RATIO ANALYSIS
[1] (20 points)
{a} Why is it necessary to examine both a firm's times interest earned ratio as well its debt to asset ratio when analyzing the firm's debt position?
{b} Suppose that one week before its fiscal year ended, the Ace Appliance Company had the opportunity to purchase all of the in-process and raw goods inventories of one of its bankrupt competitors at a very attractive price. The inventory was financed by an equal increase in notes payable. Comment on how Ace's current ratio, acid test and inventory turnover (based on sales) ratios would be immediately affected. If year end figures were used in the calculation of the ratios, how might erroneous conclusions be drawn? What could you, a credit analyst do to make the ratios more accurate?
TIME VALUE OF MONEY - EFFECTIVE RATES
[2] (30 points)
You plan to buy a new turbo Parmesan GT for $170,000. You will definitely put $20,000 down but are unsure as to how to finance the remainder. The dealer will give you a 5 year loan at an annual rate of 24% compounded monthly (first payment in one month). But you know that Jim Palmer and the Money Store will give you a 5 year loan with quarterly payments of $13,077.71.
{a} Compute the total annual payment for each loan.
{b} Compute the effective rate of each loan.
{c} Which loan should you choose? Why? Be complete in your explanation.
EFFECTIVE RATES
[3] (15 points)
Suppose while driving home one day you hear on the car radio a newscaster say "and the price index fell by *#@!& last month. This is an annual rate of deflation of 18%."
{a} You immediately pull safely off the road, whip out your calculator and determine that static caused you to miss the monthly rate of what percent (four decimal places, please)?
{b} You're extra excited because you know your investment that is earning 1%, compounded monthly is actually earning what annual rate in REAL TERMS, after allowing for the deflation?
TIME VALUE OF MONEY
[4] (30 points)
On February 15, 1988 Mr. Louis Bunick signs a senior class gift pledge agreeing to pay Lehigh $100 a year starting that day for 20 years; the last payment is scheduled for February 15, 2007. Lou makes the initial six payments but skips the next three. Sensing a trend developing, the University sends him a letter on February 15, 1996 threatening to sue him for the value (at that time) of the 14 payments they believe he has pledged but has no intention of paying. The funds are being invested by the school to earn 6% interest.
Since Lou is a successful businessman and fears the negative publicity of a suit, he offers to pay the school a lump sum on February 15 equal to the value of the 14 payments (the amount of the suit) plus an additional 10%. The University accepts the offer and drops the suit.
Lou wishes he had never entered into the contract. If money is worth 12% to him, how much did signing the original pledge cost him; i.e., its value on February 15, 1988?
TIME VALUE OF MONEY - ANNUITIES
[5] (30 points)
In the spring of 1980 you get the idea of amassing a nest egg of $50,000 by September 26, 1992 by making nine equal annual deposits, starting on September 26, 1982 and ending on September 26, 1990. As it turns out, you make only the first six deposits and miss years 1988, 89 and 90. What four EQUAL extra deposits, over and above those you did make, would have been enough to enable you to still amass the $50,000 if the extra deposits were made on September 26, 1982, 83, 84 and 91 and the $50,000 is not needed until two years later than originally planned, i.e., September 26, 1994? Assume an annual interest rate of 12 per cent.
EFFECTIVE RATES AND ANNUITIES
[6] (20 points) BASED ON A TRUE STORY
Chase Manhattan offers a loan at an annual rate of 10% (APR), compounded monthly. They offer a unique feature that enables the borrower to skip one monthly payment each year. In other words, the borrower pays only 11 equal payments each year. The borrower must specify at the time the loan is taken out which payment he intends to skip. For example, borrowers often select the end of April's payment because they've just had to pay their income taxes. A large number of borrowers choose to skip the end of November's payment so they will have more available funds for the holidays.
Suppose that on December 31st, Josh borrows $3,000 for a term of
one year. He must pay back the loan with 11 equal monthly payments (due
on the last day of each month starting with January 31). He elects to skip
the April 30th payment. Suppose that Margaret also borrows $3,000 on the
same date and with the same terms but elects to skip the November 30th
payment.
{a} If Chase charges an annual rate of 10% (APR), compounded monthly, on both loans, compute the monthly payment for both Josh and Margaret. Explain why Josh's payment is either smaller or bigger than Margaret's.
{b} Citicorp offers a loan that competes directly with the Chase loan. If Citicorp compounds its interest quarterly, what must be the nominal APR it charges in order to provide the same effective rate? (Citicorp borrowers do not have the option of skipping any payments).
CAPITAL BUDGETING - CERTAINTY
[7] (30 points)
Bunky's Burgers, Inc. is currently using a Widgetron that originally cost the firm $660,000 ten years ago. This machine is being depreciated over a 15 year life using the straight-line method to a salvage value of $60,000. The Widgetron has a current market value of $160,000. The firm's marginal tax rate is 40% and it has a required rate of return of 12%.
Bunky's is considering the purchase of a new model to replace the existing one. The new machine is forecasted to increase annual sales by $50,000. It would be depreciated over an expected 5 year life using the straight-line method. The replacement would require additional net working capital of $20,000. Assuming a zero salvage value, what is the maximum price the firm would be willing to pay for the new machine if the replacement is favorable?
CAPITAL BUDGETING - CERTAINTY - NPV
[8] (30 points)
Bunky's Burgers is considering the purchase of a new piece of equipment to replace an older model. The existing equipment was purchased two years ago for $120,000. It is being depreciated over a 12 life to a salvage value of $24,000. If it were scrapped today, the firm would receive $80,000. The new, more efficient model would lower annual operating expenses by $45,000. It has a purchase price of $200,000, an expected life of 10 years and would depreciated using the straight-line method to a salvage value of $10,000. Bunky estimates a required return of 15% for this project. Bunky is worried that a new federal tax law could affect the decision to buy the new model.
What is the maximum marginal tax rate that will just make the replacement acceptable to the firm?
CAPITAL BUDGETING - RISK ADJUSTED DISCOUNT RATES
[9] (35 points)
The Garfield Company is contemplating the purchase of some new equipment and uses the risk adjusted discount rate method in its capital budgeting decisions. The equipment would cost $100,000 and would be depreciated over an 8 year life using the straight line method. The estimated salvage value is zero. There is a 40% chance that the new equipment would increase annual sales by $20,000 and annual operating expenses by $5,000; a 40% chance that the respective increases would be $40,000 and $10,000; and a 20% chance of $60,000 and $15,000. The firm's marginal tax rate is 40%. The firm selects its discount rate from the following table:
Coeff of Var. Cash Flows |0 - .2|.21 - .8 |.81 - 1.2 | 1.21+ |
---------------------------------------------------------------
Discount Rate | .12 | .15 | .18 | .20 |
It is not known how long the equipment will actually last. There is a 20% chance it will last only 6 years and be scrapped for $50,000, a 50% chance that it will last 10 years ($0 scrap value) and a 30% chance it will last 15 years ($0 scrap value). Calculate the expected Net Present Value.
CAPITAL BUDGETING - CERTAINTY EQUIVALENTS
[10] (40 points)
Bunky's Burgers, Inc. is considering the purchase of equipment which has a purchase price of $600,000. The machinery will be depreciated using the straight-line method over a life of six years to a zero salvage value. If the purchase is made, additional net working capital of $30,000 will be needed. The firm has made the following forecasts of the change in sales over operating costs:
For each of the first three years:
Probability Change in Sales over Costs
10% $50,000
80% $150,000
10% $250,000
For all years 4 and beyond:
30% $50,000
40% $150,000
30% $250,000
The firm has a cost of capital of 14% and a marginal tax rate of 40%. The risk-free rate of interest is 6%. Bunky's uses the certainty equivalents approach when making its capital budgeting decision and chooses the certainty equivalents coefficients from this table:
Coefficient of Variation
of Cash Flows 0-.180 .181-.320 .321-.500 .5+
Certainty Equiv Coeff. .9 .8 .6 .4
If there is a 40 percent chance the equipment will actually last only 4 years and be scrapped for $50,000 (assume this value is known with certainty) and a 60 percent chance if will last 8 years and have a zero scrap value, compute its expected net-present-value using the certainty equivalents method.
CAPM
[11] (20 points)
Your younger brother and sister both know you're taking a finance course and ask your advice on investing their paper route money. Both are considering buying 100 shares of Levis, a company that makes only jeans and related apparel. For your brother, the stock purchase would be his first. On the other hand, your sister owns shares of 10 different companies representing a wide-range of industries such as bio-technology, aerospace, lodging, pharmaceuticals, retailing and fast-foods. Both have questions regarding the risk involved in their contemplated purchases. Specifically,
{a} What kind of risk is important; i. e., total risk? Systematic risk? Unsystematic risk? Define and give two examples of each of the last two.
{b} What method or equation would you recommend to each of your siblings for measuring risk and setting a required rate of return for the investment?
OPERATING AND FINANCIAL LEVERAGE
[12] (20 points)
The Ace Watch Company currently manufactures its only product, a hand-made watch, (sold for $1000 each) with variable costs (mostly labor) of $300 per watch and fixed costs (rent, equipment, administrative personnel, etc.) of $4,000,000. Suppose its skilled craftsmen renegotiate their contract from the current piece rate to a fixed salary of $50,000 per craftsman per year. The firm employs 100 workers. Variable costs drop to $75 per watch.
{a} Calculate the break-even point before and after the renegotiation.
{b} Calculate the degree of operating leverage before and after the renegotiation at output levels of $10,000,000 and $20,000,000.
{c} What are the ramifications of the new contract should demand for the watches begin to fluctuate?
{d} Why does the degree of operating leverage decline as the level of sales increases?
OPERATING LEVERAGE - BREAK-EVEN
[13] (20 points)
Most baseball fans know that the Pittsburgh Pirates are going to have to renegotiate the contracts of all of their players during the coming winter. Suppose that the owners have three possible ways of compensating the players.
Plan [A] A fixed sum of $30 million.
Plan [B] A fixed sum of $15 million plus $7.50 for each fan who comes to a game.
Plan [C] $15.00 for each fan attending a game.
Funds to pay these salaries will be raised through a loan with a fixed interest cost of $3,000,000. The Pirate owners know that they receive an average of $30 (treat this as PRICE) for each fan attending a game through the purchase of a ticket, refreshments and souvenirs and that last season's attendance was approximately 2 million people.
Assuming that the Pirates' "product" is a seat at the ballpark, that it sells for $30, and that there are no other costs involved, compute the following:
{a} The break-even point for Plans A and B.
{b} The degree of operating leverage at an attendance of 2 million fans for each of the three plans. Repeat for 3 million.
{c} What does the degree of operating leverage for Plan A and 2 million fans computed in {b} mean; i. e., what is its significance?
{d} Which plan should the owners select? Back up your answer.
STOCK RIGHTS
[14] (20 points)
Hogan International wants to raise $180,000,000 through a rights offering. There are currently 60 million shares outstanding. On October 24 the firm announces a rights offering for stockholders as of October 31. The expiration date is November 30. On October 28 the value of a right is $4.00 and the stock is trading at $39 a share.
If the stock is trading at $45 a share on November 10, what is the theoretical value of a right on that date?
BONDS - TERM STRUCTURE
[15] (30 points)
{b} The consensus opinion of economists is that we headed for a recession. Explain how this news will most likely affect the yield differential between mortgage bonds and subordinated debentures.
{c} Given an upward sloping yield curve (term structure of interest rates). Your firm has a large issue of bonds maturing in six weeks and the VP of Finance drops by your cubicle to ask what course of action the firm should adopt and why. Clearly and concisely what do you tell him?
COST OF CAPITAL
[16] (30 points)
The Aardvark Sportshop (519 Main Street, Bethlehem) can raise up
to $20 million at an after tax cost of 12%; an additional $30 million can
be raised at 14%; an additional $20 million will cost 18% and all capital
beyond that point will cost 20%. The firm is considering five projects
with the following information:
Project Outlay
Life Annual CF
A $15,000,000
5
$4,369,230
B
10,000,000 5
3,197,750
C
10,000,000 5
3,343,800
D
20,000,000 5
5,966,230
E
15,000,000 5
4,581,130
{a} Calculate the IRR of each project and carefully plot the five projects on an IRR schedule. Which projects should the firm accept? Back up your conclusion with the appropriate calculations. {b} Calculate the net-present-value of each of the projects that you selected in {a}.
{c} Why do retained earnings have a cost? In other words, since the funds have already been earned, isn't the cost of retained earnings zero? How do the personal tax on dividend income and brokerage commissions on the purchase of new stock affect your answer to the cost of retained earnings? Think about this last part!
VALUATION - SUPER GROWTH EQUITIES
[17] (25 points)
Six years ago you purchased a 20 year subordinated debenture of Bunky's Burgers for $970. The bond is convertible into Bunky's common stock at a conversion price of $50. The coupon is 12%, compounded semi-annually. At the time of purchase, the firm had just paid a dividend of $1.00 and you forecasted that the earnings and dividends would grow at 25% for 10 years before declining to 8% for the indefinite future. You also estimated that stockholders require a return of 16% for a company in Bunky's risk class.
If all of your forecasts materialize and you hold the debenture for
6 years and then convert it today, what rate of return did you earn on
your money over the 6 year period?
CONVERTIBLE BONDS - SUPER(?) GROWTH VALUATION
[18] (30 points)
In 1991 you purchase a $1,000 par value bond which matures in 15 years. The bond has an annual coupon rate of 16%, payable semi-annually. At the time of purchase, the yield to maturity on the bond is 14%, compounded semiannually. The bond is convertible into the firm's common stock at a conversion price of $12.50 a share. At the time of purchase, the firm's earnings and dividends are forecasted to decline at an annual rate of 10% for the following 10 years before the company gets back on track and growth stabilizes at a positive 5% for the indefinite future. The company has a cost of equity capital of 18%. The day before you purchased the bond, the company paid a common stock dividend of $6.30. Six years after the purchase, the yield to maturity is 16% on new 15 year bonds and 18% on 9 year bonds.
If you convert the bond into stock after holding it for 6 years, what rate of return did you earn on your investment over the 6 year holding period?
BOND VALUATION
[19] (20 points)
The Dale Falcinelli Vinyl Leisure Suit Company has some bonds outstanding that mature in 15 years. The $1000 par value debentures carry a 12% coupon rate (payable semiannually) and are callable at a price above par. They were issued four years ago with a yield to maturity of 14%, compounded semiannually. Now that the yield to maturity on 15 year bonds has fallen to 10% compounded semiannually, the firm is wondering if it is prudent to refinance with a new issue of securities. If the new debentures would carry an annual coupon of 9.5%, payable semiannually, find the maximum call price that will leave the firm indifferent to making the call. Ignore any tax effects and flotation costs.
COST OF CAPITAL
[20] (40 points)
Crazy Joey's, a discount electronics chain, is planning its 1991 capital needs and wants your financial advice. The firm has a marginal tax rate of 50% and $12,000,000 available from retained earnings for investment this period. In November of 1984 the firm paid a dividend on its common stock of $2.26 and yesterday it paid a dividend of $4.00. This growth rate is expected to continue indefinitely. Its common stock is traded at $44 a share.
New securities can be sold under the following conditions:
BONDS: Up to $12,000,000 in new perpetual bonds can be sold to net the firm $1067. The coupon rate is 16%. From $12,000,000 to $18,000,000 the firm nets only $941 and beyond $18,000,000 the net is only $800.
PREFERRED STOCK: $50 par value, dividend rate of 15%, the selling price is $46.88 with flotation costs of $5.21.
COMMON EQUITY: Any size issue can be sold with flotation costs and underpricing of $12.57.
The current capital structure is believed to be optimal.
DEBT $60,000,000
PREFERRED STOCK 10,000,000
COMMON EQUITY 30,000,000
------------
CLAIMS $100,000,000
{a} Calculate the marginal cost of capital for all segments of the marginal cost of capital schedule. Accurately display this schedule on a graph.
{b} Should the firm accept its most profitable investment proposal which has an outlay of $40,000,000, an expected life of 5 years and uniform annual after-tax cash flows of $11,372,580? (Hint: find the integer IRR).
COST OF CAPITAL
[21] (50 points)
On January 1, 1992 Bunky's Burgers, Inc. is planning its yearly capital budget and is faced with a list of 7 potential independent proposals:
Project Outlay IRR
======= ====== ===
A 4,000,000 14.0%
B 3,000,000 20.5%
C 2,000,000 19.0%
D 6,000,000 13.0%
E 3,000,000 15.0%
F 3,000,000 21.5%
G 14,000,000 16.5%
The firm's capital structure relations shown below are considered optimal and will be maintained:
Debt $50,000,000
Preferred Stock 10,000,000
Common Stock 12,000,000
Retained Earnings 28,000,000
Common Equity 40,000,000
==========
TOTAL CLAIMS $100,000,000
The firm has a marginal tax rate of 35% and has $8,000,000 from internal sources of equity available for investment. Investors require a total rate of return on 20% on a stock in Bunky's risk class. Earnings and dividends are expected to grow indefinitely at a 5% rate.
Bunky's can raise new funds under the following conditions:
BONDS: (Up to $15,000,000) New perpetual $1000 par value bonds carrying a coupon of 16 per cent (payable annually) can be sold to the public for $1103.45. Total underwriting and flotation fees are $36.78.
(Beyond $15,000,000) A second issue of perpetual 16 per cent bonds can be sold for $914.29. Underwriting fees total $25.40.
PREFERRED STOCK: (Up to $3,000,000) New $50 par value preferred stock can be sold for $48. The firm nets $45 and the dividend rate is 16%.
(Beyond $3,000,000) The dividend rate must be 18% and the firm still nets $45 and the public still pays $48.
COMMON EQUITY: The cost of issuing any new common stock requires underpricing and flotation costs equal to 10% of the stock's price.
{a} Which projects should Bunky's accept? Your analysis must include the calculation of the marginal cost of capital along all of the various segments. CLEARLY display your results on a CAREFULLY labeled LARGE graph. (Carry all calculations to three decimal places; e.g., .123 or 12.3%).
{b} What is the weighted average cost of capital for the capital budget you are advocating in part {a}?
{c} Suppose that instead of having $8,000,000 available from internal sources, the firm has $12,000,000. CLEARLY make the change on the same graph. Does this change your answer to part {a}? You are required to back up your answer with the appropriate calculations.
CAPITAL STRUCTURE
[22] (25 points)
What is meant by the optimal capital structure (be specific). Does it exist? Graphically display the "saucer shaped" approach to this question shown in lecture and fully explain why each of the curves behaves as it does? How does this "saucer shape" differ for electrical utilities and retail stores?
OPTIMAL CAPITAL STRUCTURE
[23] (5 points)
Hopefully you discovered that Joey's cost of debt was a lot less than its cost of equity. Given that this is true, how can the firm believe the present capital structure is "optimal" when it's using only 60% debt? Why not use 90+% debt if it's so much cheaper? (Note: It will take me 50 minutes next Tuesday to answer this in lecture. Hopefully you can do it in a couple of sentences).
TIME VALUE OF MONEY - ANNUITIES
[24] (30 points)
Starting today you PLAN to make 5 EQUAL annual deposits that will enable you to withdraw $50 each year forever starting at the end of the 10th year. You expect to earn an 8% interest rate in perpetuity.
You ACTUALLY make only the first 4 deposits (today and the end of years 1, 2 and 3). As you're about to make the 5th deposit you learn that the interest rate on all funds will drop to 5% starting at the end of year 11 and it will stay at that rate forever. You still plan on making the same $50 withdrawals starting at the end of the 10th year. How big must the 5th deposit (still made end of year 4) be if you are to make your $50 withdrawals as planned.
CAPITAL BUDGETING
[25] (30 points)
Corrigan Baked Goods, Inc. is contemplating replace some existing equipment with some new hardware. The existing machinery was purchased 2 years ago for $400,000. It is being depreciated using the straight-line method to a salvage value of $50,000 over its original expected life of 10 years.
The new machinery would cost $1,000,000 and would be depreciated using the straight-line method to salvage value of $200,000 over its expected life of 8 years. The new equipment would be expected to increase annual sales by $165,000. The new machinery would require additional new-working-capital of $50,000. Corrigan has a required return of 12% and a marginal tax rate of 40%.
Find the minimum amount the firm must receive from the sale of the old equipment if the replacement is to be worthwhile.
RATIO ANALYSIS
[26] (21 points)
{a} Why should a firm be concerned if its inventory turnover ratio is unusually low relative to its industry norm?
{b} Why should a firm be concerned if its accounts receivable turnover ratio is unusually high compared to its industry norm?
{c} Give two possible reasons how a firm could have a steadily rising
net profit margin while its gross profit margin has been stable over the
same time period.
VALUATION MODELS - BONDS
[27] (20 points)
Bunky's Burgers has some outstanding shares of preferred stock. The par value is $50 per share. The dividend rate is 10% (paid annually).
{a} Find the current market value if the going rate of return (investors' required rate of return) is 8% per year.
{b} Suppose an investor bought 100 shares 5 years ago when the going rate of return was 12.5%. Calculate the IRR of this investment if she sells them for the current market price in {a}.
CAPITAL BUDGETING - RISK
[28] (50 points)
The MEGA Corp. is involved only in the auto parts industry. It is thinking of investing in a new project that deals with the remanufacturing of carburetors for domestic cars. The cost of the project is $1,000,000; the equipment would be depreciated using the straight-line method to a zero salvage value over a life of 10 years. The firm's marginal tax rate is 40%.
Below are the forecasts of the expected change in sales revenues less expenses for each year.
60% Probability of $200,000 per year
40% Probability of $450,000 per year.
The risk-free rate of interest is 3%. The project has a beta coefficient of 1.2. The market's risk premium is 4%. The firm also found the table below from an old copy of a Fin 225 exam that may or may not prove useful:
|
Coefficient of Variation
of CF
|
|
|
|
|
|
|
|
|
|
|
READ {a}, {b} AND {c} BEFORE PROCEEDING!
{a} Compute the NPV assuming the actual life
is 5 years and the equipment can be scrapped at that time for $200,000.
Repeat assuming an actual life of 12 years and no scrap value.
{b} Now repeat the two NPV calculations assuming that MEGA is a well-diversified conglomerate with interests in fast foods, ethical drugs, plastics, clothing, financial services, etc. The carburetor project would their first venture into auto parts.
{c} Explain how and why you are accounting for risk in {a} and {b} and explain your choice of the discount rate in both parts.
YIELD DIFFERENTIALS
[29] (32 points)
{a} A firm is about to sell a new issue of 20 year callable debentures and another issue of 20 year noncallable debentures. The level of interest rates has steadily been declining so now rates are thought to be near their historical lows. Comment on what the yield differential between the two issues is likely to be and provide support for your answer.
{b} Interest rates are near their historical highs. Forecasters are predicting they are going to fall soon. Describe the probable shape of the yield curve. What advice would you give to a firm regarding the maturity they should choose for their impending bond issue? Be very thorough!
{c} Explain what happens to the yield differential between a firm's mortgage bonds and its subordinated debentures as the outlook for the economy brightens?
{d} Explain what happens to the yield differential between a firm's outstanding straight (nonconvertible) bonds and its outstanding convertible bonds if negative publicity regarding the company begins to surface. For example, consider a pharmaceutical company whose applications for FDA approval of several of their new drugs appear likely to be rejected.
VALUATION MODELS - EQUITIES
[30] (40 points)
You own a convertible bond of Slane Sanitation. The $1,000 par value bond matures in 20 years, has a coupon rate of 15%, payable semiannually and is convertible into Slane stock at a conversion price of $20 per share. The common stock of Slane is forecasted to pay the following annual dividends, all on November 30:
1995 $3.00 1998 4.00 2000 4.50
1996 3.00 1999 4.50 2001 5.00
1997 3.50
After 2001, Slane's earnings and dividends are forecasted to grow at an annual rate of 8% forever. Investors require a return of 20% for a stock of Slane's risk. Assume that all of the dividend forecasts are accurate.
{a} Suppose you convert your bond today. What would you get for it?
{b} Suppose you wait and convert on 1 December 1999. What would you get for it?
{c} What rate of return did you earn between today and 1 December 1999 if you decided to wait until then to convert? [HINT: Draw a time line of all the cash flows from 1994 to 1999. How much do you have "invested" in the bond on 1 December 1994?]
{d} What rate of return would have you earned between today and 1 December 1999 if you converted today? Explain your answer. [HINT: If you think about this one for a minute or two, you may not need any calculations.]
COST OF CAPITAL
[31] (60 points)
Bunky's Burgers, Inc. is planning its 1995 financing needs. The firm has the following capital structure which it believes to be optimal:
Long-term Debt $60,000,000
Preferred Stock 10,000,000
Retained Earnings
$10,000,000
Common Stock
20,000,000
Total Common Equity 30,000,000
-----------
TOTAL CLAIMS $100,000,000
The firm has a marginal tax rate of 40% and there is $9 million from retained earnings available for investment this period. The dividend yield on the common stock is 12%. Earnings and dividends are expected to grow indefinitely at 8%.
New securities can be sold under the following conditions:
BONDS:
(Up to $18 million) New $1000 par value perpetual bonds can be sold for $950 with a coupon of 9%. Flotation costs total $50 per bond.
(Beyond $18 million) The coupon rate rises to 12%, the selling price is $973 and the flotation costs again total $50.00.
PREFERRED STOCK:
(Up to $3 million) $50 par value preferred stock with a dividend rate of 15% can be sold for $50. Flotation costs total $5.88.
(Beyond $3 million) The dividend rate must be 17%; it's still sold at par; and the flotation costs are $5.26 a share.
COMMON STOCK:
(Up to $9 million) Underpricing and flotation costs total 20% of the stock's price.
(Beyond $9 million) Underpricing and flotation costs total 40% of the stock's price.
{a} Calculate the marginal cost of capital for each segment of the cost of capital schedule. Roughly plot your cost of capital schedule.
{b} Calculate the average cost of capital for an expansion of $75 million.
{c} Suppose an extra project beyond the $75 million point is being considered. It has an outlay of $10 million and annual returns of $4.3 million for 3 years. Calculate its IRR and NPV. Should it be accepted? Justify your answer.
SOME SELECTED ANSWERS
2. R = 4,315.19 EAR Dealer = 26.8%
3. *#@!& = 1.64%
4. Payoff = 1,217.75 Pledge
in 1988 = $952.31
5. D = 2,697.66
6. Josh = 288.26
7. DD = .2P
- 40000 DCF = 14000 + .08P
P=291,969.44
8. Outlay = 120000 - 24000t
DCF = 45000 - 34000t
9. cv = .32 NPV(6) = -2475.86
NPV(15) = 17,164
10. cv = .21 cv(4) = .36
NPV = -179330
12. Q = 5715 units Q'
= 9730 units
13. Q = 666,667 fans OL(A)
= 2 times
14. S = 3N S = $15/share
16. NPV(c) = 2,053,651 IRR(a)
= 14.00
17 P(6) = 87.90 r/r = 19.97%/year
compounded semi-annually
18. P(6) = $16.27/share Value
= 1301.72 r/r = 16.54%/year
19. P = 1153.73
20. 20, 30, 40 million MC(20-30)
= 12.90%
21. k(n) = 21.67% MC(20-30) = 15.30%
ACC = 14.69%
24. Planned = $72.51/year
25. Outlay = 918000 - .6MV
DCF
= 125,000
27. (b) P(-5) = $40/share k = 20.05%
28. cv = .334 CF(1-10) = 220,000
NPV(5) = 31,686 NPV(12) = 599,696
30. P(94) = $25.81 P(99) =
$38.47 r/r = 18.89%/yr (EAR)
31. 30 - 60 million MCC = 13.48%,
60+ MCC = 14.98%