1

CHAPTER TWO PROBLEMS 1. Last year Rattner Robotics had $5 million in operating income (EBIT). The company had net depreciation expense o $1 million and an interest expense o $1 million! its corporate tax rate "as #$ percent. The company has $1# million in c%rrent assets and $# million in non&interest&bearing c%rrent liabilities! it has $15 million in net plant and e'%ipment. It estimates that it has an a ter&tax cost o capital o 1$ percent. (ss%me that Rattner)s only non&cash item is depreciation. a. b. c. d. e. *hat "as the company)s net income or the year+ $,.# million *hat "as the company)s net cash lo"+ $-.# million *hat "as the company)s net operating pro it a ter taxes (./0(T)+ $-.$ million *hat "as the company)s operating cash lo"+ $#.$ million I operating capital in the pre1io%s year "as $,# million2 "hat "as the company)s ree cash lo" (343) or the year+ $,.$ million *hat "as the company)s economic 1al%e added+ $5$$2$$$

,.

(s an instit%tional in1estor paying a marginal tax rate o #562 yo%r a ter&tax di1idend yield on pre erred stoc7 "ith a 156 be ore&tax di1idend yield "o%ld be8 1#.96

-.

( :6 co%pon bond iss%ed by the state o .e" ;or7 sells or $12$$$ and th%s pro1ides a :6 yield to mat%rity. 3or an in1estor in the #$6 tax brac7et2 "hat co%pon rate on a 4arter 4hemical 4ompany bond that also sells at its $12$$$ par 1al%e "o%ld ca%se the t"o bonds to pro1ide the in1estor "ith the same a ter&tax rate o ret%rn+ 11.5:6

#.

( corporation "ith a marginal tax rate o #56 "o%ld recei1e "hat (3TER&T(< ;IEL= on a 1,6 co%pon rate pre erred stoc7 bo%ght at par+ (ns"er8 11.1:,6

5.

;o% ha1e >%st recei1ed inancial in ormation or the past t"o years or 0o"ell 0anther 4orporation8

Income ?tatements Ending =ecember -1 (millions o dollars) ,$$$ ?ales $12,$$.$ /perating 4osts (excl%ding depreciation) 12$,$.$ =epreciation -$.$ Earnings be ore interest and taxes $ 15$.$ Less Interest expense ,1.: Earnings be ore taxes $ 1,@.Less taxes (#$6) 51..et income a1ailable to common e'%ity $ ::.$ 4ommon di1idends $ $.5$5 Balance ?heets Ending =ecember -1 (millions o dollars) ,$$$ 4ash and mar7etable sec%rities $ 1,.$ (cco%nts recei1able 1@$.$ In1entories 1@$.$ .et plant and e'%ipment -$$.$ Total (ssets $ 5:,.$ (cco%nts payable .otes payable (ccr%als Long&term bonds 4ommon stoc7 (5$ million shares) Retained earnings Total liabilities and e'%ity a. b. c. d. e. . $ 1$@.$ 5:.$ :,.$ $ 15$.$ 5$.$ ,,5.$ $ 5:,.$

1999 $12$$$.$ @5$.$ ,5.$ $ 1,5.$ ,$., $ 1$#.@ #1.9 $ 5,.9 $ $.#5#

1999 1$.$ 15$.$ ,$$.$ ,5$.$ $ 51$.$ $ $ 9$.$ 51.5 5$.$ $ 15$.$ 5$.$ ,$@.5 $ 51$.$

*hat is the net operating pro it (./0(T) or ,$$$+ $9$2$$$2$$$ *hat are the amo%nts o net operating "or7ing capital or 1999 and ,$$$+ $,1$2$$$2$$$ and $19,2$$$2$$$ *hat are the amo%nts o total operating capital or 1999 and ,$$$+ $#5$2$$$2$$$ and $#9,2$$$2$$$ *hat is ree cash lo" or ,$$$+ $5@2$$$2$$$ Ao" m%ch did the irm rein1est in itsel o1er the acco%nting period+ $1525$$2$$$ (t the present time (1,B-1B,$$$)2 ho" large a chec7 co%ld the irm "rite "itho%t it bo%ncing+ $1,2$$$2$$$

5.

( irmCs operating income (EBIT) "as $#$$ million2 their depreciation expense "as $#$ million2 and their increase in net in1estment in operating capital "as $:$ million. (ss%ming that the irm is in the #$6 tax brac7et2 "hat "as their ree cash lo"+

$1:$ million :. In its recent income statement2 ?mith ?o t"are Inc. reported $,- million o net income2 and in its year&end balance sheet2 ?mith reported $#$1 million o retained earnings. The pre1io%s year2 its balance sheet sho"ed $-@9 million o retained earnings. *hat "ere the total di1idends paid to shareholders d%ring the most recent year+ $11.$ million @. 4ox 4orporation recently reported an EBIT=( o $5@ million and $: million o net income. The company has $1, million interest expense and the corporate tax rate is #$.$6 percent. *hat "as the companyCs depreciation and amortiDation expense+ $-#.-- million 9. Ra1ings Incorporated recently reported net income o $5.# million. Its operating income (EBIT) "as $15 million2 and its tax rate "as #$ percent. *hat "as the company)s interest expense+ $5 million 1$. In its recent income statement2 ?mith ?o t"are Inc. reported paying $1$ million in di1idends to common shareholders2 and in its year&end balance sheet2 ?mith reported $#19 million o retained earnings. The pre1io%s year2 its balance sheet sho"ed $#$# million o retained earnings. *hat "as the irm)s net income d%ring the most recent year+ $,5.$ million 11. 4asey Eotors recently reported net income o $19 million. The irmCs tax rate "as #$.$6 and interest expense "as $5 million. The companyCs a ter&tax cost o capital is 1#.$6 and the irmCs total in1estor s%pplied operating capital employed e'%als $95 million. *hat is the companyCs EF(+ $9.-$ million 1,. Broo7s ?istersC operating income (EBIT) is $19# million. The companyCs tax rate is #$.$62 and its operating cash lo" is $1#@.# million. The companyCs interest expense is $-9 million. *hat is the companyCs net cash lo"+ ((ss%me that depreciation is the only non&cash item in the irmCs inancial statements.) $1,5.$ million 1-. Fal%able Incorporated)s stoc7 c%rrently sells or $#5 per share. The irm has ,$ million share o common o%tstanding. The irm)s total debt e'%als $5$$ million and its common e'%ity e'%als $#$$ million. *hat is the irm)s mar7et 1al%e added+ $5$$ million CHAPTER THREE PROBLEMS 1. (B42 Inc.2 sells all its merchandise on credit. It has a pro it margin o #62 an a1erage

collection period o 5$ days2 recei1ables o $15$2$$$2 total assets o $- million and a debt ratio o $.5#. *hat is the irmCs ret%rn on e'%ity+ -.-- percent ,. The ?mythe 4orporationCs common stoc7 is c%rrently selling at $1$$ per share "hich represents a 0BE ratio o 1$. I the irm has 1$$ shares o common stoc7 o%tstanding2 a ret%rn on e'%ity o $.,$2 and a debt ratio o $.5:2 "hat is its ret%rn on total assets+ 5.: percent -. I *in7ler2 Inc.2 has sales o $, million per year (all credit) and an a1erage collection period o -5 days2 "hat is its a1erage amo%nt o acco%nts recei1able o%tstanding (ass%me a -5$ day year)+ $19#2### #. I a irm has total interest charges o $1$2$$$ per year2 sales o $1 million2 a tax rate o #$62 and a net pro it margin o 562 "hat is the irmCs times interest earned ratio+ 11 times 5. ( irm that has an e'%ity m%ltiplier o #.$ "ill ha1e a debt ratio o 8 $.:5. 5. Gi1en the ollo"ing in ormation2 calc%late the mar7et price per share o *(E2 Inc.8 Earnings a ter interest and taxes H $,$$2$$$ Earnings per share H $,.$$ ?toc7holdersC e'%ity H $,2$$$2$$$ Ear7etBBoo7 ratio H $.,$ $#.$$ :. ( ire has destroyed a large percentage o the inancial records o Aanson (ssociates. ;o% are charged "ith piecing together in ormation in order to release a inancial report. ;o% ha1e o%nd the ret%rn on e'%ity to be 1@6. I sales "ere $# million2 the debt ratio $.#$2 and total liabilities $, million2 "hat "as the ret%rn on assets+ 1$.@6 @. (ss%me 4onser1ati1e 4orporation is 1$$6 e'%ity inanced. 4alc%late the ret%rn on e'%ity gi1en the ollo"ing in ormation8 1. Earnings be ore taxes H $,2$$$ ,. ?ales H $52$$$ -. =i1idend payo%t ratio H 5$6 #. Total asset t%rno1er H ,.$ 5. (pplicable tax rate H 5$6 #$ percent ;o% are considering a ne" prod%ct or yo%r irm to sell. It sho%ld ca%se a 156 increase in yo%r pro it margin b%t it "ill also re'%ire a 5$6 increase in total assets. ;o% expect to inance this asset gro"th entirely by debt. I the ollo"ing ratios "ere comp%ted

9.

be ore the change2 "hat "ill be the ne" R/E i the ne" prod%ct is sold b%t sales remain constant+ 0ro it margin H $.1$ Total asset t%rno1er H ,.$ E'%ity m%ltiplier H, #5 percent 1$. Iohnsto"n 4hemicals2 Inc.2 has a c%rrent ratio o -.$2 a '%ic7 ratio o ,.#2 and an in1entory t%rno1er o 5. Iohnsto"nCs total assets are $1 million and its debt ratio is $.,$. (The irm has no long&term debt.) *hat is Iohnsto"nCs sales ig%re+ $:,$2$$$ 11. 4alc%late the mar7et price o a share o (B42 Inc.2 gi1en the ollo"ing in ormation8 ?toc7holdersC e'%ity H $12,5$! priceBearnings ratio H 5! shares o%tstanding H ,5! mar7etBboo7 ratio H 1.5. $:5.$$ 1,. Iamesto"n2 Inc.2 has earnings a ter interest ded%ctions b%t be ore taxes o $-$$. The companyCs be ore&tax times interest earned ratio is :.$$. 4alc%late the companyCs interest charges. $5$.$$ The G. Aobbs 4ompany has determined that its ret%rn on e'%ity is 156. Eanagement is interested in the 1ario%s components that "ent into this calc%lation. Ao"e1er2 one o the acco%ntants has misplaced the pro it margin ratio. (s a inance "iDard2 yo% 7no" ho" to calc%late the pro it margin2 gi1en the ollo"ing in ormation8 total debtBtotal assets H $.-52 and total asset t%rno1er H ,.@. *hat is the pro it margin+ -.#@ percent 1#. Lo"e J 4ompany has a debt ratio o $.52 a capital intensity ratio o #2 and a pro it margin o 1$6. The Board o =irectors is %nhappy "ith the c%rrent ret%rn on e'%ity (R/E)2 and they thin7 it co%ld be do%bled. This co%ld be accomplished (1) by increasing the pro it margin to 1,6 and (,) by increasing debt %tiliDation. Total asset t%rno1er "ill not change. *hat ne" debt ratio2 along "ith the 1,6 pro it margin2 is re'%ired to do%ble the R/E+ :$ percent The Local 4ompany is a relati1ely small2 pri1ately o"ned irm. In 19@1 Local had an a ter&tax income o $152$$$2 and 1$2$$$ shares "ere o%tstanding. The o"ners "ere trying to determine the e'%ilibri%m mar7et 1al%e or LocalCs stoc72 prior to ta7ing the company p%blic. ( similar irm that is p%blicly traded had a priceBearnings ratio o 5.$. Ksing only the in ormation gi1en2 estimate the mar7et 1al%e o one share o LocalCs stoc7. $:.5$ 15. Epsilon 4o.Cs records ha1e recently been destroyed by ire. Gi1en the ollo"ing bits o in ormation sa1ed rom the in erno2 determine EpsilonCs net income or 1999. Ret%rn on e'%ity ,,6

1-.

15.

(ssetsBnet "orth 0ro it margin Total assets $ 1:. 55.$$ million

,.15: 5.56 $55$ million

=elta 4orp. has sales o $-$$2$$$2 a pro it margin o 5.5 percent2 a tax rate o 15 percent2 and ann%al interest charges o $:25$$. *hat is =eltaCs times interest earned+ #.$5

1@.

4oastal 0ac7aging Ls R/E last year "as only - percent2 b%t its management has de1eloped a ne" operating plan designed to impro1e things. The ne" plan calls or a total debt ratio o 5$ percent2 "hich "ill res%lt in interest charges o $-$$ per year. Eanagement pro>ects an EBIT o $12$$$ on sales o $1$2$$$2 and it expects to ha1e a total asset t%rno1er ratio o ,.$. Knder these conditions2 the a1erage tax rate "ill be -$ percent. I the changes are made2 "hat ret%rn on e'%ity "ill 4oastal earn+ ,#.5 percent

19.

;ohe Inc. has an R/( o 1-.#6 and a 1$6 pro it margin. The company has sales e'%al to $5 million. *hat are the companyCs total assets+ $-.:- million

,$.

;ohe Inc. has a c%rrent ratio o ,2 and a '%ic7 ratio o 1.#. 3%rthermore2 the irm has $1.5 million in c%rrent liabilities. Based %pon this in ormation2 ho" m%ch in1entory is ;ohe holding+ $9$$2$$$

,1.

K M./2 Inc. %ses only debt and common e'%ity %nds to inance its assets. This past year the irmCs ret%rn on total assets "as 1-6. The irm inanced #,6 percent o its assets %sing debt. *hat "as the irmCs ret%rn on common e'%ity+ ,,.#16

,,.

4le1eland 4orporation has 1:2#9$2$$$ shares o common stoc7 o%tstanding2 its net income is $19# million2 and its 0BE ratio is 15.1. *hat is the company)s stoc7 price+ $15:.#9

,-.

(((Cs in1entory t%rno1er ratio is 11.$9 based on sales o $152,$$2$$$. The irmCs c%rrent ratio e'%als -.,, "ith c%rrent liabilities e'%al to $9:$2$$$. *hat is the irmCs '%ic7 ratio+ 1.@1 CHAPTER FOUR PROBLEMS

1.

Interest rates on one&year Treas%ry sec%rities are c%rrently 5.5 percent2 "hile t"o&year Treas%ry sec%rities are yielding 5 percent. I the p%re expectations theory is correct2 "hat does the mar7et belie1e "ill be the yield on one&year sec%rities one year rom no"+ 5.# percent

,.

Interest rates on o%r&year Treas%ry sec%rities are c%rrently : percent2 "hile interest rates on six&year Treas%ry sec%rities are c%rrently :.5 percent. I the p%re expectations theory is correct2 "hat does the mar7et belie1e that t"o&year sec%rities "ill be yielding o%r years rom no"+ @.5 percent

-.

The real ris7& ree rate o interest is - percent. In lation is expected to be , percent this year and # percent d%ring the next t"o years. (ss%me that the mat%rity ris7 premi%m is Dero. *hat is the yield on -&year Treas%ry sec%rities+ 5.-- percent

#.

( Treas%ry bond that mat%res in 1$ years has a yield o 5 percent. ( 1$&year corporate bond has a yield o @ percent. (ss%me that the li'%idity premi%m on the corporate bond is $.5 percent. *hat is the de a%lt ris7 premi%m on the corporate bond+ 1.5 percent

5.

/ne&year Treas%ry sec%rities yield 5 percent. The mar7et anticipates that 1 year rom no"2 one&year Treas%ry sec%rities "ill yield 5 percent. I the p%re expectations theory is correct2 "hat sho%ld be the yield today or ,&year Treas%ry sec%rities+ 5.5 percent

5.

The real ris7& ree rate is - percent2 and in lation is expected to be - percent or the next , years. ( ,&year Treas%ry sec%rity yields 5., percent. *hat is the mat%rity ris7 premi%m or the ,&year sec%rity+ $., percent

:.

The real ris7& ree rate is - percent. In lation is expected to be - percent this year2 # percent next year2 and then -.5 percent therea ter. The mat%rity ris7 premi%m is estimated to be $.$$$5 < (t&1)2 "here t H n%mber o years to mat%rity2 *hat is the nominal interest rate on a :&year Treas%ry note+ 5.@ percent

@.

(ss%me that the real ris7& ree rate is , percent and that the mat%rity ris7 premi%m is Dero. I the nominal rate o interest on 1&year bonds is 5 percent and that on comparable ris7 ,&year bonds is : percent2 "hat is the 1&year interest rate that is expected or year t"o+

: percent 9. ;o% see that the c%rrent -$&day T&bill rate is #.56. ;o% are told by a riend "ho "or7s or an in1estment irm that the best estimates o the c%rrent interest rate premi%ms or relati1ely sa e corporate irms is as ollo"s8 in lation premi%m H ,.16! de a%lt ris7 premi%m H 1.#6. Based on this data2 "hat is the real ris7& ree rate o ret%rn+ ,.#6 1$. The real ris7& ree rate o interest is - percent. In lation is expected to be 5 percent this coming year2 >%mp to 5 percent next year2 and increase to : percent the ollo"ing year (;ear -). (ccording to the expectations theory2 "hat sho%ld be the interest rate on -& year2 ris7& ree sec%rities today+ 9 percent 11. =rongo 4orporation)s #&year bonds c%rrently yield @.# percent. The real ris7& ree rate o interest2 7N2 is ,.: percent and is ass%med to be constant. The mat%rity ris7 premi%m (ER0) is estimated to be $.16(t & 1)2 "here t is e'%al to the time to mat%rity. The de a%lt ris7 and li'%idity premi%ms or this company)s bonds total $.9 percent and are belie1ed to be the same or all bonds iss%ed by this company. I the a1erage in lation rate is expected to be 5 percent or years 52 52 and :2 "hat is the yield on a :&year bond or =rongo 4orporation+ @.91 percent 1,. /ne&year Treas%ry sec%rities yield 5 percent2 ,&year Treas%ry sec%rities yield 5.5 percent2 and -&year Treas%ry sec%rities yield : percent. (ss%me that the expectations theory holds. *hat does the mar7et expect "ill be the yield on 1&year Treas%ry sec%rities t"o years rom no"+ @ percent 1-. (ss%me that a -&year Treas%ry note has no mat%rity ris7 premi%m2 and that the real ris7& ree rate o interest is - percent. I the T&note carries a yield to mat%rity o 1$ percent2 and i the expected a1erage in lation rate o1er the next , years is @ percent2 "hat is the implied expected in lation rate d%ring ;ear -+ 5 percent

CHAPTER FIVE PROBLEMS 1. (n in1estor holds a di1ersi ied port olio consisting o a $52$$$ in1estment in each o ,$ di erent common stoc7s. The port olio beta is e'%al to 1.1,. The in1estor has decided to sell a lead mining stoc7 (beta H 1.$) at $52$$$ net and %se the proceeds to b%y a li7e amo%nt o a steel company stoc7 (beta H ,.$). *hat is the ne" beta or the

port olio+ 1.1: ,. 4onsider the ollo"ing in ormation and calc%late the re'%ired rate o ret%rn or the *in7ler In1estment 3%nd. The total in1estment %nd is $, million. ?toc7 &&&&& ( B 4 = In1estment &&&&&&&&&& $ ,$$2$$$ -$$2$$$ 5$$2$$$ 12$$$2$$$ Beta &&&& 1.5$ &$.5$ 1.,5 $.:5

The mar7et re'%ired rate o ret%rn is 156 and the ris7& ree rate is : percent. 1-.1 percent -. The ?andy 4ompany has de1eloped the ollo"ing data regarding a pro>ect to add ne" distrib%tion acilities8 ?T(TE 0R/B(BILIT; 0R/IE4T RETKR. E(RMET RETKR. 1 .$.$1 $.1$ , .: $.15 $.1# (. B. 4. =. E. *hat is the expected ret%rn on the pro>ect+ *hat is the standard de1iation o the pro>ect ret%rns+ *hat is the coe icient o 1ariation o pro>ect ret%rns+ *hat is the co1ariance o pro>ect ret%rns "ith mar7et ret%rns+ 1$.@6 $.$5#, $.59# $.$$1,

*hat is the correlation coe icient bet"een the pro>ect ret%rns and the mar7et ret%rns+ 1.$$

#.

4alc%late the re'%ired rate o ret%rn or Eanagement2 Inc.2 ass%ming that in1estors expect a 56 rate o in lation in the %t%re. The real rate is e'%al to -6 and the mar7et ris7 premi%m is 56. Eanagement has a beta o ,.$ and has historically ret%rned an a1erage o 156. 1@ percent 3irst In1estment Tr%st is a m%t%al %nd in1esting in the common stoc7 o six irms. The irms2 mar7et 1al%e o shares held2 and the beta o each stoc7 are as ollo"s8 E(RMET F(LKE /3 3IRE ?A(RE? AEL= BET( (ce Electronics $ 9$ million $.5 BobCs Ind%stries 11$ million 1., 4BE International 5$ million $.: =a1eCs 4en 1-$ million 1.@ EdCs Eatery :$ million $.9

5.

10

?pace =eli Total (. B. 5.

#$ million 5$$ million

,.5 1.,5

4alc%late the beta o the m%t%al %nd.

?%ppose Rm H 15 percent and R H 5 percent! "hat is the expected port olio ret%rn+ 1@.5 percent

The ollo"ing data pertains to the next o%r '%estions. ?toc7s ( and B ha1e ret%rns and probability distrib%tions as gi1en belo". 0R/B(BILIT; $.,5 $.-$ $.,5 $.,$ (. B. 4. =. E. ?T/4M ( 56 1$6 #6 @6 ?T/4M B @6 ,6 56 @6

4alc%late the expected ret%rns or ?toc7s ( and B. :.16 and 5.:6 *hat are the standard de1iations o expected ret%rns or ?toc7s ( and B+ ,.-,6 and ,.556 The co1ariance bet"een ?toc7s ( and B is8 &$.$$$-5: The correlation coe icient bet"een ?toc7s ( and B is8 &$.5, ?%ppose yo% "ant to hold a port olio composed o 5$6 o ?toc7 ( and 5$6 o ?toc7 B. *hat "ill be the expected ret%rn (mean) and ris7 (standard de1iation) o yo%r port olio+ 5.#6 and 1.$:6

:.

;o% are managing a port olio o 1$ stoc7s "hich are held in e'%al amo%nts. The c%rrent beta o the port olio is 1.5#2 and the beta o ?toc7 ( is ,.$. I ?toc7 ( is sold2 "hat does the beta o the replacement stoc7 ha1e to be to ha1e a ne" port olio beta o 1.55+ 1.1$

@.

Gi1en the ollo"ing in ormation concerning (??ET? < and ;8 0ossible /%tcomes Ret%rns o (ssets 0robability < ;

11

1 , # 5 (.

$.1$ $.,$ $.#$ $.,$ $.1$

$.$$ $.$@ $.1, $.-$ $.5$

&$.$# $.1$ $.1, $.1# $.15

*hat are the expected ret%rns or (??ET? < and ; gi1en the abo1e probabilities+ 1@.#$ percent and1$.@$ percent

B.

*hat is the expected ret%rn o a port olio comprised o #$ percent o an in1estorCs "ealth in1ested in (??ET < and 5$ percent in1ested in (??ET ;+ 1-.@# percent *hat are the standard de1iations o the ret%rns o the t"o sec%rities+ 15.# percent and 5., percent

4.

=.

*hat is the 4/F(RI(.4E bet"een the t"o sec%rities+ $.$$5#@@

E.

*hat is the 4/RREL(TI/. bet"een these t"o sec%rities+ $.5-5

3.

*hat is the standard de1iation o a port olio comprised o #$ percent o an in1estorCs "ealth in1ested in (??ET < and 5$ percent in1ested in (??ET ;+ @.9- percent

CHAPTER SIX PROBLEMS 1. I yo% b%y a actory or $,5$2$$$ and the terms are ,$6 do"n2 the balance to be paid o o1er -$ years at a 1,6 rate o interest on the %npaid balance2 "hat are the -$ e'%al ann%al payments+

12

$,#2@,9 ,. (n in1estor is considering the p%rchase o ,$ acres o land. Ais analysis is that i the land is %sed or cattle graDing2 it "ill prod%ce a cash lo" o $12$$$ per year inde initely. I the in1estor re'%ires a ret%rn o 1$6 on in1estments o this type2 "hat is the most he "o%ld be "illing to pay or the land+ $1$2$$$ 3. /n Ian%ary 12 19952 a grad%ate st%dent de1eloped a inancial plan "hich "o%ld pro1ide eno%gh money at the end o his grad%ate "or7 (Ian%ary 12 ,$$$) to open a b%siness o his o"n. Ais plan "as to deposit $@2$$$ per year2 starting immediately2 into an acco%nt paying 1$6 compo%nded ann%ally. Ais acti1ities proceeded according to plan except that at the end o his third year he "ithdre" $52$$$ to ta7e a 4aribbean cr%ise2 at the end o the o%rth year he "ithdre" $52$$$ to b%y a %sed 4amaro2 and at the end o the i th year he had to "ithdra" $52$$$ to pay to ha1e his dissertation typed. Ais acco%nt2 at the end o the i th year2 "ill be less than the amo%nt he had originally planned on by ho" m%ch+ $15255$ #. ;o% ha1e been gi1en the ollo"ing cash lo"s. *hat is the present 1al%e (t H $) i the disco%nt rate is 1,6+ $ 1 , # 5 5 &&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&& $$ $1 $,$$$ $,$$$ $,$$$ $$ &$,$$$ $-2,:5 5. (B4 4orporation has been en>oying a phenomenal rate o gro"th since its inception one year ago. 4%rrently assets total $1$$2$$$. I gro"th contin%es at the c%rrent rate o 1,6 compo%nded '%arterly2 "hat "ill be total assets in , 1B, years+ $1-#2-9$

5.

4harter (ir is considering the p%rchase o an aircra t to s%pplement its c%rrent leet. In estimating the impact o adding this cra t to their leet2 they ha1e de1eloped the ollo"ing cash lo" analysis8 End o year 1 , # &$12$$$ $1$$2$$$ $1$$2$$$ $1$$2$$$

13

5 5 :

$1$$2$$$ $1$$2$$$ &$-$$2$$$

I the disco%nt rate is 1$62 "hat is the present 1al%e o these estimated lo"s+ $1@92:5, :. 3ind the present 1al%e or the ollo"ing income stream i the interest rate is 1, percent. ;E(R? 1&# 5&1$ 11&15 4(?A3L/* $ 52$$$ $ :25$$ $ 1$2$$$ $-121#@.5$ @. ;o% are thin7ing abo%t b%ying a car2 and a local ban7 is "illing to lend yo% $,$2$$$ to b%y the car. Knder the terms o the loan2 it "ill be %lly amortiDed o1er i1e years (5$ monthly payments) and the nominal interest "ill be 1, percent. *hat "o%ld be the monthly payment on the loan+ $###.@9 9. ;o% ha1e been sa1ing money or the last t"o years. ;o% made deposits o $1$$ on Ian%ary 12 ,$$12 and I%ly 12 ,$$12 in a sa1ings acco%nt paying 1$6 compo%nded semi&ann%ally. /n Ian%ary 12 ,$$,2 the ban7 increased the interest rate paid on sa1ings acco%nts to 1,62 ann%al compo%nding. ;o% made a third $1$$ deposit on (pril 12 ,$$,. Ao" m%ch "ill be in yo%r acco%nt on Ian%ary 12 ,$$-+ $-#9.95 1$. ;o% plan on "or7ing or 1$ years and then lea1ing or the (las7an Pbac7 co%ntryQ. ;o% ig%re yo% can sa1e $12$$$ a year or the irst 5 years and $,2$$$ a year or the last 5 years. In addition2 yo%r amily has gi1en yo% a $52$$$ grad%ation gi t. I yo% p%t the gi t and yo%r %t%re sa1ings in an acco%nt paying @ percent compo%nded ann%ally2 "hat "ill yo%r Psta7eQ be "hen yo% lea1e or the "ilderness 1$ years hence+ $-121#@ 11. I $1$$ is placed in an acco%nt that earns a nominal #62 compo%nded '%arterly2 or 5 years2 "hat "ill it be "orth in 5 years+ $1,,.$, 1,. Aess =istrib%tors is inancing a ne" tr%c7 "ith a loan o $1$2$$$ to be repaid in 5 ann%al installments o $,25$5. *hat ann%al interest rate is the company paying+ @6 1-. ;o% ha1e decided to deposit yo%r scholarship money ($12$$$) in a sa1ings acco%nt paying @6 interest2 compo%nded '%arterly. Eighteen months later2 yo% decide to go to the mo%ntains rather than school and yo% close o%t yo%r acco%nt. Ao" m%ch money

14

"ill yo% recei1e+ $121,5 1#. The present 1al%e (t H $) o the ollo"ing cash lo" stream is $529:9.$# "hen disco%nted at 1-6 ann%ally. *hat is the 1al%e o the EI??I.G (t H ,) cash lo"+ $ 1 , # &&&O&&&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&&O&&&&&&&&&&&O&&&&& $$ $ 9$$ $+ $,21$$ $12@$$ $ #25,: 15. ;o% "ant to set %p a tr%st %nd. I yo% ma7e a payment at the end o each year or t"enty years and earn 1$6 per year2 ho" large m%st yo%r ann%al payments be so that the tr%st is "orth $1$$2$$$ at the end o the t"entieth year+ $12:#5.95 15. T"el1e years ago yo% bo%ght a $,5 stoc7 "hich is no" "orth $:@.#:. (ss%ming that the stoc7 paid no di1idends2 the rate o ret%rn on yo%r in1estment "as8 1$6 1@. ?tarting on Ian%ary 12 19912 and then on each Ian%ary 1 %ntil ,$$$ (1$ payments)2 yo% "ill ma7e payments o $12$$$ into an in1estment "hich yields 1$ percent. Ao" m%ch "ill yo%r in1estment be "orth on =ecember -1 in the year ,$1$+ $#52#5@.,5 19. ;o%r 59&year old a%nt has sa1ings o $-52$$$. ?he has made arrangements to enter a home or the aged on reaching the age o @$. ;o%r a%nt "ants to decrease at a constant amo%nt each year or ten years2 "ith a Dero balance remaining. Ao" m%ch can she "ithdra" each year i she earns 5 percent ann%ally on her sa1ings+ Aer irst "ithdra"al "o%ld be one year rom today. 8. $#2:55 ,$. ( rich a%nt promises yo% $-52$$$ exactly 5 years a ter yo% grad%ate rom college. *hat is the 1al%e o the promised $-52$$$ i yo% co%ld negotiate payment %pon grad%ation+ (ss%me an interest rate o 1, percent. $192@5$.$5 ,1. In planning to b%y a home yo% are p%tting $,25$$ o yo%r end o year bon%s in an acco%nt that earns 1$ percent. I yo%r irst payment begins in exactly one year2 ho" m%ch o a do"n payment "ill yo% be able to a ord at the end o # years+ $1125$,.5$ ,,. 3red Iohnson is retiring one year rom today. Ao" m%ch sho%ld 3red c%rrently ha1e in a retirement acco%nt earning 1$ percent interest to g%arantee "ithdra"als o $,52$$$ per year or 1$ years+

15

$15-2515 ,-. I yo% "ere promised 1$ ann%al payments o $#2$$$ starting "ith the irst payment today2 comp%te the present 1al%e o these lo"s i yo%r opport%nity cost is : percent. $-$2$5$.@$ ,#. ;o% place $52$$$ in yo%r credit %nion at an ann%al interest rate o 1, percent compo%nded monthly. Ao" m%ch "ill yo% ha1e in , years i all interest remains in the acco%nts+ $52-#@.5$ ,5. ;o% ha1e >%st had yo%r thirtieth birthday. ;o% ha1e t"o children. /ne "ill go to college @ years rom no" and re'%ire o%r beginning&o &year payments or college expenses o $1,2$$$2 $1-2$$$2 $1#2$$$2 and $152$$$. The second child "ill go to college 1# years rom no" and re'%ire o%r beginning&o &year payments o $152$$$2 $1:2$$$2 $1@2$$$2 and $192$$$. In addition2 yo% plan to retire in ,5 years. ;o% "ant to be able to "ithdra" $5$2$$$ per year (at the end o each year) rom an acco%nt thro%gho%t yo%r retirement. ;o% expect to li1e ,5 years beyond retirement. The irst "ithdra"al "ill occ%r on yo%r i ty&sixth birthday. *hat e'%al2 ann%al2 end&o &year amo%nt m%st yo% sa1e or each o the next ,5 years to meet these goals2 i all sa1ings earn a 1- percent ann%al rate o ret%rn+ $ 525#5 ,5. 3ind the present 1al%e o the cash lo"s sho"n %sing a disco%nt rate o 9 percent. ;E(R 1&5 5 : @&15 1:&,$ 4(?A3L/* $15$Byr. ,$$ ,5$ 15$Byr. -$$Byr. $ 125:5.,$ ,:. (ccording to a local department store2 the store charges c%stomers 16 per month on the o%tstanding balances o their charge acco%nts. *hat is the e ecti1e ann%al rate on s%ch c%stomer credit+ (ss%me the store recalc%lates yo%r acco%nt balance at the end o each month. 1,.5@6 ;o%r ban7 has o ered yo% a $152$$$ loan. The terms o the loan re'%ire yo% to pay bac7 the loan in i1e e'%al ann%al installments o $#2151.$$. The irst payment "ill be made a year rom today. *hat is the e ecti1e rate o interest on this loan+ 8 ,9. 1,6

,@.

;o% ha1e p%rchased a ne" sailboat and ha1e the option o paying the entire $@2$$$ no" or ma7ing e'%al2 ann%al payments or the next # years2 the irst payment d%e one year rom no". I yo%r time 1al%e o money is : percent2 "hat "o%ld be the largest

16

amo%nt or the e'%al2 ann%al payments that yo% "o%ld be "illing to %nderta7e+ $,2-5,.$$ -$. ( irm p%rchases 1$$ acres o land or $,$$2$$$ and agrees to remit t"enty e'%al ann%al installments o $#12$5: each. *hat is the tr%e ann%al interest rate on this loan+ ,$ percent -1. Thirty years ago2 Iessie Iohnson bo%ght ten acres o land or $5$$ per acre in "hat is no" do"nto"n Ao%ston. I this land gre" in 1al%e at a 1$ percent per ann%m rate2 "hat is it "orth today+ $ @:2,#5 -,. I yo% p%t yo%r money in a ban7 o ering 1, percent compo%nded '%arterly2 ho" m%ch "ill $12$## gro" to in i1e years+ 8 $12@@5.5@ --. *hat is the %t%re 1al%e o $12,5$ compo%nded at an @ percent rate or ten years+ $,259@.5-#. Iames ?treetsC son Aarold is i1e years old today. Aarold is already ma7ing plans to go to college on his eighteenth birthday and his ather "ants to start p%tting a"ay money no" or that p%rpose. ?treet estimates that Aarold "ill need $1#2$$$2 $152$$$2 $152$$$2 and $1:2$$$ or his reshman2 sophomore2 >%nior2 and senior years. Ae plans on ma7ing these amo%nts a1ailable to Aarold at the beginning o each o these years. ?treet "o%ld li7e to ma7e t"el1e deposits (the irst o "hich "o%ld be made on AaroldCs sixth birthday2 1 year rom no") in an acco%nt earning 1, percent. Ae "ants the acco%nt to e1ent%ally be "orth eno%gh to pay or AaroldCs college expenses. (ny balances remaining in the acco%nt "ill contin%e to earn 1, percent. Ao" m%ch "ill ?treet ha1e to deposit in this planning acco%nt each year to pro1ide or AaroldCs ed%cation+ $,155

-5.

In yo%r analysis o =BE 4orporation yo% ind that the c%rrent earnings per share are $5.$$ per share and most analysts are pro>ecting the earnings per share to gro" at a 1, percent rate ann%ally. *hat can yo% expect the earnings per share o this irm to be in : years+ $11.$5

-5.

;o%r grandmother is thrilled that yo% are going to college and plans to re"ard yo% at grad%ation "ith a 0orsche T%rbo a%tomobile. ?he "o%ld li7e to set aside an e'%al

17

amo%nt at the completion o each o yo%r college years rom her meager pension. I her acco%nt earns 1, percent and a ne" 0orsche "ill cost $5$2$$$2 ho" m%ch "ill she deposit each year+ (ss%me her irst deposit is in exactly one year. $1$2#5,.## -:. ?ellDar 4orporation c%rrently has sales o $1$$ million and its mar7eting department is pro>ecting sales to be $@$$ million in # years. *hat rate o gro"th in sales are the mar7eting people pro>ecting+ 5@6 -@. ?%ppose that a local sa1ings and loan association ad1ertises a 5 percent ann%al rate o interest on reg%lar acco%nts2 compo%nded monthly. *hat is the e ecti1e ann%al percentage rate o interest paid by the sa1ings and loan+ 5.156 -9. Greg 0erry2 KTE0Cs reno"ned comp%ter >oc72 is grad%ating in one year and plans to start his o"n comp%ter irm2 namely 0erryCs 0eriphals2 Inc. Being a science iction b% 2 Greg is planning to start his irm %sing $5$2$$$ he earned as a trombone player in the Bits and =iscs IaDD Band d%ring college and retire in ,$ years in order to ta7e the irst Intergalactic ?pace ?h%ttle trip at an estimated cost o $1$.5 million. *hen Greg ret%rns to earth 1$ years therea ter2 he plans to li1e o an ann%ity o $-$$2$$$ per year2 starting on the day o his ret%rn. This ann%ity "as %nded "hen he le t on his space >o%rney and is earning interest at 1, percent per year. B%t one o the side e ects o the space sh%ttle program has been that e1ery tra1eler dies exactly ,$ years rom the day o ret%rn. 4alc%late the gro"th rate o 0erryCs 0eriphals that "ill ma7e GregCs long&range plans possible. -1.1 percent Iason and Bryan Ec.%tt are presently - and 5 years old. Their parents are planning to send them to college at age 1@ at a cost o $1$2$$$ per year or each. Ao" m%ch m%st the parents contrib%te ann%ally to a college %nd to ens%re the boysC college ed%cation i the interest rate is 1, percent compo%nded ann%ally+ The payments start in one year and end "hen the yo%nger brother starts college. $,2$5: #1. I yo% ha1e $52#-5 in an acco%nt that has been paying an ann%al rate o 1$62 compo%nded contin%o%sly2 since yo% deposited some %nds 1$ years ago2 ho" m%ch "as the original deposit+ $,2$$$ Ao" m%ch sho%ld yo% be "illing to pay or an acco%nt today that "ill ha1e a 1al%e o $12$$$ in 1$ years %nder contin%o%s compo%nding i the nominal rate is 1$6+ $-5@ #-. ;o%r irm has recently borro"ed $1$$2$$$ rom a local ban7 at an interest rate o 1$ percent. The loan is to be repaid in 5 e'%al2 end&o &year payments. The ollo"ing is a partial amortiDation sched%le or the loan.

#$.

#,.

18

0rincipal ;ear 0ayment Interest Red%ction $ 1 $ ,52-@$ $ 1$2$$$ $ 152-@$ , $ ,52-@$ $ @2-5, $ ( - $ ,52-@$ $ B $ 192@,$ # $ ,52-@$ $ #25:@ $ ,12@$1 5 $ ,52-@$ $ ,2-9@ $ ,-29@1 (.

Balance $ 1$$2$$$ $ @-25,$ $ 5525$, $ #52:@$ ,-29@1 $ $

The missing 1al%e or the 0rincipal Red%ction in the second year (labeled () is8 $ 1@2$1@

B.

The missing 1al%e or the Interest 0ayment in the third year (labeled B) is8 $ 5255$

##.

;o% are 1al%ing an in1estment that "ill pay yo% $,#2$$$ per year or the irst 5 years2 $,@2$$$ per year or the next 1$ years2 and $5#2$$$ per year the ollo"ing 1# years (all payments are at the end o each year). I the appropriate ann%al disco%nt rate is 5.$$62 "hat is the 1al%e o the in1estment to yo% today+ $#5$2@:@ CHAPTER SEVEN PROBLEMS

1.

4alc%late the price o a 1$ year bond paying a 5 percent ann%al co%pon (hal o the 5 percent semiann%ally) on a ace 1al%e o $12$$$ i in1estors can earn @ percent on similar ris7 in1estments. $@5-.:$

,.

( ma>or a%to man% act%rer has experienced a mar7et re&e1al%ation lately d%e to a n%mber o la"s%its. The irm has a bond iss%e o%tstanding "ith 15 years to mat%rity and a co%pon rate o @6 (paid semiann%ally). The re'%ired rate has no" risen to 156. (t "hat price can these sec%rities be p%rchased on the mar7et+ $5#9.:1

-.

The c%rrent mar7et price o a IonesC 4ompany bond is $12,9:.5@. ( 1$6 co%pon interest rate is paid semi&ann%ally2 and the par 1al%e is e'%al to $12$$$. *hat is the ;TE (on an ann%al basis) i the bonds mat%re 1$ years rom today+ 5 percent 4ommon"ealth 4ompany has 1$$ bonds o%tstanding (mat%rity 1al%e H $12$$$). The re'%ired rate o ret%rn on these bonds is c%rrently 1$62 and interest is paid semiann%ally. The bonds mat%re in 5 years2 and their c%rrent mar7et 1al%e is $:5@ per bond. *hat is the ann%al co%pon interest rate+ #6 percent

#.

5.

;o% ha1e >%st been o ered a bond or $@#:.@@. The co%pon rate is @62 payable ann%ally2 and interest rates on ne" iss%es o the same degree o ris7 are 1$6. ;o%

19

"ant to 7no" ho" many more interest payments yo% "ill recei1e2 b%t the party selling the bond cannot remember. 4an yo% help him o%t+ 15 5. 3ord and GE ha1e similar bond iss%es o%tstanding. The 3ord bond has interest payments o $@$ paid ann%ally and mat%res in the year ,$$, (,$ years rom today). The GE bond has interest payments o $@$ paid semiann%ally and also mat%res in the year ,$$,. I the re'%ired rate o ret%rn (7d) is 1,62 "hat is the di erence in c%rrent selling price o the t"o bonds+ $,.1@ :. (cme 0rod%cts has a bond o%tstanding "ith @ years remaining to mat%rity and a co%pon rate o 56 paid semiann%ally. I the c%rrent mar7et price is $:,9.$52 "hat is the yield to mat%rity+ 1$ percent @. Recently2 TLE2 Inc.2 iled ban7r%ptcy papers. The irm "as reorganiDed as =L2 Inc.2 and the co%rt permitted a ne" indent%re on an o%tstanding bond iss%e to be p%t into e ect. The iss%e has 1$ years to mat%rity and a co%pon rate o 1$62 paid ann%ally. The ne" agreement allo"s the irm to pay no interest or 5 years and then at mat%rity to repay principal and any %npaid interest (no interest on the %npaid interest). I the re'%ired ret%rn is ,$62 "hat sho%ld s%ch bonds sell or in the mar7et today+ $-5,.## 9. In order to assess acc%rately the capital str%ct%re o a irm2 it is necessary to con1ert the balance sheet to a mar7et 1al%e basis. The c%rrent balance sheet is as ollo"s8 Long&term debt (bonds) 0re erred stoc7 4ommon stoc7 ($1$ par) Retained earnings Total debt and e'%ity $1$2$$$2$$$ ,2$$$2$$$ 1$2$$$2$$$ #2$$$2$$$ &&&&&&&&&&& $,52$$$2$$$

The bonds mat%re in 1$ years. Interest is payable semiann%ally and the yield to mat%rity is 1,6. The co%pon rate is # percent. *hat is the c%rrent mar7et 1al%e o the irmCs debt+ $5.#1, million 1$. 4alc%late the yield to mat%rity (on an ann%al basis) o an @ percent co%pon2 1$&year bond that pays interest semiann%ally i its price is no" $::$.5$. 1, percent 11. ;o% are the o"ner o 1$$ bonds iss%ed by Eidterm 4orporation. These bonds ha1e @ years remaining to mat%rity2 an ann%al co%pon payment o $@$2 and a par 1al%e o $12$$$. Kn ort%nately2 Eidterm is on the brin7 o ban7r%ptcy2 and the creditors2

20

incl%ding yo%rsel 2 ha1e agreed to a postponement o the next # interest payments. The remaining interest payments "ill be made as sched%led. The postponed payments "ill accr%e interest at an ann%al rate o 56 and "ill be paid as a l%mp s%m at mat%rity @ years hence. The re'%ired rate o ret%rn on these bonds2 considering their s%bstantial ris72 is no" ,@6. *hat is the present 1al%e o each bond+ $,55.@9 1,. The <;R 4ompany recently iss%ed a ,$&year2 : percent semiann%al co%pon bond at par. ( ter three months2 the mar7et interest rates on similar bonds increased to @ percent. (t "hat price sho%ld the bonds sell+ $91@.@@ 1-. IB< has a bond iss%e o%tstanding that is callable in three years at a 5 percent call premi%m. The bond pays a 1$ percent ann%al co%pon and has a remaining mat%rity o ,- years. I the c%rrent mar7et price is $1$$$2 than "hat is the yield to call+ 11.#@ percent CHAPTER EIGHT PROBLEMS 1. The =(0 4ompany has decided to ma7e a ma>or in1estment. The in1estment "ill re'%ire a s%bstantial early cash o%t& lo"2 and in lo"s "ill be relati1ely late. (s a res%lt2 it is expected that the impact on the irmCs earnings or the irst , years "ill be a negati1e gro"th o 56 ann%ally. 3%rther2 it is anticipated that the irm "ill then experience , years o Dero gro"th a ter "hich it "ill begin a positi1e ann%al s%stainable gro"th o 56. I the irmCs cost o capital is 1$6 and its c%rrent di1idend (= $) is $, per share2 "hat sho%ld be the c%rrent price per share+ $-@.#: ,. The Radley 4ompany has decided to %nderta7e a large ne" pro>ect. 4onse'%ently2 there is a need or additional %nds. The inancial manager decides to iss%e pre erred stoc7 "hich has a stated di1idend o $5 per share and a par 1al%e o $-$. I the re'%ired ret%rn on this stoc7 is c%rrently ,$62 "hat sho%ld be the stoc7Cs c%rrent mar7et 1al%e+ $,5

-.

?.GCs stoc7 is selling or $15 per share. The irmCs income2 assets2 and stoc7 price ha1e been gro"ing at an ann%al 156 rate and are expected to contin%e to gro" at this rate or - more years. .o di1idends ha1e been declared as yet2 b%t the irm intends to declare a $,.$$ di1idend at the end o the last year o its s%pernormal gro"th. ( ter that2 di1idends are expected to gro" at the irmCs normal gro"th rate o 56. The irmCs re'%ired rate o ret%rn is 1@6. ;o% sho%ld8 ?ell the stoc7! it is o1er1al%ed by $-.$-.

21

#.

BB02 Inc.2 has experienced a recent res%rgence in b%siness as it has gained ne" national identity. Eanagement is orecasting rapid gro"th o1er the next # years (ann%al rate o 156). ( ter that2 it is expected that the irm "ill re1ert to its historical gro"th rate o ,6 ann%ally. The last di1idend paid "as $1.5$ per share2 and the re'%ired ret%rn is 1$6. *hat is the c%rrent price per share2 ass%ming e'%ilibri%m+ $,9.51

5.

The 4l%b (%to 0arts 4ompany has >%st recently been organiDed. It is expected to experience no gro"th or the next , years as it identi ies its mar7et and ac'%ires its in1entory. Ao"e1er2 4l%b "ill gro" at an ann%al rate o 56 in the third and o%rth years and2 beginning "ith the i th year2 sho%ld attain a 1$6 gro"th rate "hich it "ill s%stain therea ter. The last di1idend paid "as $$.5$ per share. 4l%b has a cost o capital o 1,6. *hat sho%ld be the present price per share o 4l%b common stoc7+ $,$.@#

5.

( share o =RF2 Inc.2 stoc7 paid a di1idend o $1.5$ last year2 and the di1idend is expected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rn on this stoc7 is belie1ed to be 1,6. *hat sho%ld the stoc7 sell or today+ $19.5$

:.

The 0et 4ompany has recently disco1ered a type o roc7 "hich2 "hen cr%shed2 is extremely absorbent. It is expected that the irm "ill experience (beginning no") an %n%s%ally high gro"th rate (,$6) d%ring the period (- years) "hen it has excl%si1e rights to the property "here this roc7 can be o%nd. Ao"e1er2 beginning "ith the o%rth year the irmCs competition "ill ha1e access to the material2 and rom that time on the irm "ill ass%me a normal gro"th rate o @6 ann%ally. =%ring the rapid gro"th period2 the irmCs di1idend payo%t ratio "ill be relati1ely lo" (,$6)2 to conser1e %nds or rein1estment. Ao"e1er2 the decrease in gro"th "ill be accompanied by an increase in di1idend payo%t to 5$6. Last yearCs earnings "ere $,.$$ per share (E $) and the irmCs cost o e'%ity is 1$6. *hat sho%ld be the c%rrent price o the common stoc7+ $:1.5@

@.

ITJE2 Inc.2 a large conglomerate2 has decided to ac'%ire another irm. (nalysts are orecasting that there "ill be a period (, years) o extraordinary gro"th (,$6) ollo"ed by another , years o %n%s%al gro"th (1$6)2 and that inally the pre1io%s gro"th pattern o 56 ann%ally "ill res%me. I the last di1idend "as $1 per share and the re'%ired ret%rn is @62 "hat sho%ld the mar7et price be today+ $:-.:#

9.

( share o =RF2 Inc.2 stoc7 paid a di1idend o $1.5$ last year2 and the di1idend is expected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rn on this stoc7 is belie1ed to be 1,6. ?%ppose =RF stoc7 "ere selling or $,5 today. *hat "o%ld be the implied 1al%e o 7s 2 ass%ming the other data remain the same+ 1$.,# percent

1$.

The 4anning 4ompany has been hit hard d%e to increased competition. The companyCs analysts predict that earnings (and di1idends) "ill decline at a rate o 56

22

ann%ally into the oreseeable %t%re. (ss%me that 7 s H 116 and =$ H $,.$$. *hat "ill be the price o the companyCs stoc7 in three years+ $1$.19 11. IBE is c%rrently selling at $55 per share. .ext yearCs di1idend is expected to be $,.5$. I in1estors on this partic%lar day expect a ret%rn o 1,6 on their in1estment2 "hat do they thin7 IBECs gro"th rate "ill be+ @ percent 1,. The EE 4ompany has allen on hard times. Its management expects to pay no di1idends or the next , years. Ao"e1er2 the di1idend or ;ear - (= -) "ill be $1.$$ per share2 and it is expected to gro" at a rate o -6 in ;ear #2 56 in ;ear 52 and 1$6 in ;ear 5 and therea ter. I the re'%ired ret%rn or EE 4o. is ,$62 "hat is the c%rrent e'%ilibri%m price o the stoc7+ $5.-# 1-. ;o%r brother&in&la"2 a stoc7bro7er at In1est2 Inc.2 is trying to sell yo% a stoc7 "ith a c%rrent mar7et price o $,$. The stoc7 had a last di1idend (= $) o $,.$$ and a constant gro"th rate o @6. ;o%r re'%ired ret%rn on this stoc7 is ,$6. 3rom a strict 1al%ation standpoint2 yo% sho%ld8 .ot b%y the stoc7! it is o1er1al%ed by $,.$$. 1#. .egati1e Limited is expected to gro" or o%r years at a rate o 5$ percent. ( ter o%r years2 the prod%ct ad is expected to decline2 and .egati1e "ill gro" at a negati1e gro"th rate o 5 percent. .egati1e c%rrently pays a di1idend o $1.$$ per share and stoc7holders ha1e a re'%ired rate o ret%rn o 1@ percent. *hat sho%ld be the mar7et 1al%e or a share o .egati1e Limited stoc7+ $1@.-# 15. (ss%me the irm has been gro"ing at a 156 ann%al rate and is expected to contin%e to do so or - more years. (t that time2 gro"th is expected to slo" to a constant #6 rate. The irm maintains a -$6 payo%t ratio2 and this yearCs retained earnings "ere $1.# million. The irmCs beta is 1.,52 the ris7& ree rate is @62 and the mar7et ris7 premi%m is #6. I the mar7et is in e'%ilibri%m2 "hat is the mar7et 1al%e o the irmCs common e'%ity (1 million shares o%tstanding)+ $9.15 million 15. =exter2 Inc.2 has >%st paid a di1idend o $,.$$. Its stoc7 is no" selling or $#@ per share. The irm is hal as 1olatile as the mar7et. The expected ret%rn on the mar7et is 1#6 and the yield on K.?. Treas%ry bonds is 116. I the mar7et is in e'%ilibri%m2 "hat rate o gro"th is expected+ @ percent 1:. Gi1en the ollo"ing in ormation2 calc%late the expected capital gains yield or Bimlo Bottle 4aps! beta H $.5! 7m H 156! R H @6! =1 H $,.$$! 0$ H $,5.$$. (ss%me the stoc7 is a constant gro"th stoc7 and is in e'%ilibri%m.

23

#., percent 1@. <;R stoc7 is c%rrently paying a di1idend o $,.$$ per share (= $ H $,) and is in e'%ilibri%m. The company has a gro"th rate o 56 and beta e'%al to 1.5. The re'%ired rate o ret%rn on the mar7et is 1562 and the ris7& ree rate is :6. <;R is considering a change in policy that "ill increase its beta coe icient to 1.:5. I mar7et conditions remain %nchanged2 "hat ne" gro"th rate "ill ca%se the common stoc7 price o <;R to remain %nchanged+ 5.:5 percent 19. Knion 0aperCs stoc7 is c%rrently in e'%ilibri%m selling at $-$ per share. The irm has been experiencing a 56 ann%al gro"th rate. Earnings per share (E $) "ere $#.$$ and the di1idend payo%t ratio is #$6. The ris7& ree rate is @6 and the mar7et ris7 premi%m is 56. I systematic ris7 increases by 5$62 all other actors remaining constant2 the stoc7 price "ill increaseBdecrease by8 &$:.-1 ,$. 4harter /il 4ompany is c%rrently selling at its e'%ilibri%m price o $1$$ per share. The beta coe icient c%rrently is ,. The ris7& ree rate is 1$6. The ollo"ing e1ents "ill soon occ%r8 (1) top management "ill lo"er 4harterCs beta to 1., by in1esting in se1eral lo" ris7 pro>ects! (,) the 3ederal Reser1e Board "ill red%ce the money s%pply ca%sing the in lation premi%m to be red%ced by - percentage points! and (-) decreased "orld stability d%e to global politics "ill ca%se the mar7et ris7 premi%m to increase , percentage points to 56. The company has a constant gro"th rate o 56. *hat "ill be the ne" e'%ilibri%m price or a share o 4harter /il common stoc7 a ter the abo1e e1ents ha1e ta7en place+ ((ss%me the expected di1idend "ill not change.) $1-:.5$ ,1. *heeler2 Inc.2 is presently in a stage o abnormally high gro"th beca%se o the excess demand or "idgets. The company expects earnings and di1idends to gro" at a rate o ,$6 or the next # years2 a ter "hich time there "ill be no gro"th in earnings and di1idends. The companyCs last di1idend "as $1.5$. *heeler has a beta o 1.52 the ret%rn on the mar7et is c%rrently 1,.:562 and the ris7& ree rate is #6. *hat sho%ld be the c%rrent price per share o common stoc7+ $15.1:

,,. ;o% are gi1en the ollo"ing data8 1. ,. -. #. 5. The ris7& ree rate is $.$5. The re'%ired ret%rn on the mar7et is $.$@. The expected gro"th rate or the irm is $.$#. The last di1idend paid "as $$.@$ per share. Beta is 1.-.

.o" ass%me the ollo"ing changes occ%r8

24

1. ,. -. #.

The in lation premi%m decreases by the amo%nt o $.$1. (n increased degree o ris7 a1ersion ca%ses the re'%ired ret%rn on the mar7et to go to $.1$ a ter ad>%sting or the changed in lation premi%m. The expected gro"th rate increases to $.$5. Beta rises to 1.5.

*hat "ill be the change in price per share ass%ming the stoc7 "as in e'%ilibri%m be ore the changes+ &$#.@: ,-. ;o% are considering b%ying common stoc7 in Gro" /n2 Inc. ;o% ha1e calc%lated that the irmCs ree cash lo" "as $:.5$ million last year. ;o% pro>ect that ree cash lo" "ill gro" at a rate o 5.$6 per year inde initely. The irm c%rrently has o%tstanding debt and pre erred stoc7 "ith a total mar7et 1al%e o $,,.,- million. The irm has ,.9# million shares o common stoc7 o%tstanding. I the irmCs cost o capital is 19.$62 "hat is the most yo% sho%ld pay per share or the stoc7 no"+ $11.@,#. =%e to the highly specialiDed nat%re o the electronic ind%stry2 Borrett Ind%stries in1est a lot o money in RJ= on prospecti1e prod%cts. 4onse'%ently2 it retains all o its earning and rein1ests them into the irm. (t this time2 Borrett does not any plans to pay di1idends in the near %t%re. ( ma>or pension %nd is interested in p%rchasing BorrettCs stoc72 "hich is traded on the .;?E. The treas%rer or the pension %nd has done research on the company and has estimated BorrettCs ree cash lo" or the next o%r years as ollo"s8 $- million2 $5 million2 $1$ million and $15 million. ( ter the o%rth year2 ree cash lo" is pro>ected to gro" at a constant : percent. BorrettCs *(44 is 1, percent2 it has $5$ million o total debt and pre erred stoc7 and 1$ million shares o common stoc7. (. *hat is the present 1al%e o BorrettCs ree cash lo"s d%ring the next o%r years+ $,#211,2-$@ *hat is the companyCs terminal 1al%e+ $-,12$$$2$$$ *hat is the total 1al%e o the irm today+ $,,@211-251, *hat is BorrettCs price per share+ $15.@1

B. 4. =. ,5.

(ss%me that today is =ecember -12 ,$$$ and that the ollo"ing in ormation applies to Fermeil (irlines8 (. B. 4. =. E. ( ter&tax operating income SEBIT(1&t)T or ,$$1 is expected to be $5$$ million. The companyCs depreciation expense or ,$$1 is expected to be $1$$ million. The companyCs capital expendit%res or ,$$1 are expected to be $,$$ million .o change is expected in the companyCs net operating "or7ing capital. The companyCs ree cash lo" is expected to gro" at a constant rate o 5 percent per year.

25

3. G. A. I.

The companyCs cost o e'%ity is 1# percent. The companyCs *(44 is 1$ percent. The mar7et 1al%e o the companyCs debt is $- billion. The company has ,$$ million shares o stoc7 o%tstanding.

Ksing the ree cash lo" approach2 "hat sho%ld the companyCs stoc7 price be today+ $-5.$$ per share

CHAPTER NINE PROBLEMS 1. The chie inancial o icer o 0ortland /il has gi1en yo% the assignment o determining the irmCs marginal cost o capital. The present capital str%ct%re "hich is considered optimal2 is8 Boo7 Fal%e Ear7et Fal%e =ebt $ 5$ million $ #$ million 0re erred ?toc7 1$ million 5 million 4ommon E'%ity -$ million 55 million Total $ 9$ million $ 1$$ million The anticipated inancing opport%nities are these8 =ebt can be iss%ed "ith a 15 percent be ore&tax cost. 0re erred stoc7 "ill be $1$$ par2 carry a di1idend o 1- percent2 and can be sold to net the irm $95 per share. 4ommon e'%ity has a beta o 1.,$2 the ret%rn on the mar7et is 1: percent2 and the ris7& ree rate is 1, percent. I the irmCs tax rate is #$ percent2 "hat is its marginal cost o capital+ 1#., percent ,. ?ilicon 4orp. recently iss%ed 1$&year2 1, percent co%pon bonds at par 1al%e. ?iliconCs beta is $.5! the optimal capital str%ct%re contains #5 percent debtB55 percent e'%ity! and the marginal tax rate is #$ percent. I the expected ret%rn on the mar7et is 15 percent and the treas%ry bill rate is 9 percent2 estimate ?iliconCs "eighted a1erage cost o capital. 1$.5 percent

-.

Ie erson re'%ires $15 million to %nd its c%rrent year)s capital pro>ects. Ie erson "ill inance part o its needs "ith $9 million in internally generated %nds. The irms) common stoc7 mar7et price is $1,$ per share. The irm)s last di1idends "as $5 per share and is expected to gro" at a rate o 11 percent ann%ally or the oreseeable %t%re. (nother portion o the re'%ired %nds "ill come rom the iss%e o 92-:5 shares o 1, percent $1$$ par pre erred stoc7 that "ill be pri1ately placed. The irm "ill net $95 per share rom the sale o these shares. The remainder o the %nding needs "ill be met "ith debt. 3i1e tho%sand 1$&year $12$$$ par bonds "ith a co%pon rate o 15 percent "ill be iss%es to net the irm $12$,$ each. Interest "ill be paid ann%ally on the

26

bonds. The irm)s tax rate is -$ percent. 1-.51 percent #. (1erage 4orporationCs stoc7 c%rrently sells or $#5.$$ per share2 it is expected to pay a di1idend o $-.1$ next year2 its gro"th rate is a constant :.$62 and the company "ill inc%r a lotation cost o 1,.$6 o the mar7et 1al%e i it sells ne" common stoc7. The irmCs tax is #$6. *hat is the irmCs cost o retained earnings+ 1-.@96 5. ;o% are determining <;R2 Inc.Cs optimal capital b%dget or the next year. ;o% ha1e identi ied the ollo"ing possible I.=IFI?IBLE capital pro>ects8 0R/IE4T 4/?T ( $ 1$$2$$$ B @$$2$$$ 4 5$$2$$$ = -$$2$$$ E #$$2$$$ 3 :$$2$$$ G 5$$2$$$ IRR 15 6 1# 6 1@ 6 15 6 1, 6 1: 6 ,$ 6

<;RCs marginal cost o capital is8 .E* 4(0IT(L REUKIRE= $ $ & 5$$2$$$ $ 5$$2$$1 & 9992999 $ 12$$$2$$$ & 12#992999 $ 125$$2$$$ & 129992999 $ ,2$$$2$$$ & ,2#992999 $ ,25$$2$$$ & -2$$$2$$$ (B/FE $ -2$$$2$$$ E(RGI.(L 4/?T 1-.$ 6 1#., 6 15.$ 6 15.5 6 1:.$ 6 1:.5 6 1@.$ 6

*hat is <;RCs optimal capital b%dget or the %pcoming year+ $1.9 million

5.

Earginal Incorporated has determined that its be ore&tax cost o debt is 1$.$6. Its cost o pre erred stoc7 is 11.$6. Its cost o internal e'%ity is 15.$62 and its cost o external e'%ity is 15.96. 4%rrently2 the irmCs capital str%ct%re consists o -,6 debt2 1#6 pre erred stoc72 and 5#6 common e'%ity. The irmCs marginal tax rate is -96. *hat is the irmCs "eighted a1erage cost o capital i it "ill ha1e to iss%e ne" common stoc7 to %nd the e'%ity portion o its capital b%dget+ 1,.5, percent

27

CHAPTER TEN PROBLEMS 1. Gi1en the ollo"ing net cash lo"s2 determine the IRR o the pro>ect8 Time &&&& $ 1 , ,#6 ,. (cme 0rod%cts2 Inc.2 re'%ires a ne" machine to prod%ce a part or a heat generator. T"o companies ha1e s%bmitted bids2 and yo% ha1e been assigned the tas7 o choosing one o the machines. 4ash lo" analysis indicates the ollo"ing8 ;ear &&&& $ , # Eachine ( &&&&&&&&& &$12$$$ $ $ $ 129-@ Eachine B &&&&&&&&& &$12$$$ #1: #1: #1: #1: .et cash lo" &&&&&&&&&&&&& $ 125,$ &12$$$ &125$$ 5$$

(.

*hat is the internal rate o ret%rn or each machine+ IRR( H $.1@! IRRB H $.,#

B.

I the cost o capital or (cme 0rod%cts is 562 "hich o the ollo"ing is tr%e+ The .0F( V .0FB 2 there ore accept Eachine (.

-.

0ro>ects 4 and * are m%t%ally excl%si1e2 and they ha1e the ollo"ing net cash lo"s8 ;ear &&&& $ 1 , # 5 0ro>ect 4 &&&&&&&&& &$5$2$$$ -$2$$$ #$2$$$ 5$2$$$ $ $ 0ro>ect * &&&&&&&&& &$1$$2$$$ #$2$$$ #$2$$$ #$2$$$ #$2$$$ #$2$$$

28

;o% are to %se the e'%i1alent ann%al ann%ity method or comparing these pro>ects since they ha1e %ne'%al li1es. The cost o capital is 1$6. *hich pro>ect sho%ld be chosen+ 0ro>ect 4 since it has a higher e'%i1alent ann%al ann%ity. #. The ?mith 4ompany is considering t"o m%t%ally excl%si1e in1estments that "o%ld increase its capacity to ma7e stra"berry tarts. The irm %ses a 1, percent cost o capital to e1al%ate potential in1estments. The pro>ects ha1e the ollo"ing costs and cash lo" streams8 ;E(R $ 1 , # 5 5 : @ (LTER.(TIFE ( (LTER.(TIFE B $ &-$2$$$ $ &-$2$$$ 1$25$$ 525$$ 1$25$$ 525$$ 1$25$$ 525$$ 1$25$$ 525$$ && 525$$ && 525$$ && 525$$ && 525$$

*hat are the respecti1e EUKIF(LE.T (..K(L (..KITIE? or alternati1es ( and B+ (LTER.(TIFE ( (LTER.(TIFE B 8 $ 5,1.-5 $ #51.-5 5. *hat is the paybac7 period2 the .0F at a disco%nt rate o 1$ percent2 and the IRR or a pro>ect "ith the ollo"ing cash lo"s+ ;E(R $ 1 , 4(?A /KT3L/* $ 1$$$ && && && 0(;B(4M 1 5B5 yrs 5. 4(?A I.3L/* && $ 5$$ 5$$ 1$5 IRR 1, 6

.0F -$

( pro>ect has an initial cost o $92#,:. I it ret%rns a net cash lo" o $12$$$ at the end o each year or the next -$ years2 the internal rate o ret%rn m%st be8 1$ 6

:.

*hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+ TIEE 4(?A /KT3L/* 4(?A I.3L/*? $ $ #-2,95 && 1 && $ 1$2$$$ , && 1$2$$$ && 1$2$$$ # && 1$2$$$ 5 && 1$2$$$

29

56 @. ;o%r company is considering t"o m%t%ally excl%si1e pro>ects2 < and ;2 "hose costs and cash lo"s are sho"n belo"8 ;ear < ; $ &$12$$$ &$12$$$ 1 1$$ 12$$$ , -$$ 1$$ #$$ 5$ # :$$ 5$ The pro>ects are e'%ally ris7y2 and their cost o capital is 1, percent. *hat is the modi ied IRR o each pro>ect+ < ; 1-.596 1-.1$6 9. 4onglomerates2 Inc.2 is considering the p%rchase o ?mall J 4ompany. The ac'%isition "o%ld re'%ire an initial in1estment o $19$2$$$2 b%t 4onglomeratesC net cash lo"s "o%ld increase by $-$2$$$ per year and remain at the ne" le1el ore1er. ?ho%ld 4onglomerates b%y ?mall+ (ss%me a cost o capital o 156. ;es2 beca%se the .0F H $1$2$$$. 1$. I the re'%ired rate o ret%rn is 1, percent2 "hat is the net present 1al%e o the pro>ect described belo"8 4/?T /3 .E* EUKI0EE.T $ 5$2$$$ LI3E /3 EUKI0EE.T 5 ;E(R? ?(LF(GE F(LKE $ 52$$$ (..K(L .ET 4(?A 3L/* $ 1,2$$$ $ &:25,# 11. *hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+ ;E(R $ 1 , # 5 4(?A3L/* $ $ $ $ $ &,5$$ $ 1$$$ $ 1$$$ $ 1$$$

9&1$ 6 1,. *hat is the net present 1al%e o this in1estment+ I.ITI(L 4/?T $ 152$$$ 0R/IE4T LI3E 5 years ?(LF(GE F(LKE $ $ (..K(L .ET 4(?A 3L/*? $ 52$$$ =I?4/K.T R(TE 1$ 6 $ -295#.$$

30

1#.

I a capital b%dgeting pro>ect has an initial o%tlay o $125$$ and an .0F o $52$$$2 "hat is its pro itability index+ #.--

15.

4%mmings 0rod%cts 4ompany is considering t"o m%t%ally excl%si1e in1estments. The pro>ectCs expected net cash lo"s are as ollo"s8 ;ear $ 1 , # 5 5 : (. Expected .et 4ash 3lo"s 0ro>ect ( 0ro>ect B ($-$$) ($#$5) (-@:) 1-# (19-) 1-# (1$$) 1-# 5$$ 1-# 5$$ 1-# @5$ 1-# (1@$) $

I the cost o capital or each pro>ect is 1, percent2 "hat is the .0F or each pro>ect+ *hich pro>ect sho%ld be accepted+ $,$$.#1 and $1#5.9- 0ro>ect (

B.

I the cost o capital or each pro>ect is 1@ percent2 "hat is the .0F or each pro>ect+ *hich pro>ect sho%ld be accepted+ $,.55 and $5-.5@ 0ro>ect B

4. *hat is the internal rate o ret%rn or each pro>ect+ 1@.16 and ,#.$6 =. *hat is the crosso1er rate+ 1#.5-6

CHAPTER ELEVEN PROBLEMS 1. The capital b%dgeting director is e1al%ating a pro>ect that costs $,$$2$$$2 is expected to last or 1$ years and to prod%ce a ter&tax income o $,925$- per year. =epreciation applicable to this pro>ect "o%ld be $,$2$$$ per year. I the cost o capital o the irm is 1#62 "hat is the pro>ectCs IRR (tax rate H #$6)+ ,1.1 percent

31

,.

EJE Inc.2 is considering the p%rchase o a ne" machine "hich "ill red%ce man% act%ring costs by $52$$$ ann%ally. EJE "ill %se the straight&line method to depreciate the machine2 and it expects to sell the machine at the end o its 5 year li e or $1$2$$$. The irm expects to be able to red%ce "or7ing capital by $152$$$ "hen the machine is installed. The irmCs marginal tax rate is #$6 and it %ses a 1,6 cost o capital to e1al%ate pro>ects o this nat%re. I the machine costs $5$2$$$2 "hat is the .0F o the pro>ectCs cash lo"s+ &$,,25$#

-.

Bla7e 4orporationCs ne" pro>ect calls or an in1estment o $1$2$$$. It has an estimated li e o 1$ years. The IRR has been calc%lated to be 156. I cash lo"s are e1enly distrib%ted and the tax rate is #$62 "hat is the ann%al BE3/RE&T(< cash lo" each year+ ((ss%me depreciation is a negligible amo%nt.) $-2-,1

#.

G Eart2 Inc.2 is considering the ac'%isition o e'%ipment to expand its sales. The initial cost o the e'%ipment is $1$$2$$$. Ao"e1er2 the prod%ction manager has estimated the expansion program "ill increase cash operating costs by $,$2$$$. (ss%me straight line depreciation to a Dero sal1age 1al%e2 a tax rate o #$62 and a cost o capital o 1$6. Ao" m%ch "ill the additional cash re1en%e d%ring the 1$ year li e o the asset ha1e to be to ca%se the IRR o the pro>ect to be e'%al to 7+ $#$2#5:

5.

Blain 4orporation is considering the p%rchase o a machine "hich has an expected @ year li e and costs $,$2$$$. The ann%al expected .ET 4(?A 3L/* rom the machine is $52$$$ or the irst : years and $92$$$ in year @2 excl%ding sal1age 1al%es. The asset "ill be depreciated on a straight line basis to a $#2$$$ sal1age 1al%e. It is eligible or a :6 in1estment tax credit. I the disco%nt rate is 1$62 "hat is the machineCs .0F+ $112@$:

5.

:.

0recision Eetals2 Inc. is considering the replacement or its existing lathe2 "hich cost $,$$2$$$ at the time o p%rchase i1e years ago2 and "hich no" has a remaining li e o i1e years "ith no sal1age 1al%e. It can be sold c%rrently or $1$$2$$$. ( ne"2 more operationally e icient lathe costs $-$$2$$$ and has a %se %l li e o i1e years "ith a sal1age 1al%e o $5$2$$$. It is expected to red%ce operating costs by $552$$$ ann%ally. (n in1estment tax credit o 1$ percent o the p%rchase price can be %sed i the lathe is ac'%ired. The irmCs re'%ired rate o ret%rn or replacement decisions is 1, percent. (ss%me straight&line depreciation and a tax rate o #$ percent. The net present 1al%e o this capital b%dgeting decision is8 $ ##2-@$ 4=B J (ssociates is considering the p%rchase o a ne" piDDa o1en. The original cost o the old o1en "as $-$2$$$. The machine is no" 5 years old and has a c%rrent mar7et 1al%e o $52$$$. The o1en is being depreciated o1er a 1$&year li e to"ard a Dero estimated sal1age 1al%e on a straight&line basis. Eanagement is contemplating the p%rchase o a ne" o1en "hose cost is $,52$$$ and "hose estimated sal1age 1al%e is Dero. Expected cash sa1ings rom the ne" o1en are $,2$$$ a year (be ore tax). =epreciation is on a straight&line basis o1er a 5 year li e2 and the cost o capital is 1$6. (ss%me a 5$6 tax rate. *hat is the net present 1al%e o the ne" machine+

32

&$:2#1@ @. ?andals2 Inc.2 is considering the p%rchase o a ne" leather&c%tting machine to replace an existing machine that has a boo7 1al%e o $-2$$$ and can be sold or $125$$. The estimated sal1age 1al%e o the old machine in # years is Dero. The ne" machine "ill red%ce costs (be ore tax) by $:2$$$ per year! that is2 $:2$$$ cash sa1ings o1er the old machine. The ne" machine has a # year li e2 cost $1#2$$$2 and can be sold or an expected $,2$$$ at the end o the o%rth year. (ss%ming straight line depreciation or both machines2 a #$6 tax rate2 and a cost o capital o 1562 ind the .0F. $-2#:5 9. Gi1en the ollo"ing in ormation2 "hat is the e ecti1e cost o the ne" machine! that is2 "hat is the cash lo" at t H $+ 0%rchase price o ne" machine Installation charge Ear7et 1al%e o old machine Boo7 1al%e o old machine In1entory decrease i ne" machine is installed (cco%nts payable increase i ne" machine is installed Tax rate #@6 4ost o capital 156 $529@$ 1$. U%i72 Inc.2 is a ast& ood establishment that needs to p%rchase ne" ryolators. I the machines are p%rchased2 they "ill replace old machines p%rchased 1$ years ago or $1$$2$$$2 being depreciated on a straight line basis to a Dero sal1age 1al%e (,$ years depreciable li e). The old machines can be sold or $1,$2$$$. The ne" machines "ill cost $,$$2$$$ installed and "ill be depreciated on a straight&line basis to a Dero sal1age 1al%e in 1$ years. It is expected that there "ill be increased re1en%es o $1@2$$$ per year and increased cash expenses o $,25$$ per year. I the irmCs cost o capital (7) is 1$62 the tax rate on ordinary income is #$62 and the tax rate on capital gains is -$62 "hat is the .0F o the machine+ &$529@@ $@2$$$ ,2$$$ ,2$$$ 12$$$ 12$$$ 5$$

11.

042 Inc.2 has a stamping machine "hich is 5 years old and "hich is expected to last another 1$ years. It has a boo7 1al%e o $1$$2$$$ and is being depreciated by the straight&line method to Dero. Tri&?tate Ind%stries has demonstrated a ne" machine "ith an expected %se %l li e o 1$ years (scrap 1al%e $5$2$$$) that sho%ld sa1e 04 $152$$$ a year in labor and maintenance costs. I 04Cs cost o capital is 1$62 sho%ld the replacement be made+ 04Cs tax rate is #$62 the ne" machine "ill cost $,$$2$$$2 and an in1estment tax credit o 1$6 applies. The mar7et 1al%e o the old machine is $1$2$$$ and a $1$2$$$ increase in "or7ing capital "ill be needed to s%pport the ne" machine.

33

.o! .0F H &$5-2,:@ 1,. GIG/2 Inc.2 is considering replacing its c%rrent comp%ter "ith a ne" generation model. The (BE salesperson has demonstrated a model "hich "o%ld cost GIG/ $:5$2$$$2 sho%ld last 1$ years2 and red%ce costs $1552$#- per year. (BE estimates that this ne" comp%ter can be sold or $1$2$$$ at the end o its %se %l li e. The comp%ter GIG/ c%rrently %ses has a boo7 1al%e o $#5$2$$$ (remaining li e o 1$ years2 a sal1age 1al%e o $1$2$$$2 and a c%rrent mar7et 1al%e o $1$2$$$. I an in1estment tax credit o 1$6 is applicable to the ne" comp%ter2 and the ne" machine "ill permit a $1$2$$$ decrease in "or7ing capital "hen the comp%ter is installed2 "hat is the .0F (7 H 1562 t H #$62 depreciation is straight line)+ $:@2:51-. ;o% ha1e been as7ed by the irmCs president to e1al%ate the proposed ac'%isition o a ne" machine. The machineCs price is $5$2$$$2 and it "ill cost $1$2$$$ to transport and install. It "ill be depreciated by the straight&line method o1er its 5&year %se %l li e to a $1$2$$$ sal1age 1al%e. The machine "ill increase re1en%es by $1$2$$$ per year2 and it "ill decrease operating costs by $,$2$$$ per year. (lso2 the machine "ill allo" the irm to red%ce in1entories by $52$$$. The ne" machine (incl%ding deli1ery and installation costs) '%ali ies or a 1$6 in1estment tax credit. I the irmCs cost o capital is 1,62 and its marginal tax rate is #$62 "hat is the ne" machineCs .0F+ $--21#1#. Knion Bric72 Inc.2 has an electric 7iln "hich is 5 years old and is expected to last another 1$ years. It has a boo7 1al%e o $1$$2$$$2 and it is being depreciated by the straight&line method to a Dero sal1age 1al%e. (s =irector o 4apital B%dgeting2 yo% are e1al%ating a ne" gas 7iln that sho%ld sa1e KBI $,52$$$ a year in %el costs. The ne" 7iln "o%ld cost $,$$2$$$2 and it is eligible or a 1$6 in1estment tax credit. It "o%ld be depreciated o1er 1$ years by the straight&line method to a $,$2$$$ sal1age 1al%e. The mar7et 1al%e o the old 7iln is $1$2$$$. KBICs marginal tax rate is #$62 and the irmCs cost o capital is 1$6. *hat is the .0F o the replacement pro>ect+ &$1#2#5@ W

15.

( company is planning to in1est $5$2$$$ (be ore tax) in a personnel training program. The $5$2$$$ o%tlay "ill be charged o as an expense by the irm this year (time $). the ret%rns rom the program2 in the orm o greater prod%cti1ity and a red%ction in employee t%rno1er2 are estimated as ollo"s (on an a ter&tax basis)8 ;E(R? 1&1$ ;E(R? 11&,$ $ 52$$$ per year $ 152$$$ per year

34

The company has estimated its cost o capital to be 15 percent. (ss%me that the entire $5$2$$$ is paid at time $ (the beginning o the pro>ect). The marginal tax rate or the irm is #$ percent. *hat is the in1estmentCs .0F+ $ 1-259$ 15. The *R(.GLER 4orporation is considering the ac'%isition o a ne" splicing machine to impro1e the e iciency o its clothing operations. The ne" machine "ill cost $5$2$$$ pl%s installation costs o $52$$$. The machineCs e iciency "ill create additional o%tp%t! th%s2 re1en%es "ill increase by $52$$$ ann%ally. The amo%nt o "asted material "ill decline2 so operating costs "ill decline by $,2$$$ ann%ally. The machine "ill re'%ire a $,2$$$ increase in in1entory and spare parts. The machineCs estimated sal1age 1al%e (at the end o its 5 year li e) is $5$$. (Kse this 1al%e or depreciation p%rposes.) The irmCs marginal tax rate is #$ percent and its re'%ired rate o ret%rn is 1$ percent. (ss%me that the irm %ses straight&line depreciation or analysis o this type. (. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash o%t lo"+) $ &5:2$$$ *hat are the net operating cash lo"s or ;ear 1 thro%gh 5+ $ 92-5$ 4. *hat is the total 1al%e o the additional considerations at the end o the i1e years+ $ ,25$$ *hat is the .et 0resent Fal%e o the decision+ $ &,92955

B.

=.

35

1:.

The .elson E'%ipment 4ompany p%rchased a machine 5 years ago at a cost o $,$$2$$$. The machine had an expected li e o 1$ years at the time o the p%rchase and an expected sal1age 1al%e o $5$2$$$ at the end o the 1$ years. It is being depreciated by the straight&line method to"ard a sal1age 1al%e o $5$2$$$2 or by $152$$$ per year. ( ne" machine can be p%rchased or $#$$2$$$ and re'%ire an additional $152$$$ in installation costs. The ne" machine "ill re'%ire $,$2$$$ in additional spare parts. =%ring its 5&year li e2 it "ill red%ce cash operating expenses by $15$2$$$ per year. ?ales are not expected to change. (t the end o its %se %l li e2 the machine is estimated to be "orth $5$2$$$. (4R? depreciation "ill be %sed2 and the machine "ill be depreciated o1er its -&year class li e rather than its 5&year economic li e. The old machine can be sold today or $1:52$$$. The irmCs tax rate is #$ percent and the appropriate disco%nt rate is 1, percent. (The reco1ery allo"ance percentages or -&year property are --62 #562 1562 and :6.) (. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash o%t lo"+) $ &,@$2$$$ B. *hat are the net operating cash lo"s or ;ear 1 and ,+ ;ear 1 $ 1-@2:@$ 4. ;ear , $ 15@2:$$

*hat is the total 1al%e o the additional considerations at the end o the i1e years+ $ $

=.

*hat is the .et 0resent Fal%e o the replacement decision+ $ 1552-:$

36

1@.

Eac=o%galCs is a ast& ood establishment that needs to p%rchase ne" ryolators. I the ne" ryolators are p%rchased2 they "ill replace old machines p%rchased 1$ years ago or $15$2$$$. The old machines are being depreciated on a straight&line basis to a Dero sal1age 1al%e. The original estimated li e o the old machines "as i teen years. (The old machines ha1e i1e years o estimated li e remaining.) The old ryolators can c%rrently be sold to another irm in the ind%stry or $#$2$$$. The ne" machines "ill cost $,5$2$$$ pl%s an additional $,$2$$$ or installation. The ne" ryolators ha1e an estimated %se %l li e o i1e years and ha1e an estimated sal1age 1al%e (?4R(0) at the end o i1e years o $1$2$$$. The ne" ryolators ha1e extra capacity and "ill2 th%s2 increase re1en%es by $5$2$$$ ann%ally. The machines "ill also red%ce operating expenses (electricity) by $1$2$$$ ann%ally. The irm "ill re'%ire $52$$$ in additional "or7ing capital to s%pport the increased o%tp%t. Eac=o%galCs depreciates their capital impro1ements at the maxim%m rate allo"ed by the IR?. 3or property o this type (-&year)2 the E(4R? rates are --62 #562 156 and :6. The irmCs marginal tax rate is #$ percent and their re'%ired rate on pro>ects o this nat%re is 1, percent. (. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash o%t lo"+) $ &,-12$$$ B. *hat are the net operating cash lo"s or ;ear 1 and ,+ ;ear 1 $ :-25#$ 4. ;ear , $ @525$$

*hat is the total 1al%e o the additional considerations at the end o the i1e years+ $ 112$$$

=.

*hat is the .et 0resent Fal%e o the machine+ $ &@:5

37

19.

.at%ral Be1erages is contemplating the replacement o one o its bottling machines "ith a ne"er and more e icient one. The old machine has a boo7 1al%e o $#$$2$$$ and a remaining %se %l li e o i1e years. The sal1age 1al%e o the old machine ( or depreciation and cash lo" p%rposes) is $5$2$$$. The irm can sell it no" to another irm in the ind%stry or $,$$2$$$. The ne" machine has a p%rchase price o $1., million2 an estimated %se %l li e o i1e years2 and an estimated sal1age 1al%e in i1e years o $,$2$$$. (dditional costs o installation "ill be $,52$$$. It is expected to economiDe on operating costs and to red%ce the n%mber o de ecti1e bottles. In total2 an ann%al sa1ing o $,5$2$$$ "ill be realiDed i the ne" machine is installed. The ne" machine "ill re'%ire an additional $152$$$ in in1entory (spare parts). The company is in the #$ percent marginal tax brac7et and has a 1, percent re'%ired rate o ret%rn. The machine '%ali ies as a -&year property %nder E(4R? (--62 #562 1562 :6). (. *hat is the initial in1estment re'%ired or this replacement decision+ &$95$2$$$ B. *hat are the net operating cash lo"s or years one and t"o+ $,@-2:$$ 4. $-#,25$$

*hat is the 1al%e o the additional considerations in year 5+ &$,-2$$$

=.

*hat is the .ET 0RE?E.T Fal%e o this replacement decision+ &$1-@299@

38

,$.

A%ang Ind%stries is considering a proposed pro>ect or its capital b%dget. The company estimates that the pro>ectCs .0F is $1, million. This estimate ass%mes that the economy and mar7et conditions "ill be a1erage o1er the next e" years. The companyCs 43/2 ho"e1er2 orecasts that there is only a 5$ percent chance that the economy "ill be a1erage. RecogniDing this %ncertainty2 she has per ormed the ollo"ing scenario analysis8 Economic ?cenario Recession Belo" (1erage (1erage (bo1e (1erage Boom 0robability o /%tcome $.$5 $.,$ $.5$ $.,$ $.$5 .0F ($:$ million) ($,5 million) $1, million $,$ million $-$ million

*hat is the pro>ectCs expected .0F2 its standard de1iation2 and its coe icient o 1ariation+ E(.0F) H $-.$ million .0F H $,-.5 million 4F H :.@:#

39

CHAPTER TWELVE PROBLEMS 1. U%ic7 La%nch Roc7et 4ompany2 a satellite la%nching irm2 expects its sales to increase by 5$ percent in the coming year as a res%lt o .(?(Cs recent problems "ith the space sh%ttle. The irmCs c%rrent E0? is $-.,5. Its degree o operating le1erage is 1.52 "hile its degree o inancial le1erage is ,.1. *hat is the irmCs pro>ected E0? or the coming year %sing the =TL approach+ $ @.:1 ( irm expects to ha1e a 15 percent increase in sales o1er the coming year. I it has operating le1erage e'%al to 1.,5 and inancial le1erage e'%al to -.52 then "hat "ill be the percentage change in E0?+ 55 percent -. The 4ongress 4ompany has identi ied t"o method o prod%cing playing cards. /ne method in1ol1es a machine ha1ing a ixed cost o $1$2$$$ and 1ariable costs o $1.$$ per dec7 o cards. The other method "o%ld %se a less expensi1e machine ( ixed costs H $52$$$)2 b%t it "o%ld re'%ire greater 1ariable costs ($1.5$ per dec7 o cards). I the selling price per dec7 o cards "ill be the same %nder each method2 at "hat le1el o o%tp%t "ill the t"o methods prod%ce the same net operating income+ 1$2$$$ dec7s #. (ss%me that a irm c%rrently has EBIT o $,2$$$2$$$2 =TL o :.52 and =3L o 1.@:5. I sales decline by ,$ percent next year2 then "hat "ill be the irmCs expected EBIT in one year+ $#$$2$$$ 5. (ss%me that a irm has a =3L o 1.,5. I sales increase by ,$ percent2 the irm "ill experience a 5$ percent increase in E0?2 and it "ill ha1e an EBIT o $1$$2$$$. *hat "ill be the EBIT or this irm i sales do not increase+ (ns"er8 $5:255@ 5. 4alc%late the c%rrent price per share (0$) or /lson 4orporation2 gi1en the ollo"ing in ormation. The data all pertain to the year >%st ended. ?ales H 1$2$$$ %nits ?ales price per %nit H $1$.$$ Fariable cost per %nit H $ 5.$$ 3ixed cost H $1$2$$$ =ebt o%tstanding H $152$$$ Interest rate on debt H 5 percent Tax Rate H -$ percent 4ommon stoc7 shares o%tstanding H 1$2$$$ shares Beta H 1.5 7R3 H 5 percent 7E H 9 percent 0ayo%t ratio H #$ percent Gro"th rate in earnings and di1idends H : percent $ ,9.#-

,.

40

:.

( company c%rrently has assets o $5 million. The irm is 1$$ percent e'%ity inanced. The company c%rrently has net income o $1 million2 and it pays o%t #$ percent o its net income as di1idends. Both net income and di1idends are expected to gro" at a constant rate o 5 percent per year. There are ,$$2$$$ shares o stoc7 o%tstanding2 and it is estimated that the c%rrent cost o capital is 1-.#$ percent. The company is considering a recapitaliDation "here it "ill iss%e $1 million in debt and %se the proceeds to rep%rchase stoc7. In1estment ban7ers ha1e estimated that i the company goes thro%gh "ith the plan2 its be ore tax cost o debt "ill be 11 percent2 and the cost o e'%ity "ill rise to 1#.5 percent. The company has a #& percent ederal&pl%s&state tax rate. (. *hat is the c%rrent share price (be ore recapitaliDation)+ $,5.$$ B. (ss%ming that the irm maintains the same payo%t ratio2 "hat "ill be its stoc7 price ollo"ing the recapitaliDation+ $,5.@1

@.

The (4E *ine 4ompany o El 0aso prod%ces a pop%lar2 lo"&cost "ine. The irm has ixed costs o $1$$2$$$ ann%ally and 1ariable costs per bottle o $-.$$. The di1ision has $15$2$$$ in debt o%tstanding at an ann%al interest rate o 1, percent. (. I the price per bottle is $:.$$2 "hat is the di1isionCs brea7e1en re1en%e+. $ 1:52$$$ B. I the irm expects to sell 1$$2$$$ bottles2 at "hat price m%st it sell each bottle in order to brea7 e1en+ $ #.$$ 4. I the irm sells 5$2$$$ bottles at a price o $:.$$2 "hat is the irmCs degree o operating le1erage+ ,.$$ =. I the irm sells 5$2$$$ bottles at a price o $:.$$2 "hat is the irmCs degree o inancial le1erage+ 1.,, E. *hat is the degree o total le1erage at this le1el o o%tp%t and sales price+ ,.##

9.

The irms AL and LL are identical except or their le1erage ratios and interest rates on

41

debt. Each has $,$ million in assets2 earned $# million be ore interest and taxes in ,$$$2 and has a #$ percent ederal&pl%s&state tax rate. 3irm AL2 ho"e1er2 has a le1erage ratio (=B() o 5$ percent and pays 1, percent interest on its debt2 "hereas LL has a -$ percent le1erage ratio and pays only 1$ percent interest on its debt. (. *hat is the ret%rn on e'%ity or each irm+ R/E or LL8 R/E or AL8 B. 1#.5 percent 15.@ percent

I LL raises its debt ratio to 5$ percent and the interest rate on all o its debt increases to 15 percent2 "hat "o%ld its ne" R/E be+ R/E or LL at 5$ percent =B(8 15.5 percent

1$.

The <;R 4ompany man% act%res and sells only one prod%ct2 a "idget. The irm sells e1ery %nit that it prod%ces or a sales price o $5.$$ a %nit. The irmCs 1ariable cost per %nit is $,.$$2 and the ixed operating cost is $-$2$$$. <;R has c%rrent interest costs o $152$$$ ann%ally and a marginal tax rate o #$ percent. I the irm prod%ces and sells ,$2$$$ %nits8 (. *hat is the irmCs brea7e1en '%antity and re1en%e+ 1$2$$$ %nits and $5$2$$$ B. *hat is the irmCs degree o operating le1erage+ ,.$ 4. *hat is the irmCs degree o inancial le1erage+ ,.$ =. *hat is the irmCs degree o total le1erage+ #.$$

11.

( gro%p o retired college pro essors has decided to orm a small man% act%ring

42

corporation. The company "ill prod%ce a %ll line o traditional o ice %nit%re. T"o inancing plans ha1e been proposed by in1estors. 0lan ( is an all&e'%ity alternati1e. Knder this agreement2 one million shares "ill be sold to net the irm $,$ per share. 0lan B in1ol1es the %se o inancial le1erage. ( debt iss%e "ith a ,$&year mat%rity "ill be pri1ately placed. The debt iss%e "ill carry an interest rate o 1$ percent2 and the principal borro"ed "ill amo%nt to $5 million. (ss%me a corporate tax rate o -# percent. (. 3ind the EBIT indi erence le1el associate "ith the t"o inancing alternati1es. $,2$$$2$$$ B. *hat is the E0? at this indi erence le1el o EBIT+ $1.-, 4. The a1erage ann%al EBIT has been estimated at $-2$$$2$$$! "hat is the expected E0? o each plan at this le1el o EBIT+ *hich plan sho%ld be selected+ 0lan (8 $1.9@ 0lan B8 $-.#-

43

1,.

3o%r recent liberal arts grad%ates ha1e interested a gro%p o 1ent%re capitalists in bac7ing a ne" enterprise. The proposed operation "o%ld consist o a series o retail o%tlets to distrib%te and ser1ice a %ll line o 1ac%%m cleaners and accessories. These stores "o%ld be located in Ao%ston2 =allas and ?an (ntonio. T"o inancing plans ha1e been proposed by the grad%ates. 0lan ( is an all&common e'%ity str%ct%re. T"o million dollars "o%ld be raised by selling @$2$$$ shares o common stoc7. 0lan B "o%ld in1ol1e the %se o long&term debt inancing. /ne million dollars "o%ld be raised mar7eting bonds "ith an e ecti1e interest rate o 1, percent. Knder this alternati1e2 another million dollars "o%ld be raised by selling #$2$$$ shares o common stoc7. *ith both plans2 then $, million is needed to la%nch the ne" irm)s operations. The debt %nds raised %nder 0lan B are tho%ght to be part o the irm)s permanent capital str%ct%re. (ss%me a -# percent marginal tax rate or the analysis. (. 3ind the EBIT indi erence le1el bet"een the t"o proposals. $,#$2$$$ B. *hat is the E0? at this indi erence le1el o EBIT+ $1.9@ 4. The a1erage ann%al EBIT has been estimated at $5$$2$$$! "hat is the expected E0? o each plan at this le1el o EBIT+ *hich plan sho%ld be selected+ 0lan (8 $#.1,5 0lan B8 $5.,:

1-.

The *ingler 4orporation s%pplies headphones to airlines or %se "ith mo1ie and stereo programs. The headphones %se the latest in electronic components and sell or $,@.@$ per set. This yearCs sales are expected to be #5$2$$$ %nits. Fariable prod%ction costs or the expected sales %nder present prod%ction methods are estimated at $1$2,$$2$$$2 and ixed prod%ction costs at present are $1255$2$$$. *ingler has $#2@$$2$$$ o debt o%tstanding at an interest rate o @ percent. There are ,#$2$$$ shares o common stoc7 o%tstanding2 and there is no pre erred stoc7. The di1idend payo%t ratio is :$ percent2 *ingler is in the #$ percent ederal&pl%s&state tax brac7et. The company is considering in1esting $:2,$$2$$$ in ne" e'%ipment. ?ales "o%ld not increase2 b%t 1ariable costs per %nit "o%ld decline by ,$ percent. (lso2 ixed operating costs "o%ld increase rom $1255$2$$$ to $12@$$2$$$. *ingler co%ld raise the re'%ired capital by borro"ing $:2,$$2$$$ at 1$ percent or by selling ,#$2$$$ additional shares at $-$ per share. (. /ld8 B. *hat "o%ld be *inglerCs E0? %nder (1) the old prod%ction process! (,) %nder the ne" process i it %ses debt2 and (-) the ne" process i it %ses e'%ity+ $,.$# .e" debt8 $#.:# .e" e'%ity8 $-.,:

(t "hat %nit sales le1el "o%ld *ingler ha1e the same E0? i the ne" prod%ction process is implemented+ *hat is the E0? at this le1el+ --92:5$ %nits and $1.@$

44

CHAPTER THIRTEEN PROBLEMS 1. 4ra1en 4orp. has retained earnings o $1.:5 million and 1$$2$$$ shares o stoc7 o%tstanding "ith a mar7et 1al%e o $,5 per share. I 4ra1en declares a 15 percent stoc7 di1idend2 "hat "ill 4ra1enCs retained earnings be a ter the di1idend+ $ 1.-:5 million , ( company has a net income o $1$$ million and a policy o paying o%t 5$ percent o its earnings in di1idends. Ao" m%ch total inancing can be accomplished be ore the company has to sell common stoc7+ (ss%me a debtBe'%ity ratio o 55.5 percent. $ 55.55 million -. (lton 4orp. has earnings o $1.5 million and a policy o paying o%t 5$ percent o earnings. (lton has $1.@ million in acceptable in1estments b%t is %nable to iss%e ne" e'%ity. (ss%ming a =BE o $.#2 ho" m%ch "ill (lton be able to spend on capital b%dgeting i it "ishes to stic7 "ith the 5$ percent payo%t+ $ $.@# million #. Be ore a ,& or&1 stoc7 split2 =ean 4ompany sold or $5$ a share2 earning $15 and paying $@ di1idend per share. ( ter the split2 the di1idend per share becomes $5.,$. By "hat percentage has the payo%t ratio risen+ -$6 5. B%tler 4orporation has declared a 1$ percent stoc7 di1idend. B%tler has , million shares o%tstanding "ith a c%rrent mar7et price o $:. Its capital stoc7 acco%nt is $1 million2 and the irmCs retained earnings are $@ million. *hat balances "ill the retained earnings and capital stoc7 acco%nts sho" a ter the distrib%tion o the stoc7 di1idend+ 4(0IT(L ?T/4M $ 121$$2$$$ 5. RET(I.E= E(R.I.G? $ 525$$2$$$

The ?herman ?teel 4ompany has an order bac7log o $5 million. It desires to expand prod%ction capacity by ,$ percent2 "hich "ill in1ol1e a $15 million in1estment in plant and e'%ipment. Eanagement desires to maintain #$ percent debt in its capital str%ct%re. The di1idend policy has been to distrib%te ,5 percent o their a ter&tax earnings2 "hich this year "ere $5 million. I management "ishes to maintain its di1idend policy2 ho" m%ch external e'%ity m%st the irm see7 at the beginning o the year+ $ #25$$2$$$

:.

/n Earch 152 the directors o Gl%t /il 4ompany met and declared the reg%lar di1idend o #@ cents a share to holders o record on Earch -12 payment to made on Eay 15. / the 1$$ shares o Gl%t /il yo% no" o"n2 ,5 shares at a time "ere p%rchased on each o the ollo"ing dates8 Ian%ary 12 3ebr%ary 152 Earch 152 and (pril 1. *hat total di1idends "ill yo% recei1e+ ((ss%me ex&di1idend o%r days prior to record date.) $ -5.$$

45

@.

*ilbert 4ompany expects next yearCs a ter&tax income to be $1$ million. The irmCs c%rrent debt&e'%ity ratio is 1$$ percent. I *ilbert has $1, million o pro itable in1estment opport%nities and "ishes to maintain its c%rrent debt ratio "ith no external e'%ity inancing2 ho" m%ch sho%ld it pay o%t in di1idends next year+ $ #2$$$2$$$

9.

Iacobs 4orporation earned $, million a ter&tax. The irm has 1.5 million shares o%tstanding. I IacobsC di1idend policy calls or a #$ percent payo%t ratio2 "hat are the di1idends per share+ $ $.5$

1$.

4hampo%x Aair 3actory2 Inc. has earnings be ore interest and taxes o $1$$2$$$. (nn%al interest amo%nts to $#$2$$$2 and the ann%al depreciation is $#$2$$$. Taxes are comp%ted at the #$ percent rate. Existing bond obligations re'%ire the payment o $,$2$$$ into a sin7ing %nd. 4hampo%x "ishes to pay $1 per share di1idend on the existing ,$2$$$ shares o%tstanding. The irmCs bond indent%re prohibits the payment o di1idends %nless the cash lo" (be ore tax and sin7ing %nd payments) is greater than the total di1idend2 interest2 and sin7ing %nd obligations. *hat is the maxim%m di1idend per share that 4hampeo%x can pay+ $ $.@$

11.

/ne share o Fan Aorn =istrib%tors2 Inc. has a mar7et price o $1,$. The irm lists the ollo"ing on its ann%al report (dollars in tho%sands)8 4ommon ?toc72 $,.5$ par! a%thoriDed2 52$$$2$$$ shares! iss%ed and o%tstanding2 #2$$$2$$$ shares (dditional 0aid&In 4apital Retained Earnings (.

$ 1$2$$$ -2$$$ 5$2$$$

The irm is considering a 5& or&1 stoc7 split. *hich o the ollo"ing "o%ld be expected+ (pproximate 0ar Fal%e ?hares Iss%ed Ear7et 0rice $ $.5$ ,$2$$$2$$$ $ ,#.$$

B.

*hat "o%ld the balances in the e'%ity acco%nts be i the irm iss%ed a one percent stoc7 di1idend+ 4ommon ?toc7 $ 1$21$$ (dditional 0aid&In $ :2:$$ Retained Earnings $ #52,$$

46

1,.

(ber"ald Aeating2 Inc. has a six&month bac7log o orders or its patented solar heating system. Eanagement plans to expand prod%ction capacity by 5$ percent2 "ith an $1, million in1estment in plant machinery2 to meet this demand. The irm "ants to maintain a -$ percent debt&to&asset ratio in its capital str%ct%re! it also "ants to maintain its past di1idend policy o distrib%ting -$ percent o last yearCs a ter&tax earnings. In 199$2 a ter&tax earnings "ere $, million. (. I the irm has 12$$$2$$$ shares o%tstanding2 "hat "ill be the irmCs di1idends per share (=0?) i it contin%es the c%rrent policy+ $ $.5$ B. *hat "o%ld the di1idend per share be i the irm employs the resid%al theory o di1idends+ (ss%me 1 million shares o%tstanding. $ $.$$ 4. I (ber"ald is to meet both capital %nding and di1idend re'%irements2 ho" m%ch external %nding "ill be re'%ired+ $ :2$$$2$$$

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Iacobs 4orporation earned $, million in a ter&tax net income last '%arter. The irm has 1.5 million shares o%tstanding. I IacobsC di1idend policy calls or a #$ percent payo%t ratio2 "hat are the di1idends per share+ $$.5$ per share

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Eaxi&Trac7Cs pro it margin and sales are expected to be 1$ percent and $5$ million2 respecti1ely2 or the %pcoming '%arter. The irmCs traditional payo%t ratio is #$ percent o net income. =%e to mar7et conditions2 the irm does not "ish to raise any ne" e'%ity at this time. Eaxi&Trac7Cs optimal capital str%ct%re contains #$ percent debtB5$ percent e'%ity. (. *hat is the irmCs expected net income+ $52$$$2$$$ B. *hat is the irmCs expected le1el o retained earnings+ $-2$$$2$$$ 4. *hat is the largest capital b%dget that Eaxi&Trac7 select "itho%t changing the irmCs payo%t policy or capital str%ct%re "eights+ $52$$$2$$$