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FINC 340 FINANCIAL MANAGEMENT

EXERCISES
Chapter 2 & 3:
1. Operating and Financing Free Cash Flows:
Balance Sheets
The Visual Corporation
December 31, 2001 and 2002
Assets 2001 2002 Liabilities and Equity 2001 2002
Current Assets Current Liabilities
Cash $39,000 $44,000 Accounts Payable $60,810 $76,110
Accounts Receivables 70,500 78,000 Income Tax Payable 12,000 17,390
Inventories 177,000 211,400 Accrued Wages and Salaries 3,400 3,900
Other Current Assets 13,500 13,800 Interest payable 2,000 2,500
Total Current Assets $300,000 $347,200 Total Current Liabilities* $78,210 $99,900
Fixed Assets Long term Notes Payable 146,000 200,000
Net Plant and Equipment $404,000 $454,800 Total liabilities $224,210 $299,900
Land 70,000 70,000 Common Stock $300,000 $300,000
Patents 30,000 55,000 Retained Earnings 279,790 327,100
Total Net Fixed Assets* $504,000 $579,800 Total Stockholders Equity $579,790 $627,100
Total Assets $804,000 $927,000 Total L. & Equity $804,000 $927,000
* Net value of fixed assets after depreciation.
* There is no interest bearing current liability.

Income Statement
The Visual Corporation
December 31, 2002
Sales $830,200
Cost of Goods Sold 539,750
Gross Profit on Sales 290,450
Operating Expenses
Marketing Expenses $90,750
General and Administrative 71,800
Depreciation 28,200
Total operating Expenses $190,750 $190,750
Earnings Before Interest and taxes (EBIT) $99,700
Interest Expenses 20,000
Earnings Before Taxes (EBT) $79,700
Income Tax 17,390
Earnings After Tax (EAT) (NI) $62,310
Addition to Retained Earnings $47,310
a. Compute the Operating Cash Flow for 2002.

b. Compute the Change in Net Working Capital (NWC).

c. Compute the Net Capital Spending (NCS).

d. Compute the Operating Free Cash Flow.

e. Check to see if operating free cash flow is equal to financing free cash flow.

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f. Compute the following ratios for the Visual Corporation during 2002. You are also
provided industry data.
Ratio Industry Visual Comparison
Current ratio 2.70
Acid Test Ratio 1.25
Debt Ratio 40%
Times Interest Earned 4.00
Inventory Turnover 4.00
Receivable Turnover 10.4
Total Asset Turnover 1.20
Net Profit Margin 7.9%
Return on Assets 7.2%
Return on Equity 12.5%

g. Calculate the Return on Equity through DuPont Identity.

h. Considering your answers to previous sections what would you recommend to the Visual Corp.
management?

Chapter 4:
1. Lexar is evaluating its financing requirements for the next year. Information regarding current year and
expected sales and net income for the next year is presented below. The firm does not pay any dividends.
What is the amount of discretionary financing need?

Lexar, Inc.
1997 1998
Sales $12,000,000 $15,000,000
Net Income $1,200,000 $2,000,000

Balance Sheet
Assets 12/31/1997 % of Sales 1998
Current Assets $3,000,000
Net Fixed Assets $6,000,000
Total $9,000,000

Liabilities and Owners Equity


Accounts Payable $3,000,000
Long-term Debt $2,000,000
Total Liabilities $5,000,000
Common Stock $1,000,000
Paid-in Capital $1,800,000
Retained Earnings $1,200,000
Total Equity $4,000,000
Total $9,000,000

DFN

2. Bonanza projects to have $4mil in sales during the next year. The net income is expected to be 5% of sales.
The firm makes the following assumptions before determining the discretionary financing need: Current
assets will equal to 20% of sales, while fixed assets will remain at $1mil. Common equity is $0.8mil and
the firm pays 50% of earnings in dividends. The current liabilities equal to 10% of sales, and there is no
long-term debt. What is the amount of discretionary financing need?

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Bonanza, Inc.
t t+1
Sales N/A $4,000,000
Net Income N/A

Balance Sheet
Assets t % of Sales t+1
Current Assets N/A 20.00%
Net Fixed Assets $1,000,000 Constant $1,000,000
Total N/A

Liabilities and Owners Equity


Current Liabilities N/A 10.00%
Total Liabilities N/A $400,000
Common Stock $800,000 Constant $800,000
Retained Earnings N/A
Total Equity $800,000
Total NA

DFN

Chapter 5:
1. Mr. Ace Investor has $10,000 to invest for one year. He has three investment alternatives: (1) earn 8
percent, compounded annually, (2) earn interest compounded quarterly, and (3) earn interest compounded
monthly. What must the nominal interest rates be on the second and third options to make all the
investments earn the same yield?

2. An apartment house has a projected net income of $15,000 per year, and its projected net sales price after
five years is $150,000. Considering its risk, you require a 14 percent annual return on this investment.
How much would you be willing to pay for it?

3. Suppose you are interested in buying 25 acres of land to start a blueberry farm. The owner is willing to
finance 70 percent of the $100,000 purchase price at 10% interest over 8 years.

a. What will be the payment if it is made annually?

b. What will be the payment if it is made monthly?

4. What is the present worth of an income-producing property which receives an after-tax cash flow of
$20,000 in year one, $22,000 in year two, $25,000 in year three, $30,000 in year four, and $32,000 in year
five? Assume the discount rate is 15 percent.

5. Mike is considering the purchase of a vacant lot. He expects the price of the lot to be $30,000 at the end of
8 years. He requires an investment yield of 10 percent annually.

a. Should he buy the lot at the asking price of $15,000?

b. What is the effective yield of the investment if Mike does purchase the land for $15,000 and sells
it 8 years later for $30,000?

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6. You have purchased a building for $1,000,000 and expect it to grow in value at an annual rate of 7% for ten
years. In addition it also expected to provide cash flows of $30,000 annually, beginning at the end of the
first and ending with the end of the tenth year, what rate of return would you get on your investment?

7. You plan to retire at the end of ten years. You want to have a fund at that time that will allow you to draw
out nine annual payments of $100,000 beginning at the end of the first year of retirement. You can make
9% annually on the fund at all times. What is the amount of ten equal annual payments you must put into
the fund (the last payment on the date of retirement) if you want to accomplish your goal?

8. How much would you have to invest today at 9% compounded quarterly to have $28,000 to buy a Mustang
in 5 years?

9. Your grandfather placed $1,500 in a trust fund for you. In 216 months, the fund will be worth $15,000.
What is the annual rate of return compounded monthly?

10. Mr. Bill Preston purchased a new house for $145,000. He paid $20,000 down and First Bank agreed to
finance the rest of the purchase price at 9% compounded monthly. What is his monthly payment, if the
loan is a 30-year mortgage?

11. Given the following cash flows and respective timing, what is the total present value if the discount rate is
11% compounded annually? Assume year-end cash flows.
Year Annual Year End Cash Flows
1 $300
2 $400
3 $000
4 $500

12. A famous quarterback just signed a contract providing $3 million a year for 5 years. A less famous receiver
signed a 5-year contract providing $4 million today and $2 million a year for 5 years. Who is better paid if
interest rate is 10% compounded annually?

13. You are planning to buy a computer. The computer you would like to have costs $1,799.00 today. Saint
Louis Community Credit Union can loan you the money at 14% compounded monthly. If you can make a
payment of $160 per month, how long would it take you to pay the loan back to the Credit Union?

14. Karen borrows $7,500 from a bank at 8% compounded monthly. She will make equal monthly payments
during the next 10 years to pay off the loan. What is her monthly payment?

15. You are planning to borrow to purchase a new home. The amount of the loan is $120,000 at 6%
compounded semi annually. The loan term is 30 years with monthly payments. What is your payment?

16. After examining the various personal loan rates available to you, you find that you can borrow funds from a
finance company at 12% compounded monthly or from a bank at 13% compounded annually. Which
alternative is more attractive?

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Chapter 6:

1. You are given the following information:


Probabilities Asset X Asset Y
0.30 7% 11%
0.60 13% 15%
0.10 15% 4%
a. What are the expected return, variance, and standard deviation of expected return on asset X?
b. What are the expected return, variance, and standard deviation of expected return on asset Y?

2. Use the following information to answer questions below.


Asset Beta Portfolio Weights
Z 0.9 0.55
T 1.4 0.45
E(km) = 13.00%
E(krf) = 5.00%
a. By using CAPM, what are the required returns on Asset Z and T?
b. Based on given portfolio weights, what would be the portfolio Beta and required return?

Chapter 7:
1. Complex Manufacturing has just issued a 12-year bond. The bond has a coupon interest rate of 9% and
coupon payments are made semi-annually. Find the value of the bond if the required return on similar-risk
bonds is 14%.

2. Bankers Trust has bonds outstanding that mature 10 years from today and have a coupon interest rate of 8%
paid annually. Calculate the maximum price an investor should be willing to pay if the investor desires a
7.5% required return?

3. Allied Corporation has zero coupon bonds outstanding that mature in 15 years. Calculate the yield-to-
maturity if an investor purchases on of these bonds today at a price of $275. The bond is expected to pay
$1,000 at maturity?

4. AT&T has issued 7.25% debentures that will mature in 8 years. Assume that interest is paid annually. If an
investor purchases a bond for $865 today. What is the yield-to-maturity of this bond?

5. You are given the following partial quote from a newspaper dated May 11, 2006. Assume the bond has a
face value of $100 and pays interest semi-annually. What are the yield-to-maturity, current yield and yield-
to-maturity on a comparable Treasury?
Issuer Coupon (%, paid semi-annually) Maturity Price Est Spread
ABCD Corp 8.50 06/18/2011 97.67 412

Chapter 8:
1. You own 250 shares of Dalton Resources preferred stock, which currently sells for $38.50 per share and
pays annual dividends of $3.25 per share.
a. What is your expected return?

b. If you require an 8% return, given the current price, should you sell or buy more stock?

2. The preferred stock of Armlo pays a $2.75 dividend. What is the value of the stock if your required return
is 9%?

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3. Crosby Corporations common stock paid $1.32 in dividends last year and is expected to grow indefinitely
at an annual 7% rate. What is the value of the stock if you require an 11% return?

4. Johnsons common stock currently sells for $22.50 per share. The companys executives anticipate a
constant growth rate of 10% and $2.00 dividend for the next year.
a. What is your expected rate of return if you buy the stock for $22.50?

b. If you require a 17% return, should you purchase the stock?

5. The common stock of Zalid Co. is selling for $40.84. The stock recently paid dividends of $2.94 per share
and your expected return is 15%? If you purchase the stock at the market price, what is the expected
dividend payment in two years? Assume that dividends will grow at a constant rate. Also the selling price
and expected returns should be considered same as value of common stock, Vcs and required return, kcs,
respectively.

6. The next annual dividend payment of Honeywagy is expected to be $2.85, and the market price is projected
to be $32.50 by the end of the year. If the investors required rate of return is 10%, what is the current
value of the stock?

Chapter 9:
1. You are given the following two independent projects. Required return is 11% for both
projects.
Year Cash Flow (L) Cash Flow (N)
0 -12,500.00 -12,500.00
1 4,000.00 1,000.00
2 5,000.00 6,000.00
3 6,000.00 5,000.00
4 1,000.00 4,000.00
a. What are the Payback periods of L and N?

b. What are the Discounted Payback periods of L and N?

c. What are NPV of project L and N?

d. What are Profitability Indexes of each project?

e. What are the IRRs?

f. What are the Modified IRRs?

g. Which project(s) would you take?

Chapter 10:
1. You are given the following information to analyze an inverstment:
Cost of equipment = $400,000
Shipping & installation will be $20,000
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$25,000 in net working capital required at setup
3-year project life, 5-year class life
Simplified straight line depreciation
Revenues will increase by $220,000 per year
Defects costs will fall by $10,000 per year
Operating costs will rise by $30,000 per year
Salvage value after year 3 is $200,000
Cost of capital = 12%, marginal tax rate = 34%
What are the NPV and IRR of the investment?

2. Use the following information to answer questions below.


Cost of equipment = $550,000
Shipping & installation will be $25,000
$15,000 in net working capital required at setup
8-year project life, 5-year class life
Simplified straight line depreciation
Current operating expenses are $640,000 per yr.
New operating expenses will be $400,000 per yr.
Already paid consultant $25,000 for analysis.
Salvage value after year 8 is $40,000
Cost of capital = 14%, marginal tax rate = 34%
What are the NPV and IRR of the investment?

3. You are given the following two mutually exclusive projects.


Year Cash Flow (K) Cash Flow (T)
0 -135,000.00 -55,000.00
1 80,000.00 14,000.00
2 60,000.00 25,000.00
3 30,000.00 30,000.00
4 20,000.00 20,000.00

a. If required return is 12% for both projects, what are NPV of project K and T?

b. What are Profitability Indexes and IRR of each project?

c. What would you decide?

d. If you had $60,000 to invest which project would you choose?

e. Now assume that project K has 3 years of life and that last cash flow (CF year 3) is $38,000 instead of
$30,000. Which project would you choose?

Chapter 11:
1. The Gibson Corporation is examining two capital-budgeting projects with 5-year lives.
The first, project A, is a replacement project; the second, project B, is a project unrelated
to current operations. The initial investments of projects are $300,000 and $450,000 for
A and B, respectively. Gibson Corporation uses the risk-adjusted discount rate method
and groups projects according to purpose and then uses a required rate of return or
discount rate that has been pre-assigned to that purpose or risk class. The expected cash
flows for these projects are given below
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Year Project A Project B
1 30,000.00 130,000.00
2 40,000.00 130,000.00
3 50,000.00 130,000.00
4 80,000.00 130,000.00
5 120,000.00 130,000.00
The purpose-risk classes and pre-assigned required rates of return are as follows:
Purpose Required Return
Replacement decision 13%
Modification or expansion of existing product line 16%
Project unrelated to current operations 18%
Research and development operations 20%
What are the risk-adjusted NPVs of project A and B?

2. Akron Corporation is considering purchasing a new machine with a useful life of four
years. The initial outlay for the machine is $115,000. The expected cash inflows and
certainty equivalents are as follows:
Year After Tax Expected Cash Flow Certainty Equivalent
1 $10,000 0.96
2 $40,000 0.92
3 $80,000 0.88
4 $70,000 0.84
Given that the firm has a 12% required rate of return and the risk free rate is 4%, what is the NPV?

Chapter 12:
1. Given the following, what is HM Corporations WACC?
Common Stock : 1 million shares outstanding
: $40.00 per share, $1.00 par value
: = 1.3
Bonds : 10,000 bonds outstanding
: $1,000 face value for each bond
: 8% annual coupon
: 22 years to maturity
: Market price $1,101.23 for each bond
Market risk premium : 8.6%
Risk-free rate : 4.5%
Marginal tax rate : 34%

Chapter 15:
1. You are supplied with the following analytical income statement for your firm. It reflects last years
operations.
Sales $18,000,000
Variable costs 7,000,000
Revenue before fixed costs $11,000,000
Fixed costs 6,000,000
EBIT $5,000,000
Interest expense 1,750,000
Earnings before taxes $3,250,000
Taxes 1,250,000
Net income $2,000,000
a. At this level of output, what is the degree of operating leverage?

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b. What is the degree of financial leverage?

c. What is the degree of combined leverage?

d. If sales should increase by 15%, by what percent would EBIT and Net Income (NI) increase?

e. What is your firms break-even point in sales dollars?

Chapter 16:
1. A corporation is considering two alternative financing plans. Plan A: sell 1,200,000 shares at $10 per share
($12 million total). Plan B: issue $3.5 million in 9% debt and sell 850,000 shares at $10 per share ($12
million total). Assume a marginal tax rate of 50%. What is the crossover EBIT level that would provide
the same EPS?