testbank for business finance (1)

8/14/2019 Testbank for Business Finance (1)

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CHAPTER TWO PROBLEMS

1. Your corporation has the following cash flows:

Operating income $250,000 Interest received 10,000

Interest paid 5,000 !ividends received 20,000 !ividends paid 50,000If the applica"le ta# ta"le is as follows: a#a"le Income %ate &&&&&&&&&&&&&& &&&& $ 0 & 25,000 1'( 25 & 50,000 1) 50 & *5,000 +0 *5 &100,000 0 over 100,000 '

hat is the corporation-s ta# lia"ilit/

$0,5+0

2. ast ear %attner %o"otics had $5 million in operating income 34I. he companhad net depreciation e#pense of $1 million and an interest e#pense of $1 million6 itscorporate ta# rate was 0 percent. he compan has $1 million in current assets and$ million in non&interest&"earing current lia"ilities6 it has $15 million in net plant ande7uipment. It estimates that it has an after&ta# cost of capital of 10 percent. 8ssumethat %attner9s onl non&cash item is depreciation.

a. hat was the compan9s net income for the ear/$2. million

". hat was the compan9s net cash flow/$+. million

c. hat was the compan9s net operating profit after ta#es O;8/$+.0 million

d. hat was the compan9s operating cash flow/$.0 million

e. If operating capital in the previous ear was $2 million, what was thecompan9s free cash flow


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ield on preferred stoc> with a 1'( "efore&ta# dividend ield would "e:

1.)(

. 8 *( coupon "ond issued " the state of ew Yor> sells for $1,000 and thus providesa *( ield to maturit. 50 million shares 50.0 50.0%etained earnings 225.0 20.5otal lia"ilities and e7uit $ '*2.0 $ '10.0

a. hat is the net operating profit O;8 for 2000/

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$)0,000,000

". hat are the amounts of net operating wor>ing capital for 1))) and 2000/

$210,000,000 and $1)2,000,000

c. hat are the amounts of total operating capital for 1))) and 2000/

$'0,000,000 and $)2,000,000

d. hat is free cash flow for 2000/

$5,000,000

e. Bow much did the firm reinvest in itself over the accounting period/

$1',500,000

f. 8t the present time 12C+1C2000, how large a chec> could the firm write withoutit "ouncing/

$12,000,000

*. 8 firm-s operating income 34I was $00 million, their depreciation e#pense was $0million, and their increase in net investment in operating capital was $*0 million.

8ssuming that the firm is in the 0( ta# "rac>et, what was their free cash flow/

$1*0 million

. In its recent income statement, Amith Aoftware Inc. reported $2+ million of net income,

and in its ear&end "alance sheet, Amith reported $01 million of retained earnings.he previous ear, its "alance sheet showed $+) million of retained earnings. hatwere the total dividends paid to shareholders during the most recent ear/

$11.0 million

). =o# =orporation recentl reported an 34I!8 of $5 million and $* million of netincome. he compan has $12 million interest e#pense and the corporate ta# rate is0.0( percent. hat was the compan-s depreciation and amortiDation e#pense/

$+.++ million

10. %avings Incorporated recentl reported net income of $5. million. Its operating income34I was $15 million, and its ta# rate was 0 percent. hat was the compan9sinterest e#pense/

$' million

11. In its recent income statement, Amith Aoftware Inc. reported paing $10 million individends to common shareholders, and in its ear&end "alance sheet, Amith reported$1) million of retained earnings. he previous ear, its "alance sheet showed $0

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million of retained earnings. hat was the firm9s net income during the most recentear/

$25.0 million

12. =ase Eotors recentl reported net income of $1) million. he firm-s ta# rate was

0.0( and interest e#pense was $' million. he compan-s after&ta# cost of capital is1.0( and the firm-s total investor supplied operating capital emploed e7uals $)5million. hat is the compan-s 3F8/

$).+0 million

1+. 4roo>s Aisters- operating income 34I is $1) million. he compan-s ta# rate is0.0(, and its operating cash flow is $1. million. he compan-s interest e#pense is$+) million. hat is the compan-s net cash flow/ 8ssume that depreciation is theonl non&cash item in the firm-s financial statements.

$125.0 million

1. Falua"le Incorporated9s stoc> currentl sells for $5 per share. he firm has 20 millionshare of common outstanding. he firm9s total de"t e7uals $'00 million and its commone7uit e7uals $00 million. hat is the firm9s mar>et value added/

$500 million

CHAPTER THREE PROBLEMS

1. 84=, Inc., sells all its merchandise on credit. It has a profit margin of (, an average

collection period of '0 das, receiva"les of $150,000, total assets of $+ million and ade"t ratio of 0.'. hat is the firm-s return on e7uit/

+.++ percent

2. he Amthe =orporation-s common stoc> is currentl selling at $100 per share whichrepresents a ;C3 ratio of 10. If the firm has 100 shares of common stoc> outstanding,a return on e7uit of 0.20, and a de"t ratio of 0.'*, what is its return on total assets/

'.* percent

+. If in>ler, Inc., has sales of $2 million per ear all credit and an average collectionperiod of +5 das, what is its average amount of accounts receiva"le outstandingassume a +'0 da ear/

$1),

. If a firm has total interest charges of $10,000 per ear, sales of $1 million, a ta# rate of0(, and a net profit margin of '(, what is the firm-s times interest earned ratio/

11 times5. 8 firm that has an e7uit multiplier of .0 will have a de"t ratio of:

0.*5.

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'. Given the following information, calculate the mar>et price per share of 8E, Inc.:

3arnings after interest and ta#es H $200,000 3arnings per share H $2.00 Atoc>holders- e7uit H $2,000,000

Ear>etC4oo> ratio H 0.20

$.00

*. 8 fire has destroed a large percentage of the financial records of Banson 8ssociates.You are charged with piecing together information in order to release a financial report.You have found the return on e7uit to "e 1(. If sales were $ million, the de"t ratio0.0, and total lia"ilities $2 million, what was the return on assets/

10.(

. 8ssume =onservative =orporation is 100( e7uit financed. =alculate the return one7uit given the following information:

1. 3arnings "efore ta#es H $2,000 2. Aales H $5,000 +. !ividend paout ratio H '0( . otal asset turnover H 2.0 5. 8pplica"le ta# rate H 50(

0 percent

). You are considering a new product for our firm to sell. It should cause a 15( increasein our profit margin "ut it will also re7uire a 50( increase in total assets. You e#pectto finance this asset growth entirel " de"t. If the following ratios were computed"efore the change, what will "e the new %O3 if the new product is sold "ut salesremain constant/

;rofit margin H 0.10 otal asset turnover H 2.0 37uit multiplier H 2

' percent

10. ohnstown =hemicals, Inc., has a current ratio of +.0, a 7uic> ratio of 2., and aninventor turnover of '. ohnstown-s total assets are $1 million and its de"t ratio is 0.20.he firm has no long&term de"t. hat is ohnstown-s sales figure/

$*20,000

11. =alculate the mar>et price of a share of 84=, Inc., given the following information:Atoc>holders- e7uit H $1,2506 priceCearnings ratio H 56 shares outstanding H 256mar>etC"oo> ratio H 1.5.

$*5.00

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12. amestown, Inc., has earnings after interest deductions "ut "efore ta#es of $+00. hecompan-s "efore&ta# times interest earned ratio is *.00. =alculate the compan-sinterest charges.

$50.00

1+. he G. Bo""s =ompan has determined that its return on e7uit is 15(. Eanagementis interested in the various components that went into this calculation. Bowever, one ofthe accountants has misplaced the profit margin ratio. 8s a finance wiDard, ou >nowhow to calculate the profit margin, given the following information: total de"tCtotalassets H 0.+5, and total asset turnover H 2.. hat is the profit margin/

+. percent

1. owe J =ompan has a de"t ratio of 0.5, a capital intensit ratio of , and a profitmargin of 10(. he 4oard of !irectors is unhapp with the current return on e7uit%O3, and the thin> it could "e dou"led. his could "e accomplished 1 "increasing the profit margin to 12( and 2 " increasing de"t utiliDation. otal assetturnover will not change. hat new de"t ratio, along with the 12( profit margin, is

re7uired to dou"le the %O3/*0 percent

15. he ocal =ompan is a relativel small, privatel owned firm. In 1)1 ocal had anafter&ta# income of $15,000, and 10,000 shares were outstanding. he owners weretring to determine the e7uili"rium mar>et value for ocal-s stoc>, prior to ta>ing thecompan pu"lic. 8 similar firm that is pu"licl traded had a priceCearnings ratio of 5.0.Ksing onl the information given, estimate the mar>et value of one share of ocal-sstoc>.

$*.50

1'. 3psilon =o.-s records have recentl "een destroed " fire. Given the following "its ofinformation saved from the inferno, determine 3psilon-s net income for 1))). %eturn on e7uit 22(

8ssetsCnet worth 2.1'*;rofit margin 5.'(otal assets $'50 million

$ ''.00 million

1*. !elta =orp. has sales of $+00,000, a profit margin of '.5 percent, a ta# rate of 15percent, and annual interest charges of $*,500. hat is !elta-s times interest earned/

.0'

1. =oastal ;ac>aging Ls %O3 last ear was onl + percent, "ut its management hasdeveloped a new operating plan designed to improve things. he new plan calls for atotal de"t ratio of '0 percent, which will result in interest charges of $+00 per ear.Eanagement pro@ects an 34I of $1,000 on sales of $10,000, and it e#pects to have atotal asset turnover ratio of 2.0. Knder these conditions, the average ta# rate will "e +0percent. If the changes are made, what return on e7uit will =oastal earn/

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2.5 percent

1). Yohe Inc. has an %O8 of 1+.( and a 10( profit margin. he compan has salese7ual to $5 million. hat are the compan-s total assets/

$+.*+ million

20. Yohe Inc. has a current ratio of 2, and a 7uic> ratio of 1..


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now/

'. percent

2. Interest rates on four&ear reasur securities are currentl * percent, while interestrates on si#&ear reasur securities are currentl *.5 percent. If the pure e#pectations

theor is correct, what does the mar>et "elieve that two&ear securities will "e ieldingfour ears from now/

.5 percent

+. he real ris>&free rate of interest is + percent. Inflation is e#pected to "e 2 percent thisear and percent during the ne#t two ears. 8ssume that the maturit ris> premium isDero. hat is the ield on +&ear reasur securities/

'.++ percent

. 8 reasur "ond that matures in 10 ears has a ield of ' percent. 8 10&ear corporate

"ond has a ield of percent. 8ssume that the li7uidit premium on the corporate"ond is 0.5 percent. hat is the default ris> premium on the corporate "ond/

1.5 percent

5. One&ear reasur securities ield 5 percent. he mar>et anticipates that 1 ear fromnow, one&ear reasur securities will ield ' percent. If the pure e#pectations theor iscorrect, what should "e the ield toda for 2&ear reasur securities/

5.5 percent

'. he real ris>&free rate is + percent, and inflation is e#pected to "e + percent for the ne#t2 ears. 8 2&ear reasur securit ields '.2 percent. hat is the maturit ris>premium for the 2&ear securit/

0.2 percent

*. he real ris>&free rate is + percent. Inflation is e#pected to "e + percent this ear, percent ne#t ear, and then +.5 percent thereafter. he maturit ris> premium isestimated to "e 0.0005 ? t&1, where t H num"er of ears to maturit, hat is thenominal interest rate on a *&ear reasur note/

'. percent

. 8ssume that the real ris>&free rate is 2 percent and that the maturit ris> premium isDero. If the nominal rate of interest on 1&ear "onds is 5 percent and that oncompara"le ris> 2&ear "onds is * percent, what is the 1&ear interest rate that ise#pected for ear two/

* percent

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). You see that the current +0&da &"ill rate is .5(. You are told " a friend whowor>s for an investment firm that the "est estimates of the current interest ratepremiums for relativel safe corporate firms is as follows: inflation premium H2.1(6 default ris> premium H 1.(. 4ased on this data, what is the real ris>&freerate of return/

2.(

10. he real ris>&free rate of interest is + percent. Inflation is e#pected to "e 5 percent thiscoming ear, @ump to ' percent ne#t ear, and increase to * percent the following earYear +. 8ccording to the e#pectations theor, what should "e the interest rate on +&ear, ris>&free securities toda/

) percent

11. !rongo =orporation9s &ear "onds currentl ield . percent. he real ris>&free rate of

interest, >N, is 2.* percent and is assumed to "e constant. he maturit ris> premiumE%; is estimated to "e 0.1(t & 1, where t is e7ual to the time to maturit. hedefault ris> and li7uidit premiums for this compan9s "onds total 0.) percent and are"elieved to "e the same for all "onds issued " this compan. If the average inflationrate is e#pected to "e 5 percent for ears 5, ', and *, what is the ield on a *&ear"ond for !rongo =orporation/

.)1 percent

12. One&ear reasur securities ield ' percent, 2&ear reasur securities ield '.5percent, and +&ear reasur securities ield * percent. 8ssume that the e#pectationstheor holds. hat does the mar>et e#pect will "e the ield on 1&ear reasur

securities two ears from now/

percent

1+. 8ssume that a +&ear reasur note has no maturit ris> premium, and that the realris>&free rate of interest is + percent. If the &note carries a ield to maturit of 10percent, and if the e#pected average inflation rate over the ne#t 2 ears is percent,what is the implied e#pected inflation rate during Year +/

5 percent

CHAPTER FIVE PROBLEMS

1. 8n investor holds a diversified portfolio consisting of a $5,000 investment in each of 20different common stoc>s. he portfolio "eta is e7ual to 1.12. he investor has decidedto sell a lead mining stoc> "eta H 1.0 at $5,000 net and use the proceeds to "u ali>e amount of a steel compan stoc> "eta H 2.0. hat is the new "eta for theportfolio/

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1.1*

2. =onsider the following information and calculate the re7uired rate of return for thein>ler Investment Investment 4eta

&&&&& &&&&&&&&&& &&&& 8 $ 200,000 1.50 4 +00,000 &0.50 = 500,000 1.25 ! 1,000,000 0.*5

he mar>et re7uired rate of return is 15( and the ris>&free rate is * percent.

1+.1 percent

+. he Aand =ompan has developed the following data regarding a pro@ect to add newdistri"ution facilities:

A83 ;%O484IIY ;%O3= %3K% E8%M3 %3K% 1 .+ 0.01 0.10 2 .* 0.15 0.1

8. hat is the e#pected return on the pro@ect/ 10.(

4. hat is the standard deviation of the pro@ect returns/ 0.0'2

=. hat is the coefficient of variation of pro@ect returns/ 0.5)

!. hat is the covariance of pro@ect returns with mar>et returns/ 0.0012

3. hat is the correlation coefficient "etween the pro@ect returns and the mar>etreturns/ 1.00

. =alculate the re7uired rate of return for Eanagement, Inc., assuming that investorse#pect a 5( rate of inflation in the future. he real rate is e7ual to +( and the mar>etris> premium is 5(. Eanagement has a "eta of 2.0 and has historicall returned anaverage of 15(.

1 percent

5. of si# firms. hefirms, mar>et value of shares held, and the "eta of each stoc> are as follows:

E8%M3 F8K3 O<


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8. =alculate the "eta of the mutual fund. 1.25

4. Auppose %mH 1' percent and %fH ' percent6 what is the e#pected portfolioreturn/ 1.5 percent

'. he following data pertains to the ne#t four 7uestions. Atoc>s 8 and 4 have returnsand pro"a"ilit distri"utions as given "elow.

;%O484IIY AO=M 8 AO=M 4 0.25 '( ( 0.+0 10( 2( 0.25 ( '( 0.20 ( (

8. =alculate the e#pected returns for Atoc>s 8 and 4.*.1( and 5.*(

4. hat are the standard deviations of e#pected returns for Atoc>s 8 and 4/

2.+2( and 2.55(

=. he covariance "etween Atoc>s 8 and 4 is: &0.000+'*

!. he correlation coefficient "etween Atoc>s 8 and 4 is: &0.'2

3. Auppose ou want to hold a portfolio composed of 50( of Atoc> 8 and 50( ofAtoc> 4. hat will "e the e#pected return mean and ris> standard deviationof our portfolio/

'.( and 1.0*(

*. You are managing a portfolio of 10 stoc>s which are held in e7ual amounts. hecurrent "eta of the portfolio is 1.', and the "eta of Atoc> 8 is 2.0. If Atoc> 8 is sold,what does the "eta of the replacement stoc> have to "e to have a new portfolio "eta of1.55/

1.10

. Given the following information concerning 8AA3A ? and Y:

;ossi"le %eturns of 8ssets Outcomes ;ro"a"ilit ? Y 1 0.10 0.00 &0.0 2 0.20 0.0 0.10 + 0.0 0.12 0.12 0.20 0.+0 0.1 5 0.10 0.'0 0.1'

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8. hat are the e#pected returns for 8AA3A ? and Y given the a"ovepro"a"ilities/

1.0 percent and10.0 percent

4. hat is the e#pected return of a portfolio comprised of 0 percent of an

investor-s wealth invested in 8AA3 ? and '0 percent invested in 8AA3 Y/1+. percent

=. hat are the standard deviations of the returns of the two securities/

1'. percent and 5.2 percent

!. hat is the =OF8%I8=3 "etween the two securities/

0.005

3. hat is the =O%%38IO "etween these two securities/

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$10,000

+. You start saving for our college education. You "egin college at age 1 and ou willneed $,000 per ear at the end of each of the ne#t ears. You will ma>e a deposit 1ear from toda in an account which pas '( compounded annuall and an identical

deposit each ear until ou start college. If a deposit of $1,)* will allow ou to reachour goal, how old are ou now/

12 ears old

4. On anuar 1, 1))5, a graduate student developed a financial plan which wouldprovide enough mone at the end of his graduate wor> anuar 1, 2000 to open a"usiness of his own. Bis plan was to deposit $,000 per ear, starting immediatel, intoan account paing 10( compounded annuall. Bis activities proceeded according toplan e#cept that at the end of his third ear he withdrew $5,000 to ta>e a =ari""eancruise, at the end of the fourth ear he withdrew $5,000 to "u a used =amaro, and atthe end of the fifth ear he had to withdraw $5,000 to pa to have his dissertationtped. Bis account, at the end of the fifth ear, will "e less than the amount he had

originall planned on " how much/

$1',550

5. You have "een given the following cash flows. hat is the present value t H 0 if thediscount rate is 12(/

0 1 2 + 5 ' &&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&& $0 $1 $2000 $2000 $2000 $0 &$2000

$+,2*'

'. 84= =orporation has "een en@oing a phenomenal rate of growth since its inceptionone ear ago. =urrentl assets total $100,000. If growth continues at the current rateof 12( compounded 7uarterl, what will "e total assets in 2 1C2 ears/

$1+,+)0

*. =harter 8ir is considering the purchase of an aircraft to supplement its current fleet. Inestimating the impact of adding this craft to their fleet, the have developed thefollowing cash flow analsis:

3nd of ear 1 &$1,000 2 $100,000 + $100,000 $100,000 5 $100,000 ' $100,000 * &$+00,000

If the discount rate is 10(, what is the present value of these estimated flows/

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$1),*52

. increased the interest rate paid onsavings accounts to 12(, annual compounding. You made a third $100 deposit on

8pril 1, 1)2. Bow much will "e in our account on anuar 1, 1)+/

$+).)5

11. You plan on wor>ing for 10 ears and then leaving for the 8las>an P"ac> countrQ. Youfigure ou can save $1,000 a ear for the first 5 ears and $2,000 a ear for the last 5ears. In addition, our famil has given ou a $5,000 graduation gift. If ou put thegift and our future savings in an account paing percent compounded annuall, whatwill our Psta>eQ "e when ou leave for the wilderness 10 ears hence/

$+1,112. If $100 is placed in an account that earns a nominal (, compounded 7uarterl, for 5

ears, what will it "e worth in 5 ears/

$122.02

1+. Bess !istri"utors is financing a new truc> with a loan of $10,000 to "e repaid in 5annual installments of $2,505. hat annual interest rate is the compan paing/

(

1. You have decided to deposit our scholarship mone $1,000 in a savings accountpaing ( interest, compounded 7uarterl. 3ighteen months later, ou decide to go tothe mountains rather than school and ou close out our account. Bow much mone

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will ou receive/

$1,12'

15. he present value t H 0 of the following cash flow stream is $',)*).0 whendiscounted at 1+( annuall. hat is the value of the EIAAIG t H 2 cash flow/

0 1 2 + &&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&&& $0 $ )00 $/ $2,100 $1,00

$ ,'2*

1*. You want to set up a trust fund. If ou ma>e a pament at the end of each ear fortwent ears and earn 10( per ear, how large must our annual paments "e so thatthe trust is worth $100,000 at the end of the twentieth ear/

$1,*5.)'

1. welve ears ago ou "ought a $25 stoc> which is now worth $*.*. 8ssuming thatthe stoc> paid no dividends, the rate of return on our investment was:

10(

1). Atarting on anuar 1, 1))1, and then on each anuar 1 until 2000 10 paments,ou will ma>e paments of $1,000 into an investment which ields 10 percent. Bowmuch will our investment "e worth on !ecem"er +1 in the ear 2010/

$5,'.2'

20. Your ')&ear old aunt has savings of $+5,000. Ahe has made arrangements to enter a

home for the aged on reaching the age of 0. Your aunt wants to decrease at aconstant amount each ear for ten ears, with a Dero "alance remaining. Bow muchcan she withdraw each ear if she earns ' percent annuall on her savings/ Ber firstwithdrawal would "e one ear from toda.

:. $,*55

21. 8 rich aunt promises ou $+5,000 e#actl 5 ears after ou graduate from college.hat is the value of the promised $+5,000 if ou could negotiate pament upongraduation/ 8ssume an interest rate of 12 percent.

$1),'0.05

22. In planning to "u a home ou are putting $2,500 of our end of ear "onus in anaccount that earns 10 percent. If our first pament "egins in e#actl one ear, howmuch of a down pament will ou "e a"le to afford at the end of ears/

$11,'02.50

2+.


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$15+,'15

2. If ou were promised 10 annual paments of $,000 starting with the first pamenttoda, compute the present value of these flows if our opportunit cost is * percent.

$+0,0'0.0

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12.'(

+0. Your "an> has offered ou a $15,000 loan. he terms of the loan re7uire ou to pa"ac> the loan in five e7ual annual installments of $,1'1.00. he first pament will "emade a ear from toda. hat is the effective rate of interest on this loan/

: 12(

+1. You have purchased a new sail"oat and have the option of paing the entire $,000now or ma>ing e7ual, annual paments for the ne#t ears, the first pament due oneear from now. If our time value of mone is * percent, what would "e the largestamount for the e7ual, annual paments that ou would "e willing to underta>e/

$2,+'2.00

+2. 8 firm purchases 100 acres of land for $200,000 and agrees to remit twent e7ualannual installments of $1,0'* each. hat is the true annual interest rate on thisloan/

20 percent

++. hirt ears ago, essie ohnson "ought ten acres of land for $500 per acre in what isnow downtown Bouston. If this land grew in value at a 10 percent per annum rate,what is it worth toda/

$ *,25

+. If ou put our mone in a "an> offering 12 percent compounded 7uarterl, how muchwill $1,0 grow to in five ears/

: $1,5.5

+5. hat is the future value of $1,250 compounded at an percent rate for ten ears/

$2,').'++'. ames Atreets- son Barold is five ears old toda. Barold is alread ma>ing plans to go

to college on his eighteenth "irthda and his father wants to start putting awa monenow for that purpose. Atreet estimates that Barold will need $1,000, $15,000,$1',000, and $1*,000 for his freshman, sophomore, @unior, and senior ears. Be planson ma>ing these amounts availa"le to Barold at the "eginning of each of these ears.Atreet would li>e to ma>e twelve deposits the first of which would "e made on Barold-ssi#th "irthda, 1 ear from now in an account earning 12 percent. Be wants theaccount to eventuall "e worth enough to pa for Barold-s college e#penses. 8n"alances remaining in the account will continue to earn 12 percent. Bow much willAtreet have to deposit in this planning account each ear to provide for Barold-seducation/

$21'5

+*. In our analsis of !4E =orporation ou find that the current earnings per share are$5.00 per share and most analsts are pro@ecting the earnings per share to grow at a12 percent rate annuall. hat can ou e#pect the earnings per share of this firm to "ein * ears/

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$11.0'

+. Your grandmother is thrilled that ou are going to college and plans to reward ou atgraduation with a ;orsche ur"o automo"ile. Ahe would li>e to set aside an e7ualamount at the completion of each of our college ears from her meager pension. If

her account earns 12 percent and a new ;orsche will cost $50,000, how much will shedeposit each ear/ 8ssume her first deposit is in e#actl one ear.

$10,'2.

+). AellDar =orporation currentl has sales of $100 million and its mar>eting department ispro@ecting sales to "e $00 million in ears. hat rate of growth in sales are themar>eting people pro@ecting/

'(

0. Auppose that a local savings and loan association advertises a ' percent annual rate ofinterest on regular accounts, compounded monthl. hat is the effective annual

percentage rate of interest paid " the savings and loan/

'.1'(

1. Greg ;err, K3;-s renowned computer @oc>, is graduating in one ear and plans tostart his own computer firm, namel ;err-s ;eriphals, Inc. 4eing a science fiction "uff,Greg is planning to start his firm using $50,000 he earned as a trom"one plaer in the4its and !iscs aDD 4and during college and retire in 20 ears in order to ta>e the firstIntergalactic Apace Ahuttle trip at an estimated cost of $10.5 million. hen Gregreturns to earth 10 ears thereafter, he plans to live off an annuit of $+00,000 perear, starting on the da of his return. his annuit was funded when he left on hisspace @ourne and is earning interest at 12 percent per ear. 4ut one of the sideeffects of the space shuttle program has "een that ever traveler dies e#actl 20 earsfrom the da of return. =alculate the growth rate of ;err-s ;eriphals that will ma>eGreg-s long&range plans possi"le.

+1.1 percent

2. ason and 4ran Ecutt are presentl + and 5 ears old. heir parents are planning tosend them to college at age 1 at a cost of $10,000 per ear for each. Bow much mustthe parents contri"ute annuall to a college fund to ensure the "os- college educationif the interest rate is 12 percent compounded annuall/ he paments start in one earand end when the ounger "rother starts college.

$2,05*

+. If ou have $5,+' in an account that has "een paing an annual rate of 10(,compounded continuousl, since ou deposited some funds 10 ears ago, how muchwas the original deposit/

$2,000

.


19/49

.0 percent

5. Bow much should ou "e willing to pa for an account toda that will have a value of$1,000 in 10 ears under continuous compounding if the nominal rate is 10(/

$+'

'. Your firm has recentl "orrowed $100,000 from a local "an> at an interest rate of 10percent. he loan is to "e repaid in 5 e7ual, end&of&ear paments. he following is apartial amortiDation schedule for the loan.

;rincipal Year ;ament Interest %eduction 4alance 0 $ 100,000 1 $ 2',+0 $ 10,000 $ 1',+0 $ +,'20 2 $ 2',+0 $ ,+'2 $ 8 $ '5,'02 + $ 2',+0 $ 4 $ 1),20 $ 5,*+ $ 2',+0 $ ,5* $ 21,01 $ 2+,)1 5 $ 2',+0 $ 2,+) $ 2+,)1 $ 0

8. he missing value for the ;rincipal %eduction in the second ear la"eled 8 is:

$ 1,01

4. he missing value for the Interest ;ament in the third ear la"eled 4 is:

$ ',5'0

*. You are valuing an investment that will pa ou $2,000 per ear for the first ' ears,$2,000 per ear for the ne#t 10 ears, and $5,000 per ear the following 1 ears allpaments are at the end of each ear. If the appropriate annual discount rate is

'.00(, what is the value of the investment to ou toda/

$'0,*CHAPTER SEVEN PROBLEMS

1.. =alculate the price of a 10 ear "ond paing a ' percent annual coupon half of the 'percent semiannuall on a face value of $1,000 if investors can earn percent onsimilar ris> investments.

$'+.*0

2. 8 ma@or auto manufacturer has e#perienced a mar>et re&evaluation latel due to anum"er of lawsuits. he firm has a "ond issue outstanding with 15 ears to maturit

and a coupon rate of ( paid semiannuall. he re7uired rate has now risen to 1'(.8t what price can these securities "e purchased on the mar>et/

$5).*1

+. he current mar>et price of a ones- =ompan "ond is $1,2)*.5. 8 10( couponinterest rate is paid semi&annuall, and the par value is e7ual to $1,000. hat is theYE on an annual "asis if the "onds mature 10 ears from toda/

19


20/49

' percent

. =ommonwealth =ompan has 100 "onds outstanding maturit value H $1,000. here7uired rate of return on these "onds is currentl 10(, and interest is paidsemiannuall. he "onds mature in 5 ears, and their current mar>et value is $*' per"ond. hat is the annual coupon interest rate/

( percent

5. You have @ust "een offered a "ond for $*.. he coupon rate is (, paa"leannuall, and interest rates on new issues of the same degree of ris> are 10(. Youwant to >now how man more interest paments ou will receive, "ut the part sellingthe "ond cannot remem"er. =an ou help him out/

15

'. ruptc papers. he firm was reorganiDed as !, Inc., andthe court permitted a new indenture on an outstanding "ond issue to "e put into effect.he issue has 10 ears to maturit and a coupon rate of 10(, paid annuall. he newagreement allows the firm to pa no interest for 5 ears and then at maturit to repaprincipal and an unpaid interest no interest on the unpaid interest. If the re7uiredreturn is 20(, what should such "onds sell for in the mar>et toda/

$+'2.

). In order to assess accuratel the capital structure of a firm, it is necessar to convertthe "alance sheet to a mar>et value "asis. he current "alance sheet is as follows:

ong&term de"t "onds $10,000,000 ;referred stoc> 2,000,000 =ommon stoc> $10 par 10,000,000 %etained earnings ,000,000 &&&&&&&&&&& otal de"t and e7uit $2',000,000

he "onds mature in 10 ears. Interest is paa"le semiannuall and the ield to maturit

20


21/49

is 12(. he coupon rate is percent. hat is the current mar>et value of the firm-sde"t/

$5.12 million

10. =alculate the ield to maturit on an annual "asis of an percent coupon, 10&ear

"ond that pas interest semiannuall if its price is now $**0.'0.

12 percent

11. You are the owner of 100 "onds issued " Eidterm =orporation. hese "onds have ears remaining to maturit, an annual coupon pament of $0, and a par value of$1,000. Knfortunatel, Eidterm is on the "rin> of "an>ruptc, and the creditors,including ourself, have agreed to a postponement of the ne#t interest paments.he remaining interest paments will "e made as scheduled. he postponed pamentswill accrue interest at an annual rate of '( and will "e paid as a lump sum at maturit ears hence. he re7uired rate of return on these "onds, considering their su"stantialris>, is now 2(. hat is the present value of each "ond/

$2''.)

12. he ?YR =ompan recentl issued a 20&ear, * percent semiannual coupon "ond atpar. 8fter three months, the mar>et interest rates on similar "onds increased to percent. 8t what price should the "onds sell/

$)1.

1+. I4? has a "ond issue outstanding that is calla"le in three ears at a 5 percent callpremium. he "ond pas a 10 percent annual coupon and has a remaining maturit of2+ ears. If the current mar>et price is $1000, than what is the ield to call/

11. percent

CHAPTER EIGHT PROBLEMS

1. he !8; =ompan has decided to ma>e a ma@or investment. he investment willre7uire a su"stantial earl cash out&flow, and inflows will "e relativel late. 8s a result,it is e#pected that the impact on the firm-s earnings for the first 2 ears will "e anegative growth of 5( annuall.


22/49

+. AG-s stoc> is selling for $15 per share. he firm-s income, assets, and stoc> pricehave "een growing at an annual 15( rate and are e#pected to continue to grow at thisrate for + more ears. o dividends have "een declared as et, "ut the firm intends todeclare a $2.00 dividend at the end of the last ear of its supernormal growth. 8fterthat, dividends are e#pected to grow at the firm-s normal growth rate of '(. he firm-sre7uired rate of return is 1(. You should:

Aell the stoc>6 it is overvalued " $+.0+.

. 44;, Inc., has e#perienced a recent resurgence in "usiness as it has gained newnational identit. Eanagement is forecasting rapid growth over the ne#t earsannual rate of 15(. 8fter that, it is e#pected that the firm will revert to its historicalgrowth rate of 2( annuall. he last dividend paid was $1.50 per share, and there7uired return is 10(. hat is the current price per share, assuming e7uili"rium/

$2).51

5. he =lu" 8uto ;arts =ompan has @ust recentl "een organiDed. It is e#pected toe#perience no growth for the ne#t 2 ears as it identifies its mar>et and ac7uires its

inventor. Bowever, =lu" will grow at an annual rate of 5( in the third and fourth earsand, "eginning with the fifth ear, should attain a 10( growth rate which it will sustainthereafter. he last dividend paid was $0.50 per share. =lu" has a cost of capital of12(. hat should "e the present price per share of =lu" common stoc>/

$20.

'. 8 share of !%F, Inc., stoc> paid a dividend of $1.50 last ear, and the dividend ise#pected to grow at a constant rate of ( in the future. he appropriate rate of returnon this stoc> is "elieved to "e 12(. hat should the stoc> sell for toda/

$1).50*. he ;et =ompan has recentl discovered a tpe of roc> which, when crushed, ise#tremel a"sor"ent. It is e#pected that the firm will e#perience "eginning now anunusuall high growth rate 20( during the period + ears when it has e#clusiverights to the propert where this roc> can "e found. Bowever, "eginning with the fourthear the firm-s competition will have access to the material, and from that time on thefirm will assume a normal growth rate of ( annuall. !uring the rapid growth period,the firm-s dividend paout ratio will "e relativel low 20(, to conserve funds forreinvestment. Bowever, the decrease in growth will "e accompanied " an increase individend paout to 50(. ast ear-s earnings were $2.00 per share 30 and the firm-scost of e7uit is 10(. hat should "e the current price of the common stoc>/

$*1.'

. IJE, Inc., a large conglomerate, has decided to ac7uire another firm. 8nalsts areforecasting that there will "e a period 2 ears of e#traordinar growth 20( followed" another 2 ears of unusual growth 10(, and that finall the previous growthpattern of '( annuall will resume. If the last dividend was $1 per share and there7uired return is (, what should the mar>et price "e toda/

$*+.*

22


23/49

). 8 share of !%F, Inc., stoc> paid a dividend of $1.50 last ear, and the dividend ise#pected to grow at a constant rate of ( in the future. he appropriate rate of returnon this stoc> is "elieved to "e 12(. Auppose !%F stoc> were selling for $25 toda.hat would "e the implied value of >s, assuming the other data remain the same/

10.2 percent

10. he =anning =ompan has "een hit hard due to increased competition. hecompan-s analsts predict that earnings and dividends will decline at a rate of 5(annuall into the foreseea"le future. 8ssume that >sH 11( and !0H $2.00. hat will"e the price of the compan-s stoc> in three ears/

$10.1)

11. I4E is currentl selling at $'5 per share. e#t ear-s dividend is e#pected to "e $2.'0.If investors on this particular da e#pect a return of 12( on their investment, what dothe thin> I4E-s growth rate will "e/

percent

12. he EE =ompan has fallen on hard times. Its management e#pects to pa nodividends for the ne#t 2 ears. Bowever, the dividend for Year + !+ will "e $1.00 pershare, and it is e#pected to grow at a rate of +( in Year , '( in Year 5, and 10( inYear ' and thereafter. If the re7uired return for EE =o. is 20(, what is the currente7uili"rium price of the stoc>/

$'.+

1+. Your "rother&in&law, a stoc>"ro>er at Invest, Inc., is tring to sell ou a stoc> with acurrent mar>et price of $20. he stoc> had a last dividend !0 of $2.00 and aconstant growth rate of (. Your re7uired return on this stoc> is 20(. holders have a re7uired rate of return of 1 percent. hat should "e the mar>etvalue for a share of egative imited stoc>/

$1.+

15. 8ssume the firm has "een growing at a 15( annual rate and is e#pected to continue todo so for + more ears. 8t that time, growth is e#pected to slow to a constant ( rate.he firm maintains a +0( paout ratio, and this ear-s retained earnings were $1.million. he firm-s "eta is 1.25, the ris>&free rate is (, and the mar>et ris> premium is(. If the mar>et is in e7uili"rium, what is the mar>et value of the firm-s commone7uit 1 million shares outstanding/

23


24/49

$).1' million

1'. !e#ter, Inc., has @ust paid a dividend of $2.00. Its stoc> is now selling for $ per share.he firm is half as volatile as the mar>et. he e#pected return on the mar>et is 1(and the ield on K.A. reasur "onds is 11(. If the mar>et is in e7uili"rium, what rateof growth is e#pected/

percent

1*. Given the following information, calculate the e#pected capital gains ield for 4imlo4ottle =aps6 "eta H 0.'6 >mH 15(6 %fH (6 !1H $2.006 ;0H $25.00. 8ssume thestoc> is a constant growth stoc> and is in e7uili"rium.

.2 percent

1. ?YR stoc> is currentl paing a dividend of $2.00 per share !0H $2 and is ine7uili"rium. he compan has a growth rate of 5( and "eta e7ual to 1.5. here7uired rate of return on the mar>et is 15(, and the ris>&free rate is *(. ?YR isconsidering a change in polic that will increase its "eta coefficient to 1.*5. If mar>et

conditions remain unchanged, what new growth rate will cause the common stoc> priceof ?YR to remain unchanged/

'.*' percent

1). Knion ;aper-s stoc> is currentl in e7uili"rium selling at $+0 per share. he firm has"een e#periencing a '( annual growth rate. 3arnings per share 30 were $.00 andthe dividend paout ratio is 0(. he ris>&free rate is ( and the mar>et ris> premiumis 5(. If sstematic ris> increases " 50(, all other factors remaining constant, thestoc> price will increaseCdecrease ":

&$*.+1

20. =harter Oil =ompan is currentl selling at its e7uili"rium price of $100 per share. he"eta coefficient currentl is 2. he ris>&free rate is 10(. he following events will soonoccur: 1 top management will lower =harter-s "eta to 1.2 " investing in several lowris> pro@ects6 2 the et ris> premium to increase 2percentage points to 5(. he compan has a constant growth rate of 5(. hat will"e the new e7uili"rium price for a share of =harter Oil common stoc> after the a"oveevents have ta>en place/ 8ssume the e#pected dividend will not change.

$1+*.50

21. heeler, Inc., is presentl in a stage of a"normall high growth "ecause of the e#cessdemand for widgets. he compan e#pects earnings and dividends to grow at a rate of20( for the ne#t ears, after which time there will "e no growth in earnings anddividends. he compan-s last dividend was $1.50. heeler has a "eta of 1.', thereturn on the mar>et is currentl 12.*5(, and the ris>&free rate is (. hat should "ethe current price per share of common stoc>/

$15.1*

24


25/49

22. You are given the following data:

1. he ris>&free rate is 0.05.2. he re7uired return on the mar>et is 0.0.+. he e#pected growth rate for the firm is 0.0.. he last dividend paid was $0.0 per share.

5. 4eta is 1.+.

ow assume the following changes occur:

1. he inflation premium decreases " the amount of 0.01.2. 8n increased degree of ris> aversion causes the re7uired return on the

mar>et to go to 0.10 after ad@usting for the changed inflation premium.+. he e#pected growth rate increases to 0.0'.. 4eta rises to 1.5.

hat will "e the change in price per share assuming the stoc> was in e7uili"rium"efore the changes/

&$.*

2+. You are considering "uing common stoc> in Grow On, Inc. You have calculated thatthe firm-s free cash flow was $*.'0 million last ear. You pro@ect that free cash flow willgrow at a rate of 5.0( per ear indefinitel. he firm currentl has outstanding de"t andpreferred stoc> with a total mar>et value of $22.2+ million. he firm has 2.) millionshares of common stoc> outstanding. If the firm-s cost of capital is 1).0(, what is themost ou should pa per share for the stoc> now/

$11.+

2. !ue to the highl specialiDed nature of the electronic industr, 4orrett Industries investa lot of mone in %J! on prospective products. =onse7uentl, it retains all of itsearning and reinvests them into the firm. 8t this time, 4orrett does not an plans to padividends in the near future. 8 ma@or pension fund is interested in purchasing 4orrett-sstoc>, which is traded on the YA3. he treasurer for the pension fund has doneresearch on the compan and has estimated 4orrett-s free cash flow for the ne#t fourears as follows: $+ million, $' million, $10 million and $15 million. 8fter the fourthear, free cash flow is pro@ected to grow at a constant * percent. 4orrett-s 8== is 12percent, it has $'0 million of total de"t and preferred stoc> and 10 million shares ofcommon stoc>.

8. hat is the present value of 4orrett-s free cash flows during the ne#t fourears/

$2,112,+0

4. hat is the compan-s terminal value/

$+21,000,000

=. hat is the total value of the firm toda/

$22,11+,'12

25


26/49

!. hat is 4orrett -s price per share/

$1'.1

25. 8ssume that toda is !ecem"er +1, 2000 and that the following information applies to

Fermeil 8irlines:

8. 8fter&ta# operating income S34I1&tT for 2001 is e#pected to "e $500 million.4. he compan-s depreciation e#pense for 2001 is e#pected to "e $100 million.=. he compan-s capital e#penditures for 2001 are e#pected to "e $200 million!. o change is e#pected in the compan-s net operating wor>ing capital.3. he compan-s free cash flow is e#pected to grow at a constant rate of '

percent per ear.et value of the compan-s de"t is $+ "illion.I. he compan has 200 million shares of stoc> outstanding.

Ksing the free cash flow approach, what should the compan-s stoc> price "e toda/

$+5.00 per share

CHAPTER NINE PROBLEMS

1. he chief financial officer of ;ortland Oil has given ou the assignment of determiningthe firm-s marginal cost of capital. he present capital structure which is consideredoptimal, is:

4oo> Falue Ear>et Falue!e"t $ 50 million $ 0 million;referred Atoc> 10 million 5 million=ommon 37uit +0 million 55 million

otal $ )0 million $ 100 million

he anticipated financing opportunities are these: !e"t can "e issued with a 15 percent"efore&ta# cost. ;referred stoc> will "e $100 par, carr a dividend of 1+ percent, andcan "e sold to net the firm $)' per share. =ommon e7uit has a "eta of 1.20, thereturn on the mar>et is 1* percent, and the ris>&free rate is 12 percent. If the firm-s ta#rate is 0 percent, what is its marginal cost of capital/

1.2 percent

2. Ailicon =orp. recentl issued 10&ear, 12 percent coupon "onds at par value. Ailicon-s

26


27/49

"eta is 0.'6 the optimal capital structure contains 5 percent de"tC55 percent e7uit6and the marginal ta# rate is 0 percent. If the e#pected return on the mar>et is 1'percent and the treasur "ill rate is ) percent, estimate Ailicon-s weighted average costof capital.

10.5 percent

+. efferson re7uires $15 million to fund its current ear9s capital pro@ects. efferson willfinance part of its needs with $) million in internall generated funds. he firms9common stoc> mar>et price is $120 per share. he firm9s last dividends was $5 pershare and is e#pected to grow at a rate of 11 percent annuall for the foreseea"lefuture. 8nother portion of the re7uired funds will come from the issue of ),+*5 sharesof 12 percent $100 par preferred stoc> that will "e privatel placed. he firm will net$)' per share from the sale of these shares. he remainder of the funding needs will"e met with de"t.


28/49

hat is ?YR-s optimal capital "udget for the upcoming ear/

$1.) million

'. Earginal Incorporated has determined that its "efore&ta# cost of de"t is 10.0(. Its cost

of preferred stoc> is 11.0(. Its cost of internal e7uit is 15.0(, and its cost of e#ternale7uit is 1'.)(. =urrentl, the firm-s capital structure consists of +2( de"t, 1(preferred stoc>, and 5( common e7uit. he firm-s marginal ta# rate is +)(. hat isthe firm-s weighted average cost of capital if it will have to issue new common stoc> tofund the e7uit portion of its capital "udget/

12.'2 percent

28


29/49

CHAPTER TEN PROBLEMS

1. 8n insurance firm agrees to pa ou $+,+01 at the end of 20 ears if ou pa premiumsof $100 per ear at the end of each ear of the 20 ears. ofchoosing one of the machines. =ash flow analsis indicates the following:

Year Eachine 8 Eachine 4 &&&& &&&&&&&&& &&&&&&&&& 0 &$1,000 &$1,000

1 0 1* 2 0 1* + 0 1* 1,)+ 1*

8. hat is the internal rate of return for each machine/

I%%8H 0.16 I%%4 H 0.2

4. If the cost of capital for 8cme ;roducts is 5(, which of the following is true/

he ;F8V ;F4, therefore accept Eachine 8.

5. ;ro@ects = and are mutuall e#clusive, and the have the following net cash flows:

29


30/49

Year ;ro@ect = ;ro@ect

&&&& &&&&&&&&& &&&&&&&&& 0 &$50,000 &$100,000 1 +0,000 0,000 2 0,000 0,000

+ 50,000 0,000 0 0,000 5 0 0,000

You are to use the e7uivalent annual annuit method for comparing these pro@ectssince the have une7ual lives. he cost of capital is 10(. hich pro@ect should "echosen/

;ro@ect = since it has a higher e7uivalent annual annuit.

'. he Amith =ompan is considering two mutuall e#clusive investments that wouldincrease its capacit to ma>e straw"err tarts. he firm uses a 12 percent cost ofcapital to evaluate potential investments. he pro@ects have the following costs and

cash flow streams:

Y38% 83%8IF3 8 83%8IF3 40 $ &+0,000 $ &+0,0001 10,500 ',5002 10,500 ',500+ 10,500 ',500 10,500 ',5005 && ',500' && ',500* && ',500 && ',500

hat are the respective 3UKIF83 8K8 8KII3A for alternatives 8 and 4/ 83%8IF3 8 83%8IF3 4

: $ '21.+5 $ '1.+5

*. hat is the pa"ac> period, the ;F at a discount rate of 10 percent, and the I%% for apro@ect with the following cash flows/

Y38% =8AB OK


31/49

IE3 =8AB OK


32/49

III8 =OA $ 15,000;%O3= I


33/49

CHAPTER ELEVEN PROBLEMS

1. EJE Inc., is considering the purchase of a new machine which will reducemanufacturing costs " $5,000 annuall. EJE will use the straight&line method todepreciate the machine, and it e#pects to sell the machine at the end of its 5 ear lifefor $10,000. he firm e#pects to "e a"le to reduce wor>ing capital " $15,000 when

the machine is installed. he firm-s marginal ta# rate is 0( and it uses a 12( cost ofcapital to evaluate pro@ects of this nature. If the machine costs $'0,000, what is the;F of the pro@ect-s cash flows/

&$22,'0

2. 4la>e =orporation-s new pro@ect calls for an investment of $10,000. It has an estimatedlife of 10 ears. he I%% has "een calculated to "e 15(. If cash flows are evenldistri"uted and the ta# rate is 0(, what is the annual 43/

$0,5*

. 4lain =orporation is considering the purchase of a machine which has an e#pected ear life and costs $20,000. he annual e#pected 3 =8AB


34/49

'. =!4 J 8ssociates is considering the purchase of a new piDDa oven. he original costof the old oven was $+0,000. he machine is now 5 ears old and has a currentmar>et value of $5,000. he oven is "eing depreciated over a 10&ear life toward aDero estimated salvage value on a straight&line "asis. Eanagement is contemplatingthe purchase of a new oven whose cost is $25,000 and whose estimated salvage valueis Dero. 3#pected cash savings from the new oven are $2,000 a ear "efore ta#.

!epreciation is on a straight&line "asis over a 5 ear life, and the cost of capital is 10(.8ssume a 50( ta# rate. hat is the net present value of the new machine/

&$*,1

*. Aandals, Inc., is considering the purchase of a new leather&cutting machine to replacean e#isting machine that has a "oo> value of $+,000 and can "e sold for $1,500. heestimated salvage value of the old machine in ears is Dero. he new machine willreduce costs "efore ta# " $*,000 per ear6 that is, $*,000 cash savings over the oldmachine. he new machine has a ear life, cost $1,000, and can "e sold for ane#pected $2,000 at the end of the fourth ear. 8ssuming straight line depreciation for"oth machines, a 0( ta# rate, and a cost of capital of 1'(, find the ;F.

$+,*5

. Given the following information, what is the effective cost of the new machine6 that is,what is the cash flow at t H 0/

;urchase price of new machine $,000 Installation charge 2,000 Ear>et value of old machine 2,000 4oo> value of old machine 1,000 Inventor decrease if new machine is installed 1,000 8ccounts paa"le increase if new machine is installed 500 a# rate ( =ost of capital 15(

$',)0

). Uui>, Inc., is a fast&food esta"lishment that needs to purchase new frolators. If themachines are purchased, the will replace old machines purchased 10 ears ago for$100,000, "eing depreciated on a straight line "asis to a Dero salvage value 20 earsdeprecia"le life. he old machines can "e sold for $120,000. he new machines willcost $200,000 installed and will "e depreciated on a straight&line "asis to a Derosalvage value in 10 ears. It is e#pected that there will "e increased revenues of$1,000 per ear and increased cash e#penses of $2,500 per ear. If the firm-s cost ofcapital > is 10(, the ta# rate on ordinar income is 0(, and the ta# rate on capitalgains is +0(, what is the ;F of the machine/

&$',)

10. ;=, Inc., has a stamping machine which is 5 ears old and which is e#pected to last

34


35/49

another 10 ears. It has a "oo> value of $100,000 and is "eing depreciated " thestraight&line method to Dero. ri&Atate Industries has demonstrated a new machine withan e#pected useful life of 10 ears scrap value $50,000 that should save ;= $15,000a ear in la"or and maintenance costs. If ;=-s cost of capital is 10(, should thereplacement "e made/ ;=-s ta# rate is 0(, the new machine will cost $200,000, andan investment ta# credit of 10( applies. he mar>et value of the old machine is

$10,000 and a $10,000 increase in wor>ing capital will "e needed to support the newmachine.

o6 ;F H &$5+,2*

11. GIGO, Inc., is considering replacing its current computer with a new generation model.he 84E salesperson has demonstrated a model which would cost GIGO $*50,000,should last 10 ears, and reduce costs $1'',0+ per ear. 84E estimates that thisnew computer can "e sold for $10,000 at the end of its useful life. he computer GIGOcurrentl uses has a "oo> value of $50,000 remaining life of 10 ears, a salvagevalue of $10,000, and a current mar>et value of $10,000. If an investment ta# credit of10( is applica"le to the new computer, and the new machine will permit a $10,000decrease in wor>ing capital when the computer is installed, what is the ;F > H 15(, t

H 0(, depreciation is straight line/

$*,*5+

12. You have "een as>ed " the firm-s president to evaluate the proposed ac7uisition of anew machine. he machine-s price is $50,000, and it will cost $10,000 to transport andinstall. It will "e depreciated " the straight&line method over its 5&ear useful life to a$10,000 salvage value. he machine will increase revenues " $10,000 per ear, andit will decrease operating costs " $20,000 per ear. 8lso, the machine will allow thefirm to reduce inventories " $5,000. he new machine including deliver andinstallation costs 7ualifies for a 10( investment ta# credit. If the firm-s cost of capital is12(, and its marginal ta# rate is 0(, what is the new machine-s ;F/

$++,1+

1+. Knion 4ric>, Inc., has an electric >iln which is 5 ears old and is e#pected to lastanother 10 ears. It has a "oo> value of $100,000, and it is "eing depreciated " thestraight&line method to a Dero salvage value. 8s !irector of =apital 4udgeting, ou areevaluating a new gas >iln that should save K4I $25,000 a ear in fuel costs. he new>iln would cost $200,000, and it is eligi"le for a 10( investment ta# credit. It would "edepreciated over 10 ears " the straight&line method to a $20,000 salvage value. hemar>et value of the old >iln is $10,000. K4I-s marginal ta# rate is 0(, and the firm-scost of capital is 10(. hat is the ;F of the replacement pro@ect/

&$1,5

1. 8 compan is planning to invest $50,000 "efore ta# in a personnel training program.

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he $50,000 outla will "e charged off as an e#pense " the firm this ear time 0. thereturns from the program, in the form of greater productivit and a reduction inemploee turnover, are estimated as follows on an after&ta# "asis:

Y38%A 1&10 $ 5,000 per earY38%A 11&20 $ 15,000 per ear

he compan has estimated its cost of capital to "e 15 percent. 8ssume that the entire$50,000 is paid at time 0 the "eginning of the pro@ect. he marginal ta# rate for thefirm is 0 percent. hat is the investment-s ;F/

$ 1+,')0

15. he %8G3% =orporation is considering the ac7uisition of a new splicing machineto improve the efficienc of its clothing operations. he new machine will cost $'0,000plus installation costs of $5,000. he machine-s efficienc will create additional output6thus, revenues will increase " $5,000 annuall. he amount of wasted material willdecline, so operating costs will decline " $2,000 annuall. he machine will re7uire a$2,000 increase in inventor and spare parts. he machine-s estimated salvage value

at the end of its 5 ear life is $500. Kse this value for depreciation purposes. hefirm-s marginal ta# rate is 0 percent and its re7uired rate of return is 10 percent.

8ssume that the firm uses straight&line depreciation for analsis of this tpe.

8. hat is the 3 =OA of the machine/ hat is, what is the initial cashoutflow/

$ &'*,000

4. hat are the net operating cash flows for Year 1 through 5/

$ ),+'0

=. hat is the total value of the additional considerations at the end of the fiveears/

$ 2,500

!. hat is the et ;resent Falue of the decision/

$ &2),)''

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1'. he elson 37uipment =ompan purchased a machine 5 ears ago at a cost of$200,000. he machine had an e#pected life of 10 ears at the time of the purchaseand an e#pected salvage value of $50,000 at the end of the 10 ears. It is "eingdepreciated " the straight&line method toward a salvage value of $50,000, or "$15,000 per ear.

8 new machine can "e purchased for $00,000 and re7uire an additional

$15,000 in installation costs. he new machine will re7uire $20,000 in additional spareparts. !uring its 5&ear life, it will reduce cash operating e#penses " $150,000 perear. Aales are not e#pected to change. 8t the end of its useful life, the machine isestimated to "e worth $50,000. 8=%A depreciation will "e used, and the machine will"e depreciated over its +&ear class life rather than its 5&ear economic life.

he old machine can "e sold toda for $1*5,000. he firm-s ta# rate is 0percent and the appropriate discount rate is 12 percent. he recover allowancepercentages for +&ear propert are ++(, 5(, 15(, and *(.

8. hat is the 3 =OA of the machine/ hat is, what is the initial cashoutflow/

$ &20,000

4. hat are the net operating cash flows for Year 1 and 2/

Year 1 Year 2 $ 1+,*0 $ 15,*00

=. hat is the total value of the additional considerations at the end of the fiveears/

$ 0

!. hat is the et ;resent Falue of the replacement decision/

$ 15',+*0

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1*. Eac!ougal-s is a fast&food esta"lishment that needs to purchase new frolators. If thenew frolators are purchased, the will replace old machines purchased 10 ears agofor $150,000. he old machines are "eing depreciated on a straight&line "asis to aDero salvage value. he original estimated life of the old machines was fifteen ears.he old machines have five ears of estimated life remaining. he old frolators cancurrentl "e sold to another firm in the industr for $0,000.

he new machines will cost $250,000 plus an additional $20,000 for installation.he new frolators have an estimated useful life of five ears and have an estimatedsalvage value A=%8; at the end of five ears of $10,000. he new frolators havee#tra capacit and will, thus, increase revenues " $'0,000 annuall. he machineswill also reduce operating e#penses electricit " $10,000 annuall. he firm willre7uire $5,000 in additional wor>ing capital to support the increased output.

Eac!ougal-s depreciates their capital improvements at the ma#imum rateallowed " the I%A.


39/49

1. atural 4everages is contemplating the replacement of one of its "ottling machineswith a newer and more efficient one. he old machine has a "oo> value of $00,000and a remaining useful life of five ears. he salvage value of the old machine fordepreciation and cash flow purposes is $50,000. he firm can sell it now to anotherfirm in the industr for $200,000. he new machine has a purchase price of $1.2million, an estimated useful life of five ears, and an estimated salvage value in five

ears of $20,000. 8dditional costs of installation will "e $25,000. It is e#pected toeconomiDe on operating costs and to reduce the num"er of defective "ottles. In total,an annual saving of $250,000 will "e realiDed if the new machine is installed. he newmachine will re7uire an additional $15,000 in inventor spare parts. he compan isin the 0 percent marginal ta# "rac>et and has a 12 percent re7uired rate of return.he machine 7ualifies as a +&ear propert under E8=%A ++(, 5(, 15(, *(.

8. hat is the initial investment re7uired for this replacement decision/

&$)'0,000

4. hat are the net operating cash flows for ears one and two/

$2+,*00 $+2,500

=. hat is the value of the additional considerations in ear 5/

&$2+,000

!. hat is the 3 ;%3A3 Falue of this replacement decision/

&$1+,))

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1). Buang Industries is considering a proposed pro@ect for its capital "udget. he companestimates that the pro@ect-s ;F is $12 million. his estimate assumes that theeconom and mar>et conditions will "e average over the ne#t few ears. hecompan-s =


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CHAPTER TWELVE PROBLEMS

1. Uuic> aunch %oc>et =ompan, a satellite launching firm, e#pects its sales to increase" 50 percent in the coming ear as a result of 8A8-s recent pro"lems with the spaceshuttle. he firm-s current 3;A is $+.25. Its degree of operating leverage is 1.', whileits degree of financial leverage is 2.1. hat is the firm-s pro@ected 3;A for the coming

ear using the ! approach/$ .*1

2. 8 firm e#pects to have a 15 percent increase in sales over the coming ear. If it hasoperating leverage e7ual to 1.25 and financial leverage e7ual to +.5, then what will "ethe percentage change in 3;A/

'' percent

+. he =ongress =ompan has identified two method of producing plaing cards. Onemethod involves a machine having a fi#ed cost of $10,000 and varia"le costs of $1.00per dec> of cards. he other method would use a less e#pensive machine fi#ed costsH $5,000, "ut it would re7uire greater varia"le costs $1.50 per dec> of cards. If the

selling price per dec> of cards will "e the same under each method, at what level ofoutput will the two methods produce the same net operating income/

10,000 dec>s

. 8ssume that a firm currentl has 34I of $2,000,000, ! of *.5, and !


42/49

*. 8 compan currentl has assets of $5 million. he firm is 100 percent e7uit financed.he compan currentl has net income of $1 million, and it pas out 0 percent of itsnet income as dividends. 4oth net income and dividends are e#pected to grow at aconstant rate of 5 percent per ear. here are 200,000 shares of stoc> outstanding,and it is estimated that the current cost of capital is 1+.0 percent.

he compan is considering a recapitaliDation where it will issue $1 million inde"t and use the proceeds to repurchase stoc>. Investment "an>ers have estimatedthat if the compan goes through with the plan, its "efore ta# cost of de"t will "e 11percent, and the cost of e7uit will rise to 1.5 percent. he compan has a & percentfederal&plus&state ta# rate.

8. hat is the current share price "efore recapitaliDation/

$25.00

4. 8ssuming that the firm maintains the same paout ratio, what will "e its stoc>price following the recapitaliDation/

$25.1

. he 8=3 ine =ompan of 3l ;aso produces a popular, low&cost wine. he firm hasfi#ed costs of $100,000 annuall and varia"le costs per "ottle of $+.00. he divisionhas $150,000 in de"t outstanding at an annual interest rate of 12 percent.

8. If the price per "ottle is $*.00, what is the division-s "rea>even revenue/.

$ 1*5,000

4. If the firm e#pects to sell 100,000 "ottles, at what price must it sell each "ottle inorder to "rea> even/

$ .00

=. If the firm sells 50,000 "ottles at a price of $*.00, what is the firm-s degree ofoperating leverage/

2.00

!. If the firm sells 50,000 "ottles at a price of $*.00, what is the firm-s degree offinancial leverage/

1.22

3. hat is the degree of total leverage at this level of output and sales price/

2.

). he firms B and are identical e#cept for their leverage ratios and interest rates on

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de"t. 3ach has $20 million in assets, earned $ million "efore interest and ta#es in2000, and has a 0 percent federal&plus&state ta# rate.


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corporation. he compan will produce a full line of traditional office funiture. wofinancing plans have "een proposed " investors. ;lan 8 is an all&e7uit alternative.Knder this agreement, one million shares will "e sold to net the firm $20 per share.;lan 4 involves the use of financial leverage. 8 de"t issue with a 20&ear maturit will"e privatel placed. he de"t issue will carr an interest rate of 10 percent, and theprincipal "orrowed will amount to $' million. 8ssume a corporate ta# rate of +

percent.

8.


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12. ing a new enterprise. he proposed operation would consist of a series of retailoutlets to distri"ute and service a full line of vacuum cleaners and accessories. hesestores would "e located in Bouston, !allas and Aan 8ntonio. wo financing plans have"een proposed " the graduates. ;lan 8 is an all&common e7uit structure. womillion dollars would "e raised " selling 0,000 shares of common stoc>. ;lan 4

would involve the use of long&term de"t financing. One million dollars would "e raisedmar>eting "onds with an effective interest rate of 12 percent. Knder this alternative,another million dollars would "e raised " selling 0,000 shares of common stoc>.ith "oth plans, then $2 million is needed to launch the new firm9s operations. hede"t funds raised under ;lan 4 are thought to "e part of the firm9s permanent capitalstructure. 8ssume a + percent marginal ta# rate for the analsis.

8. outstanding, and there is no preferred stoc>. he dividendpaout ratio is *0 percent, ingler is in the 0 percent federal&plus&state ta# "rac>et.

he compan is considering investing $*,200,000 in new e7uipment. Aaleswould not increase, "ut varia"le costs per unit would decline " 20 percent. 8lso, fi#edoperating costs would increase from $1,5'0,000 to $1,00,000. ingler could raisethe re7uired capital " "orrowing $*,200,000 at 10 percent or " selling 20,000additional shares at $+0 per share.

8. hat would "e ingler-s 3;A under 1 the old production process6 2 underthe new process if it uses de"t, and + the new process if it uses e7uit/

Old: $2.0 ew de"t: $.* ew e7uit: $+.2*

4. 8t what unit sales level would ingler have the same 3;A if the new productionprocess is implemented/ hat is the 3;A at this level/

++),*50 units and $1.0

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CHAPTER THIRTEEN PROBLEMS

1. =raven =orp. has retained earnings of $1.*5 million and 100,000 shares of stoc>outstanding with a mar>et value of $25 per share. If =raven declares a 15 percentstoc> dividend, what will =raven-s retained earnings "e after the dividend/

$ 1.+*5 million

2 8 compan has a net income of $100 million and a polic of paing out '0 percent of itsearnings in dividends. Bow much total financing can "e accomplished "efore thecompan has to sell common stoc>/ 8ssume a de"tCe7uit ratio of ''.' percent.

$ ''.'' million

+. 8lton =orp. has earnings of $1.5 million and a polic of paing out '0 percent ofearnings. 8lton has $1. million in accepta"le investments "ut is una"le to issue newe7uit. 8ssuming a !C3 of 0., how much will 8lton "e a"le to spend on capital"udgeting if it wishes to stic> with the '0 percent paout/

$ 0. million

. 4efore a 2&for&1 stoc> split, !ean =ompan sold for $'0 a share, earning $15 andpaing $ dividend per share. 8fter the split, the dividend per share "ecomes $5.20. 4what percentage has the paout ratio risen/

+0(

5. 4utler =orporation has declared a 10 percent stoc> dividend. 4utler has 2 millionshares outstanding with a current mar>et price of $*. Its capital stoc> account is $1million, and the firm-s retained earnings are $ million. hat "alances will the retainedearnings and capital stoc> accounts show after the distri"ution of the stoc> dividend/

=8;I8 AO=M %38I3! 38%IGA$ 1,100,000 $ ','00,000

'. he Aherman Ateel =ompan has an order "ac>log of $5 million. It desires to e#pandproduction capacit " 20 percent, which will involve a $15 million investment in plantand e7uipment. Eanagement desires to maintain 0 percent de"t in its capitalstructure. he dividend polic has "een to distri"ute 25 percent of their after&ta#earnings, which this ear were $' million. If management wishes to maintain itsdividend polic, how much e#ternal e7uit must the firm see> at the "eginning of theear/

$ ,500,000

*. On Earch 15, the directors of Glut Oil =ompan met and declared the regular dividendof cents a share to holders of record on Earch +1, pament to made on Ea 15. Ofthe 100 shares of Glut Oil ou now own, 25 shares at a time were purchased on eachof the following dates: anuar 1,


47/49

. il"ert =ompan e#pects ne#t ear-s after&ta# income to "e $10 million. he firm-scurrent de"t&e7uit ratio is 100 percent. If il"ert has $12 million of profita"leinvestment opportunities and wishes to maintain its current de"t ratio with no e#ternale7uit financing, how much should it pa out in dividends ne#t ear/

$ ,000,000

). aco"s =orporation earned $2 million after&ta#. he firm has 1.' million sharesoutstanding. If aco"s- dividend polic calls for a 0 percent paout ratio, what are thedividends per share/

$ 0.50

10. =hampou# Bair ing fund paments is greater than

the total dividend, interest, and sin>ing fund o"ligations. hat is the ma#imum dividendper share that =hampeou# can pa/

$ 0.0

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11. One share of Fan Born !istri"utors, Inc. has a mar>et price of $120. he firm lists thefollowing on its annual report dollars in thousands:

=ommon Atoc>, $2.50 par6 authoriDed, ',000,000 shares6 issued and outstanding, ,000,000 shares $ 10,000

8dditional ;aid&In =apital +,000 %etained 3arnings 50,000

8. he firm is considering a 5&for&1 stoc> split. hich of the following would "ee#pected/

8ppro#imate ;ar Falue Ahares Issued Ear>et ;rice

$ 0.50 20,000,000 $ 2.00

4. hat would the "alances in the e7uit accounts "e if the firm issued a onepercent stoc> dividend/

=ommon 8dditional %etained Atoc> ;aid&In 3arnings

$ 10,100 $ *,*00 $ 5,200

12. 8"erwald Beating, Inc. has a si#&month "ac>log of orders for its patented solar heatingsstem. Eanagement plans to e#pand production capacit " 50 percent, with an $12million investment in plant machiner, to meet this demand. he firm wants to maintaina +0 percent de"t&to&asset ratio in its capital structure6 it also wants to maintain its pastdividend polic of distri"uting +0 percent of last ear-s after&ta# earnings. In 1))0,after&ta# earnings were $2 million.

8. If the firm has 1,000,000 shares outstanding, what will "e the firm-s dividendsper share !;A if it continues the current polic/

$ 0.'0

4. hat would the dividend per share "e if the firm emplos the residual theor ofdividends/ 8ssume 1 million shares outstanding.

$ 0.00

=. If 8"erwald is to meet "oth capital funding and dividend re7uirements, howmuch e#ternal funding will "e re7uired/

$ *,000,000

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1+. aco"s =orporation earned $2 million in after&ta# net income last 7uarter. he firm has1.' million shares outstanding. If aco"s- dividend polic calls for a 0 percent paoutratio, what are the dividends per share/

$0.50 per share

1. Ea#i&rac>-s profit margin and sales are e#pected to "e 10 percent and $50 million,respectivel, for the upcoming 7uarter. he firm-s traditional paout ratio is 0 percentof net income. !ue to mar>et conditions, the firm does not wish to raise an new e7uitat this time. Ea#i&rac>-s optimal capital structure contains 0 percent de"tC'0 percente7uit.

8. hat is the firm-s e#pected net income/

$5,000,000

4. hat is the firm-s e#pected level of retained earnings/

$+,000,000

=. hat is the largest capital "udget that Ea#i&rac> select without changing thefirm-s paout polic or capital structure weights/

$5,000,000

49

testbank for business finance (1)

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