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CHAPTER 2 - Solutions To Assignment Problems
CHAPTER 2 - Solutions To Assignment Problems
Assignment 2.1:
a.
Freida, Incorporated
Income Statement
For the Year ending December 31, 2006
Windcharter Company
Balance Sheet
For the Year ending December 31, 2006
b. Assume for this problem that the number given for Net income is actually Net income
available to common stockholders (that is, reported Net income minus preferred dividends).
Thus, Annual addition to Retained earnings = Net income available to common stockholders
– Common stock dividends paid.
Thus, Common stock dividends paid = Net income – Addition to (i.e., change in) Retained
earnings.
Common stock dividends paid = 25,400 – (89,280 – 79,880) = 16,000.
c. Cash spent on new plant and equipment = Depreciation for the year as listed on the income
statement plus the change in net fixed assets.
Thus, Cash spent on fixed assets in 1999 = 10,260 + (202,640 – 184660) = $28,240.
Assignment 2.3:
1. $4,055,740
$4,100,144
Although Gross sales decreased by 2 percent, net sales (the only number reported) show an
increase of 1.1 percent. Since Returns and allowances are estimates made by management,
there is some chance that the growth in sales conclusion may be misleading.
6.
Sales 32,000
Cost of goods sold 19,200
Gross profit 12,800
Operating expenses 4,000
Depreciation 3,000
Operating profit 5,800
Interest expense 2,800
EBT 3,000
Taxes 900
Net income 2,100
7.
Inventory – current asset Retained earnings - equity
Accounts receivable – current asset Accounts payable – current liability
Long-term debt – noncurrent liability Accrued wages and taxes – current liability
Common stock (par value) - equity Notes payable (bank loans) – current liability
Plant and equipment – noncurrent asset Marketable securities – current asset
Cash – current asset Prepaid expenses – current asset
Quest-Mar, Incorporated
Balance Sheet
For the Year Ending Decemebr 31, 2006
12. a. 75,000 shares (note that all figures for this problem are in thousands).
b. (10,450,000 – 8,700,000) / 75,000 = $23.33 c. $1.12 (total dividends paid by the
company = NI(2006) – change in retained earnings = 700,000. Divide this by 625,000
shares outstanding to get $1.12 per share).
13. Total dividends paid = $6,000,000 ; Dividends per share = $1.20
14. a. EPS=$6.14; DPS = $1.89 b. $180,400 c. EPS=$6.01; DPS=$1.76 (assumes
3,000 shares issued – typo on problem).
Assignment 3.1:
Change in LT Debt -
Change in Common Stock -
- Payment of dividends** (1,200)
Net Cash Flow from Financing Activities (1,200)
Problems:
1. Raise prices, reduce growth rate, speed up collections, hold smaller inventory levels, etc.
4. The growth in sales slowed to zero percent per year. Note that outflows for this company are
based on the current month’s sales level. That is, outflows in February are based on February
purchases (which are based on February sales). Outflows in March are based on March
purchases (which are based on March sales). And so on. Conversely, inflows are based on
sales that occurred one month ago. Thus, inflows in February are based on January sales and
inflows in March are based on February sales. In periods of rapid growth, this one-month lag
can cause outflows to exceed inflows even though revenue exceeds costs for that period.
When sales growth slows to zero, the lag effectively disappears since sales in each month are
the same. In this case, inflows minus outflows are essentially the same as revenue minus cost.
10.
Net income 3,200
+ Depreciation 1,800
+ Decrease in Accounts receivable 500
- Increase in Inventories (600)
+ Increase in Accounts payable 1,800
- Decrease in Accruals (400)
Net Cash Flow from Operating Activities 6,300
16. a. ($6,000) - note that change in cash and marketable securities = ($4,000)
b. ($2,000) c. ($28,000) d. $26,000
The sum of these three cash flows = -$4000, which is the change in cash and marketable
securities. Marketable securities, as explained in chapter 2, are an alternative form of cash.
They are very short-term investments that generate a positive return; they can be converted
into cash very quickly. Essentially, cash that earns a return.
CHAPTER 4 – Solutions to Assignment Problems
Assignment 4.1:
1. a.
2005 2006
Net sales 100.0% 100.0%
Cost of goods sold 62.9% 64.1%
Gross profit 37.1% 35.9%
Operating expenses 27.1% 26.5%
Operating income 10.0% 9.5%
Income taxes 4.2% 4.1%
Net income 5.8% 5.4%
Note that the gross profit margin deteriorates by 1.2% and Operating profit margin deteriorates
by 0.5%. Company has been able to offset some of the gross margin deterioration by controlling
operating expenses – either real or manipulation of discretionary expenses.
2. (Note that some of the ratios you compute for this problem will look nonsensical. This is
done on purpose to stress computation of the ratios. Hopefully you will note that a company
with some of these ratios – in particular ACP and Inventory turnover, would probably be in
very poor shape).
2005 2006
Current ratio 2.3 2.4
Average collection period 288.2 365
Inventory turnover ratio .40 .39
Total asset turnover ratio .28 .24
Payables ratio 488.3 491.8
Debt ratio 57% 35%
Cash conversion cycle 715.5 805.1
Net profit margin 5.8% 5.4%
Return on equity 3.8% 3.2%
Assignment 4.2:
a. Total dividends = Net income – Change in Retained earnings = 1,600,000 – 600,000 =
1,000,000.
b. Number of shares = Common stock/ Par value per share = 1,500,000/.25 = 6,000,000 shares.
c. Number of shares = Common stock/ Par value per share = 1,900,000/.25 = 7,600,000 shares.
d. Dividends per share = Total dividends / Number of shares = 1,000,000/7,600,000 = 13 cents.
e. ROE = Net income / Total Equity = 1,400,000/ (1,500,000 + 1,000,000 + 1,000,000) = 40%.
f. ROE = Net income / Total Equity = 1,600,000/ (1,600,000 + 2,400,000 + 1,900,000) = 27%.
g. ROE (Dupont) = Net income/Sales x Sales/Total assets x Total assets/Total equity.
ROE (2002-Dupont) = .200 x 1.167 x 1.714 = .40 = 40%
ROE (2003-Dupont) = .178 x 0.900 x 1.695 = .27 = 27%
Net profit margin declined in 2003 by 11% (from 20% to 17.8%), Total asset turnover ratio
declined by 23% (from 1.714 to 0.900) and the equity multiplier declined by 1.1%. The
major reason for the deterioration in ROE is a decrease in the efficiency of asset utilization.
Secondary reason is a decline in profitability.
Assignment 4.3:
The best approach to do these “fill in the balance sheet” type problems is to use any given values
(in this case, Total assets = $1,000,000) to compute as many related values as possible.
For example, given that Assets (A) = 1,000,000, then from the fact that the Debt ratio (Total
liabilities/Total assets) = 60%, Total liabilities = 600,000. Since Total assets = Total liabilities +
Total equity (basic accounting relationship), Total equity must be 400,000.
On the given balance sheet, Total liabilities = Accounts payable + Long-term debt, and since
Long-term debt is given as 180,000, Accounts payable = 420,000. Also, on the given balance
sheet, since Total equity = Common stock + Retained earnings, and since Retained earnings is
given as 200,000, Common stock = 200,000.
Next use, Average collection period = 45 days = (Accounts receivable/Sales) x 360. From Total
asset turnover = Sales/Total assets = 2.0, Sales = 2,000,000. Thus,
45 = (Accounts receivable/2,000,000) x 360, so Accounts receivable = 250,000.
Then use, Inventory turnover ratio = 5 = COGS/Inventory. From Gross profit margin = 25% and
Sales = 2,000,000, COGS = 1,500,000. Thus,
5 = 1,500,000/Inventory, so Inventory = 300,000.
Then use Quick ratio = 1.0 = (Current assets - Inventory)/(Current liabilities). Note that Current
assets for this balance sheet = Cash + Accounts receivable + Inventory, so Current assets –
Inventory = Cash + Accounts receivable. Also note that for this balance sheet, Current liabilities
= Accounts payable. Thus,
1 = (Cash + 250,000)/(420,000), so Cash = 170,000.
Finally, Cash + Accounts receivable + Inventory + Fixed assets = Total assets. Thus, Fixed assets
= 280,000.
Summarizing:
Cash 170,000 Accounts payable 420,000
Accounts receivable 250,000 Current liabilities 420,000
Inventories 300,000 Long-term debt 180,000
Current assets 720,000 Total liabilities 600,000
Fixed assets 280,000 Common stock 200,000
Total assets 1,000,000 Retained earnings 200,000
Total claims 1,000,000
2. Sales = 2,000,000; COGS = 1,500,000
3. CCC = Inventory conversion period + Average collection period – Payables period
i. = 72 + 45 – 100.8 = 16.2 days.
4. ROE = Net profit margin x Total asset turnover ratio x (Total assets/Equity)
= .10 x 2.0 x (1,000,000/400,000) = .50 = 50%
Problems:
1. A grocery store. Would you want to shop at a grocery store that had an inventory turnover
ratio of 2? That is, all items (fruit, meat, vegetables, etc.) turned over (i.e., sold) on average
only once every 6 months!
2. High inflation can distort the relationship between book values of assets and true economic
values. For example, if a firm has land on its balance sheet listed in value at $1,000 and
inflation in land values in running at 40 percent annually, 5 years later the market value of the
land would be worth approximately $5,400 but would only be listed on the balance sheet as
being worth $1,000. A similar distortion would apply to plant and equipment.
For short-term assets, however, values would, in general, adjust with inflation. If inventory
turns over relatively rapidly, each turnover would adjust inventory values upward. The same
would be true of accounts receivable. Thus, the relationship between the book value of short-
term assets and long term assets will be distorted. Finally, since the income statement is a
flow measure, high inflation usually affects all revenues and costs in a similar manner.
Assume that a firm has revenue of $1,000 and costs (total) of $800 and thus profit of $200. If
inflation is 50 percent and it impacts revenue and costs in a similar manner, then revenue will
grow to $1,500 (due solely to inflation) and costs will increase to $1,200 causing profit to
grow to $300. Thus inflation can cause a dramatic increase in net income (even more
pronounced if some costs are fixed). Now consider the impact of this increase on a ratio such
as ROA (recall from above that assets do not necessarily grow in line with inflation).
3. The current ratio is CA/CL. A declining ratio can either be due to a relative decline in CA or
a relative increase in CL. Since the inventory turnover ratio and the ACP are constant through
time, inventory and accounts receivable appear to be relatively stable. The increase in the
Payables period would indicate a relatively rapidly increasing Accounts payable value, which
would cause a relative increase in CL and therefore a decline in the current ratio. The analyst
should investigate the causes of the increase in AP perhaps a new supplier to the firm offers
more lax credit terms than the previous supplier.
4. 72%; 14.4%; 45%
5. CA = 2(CL) = 200,000. (CA - Inv)/100,000 = 1.5; thus, Inv = 50,000.
6. HINT: For problems where you are only given ratios and NO actual dollar amounts, assume
that assets are $100 and solve for all other numbers - then find the answer.
Thus, assume A = 100.
From ROA = NI/A; .20 = NI/100; thus, NI = 20.
Then, from ROE = NI/E; .50 = 20/E; thus, E = 40.
Then, from the definition, A = D + E; 100 = D + 40; thus, D = 60. (NOTE: this relationship
can be used for most of these types of problems).
Finally, compute the debt ratio = D/A = 60/100 = .60 = 60%.
7. Assume A = 100. Then from S/A = 4, S = 400. Then from D/A = .20, D = 20. Then from A =
D + E, E = 80. Then from NI/E = .10, NI = 8.
Finally, compute net profit margin = NI/S = 8/400 = 2%.
8. For this problem, you are given a dollar amount, so DO NOT assume that A = 100. Instead,
from ACP =(AR/S) x 360; 20 = (1,000/S) x 360; thus, S = 18,000. Then from NI/S = .05, NI
= 900. Then from S/A = 2, A = 9,000. Then from D/A = .75, D = 6,750. Then from A = D +
E, E = 2,250. Finally, ROE = NI/E = 900/2,250 = 40%.
9. Net profit margin = 8%; Debt ratio = 52%
10. ROA = 12.5%; ROE = 16.7%
11. Net profit margin = 8%; Debt ratio = 52%
We know that if we solve for x in (1950+x)/(800+x) = 2, we get the maximum amount by
which inventory = bank debt =x can increase without violating a current ratio of 2.Solving
for x we get, x = 350. In this case, Inv will be 1,050. Thus, (CA-Inv)/CL = (1950+350-1050)/
(800+350), and Quick ratio = 1.087.
12. Assume A = 100. Then D = 75 and E = 25 (recall A = D + E). Thus, Equity multiplier = A/E
= 100/25 = 4.
13. Answers assume a 360-day year.
a. $100
b. $450
c. $150
d. 5.7%
e. $400
f. $500
14. ROE = 42% (since all equity financed, equity = total assets)
15. Max Increase in debt = 1.4
16. B
17. From ACP = (ARx360)/S, 60 = (150,000x360)/S, S = 900,000. From NI/S = .04, NI =
36,000. From D/A = .64 and A = 3,000,000, D = 1,920,000. From A = D + E, E = 1,080,000.
Then, ROE = NI/E = .033 = 3.3%.
18. Note that CA = Cash & Mkt. Sec. + AR + Inv. and Inventory turnover here is defined as
S/Inv. From CA/CL = 3 and CA = 810,000, CL = 270,000. From (CA-Inv)/CL = 1.4 and note
above and Cash & Mkt. Sec. = 120,000, AR = 258,000. From note above, now Inv = 810,000
- 120,000 - 258,000 = 432,000. From S/Inv = 6, S = 2,592,000. From ACP = (ARx360)/S,
ACP = 35.8 days.
19. From NI/S = .06, NI = 120,000. From tax rate = .40 and from NI = EBT - (.40)x(EBT), EBT
= 200,000. To check, note that 200,000 x .4 = taxes of 80,000 and EBT - taxes = 120,000.
From EBT = EBIT - Interest, EBIT = 220,000. Thus, TIE = EBIT/Interest = 11 times.
20. Assume that currently A = 100. Then, currently, from debt ratio = .5, D = 50 and E = 50.
From S/A = .25, S = 25. From NI/S = .10, NI = 2.5. Using these numbers note that ROE =
5% (they want to double the current ROE from 5% to 10%) checks out. For new, assume that
S and A remain the same such that S/A will remain the same. Thus, S = 25 and A = 100. From
NI/S = .14, NI = 3.5 For ROE = NI/E to be .10, E must be 35. From A = D + E, D = 65 and
thus, debt ratio = D/A = 65%.
21. Assume A = 100. From D/A = .35, D = 35 and E = 65. From NI/E = .15, NI = 9.75. From S/A
= 2.8, S = 280 Thus, NI/S = .0348 = 3.48%.
22. For these conversion type problems, note that if D = D/E and E = 1, D/E will be the stated
amount. Thus, for the first one, if D = 2.5 and E = 1, then D/E = 2.5. From A = D + E, A =
2.5 + 1 = 3.5. Then, D/A = 2.5/3.5 = .714 = 71.5% and A/E (the equity multiplier) = 3.5/1 =
3.5 times. For the second one, let D = 1 and E = 1 (thus, D/E = 1). Then A = D + E and A = 2.
Thus, D/A = .5 and A/E = 2. For the third one, let D = .6 and E = 1. Then, A = 1.6. Thus, D/A
= .375 = 37.5% and A/E = 1.6 times.
23. From NI/S = .075, NI = 150,000.
From NI/E = .24, E = 625,000
From NI/A = .15, A = 1,000,000
Thus, Total liabilities = NP + AP + LT Debt = 375,000.
From S = 2,000,000 and Gross profit = 400,000, COGS = 1,600,000.
From COGS/Inv = 4, Inv = 400,000.
From (APx360)/COGS = 20, AP = 88,889.
From ACP = (ARx360)/S = 40, AR = 222,222.
From CA/CL = 3.8 and CA = AR + Inv = 622,222, CL = 163,743.
From CL = Notes payable + AP, Notes payable = 74,854.
Thus, long-term debt = 375,000 - 74,854 - 88,889 = 211,257.
Finally, A = 1,000,000 = AR + Inv + Fixed Assets.
Thus, Fixed assets = 377,778.
Summarizing, AR = 222,222; Inv = 400,000; Fixed assets = 377,778;
Total assets = 1,000,000; Notes payable = 74,854; AP = 88,889;
Long-term debt = 211, 257; Equity = 625,000;
Total liab & eq. = 1,000,000.
24. See if you can derive the following answer on your own. Hint, compute Accounts receivable
first, and then use the Quick ratio and Current ratio to compute Current liabilities and
Inventories.
Accounts receivable 400 Current liabilities 400
Inventories 800 Long-term debt 2000
Fixed assets 2800 Equity 1600
Total assets 4000 Total claims 4000
CHAPTER 5 – Solutions to Assignment Problems
Assignment 5.1:
Balance Sheet
FreshFish, Inc.
Years ending December 31, 2006 and 2007
2006 2007
Cash $ 20,000 $ 30,000
Accounts receivable 10,000 15,000
Inventory 80,000 120,000
Total Current Assets $110,000 165,000
Net plant and equipment $430,000 645,000
Total assets $540,000 $810,000
Assignment 5.2:
You can answer this question for all parts using the OFN equation. Note that in that equation, the
last part is the change in retained earnings due to projected profit that is reinvested back into the
firm. This part of the equation is given as:
[(S0 + (g)(S0)](NPM) – Div0]
The first part of this equation is projected net income. With some minor mathematical
rearrangement, it can be written as (S0)(1+g)(NPM). The last term in the equation is the amount
of net income that is paid out in dividends. In the equation, it is given as a constant. For
Assignment 6.2, it is stated as a percent of net income (i.e., “Tabler pays out 40 percent of all its
annual profit in dividends”). If 40% of profit is paid out, then the remainder (i.e., 60%) must be
retained. Mathematically, this can be written as:
(S0)(1+g)(NPM)(.60)
Thus, the OFN equation becomes:
OFN = (TA0)(g) – [(L0)(g) + (S0)(1+g)(NPM)(.60)]
And filling in all other given values:
OFN = (1,220,000)(g) – [(500,000)(g) + (4,000,000)(1+g)(.05)(.60)]
= 1,220,000g – 500,000g – 120,000g – 120,000
= 600,000g – 120,000.
a. For g = 0% = 0, OFN = -120,000
b. For g = 10% = .10, OFN = -60,000
c. For g = 20% = .10, OFN = 0
d. For g = 30% = .10, OFN = 60,000
e. For g = 40% = .10, OFN = 120,000
f. For g = 50% = .10, OFN = 180,000
Assignment 5.3:
a. Earnings per share = Net income divided by number of shares of common stock
outstanding. Net income = (.05)(90,000) = 4,500. Number of shares = Common stock
value of balance sheet divided by par value per share = 60,000/2 = 30,000. Thus,
Earnings per share = 4,500/30,000 = .15 = 15%
Problems:
1. Reduce the dividend payout rate or increase the net profit margin.
2. a. and b.
Apr May Jun Jul Aug Sep
Cash Collections 75,000 100,000 300,000 500,000 900,000 500,000
Cash Expenses 350,000 350,000 350,000 350,000 350,000 350,000
Net Cash Flow (NCF) (275,000) (250,000) (50,000) 150,000 550,000 150,000
NOTE: If ending cash balance is greater than 50,000, the ST loan is zero. If ending cash balance is less than
50,000, the ST loan will grow so as to make ending cash equal to 50,000.
Check:
OFN = (TA0)(g) – [(L0)(g) + [(S0 + (g)(S0)](NPM) – Div0]
= (850,000)(.40) – [(30,000)(.40) + [(800,000 + (.40)(800,000)](.05) – 40,000
= 340,000 – [12,000 + 16,000]
= 312,000.
5.
COFFYS
Proforma Balance Sheet
For the Year Ending June 30, 2004
To solve for Notes payable, use the fact that the current ratio will be 2.5. Since you have
projected current assets = 126,000, this implies that projected current liabilities will be 50,400.
With Accounts payable = 35,000 and Accruals = 7,000 (due to spontaneous liabilities grow by
40%), Notes payable = 52,000 – 35,000 – 7,000 = 8,400.
The remaining financing variable (i.e., Long-term bank loan and Common stock) values stay
fixed. The change in Retained earnings is due to net income that is not paid in dividends.
Specifically,
Change in RE = (2003 Sales)(1 + Projected growth rate)(Net profit margin) – Dividends
= (800,000)(1.4)(.05) – 40,000
= 16,000
And thus proforma Retained earnings = 210,000 + 16,000 = 226,000.
Long term outside funds needed = 1,190,000 – 876,400 = 313,600. (This money will come from
some combination of additional long-term debt and additional common stock).
6.
COFFYS
Proforma Balance Sheet
For the Year Ending June 30, 2004
To solve for Notes payable, use the fact that the current ratio will be 2.0. Since you have
projected current assets = 126,000, this implies that projected current liabilities will be 63,000.
With Accounts payable = 35,000 and Accruals = 7,000 (due to spontaneous liabilities grow by
40%), Notes payable = 63,000 – 35,000 – 7,000 = 21,000.
To solve for Long-term bank loan, use the fact that the debt ratio will be 40 percent. The debt
ratio = total liabilities divided by total assets. With total assets projected to be 1,190,000, total
liabilities will be (.40)(1,190,000) = 476,000. Since Current liabilities = 63,000, Long-term bank
loan must be 476,000 – 63,000 = 413,000.
The remaining financing variable (i.e., Common stock) value stay fixed. The change in Retained
earnings is due to net income that is not paid in dividends. Specifically,
Change in RE = (2003 Sales)(1 + Projected growth rate)(Net profit margin) – Dividends
= (800,000)(1.4)(.05) – 40,000
= 16,000
And thus proforma Retained earnings = 210,000 + 16,000 = 226,000.
Money needed from selling additional common stock = 1,190,000 – 902,000 = 288,000.
7. a. $101,000
b. - $24,000
(TA = 1250000*1.15 =1437,500, 60% of which is debt, Total equity needed = 0.4 of
1437,500 = 575,000. Now addition to R. E = 49,000. Total R. E = 300,000+49,000 =
349,000. Total equity fund available = (50,000+200,000+349,000) = 599,000. Therefore,
common stock needed (575,000-599,000) = -24,000
8. $130,400
9. $112,500
10. a. $150,000 b. $137,400 c. $124,800
11.
(a) 2003 Actual 2004 Proforma
Cash 400,000 500,000
Acc. receivable 900,000 1,125,000
Inventory 1,200,000 1,500,000
Net Prop. & Plant 2,500,000 3,125,000
Total Assets 5,000,000 6,250,000
Assignment 6.1:
1. FV = PV (1+r). Let FV = 2 and PV =1. Thus, 2 = 1(1+r). When you solve for r, you get r=1.
Expressed as a percent, the interest rate is 100%.
2. FV = PV (1+r); 7397 = PV(1+.0439) or PV = 7297/1.0439; Solve PV = 7,085.93.
3. FV = PV (1+r); 13000 = PV(1.08) or PV = 13000/1.08; Solve for PV = 12,037.04.
4. Note that you will only need 25000 – 4500 = 20,500 one year from today. Thus, FV = PV
(1+r); 20500 = PV(1.075) or PV = 20500/1.075; Solve for PV = 19,069.77
5. FV = PV (1+r); 14739 = PV(1.12) or PV = 14739/1.12; Solve for PV = 13,159.82.
Assignment 6.2:
1. FVn = PV (1+r)n. Let FV = 2 and PV =1. Thus, 2 = 1(1+r)2 or 2½ = (1+r). When you solve for
r, you get r=.4142. Expressed as a percent, the interest rate is 41.42%.
2. PV = FV1(1/1+r)1 + FV2(1/1+r)2 ; PV = 3200(1/1.06)1 + 7300(1/1.06)2 ; PV = 3018.87 +
6496.97 = 9,515.84.
3. Note that the first deposit will grow for one year – that is, it will grow to become 7448 (1.07)
= 7969.36. When you add the extra 2476, you will have a total of 10,445.36 in your account.
4. Continuing from #3, the 10,445.36 will grow again by 7 percent to be 10445.367(1.07) =
11,176.54.
5. 15000 = X(1.12)2 + X(1.12)1 = X [(1.12)2 + (1.12)1] = X[2.3744]. Thus, X = 6,317.39.
Assignment 6.3:
1. FV2 = Deposit0 (1+r)2 + Deposit1 (1+r)1. (Note that the deposit made today (at t=0) will earn
interest for 2 years and the deposit made one year from today will earn interest for 1 year).
Thus, 4000 = 8000(1.04)2 + Deposit (1.04)1; 4000 = 8652 + Deposit (1.04). Solve for Deposit
and you get Deposit = -4,473.85. The negative sign implies that you will withdraw this
amount at the end of year one.
2. The question is what is the present value of the investment. That is, what is the present value
of 6500 one year from today + 5000 two years from today. We then compare the value of the
investment with the cost. If value > cost, you should buy. If value < cost, you should not buy.
PV = FV1(1/1+r)1 + FV2(1/1+r)2 ; PV = 6500(1/1.12)1 + 5000(1/1.12)2 ; PV = 5803.57 +
3958.97 = 9,789.54. Do not make investment.
3. 538 = 500 (1+r)1; 1.0760 = 1+r; r = .0760 = 7.6%
4. (1 + rnominal) = (1 + rreal) x (1 + i); (1 + rnominal) = (1.08) x (1.04) = 1.1232. rnominal = .1232 =
12.32%.
5. (1 + rnominal) = (1 + rreal) x (1 + i); (1.122) = (1 + rreal) x (1.036); (1 + rreal) = 1.083. rreal = .083 =
8.3%.
6. (1 + rnominal) = (1 + rreal) x (1 + i); (1.086) = (1.047)(1 + i); (1 + i) = 1.0372. i = .0372 = 3.72%
CHAPTER 6 – Answers to Additional Problems and Questions
Problems:
1. 10.24%
2. 8.112%
3. 5.77%
4. 5.15%
5. 1.92%
6. 10.04%
7. 1294.80
8. 4108.90
9. 237.60
10. 4917.12
11. 969.31
12. 1696.25
13. 3752.35
14. 612.83
15. E(R) [i.e., Expected Return] on first = 11.5%;E(R) on second = 12.1%
Choose both since Expected Return > Required Return. NOTE: This problem implicitly
assumes that these two investments are of equal risk. Unless otherwise explicitly stated, for
all problems in this book, we will assume that all comparable investments are of equal risk.
16. E(R) on first = 10.2%; E(R) on second = 7.48%
Choose neither since for both E(R) < Required Return.
17. (d) is correct. For (a), PV must be less than 432 since interest rate is greater than 0.for (b), the
FV (t=1) must be greater than the PV (t=0) value since interest rate is greater than 0.for (c),
you would never pay more than the simple sum of all future cash flows (i.e., 2,300+2,300 =
4,600 < 6,600)
18. 70,661.16
19. 1,680.00; 1,915.20
20. In the following equation, solve for X (note that ^2 means raised to the second power, or int
this case, squared): 10,000 = 7,000 (1/1.13)^1 + X(1/1.13)^2 ==> X = 4,859
21. In the following equation, solve for r: 4,100 = 3,500 (1+r)^2 ==> r = 8.233%
22. Buy the two year subscription because the PV of buying a one year subscription today and
another one year subscription one year from today = 48 + 48(1/1.10) = 91.64 which is greater
than the two year subscription price of 70. This answer of course assumes that you actually
want to read this magazine for two years!
23. Assume that the two payments are due one month from today and 2 months from today.
Payoff = 791.09
24. Compare 20,000 - 2,850 = 17,150 to the PV of 20,000 two years from today.
20,000(1/1.08)^2 = 17,146.78. Since 17,150 > 17,146.78, choose (b) because it is "cheaper."
CHAPTER 7 – Solutions to Assignment Problems
Assignment 7.1:
1. PV = -30000, FV = 49000, n = 5, Compute I/Y = 10.31%.
PV = -73000, FV = 128000, n = 7, Compute I/Y = 8.35%.
2. Use cash flow register: CF0 = 0, C01 = 22000, F01 = 1, C02 = 27500, F02 = 1, C03 =
33000, F03 = 1, C04 = 35000, F04 = 1; Compute NPV (with I = 6%) = 100,660.33
3. Use cash flow register to find NPV. Then find FV of this amount. Thus, CF0 = 11000, C01 =
13000, F01 = 1, C02 = 17400, F02 = 1, C03 = 12800, F03 = 1, C04 = 9600, F04 = 1; C05 =
17200, F05 = 1; Compute NPV (with I = 8%) = 66878.10. Now find the future value of this
amount 10 years from today. PV = 66878.10, I = 8, n = 10, Compute FV = 144,384.81.
Assignment 7.2:
1. PV = -28000, fv = 30000, I = 6, n = 10, Compute PMT = 1,528.26.
2. First find F of deposits. PMT = 2500, I = 8, n = 20, Compute FV20 = 114404.91. Now find
withdrawals. PV = 114404.91, n = 25, I = 8, Compute PMT = 10,717.31
3. First find NPV of all cash flows with the unknown cash flow assumed to be 0. That is, CF0 =
5000, C01 = 0, F01 = 10, C02 = -60000, F02 = 1, C03 = 0, F03 = 2, C04 = 25000, F04 = 1,
C05 = 0, F05 = 11, C06 = -1500000, F06 = 25; Compute NPV (with I = 7%) = 335884.60.
Now find PMT. PV = 335884.60, I = 7, n = 25, Compute PMT = 28,822.43.
4. First find PV20 of perpetuity = 30000/.12 = 250000 (note this is value in year 20).
CF0 = 0, C01 = 12000, F01 = 3, C02 = 17000, F02 = 4, C03 = 21000, F03 = 8, C04 = 24000,
Assignment 7.3:
1. PV = -1, FV = 2, I = 7/2 = 3.5, Compute n = 20.1488 semi-annual periods = 10.07 years.
2. Bank A: 10.00%; Bank B: 10.04%; Bank C: 9.95%; Bank D: 9.93%; Bank E: 9.86%.
3. PMT = 140000, n = 10, I = 9, Compute PV = 898472.08. This is value need at the end of year
20. Since first deposit will be made today, set calculator in BEGIN mode. Now, FV =
898472.08, I = 9, n = 20, Compute PMT = 16,111.89.
4. Annual payment = $8,652.62.
Beginning Ending
Year Balance Interest Payment Balance
Problems:
1. a – more compounding periods per year creates a larger effective interest rate.
2. e
3. 17 years
4. 4.45%
5. $10,962.37
6. d
7. a
8. 19.56%
9. $704
10. e
11. e
Rate PV FV
0 5,000.00 5,000.00
5 3,069.57 8,144.47
10 1,927.72 12,968.71
15 1,235.92 20,227.79
20 807.53 30,958.68
25 536.87 46,566.13
30 362.69 68,929.25
35 248.68 100,532.78
40 172.86 144,627.33
45 121.70 205,423.45
50 86.71 288,325.20
Plot of Present Values
6,000.00
5,000.00
Present Value
4,000.00
3,000.00 Series1
2,000.00
1,000.00
-
0 5 10 15 20 25 30 35 40 45 50
Interest Rate
350,000.00
300,000.00
250,000.00
Future Value
200,000.00
Series1
150,000.00
100,000.00
50,000.00
-
0 5 10 15 20 25 30 35 40 45 50
Interest Rate
13. $15,129.38
14. $45,349.14
15. $26.97
16. $889.23
17. 2.74%
18. 4.47%
19. $96,969.53
20. 7.10%; 7.23%
21. $31,265.66
22. 8.654%
23. $7,669.12; $18,419.93
24. $76,175.84
25. $6,714.27
Alternative 1:
I do not think solution manual gave right answer, I did in two different method and this is what I
get
CF1 = 20,000, CF1 = 0, F1= 10 (assume that t = 12 means ending of year 11)
CF2 = -25,000, F2 = 4, (ending at t = 14 or beginning at t = 15)
Cf3 = 0, f3 = 2 (assume that t = 18 means ending of year 17)
Cf4= -33,000, f4 = 4
I = 8%, NPV = - 50,257.52 (this is the spending at t =0)
You have to save for this for 10 yrs
Pv = - 70,257.52, FV = 0, N = 10, 1/Y = 8, PMT = ? 7,489.85
Alternative 2:
Pv1) PMT= 33,000; n=4; FV=0; PV=-118, 044.2006; 1/y= 8, (Solved as ANN Due) at the end of
t =17
Pv2) PMT=0; n=7; 1/y=8; FV= 118, 044.2006, PV=- 68,877.65 at the end of t = 10
PV3) PMT= 25000; n=4; i/y= 8; FV=0; Pv= -89,427.42468 (Solved as ANN Due) at the end of t
=11
PV4) Fv= 89,427.42468; n=1; 1/y= 8, PMT=0, PV= -82,803.171 at the end of t = 10
Pt 5) Pv= -20,000, n=10, FV= (68,877.65 +82,803.171), 1/y=8, PMT= -7,489.85
31. Amount of payment that goes to principal = 7757.16; Amount that goes to interest = 1,698.84
32. $925,764
33. $86,303.09
34. $17,954.13
Correct method for the solution in END mode is as follows:
PV= -3000, PMT= -3000, n=4, I/y=9, FV= 17, 954. 13
35. $276.21
36. $167,790.24
37. $5,468.21
38. $61,534.10
39. $165,918.32
40. $71,474.07
41. $871.47
As a first step, calculate the PV of the cash flows (at 10.5%): cf0 = 0, Cf1=1700, f1 = 1,
Cf2=1800, f2 = 1, cf3 = 0, f3 =1, cf4 = 2000, f4 = 1, NPV =4354. 1026
Therefore, you are 5000-4354. 1026=645.897 “short” of the 5000. This represents the PV of the
missing cash flow. To calculate the actual cash flow, calculate the FV of the 645.897:
PV=645.897, N=3; I=10.5; PMT = 0; FV=??=871.47
To verify your answer, enter the 871.47 as Cf3 and calculate the PV (it works out
to 5,000)
CHAPTER 9
ASSIGNMENT 9.1
1.
a. Treat as a perpetuity. P = Coupon/Interest Rate = 82.50/0.08 = $1,031.25
b. P = 1000/(1.0815) = $315.24
2.
a. N = 60; FV = 1000; PMT = 35; I/Y = 4.5; CPT PV. P = $793.62
3. PV = -978; FV = 1000; PMT = 90; N = 14; CPT I/Y. Cost of Debt = YTM = 9.29%
4. N = 68; (i.e. 17x4 quarters) PV = -1020; FV = 1000; PMT = 20; CPT I/Y;
I/Y = 1.9467; Thus, Cost of Debt = YTM = 1.9467 x 4 = 7.79%
ASSIGNMENT 9.2
QWE’s estimate of the required rate of return is higher than the actual required rate of return
investors are using to value the preferred stock.
The actual rate = 2.25/24 = 9.375%
2. Since the common stock pays constant dividends forever, the present value of the dividends is
obtained using the perpetuity formula, as in 1 above.
P = 1.50/0.09 = $16.67
You can also use the CF (cash flow) procedure to do the calculations in the last step:
C01 = 2; F01 =1; C02 = 1; F02 =1; C03 = 42.75 (3+39.75); F03 = 1; I=14.
3.
D6 = 1.75(1.52)(1.32)(1.2)(1.07) = 8.5442175.
Again, you can use the CF procedure (probably easier) for the last step.
After this, it is probably best to use the cash flow procedure for the last step:
C04 = 2.95245; F04 =1; C05 = 3.54294; F05 = 1; C06 = 4.251528; F06 = 999.
ADDITIONAL PROBLEMS
2. To be indifferent between calling the bond and not calling the bond, the call price of $1,075
must be equal to the present value of the remaining payments. Thus:
3. Use the usual procedure for finding the price of a bond. Just be careful to use the appropriate
YTM for I/Y for the various times.
4. FV = 1000; PV = -1092; PMT = 50; N=40; CPT I/Y. I/Y = 4.5%. Thus YTM = 9%
7. FV = 1000; N = 30; PMT = 35; PV = -825; CPT I/Y. I/Y = 4.585. YTM = 9.17%
8. YTM = 9.09%
9. P = $859.16
10. First find the yield to maturity of the zero coupon bonds.
N = 30; FV =1000; PV = -99.38; PMT = 0; CPT I/Y . YTM = 8%.
Now, the yield to maturity of the coupon bond is also 8%. Thus for the coupon bond:
N = 60; FV = 1000; PV = -886.88; I/Y = 4; CPT PMT. PMT = 35. Coupon Rate = 7%.
11. Price per share = 20000000/1000000 = $2. D = P x k = 2x0.11 = $2.20 per share.
16. The first dividend that begins the constant growth forever is D5. Thus, we can find P4 using:
Now, either use he cash flow procedure or the analytical method to solve for P0.
17. First let’s find the discount rate, k. 24 = 3/k. Thus k = 12.5%.
Now, with the 3 percent expected growth, the dividend one year from now, D1 = 3(1.03) = $3.09.
Therefore, P0 = 3.09/(0.125-0.03) = $32.53.
Take note of the fact that the question gave some pieces of information that were irrelevant to
solving the problem.
19. First determine k, the investors required rate of return. k = 2.10/15 = 14%.
ASSIGNMENT 10.1
1.
Payback Discounted
NPV IRR PI Period Payback Per.
2.
PMT = $26,000,000; FV = 20,000,000; N = 10; I/Y = 12; CPT PV.
PV (Benefits) = $153,345,263.50.
Thus, NPV = PV (Benefits) – PV (Costs) = 153,345,263.50 – 200,000,000 = - $ 46,654,736.50
IRR = 6.25%
PI = PV (Benefits)/PV (Costs) = 153,345,263.5/200,000,000 = 0.77
3. P0 = 10,000,000/(0.14-0.05) = $111,111,111.11
The IRR is the discount rate that will make the present value of the benefits equal to the initial
cost (that is the discount rate that will make the NPV equal to zero). 100,000,000 =
10,000,000/(k-0.05);
k = IRR = 15%
PI = 111,111,111.11/100,000,000 = 1.11
ASSIGNMENT 10.2
1.
R NPV
0 -300
10 86.78
20 250
30 275.15
40 214.29
50 100
60 -46.86
70 -212.80
80 -388.89
2.
ASSIGNMENT 10.3
3. YTM = 8.5% = Pretax cost of debt. After tax cost of debt = (1-0.3)x(8.5%) = 5.95%.
For common stock: 20=1.5(1.05)/(k-0.05). Solve this equation for k, the
investors required rate of return.
1.
2. The project has 2 IRRs because the cash flows change signs two times. The IRRs are 48.18%
and -50.55%. To solve for the IRR, you need to solve the following equation for r.
1996/(1+r) – 740/(1+r)2 -1010 = 0. You can use trial and error or you can solve using the
quadratic formula. For the quadratic, first multiply the equation through by (1+r)2 and simplify to
obtain a quadratic equation. Then use the quadratic formula.
If the cost of capital is 20%, the project should be accepted because it has a positive NPV. NPV =
$139.44.
3. a. $100,000
b. $65,738.04
c. 18%
Cost of capital (or discount rate). Since we know that the present value of the benefits equals
$21,900, we can solve for the discount rate.
PMT = 4500; N = 8; PV = -21,900; FV = 0; CPT I/Y. I/Y = cost of capital = 12.59%.
6. b.
7. e
8. a
13. Bonds: PV = -1095; FV = 1000; PMT = 116; N =24; CPT I/Y. I/Y = Pretax cost of debt
= 10.50%. After-tax cost of debt = (1-0.3) (10.5) = 7.35%
14. Bonds: PV = -8785; N = 60; FV = 10000; PMT = 390; CPT I/Y. I/Y = 4.487%. Thus the
YTM = Pre-tax cost of debt = 2(4.487) = 8.97%.
After-tax cost of debt = (1-0.30)(8.97%) = 6.28%.
2. Project A: CF0 = -80000; C01=18000; F01=8; Compute NPV (with I = 10) = 16,028.67. With same
figures in CF register, compute IRR = 15.29%
Project B: CF0 = -40000; C01=10000; F01=8; Compute NPV (with I = 10) = 13,349.26. With same
figures in CF register, compute IRR = 18.62%
Note that NPV indicates that we should accept Project A and IRR indicates that we should accept
Project B. ALWAYS CHOOSE THE PROJECT WITH THE HIGHEST NPV, so choose Project A.
4. If you construct graph correctly, you should find that the two lines cross at a discount rate of
approximately 16.25%. Note that with I = 16.25, NPV (P) = 1249.76 and NPV (Q) = 1249.77.
At rates above 16.25%, NPV(P) > NPV(Q)
At rates above 16.25%, NPV(P) < NPV(Q).
Assignment 11.2:
1. (Assume tax rate = 0). First compute the NPV of cost of each machine.
X100: CF0=-45000; C01=-5000; F01=4; C02=-5000+6000=1000; F02=1; Compute NPV (I=12) =
-59619.32. Note that this is NPV of costs.
Because these two projects have different lives, to compare we must now compute EAC.
EAC(X100): PV = -59619.32; N=5 (i.e., project life); I/Y=12, CPT PMT = 16,538.98.
EAC(X1300): PV = -69604.02; N=7 (i.e., project life); I/Y=12, CPT PMT = 15,251.48.
Thus EAC (X100) = 16,538.98. EAC (X1300) = 15,251.48. Choose X1300 because it has a lower
equivalent annual cost.
2. Initial Cash Outflow:
Buy Machine -31M
Decrease in NWC + 2M
CF0 -29M
To Compute NPV: CF0 = -29, C01 = 1.26; F01 = 19; C02 = 2.26; F02 = 1;
CPT NPV (with I = 11) = -18.842M
Assignment 11.3:
Q36: CF0 = -3M; C01 = .6M; F01 = 8; CPT NPV = 200,955.72.
Z96: CF0 = -4M; C01 = .7M; F01 = 10; CPT NPV = 301,196.97.
Since these projects have different lives, to compare, must compute Equivalent Annual Annuity.
Problems:
1. Must compute EAA of each project. Rank of EAA: D, C, A, B.
2.
Relevant – Opportunity cost
Not relevant – Sunk cost
Relevant – Initial cost
Not relevant – Sunk cost
Relevant – Incremental expense
Not relevant – Sunk cost
The incremental revenue of 93% of $2 million is relevant.
The tax savings associated with depreciation is relevant. Specifically, 36% of incremental
depreciation.
Relevant – Incremental expense
Not relevant – No incremental cost
Relevant – Incremental
Not relevant – must be paid regardless of whether project is accepted or rejected. Therefore, not
incremental.
3. The easiest way to do this problem is to assume the company can sell radiators for $150 per radiator.
Then:
NPV (Buy from Supplier) = 13,477,081. NPV (Manufacture) = 9,439,730. ???
Project Buy: CF0=0, CF1=(150-120)*100,00*(1-0.3)=2.1 million, F1=10, NPV=13,477,081
Project Manufacture:
4. EAC(A) = 1160.76; EAC(B) = 1813.90 – Choose project with lower equivalent annual cost.
5. NPV(Superior) = 17,802.68; NPV (Peerless) = 16,816.12 – Choose project with highest NPV.
6. IRR(A) = 34.90%; NPV(A) = 5,849.33
IRR(B) = 31.61%; NPV(B) = 10,490.40
7. Crossover rate = 7.167%; NPV(X) = NPV(Y) = 6720.60.
8. a. Yes – incremental; b. No – Sunk; c. No – financing cost (captured in NPV analysis);
d. Yes – incremental; e. Yes – incremental.
9. Note that annual NCF = Net income + Depreciation = 700,000 per year. NPV = 227,462.17.
10. 3,690.93
11. Note that annual NCF = Net income + Depreciation = 6.55M per year. NPV = -5.879M.
12. CF0 = (12,000,000); CF1 through CF10 = 2,880,000; No final year non-operating cash flow. NPV =
1,919,695.
13. CF0 = (26,800,000); Operating net cash flow = 26,800,000; Final year non-operating cash flow =
2,200,000. NPV = 97,762,829.
14. (56,004.33)
15. For this problem, assume that the cost of capital is 14%. Then, NPV = (320,096). Reject.
16.
Step 1: Initial Investment in the Project
NCF = (27M - 3.2M - 4.5M - 2.3M - 3.0M)(.6) + 3.0M = 11.4M for 25 years.
To compute NPV:
CF0=-93.7; C01 = 11.4; F01=24; C02=11.4+18.7=30.1; F02 = 1; CPT NPV = -14.642M.