FIN 4440

Study guide



1. O'Neil Inc. has the following data: r
RF
= 4.00%; RPM (market risk premium)
= 3.00%; and b = 1.35. What is the firm's cost of common equity based on
the CAPM? 8.05%

2. Kelly Toys Co has the following data: r
RF
= 4.35%; R
m
(return on the market)
= 6.85%; and b = .85. What is the firm's cost of common equity based on
the CAPM? 6.48%


3. Assume that you are a consultant to Tandem Inc., and you have been provided
with the following data: D1 = $1.67; P0 = $37.50; and g = 7.00%
(constant). What is the cost of common from retained earnings based on
the DCF approach? 11.45%


4. Assume that you are a consultant to TTT Inc., and you have been provided
with the following data: D0 = $.38; P0 = $9.15; and g = 4.00% (constant).
What is the cost of common from retained earnings based on the DCF
approach? 8.32%


5. You were hired as a consultant to Venzetti Company, whose target capital
structure is 45% debt, 5% preferred, and 50% common equity. The after-tax
cost of debt is 5.80%, the cost of preferred is 7.00%, and the cost of
common using retained earnings is 11.25%. What is its WACC?
8.59%

6. You were hired as a consultant to EuroTours, whose target capital structure
is 25% debt, 10% preferred, and 65% common equity. Current bonds yield
9.00%, return on preferred is 8.00%, and the cost of common using retained
earnings is estimated at 12.00%. Tax rate is 35%. What is its WACC?
10.06%


7. Jerry's Inc. is considering a project that has the following cash flow and
WACC data. What is the project's NPV?

WACC: 9.00%
Year 0 1 2 3 4 5_______6
Cash flows -$3,000 $900 $900 $900 $900 $900 $900


$1037.33








8. Theory Inc. is considering a project that has the following cash flow data.
What is the project's IRR?

Year 0 1 2 3 4
Cash flows -$2,250 $600 $600 $600 $600

2.63%

9. Kyle & Deena Inc. is in a cyclical industry, cycles spanning several years.
It considering a project that has the following cash flow data. What is
the project's MIRR? WACC is 9%.

Year 0 1 2 3 4
Cash flows -$2,250 $800 $1500 $800 -$800

6.99%

10. Your company, UNI Inc., is considering a new project whose data are shown
below. What is the projects Year 1 cash flow?

Sales revenues $175,000
Other operating costs $126,000
Depreciation $80,000
Tax rate 35.0%

$59,850

11. Sainsburys is now at the end of the final year of a project. The equipment
originally cost $55,800, of which 85% has been depreciated. The firm can
sell the used equipment today for $12,000, and its tax rate is 30%. What
is the equipments after-tax salvage value for use in a capital budgeting
analysis?
$10,911


12. The term additional funds needed (AFN) is generally defined as follows:

a. Funds that are obtained automatically from routine business transactions.
b. Funds that a firm must raise externally from non-spontaneous sources,
i.e., by borrowing or by selling new stock to support operations.
c. The amount of assets required per dollar of sales.
d. The amount of internally generated cash in a given year minus the amount
of cash needed to acquire the new assets needed to support growth.
e. A forecasting approach in which the forecasted percentage of sales for
each balance sheet account is held constant.

13. The capital intensity ratio is generally defined as follows:

a. Sales divided by total assets, i.e., the total assets turnover ratio.
b. The percentage of liabilities that increase spontaneously as a
percentage of sales.
c. The ratio of sales to current assets.
d. The ratio of current assets to sales.
e. The amount of assets required per dollar of sales, or A
0
*/S
0
.

14. Last year Liberty Corp. had $830 million of sales, and it had $270 million
of fixed assets that were being operated at 80% of capacity. In millions,
how large could sales have been if the company had operated at full
capacity?

$1037.50


15. Dalton Industries is planning its operations for next year, and the CEO
wants you to forecast the firm's additional funds needed (AFN). The firm
is operating at full capacity. Data for use in your forecast are shown
below. Based on the AFN equation, what is the AFN for the coming year?
Dollars are in millions.

Last years sales = S
0
$700 Last years accounts payable $80
Sales growth rate = g 15% Last years notes payable $100
Last years total assets = A
0
* $1000 Last years accruals $60
Last years profit margin = PM 4% Target payout ratio 40%

$109.68

16. Swenson Ice Cream, Inc. is planning its operations for next year. The firm
is operating at full capacity. Forecasted and historical data are shown
below. Based on the AFN equation, what is the AFN for the coming year?

Last years sales = S
0
$1,700,000 Last years accounts payable $200,000
Sales growth rate = g 6% Last years notes payable $250,000
Last years total assets = A
0
* $2,300,000 Last years accruals $180,000
Last years profit margin = PM 5% Target payout ratio 60%

$79,160


17. Danconia Inc. forecasts a free cash flow of $80 million in Year 4, i.e., at
t = 4, and it expects FCF to grow at a constant rate of 3% thereafter. If
the weighted average cost of capital is 11%, what is the horizon value, in
millions at t = 4?

$1,030

18. Suppose Creative Corporations free cash flow during the just-ended year (t
= 0) was $500 million, and FCF is expected to grow at a constant rate of
6% in the future. If the weighted average cost of capital is 15%, what is
the firms value of operations, in millions?

$5,889












19. A company forecasts the free cash flows (in millions) shown below. The
weighted average cost of capital is 11%, and the FCFs are expected to
continue growing at a 4% rate after Year 3. Assuming that the ROIC is
expected to remain constant in Year 3 and beyond, what is the Year 0 value
of operations, in millions? (Note the negative cash flow in year 1)

Year: 1 2 3
Free cash flow: -$250 $115 $150

$1607.30

20. A company forecasts the free cash flows (in millions) shown below. The
weighted average cost of capital is 15%, and the FCFs are expected to
continue growing at a 6% rate after Year 3. Assuming that the ROIC is
expected to remain constant in Year 3 and beyond, what is the Year 0 value
of operations, in millions? (Note the negative cash flow in year 1)

Year: 1 2 3
Free cash flow: -$25 $10 $11

$78.24


21. Based on the corporate valuation model, the value of a companys operations
is $675,000. The companys balance sheet shows $45,000 in accounts
receivable, $60,000 in inventory, and $55,000 in short-term investments
that are unrelated to operations. The balance sheet also shows $70,000 in
accounts payable, $90,000 in notes payable, $160,000 in long-term debt,
$30,000 in preferred stock, $100,000 in retained earnings, and $400,000 in
total common equity. If the company has 50,000 shares of stock
outstanding, what is the best estimate of the stocks price per share?

$9.00

22. Based on the corporate valuation model, the value of a companys operations
is $300 million. The companys balance sheet shows $25 million in
accounts receivable, $30 million in inventory, and $20 million in short-
term investments that are unrelated to operations. The balance sheet also
shows $35 million in accounts payable, $45 million in notes payable, $80
million in long-term debt, $15 million in preferred stock, $50 million in
retained earnings, and $150 million in total common equity. If the
company has 10 million shares of stock outstanding, what is the best
estimate of the stocks price per share?

$18.00

















23.




$10,000

24.
27.14%



25.
Printemps recently completed an 8-for-3 stock split. Prior to the split, its
stock sold for $130 per share. If the total market value was unchanged by the
split, what was the price of the stock following the split?


$48.75


26.
1.10




27. Other things held constant, which of the following will cause an increase in
net working capital?

a. Cash is used to buy marketable securities.
b. A cash dividend is declared and paid.
c. Merchandise is sold at a profit, but the sale is on credit.
d. Long-term bonds are retired with the proceeds of a preferred stock issue.
e. Missing inventory is written off against retained earnings.
A company has a capital budget of $200,000. The company wants to maintain a
target capital structure which is 25% debt and 75% equity. The company
forecasts that its net income this year will be $160,000. If the company
follows a residual dividend policy, what will be its total dividend payment?
A company has a capital budget of $3,000,000. The company wants to
maintain a target capital structure that is 15% debt and 85% equity.
The company forecasts that its net income this year will be $3,500,000.
If the company follows a residual dividend policy, what will be payout
ratio?

Stratosphere Enterprises has a levered beta of 1.4, its capital structure
consists of 30% debt and 70% equity, and its tax rate is 36%. What would
Harrods beta be if it used no debt, i.e., what is its unlevered beta?



28. Which of the following actions would be likely to shorten the cash
conversion cycle?

a. Adopt a new manufacturing process that speeds up the conversion of raw
materials to finished goods from 20 days to 10 days.
b. Change the credit terms offered to customers from 3/10 net 30 to 1/10 net
50.
c. Begin to take discounts on inventory purchases; we buy on terms of 2/10
net 30.
d. Adopt a new manufacturing process that saves some labor costs but slows
down the conversion of raw materials to finished goods from 10 days to 20
days.
e. Change the credit terms offered to customers from 2/10 net 30 to 1/10 net
60.


29. Harper Company is a no-growth firm. Its sales fluctuate seasonally, causing
total assets to vary from $7.2 million to $7.9 million, but fixed assets
remain constant at $5.85 million. If the firm follows a maturity matching
(or moderate) working capital financing policy, what is the most likely
total of long-term debt plus equity capital?

$7.2 million


30. Romano Inc. has the following data. What is the firm's cash conversion
cycle?

Inventory conversion period = 52 days
Average collection period = 61 days
Payables deferral period = 30 days

83 days



31. Visage Inc. is preparing its cash budget. It expects to have sales of
$380,000 in January, $410,000 in February, and $450,000 in March. If 30%
of sales are for cash, 40% are credit sales paid in the month after the
sale, and another 30% are credit sales paid 2 months after the sale, what
are the expected cash receipts for March?

$413,000

32. If the inflation rate in the United States is greater than the inflation
rate in Britain, other things held constant, the British pound will

a. Appreciate against the U.S. dollar.
b. Depreciate against the U.S. dollar.
c. Remain unchanged against the U.S. dollar.
d. Appreciate against other major currencies.
e. Appreciate against the dollar and other major currencies.



33. If one Swiss franc can purchase $0.71 U.S. dollars, how many Swiss francs
can one U.S. dollar buy?

a. 0.50
b. 0.71
c. 1.00
d. 1.41
e. 2.81


34. Suppose the exchange rate between U.S. dollars and Argentine Pesos is
ARS 4.39 = $1.00, and the exchange rate between the U.S. dollar and the
euro is $1.00 = 0.76 euros. What is the cross-rate of Argentine Pesos to
euros?
5.78

35. Suppose 90-day investments in Britain have a 5% annualized return. In the
U.S., 90-day investments of similar risk have a 3% annualized return. In
the 90-day forward market, 1 British pound equals $1.75. If interest rate
parity holds, what is the spot exchange rate?

Solution: 90-day (quarterly) return in Britain = 5/4 =1.25%
90-day (quarterly) return in the U.S.= 3/4 =0.75%
Spot rate = Forward rate x [(1+R
BRITAIN
)

/(1+R
U.S.
)]=
= 1.75 x (1.0125/1.0075) = 1.7587


36. Avalanche Corporation, a U.S. based importer, makes a purchase of lighting
fixtures from a firm in Germany for 300,000 Euros, or $400,000, at the
spot rate of .75 Euros per dollar. The terms of the purchase are net 90
days, and the U.S. firm wants to cover this trade payable with a forward
market hedge to eliminate its exchange rate risk. Suppose the firm
completes a forward hedge at the 90-day forward rate of .77 Euros. If the
spot rate in 90 days is actually .78 Euros, how much will the U.S. firm
have saved or lost in U.S. dollars by hedging its exchange rate exposure?

-$4995



37. Suppose in the spot market 1 U.S. dollar equals 80.895 Yen. 6-month
Japanese securities have an annualized return of 6% (and thus a 6-month
periodic return of 3%). 6-month U.S. securities have an annualized return
of 6.5% and a periodic return of 3.25%. If interest rate parity holds,
what is the U.S. dollar-Japanese Yen exchange rate in the 180-day forward
market?

1 U.S. dollar = 80.6991 Japanese Yen









38. Suppose in the spot market 1 U.S. dollar equals 0.915 Swiss Franks. 6-month
Swiss securities have an annualized return of 5% (and thus a 6-month
periodic return of 2.5%). 6-month U.S. securities have an annualized
return of 6% and a periodic return of 3%. If interest rate parity holds,
what is the U.S. dollar-Swiss Franc exchange rate in the 180-day forward
market?

1 U.S. dollar = SF 0.9105