testbank for business finance

8/12/2019 Testbank for Business Finance

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CHAPTER TWO PROBLEMS

1. Last year Rattner Robotics had $5 million in operating income (EBIT). The companyhad net depreciation expense o $1 million and an interest expense o $1 million! itscorporate tax rate "as # percent. The company has $1# million in c%rrent assets and$# million in non&interest&bearing c%rrent liabilities! it has $15 million in net plant and

e'%ipment. It estimates that it has an ater&tax cost o capital o 1 percent. ss%methat Rattners only non&cash item is depreciation.

a. *hat "as the companys net income or the year+$,.# million

b. *hat "as the companys net cash lo"+$-.# million

c. *hat "as the companys net operating proit ater taxes (/0T)+$-. million

d. *hat "as the companys operating cash lo"+$#. million

e. I operating capital in the preio%s year "as $,# million2 "hat "as thecompanys ree cash lo" (343) or the year+

$,. million

. *hat "as the companys economic al%e added+$52

,. s an instit%tional inestor paying a marginal tax rate o #62 yo%r ater&tax diidendyield on preerred stoc7 "ith a 16 beore&tax diidend yield "o%ld be8

1#.96

-. :6 co%pon bond iss%ed by the state o e" ;or7 sells or $12 and th%s proidesa :6 yield to mat%rity. 3or an inestor in the #6 tax brac7et2 "hat co%pon rate on a4arter 4hemical 4ompany bond that also sells at its $12 par al%e "o%ld ca%se thet"o bonds to proide the inestor "ith the same ater&tax rate o ret%rn+

11.:6

#. corporation "ith a marginal tax rate o #6 "o%ld receie "hat 3TER&T< ;IEL=on a 1,6 co%pon rate preerred stoc7 bo%ght at par+

ns"er8 11.1:,6

5. ;o% hae >%st receied inancial inormation or the past t"o years or 0o"ell 0anther4orporation8

1



Income ?tatements Ending =ecember -1(millions o dollars)

, 1999?ales $12,. $12./perating 4osts (excl%ding depreciation) 12,. @5.=epreciation -. ,5.

Earnings beore interest and taxes $ 15. $ 1,5.Less Interest expense ,1.: ,.,

Earnings beore taxes $ 1,@.- $ 1#.@Less taxes (#6) 51.- #1.9

et income aailable to common e'%ity $ ::. $ ,.94ommon diidends $ .5 $ .##

Balance ?heets Ending =ecember -1(millions o dollars)

, 19994ash and mar7etable sec%rities $ 1,. $ 1.

cco%nts receiable 1@. 15.

Inentories 1@. ,.et plant and e'%ipment -. ,5.Total ssets $ :,. $ 1.

cco%nts payable $ 1@. $ 9.otes payable :. 51.5

ccr%als :,. .Long&term bonds $ 15. $ 15.4ommon stoc7 (5 million shares) 5. 5.Retained earnings ,,5. ,@.5Total liabilities and e'%ity $ :,. $ 1.

a. *hat is the net operating proit (/0T) or ,+$922

b. *hat are the amo%nts o net operating "or7ing capital or 1999 and ,+$,122 and $19,22

c. *hat are the amo%nts o total operating capital or 1999 and ,+$#22 and $#9,22

d. *hat is ree cash lo" or ,+$5@22

e. Ao" m%ch did the irm reinest in itsel oer the acco%nting period+$1252

. t the present time (1,-1,)2 ho" large a chec7 co%ld the irm "rite "itho%tit bo%ncing+

$1,22

. irmCs operating income (EBIT) "as $# million2 their depreciation expense "as $#million2 and their increase in net inestment in operating capital "as $: million.

ss%ming that the irm is in the #6 tax brac7et2 "hat "as their ree cash lo"+

2



$1: million

:. In its recent income statement2 ?mith ?ot"are Inc. reported $,- million o net income2and in its year&end balance sheet2 ?mith reported $#1 million o retained earnings.The preio%s year2 its balance sheet sho"ed $-@9 million o retained earnings. *hat"ere the total diidends paid to shareholders d%ring the most recent year+

$11. million

@. 4ox 4orporation recently reported an EBIT= o $5@ million and $: million o netincome. The company has $1, million interest expense and the corporate tax rate is#.6 percent. *hat "as the companyCs depreciation and amortiDation expense+

$-#.-- million

9. Raings Incorporated recently reported net income o $5.# million. Its operating income(EBIT) "as $15 million2 and its tax rate "as # percent. *hat "as the companys

interest expense+

$ million

1. In its recent income statement2 ?mith ?ot"are Inc. reported paying $1 million indiidends to common shareholders2 and in its year&end balance sheet2 ?mith reported$#19 million o retained earnings. The preio%s year2 its balance sheet sho"ed $##million o retained earnings. *hat "as the irms net income d%ring the most recentyear+

$,5. million

11. 4asey otors recently reported net income o $19 million. The irmCs tax rate "as

#.6 and interest expense "as $ million. The companyCs ater&tax cost o capital is1#.6 and the irmCs total inestor s%pplied operating capital employed e'%als $95million. *hat is the companyCs EF+

$9.- million

1,. Broo7s ?istersC operating income (EBIT) is $19# million. The companyCs tax rate is#.62 and its operating cash lo" is $1#@.# million. The companyCs interest expense is$-9 million. *hat is the companyCs net cash lo"+ (ss%me that depreciation is theonly non&cash item in the irmCs inancial statements.)

$1,5. million

1-. Fal%able Incorporateds stoc7 c%rrently sells or $#5 per share. The irm has , millionshare o common o%tstanding. The irms total debt e'%als $ million and its commone'%ity e'%als $# million. *hat is the irms mar7et al%e added+

$5 million

CHAPTER THREE PROBLEMS

1. B42 Inc.2 sells all its merchandise on credit. It has a proit margin o #62 an aerage

3



collection period o days2 receiables o $1522 total assets o $- million and adebt ratio o .#. *hat is the irmCs ret%rn on e'%ity+

-.-- percent

,. The ?mythe 4orporationCs common stoc7 is c%rrently selling at $1 per share "hich

represents a 0E ratio o 1. I the irm has 1 shares o common stoc7 o%tstanding2a ret%rn on e'%ity o .,2 and a debt ratio o .:2 "hat is its ret%rn on total assets+

.: percent

-. I *in7ler2 Inc.2 has sales o $, million per year (all credit) and an aerage collectionperiod o -5 days2 "hat is its aerage amo%nt o acco%nts receiable o%tstanding(ass%me a - day year)+

$19#2###

#. I a irm has total interest charges o $12 per year2 sales o $1 million2 a tax rate o#62 and a net proit margin o 62 "hat is the irmCs times interest earned ratio+

11 times

5. irm that has an e'%ity m%ltiplier o #. "ill hae a debt ratio o8

.:5.

. Gien the ollo"ing inormation2 calc%late the mar7et price per share o *2 Inc.8 Earnings ater interest and taxes H $,2 Earnings per share H $,. ?toc7holdersC e'%ity H $,22 ar7etBoo7 ratio H .,

$#.

:. ire has destroyed a large percentage o the inancial records o Aanson ssociates.;o% are charged "ith piecing together inormation in order to release a inancial report.;o% hae o%nd the ret%rn on e'%ity to be 1@6. I sales "ere $# million2 the debt ratio.#2 and total liabilities $, million2 "hat "as the ret%rn on assets+

1.@6

@. ss%me 4onseratie 4orporation is 16 e'%ity inanced. 4alc%late the ret%rn one'%ity gien the ollo"ing inormation8 1. Earnings beore taxes H $,2

,. ?ales H $52 -. =iidend payo%t ratio H 6 #. Total asset t%rnoer H ,. 5. pplicable tax rate H 56

# percent9. ;o% are considering a ne" prod%ct or yo%r irm to sell. It sho%ld ca%se a 156 increase

in yo%r proit margin b%t it "ill also re'%ire a 56 increase in total assets. ;o% expectto inance this asset gro"th entirely by debt. I the ollo"ing ratios "ere comp%ted

4



beore the change2 "hat "ill be the ne" R/E i the ne" prod%ct is sold b%t salesremain constant+ 0roit margin H .1 Total asset t%rnoer H ,. E'%ity m%ltiplier H ,

# percent

1. ohnsto"n 4hemicals2 Inc.2 has a c%rrent ratio o -.2 a '%ic7 ratio o ,.#2 and aninentory t%rnoer o . ohnsto"nCs total assets are $1 million and its debt ratio is .,.(The irm has no long&term debt.) *hat is ohnsto"nCs sales ig%re+

$:,2

11. 4alc%late the mar7et price o a share o B42 Inc.2 gien the ollo"ing inormation8?toc7holdersC e'%ity H $12,5! priceearnings ratio H 5! shares o%tstanding H ,5!mar7etboo7 ratio H 1.5.

$:5.

1,. amesto"n2 Inc.2 has earnings ater interest ded%ctions b%t beore taxes o $-. ThecompanyCs beore&tax times interest earned ratio is :.. 4alc%late the companyCsinterest charges.

$5.

1-. The G. Aobbs 4ompany has determined that its ret%rn on e'%ity is 156. anagementis interested in the ario%s components that "ent into this calc%lation. Ao"eer2 one othe acco%ntants has misplaced the proit margin ratio. s a inance "iDard2 yo% 7no"ho" to calc%late the proit margin2 gien the ollo"ing inormation8 total debttotalassets H .-52 and total asset t%rnoer H ,.@. *hat is the proit margin+

-.#@ percent

1#. Lo"e J 4ompany has a debt ratio o .52 a capital intensity ratio o #2 and a proitmargin o 16. The Board o =irectors is %nhappy "ith the c%rrent ret%rn on e'%ity(R/E)2 and they thin7 it co%ld be do%bled. This co%ld be accomplished (1) byincreasing the proit margin to 1,6 and (,) by increasing debt %tiliDation. Total assett%rnoer "ill not change. *hat ne" debt ratio2 along "ith the 1,6 proit margin2 isre'%ired to do%ble the R/E+

: percent

15. The Local 4ompany is a relatiely small2 priately o"ned irm. In 19@1 Local had anater&tax income o $1522 and 12 shares "ere o%tstanding. The o"ners "eretrying to determine the e'%ilibri%m mar7et al%e or LocalCs stoc72 prior to ta7ing the

company p%blic. similar irm that is p%blicly traded had a priceearnings ratio o 5..Ksing only the inormation gien2 estimate the mar7et al%e o one share o LocalCsstoc7.

$:.5

1. Epsilon 4o.Cs records hae recently been destroyed by ire. Gien the ollo"ing bits oinormation saed rom the inerno2 determine EpsilonCs net income or 1999. Ret%rn on e'%ity ,,6

5



ssetsnet "orth ,.1:0roit margin 5.6Total assets $5 million

$ . million

1:. =elta 4orp. has sales o $-22 a proit margin o .5 percent2 a tax rate o 15percent2 and ann%al interest charges o $:25. *hat is =eltaCs times interest earned+

#.

1@. 4oastal 0ac7aging s R/E last year "as only - percent2 b%t its management hasdeeloped a ne" operating plan designed to improe things. The ne" plan calls or atotal debt ratio o percent2 "hich "ill res%lt in interest charges o $- per year.anagement pro>ects an EBIT o $12 on sales o $122 and it expects to hae atotal asset t%rnoer ratio o ,.. Knder these conditions2 the aerage tax rate "ill be -percent. I the changes are made2 "hat ret%rn on e'%ity "ill 4oastal earn+

,#.5 percent

19. ;ohe Inc. has an R/ o 1-.#6 and a 16 proit margin. The company has salese'%al to $5 million. *hat are the companyCs total assets+

$-.:- million

,. ;ohe Inc. has a c%rrent ratio o ,2 and a '%ic7 ratio o 1.#. 3%rthermore2 the irm has$1.5 million in c%rrent liabilities. Based %pon this inormation2 ho" m%ch inentory is;ohe holding+

$92

,1. K M/2 Inc. %ses only debt and common e'%ity %nds to inance its assets. This pastyear the irmCs ret%rn on total assets "as 1-6. The irm inanced #,6 percent o itsassets %sing debt. *hat "as the irmCs ret%rn on common e'%ity+

,,.#16

,,. 4leeland 4orporation has 1:2#92 shares o common stoc7 o%tstanding2 its netincome is $19# million2 and its 0E ratio is 15.1. *hat is the companys stoc7 price+

$1:.#9

,-. Cs inentory t%rnoer ratio is 11.9 based on sales o $152,2. The

irmCs c%rrent ratio e'%als -.,, "ith c%rrent liabilities e'%al to $9:2. *hat isthe irmCs '%ic7 ratio+

1.@1

CHAPTER FOUR PROBLEMS

6



1. Interest rates on one&year Treas%ry sec%rities are c%rrently 5. percent2 "hile t"o&yearTreas%ry sec%rities are yielding percent. I the p%re expectations theory is correct2"hat does the mar7et beliee "ill be the yield on one&year sec%rities one year romno"+

.# percent

,. Interest rates on o%r&year Treas%ry sec%rities are c%rrently : percent2 "hile interestrates on six&year Treas%ry sec%rities are c%rrently :.5 percent. I the p%re expectationstheory is correct2 "hat does the mar7et beliee that t"o&year sec%rities "ill be yieldingo%r years rom no"+

@.5 percent

-. The real ris7&ree rate o interest is - percent. Inlation is expected to be , percent thisyear and # percent d%ring the next t"o years. ss%me that the mat%rity ris7 premi%m isDero. *hat is the yield on -&year Treas%ry sec%rities+

.-- percent

#. Treas%ry bond that mat%res in 1 years has a yield o percent. 1&year corporatebond has a yield o @ percent. ss%me that the li'%idity premi%m on the corporatebond is .5 percent. *hat is the dea%lt ris7 premi%m on the corporate bond+

1.5 percent

5. /ne&year Treas%ry sec%rities yield 5 percent. The mar7et anticipates that 1 year romno"2 one&year Treas%ry sec%rities "ill yield percent. I the p%re expectations theory iscorrect2 "hat sho%ld be the yield today or ,&year Treas%ry sec%rities+

5.5 percent

. The real ris7&ree rate is - percent2 and inlation is expected to be - percent or the next, years. ,&year Treas%ry sec%rity yields ., percent. *hat is the mat%rity ris7premi%m or the ,&year sec%rity+

., percent

:. The real ris7&ree rate is - percent. Inlation is expected to be - percent this year2 #percent next year2 and then -.5 percent thereater. The mat%rity ris7 premi%m isestimated to be .5 < (t&1)2 "here t H n%mber o years to mat%rity2 *hat is thenominal interest rate on a :&year Treas%ry note+

.@ percent

@. ss%me that the real ris7&ree rate is , percent and that the mat%rity ris7 premi%m isDero. I the nominal rate o interest on 1&year bonds is 5 percent and that oncomparable ris7 ,&year bonds is : percent2 "hat is the 1&year interest rate that isexpected or year t"o+

7



: percent

9. ;o% see that the c%rrent -&day T&bill rate is #.56. ;o% are told by a riend "ho"or7s or an inestment irm that the best estimates o the c%rrent interest ratepremi%ms or relatiely sae corporate irms is as ollo"s8 inlation premi%m H,.16! dea%lt ris7 premi%m H 1.#6. Based on this data2 "hat is the real ris7&reerate o ret%rn+

,.#6

1. The real ris7&ree rate o interest is - percent. Inlation is expected to be 5 percent thiscoming year2 >%mp to percent next year2 and increase to : percent the ollo"ing year(;ear -). ccording to the expectations theory2 "hat sho%ld be the interest rate on -&year2 ris7&ree sec%rities today+

9 percent

11. =rongo 4orporations #&year bonds c%rrently yield @.# percent. The real ris7&ree rate ointerest2 7N2 is ,.: percent and is ass%med to be constant. The mat%rity ris7 premi%m(R0) is estimated to be .16(t & 1)2 "here t is e'%al to the time to mat%rity. Thedea%lt ris7 and li'%idity premi%ms or this companys bonds total .9 percent and arebelieed to be the same or all bonds iss%ed by this company. I the aerage inlationrate is expected to be 5 percent or years 52 2 and :2 "hat is the yield on a :&yearbond or =rongo 4orporation+

@.91 percent

1,. /ne&year Treas%ry sec%rities yield percent2 ,&year Treas%ry sec%rities yield .5

percent2 and -&year Treas%ry sec%rities yield : percent. ss%me that the expectationstheory holds. *hat does the mar7et expect "ill be the yield on 1&year Treas%rysec%rities t"o years rom no"+

@ percent

1-. ss%me that a -&year Treas%ry note has no mat%rity ris7 premi%m2 and that the realris7&ree rate o interest is - percent. I the T&note carries a yield to mat%rity o 1percent2 and i the expected aerage inlation rate oer the next , years is @ percent2"hat is the implied expected inlation rate d%ring ;ear -+

5 percent

CHAPTER FIVE PROBLEMS

1. n inestor holds a diersiied portolio consisting o a $52 inestment in each o ,dierent common stoc7s. The portolio beta is e'%al to 1.1,. The inestor has decidedto sell a lead mining stoc7 (beta H 1.) at $52 net and %se the proceeds to b%y ali7e amo%nt o a steel company stoc7 (beta H ,.). *hat is the ne" beta or the

8



portolio+

1.1:

,. 4onsider the ollo"ing inormation and calc%late the re'%ired rate o ret%rn or the*in7ler Inestment 3%nd. The total inestment %nd is $, million.

?toc7 Inestment Beta &&&&& &&&&&&&&&& &&&& $ ,2 1.5 B -2 &.5 4 52 1.,5 = 122 .:5

The mar7et re'%ired rate o ret%rn is 156 and the ris7&ree rate is : percent.

1-.1 percent

-. The ?andy 4ompany has deeloped the ollo"ing data regarding a pro>ect to add ne"distrib%tion acilities8

?TTE 0R/BBILIT; 0R/E4T RETKR RMET RETKR 1 .- .1 .1 , .: .15 .1#

. *hat is the expected ret%rn on the pro>ect+ 1.@6

B. *hat is the standard deiation o the pro>ect ret%rns+ .#,

4. *hat is the coeicient o ariation o pro>ect ret%rns+ .59#

=. *hat is the coariance o pro>ect ret%rns "ith mar7et ret%rns+ .1,

E. *hat is the correlation coeicient bet"een the pro>ect ret%rns and the mar7etret%rns+ 1.

#. 4alc%late the re'%ired rate o ret%rn or anagement2 Inc.2 ass%ming that inestorsexpect a 56 rate o inlation in the %t%re. The real rate is e'%al to -6 and the mar7etris7 premi%m is 56. anagement has a beta o ,. and has historically ret%rned anaerage o 156.

1@ percent

5. 3irst Inestment Tr%st is a m%t%al %nd inesting in the common stoc7 o six irms. Theirms2 mar7et al%e o shares held2 and the beta o each stoc7 are as ollo"s8

RMET FLKE /3 3IR ?ARE? AEL= BET ce Electronics $ 9 million . BobCs Ind%stries 11 million 1., 4B International million .: =aeCs 4en 1- million 1.@ EdCs Eatery : million .9

9



?pace =eli # million ,.5 Total 5 million

. 4alc%late the beta o the m%t%al %nd. 1.,5

B. ?%ppose Rm H 1 percent and R H percent! "hat is the expected portolio

ret%rn+ [email protected] percent

. The ollo"ing data pertains to the next o%r '%estions. ?toc7s and B hae ret%rnsand probability distrib%tions as gien belo".

0R/BBILIT; ?T/4M ?T/4M B .,5 6 @6 .- 16 ,6 .,5 #6 6 ., @6 @6

. 4alc%late the expected ret%rns or ?toc7s and B. :.16 and 5.:6

B. *hat are the standard deiations o expected ret%rns or ?toc7s and B+ ,.-,6 and ,.556

4. The coariance bet"een ?toc7s and B is8 &.-:

=. The correlation coeicient bet"een ?toc7s and B is8 &.,

E. ?%ppose yo% "ant to hold a portolio composed o 56 o ?toc7 and 56 o?toc7 B. *hat "ill be the expected ret%rn (mean) and ris7 (standard deiation)

o yo%r portolio+

.#6 and 1.:6

:. ;o% are managing a portolio o 1 stoc7s "hich are held in e'%al amo%nts. Thec%rrent beta o the portolio is 1.#2 and the beta o ?toc7 is ,.. I ?toc7 is sold2"hat does the beta o the replacement stoc7 hae to be to hae a ne" portolio beta o1.55+

1.1

@. Gien the ollo"ing inormation concerning ??ET? < and ;8

0ossible Ret%rns o ssets /%tcomes 0robability < ;

10



1 .1 . &.# , ., .@ .1 - .# .1, .1, # ., .- .1# 5 .1 . .1

. *hat are the expected ret%rns or ??ET? < and ; gien the aboeprobabilities+

1@.# percent and1.@ percent

B. *hat is the expected ret%rn o a portolio comprised o # percent o aninestorCs "ealth inested in ??ET < and percent inested in ??ET ;+

1-.@# percent

4. *hat are the standard deiations o the ret%rns o the t"o sec%rities+

1.# percent and 5., percent

=. *hat is the 4/FRI4E bet"een the t"o sec%rities+

.5#@@

E. *hat is the 4/RRELTI/ bet"een these t"o sec%rities+

.-

3. *hat is the standard deiation o a portolio comprised o # percent o aninestorCs "ealth inested in ??ET < and percent inested in ??ET ;+

@.9- percent

CHAPTER SIX PROBLEMS

1. I yo% b%y a actory or $,52 and the terms are ,6 do"n2 the balance to be paido oer - years at a 1,6 rate o interest on the %npaid balance2 "hat are the -e'%al ann%al payments+

11



$,#2@,9

,. n inestor is considering the p%rchase o , acres o land. Ais analysis is that i theland is %sed or cattle graDing2 it "ill prod%ce a cash lo" o $12 per year indeinitely.I the inestor re'%ires a ret%rn o 16 on inestments o this type2 "hat is the most he

"o%ld be "illing to pay or the land+

$12

3. /n an%ary 12 19952 a grad%ate st%dent deeloped a inancial plan "hich "o%ldproide eno%gh money at the end o his grad%ate "or7 (an%ary 12 ,) to open ab%siness o his o"n. Ais plan "as to deposit $@2 per year2 starting immediately2 intoan acco%nt paying 16 compo%nded ann%ally. Ais actiities proceeded according toplan except that at the end o his third year he "ithdre" $52 to ta7e a 4aribbeancr%ise2 at the end o the o%rth year he "ithdre" $52 to b%y a %sed 4amaro2 and atthe end o the ith year he had to "ithdra" $52 to pay to hae his dissertationtyped. Ais acco%nt2 at the end o the ith year2 "ill be less than the amo%nt he hadoriginally planned on by ho" m%ch+

$1255

#. ;o% hae been gien the ollo"ing cash lo"s. *hat is the present al%e (t H ) i thedisco%nt rate is 1,6+

1 , - # 5 &&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&& $ $1 $, $, $, $ &$,

$-2,:

5. B4 4orporation has been en>oying a phenomenal rate o gro"th since its inceptionone year ago. 4%rrently assets total $12. I gro"th contin%es at the c%rrent rateo 1,6 compo%nded '%arterly2 "hat "ill be total assets in , 1, years+

$1-#2-9

. 4harter ir is considering the p%rchase o an aircrat to s%pplement its c%rrent leet. Inestimating the impact o adding this crat to their leet2 they hae deeloped theollo"ing cash lo" analysis8

End o year 1 &$12 , $12 - $12 # $12

12



5 $12 $12 : &$-2

I the disco%nt rate is 162 "hat is the present al%e o these estimated lo"s+

$1@92:5,

:. 3ind the present al%e or the ollo"ing income stream i the interest rate is 1, percent.

;ER? 4?A3L/* 1&# $ 52 5&1 $ :25 11&15 $ 12

$-121#@.5

@. ;o% are thin7ing abo%t b%ying a car2 and a local ban7 is "illing to lend yo% $,2 tob%y the car. Knder the terms o the loan2 it "ill be %lly amortiDed oer ie years (

monthly payments) and the nominal interest "ill be 1, percent. *hat "o%ld be themonthly payment on the loan+

$###.@9

9. ;o% hae been saing money or the last t"o years. ;o% made deposits o $1 onan%ary 12 ,12 and %ly 12 ,12 in a saings acco%nt paying 16 compo%ndedsemi&ann%ally. /n an%ary 12 ,,2 the ban7 increased the interest rate paid onsaings acco%nts to 1,62 ann%al compo%nding. ;o% made a third $1 deposit on

pril 12 ,,. Ao" m%ch "ill be in yo%r acco%nt on an%ary 12 ,-+

$-#9.95

1. ;o% plan on "or7ing or 1 years and then leaing or the las7an Pbac7 co%ntryQ. ;o%ig%re yo% can sae $12 a year or the irst 5 years and $,2 a year or the last 5years. In addition2 yo%r amily has gien yo% a $52 grad%ation git. I yo% p%t thegit and yo%r %t%re saings in an acco%nt paying @ percent compo%nded ann%ally2 "hat"ill yo%r Psta7eQ be "hen yo% leae or the "ilderness 1 years hence+

$-121#@

11. I $1 is placed in an acco%nt that earns a nominal #62 compo%nded '%arterly2 or 5years2 "hat "ill it be "orth in 5 years+

$1,,.,

1,. Aess =istrib%tors is inancing a ne" tr%c7 "ith a loan o $12 to be repaid in 5ann%al installments o $,255. *hat ann%al interest rate is the company paying+

@6

1-. ;o% hae decided to deposit yo%r scholarship money ($12) in a saings acco%ntpaying @6 interest2 compo%nded '%arterly. Eighteen months later2 yo% decide to go tothe mo%ntains rather than school and yo% close o%t yo%r acco%nt. Ao" m%ch money

13



"ill yo% receie+

$121,

1#. The present al%e (t H ) o the ollo"ing cash lo" stream is $29:9.# "hendisco%nted at 1-6 ann%ally. *hat is the al%e o the I??IG (t H ,) cash lo"+

1 , - # &&&O&&&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&&O&&&&&&&&&&&O&&&&& $ $ 9 $+ $,21 $12@

$ #2,:

15. ;o% "ant to set %p a tr%st %nd. I yo% ma7e a payment at the end o each year ort"enty years and earn 16 per year2 ho" large m%st yo%r ann%al payments be so thatthe tr%st is "orth $12 at the end o the t"entieth year+

$12:#5.9

1. T"ele years ago yo% bo%ght a $,5 stoc7 "hich is no" "orth $:@.#:. ss%ming thatthe stoc7 paid no diidends2 the rate o ret%rn on yo%r inestment "as8

16

1@. ?tarting on an%ary 12 19912 and then on each an%ary 1 %ntil , (1 payments)2yo% "ill ma7e payments o $12 into an inestment "hich yields 1 percent. Ao"m%ch "ill yo%r inestment be "orth on =ecember -1 in the year ,1+

$#52#@.,

19. ;o%r 9&year old a%nt has saings o $-52. ?he has made arrangements to enter a

home or the aged on reaching the age o @. ;o%r a%nt "ants to decrease at aconstant amo%nt each year or ten years2 "ith a Dero balance remaining. Ao" m%chcan she "ithdra" each year i she earns percent ann%ally on her saings+ Aer irst"ithdra"al "o%ld be one year rom today.

8. $#2:55

,. rich a%nt promises yo% $-52 exactly 5 years ater yo% grad%ate rom college.*hat is the al%e o the promised $-52 i yo% co%ld negotiate payment %pongrad%ation+ ss%me an interest rate o 1, percent.

[email protected]

,1. In planning to b%y a home yo% are p%tting $,25 o yo%r end o year bon%s in anacco%nt that earns 1 percent. I yo%r irst payment begins in exactly one year2 ho"m%ch o a do"n payment "ill yo% be able to aord at the end o # years+

$112,.5

,,. 3red ohnson is retiring one year rom today. Ao" m%ch sho%ld 3red c%rrently hae ina retirement acco%nt earning 1 percent interest to g%arantee "ithdra"als o $,52per year or 1 years+

14



$15-215

,-. I yo% "ere promised 1 ann%al payments o $#2 starting "ith the irst paymenttoday2 comp%te the present al%e o these lo"s i yo%r opport%nity cost is : percent.

$-2.@

,#. ;o% place $52 in yo%r credit %nion at an ann%al interest rate o 1, percentcompo%nded monthly. Ao" m%ch "ill yo% hae in , years i all interest remains in theacco%nts+

$2-#@.5

,5. ;o% hae >%st had yo%r thirtieth birthday. ;o% hae t"o children. /ne "ill go to college@ years rom no" and re'%ire o%r beginning&o&year payments or college expenses o$1,22 $1-22 $1#22 and $152. The second child "ill go to college 1# yearsrom no" and re'%ire o%r beginning&o&year payments o $122 $1:22 $1@22and $192. In addition2 yo% plan to retire in ,5 years. ;o% "ant to be able to

"ithdra" $2 per year (at the end o each year) rom an acco%nt thro%gho%t yo%rretirement. ;o% expect to lie ,5 years beyond retirement. The irst "ithdra"al "illocc%r on yo%r ity&sixth birthday. *hat e'%al2 ann%al2 end&o&year amo%nt m%st yo%sae or each o the next ,5 years to meet these goals2 i all saings earn a 1- percentann%al rate o ret%rn+

$ 25#

,. 3ind the present al%e o the cash lo"s sho"n %sing a disco%nt rate o 9 percent.

;ER 4?A3L/* 1&5 $15yr.

, : ,5 @&1 15yr. 1:&, -yr.

$ 125:.,

,:. ccording to a local department store2 the store charges c%stomers 16 per month onthe o%tstanding balances o their charge acco%nts. *hat is the eectie ann%al rateon s%ch c%stomer credit+ ss%me the store recalc%lates yo%r acco%nt balance at theend o each month.

1,.@6

,@. ;o%r ban7 has oered yo% a $152 loan. The terms o the loan re'%ire yo% to paybac7 the loan in ie e'%al ann%al installments o $#211.. The irst payment "ill bemade a year rom today. *hat is the eectie rate o interest on this loan+

8 1,6

,9. ;o% hae p%rchased a ne" sailboat and hae the option o paying the entire $@2no" or ma7ing e'%al2 ann%al payments or the next # years2 the irst payment d%e oneyear rom no". I yo%r time al%e o money is : percent2 "hat "o%ld be the largest

15



amo%nt or the e'%al2 ann%al payments that yo% "o%ld be "illing to %nderta7e+

$,2-,.

-. irm p%rchases 1 acres o land or $,2 and agrees to remit t"enty e'%alann%al installments o $#12: each. *hat is the tr%e ann%al interest rate on this

loan+

, percent

-1. Thirty years ago2 essie ohnson bo%ght ten acres o land or $5 per acre in "hat isno" do"nto"n Ao%ston. I this land gre" in al%e at a 1 percent per ann%m rate2"hat is it "orth today+

$ @:2,#5

-,. I yo% p%t yo%r money in a ban7 oering 1, percent compo%nded '%arterly2 ho" m%ch"ill $12## gro" to in ie years+

8 $12@@5.5@

--. *hat is the %t%re al%e o $12,5 compo%nded at an @ percent rate or ten years+

$,[email protected]

-#. ames ?treetsC son Aarold is ie years old today. Aarold is already ma7ing plans to goto college on his eighteenth birthday and his ather "ants to start p%tting a"ay moneyno" or that p%rpose. ?treet estimates that Aarold "ill need $1#22 $1522$122 and $1:2 or his reshman2 sophomore2 >%nior2 and senior years. Ae planson ma7ing these amo%nts aailable to Aarold at the beginning o each o these years.?treet "o%ld li7e to ma7e t"ele deposits (the irst o "hich "o%ld be made on AaroldCs

sixth birthday2 1 year rom no") in an acco%nt earning 1, percent. Ae "ants theacco%nt to eent%ally be "orth eno%gh to pay or AaroldCs college expenses. nybalances remaining in the acco%nt "ill contin%e to earn 1, percent. Ao" m%ch "ill?treet hae to deposit in this planning acco%nt each year to proide or AaroldCsed%cation+

$,15

-5. In yo%r analysis o =B 4orporation yo% ind that the c%rrent earnings per share are$5. per share and most analysts are pro>ecting the earnings per share to gro" at a1, percent rate ann%ally. *hat can yo% expect the earnings per share o this irm to bein : years+

$11.

-. ;o%r grandmother is thrilled that yo% are going to college and plans to re"ard yo% atgrad%ation "ith a 0orsche T%rbo a%tomobile. ?he "o%ld li7e to set aside an e'%al

16



amo%nt at the completion o each o yo%r college years rom her meager pension. Iher acco%nt earns 1, percent and a ne" 0orsche "ill cost $522 ho" m%ch "ill shedeposit each year+ ss%me her irst deposit is in exactly one year.

$12#,.##

-:. ?ellDar 4orporation c%rrently has sales o $1 million and its mar7eting department ispro>ecting sales to be $@ million in # years. *hat rate o gro"th in sales are themar7eting people pro>ecting+

@6

-@. ?%ppose that a local saings and loan association adertises a percent ann%al rate ointerest on reg%lar acco%nts2 compo%nded monthly. *hat is the eectie ann%alpercentage rate o interest paid by the saings and loan+

.16

-9. Greg 0erry2 KTE0Cs reno"ned comp%ter >oc72 is grad%ating in one year and plans to

start his o"n comp%ter irm2 namely 0erryCs 0eriphals2 Inc. Being a science iction b%2Greg is planning to start his irm %sing $52 he earned as a trombone player in theBits and =iscs aDD Band d%ring college and retire in , years in order to ta7e the irstIntergalactic ?pace ?h%ttle trip at an estimated cost o $1.5 million. *hen Gregret%rns to earth 1 years thereater2 he plans to lie o an ann%ity o $-2 peryear2 starting on the day o his ret%rn. This ann%ity "as %nded "hen he let on hisspace >o%rney and is earning interest at 1, percent per year. B%t one o the sideeects o the space sh%ttle program has been that eery traeler dies exactly , yearsrom the day o ret%rn. 4alc%late the gro"th rate o 0erryCs 0eriphals that "ill ma7eGregCs long&range plans possible.

-1.1 percent

#. ason and Bryan c%tt are presently - and 5 years old. Their parents are planning tosend them to college at age 1@ at a cost o $12 per year or each. Ao" m%ch m%stthe parents contrib%te ann%ally to a college %nd to ens%re the boysC college ed%cationi the interest rate is 1, percent compo%nded ann%ally+ The payments start in one yearand end "hen the yo%nger brother starts college.

$,25:

#1. I yo% hae $52#- in an acco%nt that has been paying an ann%al rate o 162compo%nded contin%o%sly2 since yo% deposited some %nds 1 years ago2 ho" m%ch"as the original deposit+

$,2

#,. Ao" m%ch sho%ld yo% be "illing to pay or an acco%nt today that "ill hae a al%e o$12 in 1 years %nder contin%o%s compo%nding i the nominal rate is 16+

$-@

#-. ;o%r irm has recently borro"ed $12 rom a local ban7 at an interest rate o 1percent. The loan is to be repaid in 5 e'%al2 end&o&year payments. The ollo"ing is apartial amortiDation sched%le or the loan.

17



0rincipal ;ear 0ayment Interest Red%ction Balance $ 12 1 $ ,2-@ $ 12 $ 12-@ $ @-2, , $ ,2-@ $ @2-, $ $ 52, - $ ,2-@ $ B $ 192@, $ #52:@-

# $ ,2-@ $ #25:@ $ ,12@1 $ ,-29@1 5 $ ,2-@ $ ,2-9@ $ ,-29@1 $

. The missing al%e or the 0rincipal Red%ction in the second year (labeled ) is8

$ 1@21@

B. The missing al%e or the Interest 0ayment in the third year (labeled B) is8

$ 25

##. ;o% are al%ing an inestment that "ill pay yo% $,#2 per year or the irst years2$,@2 per year or the next 1 years2 and $5#2 per year the ollo"ing 1# years (all

payments are at the end o each year). I the appropriate ann%al disco%nt rate is.62 "hat is the al%e o the inestment to yo% today+

$#2@:@

CHAPTER SEVEN PROBLEMS

1. 4alc%late the price o a 1 year bond paying a percent ann%al co%pon (hal o the percent semiann%ally) on a ace al%e o $12 i inestors can earn @ percent onsimilar ris7 inestments.

$@-.:

,. ma>or a%to man%act%rer has experienced a mar7et re&eal%ation lately d%e to an%mber o la"s%its. The irm has a bond iss%e o%tstanding "ith 15 years to mat%rityand a co%pon rate o @6 (paid semiann%ally). The re'%ired rate has no" risen to 16.

t "hat price can these sec%rities be p%rchased on the mar7et+

$5#9.:1

-. The c%rrent mar7et price o a onesC 4ompany bond is $12,9:.5@. 16 co%poninterest rate is paid semi&ann%ally2 and the par al%e is e'%al to $12. *hat is the;T (on an ann%al basis) i the bonds mat%re 1 years rom today+

percent

#. 4ommon"ealth 4ompany has 1 bonds o%tstanding (mat%rity al%e H $12). There'%ired rate o ret%rn on these bonds is c%rrently 162 and interest is paidsemiann%ally. The bonds mat%re in 5 years2 and their c%rrent mar7et al%e is $:@ perbond. *hat is the ann%al co%pon interest rate+

#6 percent

5. ;o% hae >%st been oered a bond or $@#:.@@. The co%pon rate is @62 payableann%ally2 and interest rates on ne" iss%es o the same degree o ris7 are 16. ;o%

18



"ant to 7no" ho" many more interest payments yo% "ill receie2 b%t the party sellingthe bond cannot remember. 4an yo% help him o%t+

15

. 3ord and G hae similar bond iss%es o%tstanding. The 3ord bond has interestpayments o $@ paid ann%ally and mat%res in the year ,, (, years rom today).The G bond has interest payments o $@ paid semiann%ally and also mat%res in theyear ,,. I the re'%ired rate o ret%rn (7d) is 1,62 "hat is the dierence in c%rrentselling price o the t"o bonds+

$,.1@

:. cme 0rod%cts has a bond o%tstanding "ith @ years remaining to mat%rity and aco%pon rate o 56 paid semiann%ally. I the c%rrent mar7et price is $:,9.52 "hat isthe yield to mat%rity+

1 percent

@. Recently2 TLE2 Inc.2 iled ban7r%ptcy papers. The irm "as reorganiDed as =L2 Inc.2 andthe co%rt permitted a ne" indent%re on an o%tstanding bond iss%e to be p%t into eect.The iss%e has 1 years to mat%rity and a co%pon rate o 162 paid ann%ally. The ne"agreement allo"s the irm to pay no interest or 5 years and then at mat%rity to repayprincipal and any %npaid interest (no interest on the %npaid interest). I the re'%iredret%rn is ,62 "hat sho%ld s%ch bonds sell or in the mar7et today+

$-,.##

9. In order to assess acc%rately the capital str%ct%re o a irm2 it is necessary to conertthe balance sheet to a mar7et al%e basis. The c%rrent balance sheet is as ollo"s8

Long&term debt (bonds) $122 0reerred stoc7 ,22 4ommon stoc7 ($1 par) 122 Retained earnings #22 &&&&&&&&&&& Total debt and e'%ity $,22

The bonds mat%re in 1 years. Interest is payable semiann%ally and the yield to mat%rityis 1,6. The co%pon rate is # percent. *hat is the c%rrent mar7et al%e o the irmCsdebt+

$5.#1, million

1. 4alc%late the yield to mat%rity (on an ann%al basis) o an @ percent co%pon2 1&yearbond that pays interest semiann%ally i its price is no" $::..

1, percent

11. ;o% are the o"ner o 1 bonds iss%ed by idterm 4orporation. These bonds hae @years remaining to mat%rity2 an ann%al co%pon payment o $@2 and a par al%e o$12. Knort%nately2 idterm is on the brin7 o ban7r%ptcy2 and the creditors2

19



incl%ding yo%rsel2 hae agreed to a postponement o the next # interest payments.The remaining interest payments "ill be made as sched%led. The postponed payments"ill accr%e interest at an ann%al rate o 6 and "ill be paid as a l%mp s%m at mat%rity @years hence. The re'%ired rate o ret%rn on these bonds2 considering their s%bstantialris72 is no" ,@6. *hat is the present al%e o each bond+

$,.@9

1,. The <; 4ompany recently iss%ed a ,&year2 : percent semiann%al co%pon bond atpar. ter three months2 the mar7et interest rates on similar bonds increased to @percent. t "hat price sho%ld the bonds sell+

$91@.@@

1-. IB< has a bond iss%e o%tstanding that is callable in three years at a 5 percent callpremi%m. The bond pays a 1 percent ann%al co%pon and has a remaining mat%rity o,- years. I the c%rrent mar7et price is $12 than "hat is the yield to call+

11.#@ percent

CHAPTER EIGHT PROBLEMS

1. The =0 4ompany has decided to ma7e a ma>or inestment. The inestment "illre'%ire a s%bstantial early cash o%t&lo"2 and inlo"s "ill be relatiely late. s a res%lt2it is expected that the impact on the irmCs earnings or the irst , years "ill be anegatie gro"th o 56 ann%ally. 3%rther2 it is anticipated that the irm "ill thenexperience , years o Dero gro"th ater "hich it "ill begin a positie ann%al s%stainablegro"th o 6. I the irmCs cost o capital is 16 and its c%rrent diidend (=) is $, pershare2 "hat sho%ld be the c%rrent price per share+

$-@.#:

,. The Radley 4ompany has decided to %nderta7e a large ne" pro>ect. 4onse'%ently2there is a need or additional %nds. The inancial manager decides to iss%e preerredstoc7 "hich has a stated diidend o $5 per share and a par al%e o $-. I there'%ired ret%rn on this stoc7 is c%rrently ,62 "hat sho%ld be the stoc7Cs c%rrent mar7etal%e+

$,5

-. ?GCs stoc7 is selling or $15 per share. The irmCs income2 assets2 and stoc7 pricehae been gro"ing at an ann%al 156 rate and are expected to contin%e to gro" at thisrate or - more years. o diidends hae been declared as yet2 b%t the irm intends todeclare a $,. diidend at the end o the last year o its s%pernormal gro"th. terthat2 diidends are expected to gro" at the irmCs normal gro"th rate o 6. The irmCsre'%ired rate o ret%rn is 1@6. ;o% sho%ld8

?ell the stoc7! it is oeral%ed by $-.-.

20



#. BB02 Inc.2 has experienced a recent res%rgence in b%siness as it has gained ne"national identity. anagement is orecasting rapid gro"th oer the next # years(ann%al rate o 156). ter that2 it is expected that the irm "ill reert to its historicalgro"th rate o ,6 ann%ally. The last diidend paid "as $1.5 per share2 and there'%ired ret%rn is 16. *hat is the c%rrent price per share2 ass%ming e'%ilibri%m+

$,9.51

5. The 4l%b %to 0arts 4ompany has >%st recently been organiDed. It is expected toexperience no gro"th or the next , years as it identiies its mar7et and ac'%ires itsinentory. Ao"eer2 4l%b "ill gro" at an ann%al rate o 56 in the third and o%rth yearsand2 beginning "ith the ith year2 sho%ld attain a 16 gro"th rate "hich it "ill s%stainthereater. The last diidend paid "as $.5 per share. 4l%b has a cost o capital o1,6. *hat sho%ld be the present price per share o 4l%b common stoc7+

$,.@#

. share o =RF2 Inc.2 stoc7 paid a diidend o $1.5 last year2 and the diidend isexpected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rn

on this stoc7 is belieed to be 1,6. *hat sho%ld the stoc7 sell or today+

$19.5

:. The 0et 4ompany has recently discoered a type o roc7 "hich2 "hen cr%shed2 isextremely absorbent. It is expected that the irm "ill experience (beginning no") an%n%s%ally high gro"th rate (,6) d%ring the period (- years) "hen it has excl%sierights to the property "here this roc7 can be o%nd. Ao"eer2 beginning "ith the o%rthyear the irmCs competition "ill hae access to the material2 and rom that time on theirm "ill ass%me a normal gro"th rate o @6 ann%ally. =%ring the rapid gro"th period2the irmCs diidend payo%t ratio "ill be relatiely lo" (,6)2 to consere %nds orreinestment. Ao"eer2 the decrease in gro"th "ill be accompanied by an increase indiidend payo%t to 56. Last yearCs earnings "ere $,. per share (E

) and the irmCs

cost o e'%ity is 16. *hat sho%ld be the c%rrent price o the common stoc7+

$:1.@

@. ITJ2 Inc.2 a large conglomerate2 has decided to ac'%ire another irm. nalysts areorecasting that there "ill be a period (, years) o extraordinary gro"th (,6) ollo"edby another , years o %n%s%al gro"th (16)2 and that inally the preio%s gro"thpattern o 6 ann%ally "ill res%me. I the last diidend "as $1 per share and there'%ired ret%rn is @62 "hat sho%ld the mar7et price be today+

$:-.:#

9. share o =RF2 Inc.2 stoc7 paid a diidend o $1.5 last year2 and the diidend isexpected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rnon this stoc7 is belieed to be 1,6. ?%ppose =RF stoc7 "ere selling or $,5 today.*hat "o%ld be the implied al%e o 7s 2 ass%ming the other data remain the same+

1.,# percent

1. The 4anning 4ompany has been hit hard d%e to increased competition. ThecompanyCs analysts predict that earnings (and diidends) "ill decline at a rate o 56

21



ann%ally into the oreseeable %t%re. ss%me that 7s H 116 and = H $,.. *hat "illbe the price o the companyCs stoc7 in three years+

$1.19

11. IB is c%rrently selling at $5 per share. ext yearCs diidend is expected to be $,..

I inestors on this partic%lar day expect a ret%rn o 1,6 on their inestment2 "hat dothey thin7 IBCs gro"th rate "ill be+

@ percent

1,. The 4ompany has allen on hard times. Its management expects to pay nodiidends or the next , years. Ao"eer2 the diidend or ;ear - (=-) "ill be $1. pershare2 and it is expected to gro" at a rate o -6 in ;ear #2 6 in ;ear 52 and 16 in;ear and thereater. I the re'%ired ret%rn or 4o. is ,62 "hat is the c%rrente'%ilibri%m price o the stoc7+

$.-#

1-. ;o%r brother&in&la"2 a stoc7bro7er at Inest2 Inc.2 is trying to sell yo% a stoc7 "ith ac%rrent mar7et price o $,. The stoc7 had a last diidend (=) o $,. and aconstant gro"th rate o @6. ;o%r re'%ired ret%rn on this stoc7 is ,6. 3rom a strictal%ation standpoint2 yo% sho%ld8

ot b%y the stoc7! it is oeral%ed by $,..

1#. egatie Limited is expected to gro" or o%r years at a rate o 5 percent. ter o%ryears2 the prod%ct ad is expected to decline2 and egatie "ill gro" at a negatiegro"th rate o 5 percent. egatie c%rrently pays a diidend o $1. per share andstoc7holders hae a re'%ired rate o ret%rn o 1@ percent. *hat sho%ld be the mar7etal%e or a share o egatie Limited stoc7+

[email protected]#

15. ss%me the irm has been gro"ing at a 156 ann%al rate and is expected to contin%e todo so or - more years. t that time2 gro"th is expected to slo" to a constant #6 rate.The irm maintains a -6 payo%t ratio2 and this yearCs retained earnings "ere $1.#million. The irmCs beta is 1.,52 the ris7&ree rate is @62 and the mar7et ris7 premi%m is#6. I the mar7et is in e'%ilibri%m2 "hat is the mar7et al%e o the irmCs commone'%ity (1 million shares o%tstanding)+

$9.1 million

1. =exter2 Inc.2 has >%st paid a diidend o $,.. Its stoc7 is no" selling or $#@ per share.

The irm is hal as olatile as the mar7et. The expected ret%rn on the mar7et is 1#6and the yield on K.?. Treas%ry bonds is 116. I the mar7et is in e'%ilibri%m2 "hat rateo gro"th is expected+

@ percent

1:. Gien the ollo"ing inormation2 calc%late the expected capital gains yield or BimloBottle 4aps! beta H .! 7m H 156! R H @6! =1 H $,.! 0 H $,5.. ss%me thestoc7 is a constant gro"th stoc7 and is in e'%ilibri%m.

22



#., percent

1@. <; stoc7 is c%rrently paying a diidend o $,. per share (= H $,) and is ine'%ilibri%m. The company has a gro"th rate o 56 and beta e'%al to 1.5. There'%ired rate o ret%rn on the mar7et is 1562 and the ris7&ree rate is :6. <; is

considering a change in policy that "ill increase its beta coeicient to 1.:5. I mar7etconditions remain %nchanged2 "hat ne" gro"th rate "ill ca%se the common stoc7 priceo <; to remain %nchanged+

.: percent

19. Knion 0aperCs stoc7 is c%rrently in e'%ilibri%m selling at $- per share. The irm hasbeen experiencing a 6 ann%al gro"th rate. Earnings per share (E) "ere $#. andthe diidend payo%t ratio is #6. The ris7&ree rate is @6 and the mar7et ris7 premi%mis 56. I systematic ris7 increases by 562 all other actors remaining constant2 thestoc7 price "ill increasedecrease by8

&$:.-1

,. 4harter /il 4ompany is c%rrently selling at its e'%ilibri%m price o $1 per share. Thebeta coeicient c%rrently is ,. The ris7&ree rate is 16. The ollo"ing eents "ill soonocc%r8 (1) top management "ill lo"er 4harterCs beta to 1., by inesting in seeral lo"ris7 pro>ects! (,) the 3ederal Resere Board "ill red%ce the money s%pply ca%sing theinlation premi%m to be red%ced by - percentage points! and (-) decreased "orldstability d%e to global politics "ill ca%se the mar7et ris7 premi%m to increase ,percentage points to 56. The company has a constant gro"th rate o 56. *hat "illbe the ne" e'%ilibri%m price or a share o 4harter /il common stoc7 ater the aboeeents hae ta7en place+ (ss%me the expected diidend "ill not change.)

$1-:.5

,1. *heeler2 Inc.2 is presently in a stage o abnormally high gro"th beca%se o the excessdemand or "idgets. The company expects earnings and diidends to gro" at a rate o,6 or the next # years2 ater "hich time there "ill be no gro"th in earnings anddiidends. The companyCs last diidend "as $1.5. *heeler has a beta o 1.2 theret%rn on the mar7et is c%rrently 1,.:562 and the ris7&ree rate is #6. *hat sho%ld bethe c%rrent price per share o common stoc7+

$15.1:

,,. ;o% are gien the ollo"ing data8

1. The ris7&ree rate is .5.,. The re'%ired ret%rn on the mar7et is [email protected]. The expected gro"th rate or the irm is .#.#. The last diidend paid "as $.@ per share.5. Beta is 1.-.

o" ass%me the ollo"ing changes occ%r8

23



1. The inlation premi%m decreases by the amo%nt o .1.,. n increased degree o ris7 aersion ca%ses the re'%ired ret%rn on the

mar7et to go to .1 ater ad>%sting or the changed inlation premi%m.-. The expected gro"th rate increases to ..#. Beta rises to 1.5.

*hat "ill be the change in price per share ass%ming the stoc7 "as in e'%ilibri%mbeore the changes+

&$#.@:

,-. ;o% are considering b%ying common stoc7 in Gro" /n2 Inc. ;o% hae calc%lated thatthe irmCs ree cash lo" "as $:. million last year. ;o% pro>ect that ree cash lo" "illgro" at a rate o 5.6 per year indeinitely. The irm c%rrently has o%tstanding debt andpreerred stoc7 "ith a total mar7et al%e o $,,.,- million. The irm has ,.9# millionshares o common stoc7 o%tstanding. I the irmCs cost o capital is 19.62 "hat is themost yo% sho%ld pay per share or the stoc7 no"+

$11.@-

,#. =%e to the highly specialiDed nat%re o the electronic ind%stry2 Borrett Ind%stries inesta lot o money in RJ= on prospectie prod%cts. 4onse'%ently2 it retains all o itsearning and reinests them into the irm. t this time2 Borrett does not any plans to paydiidends in the near %t%re. ma>or pension %nd is interested in p%rchasing BorrettCsstoc72 "hich is traded on the ;?E. The treas%rer or the pension %nd has doneresearch on the company and has estimated BorrettCs ree cash lo" or the next o%ryears as ollo"s8 $- million2 $ million2 $1 million and $15 million. ter the o%rthyear2 ree cash lo" is pro>ected to gro" at a constant : percent. BorrettCs *44 is 1,percent2 it has $ million o total debt and preerred stoc7 and 1 million shares ocommon stoc7.

. *hat is the present al%e o BorrettCs ree cash lo"s d%ring the next o%ryears+

$,#211,2-@

B. *hat is the companyCs terminal al%e+$-,122

4. *hat is the total al%e o the irm today+$,,@211-21,

=. *hat is Borrett Cs price per share+$1.@1

,5. ss%me that today is =ecember -12 , and that the ollo"ing inormation applies toFermeil irlines8

. ter&tax operating income SEBIT(1&t) or ,1 is expected to be $5 million.B. The companyCs depreciation expense or ,1 is expected to be $1 million.4. The companyCs capital expendit%res or ,1 are expected to be $, million=. o change is expected in the companyCs net operating "or7ing capital.E. The companyCs ree cash lo" is expected to gro" at a constant rate o

percent per year.

24



3. The companyCs cost o e'%ity is 1# percent.G. The companyCs *44 is 1 percent.A. The mar7et al%e o the companyCs debt is $- billion.I. The company has , million shares o stoc7 o%tstanding.

Ksing the ree cash lo" approach2 "hat sho%ld the companyCs stoc7 price be today+

$-5. per share

CHAPTER NINE PROBLEMS

1. The chie inancial oicer o 0ortland /il has gien yo% the assignment o determiningthe irmCs marginal cost o capital. The present capital str%ct%re "hich is consideredoptimal2 is8

Boo7 Fal%e ar7et Fal%e=ebt $ 5 million $ # million

0reerred ?toc7 1 million 5 million4ommon E'%ity - million 55 million

Total $ 9 million $ 1 million

The anticipated inancing opport%nities are these8 =ebt can be iss%ed "ith a 15 percentbeore&tax cost. 0reerred stoc7 "ill be $1 par2 carry a diidend o 1- percent2 andcan be sold to net the irm $9 per share. 4ommon e'%ity has a beta o 1.,2 theret%rn on the mar7et is 1: percent2 and the ris7&ree rate is 1, percent. I the irmCs taxrate is # percent2 "hat is its marginal cost o capital+

1#., percent

,. ?ilicon 4orp. recently iss%ed 1&year2 1, percent co%pon bonds at par al%e. ?iliconCsbeta is .! the optimal capital str%ct%re contains #5 percent debt55 percent e'%ity!and the marginal tax rate is # percent. I the expected ret%rn on the mar7et is 1percent and the treas%ry bill rate is 9 percent2 estimate ?iliconCs "eighted aerage costo capital.

1.5 percent

-. eerson re'%ires $15 million to %nd its c%rrent years capital pro>ects. eerson "illinance part o its needs "ith $9 million in internally generated %nds. The irmscommon stoc7 mar7et price is $1, per share. The irms last diidends "as $5 pershare and is expected to gro" at a rate o 11 percent ann%ally or the oreseeable%t%re. nother portion o the re'%ired %nds "ill come rom the iss%e o 92-:5 shareso 1, percent $1 par preerred stoc7 that "ill be priately placed. The irm "ill net$9 per share rom the sale o these shares. The remainder o the %nding needs "illbe met "ith debt. 3ie tho%sand 1&year $12 par bonds "ith a co%pon rate o 15percent "ill be iss%es to net the irm $12, each. Interest "ill be paid ann%ally on the

25



bonds. The irms tax rate is - percent.

1-.1 percent

#. erage 4orporationCs stoc7 c%rrently sells or $#5. per share2 it is expectedto pay a diidend o $-.1 next year2 its gro"th rate is a constant :.62 and the

company "ill inc%r a lotation cost o 1,.6 o the mar7et al%e i it sells ne"common stoc7. The irmCs tax is #6. *hat is the irmCs cost o retainedearnings+

1-.@96

5. ;o% are determining <;2 Inc.Cs optimal capital b%dget or the next year. ;o% haeidentiied the ollo"ing possible I=IFI?IBLE capital pro>ects8

0R/E4T 4/?T IRR $ 12 1 6

B @2 1# 6 4 52 1@ 6 = -2 15 6 E #2 1, 6 3 :2 1: 6 G 2 , 6

<;Cs marginal cost o capital is8

E* 40ITL REUKIRE= RGIL 4/?T $ & 52 1-. 6 $ 521 & 9992999 1#., 6 $ 122 & 12#992999 15. 6

$ 1252 & 129992999 15.5 6 $ ,22 & ,2#992999 1:. 6 $ ,252 & -22 1:.5 6 B/FE $ -22 1@. 6

*hat is <;Cs optimal capital b%dget or the %pcoming year+

$1.9 million

. arginal Incorporated has determined that its beore&tax cost o debt is 1.6. Its costo preerred stoc7 is 11.6. Its cost o internal e'%ity is 15.62 and its cost o externale'%ity is 1.96. 4%rrently2 the irmCs capital str%ct%re consists o -,6 debt2 1#6preerred stoc72 and 5#6 common e'%ity. The irmCs marginal tax rate is -96. *hat isthe irmCs "eighted aerage cost o capital i it "ill hae to iss%e ne" common stoc7 to%nd the e'%ity portion o its capital b%dget+

1,., percent

26



CHAPTER TEN PROBLEMS

1. Gien the ollo"ing net cash lo"s2 determine the IRR o the pro>ect8

Time et cash lo"

&&&& &&&&&&&&&&&&& $ 125, 1 &12 , &125 - 5

,#6

,. cme 0rod%cts2 Inc.2 re'%ires a ne" machine to prod%ce a part or a heat generator.T"o companies hae s%bmitted bids2 and yo% hae been assigned the tas7 ochoosing one o the machines. 4ash lo" analysis indicates the ollo"ing8

;ear achine achine B

&&&& &&&&&&&&& &&&&&&&&& &$12 &$12

1 #1: , #1: - #1: # 129-@ #1:

. *hat is the internal rate o ret%rn or each machine+

IRR H .1@! IRRB H .,#

B. I the cost o capital or cme 0rod%cts is 562 "hich o the ollo"ing is tr%e+

The 0F V 0FB 2 thereore accept achine .

-. 0ro>ects 4 and * are m%t%ally excl%sie2 and they hae the ollo"ing net cash lo"s8

;ear 0ro>ect 4 0ro>ect * &&&& &&&&&&&&& &&&&&&&&& &$52 &$12 1 -2 #2 , #2 #2 - 52 #2 # #2 5 #2

27



;o% are to %se the e'%ialent ann%al ann%ity method or comparing these pro>ectssince they hae %ne'%al lies. The cost o capital is 16. *hich pro>ect sho%ld bechosen+

0ro>ect 4 since it has a higher e'%ialent ann%al ann%ity.

#. The ?mith 4ompany is considering t"o m%t%ally excl%sie inestments that "o%ldincrease its capacity to ma7e stra"berry tarts. The irm %ses a 1, percent cost ocapital to eal%ate potential inestments. The pro>ects hae the ollo"ing costs andcash lo" streams8

;ER LTERTIFE LTERTIFE B $ &-2 $ &-21 125 25, 125 25- 125 25# 125 255 && 25

&& 25: && 25@ && 25

*hat are the respectie EUKIFLET KL KITIE? or alternaties and B+ LTERTIFE LTERTIFE B

8 $ ,1.-5 $ #1.-5

5. *hat is the paybac7 period2 the 0F at a disco%nt rate o 1 percent2 and the IRR or apro>ect "ith the ollo"ing cash lo"s+

;ER 4?A /KT3L/* 4?A I3L/*

$ 1 &&1 && $ 5, && - && 1

0;B4M 0F IRR1 5 yrs - 1, 6

. pro>ect has an initial cost o $92#,:. I it ret%rns a net cash lo" o $12 at the endo each year or the next - years2 the internal rate o ret%rn m%st be8

1 6

:. *hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+TIE 4?A /KT3L/* 4?A I3L/*?

$ #-2,95 &&1 && $ 12, && 12- && 12# && 125 && 12

28



5 6

@. ;o%r company is considering t"o m%t%ally excl%sie pro>ects2 < and ;2 "hose costsand cash lo"s are sho"n belo"8

;ear < ; &$12 &$12

1 1 12 , - 1 - # 5 # : 5

The pro>ects are e'%ally ris7y2 and their cost o capital is 1, percent. *hat isthe modiied IRR o each pro>ect+

< ; 1-.596 1-.16

9. 4onglomerates2 Inc.2 is considering the p%rchase o ?mall J 4ompany. The ac'%isition"o%ld re'%ire an initial inestment o $1922 b%t 4onglomeratesC net cash lo"s"o%ld increase by $-2 per year and remain at the ne" leel oreer. ?ho%ld

4onglomerates b%y ?mall+ ss%me a cost o capital o 156.

;es2 beca%se the 0F H $12.

1. I the re'%ired rate o ret%rn is 1, percent2 "hat is the net present al%e o the pro>ectdescribed belo"8

4/?T /3 E* EUKI0ET $ 2LI3E /3 EUKI0ET ;ER??LFGE FLKE $ 2

KL ET 4?A 3L/* $ 1,2

$ &:2,#

11. *hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+

;ER 4?A3L/* $ 1 $ , $ &,5- $ 1# $ 15 $ 1

9&1 6

1,. *hat is the net present al%e o this inestment+

IITIL 4/?T $ 1520R/E4T LI3E 5 years?LFGE FLKE $

KL ET 4?A 3L/*? $ 52=I?4/KT RTE 1 6

$ -295#.

29



1#. I a capital b%dgeting pro>ect has an initial o%tlay o $125 and an 0F o $522 "hatis its proitability index+

#.--

15. 4%mmings 0rod%cts 4ompany is considering t"o m%t%ally excl%sie inestments. Thepro>ectCs expected net cash lo"s are as ollo"s8

Expected et 4ash 3lo"s;ear 0ro>ect 0ro>ect B ($-) ($#5) 1 (-@:) 1-# , (19-) 1-# - (1) 1-# # 1-# 5 1-# @5 1-# : (1@)

. I the cost o capital or each pro>ect is 1, percent2 "hat is the 0F or eachpro>ect+ *hich pro>ect sho%ld be accepted+

$,.#1 and $1#5.9- 0ro>ect

B. I the cost o capital or each pro>ect is 1@ percent2 "hat is the 0F or eachpro>ect+ *hich pro>ect sho%ld be accepted+

$,. and $-.@ 0ro>ect B

4. *hat is the internal rate o ret%rn or each pro>ect+

[email protected] and ,#.6

=. *hat is the crossoer rate+

1#.5-6

CHAPTER ELEVEN PROBLEMS

1. The capital b%dgeting director is eal%ating a pro>ect that costs $,22 is expectedto last or 1 years and to prod%ce ater&tax income o $,925- per year. =epreciationapplicable to this pro>ect "o%ld be $,2 per year. I the cost o capital o the irm is1#62 "hat is the pro>ectCs IRR (tax rate H #6)+

,1.1 percent

30



,. J Inc.2 is considering the p%rchase o a ne" machine "hich "ill red%ceman%act%ring costs by $52 ann%ally. J "ill %se the straight&line method todepreciate the machine2 and it expects to sell the machine at the end o its 5 year lieor $12. The irm expects to be able to red%ce "or7ing capital by $152 "henthe machine is installed. The irmCs marginal tax rate is #6 and it %ses a 1,6 cost ocapital to eal%ate pro>ects o this nat%re. I the machine costs $22 "hat is the

0F o the pro>ectCs cash lo"s+

&$,,2#

-. Bla7e 4orporationCs ne" pro>ect calls or an inestment o $12. It has an estimatedlie o 1 years. The IRR has been calc%lated to be 156. I cash lo"s are eenlydistrib%ted and the tax rate is #62 "hat is the ann%al BE3/RE&T< cash lo" eachyear+ (ss%me depreciation is a negligible amo%nt.)

$-2-,1

#. G art2 Inc.2 is considering the ac'%isition o e'%ipment to expand its sales. The initialcost o the e'%ipment is $12. Ao"eer2 the prod%ction manager has estimated

the expansion program "ill increase cash operating costs by $,2. ss%me straightline depreciation to a Dero salage al%e2 a tax rate o #62 and a cost o capital o16. Ao" m%ch "ill the additional cash reen%e d%ring the 1 year lie o the assethae to be to ca%se the IRR o the pro>ect to be e'%al to 7+

$#2#5:

5. Blain 4orporation is considering the p%rchase o a machine "hich has an expected @year lie and costs $,2. The ann%al expected ET 4?A 3L/* rom the machineis $52 or the irst : years and $92 in year @2 excl%ding salage al%es. Theasset "ill be depreciated on a straight line basis to a $#2 salage al%e. It is eligibleor a :6 inestment tax credit. I the disco%nt rate is 162 "hat is the machineCs 0F+

$112@:

. 0recision etals2 Inc. is considering the replacement or its existing lathe2 "hich cost$,2 at the time o p%rchase ie years ago2 and "hich no" has a remaining lie oie years "ith no salage al%e. It can be sold c%rrently or $12. ne"2 moreoperationally eicient lathe costs $-2 and has a %se%l lie o ie years "ith asalage al%e o $52. It is expected to red%ce operating costs by $2 ann%ally.

n inestment tax credit o 1 percent o the p%rchase price can be %sed i the lathe isac'%ired. The irmCs re'%ired rate o ret%rn or replacement decisions is 1, percent.

ss%me straight&line depreciation and a tax rate o # percent. The net present al%eo this capital b%dgeting decision is8

$ ##2-@

:. 4=B J ssociates is considering the p%rchase o a ne" piDDa oen. The original costo the old oen "as $-2. The machine is no" 5 years old and has a c%rrentmar7et al%e o $52. The oen is being depreciated oer a 1&year lie to"ard aDero estimated salage al%e on a straight&line basis. anagement is contemplatingthe p%rchase o a ne" oen "hose cost is $,52 and "hose estimated salage al%eis Dero. Expected cash saings rom the ne" oen are $,2 a year (beore tax).=epreciation is on a straight&line basis oer a 5 year lie2 and the cost o capital is 16.

ss%me a 56 tax rate. *hat is the net present al%e o the ne" machine+

31



&$:2#1@

@. ?andals2 Inc.2 is considering the p%rchase o a ne" leather&c%tting machine to replacean existing machine that has a boo7 al%e o $-2 and can be sold or $125. Theestimated salage al%e o the old machine in # years is Dero. The ne" machine "illred%ce costs (beore tax) by $:2 per year! that is2 $:2 cash saings oer the old

machine. The ne" machine has a # year lie2 cost $1#22 and can be sold or anexpected $,2 at the end o the o%rth year. ss%ming straight line depreciation orboth machines2 a #6 tax rate2 and a cost o capital o 162 ind the 0F.

$-2#:5

9. Gien the ollo"ing inormation2 "hat is the eectie cost o the ne" machine! that is2"hat is the cash lo" at t H +

0%rchase price o ne" machine $@2 Installation charge ,2 ar7et al%e o old machine ,2 Boo7 al%e o old machine 12

Inentory decrease i ne" machine is installed 12 cco%nts payable increase i ne" machine is installed 5 Tax rate #@6 4ost o capital 156

$29@

1. U%i72 Inc.2 is a ast&ood establishment that needs to p%rchase ne" ryolators. I themachines are p%rchased2 they "ill replace old machines p%rchased 1 years ago or$122 being depreciated on a straight line basis to a Dero salage al%e (, yearsdepreciable lie). The old machines can be sold or $1,2. The ne" machines "illcost $,2 installed and "ill be depreciated on a straight&line basis to a Derosalage al%e in 1 years. It is expected that there "ill be increased reen%es o$1@2 per year and increased cash expenses o $,25 per year. I the irmCs cost ocapital (7) is 162 the tax rate on ordinary income is #62 and the tax rate on capitalgains is -62 "hat is the 0F o the machine+

&$29@@

11. 042 Inc.2 has a stamping machine "hich is 5 years old and "hich is expected to lastanother 1 years. It has a boo7 al%e o $12 and is being depreciated by thestraight&line method to Dero. Tri&?tate Ind%stries has demonstrated a ne" machine "ithan expected %se%l lie o 1 years (scrap al%e $52) that sho%ld sae 04 $152a year in labor and maintenance costs. I 04Cs cost o capital is 162 sho%ld thereplacement be made+ 04Cs tax rate is #62 the ne" machine "ill cost $,22 andan inestment tax credit o 16 applies. The mar7et al%e o the old machine is$12 and a $12 increase in "or7ing capital "ill be needed to s%pport the ne"machine.

32



o! 0F H &$5-2,:@

1,. GIG/2 Inc.2 is considering replacing its c%rrent comp%ter "ith a ne" generation model.The B salesperson has demonstrated a model "hich "o%ld cost GIG/ $:522sho%ld last 1 years2 and red%ce costs $12#- per year. B estimates that this

ne" comp%ter can be sold or $12 at the end o its %se%l lie. The comp%ter GIG/c%rrently %ses has a boo7 al%e o $#52 (remaining lie o 1 years2 a salageal%e o $122 and a c%rrent mar7et al%e o $12. I an inestment tax credit o16 is applicable to the ne" comp%ter2 and the ne" machine "ill permit a $12decrease in "or7ing capital "hen the comp%ter is installed2 "hat is the 0F (7 H 1562 tH #62 depreciation is straight line)+

$:@2:5-

1-. ;o% hae been as7ed by the irmCs president to eal%ate the proposed ac'%isition o ane" machine. The machineCs price is $522 and it "ill cost $12 to transport andinstall. It "ill be depreciated by the straight&line method oer its 5&year %se%l lie to a$12 salage al%e. The machine "ill increase reen%es by $12 per year2 and

it "ill decrease operating costs by $,2 per year. lso2 the machine "ill allo" theirm to red%ce inentories by $52. The ne" machine (incl%ding deliery andinstallation costs) '%aliies or a 16 inestment tax credit. I the irmCs cost o capital is1,62 and its marginal tax rate is #62 "hat is the ne" machineCs 0F+

$--21#-

1#. Knion Bric72 Inc.2 has an electric 7iln "hich is 5 years old and is expected to lastanother 1 years. It has a boo7 al%e o $122 and it is being depreciated by thestraight&line method to a Dero salage al%e. s =irector o 4apital B%dgeting2 yo% areeal%ating a ne" gas 7iln that sho%ld sae KBI $,52 a year in %el costs. The ne"7iln "o%ld cost $,22 and it is eligible or a 16 inestment tax credit. It "o%ld bedepreciated oer 1 years by the straight&line method to a $,2 salage al%e. Themar7et al%e o the old 7iln is $12. KBICs marginal tax rate is #62 and the irmCscost o capital is 16. *hat is the 0F o the replacement pro>ect+

&$1#2#5@

W

15. company is planning to inest $52 (beore tax) in a personnel training program.The $52 o%tlay "ill be charged o as an expense by the irm this year (time ). theret%rns rom the program2 in the orm o greater prod%ctiity and a red%ction inemployee t%rnoer2 are estimated as ollo"s (on an ater&tax basis)8

;ER? 1&1 $ 52 per year;ER? 11&, $ 152 per year

33



The company has estimated its cost o capital to be 15 percent. ss%me that the entire$52 is paid at time (the beginning o the pro>ect). The marginal tax rate or theirm is # percent. *hat is the inestmentCs 0F+

$ 1-29

1. The *RGLER 4orporation is considering the ac'%isition o a ne" splicing machineto improe the eiciency o its clothing operations. The ne" machine "ill cost $2pl%s installation costs o $52. The machineCs eiciency "ill create additional o%tp%t!th%s2 reen%es "ill increase by $52 ann%ally. The amo%nt o "asted material "illdecline2 so operating costs "ill decline by $,2 ann%ally. The machine "ill re'%ire a$,2 increase in inentory and spare parts. The machineCs estimated salage al%e(at the end o its 5 year lie) is $5. (Kse this al%e or depreciation p%rposes.) TheirmCs marginal tax rate is # percent and its re'%ired rate o ret%rn is 1 percent.

ss%me that the irm %ses straight&line depreciation or analysis o this type.

. *hat is the ET 4/?T o the machine+ (That is2 "hat is the initial casho%tlo"+)

$ &:2

B. *hat are the net operating cash lo"s or ;ear 1 thro%gh 5+

$ 92-

4. *hat is the total al%e o the additional considerations at the end o the ieyears+

$ ,25

=. *hat is the et 0resent Fal%e o the decision+

$ &,929

34



1:. The elson E'%ipment 4ompany p%rchased a machine 5 years ago at a cost o$,2. The machine had an expected lie o 1 years at the time o the p%rchaseand an expected salage al%e o $52 at the end o the 1 years. It is beingdepreciated by the straight&line method to"ard a salage al%e o $522 or by$152 per year.

ne" machine can be p%rchased or $#2 and re'%ire an additional

$152 in installation costs. The ne" machine "ill re'%ire $,2 in additional spareparts. =%ring its 5&year lie2 it "ill red%ce cash operating expenses by $152 peryear. ?ales are not expected to change. t the end o its %se%l lie2 the machine isestimated to be "orth $52. 4R? depreciation "ill be %sed2 and the machine "illbe depreciated oer its -&year class lie rather than its 5&year economic lie.

The old machine can be sold today or $1:52. The irmCs tax rate is #percent and the appropriate disco%nt rate is 1, percent. (The recoery allo"ancepercentages or -&year property are --62 #562 1562 and :6.)


$ &,@2

B. *hat are the net operating cash lo"s or ;ear 1 and ,+

;ear 1 ;ear , $ 1-@2:@ $ 15@2:


$

=. *hat is the et 0resent Fal%e o the replacement decision+

$ 152-:

35



1@. ac=o%galCs is a ast&ood establishment that needs to p%rchase ne" ryolators. I thene" ryolators are p%rchased2 they "ill replace old machines p%rchased 1 years agoor $152. The old machines are being depreciated on a straight&line basis to aDero salage al%e. The original estimated lie o the old machines "as iteen years.(The old machines hae ie years o estimated lie remaining.) The old ryolators canc%rrently be sold to another irm in the ind%stry or $#2.

The ne" machines "ill cost $,52 pl%s an additional $,2 or installation.The ne" ryolators hae an estimated %se%l lie o ie years and hae an estimatedsalage al%e (?4R0) at the end o ie years o $12. The ne" ryolators haeextra capacity and "ill2 th%s2 increase reen%es by $2 ann%ally. The machines"ill also red%ce operating expenses (electricity) by $12 ann%ally. The irm "illre'%ire $52 in additional "or7ing capital to s%pport the increased o%tp%t.

ac=o%galCs depreciates their capital improements at the maxim%m rateallo"ed by the IR?. 3or property o this type (-&year)2 the 4R? rates are --62 #562156 and :6. The irmCs marginal tax rate is # percent and their re'%ired rate onpro>ects o this nat%re is 1, percent.


$ &,-12

B. *hat are the net operating cash lo"s or ;ear 1 and ,+

;ear 1 ;ear , $ :-2# $ @2


$ 112

=. *hat is the et 0resent Fal%e o the machine+

$ &@:

36



19. at%ral Beerages is contemplating the replacement o one o its bottling machines"ith a ne"er and more eicient one. The old machine has a boo7 al%e o $#2and a remaining %se%l lie o ie years. The salage al%e o the old machine (ordepreciation and cash lo" p%rposes) is $52. The irm can sell it no" to anotherirm in the ind%stry or $,2. The ne" machine has a p%rchase price o $1.,million2 an estimated %se%l lie o ie years2 and an estimated salage al%e in ie

years o $,2. dditional costs o installation "ill be $,52. It is expected toeconomiDe on operating costs and to red%ce the n%mber o deectie bottles. In total2an ann%al saing o $,52 "ill be realiDed i the ne" machine is installed. The ne"machine "ill re'%ire an additional $152 in inentory (spare parts). The company isin the # percent marginal tax brac7et and has a 1, percent re'%ired rate o ret%rn.The machine '%aliies as a -&year property %nder 4R? (--62 #562 1562 :6).

. *hat is the initial inestment re'%ired or this replacement decision+

&$92

B. *hat are the net operating cash lo"s or years one and t"o+

$,@-2: $-#,25

4. *hat is the al%e o the additional considerations in year 5+

&$,-2

=. *hat is the ET 0RE?ET Fal%e o this replacement decision+

&$1-@299@

37



,. A%ang Ind%stries is considering a proposed pro>ect or its capital b%dget. The companyestimates that the pro>ectCs 0F is $1, million. This estimate ass%mes that theeconomy and mar7et conditions "ill be aerage oer the next e" years. ThecompanyCs 43/2 ho"eer2 orecasts that there is only a 5 percent chance that theeconomy "ill be aerage. RecogniDing this %ncertainty2 she has perormed theollo"ing scenario analysis8

Economic 0robability?cenario o /%tcome 0FRecession .5 ($: million)Belo" erage ., ($,5 million)

erage .5 $1, million boe erage ., $, millionBoom .5 $- million

*hat is the pro>ectCs expected 0F2 its standard deiation2 and its coeicient oariation+

E(0F) H $-. millionσ0F H $,-. million4F H :.@:#

38



CHAPTER TWELVE PROBLEMS

1. U%ic7 La%nch Roc7et 4ompany2 a satellite la%nching irm2 expects its sales to increaseby 5 percent in the coming year as a res%lt o ?Cs recent problems "ith the spacesh%ttle. The irmCs c%rrent E0? is $-.,5. Its degree o operating leerage is 1.2 "hileits degree o inancial leerage is ,.1. *hat is the irmCs pro>ected E0? or the coming

year %sing the =TL approach+$ @.:1

,. irm expects to hae a 15 percent increase in sales oer the coming year. I it hasoperating leerage e'%al to 1.,5 and inancial leerage e'%al to -.52 then "hat "ill bethe percentage change in E0?+

percent

-. The 4ongress 4ompany has identiied t"o method o prod%cing playing cards. /nemethod inoles a machine haing a ixed cost o $12 and ariable costs o $1.per dec7 o cards. The other method "o%ld %se a less expensie machine (ixed costsH $52)2 b%t it "o%ld re'%ire greater ariable costs ($1.5 per dec7 o cards). I the

selling price per dec7 o cards "ill be the same %nder each method2 at "hat leel oo%tp%t "ill the t"o methods prod%ce the same net operating income+

12 dec7s

#. ss%me that a irm c%rrently has EBIT o $,222 =TL o :.52 and =3L o 1.@:5. Isales decline by , percent next year2 then "hat "ill be the irmCs expected EBIT in oneyear+

$#2

5. ss%me that a irm has a =3L o 1.,5. I sales increase by , percent2 the irm "ill

experience a percent increase in E0?2 and it "ill hae an EBIT o $12. *hat"ill be the EBIT or this irm i sales do not increase+

ns"er8 $:25@

. 4alc%late the c%rrent price per share (0) or /lson 4orporation2 gien the ollo"inginormation. The data all pertain to the year >%st ended.?ales H 12 %nits?ales price per %nit H $1.Fariable cost per %nit H $ 5.3ixed cost H $12=ebt o%tstanding H $152Interest rate on debt H 5 percent

Tax Rate H - percent4ommon stoc7 shares o%tstanding H 12 sharesBeta H 1.57R3 H 5 percent7 H 9 percent0ayo%t ratio H # percentGro"th rate in earnings and diidends H : percent

$ ,9.#-

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:. company c%rrently has assets o $5 million. The irm is 1 percent e'%ity inanced.The company c%rrently has net income o $1 million2 and it pays o%t # percent o itsnet income as diidends. Both net income and diidends are expected to gro" at aconstant rate o 5 percent per year. There are ,2 shares o stoc7 o%tstanding2and it is estimated that the c%rrent cost o capital is 1-.# percent.

The company is considering a recapitaliDation "here it "ill iss%e $1 million indebt and %se the proceeds to rep%rchase stoc7. Inestment ban7ers hae estimatedthat i the company goes thro%gh "ith the plan2 its beore tax cost o debt "ill be 11percent2 and the cost o e'%ity "ill rise to 1#.5 percent. The company has a #& percentederal&pl%s&state tax rate.

. *hat is the c%rrent share price (beore recapitaliDation)+

$,5.

B. ss%ming that the irm maintains the same payo%t ratio2 "hat "ill be its stoc7price ollo"ing the recapitaliDation+

$,5.@1

@. The 4E *ine 4ompany o El 0aso prod%ces a pop%lar2 lo"&cost "ine. The irm hasixed costs o $12 ann%ally and ariable costs per bottle o $-.. The diisionhas $152 in debt o%tstanding at an ann%al interest rate o 1, percent.

. I the price per bottle is $:.2 "hat is the diisionCs brea7een reen%e+.

$ 1:52

B. I the irm expects to sell 12 bottles2 at "hat price m%st it sell each bottle inorder to brea7 een+

$ #.

4. I the irm sells 52 bottles at a price o $:.2 "hat is the irmCs degree ooperating leerage+

,.

=. I the irm sells 52 bottles at a price o $:.2 "hat is the irmCs degree oinancial leerage+

1.,,

E. *hat is the degree o total leerage at this leel o o%tp%t and sales price+

,.##

9. The irms AL and LL are identical except or their leerage ratios and interest rates on

40



debt. Each has $, million in assets2 earned $# million beore interest and taxes in,2 and has a # percent ederal&pl%s&state tax rate. 3irm AL2 ho"eer2 has aleerage ratio (=) o 5 percent and pays 1, percent interest on its debt2 "hereas LLhas a - percent leerage ratio and pays only 1 percent interest on its debt.

. *hat is the ret%rn on e'%ity or each irm+

R/E or LL8 1#. percentR/E or AL8 1.@ percent

B. I LL raises its debt ratio to percent and the interest rate on all o its debtincreases to 15 percent2 "hat "o%ld its ne" R/E be+

R/E or LL at percent =8 1.5 percent

1. The <; 4ompany man%act%res and sells only one prod%ct2 a "idget. The irm sellseery %nit that it prod%ces or a sales price o $5. a %nit. The irmCs ariable cost per%nit is $,.2 and the ixed operating cost is $-2. <; has c%rrent interest costs o$152 ann%ally and a marginal tax rate o # percent. I the irm prod%ces and sells

,2 %nits8

. *hat is the irmCs brea7een '%antity and reen%e+

12 %nits and $52

B. *hat is the irmCs degree o operating leerage+

,.

4. *hat is the irmCs degree o inancial leerage+

,.

=. *hat is the irmCs degree o total leerage+

#.

11. gro%p o retired college proessors has decided to orm a small man%act%ring

41



corporation. The company "ill prod%ce a %ll line o traditional oice %nit%re. T"oinancing plans hae been proposed by inestors. 0lan is an all&e'%ity alternatie.Knder this agreement2 one million shares "ill be sold to net the irm $, per share.0lan B inoles the %se o inancial leerage. debt iss%e "ith a ,&year mat%rity "illbe priately placed. The debt iss%e "ill carry an interest rate o 1 percent2 and theprincipal borro"ed "ill amo%nt to $ million. ss%me a corporate tax rate o -#

percent.

. 3ind the EBIT indierence leel associate "ith the t"o inancing alternaties.

$,22

B. *hat is the E0? at this indierence leel o EBIT+

$1.-,

4. The aerage ann%al EBIT has been estimated at $-22! "hat is theexpected E0? o each plan at this leel o EBIT+ *hich plan sho%ld be selected+

0lan 8 $1.9@ 0lan B8 $-.#-

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1,. 3o%r recent liberal arts grad%ates hae interested a gro%p o ent%re capitalists inbac7ing a ne" enterprise. The proposed operation "o%ld consist o a series o retailo%tlets to distrib%te and serice a %ll line o ac%%m cleaners and accessories. Thesestores "o%ld be located in Ao%ston2 =allas and ?an ntonio. T"o inancing plans haebeen proposed by the grad%ates. 0lan is an all&common e'%ity str%ct%re. T"omillion dollars "o%ld be raised by selling @2 shares o common stoc7. 0lan B

"o%ld inole the %se o long&term debt inancing. /ne million dollars "o%ld be raisedmar7eting bonds "ith an eectie interest rate o 1, percent. Knder this alternatie2another million dollars "o%ld be raised by selling #2 shares o common stoc7.*ith both plans2 then $, million is needed to la%nch the ne" irms operations. Thedebt %nds raised %nder 0lan B are tho%ght to be part o the irms permanent capitalstr%ct%re. ss%me a -# percent marginal tax rate or the analysis.

. 3ind the EBIT indierence leel bet"een the t"o proposals.

$,#2

B. *hat is the E0? at this indierence leel o EBIT+

$1.9@

4. The aerage ann%al EBIT has been estimated at $52! "hat is theexpected E0? o each plan at this leel o EBIT+ *hich plan sho%ld beselected+

0lan 8 $#.1,5 0lan B8 $.,:

1-. The *ingler 4orporation s%pplies headphones to airlines or %se "ith moie and stereoprograms. The headphones %se the latest in electronic components and sell or $,@.@per set. This yearCs sales are expected to be #52 %nits. Fariable prod%ction costsor the expected sales %nder present prod%ction methods are estimated at$12,22 and ixed prod%ction costs at present are $1252. *ingler has$#2@2 o debt o%tstanding at an interest rate o @ percent. There are ,#2shares o common stoc7 o%tstanding2 and there is no preerred stoc7. The diidendpayo%t ratio is : percent2 *ingler is in the # percent ederal&pl%s&state tax brac7et.

The company is considering inesting $:2,2 in ne" e'%ipment. ?ales"o%ld not increase2 b%t ariable costs per %nit "o%ld decline by , percent. lso2 ixedoperating costs "o%ld increase rom $1252 to $12@2. *ingler co%ld raisethe re'%ired capital by borro"ing $:2,2 at 1 percent or by selling ,#2additional shares at $- per share.

. *hat "o%ld be *inglerCs E0? %nder (1) the old prod%ction process! (,) %nderthe ne" process i it %ses debt2 and (-) the ne" process i it %ses e'%ity+

/ld8 $,.# e" debt8 $#.:# e" e'%ity8 $-.,:

B. t "hat %nit sales leel "o%ld *ingler hae the same E0? i the ne" prod%ctionprocess is implemented+ *hat is the E0? at this leel+

--92:5 %nits and $1.@

43



CHAPTER THIRTEEN PROBLEMS

1. 4raen 4orp. has retained earnings o $1.:5 million and 12 shares o stoc7o%tstanding "ith a mar7et al%e o $,5 per share. I 4raen declares a 15 percentstoc7 diidend2 "hat "ill 4raenCs retained earnings be ater the diidend+

$ 1.-:5 million

, company has a net income o $1 million and a policy o paying o%t percent o itsearnings in diidends. Ao" m%ch total inancing can be accomplished beore thecompany has to sell common stoc7+ ss%me a debte'%ity ratio o . percent.

$ . million

-. lton 4orp. has earnings o $1.5 million and a policy o paying o%t percent oearnings. lton has $1.@ million in acceptable inestments b%t is %nable to iss%e ne"e'%ity. ss%ming a =E o .#2 ho" m%ch "ill lton be able to spend on capitalb%dgeting i it "ishes to stic7 "ith the percent payo%t+

$ .@# million

#. Beore a ,&or&1 stoc7 split2 =ean 4ompany sold or $ a share2 earning $15 andpaying $@ diidend per share. ter the split2 the diidend per share becomes $5.,. By"hat percentage has the payo%t ratio risen+

-6

5. B%tler 4orporation has declared a 1 percent stoc7 diidend. B%tler has , millionshares o%tstanding "ith a c%rrent mar7et price o $:. Its capital stoc7 acco%nt is $1million2 and the irmCs retained earnings are $@ million. *hat balances "ill the retained

earnings and capital stoc7 acco%nts sho" ater the distrib%tion o the stoc7 diidend+

40ITL ?T/4M RETIE= ERIG?$ 1212 $ 22

. The ?herman ?teel 4ompany has an order bac7log o $5 million. It desires to expandprod%ction capacity by , percent2 "hich "ill inole a $15 million inestment in plantand e'%ipment. anagement desires to maintain # percent debt in its capitalstr%ct%re. The diidend policy has been to distrib%te ,5 percent o their ater&taxearnings2 "hich this year "ere $ million. I management "ishes to maintain itsdiidend policy2 ho" m%ch external e'%ity m%st the irm see7 at the beginning o theyear+

$ #252

:. /n arch 152 the directors o Gl%t /il 4ompany met and declared the reg%lar diidendo #@ cents a share to holders o record on arch -12 payment to made on ay 15. /the 1 shares o Gl%t /il yo% no" o"n2 ,5 shares at a time "ere p%rchased on eacho the ollo"ing dates8 an%ary 12 3ebr%ary 152 arch 152 and pril 1. *hat totaldiidends "ill yo% receie+ (ss%me ex&diidend o%r days prior to record date.)

$ -.

44



@. *ilbert 4ompany expects next yearCs ater&tax income to be $1 million. The irmCsc%rrent debt&e'%ity ratio is 1 percent. I *ilbert has $1, million o proitableinestment opport%nities and "ishes to maintain its c%rrent debt ratio "ith no externale'%ity inancing2 ho" m%ch sho%ld it pay o%t in diidends next year+

$ #22

9. acobs 4orporation earned $, million ater&tax. The irm has 1. million shareso%tstanding. I acobsC diidend policy calls or a # percent payo%t ratio2 "hat are thediidends per share+

$ .5

1. 4hampo%x Aair 3actory2 Inc. has earnings beore interest and taxes o $12. nn%al interest amo%nts to $#22 and the ann%al depreciation is $#2. Taxes arecomp%ted at the # percent rate. Existing bond obligations re'%ire the payment o$,2 into a sin7ing %nd. 4hampo%x "ishes to pay $1 per share diidend on theexisting ,2 shares o%tstanding. The irmCs bond indent%re prohibits the payment o

diidends %nless the cash lo" (beore tax and sin7ing %nd payments) is greater thanthe total diidend2 interest2 and sin7ing %nd obligations. *hat is the maxim%m diidendper share that 4hampeo%x can pay+

$ .@

11. /ne share o Fan Aorn =istrib%tors2 Inc. has a mar7et price o $1,. The irm lists theollo"ing on its ann%al report (dollars in tho%sands)8

4ommon ?toc72 $,.5 par! a%thoriDed2 22 shares! iss%ed and o%tstanding2 #22 shares $ 12

dditional 0aid&In 4apital -2 Retained Earnings 52

. The irm is considering a 5&or&1 stoc7 split. *hich o the ollo"ing "o%ld beexpected+

pproximate 0ar Fal%e ?hares Iss%ed ar7et 0rice

$ .5 ,22 $ ,#.

B. *hat "o%ld the balances in the e'%ity acco%nts be i the irm iss%ed a onepercent stoc7 diidend+

4ommon dditional Retained ?toc7 0aid&In Earnings

$ 121 $ :2: $ #52,

45



1,. ber"ald Aeating2 Inc. has a six&month bac7log o orders or its patented solar heatingsystem. anagement plans to expand prod%ction capacity by 5 percent2 "ith an $1,million inestment in plant machinery2 to meet this demand. The irm "ants to maintaina - percent debt&to&asset ratio in its capital str%ct%re! it also "ants to maintain its pastdiidend policy o distrib%ting - percent o last yearCs ater&tax earnings. In 1992

ater&tax earnings "ere $, million.

. I the irm has 122 shares o%tstanding2 "hat "ill be the irmCs diidendsper share (=0?) i it contin%es the c%rrent policy+

$ .

B. *hat "o%ld the diidend per share be i the irm employs the resid%al theory odiidends+ ss%me 1 million shares o%tstanding.

$ .

4. I ber"ald is to meet both capital %nding and diidend re'%irements2 ho"m%ch external %nding "ill be re'%ired+

$ :22

1-. acobs 4orporation earned $, million in ater&tax net income last '%arter. The irm has1. million shares o%tstanding. I acobsC diidend policy calls or a # percent payo%tratio2 "hat are the diidends per share+

$.5 per share

1#. axi&Trac7Cs proit margin and sales are expected to be 1 percent and $5 million2respectiely2 or the %pcoming '%arter. The irmCs traditional payo%t ratio is # percent

o net income. =%e to mar7et conditions2 the irm does not "ish to raise any ne" e'%ityat this time. axi&Trac7Cs optimal capital str%ct%re contains # percent debt percente'%ity.

. *hat is the irmCs expected net income+

$522

B. *hat is the irmCs expected leel o retained earnings+

$-22

4. *hat is the largest capital b%dget that axi&Trac7 select "itho%t changing the

irmCs payo%t policy or capital str%ct%re "eights+

$522

46

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