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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.

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

1

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%

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

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?

2

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

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.

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.

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?

3

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?

4

Chapter 6:

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?

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%?

5

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?

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?

Chapter 10:

1. You are given the following information to analyze an inverstment:

Cost of equipment = $400,000

Shipping & installation will be $20,000

6

$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?

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?

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?

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

7

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?

8

b. What is the degree of financial leverage?

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

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?

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