad companies and usually specifies equipment as collateral.
c.entitles the bondholder to purchase shares of common stock at a specific price.
d.is an unsecured bond with an inferior claim on assets in the event of liquidation.
Question 8
An investment banker makes money from
a.commissions from buyers.
b.fees from other investment bankers in the syndicate.
c.the spread between issue price and proceeds to the issuer.
d.artificially supporting the stock price during and after the offering.
Question 9
Raybac is about to go public. Its present stockholders own 500,000 shares. The new public issue will represent 800,000 shares. The shares will be priced at $25 to the public with a 4% spread. The out-of pocket costs will be $450,000. What are the net proceeds to the firm?
a.$18,750,000
b.$19,200,000
c.$18,250,000
d.$19,550,000
Question 10
The market stabilization function usually
a.is performed by the company.
b.lasts six to nine months.
c.provides price support for the stock during the distribution period.
d.is illegal.
Question 11
Corporate debt has
a.increased rapidly since World War II.
b.increased slowly since World War II.
c.held fairly steady over the last forty years.
d.none of the above
Question 12
Zero-coupon bonds
a.provide no annual interest payments.
b.have highly stable prices even with changing interest rates.
c.provide an investor with tax-free income until maturity.
d.two of the above.
1- What do you think happens to the ABL Line of Credit (i.e., the ABL Loan Balance) if you are using the arrangement to sell goods that consistently lose money? (i.e., the products have a negative contribution margin).
2- Asset-Based Lending
Asset-based lending is usually provided by a bank or other financial institution that lends money to a business based on collateral under a formula. I’m familiar with the situation where for every dollar of accounts receivable that is newly recognized, the company can borrow 75% of that amount. When the cash is received by the company, the funds are deposited directly in the lender’s account and the lender keeps it’s 75% and credits the company for the other 25%. (There are also formulas available to borrow against raw materials inventory as well).
Keep in mind that with many sales and deposits, the ins and outs are flowing all of the time.
what are your observations on this arrangement. Do you see advantages and disadvantages to taking on a credit facility like this?
3- Account Receivables Open Account: Does your firm sell its goods and/or services on open account? If so, what are its credit terms? If not, why not?
4- Do you think WC Management takes more effort when times are good for a company or when times are bad? Please support your view.
5- what is days sales outstanding (DSO)? What is the value of it? Can you think of other ways to calculate it other than the way the book explains it? (Hint: What if we are only 1/4th of the way done with the year, how might you calculate DSO? What if sales are highly seasonal, how might you adjust for the receivables balance)?
Problems:
1-William & Son’s last year reported sales of $10 millions and inventory turnover ratio
of 2. The company now adopting a new system. If the new system is able to reduce the firm’s inventory level and increase the firm’s inventory turnover ratio to 5, While maintaining the same level of sales, how much cash will be freed up?
2-Meddwing Corporation has a DSO of 17 days, the Company averages of $3,500 in credit sales each day. What is the Company’s averages account receivable.
1. What are the two major sources of spontaneous short-term financing for a firm?
2. How do their balances behave relative to the firm’s sales?
3. Is there a cost associated with taking a cash discount?
4. Is there any cost associated with giving up a cash discount?
5. How do short-term borrowing costs affect the cash discount decision?
6. What is “stretching accounts payable”?
7. What effect does this action have on the cost of giving up a cash discount?
8. How is the prime rate of interest relevant to the cost of short-term bank borrowing?
9. What is a floating-rate loan?
10. What does a firm have to do, legally before “going public”?
1. An investment costs $3,000 today and provides cash flows at the end of each year for 20 years. The investment’s expected return is 10 percent. The projected cash flows for years 1, 2, 3 are $100, $200, and $300 respectively. What is the annual cash flow received for each of the years 4 through 20 (17 years)? (Assume the same payment for each of these years.)
2. A financial analyst has been following Johns Inc., a new high-growth company. She estimates that the current risk-free rate is 6.25 percent, the market risk premium is 5 percent, and that John’s beta is 1.75. The current earnings per share is $2.50. The company has a 40 percent payout ratio. The analyst estimates that the company’s dividend will grow at a rate of 25 percent this year, 20 percent next year, and 15 percent the following year. After three years the dividend is expected to grow at a constant rate of 7 percent a year. The company is expected to maintain its current payout ratio. The analyst believes that the stock is fairly priced. What is the current price of the stock?
Please give explanation to your answers.
1. Britney and Christina Incorporated has a debt ratio of 0.42, noncurrent liabilities of $20,000 and total assets of $70,000. What is Britney and Christina’s level of current liabilities?
A $8,400
B $9,400
C $12,348
D $10,600
2. In 2002 Clanton, Inc. had a gross profit of $27,000 on sales of $110,000. Clanton’s operating expenses for 2002 were $13,000, and its net profit margin was .0585. Clanton had no interest expense in 2002. What was Clanton’s gross profit margin for 2002?
A 0.127
B 0.325
C 0.245
D 0.364
3. In making financial decisions, the relevant tax rate is the:
A marginal tax rate
B average (effective) tax rate
C previous year’s tax rate
D maximum allowable tax rate
4. Which of the following best reflects the mix of corporate securities issued in the U.S.?
A 74% debt, 26% equity
B 55% debt, 45% equity
C 45% debt, 55% equity
D 26% debt, 74% equity
5. Why is the quick ratio a more refined liquidity measure than the current ratio?
A It measures how “quickly” cash and other liquid assets flow through the company.
B Inventories are generally the least liquid of the firm’s current assets.
C Inventories are generally among the most liquid of the firm’s current assets.
D Cash is the most liquid current asset.
6. PDQ Corp. has sales of $3,000,000; the firm’s cost of goods sold is $1,425,000; and its total operating expenses are $700,000. The firm’s interest expense is $230,000, and the corporate tax rate is 40%. What is PDQ’s tax liability?
A $258,000
B $350,000
C $387,000
D $645,000
7. The quick ratio of a firm would be unaffected by which of the following?
A land held for investment is sold for cash
B equipment is purchased, financed by a long-term debt issue
C inventories are sold for cash
D inventories are sold on a short-term credit basis
8 Which of the following ratios would be the best way to determine how customers are paying for their purchases?
A Inventory turnover.
B Total asset turnover.
C Current ratio.
D Average collection period.
I am working on a few problems to study from. Please provide detail for the 3 attached problems.
Question 4. (15 points) Pierre Imports will be liquidated. Its current balance sheet is shown below. Fixed assets are sold for $900,000 and current assets are sold for $700,000. All fixed assets are pledged as collateral for mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $70,000.
(20 points) Thomas Corporation is evaluating whether to lease or purchase equipment. Its tax rate is 30 percent. The company expects to use the equipment for 5 years, with no expected salvage value. The purchase price is $1 million and MACRS depreciation, 3-year class, will apply. If the company enters into a 5-year lease, the lease payment is $230,000 per year, payable at the beginning of each year. If the company purchases the equipment it will borrow from its bank at an interest rate of 11 percent.
Question 2. (15 points) An investment company recently issued convertible bonds with a $1,000 par value. The bonds have a conversion price of $25 a share. At the time of issue, the company’s underlying stock price is $20.
a. Calculate the convertible issue’s conversion ratio?
b. After issuance, will the bond likely increase, decrease, or not change in value if the underlying stock price changes to $23 per share and everything else remains constant? Why?
c. The bondholder converts the bond to common stock when the price of the underlying stock reaches $35. What is the total market value of the new shares?
d. Does the company’s balance sheet change at the point the bondholders convert their bonds to common stock? Explain?
e What are the advantages to the investor in buying convertible bonds instead of the stock itself?
Please see attached file and show all your calculations.
Chapter 5
P5-3: Risk preferences Sharon Smith, the financial manager for Barnett Corporation, wishes to evaluate three prospective investments: X, Y, and Z. Currently, the firm earns 12% on its investments, which have a risk index of 6%. The expected return and expected risk of the investments are as follows:
Investment Expected Return Expected Risk Index
X 14% 7%
Y 12 8
Z 10 9
a. If Sharon were risk-indifferent, which investments would she select? Explain Why?
b. If she were risk-averse, which investments would she select? Why?
c. If she were risk-seeking, which investments would she select? Why?
d. Given the traditional risk preference behavior exhibited by financial managers, which investment would be preferred? Why?
P5-4: Risk analysis Solar Designs is considering an investment in an expanded product line. Two possible types of expansion are being considered. After investigating the possible outcomes, the company made the estimates shown in the following table:
Expansion A Expansion B
Initial Investment $12,000 $12,000
Annual Rate of Return
Pessimistic 16% 10%
Most Likely 20% 20%
Optimistic 24% 30%
a. Determine the range of the rates of return for each of the two projects.
b. Which project is less risky? Why?
c. If you were making the investment decision, which one would you choose? Why? What does this imply about your feelings toward risk?
d. Assume that expansion B’s most likely outcome is 21% per year and that all other facts remain the same. Does this change your answer to part c? Why?
P5-13: Portfolio analysis You have been given the return data shown in the first table
on three assets?F, G, and H?over the period 2007-2010.
Expected Return
Year Asset F Asset G Asset H
2007 16% 17% 14%
2008 17 16 15
2009 18 15 16
2010 19 14 17
Using these assets, you have isolated the three investment alternatives shown in
the following table:
Alternative Investment
1 100% of Asset F
2 50% of Asset F and 50% of Asset G
3 50% of Asset F and 50% of Asset H
a. Calculate the expected return over the 4-year period for each of the three
alternatives.
b. Calculate the standard deviation of returns over the 4-year period for each
of the three alternatives.
c. Use your findings in parts a and b to calculate the coefficient of variation for
each of the three alternatives.
d. On the basis of your findings, which of the three investment alternatives do
you recommend? Why?
Please look at attached document.
10-1 AFTER-TAX COST OF DEBT The Heuser Company’s currently outstanding bonds have a 10% coupon and a 12% yield to maturity. Heuser believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is Heuser’s after-tax cost of debt?
10-3 COST OF COMMON EQUITY Percy Motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company’s outstanding bonds is 9%, and its tax rate is 40%. Percy’s CFO estimates that the company’s WACC is 9.96%. What is Percy’s cost of common equity?
10-5 PROJECT SELECTION Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects:
Assume that each of these projects is just as risky as the firm’s existing assets and that the firm may accept all the projects or only some of them. Which set of projects should be accepted? Explain.
10-9 WACC The Patrick Company’s cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC.
10-11 WACC AND PERCENTAGE OF DEBT FINANCING Hook Industries’ capital structure consists solely of debt and common equity. It can issue debt at rd = 11%, and its common stock currently pays a $2.00 dividend per share (D0 = $2.00). The stock’s price is currently $24.75, its dividend is expected to grow at a constant rate of 7% per year, its tax rate is 35%, and its WACC is 13.95%. What percentage of the company’s capital structure consists of debt?
I’ve posted the problems here and in the attachment. Get back to me, thanks.
9-1 DPS CALCULATION Warr Corporation just paid a dividend of $1.50 a share (that is, D0 = $1.50). The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for each of the next 5 years?
9-3 CONSTANT GROWTH VALUATION Harrison Clothiers’ stock currently sells for $20.00 a share. It just paid a dividend of $1.00 a share (that is, D0 = $1.00). The dividend is expected to grow at a constant rate of 6% a year. What stock price is expected 1 year from now? What is the required rate of return?
9-9 PREFERRED STOCK RETURNS Bruner Aeronautics has perpetual preferred stock outstanding with a par value of $100. The stock pays a quarterly dividend of $2, and its current price is $80.
a. What is its nominal annual rate of return?
b. What is its effective annual rate of return?
1. Government Note
Rate: 2.875
Maturity: Nov10n
Bid: 99:02
Asked: 99.03
CHG: -2
ASK YLD: 3.55
A. What annual dollar coupon amount will investors receive if face value of the Treasure note is $1,000?
B. What price would you pay in dollars to purchase this Treasure note?
2. T-bill
Maturity: June 16, 2009
DAYS TO MAT: 41
Bid: 2.68
Asked: 2.67
CHG: 0.01
Asked YLD: 2.72
What price would you pay in dollars to purchase this Treasure bill?
3. Company: Gen Electric
Ticker: GE
Coupon: 7.75
Maturity: 10/19/2010
Last Price: 92.50
Last Yield: 9.797
EST spread: 600
UST: 3
Est $ Vol (000’s): 99,590
A. What annual dollar coupon amount will investors receive?
B. What price would you pay in dollars to purchase this bond?
C. What is the estimated yield on Treasury securities?
D. What is the current yield for this bond?
E. What is the yield to maturity on this bond?
4. The Wallace Company has issued a 10-year, $1,000 bond, which pays 12% interest annually. If your required annual rate of return for an investment of this risk is 16%, what is the value of this bond to you? What is the value of the same bond if the interest is paid semi-annually?
Can you help me get started on this assignment?
Exercises:
1) For 2006, Treasury bonds with 5-year maturities offered a return about 8.65%; face value of $1,200; and 7.25% coupon rate. What would be the present value of this bond?
2) Mrs. Smith has 20 common stocks from A&T Global Enterprises. If the A&T Global Enterprises’ board directors believe that the price at the end of the year, these common stocks will rise to $57.80 per common stock and the estimate dividend paid would be $2.15 per common stock, what would be the actual price for each common stock if the expected rate of return is 10.75%?
3) Simon bought a common stock from Monona Air Cleaners Inc. at $35 per share for January 5, 2006 and he expected that the price per share increase by $8 for December 31, 2006. If Monona Air Cleaners will pay $1.75 for dividend per share, what would be the expected rate of return of Simon’s shares?
4) Four Possible Outcomes for Portfolio Return
Outcome Possible Return Probability
Expansion 60% 0.1
Normal 25% 0.5
Recession 5% 0.3
Other -15% 0.1
A) Calculate the following: 1) The Expected Portfolio Return; 2) Variability of Expected Return.
5) Consider the following two-assets:
Expected return Expected risk (σ)
Company X – Japan 10% 12%
Company X – Spain 20% 25%
Correlation coefficient (ρJ-S) 0.45
A) Calculate the portfolio risk (expected return and variability) if you decide invest 35% of your profit in Spain and the other in Japan.
6) By 2005 the rate of return of Treasury bill was 5.25% and market rate of return was 9.75%, with .85 of beta for J&M Warehouse’s common stock. What is the expected rate of return of its common stocks?.
7) Consider the previous exercise and calculate beta if the market rate of return
is 12.25%.
1.
If you deposit $1,000 each year in a savings account earning 4%, compounded annually, how much will you have in 10 years?
2.
You have decided to invest $500 in a mutual fund today and make $500 end-of-the-year investments in the fund each year until you retire for 40 years. Assuming an opportunity cost of 12%, what do you estimate that you will have in this account at retirement?
3.
You have borrowed $70,000 to buy a speed boat. You plan to make monthly payments over a 15-year period. The bank has offered you a 9% interest rate, compounded monthly. Create an amortization schedule for the first two months of the loan.
4.
Describe the differences between secured and unsecured short-term credit.
5.
The December 31, 1995 balance sheet for Spitco, Inc. is presented below.
Spitco, Inc. Balance Sheet
December 31, 1995
Current assets $40,000
Net fixed assets 20,000
Total $60,000
Accounts payable 11,000
Notes payable 12,000
Total $23,000
Long-term debt (10%) 12,000
Common equity 25,000
Total $60,000
Partial Income Statement for December 31, 1995
Net operating income $10,291
Less: interest income 1,200
Earnings before taxes $9,091
Less: taxes (34%) 3,091
Net income $ 6,000
a. Calculate Spitco’s current ratio, net working capital, and return on total assets.
b. Spitco feels that its current ratio is too far below the industry average of 2.40. To improve their liquidity, the treasurer of Spitco has devised a plan to issue $12,000 in long-term debt at 12% and pay off its notes payable. The funds would be invested in marketable securities at 7% interest when not needed to finance the firm’s seasonal asset needs. The notes payable would remain outstanding through the year. Assume this plan had been implemented for 1993. The net income was $5,500. Calculate what the firm’s current ratio, net working capital, and return on total assets would have been.
c. Did Spitco improve their liquidity? What about their profitability?
6.
The Basic Sports Company produces graphite surf-casting fishing rods. The average selling price for one of their rods is $132. The variable cost per unit is $80. Basic Sports has average fixed costs per year of $90,000.
a. What is the break-even point in units for Basic Sports?
b. What is the break-even point in dollar sales?
c. What would be the profit or loss associated with the production and
sale of (1) 2,000 rods, and (2) 10,000 rods?
d. Determine the degree of operating leverage for the two levels of
production and sales given in part (c) above.
7
Table 6
Hokie Corporation Comparative Balance Sheet
For the Years Ending March 31, 1995 and 1996
(Millions of Dollars)
Assets 1995 1996
Current assets:
Cash $ 2 $ 10
Accounts receivable 16 10
Inventory 22 26
Total current assets $ 40 $ 46
Gross fixed assets: $120 $124
Less accumulated depreciation 60 64
Net fixed assets 60 60
Total assets $100 $106
Liabilities and Owners’ Equity
Current liabilities:
Accounts payable $ 16 $ 18
Notes payable 10 10
Total current liabilities $ 26 $ 28
Long-term debt 20 18
Owners’ equity:
Common stock 40 40
Retained earnings 14 20
Total liabilities and owners’ equity $100 $106
Hokie had net income of $26 million for 1996 and paid total cash dividends of $20 million to their common stockholders.
Calculate the following financial ratios for the Hokie Corporation using the information given in Table 6 and 1996 information.
current ratio
acid test ratio
debt ratio
long-term debt to total capitalization
return on total assets
return on common equity
(See attached file for full problem description)
—
7.3 The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. Cash flows are in $ thousands and the corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all cash flows occur at the end of the year.
1. Compute the incremental net income of the investment for each year.
2. Compute the incremental cash flows of the investment for each year.
3. Suppose the appropriate discount rate is 12 percent. What is the NPV of the project?
Year 0 Year 1 Year 2 Year 3 Year 4
Investment $10,000 ? ? ? ?
Sales revenue ? $7,000 $7,000 $7,000 $7,000
Operating costs ? 2,000 2,000 2,000 2,000
Depreciation ? 2,500 2,500 2,500 2,500
Net working capital (end of year) 200 250 300 200
7.12 A firm is considering an investment of $28 million (purchase price) in new equipment to replace old equipment with a book value of $12 million and a market value of $20 million. If the firm replaces the old equipment with the new equipment, it expects to save $17.5 million in operating costs the first year. The amount of these savings will grow at a rate of 12 percent per year for each of the following three years. The old equipment has a remaining life of four years. It is being depreciated by the straight-line method. 33.3 percent of the original book value of the new equipment will be depreciated in the first year, 39.9 percent will be depreciated in the second year, 14.8 percent will be depreciated in the third year, and 12.0 percent will be depreciated in the final year. The salvage value of both the old equipment and the new equipment at the end of four years is 0. In addition, replacement of the old equipment with the new equipment requires an immediate increase in net working capital of $5 million, which will not be recovered until the end of the four-year investment. Assume that the purchase and sale of equipment occurs today and all other cash flows occur at the end of their respective years. If the firm’s cost of capital is 14 percent and is subject to a 40 percent tax rate, find:
1. The net investment.
2. The after-tax incremental cash flow at the end of each year.
3. The internal rate of return on the investment.
4. The net present value of the investment.
8.13 ? The Cornchopper Company is considering the purchase of a new harvester. Cornchopper has hired you to determine the break-even purchase price (in terms of present value) of the harvester. This break-even purchase price is the price at which the project’s NPV is zero. Base your analysis on the following facts: The new harvester is not expected to affect revenues, but pretax operating expenses will be reduced by $10,000 per year for 10 years. and has been depreciated by the straight-line method.
? The old harvester can be sold for $20,000 today.
? The new harvester will be depreciated by the straight-line method over its 10-year life.
? The firm’s required rate of return is 15 percent.
? The initial investment, the proceeds from selling the old harvester, and any resulting tax effects occur immediately.
? The corporate tax rate is 34 percent when they are realized.
? All other cash flows occur at year-end.
? The market value of each harvester at the end of its economic
12.3 The correlation between the returns on Ceramics Craftsman, Inc., and the returns on the S&P 500 is 0.675. The variance of the returns on Ceramics Craftsman, Inc., is 0.004225, and the variance of the returns on the S&P 500 is 0.001467. What is the beta of Ceramics Craftsman stock?
12.8 The following table lists possible rates of return on Compton Technology’s stock and debt and on the market portfolio. The probability of each state is also listed.
State Probability Return on Stock (%) Return on Debt (%) Return on the Market (%)
1 0.1 3% 8% 5%
2 0.3 8 8 10
3 0.4 20 10 15
4 0.2 15 10 20
1. What is the beta of Compton Technology debt?
2. What is the beta of Compton Technology stock?
3. If the debt-to-equity ratio of Compton Technology is 0.5, what is the asset beta of Compton Technology? Assume no taxes.
29.1 The Lager Brewing Corporation has acquired the Philadelphia Pretzel Company in a vertical merger. Lager Brewing has issued $300,000 in new long-term debt to pay for its purchase. ($300,000 is the purchase price.) Construct the balance sheet for the new corporation if the merger is treated as a purchase for accounting purposes. The balance sheets shown here represent the assets of both firms at their true market values. Assume these market values are also the book values.
LAGER BREWING CORPORATION
Balance Sheet
(in $ thousands)
Current assets $ 400 Current liabilities $ 200
Other assets 100 Long-term debt 100
Net fixed assets 500 Equity 700
Total $1,000 Total $1,000
PHILADELPHIA PRETZEL COMPANY
Balance Sheet
(in $ thousands)
Current assets $ 80 Current liabilities $ 80
Other assets 40 Equity 120
Net fixed assets 80
Total $200 Total $200
29.4 Indicate whether you think the following claims regarding takeovers are true or false. In each case provide a brief explanation for your answer.
1. By merging competitors, takeovers have created monopolies that will raise product prices, reduce production, and harm consumers.
2. Managers act in their own interests at times and, in reality, may not be answerable to shareholders. Takeovers may reflect runaway management.
3. In an efficient market, takeovers would not occur because market price would reflect the true value of corporations. Thus, bidding firms would not be justified in paying premiums above market prices for target firms.
4. Traders and institutional investors, having extremely short time horizons, are influenced by their perceptions of what other market traders will be thinking of stock prospects and do not value takeovers based on fundamental factors. Thus, they will sell shares in target firms despite the true value of the firms.
5. Mergers are a way of avoiding taxes because they allow the acquiring firm to write up the value of the assets of the acquired firm.
6. Acquisitions analysis frequently focuses on the total value of the firms involved. An acquisition, however, will usually affect relative values of stocks and bonds, as well as their total value.
To help strengthen my skills
Weighted average cost of capital
EXAMPLE OF SETUP FOR PROBLEM 18:
(1) Cost (after-tax) (2) Weights (3) Weighted Cost
Debt Kd
Preferred stock Kp
Common equity (retained Ke
earnings)
Weighted average cost of Ka
Capital
Problem 18:
Debt 30%
Preferred stock 15
Common equity 55
Additional information:
Bond coupon rate 13%
Bond yield to maturity 11%
Dividend, expected common $3.00
Dividend, preferred $10.00
Price, common $50.00
Price, preferred $98.00
Flotation cost, preferred $5.50
Growth rate 8%
Corporate tax rate 30%
10. The shares of the Dyer Drilling Co. sell for $60. The firm has a P/E ratio of 15.
Forty percent of earnings is paid out in dividends. What is the firm’s dividend
yield?
12. Stan Pearl owns 300 shares of Royal Optical Company stock, which he bought for $16 per share.
He is in a 35 percent tax bracket. It is the first week in December, and he has already received the
Full cash dividend for the year of $1.20 per share. For his tax bracket, dividends are now taxed
At 15 percent. The stock is currently selling for 301/8. He has decided to sell the stock and
After paying broker commissions, his net proceeds will be $30 per share. His tax rate on
Capital gains is also 15 percent (the capital gains are long-term).
Page 2
4. The bonds of Goldman Sack Co. have a conversion premium of $55. Their
conversion price is $40. The common stock price is $42. What is the price of
the convertible bonds?
There was an upward trend in the ratio of the book value of debt to the book value of debt and equity throughout the 1990s. Some of this was due to the repurchasing of stock. The market value ratio of debt to debt and equity exhibited no upward trend. This can be explained by ?
1. the change in the accounting rules of the period.
2. the difference between tax accounting and accounting for financial accounting purposes.
3. a large increase in the market value of equity that was greater than the increase in debt.
4. none of the above.
A levered firm is a company that ?
1. is financed by common stock.
2. has some debt in the capital structure.
3. has all equity in the capital structure.
4. is all of the above.
5. is none of the above.
Technically speaking, a long-term corporate debt offering that features a specific attachment to property is generally called a ?
1. debenture.
2. long-term liability.
3. preferred liability.
4. bond.
In analyzing the financial decisions of a firm, it turns out that the typical firm ?
1. has more capital expenditure opportunities with positive NPVs than financing opportunities.
2. has about the same number of capital expenditure opportunities and financing opportunities.
3. has more financing opportunities with positive NPVs than capital expenditure opportunities.
4. has no opportunities for positive NPVs in either capital expenditures or in financing.
Please answer the following questions, by chosing the best answer below it.
Financial managers can create value through financing decisions that?
1. reduce costs or increase subsidies.
2. increase the product prices.
3. create a new security.
4. do both a and b.
5. do both a and c.
The change in firm value in the presence of corporate taxes is?
1. positive, as equityholders gain the tax shield on the debt interest.
2. positive, as equityholders face a lower effective tax rate.
3. negative because of the increased risk of default and fewer shares outstanding.
4. negative because of a reduction of equity outstanding.
1. which ratio’s do you feel would be a MUST in the mortgage crisis??
2. isn’t an extraordinary event posted “NET” of taxes?
3. the financial impacted is the P&L….now, where on the P&L can we see an extraordinary event listed?
4. solvency ratio’s are used mostly by banks?? What ratio’s could have been used to prevent some of the financial’s hiccups we are seeing today??
5. working capital impacts what financial decisons?
6. sales are trended commonly, also operating expenses are trended. What are operating expenses?
7. what are examples of “elements” being analyzed/trended?
8. how many years is ideal for a trend?
9. financial are top / down?
10. what financial do these extraordinary items impact?
11. how is a “discontinued operation” distinguished…what separates this from the normal operation??
12. common stock is the first type of offered stock. Which is next?
13. which acct(s) are impacted when monies are withdrawn from a business
14. What is an “operating lease
15. what is a “capital lease”?
16. When is it the RIGHT time to “lease”, or perhaps “buy”?
Please see questions attached.
Please respond in a word document format.
1. Fondren Exploration, Ltd., has 1,000 convertible bonds ($1,000 par value) outstanding, each of which may be converted to 50 shares. The $1 million worth of bonds has 25 years to maturity. The current price of the stock is $26 per share. The firm’s net income in the most recent fiscal year was $270,000. The bonds pay 12 percent interest. The corporation has 150,000 shares of common stock outstanding. Current market rates on long-term nonconvertible bonds of equal quality are 14 percent. A 35 percent tax rate is assumed.
a. Compute diluted earnings per share.
2. Worldwide Scientific Equipment is considering a cash acquisition of Medical Labs for $1.5 million Medical Labs will provide the following pattern of cash inflows and synergistic benefits for the next 25 years. There is no tax loss carryforward.
Years
1-5 6-15 16-25
Cash inflow (aftertax) $100,000 $120,000 $160,000
Synergistic Benefits (aftertax) 15,000 25,000 45,000
The cost of capital for the acquiring firm is 9 percent. Should the merger be undertaken?
3. General Meters is considering two mergers. The first is with Firm A its own volatile industry, the auto speedometer industry, wheras the second is a merger with firm B in an industry that moves in the opposite direction (and will tend to level out performance due to negative correlation).
a. Compute the mean, standard deviation, and coefficient of variation forboth investments.
Merge with Firm A
Possible Earnings (millions) Probablility
$40…………………………… .30
$50…………………………… .40
$60…………………………… .30
Merge with Firm B
Possible Earnings (millions) Probablility
$10…………………………… .25
$50…………………………… .50
$90…………………………… .25
b. Assuming investors are risk-averse, which alternative can be expected to bring the higher valuation?
Describe your question and receive a step-by-step response ASAP.
Attachment below.
1. Suppose Lucent Techologies has an equity cost of capital of 10% , market capitalization of $10.8 billiion, and an enterprise value of $14.4 billion. Suppose Lupent’s cost of capital is 6.1% and its marginal tax rate is 35%
a. What is Lucent’s WACC?
b. If Lucent maintains a constant debt-equity ratio, what is the value of a project with average risk and the following expected free cash flows?
Year 0 1 2 3
FCF -100 50 100 70
c. If Lucent maintains its debt-equity, what is the debt capacity of the project in part (b)
2. Consider Lucent’s project in Problem 1 above
a. What is Lucent’s unlevered cost of capital?
b. What is the unlevered value of the project
c. What are the interest tax shields from the project? What is their present value?
d. Show that the APV of Lucent’s project matches the value computed using the WACC method.
3. Consider Lucent’s project in problem 1 above again.
a. What is the free cash flow to equity for this project?
b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method?
Please see the attached file.
You need to show your working for your answers.
1. The Sally Corporation’s income statement is given below.
Sally Corporation
Sales…………………………………$250,000
Cost of Goods Sold………………….. 145,000
Gross Profit……………………………105,000
Fixed Charges (other than interest)…… 25,000
Income before interest and taxes………..80,000
Interest…………………………………..20,000
Income before taxes……………………. 60,000
Taxes (35%)…………………………….. 21,000
Income after taxes……………………….$39,000
a. What is Sally’s Time-Interest-Earned Ratio?
b. What is the Fixed-Charge-Coverage Ratio? Go to investopedia.com. Formula is given.
c. What is the Net Profit Margin?
d. What is the Gross Profit Margin?
2. Given the following information, prepare, in good form, an income statement for the Dental Drilling Company as of December 31, 2003.
Selling and administrative expense $ 60,000
Depreciation expense 70,000
Sales 470,000
Interest expense 40,000
Cost of goods sold 140,000
Taxes 45,000
3. Database Systems is considering expansion into a new product line. Assets to support expansion will cost $500,000. It is estimated that Database can generate $1,200,000 in annual sales, with a 6 percent profit margin. What would net income and return on assets (investment) be for the year?
4. For ABC Corporation as of December 31, 2002 prepare a Balance Sheet in proper order based on the following information.
Arrange the following items in proper balance sheet presentation.Accumulated depreciation $300,000Retained earnings 96,000Cash 10,000Bonds payable 136,000Accounts receivable 48,000Plant and equipment?original cost 680,000Accounts payable 35,000Allowance for bad debts 6,000Common stock $1 par, 100,000 shares outstanding 100,000Inventory 66,000Preferred stock, $50 par, 1,000 shares outstanding 50,000Marketable securities 20,000Investments 20,000Notes payable 33,000Capital paid in excess of par (common stock) 88,000
5. The cash account for Presley Corporation shows the following for the year ended December 31,2006.
Beginning cash balance . . . . . . . . . . $ ?
Cash receipts during year from:
Services . . . . . . . . . . . . . . . . . . . . . 2,214,000
Investments by owners . . . . . . . . . 93,000
Sale of land . . . . . . . . . . . . . . . . . . 194,000
Cash payments during year for:
Operating expenses . . . . . . . . . . . . 1,735,000
Taxes . . . . . . . . . . . . . . . . . . . . . . 207,000
Purchase of building . . . . . . . . . . . 352,000
Distributions to owners . . . . . . . . . 68,000
Ending cash balance . . . . . . . . . . . . . 815,000
Required:
Prepare a statement of cash flows for Presley Corporation for the year ended December 31,2006.
1) Bill has the chance to invest in a project that will generate year-end cash inflows of $1,500 each year for 2 yrs, $2,000 for each of the next 3 yrs, and $5,000 at the end of year 6. The required rate of return is 13.5% compounded annually. If the cost to invest in this project is $8,200, what is the Net Present Value of the project and should Bill accept the project?
2) After winning $1,000,000, Jill decides to make an endowment to the local school that will fund a scholarship of $8,000 every year for the next 30 yrs. The market interest rate for a deposit account that will disperse such an annuity is 9.5% compounded annually. What amount must Jill invest in this account today to fund this annuity for 30 yrs (the 30th payment will zero out the account)?
3) Tim has an investment budget of $25,000 available to acquire one of three mutually exclusive projects. The cost and projected cash flows for the three projects below:
Project 1 Project 2 Project 3
Project Initial Cost $20,000 $25,000 $20,000
Year 1 Cash Flow $15,000 $12,000 $10,000
Year 2 Cash Flow $5,000 $8,000 $8,000
Year 3 Cash Flow $5,000 $7,000 $6,000
Year 4 Cash Flow $6,000 $10,000 $5,000
Year 5 Cash Flow $1,000 $1,000 $3,000
1. What is the Payback Period for each project?
2. Assuming the projects are comparable in risk and therefore have the same discount rate of 12%, what is the Net Present Value for each project?
3. Which project, if any, should Tim accept and why?
1- What is the future value for $1000 compounded annually using each of variable below?
Number of years Interest Rate
5 3.0%
15 12.0%
7 5.0%
2- What is the present value of the following amounts?
Amount to be received in (n) years Discount rate
$10,000 5 10.0%
$1,000 3 5.0%
$20,000 20 8.0%
3- How much do you need to invest now in order to have 2.0 million at the end of 30 years if the interest rate is 10%.
4- You found a valuable oil painting in your attic. You have received two bids for the painting. One bid is for $1.0 million and the second bid is for $2.0 million. But you will have to wait 5 years to receive the money. Your investment advisor has informed you that you can earn 12% interest on the $1.0 million if you choose which is better?
5- What is the market price of the following bonds?
Face amount = $1000
Coupon rate= 6.00%
Market rate of the similar bonds = 10.00%
Bond maturity date = December 31,2009
Assume the today’s date is Jan. 1, 2007
6-Prepare a loan amortization schedule for a auto loan of $18,000 , 8% 60 months loan. Show only the first year make sure your schedule includes the balance of the loan at the end of the year.
3. If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $50, what is the stock’s expected dividend yield for the coming year?
a. 4.42%
b. 4.66%
c. 4.89%
d. 5.13%
e. 5.39%
8. Taggart Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year 0 1 2 3
Cash flows -$1,150 $500 $500 $500
a. 1.86 years
b. 2.07 years
c. 2.30 years
d. 2.53 years
e. 2.78 years
10. The relative risk of a proposed project is best accounted for by which of the following procedures?
a. Adjusting the discount rate upward if the project is judged to have above-average risk.
b. Adjusting the discount rate downward if the project is judged to have above-average risk.
c. Reducing the NPV by 10% for risky projects.
d. Picking a risk factor equal to the average discount rate.
e. Ignoring risk because project risk cannot be measured accurately
22. Inmoo Company’s average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?
a. 63 days
b. 67 days
c. 70 days
d. 74 days
e. 78 days
Please see word document attached.
? P-2.12, Understanding and Analyzing Financial Statement Relationships, page 66. This exercise introduces some basic relationships within financial statements.
o Gary’s TV had the following accounts and amounts in its financial statements on December 31, 2010. Assume that all balance sheet items reflect account balances at December 31, 2010, and that all income statement items reflect activities that occurred during the year then ended.
Interest expense 36,000
Paid-in capital 80,000
Accumulated depreciation 24,000
Notes payable (long-term) 280,000
Rent expense 72,000
Merchandise inventory 840,000
Accounts receivable 192,000
Depreciation expense 12,000
Land 128,000
Retained earnings 900,000
Cash 144,000
Cost of goods sold 1,760,000
Equipment 72,000
Income tax expense 240,000
Accounts payable 92,000
Sales revenue 2,480,000
Required:
a. Calculate the differences between current assets and current liabilities for Gary’s TV at December 31, 2010.
b. Calculate the total assets at December 31, 2010.
c. Calculate the earnings from operations (operating income) for the year ended December 31, 2010.
d. Calculate the net income (or loss) for the year ended December 31, 2010.
e. What was the average income tax rate for Gary’s TV for 2010?
f. If 256,000 of dividends had been declared and paid during the year, what was the January 1, 2010, balance of retained earnings?
? P-2.14, Prepare an Income Statement, Balance Sheet, and Statement of Changes in Owners’ Equity, pages 67-68. This question invites you to consider the composition of the financial statements.
Merchandise inventory 264,000
Notes payable (long-term) 300,000
Sales 900,000
Buildings and equipment 504,000
Selling, general, and administrative expenses 72,000
Accounts receivable 120,000
Common stock (42,000 shares) 210,000
Income tax expense 84,000
Cash 192,000
Retained earnings, 1/1/10 129,000
Accrued liabilities 18,000
Cost of goods sold 540,000
Accumulated depreciation 216,000
Interest expense 48,000
Accounts payable 90,000
Dividends declared and paid during 2010 39,000
Except as otherwise indicated, assume that all balance sheet items reflect account balances at December 31, 2010 and that all income statement items reflect activities that occurred during the year ended December 31, 2010. There were no changes in paid-in capital during the year.
Required:
a. Prepare an income statement and statement of changes in owners’ equity for the year ended December 31, 2010, and a balance sheet at December 31, 2010, for Shae, Inc.
? Based on the financial statements that you have prepared for part a, answer the questions in parts b-e. Provide brief explanations for each of your answers and state any assumptions you believe are necessary to ensure that your answers are correct
b. What is the company’s average income tax rate?
c. What interest rate is charged on long-term debt?
d. What is the par value per share of common stock?
e. What is the company’s dividend policy (i.e. what proportion of the company’s earning is used for dividends)?
? P-3.16, ROI Analysis Using DuPont Model, pages 98-99. This provides an opportunity to complete some useful financial analysis.
o Charlie’s Furniture Store has been in business for several years. The firm’s owners have described the store as a “high-price, high-service” operation that provides lots of assistance to its customers. Margin has averaged a relatively high 32% per year for several years, but turnover has been a relatively low 0.4 based on average total assets of $1,6000,000. A discount furniture store is about to open in the area served by Charlie’s, and management is considering lowering prices to compete effectively.
o Required:
a. Calculate current sales and ROI for Charlie’s Furniture Store.
b. Assuming that the new strategy would reduce margin to 20%, and assuming that average total assets would stay the same, calculate the sales that would be required to have the same ROI as Charlie’s currently earns.
c. Suppose you presented the results of your analysis in parts a and b of this problem to Charlie, and he replied, “What are you telling me? If I reduce my prices as planned, then I have to practically double my sales volume to earn the same return?” Given the results of your analysis, how would you react to Charlie?
d. Now suppose Charlie says, “You know, I’m not convinced that lowering prices is my only option in staying competitive. What if I were to increase my marketing effort? I’m thinking about kicking off a new advertising campaign after conducting more extensive market research to better identify who my target customer groups are.” In general, explain to Charlie what the likely impact of a successful strategy of this nature would be on margin, turnover, and ROI.
e. Think of an alternative strategy that might help Charlie maintain the competitiveness of his business. Explain the strategy, and then describe the likely impact of this strategy on margin, turnover, and ROI.
Please respond with at least five sentences to each question
1. How can firms in some industries receive a positive response from analysts and investors with return on assets (ROA) of 1 percent, while in other industries, an ROA of 10 percent is required?
2. How would one determine the viability of a company by looking at its financial statements over a given period of time?
3. How would a period of significant inflation affect the analysis of financial statements? (historical costs)
4. In examining the financial statements of a company, you notice that inventories are carried on a LIFO basis. Why would a firm choose LIFO over FIFO?
5. Why, in finance, are cash flows, as opposed to accrual accounting, used in determining the efficacy of a project?
6. How does the use of common-sized statements increase the efficiency of the financial analyst?
Chapter 8
Problems A 1
(Calculating the WACC) The required return on debt is 8%, the required return on equity is 14%, and the marginal tax rate is 40%. If the firm is financed 70% equity and 30% debt, what is the weighted average cost of capital?
A 4
(Estimating the WACC with three sources of capital) Eschevarria Research has the capital structure given here. If Eschevarria’s tax rate is 30%, what is its WACC?
Book Value Market Value Before-Tax Cost
Bonds $1,000 $1,000 8%
Preferred stock 400 300 9%
Common stock 600 1,700 14%
Chapter 9
Problems A 4
(Investment criteria) An investment of $100 returns exactly $100 in one year. The cost of capital is 10%.
1. What are the payback, NPV, and IRR for this investment?
2. Is this a profitable investment?
Chapter 10
Problem A 1
(Net income and net cash flows) Julie Stansfield has a bicycle rental shop with annual revenues of $200,000. Cash operating expenses for rent, labor, and utilities are $70,000. Depreciation is $40,000. Julie’s tax rate is 40%.
1. What should be Julie’s net income?
2. What is her net cash flow?
7. Explain why the bad debt percentage or any other similar credit-control percentage is not the ultimate measure of success in the management of accounts receivable. What is the key consideration?
8. What are three quantitative measures that can be applied to the collection policy of the firm?
9. What does the EOQ formula tell us? What assumption is made about the usage rate for inventory?
10. A borrower is often confronted with a stated interest rate and an effective interest rate. What is the difference, and which one should the financial manager recognize as the true cost of borrowing?
11. What is the difference between pledging accounts receivable and factoring accounts receivable?
12. What is meant by hedging in the financial futures market to offset interest rate risks?
Please see attached file.
All things being equal, a longer term bond ( say 20 yrs) carries a bigger risk than a shorter
term bond .
TRUE
What type of derivative contract would a corporation use to covert fixed interest payments to
floating rate interest payments ?
You want to purchase ATT Preferred Stock that pays a $2 dividend. If similar Preferred shares are earning a 5%
dividend rate, what would be the price per share you would pay for the ATT Preferred shares ?
You can afford to pay $1000/month towards a mortgage ( $12,000 annually).
30 year mortgages are currently @ 6%. How much can you borrow ?
Note: PV of an annuity ( ie periodic payment). The PV would be the mortgage amt. You want to borrow
A stock pays a Dividend of $1.20 per share and the dividend is expected to grow 6% each year. If an investor
expects a 12% return on his investment, what would be the price of the stock ?
Note: use formula for valuing common stock.
Give 2 reasons why the Payback method of evaluating different capital (long term) investment decisions
is flawed.
A stock is currently valued @ $40/share. If the risk involved in this stock increases with no change in
the dividend or the growth rate, what would you expect the price of the stock to do..FALL or RISE ?
How much money will you have in 20 years if you save $5,000 a year and earn 5% every year ?
Note: FV of an Annuity
Explain the difference between convertible bonds and bonds with warrants.
What would you pay for a 10 year savings bond that has a face value of $1000 and an annual return of 4%
Note: there are no interest payments (ie annuities) involved.
The price you pay today represents the PV of $ 1.
Which statement is FALSE ?
A
B
C
D
Under what circumstance will the DCFlow (NPV) of a long term capital project equal zero.
Note: answer involves IRR and the Cost of Capital.
How much will you have in 30 years if you invest a lump sum of $100,000 today and earn 10% per year ?
Note: FV of a $ 1
You have a Yen payable due in 6 months and you want to protect yourself from an increase in the Yen vs the Dollar.
You can use either an option or forward contract to protect you from a stronger Yen.
TRUE
FALSE
An instrument that gives you the right but not the obligation to buy or sell something in
the future at a price determined today is called..
A
B
C
D
A Bond that pay no interest during the life of the bond but is sold at a deep discount
( ie U.S. Savings Bonds) is known as a _____________________________________ Bond
A
B
C
D
The periodic fixed interest payment on a bond is referred to as a
A
B
C
D
A Bond that is issued w/o any collateral is known as a ______________________________
You buy $20,000 in bonds paying 10% coupon. The price is 106.5. What do you pay for these
bonds ?
In the example above, the yield you will earn on these bonds will be
A
B
C
You have an exposure (ie DM payable) and you protect yourself from adverse changes in the price of item
( ie you buy DM’s forward at today’s price). This action to reduce your risk is known as
_______________________________________
In the example above you enter into a Forward to Buy DM’s in the future BUT you have no underlying exposure
(ie no DM payable). You are simply betting on a higher DM to make money on your contract
This type of transaction is considered _____________________________.
Which item below is NOT considered a Capital Market instrument ?
A
B
C
D
Which of the following is NOT a derivative
A
B
C
D
E
Based on total $ amt outstanding what is the largest Capital market instument in use today?
A
B
C
D
Who usually has final approval on the dividend to be paid @ a major Corp ?
A
B
C
D
A Corp. is issuing 3 types of Bonds, all with the same maturity. Which Bond is most likely to have the highest
coupon (interest ) rate?
A
B
C
Which statement is False
A
B
C
D
A primary factor in setting dividend policy is to
A
B
C
You can purchase a 7% taxable bond or a 5% tax free muni. Your marginal
tax rate is 40%. Which provides a higher after tax return ?
The required rate of return involves three premiums. The first is the
real rate of return (usually 2-3%). What are the other two ?
Unlike common and preferred stock valuation models, determining the value of a bond
is a bit more complex (don’t worry, you do not have to calculate anything).
It involves: the PV of an annuity on the _________________________ of the bond
and the simple PV of a $ on the _______________________ of the bond.
Fill in the blanks.
If the IRR on a project is 15% and the NPV comes out negative, what can you say about your
Cost of Capital ?
Your capital stucture consist of $300 MM in Debt & $600 MM in Equity. What is your Weighted avg.cost of capital
if your borrowing rate is 9%, your cost of comn stock (equity) is 12% and your tax rate is 50% ?
All things being equal, if the inflation premium in investor’s required rate of return were to
increase, you can expect
A
B
C
D
Which is NOT a difference btw common and preferred stock
A
B
C
D
4.) Lease or Buy. Your company wants to purchase a new network file server for its wide-area computer network. The server costs $75,000. It will be completely obsolete in three years. Your options are to borrow the money at 10 percent or to lease the machine. If you lease, the payments will be $27,000 per year, payable at the end of each of the next three years. If you buy the server, you can depreciate it straight-line to zero over three years. The tax is 34 percent. Should you lease or buy?
5.) Growth Enterprises believes its latest project, which will cost $80,000 to install, will generate a perpetual growing stream of cash flows. Cash flow at the end of this year will be $5,000, and cash flows in future years are expected to grow indefinitely at an annual rate of 5 percent.
a. If the discount rate for this project is 10 percent, what is the project NPV?
b. What is the project IRR?
6.) Find the WACC of William Tell Computers. The total book value of the firm’s equity is $10 million; book value per share is $20. The stock sells for a price of $30 per share, and the cost of equity is 15 percent. The firm’s bonds have a par value of $5 million and sell at a price of 110 percent of par. The yield to maturity on the bonds is 9 percent, and the firm’s tax rate is 40 percent.
5. The agency problem can seriously restrain the economic success of a company. What avenues are available to shareholders to bring their goals and those of management into alignment?
6. What is the corporate tax paid by a firm with taxable income of $300,000, given the following tax tables.$0 – $50,000 15%$50,000 – $75,000 25%$75,000 – $100,000 34%$100,000- $335,000 39%
7. A firm is planning to lower its ACP by ten days next year. Receivables are currently $15M on credit sales of $120M Credit sales are expected to grow by 20% next year. Calculate next year’s ending receivables balance (make calculations using ending balances and a 360 day year).
8. The following information is available in general and about investments in stocks J and K. The market return (kM) = 9% The risk free rate (kRF) = 5% Stock J’s beta = 0.8 Expected constant growth rate for Stock J = 6% Investment in Stock J = $80,000 Stock K’s beta = 1.4 Expected constant growth rate for Stock K = 7% Investment in Stock K = $120,000 a. What are the expected returns on Stock J and Stock K individually? b. What is the expected return on the portfolio? c. If Stock K just paid a dividend of $2.50, what is Stock K’s intrinsic value?
9. Baxter Inc. is in a fast growing industry, but doesn’t seem to be able to match its competitors’ growth rates. Selected financial information for Baxter is as follows ($000): Baxter Sales $20,000 EAT $ 1,000 Total Assets $10,000 Equity $ 8,000 Annual dividend $ 700 Research has revealed that the average firm in Baxter’s industry pays out 10% of its earnings in dividends, earns 4 cents after tax on every sales dollar, has an equity multiplier of 3.0 and a total asset turnover of 1.9. a. Use a sustainable growth rate analysis in the following table to determine the source(s) of Baxter’s growth problems. gs = Retention Ratio x Return on Sales x Total Asset Turnover x Equity Multiplier Industry Baxter b. What negatives might be associated with fixing the problems revealed by the analysis?
10. Assume the following partially completed financial plan ($000): Income Statement Balance Sheet Next Year This Year Next Year Revenue $5,000 Total assets $1,000 $2,000 Operating expenses 4,000 Liabilities & equity: EBIT 1,000 Current liabilities $ 576 $ 200 Interest (8%) ? Long-term debt 100 ? EBT ? Equity 324 ? Taxes(40%) ? Earnings after tax ? Total liabilities & equity $1,000 $2,000 The firm pays 8% interest on all of its debt and is subject to a 40% tax rate. Complete the plan.
This is a business financials problem I need major help on.
Problem 1 –
EPS Analysis
ABC Company has 11,000 shares of equity outstanding with a market price of $100. The company is not encumbered with any debt. Management is looking at two alternative recapitalization plans. The first alternative calls for issuing $250,000 of debt. The second alternative calls for issuing $500,000 of debt. The proceeds from the debt issuance would be used to buy back equity shares at market price (i.e., treasury stock). The cost of debt is 7% annually. Assume that the company pays no taxes for purposes of this problem.
a) Earnings before interest and tax (EBIT) are expected to be either $90,000 or $150,000. What would be ABC company’s EPS at both income levels for the two refinancing plans? If both income possibilities are equally likely so that the expected EBIT is $130,000, what would be the expected EPS?
b) If EBIT will be equal to $100,000, what would EPS be under each of the two recapitalization plans? What does this confirm?
Problem 2 –
ABC Donut Company is operating an old machine that is not expected to last more than two years. In the next two years, the machine is expected to generate a cash inflow of $20,000 per year. A replacement machine is available at a cost of $150,000. The new machine would be more efficient and is expected to generate a net cash inflow of $75,000 per year for three years. Management is considering the replacement machine. The Donut Company’s cost of capital is 10 percent.
a. Assume that the current resale value of the old machine is zero and that the new machine will also have a zero resale value in the future. What is the annual-equivalent cash flow of using the new machine?
b. What should the management of the donut company do?
Problem 3 –
Company X has an equity beta of 1.25 and a debt to equity ratio of 2. The expected market portfolio return is 8 percent. The interest rate on governmental bonds is 4 percent. Company X can borrow long term at a rate of 6 percent. The corporate tax rate is 32 percent.
(a) What is the cost of equity?
(b) What is the cost of capital?
Problem 4 – C ash Flow Statement
The comparative balance sheet of Max Company, for 2008 and the preceding year ended December 31, 2007 appears below in condensed form: Year Year
2008 2007
Cash $ 45,000 $ 113,500
Accounts receivable (net) 51,300 58,000
Inventories 247,200 135,000
Investments 0 0
Equipment 493,000 375,000
Accumulated depreciation-equipment (113,700) (128,000)
$722,800 $553,500
Accounts payable $ 61,500 $ 42,600
Bonds payable, due 2012 50,000 100,000
Common stock, $10 par 250,000 200,000
Paid-in capital in excess of par–
common stock 125,000 50,000
Retained earnings 236,300 160,900
$722,800 $553,500
The income statement for the current year is as follows:
Sales $623,000
Cost of merchandise sold 348,500
Gross profit $274,500
Operating expenses:
Depreciation expense $24,700
Other operating expenses 75,300 100,000
Income from operations $174,500
Other income:
Gain on sale of investment $ 0
Other expense:
Interest expense 2,000 (2,000)
Income before income tax $172,500
Income tax 55,000
Net income $117,500
Additional data for the current year are as follows:
(a) Fully depreciated equipment costing $39,000 was scrapped, no salvage, and equipment was purchased for $157,000.
(b) Bonds payable for $50,000 were retired by payment at their face amount.
(c) 5,000 shares of common stock were issued at $25 for cash.
(d) Cash dividends declared were paid $42,100.
(e) All sales are on account.
Prepare a statement of cash flows, using the direct method of reporting cash flows from operating activities.
Problem 5 – Net Present Value
– Net Present Value, Internal Rate of Return and Profitability index methods
You must choose between the two projects whose cash flows are shown below. Both projects are of equivalent risk.
Year End Project A Project B
Now -$45,000 -$9,000
1 15,000 3,000
2 15,000 2,000
3 20,000 3,000
4 20,000 2,000
Compute for both projects:
a) the internal rate of return (IRR)
b) Assuming a 12% discount rate, compute net present value (NPV)
c) Assuming a 12% discount rate, compute profitability index (PI)
d) Assuming a 12% discount rate, which of the projects is better and why?
Finance Questions:
1. Monitoring is done by:
a. shareholders.
b the Board of Directors.
c independent accountants.
d all of the above.
2. A post-audit will
a. identify the problem that needs to be fixed.
b. check the accuracy of the cash flow forecasts.
c. suggest questions that should have been asked before.
d. do all of the above.
3. Generally, all other things being the same, firms with high levels of intangible assets tend to report.
a. higher than actual ROI.
b lower than actual ROI.
c actual ROI.
d none of the above.
4. Goodwill from the purchase of another firm is
a. not an amortized expense.
b. not tax deductible.
c. not to be expensed for financial reporting purposes.
d any of the above.
none of the above.
5. Concerning accounting treatment of mergers, which of the following statements is correct?
a. With the pooling method, the amount paid in excess of book value is added to the capital surplus account.
b. Taxes will generally be higher if the purchase method is used.
c. Firms may prefer the purchase method in order to deduct goodwill for tax purposes.
d. Firms may prefer the pooling method in order to “write up” the acquired firm’s assets.
e. None of the above statements are correct.
6. In examining the issue of whether the choice of accounting methods affects stock prices, studies have found that
a. accounting depreciation methods can affect stock prices significantly.
b. switching depreciation methods can affect stock prices significantly.
c. accounting changes that increase accounting earnings also increase stock prices.
d. accounting changes can affect stock prices if the company either withholds information or provides incorrect information.
e. all of the above are true.
7. Financial economists prefer to use market values when measuring debt ratios because
a. Market values are more stable than book values.
b. Market values are a better reflection of current value than historical value.
c. Market values are readily available and do not have to be calculated like book values.
d. Market values are more difficult to calculate, making financial economists more valuable.
e. none of the above reasons.
8. For large firms, capital investment involves which of the following steps?
a. Process
b. Information
c. Incentives
d. Measuring performance
e. All of the above
9. In a graph depicting stock price changes over time in reaction to announcements providing new information, three possible patterns exist. In a “bubble” pattern there is a sharp increase at announcement followed by a gradual increase followed by a gradual decrease. In an “early response” pattern a gradual increase in price occurs before the announcement. In the “delayed response” pattern there is a slow or late increase in price after the announcement, then a strong movement to the equilibrium price followed by no additional change in price from that announcement. Which of these patterns would be indicative of inefficient markets?
a. Bubble
b. Delayed
c Early
d All of the above
e None of the above
10. The stock market crash of October 1987 and the Great Crash of 1929, although not fully explained, may be (partially) explained by
a. new information coming to the market; being efficient, the market was priced down.
b. technical difficulties in order processing.
c. the bubble theory, which states that prices move wildly above equilibrium values and eventually fall back to equilibrium, causing large losses.
d. the conspiracy theory that large institutions and rich investors control the market and caused the general population to suffer large wealth losses.
e. none of the above.
11. An annuity
a. is a series of equal payments through time.
b. is a debt instrument that pays no interest.
c. has no value.
d. is a stream of payments that varies with current market interest.
12. The time value of money concept can be defined as
a. the time in your life when you receive an inheritance.
b. the relationship between money spent versus money received.
c. the relationship between a dollar to be received in the future and a dollar today.
d. the relationship of interest rate stated and amount paid.
e. none of the above.
13. An important reason for acquisitions is that the combined firm may generate greater revenue than the two separate firms could. Examples of revenue enhancement would not include
a. an elimination of a previously ineffective media effort.
b. an elimination of a previously ineffective advertising effort.
c. an elimination of a weak existing distribution effort.
d. economies of scale.
e. All of the above would be examples of revenue enhancement.
14. The financial aspect of strategic planning involves
a. identifying businesses in which the firm has a competitive advantage for possible acquisition.
b. identifying businesses to sell or liquidate.
c. identifying declining businesses that should be allowed to run down
d. all of the above
15. Your company has decided to expand its business and open a regional branch office in the Midwest. You have been directed to research and recommend three possible cities in which to locate the new regional branch. Which of the following criteria will be important for you to include in your recommendation?
a. The socioeconomic makeup of the communities within 20 miles of the new location
b. The unemployment rate in the area within a 30-minute drive from the new location
c. The cost per square foot for newly developed industrial and office space within 3 miles of the new location
d. The number of colleges and universities within 10 miles of the new location
e. All of the above
16. What is the best primary source of financial data for conducting initial due diligence on a public company that you may have an interest in acquiring?
a. The Delaware Secretary of State
b. The United States Federal Trade Commission
c. The industry’s trade association
d. The United States Securities Exchange Commission
I have three complex questions I’m having a hard time comprehending.
(Problem 1)
The Shrieve Corporation has $10,000 that it plans to invest in marketable securities. It is choosing among AT&T bonds, which yield 7.5%, state of Florida muni bonds, which yield 5%, and AT&T preferred stock, with a dividend yield of 6%. Shrieve’s corporate tax rate is 35%, and 70% of the dividends received are tax exempt. Find the after-tax returns on both securities.
(Problem 2)
You buy a share of The Ludwig Corporation stock for $21.40. You expect it to pay dividends of $1.07, $1.1449, and $1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $26.22 at the end of 3 years.
a. Calculate the growth rate in dividends.
b. Calculate the expected dividend yield.
c. Assuming the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to get the expected total rate of return. What is the stock’s expected total rate of return?
(Problem 3)
On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm’s present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt.
Debt $30,000,000
Common equity $30,000,000
Total capital $60,000,000
New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. Stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so $1.20/$30 = 4%.) The marginal corporate tax rate is 40%.
a. To maintain the present capital structure, how much of the new investment must be financed by common equity?
b. Assume that there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity. What is the WACC?
c. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC?
1. Paul Bearer may elect to take a lump-sum payment of $25,000 from his insurance policy or an annuity of $3,200 annually as long as he lives. How long must Paul anticipate living for the annuity to be preferable to a lump sum if his opportunity rate is 8%?
a) Approximately 8 years
b) Approximately 10 years
c) Approximately 13 years
d) Approximately 15 years
2. Jack Jones is interested in buying some bonds. The bonds have a 12% coupon rate and mature in 20 years. If the bonds have a par value of $1,000 and are currently selling for $1,160, what is the approximate yield to maturity on the bonds?
a) 12%
b) 11.6%
c) 8.3%
d) 10.22%
Could someone please help me on these problems?
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Problem 7
Heather Smith is considering a bond investment in Locklear Airlines. The $1,000 par value bonds have a quoted annual interest rate of 9 percent and interest is paid semiannually. The yield to maturity on the bonds is 12 percent annual interest. There are 15 years to maturity. Compute the price of the bonds based on semiannual analysis.
Problem 9
Stagnant Iron and Steel currently pays a $4.20 annual cash dividend (D0). They plan to maintain the dividend at this level for the foreseeable future as no future growth is anticipated.
Of the required rate of return by common stockholders (Ke) is 12 percent, what is the price of the common stock?
Problem 10
A firm pays a $3.80 dividend at the end of year one (D1), has a stock price of $50, and a constant growth rate (g) of 4 percent.
Compute the required rate of return (Ke).
Problem 11
Tom Busby owes $20,000 now. A lender will carry the debt for four more years at 8 percent interest. That is, in this particular case, the amount owed will go up 8 percent per year for four years. The lender then will require Busby to pay off the loan over 12 years at 11 percent interest. What will his annual payments be?
Problem 12
A financial analyst is attempting to asses the future dividend policy of Environmental Systems by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 10 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 45 percent, and eventually reach 60 percent during the maturity stage (IV).
a. Assuming earnings per share will be the following during each of the four stages, indicate the cash dividend per share (if any) during each stage.
Stage I $ .15
Stage II 1.80
Stage III 2.60
Stage IV 3.10
b. Assume in Stage IV that an investor owns 275 shares and is in a 31 percent tax bracket, what will be the investor’s aftertax income from the cash dividend?
c. In what two stages is the firm most likely to utilize stock dividends or stock splits?
Problem 13
Pittsburgh Steel Company has a convertible bond outstanding, trading in the marketplace at $930. The par value is $1,000, the coupon rate is 8 percent, and the bond matures in 25 years. The conversion price is $50 and the company’s common stock is selling for $44 per share. Interest is paid semiannually.
a. What is the conversion value?
b. If similar bonds, which are not convertible, are currently yielding 10 percent, what is the pure bond value of this convertible bond? (Use semiannual analysis as described in Chapter 10.)
Problem 14
In problem 13, if the interest rate on similar bonds, which are not convertible, goes up from 10 percent to 12 percent, what will be the new pure bond value of the Pittsburgh Steel Company bonds? Assume the Pittsburgh Steel Company bonds have the same coupon rate of 8 percent as described in problem 13 and that 25 years remain to maturity. Use semiannual analysis.
Problem 15
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the following facts, is she correct? (Show calculations to prove your answer.)
Debt can be issued at a yield of 10.6 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $50, and pay a dividend of $4.40. The floatation cost on the preferred stock is $2.
—
1. Air Filter, Inc., sells its products for $6 per unit. It has the following costs:
Rent $100,000
Factory labor $1.20 per unit
Executive salaries $89,000
Raw material $.60 per unit
Separate the expenses between fixed and variable cost per unit. Using this information and the sales price per unit of $6, compute the break-even point.
6. Gibson & Sons, an appliance manufacturer, computes its break-even point strictly on the basis of cash expenditures related to fixed costs. Its total fixed costs are $1,200,000, but 25 percent of this value is represented by depreciation. Its contribution margin (price minus variable cost) for each unit is $2.40. How many units does the firm need to sell to reach the cash break-even point?
10. University Catering sells 50-pound bags of popcorn to university dormitories for $10 a bag. The fixed costs of this operation are $80,000, while the variable costs of the popcorn are $.10 per pound.
1. What is the break-even point in bags?
2. Calculate the profit or loss on 12,000 bags and on 25,000 bags.
3. What is the degree of operating leverage at 20,000 bags and at 25,000 bags? Why does the degree of operating leverage change as the quantity sold increases?
20. Mr. Katz is in the widget business. He currently sells 2 million widgets a year at $4 each. His variable cost to produce the widgets is $3 per unit, and he has $1,500,000 in fixed costs. His sales-to-assets ratio is four times, and 40 percent of his assets are financed with 9 percent debt, with the balance financed by common stock at $10 per share. The tax rate is 30 percent.
His brother-in-law, Mr. Doberman, says Mr. Katz is doing it all wrong. By reducing his price to $3.75 a widget, he could increase his volume of units sold by 40 percent. Fixed costs would remain constant, and variable costs would remain $3 per unit. His sales-to-assets ratio would be 5 times. Furthermore, he could increase his debt-to-assets ratio to 50 percent, with the balance in common stock. It is assumed that the interest rate would go up by 1 percent and the price of stock would remain constant.
? Compute earnings per share under the Katz plan.
? Compute earnings per share under the Doberman plan.
? Mr. Katz’s wife does not think that fixed costs would remain constant under the Doberman plan but that they would go up by 20 percent. If this is the case, should Mr. Katz shift to the Doberman plan, based on earnings per share?
1. During 1998, the Senbet Discount Tire Company had gross sales of $1 million. The firmâ??s cost of goods sold and selling expenses were $300,000 and $200,000, respectively. These figures do not include depreciation. Senbet also had notes payable of $1 million. These notes carried an interest rate of 10 percent. Depreciation was $100,000. Senbetâ??s tax rate in 1998 was 35 percent.
a. What was Senbetâ??s net operating income?
b. What were the firmâ??s earnings before taxes?
c. What was Senbetâ??s net income?
d. What was Senbetâ??s operating cash flow?
2. Consider the following cash flows on two mutually exclusive projects that require an annual return of 15 percent. Working in the financial planning department for the Bahamas Recreation Corp., you are trying to compare different investment criteria to arrive at a sensible choice of these two projects.
Year Fishing Ride Deepwater New Submarine
0 _$600,000 _$1,800,000
1 270,000 1,000,000
2 350,000 700,000
3 300,000 900,000
a. Based on the discounted payback period rule, which project should be chosen?
b. If your decision rule is to accept the project with a greater IRR, which project should you choose?
c. Since you are fully aware of the IRR ruleâ??s scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose?
d. To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule?
3. Calgary Industries, Inc., is considering a new project that costs $25 million. The project will generate after-tax (year-end) cash flows of $7 million for five years. The firm has a debt-to-equity ratio of 0.75. The cost of equity is 15 percent and the cost of debt is 9 percent. The corporate tax rate is 35 percent. It appears that the project has the same risk as that of the overall firm. Should Calgary take on the project?
4. Explain what are the corporationâ??s advantages and disadvantages of the corporation form?
Addison Glass Company has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $925. Addison is in a 25 percent tax bracket. The firm wishes to know what the after tax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.
a. Compute the approximate yield to maturity on the old issue and use this as the yield for the new issue.
b. Make the appropriate tax adjustment to determine the after tax cost of debt.
In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market? Why?
Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market?
Why is the cost of issuing new common stock (Kn) higher than the cost of retained earnings (Ke)?
1. The price of a product is $1 a unit. A firm can produce this good with variable costs of $0.50 per unit and total fixed costs of $100. What is the break even level of output?
2. If increasing the use of financial leverage (debt financing) increases the return on equity (roe), why would a company not simply continue to use ever- increasing cost of debt financing?
3. a. Given the following schedules,
Debt/Assets Cost of Debt Cost of Equity Cost of Capital?
0% 7% 14% ?
10 7 14 ?
20 7 14 ?
30 8 14 ?
40 8 16 ?
50 10 18 ?
60 12 20 ?
What is firm’s cost of capital at the various combinations of debt and equity?
Determine the firm’s optimal capital structure by completing the balance sheet below to show the optimal combination of debt and equity financing
Balance Sheet for Firm X as of XX/XX/XX
Assets $100 Debt ?
Equity ?
$100
4. A firm has two investment opportunities. Each costs $1,000, and the firm’s cost of capital is 10 percent. The cash inflow of each investment is as follows:
cash inflow A B
year
1 300 100
2 300 200
3 300 400
4 300 500
a. Calculate the net present value (NPV) for A and B and determine which investment the firm should make?
b. What is the internal rate of return for investment A?
c. What is the payback period for each investment A and B?
5. A firm’s annual sales total is 7,890 units. The cost of placing an order is $100 and the per unit carrying costs are $2 a unit. What is the EOQ?
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