ANSWER ALL OF THE QUESTIONS

PROBLEM 1 (15 marks)

The Kensington Corporation purchased a piece of equipment three years ago for $ 230,000. It
has an Asset Depreciation range (ADR) midpoint of eight years. The new equipment can be sold
for $ 90,000. A new piece of equipment will cost $ 320,000. It also has an ADR of eight years.
Assume the old and new equipment would provide the following operating gains (or losses) over
the next six years.
New Equipment Old Equipment
1 $ 80,000 $ 25,000
2 76,000 16,000
3 70,000 9,000
4 60,000 8,000
5 50,000 6,000
6 45,000 (7,000)

The firm has a 36% tax rate and a 9% cost of capital. Should the new equipment be purchased
to replace the old equipment?
Note: ADR of 8 years indicates the use of Five year category of ACRS depreciation percentages.
Schedule is as follow 0.200; 0.320; 0.192; 0.115; 0.115; and 0.058 (rates are in order)

PROBLEM 2 (10 marks)

Given the following information, calculate the weighted average cost of capital (WACC) for Natural
Republic Cosmetics
Percent of capital structure:
Debt 40%
Preferred stock 10%
Common equity 50%

Additional Information
Bond coupon rate 12%
Bond yield 10%
Dividend, expected common $ 3.00
Dividend, preferred $ 9.20
Price, common $ 60.00
Price, preferred $ 99.00
Flotation cost, preferred $ 4.00
Corporate growth rate 9%
Corporate tax rate 30%
PROBLEM 3 (10 marks)
Your company plans to borrow $ 5 million for 12 months, and your banker gives you a stated rate
of 14% interest. You would like to know the effective rate of interest for the following types of
loans. (Each of the following parts stands alone)
a. Simple 14% interest with a 10% compensating balance
b. Discounted interest
c. An installment loan (12 payments)
d. Discounted interest with a 5% compensating balance

PROBLEM 4 (20 marks)

Hoasin Trading Co Ltd's actual sales and purchases for April and May are shown here along with
forecasted sales and purchases for June through September.

Sales Purchases
April (actual) $320,000 $130,000
May (actual) 300,000 120,000
June (forecast) 275,000 120,000
July (forecast) 275,000 180,000
August (forecast) 290,000 200,000
September (forecast) 330,000 170,000

The company makes 10 percent of its sales for cash and 90 percent on credit. Of the credit sales,
20 percent are collected in the month after the sale and 80 percent are collected two months after.
Hoasin pays for 40 percent of its purchases in the month after purchase and 60 percent two
months after. Labor expense equals 10 percent of the current month's sales. Overhead expense
equals $12,000 per month. Interest payments of $30,000 are due in June and September. A cash
dividend of $50,000 is scheduled to be paid in June. Tax payments of $25,000 are due in June
and September. There is a scheduled capital outlay of $300,000 in September. Hoasin Trading
Co Ltd's ending cash balance in May is $20,000. The minimum desired cash balance is $10,000.
Prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly
cash budget with borrowing and repayments for June through September. The maximum desired
cash balance is $50,000. Excess cash (above $50,000) is used to buy marketable securities.
Marketable securities are sold before borrowing funds in case of a cash shortfall (less than
$10,000).

PROBLEM 5 (10 marks)

Austin Electronics expects sales next year to be $ 900,000 if the economy is strong, $ 650,000 if
the economy is steady, and $ 375,000 if the economy is weak. The firm believes there is a 15%
probability the economy will be strong, 60% probability of a steady economy, and a 25%
probability of a weak economy. What is the expected level of sales for next year?
PROBLEM 6 (15 marks)
Belgium Conveyor Company is considering an expansion of its facilities. Its current income
statement as follows:
Sales $ 4,000,000
Less: Variable expense (50% of sales) 2,000,000
Fixed expense 1,500,000
Earnings Before Interest and Taxes (EBIT) 500,000
Interest (10% of cost) 140,000
Earnings Before Taxes (EBT) 360,000
Tax (30%) 108,000
Earnings After Tax (EAT) $ 252,000
Shares of common stock 200,000
Earnings per share $ 1.26

The company is currently financed with 50% debt and 50% equity (common stock, par value $
10). To expand the facilities, Mr. Belgium estimates a need for $ 2 million in additional financing.
His investment banker has laid out three plans for him to consider:
1. Sell $ 2 million of debt at 13%
2. Sell $ 2 million of common stock at $ 20 per share
3. Sell $ 1 million of debt at 12% and $ 1 million of common stock at $ 25 per share.
Variable costs are expected to stay at 50% of sales, while fixed expenses will increase to $
1,900,000 per year. Mr. Belgium is not sure by how much this expansion will add to sales, but he
estimates that sales will rise by $ 1 million per year for the next five years.
Mr. Belgium is interested in a thorough analysis of his expansion plans and methods of financing.
He would like you to analyze the following:
a. The break-even point for operating expenses before and after expansion (in sales dollars)
b. The degree of operating leverage before and after expansion. Assume sales of $ 4 million
before expansion and $ 5 million after expansion.
c. The degree of financial leverage before expansion at sales of $ 4 million and for all three
methods of financing after expansion. Assume sales of $ 5 million for the second part of
this question.
d. Compute EPS under all three methods of financing the expansion at $ 5 million in sales
(first year) and $ 9 million in sales (last year).
e. What can you conclude from the above answer about the advisability of the three methods
of financing the expansion?
PROBLEM 7 (10 marks)
City Farm Insurance has collection centers across the country to speed up collections. The
company also makes its disbursements from remote disbursement centers. The collection time
has been reduced by two days and disbursement time increased by one day because of these
policies. Excess funds are being invested in short-term instruments yielding 12% per annum.
a. If City Farm has $ 5 million per day in collections and $ 3 million per day in disbursements,
how many dollars has the cash management system freed up?
b. How much can City Farm earn in dollars per year on a short-term investments made
possible by the freed up cash?

PROBLEM 8 (10 marks)

Corporate financial management is the practice of developing strategies and plans and making
investment decisions that positively affect the operations of a corporation. Briefly explain the 3
(three) important decisions under corporate financial management.

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