Finance questions

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Homework chapter 6

1- Zane Perelli currently has $100 that he can spend today on polo shirts costing $25 each. Alternatively, he could invest the $100 in a risk-free U.S. Treasury security that is expected to earn a 9% nominal rate of interest. The consensus forecast of leading economists is a 5% rate of inflation over the coming year.

a. How many polo shirts can Zane purchase today?
b. How much money will Zane have at the end of 1 year if he forgoes purchasing the polo shirts today?
c. How much would you expect the polo shirts to cost at the end of 1 year in light of the expected inflation?
d. Use your findings in parts b and c to determine how many polo shirts (fractions are OK) Zane can purchase at the end of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy at the end of 1 year?
e. What is Zane s real rate of return over the year? How is it related to the percentage change in Zane s buying power found in part d? Explain.

2-Bond interest payments before and after taxes Charter Corp. has issued 2,500 debentures with a total principal value of $2,500,000. The bonds have a coupon interest rate of 7%.

a. What dollar amount of interest per bond can an investor expect to receive each year from Charter?

b. What is Charter s total interest expense per year associated with this bond issue?

c. Assuming that Charter is in a 35% corporate tax bracket, what is the company s net after-tax interest cost associated with this bond issue?

3 – Valuation Fundamentals: Imagine that you are trying to evaluate the economics of purchasing an automobile. You expect the car to provide annual after-tax cash benefits of $1,200 at the end of each year and assume that you can sell the car for after tax proceeds of $5,000 at the end of the planned 5-year ownership period. All funds for purchasing the car will be drawn from your savings, which are currently earning 6% after taxes.

A. Identify the cash flows, their timing, and the required return applicable to valuing the car.

B. What is the maximum price you would be willing to pay to acquire the car? Explain.

4- Midland Utilities has outstanding a bond issue that will mature to its $1,000 par value in 12 years. The bond has a coupon interest rate of 11% and pays interest annually.
a. Find the value of the bond if the required return is
(1) 11%,
(2) 15%, and
(3) 8%.
b. Plot your findings in part a on a set of required return (x axis) market value of bond (y axis) axes.
c. Use your findings in parts a and b to discuss the relationship between the coupon interest rate on a bond and the required return and the market value of the bond relative to its par value.
d. What two possible reasons could cause the required return to differ from the coupon interest rate?

5-The Salem Company bond currently sells for $955, has a 12% coupon interest rate and a $1,000 par value, pays interest annually, and has 15 years to maturity.

a. Calculate the yield to maturity(YTM) on this bond.

b. Explain the relationship that exists between the coupon interest rate and yield to maturity and the par value and market value of a bond.

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finance Questions

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P7–2 Preferred dividends Slater Lamp
Manufacturing has an outstanding issue of preferred

stock with an $80 par value and an 11%
annual dividend.

a. What is the annual dollar dividend? If
it is paid quarterly, how much will be paid

each quarter?

b. If the preferred stock is noncumulative
and the board of directors has passed the

preferred dividend for the last three
quarters, how much must be paid to preferred

stockholders in the current quarter before
dividends are paid to common

stockholders?

c. If the preferred stock is cumulative and
the board of directors has passed the preferred

dividend for the last three quarters, how
much must be paid to preferred

stockholders in the current quarter before
dividends are paid to common stockholders?

P7–8 Common stock value: Constant growth
Use the constant-growth model (Gordon

growth model) to find the value of each
firm shown in the following table.

Firm
/ Dividend expected next
year/Dividend growth rate/Required return

A $1.20 8% 13%

B 4.00 $4.00
5 15

C 0.65 10 14

D 6.00 8 9

E 2.25
8 20

P7–10 Common stock value: Constant growth
The common stock of Denis and Denis

Research, Inc., trades for $60 per share.
Investors expect the company to pay a

$3.90 dividend next year, and they expect
that dividend to grow at a constant rate

forever. If investors require a 10% return
on this stock, what is the dividend growth

rate that they are anticipating?

P7–14 Common stock value: Variable growth
Lawrence Industries’ most recent annual

dividend was $1.80 per share (D0 = $1.80),
and the firm’s required return is 11%.

Find the market value of Lawrence’s shares
when:

a. Dividends are expected to grow at 8%
annually for 3 years, followed by a 5%

constant annual growth rate in years 4 to
infinity.

b. Dividends are expected to grow at 8%
annually for 3 years, followed by a 0%

constant annual growth rate in years 4 to
infinity.

c. Dividends are expected to grow at 8%
annually for 3 years, followed by a 10%

constant annual growth rate in years 4 to
infinity.

P7–17 Using the free cash flow valuation
model to price an IPO Assume that you have an

opportunity to buy the stock of CoolTech,
Inc., an IPO being offered for $12.50 per

share. Although you are very much
interested in owning the company, you are concerned

about whether it is fairly priced. To
determine the value of the shares, you

have decided to apply the free cash flow
valuation model to the firm’s financial data

that you’ve developed from a variety of
data sources. The key values you have compiled

are summarized in the following table.

Free cash flow

Year (t) FCFt Other data

2016 $ 700,000 Growth rate of FCF,
beyond 2019 to infinity 5 2%

2017 800,000 Weighted average cost of capital
5 8%

2018 950,000 Market value of all
debt 5 $2,700,000

2019 1,100,000 Market value of preferred
stock 5 $1,000,000

Number of shares of common
stock outstanding 5 1,100,000

P7–19 Valuation with price/earnings
multiples For each of the firms shown in the following

table, use the data given to estimate its
common stock value employing price/

earnings (P/E) multiples.

Firm Expected EPS Price/earnings multiple

A
$3.00
6.2

B
4.50 10.0

C
1.80
12.6

D
2.40
8.9

E 5.10 15.0

P8–9 Rate of return, standard deviation,
and coefficient of variation Mike is searching

for a stock to include in his current stock
portfolio. He is interested in Hi-Tech,

Inc.; he has been impressed with the
company’s computer products and believes

that Hi-Tech is an innovative market
player. However, Mike realizes that any

time you consider a technology stock, risk
is a major concern. The rule he follows

is to include only securities with a
coefficient of variation of returns below 0.90.

Mike has obtained the following price
information for the period 2012 through

2015. Hi-Tech stock, being growth-oriented,
did not pay any dividends during these

4 years.

Stock price

Year Beginning
End

2012 $14.36
$21.55

2013 21.55 64.78

2014
64.78
72.38

2015 72.38
91.80

P8–14 Portfolio analysis You have been
given the expected return data shown in the first

table on three assets—F, G, and H—over the
period 2016–2019.

Expected return

Year Asset F Asset G Asset H

2016 16% 17% 14%

2017 17 16 15

2018 18 15 16

2019 19 14 17

Using these assets, you have isolated the
three investment alternatives shown in the

following table

Alternative Investment

1 100% of asset F

2 50% of asset F and 50%
of asset G

3 50% of asset F and 50%
of asset H

a. Calculate the expected return over the
4-year period for each of the three

alternatives.

b. Calculate the standard deviation of
returns over the 4-year period for each of the

three alternatives.

c. Use your findings in parts a and b to
calculate the coefficient of variation for

each of the three alternatives.

d. On the basis of your findings, which of
the three investment alternatives do you

recommend? Why?

P8–27 Portfolio return and beta Jamie
Peters invested $100,000 to set up the following

portfolio 1 year ago.

Asset
Cost Beta at purchase Yearly income Value today

A
$20,000 0.80 $1,600 $20,000

B
35,000 0.95 1,400 36,000

C
30,000 1.50 — 34,500

D
15,000 1.25 375 16,500

a. Calculate the portfolio beta on the
basis of the original cost figures.

b. Calculate the percentage return of each
asset in the portfolio for the year.

c. Calculate the percentage return of the
portfolio on the basis of original cost,

using income and gains during the year.

d. At the time Jamie made his investments,
investors were estimating that the market

return for the coming year would be 10%.
The estimate of the risk-free rate of return

averaged 4% for the coming year. Calculate
an expected rate of return for each stock

on the basis of its beta and the
expectations of market and risk-free returns.

e. On the basis of the actual results,
explain how each stock in the portfolio performed

relative to those CAPM-generated
expectations of performance. What

factors could explain these differences?

P9-5 The cost of debt Gronseth Drywall
Systems, Inc., is in discussions with its investment bankers regarding the
issuance of new bonds. The investment banker has informedthe firm that
different maturities will carry different coupon rates and sell at different
prices. The firm must choose among several alternatives. In each case, the bonds
will have a $1,000 par value and flotation costs will be $30 per bond. The company
is taxed at a rate of 40%. Calculate the after-tax cost of financing with

each of the following alternatives.

Alternative Coupon Rate Time
to Maturity (years) Premium or
Discount

A 9% 16
$250

B 7 5 50

C 6 7 par

D 5 10 – 75

P9–7 Cost of preferred stock Taylor Systems
has just issued preferred stock. The stock

has a 12% annual dividend and a $100 par
value and was sold at $97.50 per share.

In addition, flotation costs of $2.50 per
share must be paid.

a. Calculate the cost of the preferred
stock.

b. If the firm sells the preferred stock
with a 10% annual dividend and nets $90.00

after flotation costs, what is its cost?

P9–9 Cost of common stock equity: CAPM
J&M Corporation common stock has a beta,

b, of 1.2. The risk-free rate is 6%, and
the market return is 11%.

a. Determine the risk premium on J&M
common stock.

b. Determine the required return that
J&M common stock should provide.

c. Determine J&M’s cost of common stock
equity using the CAPM.

P9–10 Cost of common stock equity Ross
Textiles wishes to measure its cost of common

stock equity. The firm’s stock is currently
selling for $57.50. The firm expects to pay

a $3.40 dividend at the end of the year
(2016). The dividends for the past 5 years

are shown in the following table.

Year
Dividend

2015
$3.10

2014
2.92

2013
2.60

2012
2.30

2011
2.12

After underpricing and flotation costs, the
firm expects to net $52 per share on a

new issue.

a. Determine the growth rate of dividends
from 2011 to 2015.

b. Determine the net proceeds, Nn, that the
firm will actually receive.

c. Using the constant-growth valuation
model, determine the cost of retained earnings, rr.

d. Using the constant-growth valuation
model, determine the cost of new common stock, rn.

P9–17 Calculation of individual costs and
WACC Dillon Labs has asked its financial manager

to measure the cost of each specific type
of capital as well as the weighted average

cost of capital. The weighted average cost
is to be measured by using the following

weights: 40% long-term debt, 10% preferred
stock, and 50% common stock equity

(retained earnings, new common stock, or
both). The firm’s tax rate is 40%.

Debt The firm can sell for $980 a 10-year,
$1,000-par-value bond paying annual

interest at a 10% coupon rate. A flotation
cost of 3% of the par value is required

in addition to the discount of $20 per
bond.

Preferred stock Eight percent (annual
dividend) preferred stock having a par

value of $100 can be sold for $65. An
additional fee of $2 per share must be paid

to the underwriters.

Common stock The firm’s common stock is
currently selling for $50 per share.

The dividend expected to be paid at the end
of the coming year (2016) is $4. Its

dividend payments, which have been
approximately 60% of earnings per share in

each of the past 5 years, were as shown in
the following table.

Year
Dividend

2015
$3.75

2014
3.50

2013
3.30

2012
3.15

2011
2.85

It is expected that to attract buyers, new
common stock must be underpriced

$5 per share, and the firm must also pay $3
per share in flotation costs. Dividend

payments are expected to continue at 60% of
earnings. (Assume that rr = rs.)

a. Calculate the after-tax cost of debt.

b. Calculate the cost of preferred stock.

c. Calculate the cost of common stock.

d. Calculate the WACC for Dillon Labs.

P10–4 Long-term investment decision,
payback method Bill Williams has the opportunity

to invest in project A that costs $9,000
today and promises to pay annual end-ofyear

payments of $2,200, $2,500, $2,500, $2,000,
and $1,800 over the next 5 years.

Or, Bill can invest $9,000 in project B
that promises to pay annual end-of-year payments

of $1,500, $1,500, $1,500, $3,500, and
$4,000 over the next 5 years.

a. How long will it take for Bill to recoup
his initial investment in project A?

b. How long will it take for Bill to recoup
his initial investment in project B?

c. Using the payback period, which project
should Bill choose?

d. Do you see any problems with his choice?

P10–10 NPV: Mutually exclusive projects
Hook Industries is considering the replacement of

one of its old drill presses. Three
alternative replacement presses are under consideration.

The relevant cash flows associated with each
are shown in the following table.

The firm’s cost of capital is 15%.

LG 3

LG 2 LG 3

LG 3

Press A Press B Press C

Initial investment (CF0) $85,000 $60,000 $130,000

Year (t) Cash inflows (CFt)

1 $18,000 $12,000 $50,000

2 18,000
14,000 30,000

3 18,000 16,000 20,000

4 18,000 18,000 20,000

5 18,000 20,000 20,000

6 18,000 25,000 30,000

7 18,000 — 40,000

8 18,000 — 50,000

a. Calculate the net present value (NPV) of
each press.

b. Using NPV, evaluate the acceptability of
each press.

c. Rank the presses from best to worst
using NPV.

d. Calculate the profitability index (PI)
for each press.

e. Rank the presses from best to worst
using PI.

P10–11 Long-term investment decision, NPV
method Jenny Jenks has researched the financial

pros and cons of entering into a 1-year MBA
program at her state university. The

tuition and books for the master’s program
will have an up-front cost of $50,000. If

she enrolls in an MBA program, Jenny will
quit her current job, which pays $50,000

per year after taxes (for simplicity, treat
any lost earnings as part of the up-front

cost). On average, a person with an MBA
degree earns an extra $20,000 per year (after

taxes) over a business career of 40 years.
Jenny believes that her opportunity cost

of capital is 6%. Given her estimates, find
the net present value (NPV) of entering

this MBA program. Are the benefits of
further education worth the associated costs?

P10–15 Internal rate of return Peace of
Mind, Inc. (PMI), sells extended warranties for durable

consumer goods such as washing machines and
refrigerators. When PMI sells an extended

warranty, it receives cash up front from
the customer, but later PMI must cover any repair

costs that arise. An analyst working for PMI
is considering a warranty for a new line

of big-screen TVs. A consumer who purchases
the 2-year warranty will pay PMI $200.

On average, the repair costs that PMI must
cover will average $106 for each of the warranty’s

2 years. If PMI has a cost of capital of
7%, should it offer this warranty for sale?

P10–21 All techniques, conflicting rankings
Nicholson Roofing Materials, Inc., is considering

two mutually exclusive projects, each with
an initial investment of $150,000.

The company’s board of directors has set a
maximum 4-year payback requirement

and has set its cost of capital at 9%. The
cash inflows associated with the two projects

are shown in the following table.

Cash inflows
(CFt)

Year Project A Project B

1 $45,000 $75,000

2 45,000 60,000

3 45,000 30,000

4 45,000
30,000

5 45,000
30,000

6 45,000 30,000

a. Calculate the payback period for each
project.

b. Calculate the NPV of each project at 0%.

c. Calculate the NPV of each project at 9%.

d. Derive the IRR of each project.

e. Rank the projects by each of the
techniques used. Make and justify a recommendation.

f. Go back one more time and calculate the
NPV of each project using a cost of

capital of 12%. Does the ranking of the two
projects change compared to your

answer in part e? Why?

P10–24 All techniques: Decision among
mutually exclusive investments Pound Industries is

attempting to select the best of three
mutually exclusive projects. The initial investment

and after-tax cash inflows associated with
these projects are shown in the

following table.

Cash flows Project
A Project B Project C

Initial investment (CF0) $60,000 $100,000 $110,000

Cash inflows (CFt), t 5 1 to 5 20,000 31,500 32,500

a. Calculate the payback period for each
project.

b. Calculate the net present value (NPV) of
each project, assuming that the firm has

a cost of capital equal to 13%.

c. Calculate the internal rate of return
(IRR) for each project.

d. Draw the net present value profiles for
both projects on the same set of axes, and

discuss any conflict in ranking that may
exist between NPV and IRR.

e. Summarize the preferences dictated by
each measure, and indicate which project

you would recommend. Explain why.

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2.
If D1 = $2.00, g (which is constant) = 6%, and P0 = $40, what is the
stock’s expected capital gains yield for the coming year?

a. 5.2%
b. 5.4%
c. 5.6%
d. 6.0% 

3.
The Lashgari Company is expected to pay a dividend of $1 per share at
the end of the year, and that dividend is expected to grow at a constant
rate of 5% per year in the future. The company’s beta is 1.2, the
market risk premium is 5%, and the risk-free rate is 3%. What is the
company’s current stock price?

a. $15.00
b. $20.00
c. $25.00 
d. $30.00

4.
McKenna Motors is expected to pay a $1.00 per-share dividend at the end
of the year (D1 = $1.00). The stock sells for $20 per share and its
required rate of return is 11 percent. The dividend is expected to grow
at a constant rate, g, forever. What is the growth rate, g, for this
stock?

a. 5%
b. 6% 
c. 7%
d. 8%

5.
The last dividend paid by Klein Company was $1.00. Klein’s growth rate
is expected to be a constant 5 percent for 2 years, after which
dividends are expected to grow at a rate of 10 percent forever. Klein’s
required rate of return on equity (ks) is 12 percent. What is the
current price of Klein’s common stock?
a. $21.00
b. $33.33
c. $42.25
d. $50.16 

6.
You must estimate the intrinsic value of Gallovits Technologies’ stock.
Gallovits’s end-of-year free cash flow (FCF) is expected to be $25
million, and it is expected to grow at a constant rate of 8.5% a year
thereafter. The company’s WACC is 11%. Gallovits has $200 million of
long-term debt plus preferred stock, and there are 30 million shares of
common stock outstanding. What is Gallovits’ estimated intrinsic value
per share of common stock?

a. $22.67
b. $24.00
c. $25.33
d. $26.67 

12.
Dick Boe Enterprises, an all-equity firm, has a corporate beta
coefficient of 1.5. The financial manager is evaluating a project with
an expected return of 21 percent, before any risk adjustment. The
risk-free rate is 10 percent, and the required rate of return on the
market is 16 percent. The project being evaluated is riskier than Boe’s
average project, in terms of both beta risk and total risk. Which of the
following statements is most correct?

a. The project should be accepted since its expected return (before risk adjustment) is greater than its required return.
b. The project should be rejected since its expected return (before risk adjustment) is less than its required return.
c.
The accept/reject decision depends on the risk-adjustment policy of the
firm. If the firm’s policy were to reduce a riskier-than-average
project’s expected return by 1 percentage point, then the project should
be accepted. 
d.
Riskier-than-average projects should have their expected returns
increased to reflect their added riskiness. Clearly, this would make the
project acceptable regardless of the amount of the adjustment.

13.
Conglomerate Inc. consists of 2 divisions of equal size, and
Conglomerate is 100 percent equity financed. Division A’s cost of equity
capital is 9.8 percent, while Division B’s cost of equity capital is 14
percent. Conglomerate’s composite WACC is 11.9 percent. Assume that all
Division A projects have the same risk and that all Division B projects
have the same risk. However, the projects in Division A are not the
same risk as those in Division B. Which of the following projects should
Conglomerate accept?
a. Division A project with an 11 percent return. 
b. Division B project with a 12 percent return.
c. Division B project with a 13 percent return.
d. Statements a and c are correct.

15.
You were hired as a consultant to Giambono Company, whose target
capital structure is 40% debt, 15% preferred, and 45% common equity. The
after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and
the cost of retained earnings is 12.75%. The firm will not be issuing
any new stock. What is its WACC?

a. 8.98%
b. 9.26% 
c. 9.54%
d. 9.83%

16.
Flaherty Electric has a capital structure that consists of 70 percent
equity and 30 percent debt. The company’s long-term bonds have a
before-tax yield to maturity of 8.4 percent. The company uses the DCF
approach to determine the cost of equity. Flaherty’s common stock
currently trades at $40.5 per share. The year-end dividend (D1) is
expected to be $2.50 per share, and the dividend is expected to grow
forever at a constant rate of 7 percent a year. The company estimates
that it will have to issue new common stock to help fund this year’s
projects. The company’s tax rate is 40 percent. What is the company’s
weighted average cost of capital, WACC?

a. 10.73% 
b. 10.30%
c. 11.31%
d. 7.48%

17.
Hamilton Company’s 8 percent coupon rate, quarterly payment, $1,000 par
value bond, which matures in 20 years, currently sells at a price of
$686.86. The company’s tax rate is 40 percent. What is the firm’s
component cost of debt for purposes of calculating the WACC?

a. 3.05%
b. 7.32% 
c. 7.36%
d. 12.20%

22.
The Seattle Corporation has been presented with an investment
opportunity that will yield cash flows of $30,000 per year in Years 1
through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year
10. This investment will cost the firm $150,000 today, and the firm’s
cost of capital is 10 percent. Assume cash flows occur evenly during the
year, 1/365th each day. What is the payback period for this investment?

a. 5.23 years
b. 4.86 years 
c. 4.00 years
d. 6.12 years

22. Coughlin Motors is considering a project with the following expected cash flows:

Project
Year Cash Flow
0 -$700 million
1 200 million
2 370 million
3 225 million
4 700 million

The project’s WACC is 10 percent. What is the project’s discounted payback?

a. 3.15 years
b. 4.09 years
c. 1.62 years
d. 3.09 years 

The
PV of the outflows is -$700 million. To find the discounted payback you
need to keep adding cash flows until the cumulative PVs of the cash
inflows equal the PV of the outflow:

Discounted
Year Cash Flow Cash Flow @ 10% Cumulative PV
0 -$700 million -$700.0000 -$700.0000
1 200 million 181.8182 -518.1818
2 370 million 305.7851 -212.3967
3 225 million 169.0458 -43.3509
4 700 million 478.1094 434.7585
The
payback occurs somewhere in Year 4. To find out exactly where, we
calculate $43.3509/$478.1094 = 0.0907 through the year. Therefore, the
discounted payback is 3.091 years.

23.
As the director of capital budgeting for Denver Corporation, you are
evaluating two mutually exclusive projects with the following net cash
flows:

Project X Project Z
Year Cash Flow Cash Flow
0 -$100,000 -$100,000
1 50,000 10,000
2 40,000 30,000
3 30,000 40,000
4 10,000 60,000

If Denver’s cost of capital is 15 percent, which project would you choose?

a. Neither project. 

b. Project X, since it has the higher IRR.
c. Project Z, since it has the higher NPV.
d. Project X, since it has the higher NPV.

24.
Your company is choosing between the following non-repeatable, equally
risky, mutually exclusive projects with the cash flows shown below. Your
cost of capital is 10 percent. How much value will your firm sacrifice
if it selects the project with the higher IRR?

k = 10%
k = 10%
| | | |
-1,000 500 500 500

k = 10%
k = 10%
| | | | | |
-2,000 668.76 668.76 668.76 668.76 668.76

a. $243.43
b. $291.70 
c. $332.50
d. $481.15

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Finance questions

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Question 1

Evaluate
the following Cash Flows using the criteria in parts a-f and MARR. Parts a-d
should use a 6-year time span. Indicate
for each part whether the proposal should be accepted or rejected.

MARR=10%

Year 0 1 2 3 4 5 6

Cash
Flow ($80,000) $13,200 $19,800 $22,100
$25,000 $25,000 $20,000

a Present
Worth (PW)

b Future
Worth (FW)

c Annual
Worth (AW)

d Internal
rate of Return (IRR)

e Discounted
Payback by end of year (EOY) 4

f Traditional
Payback (no discounting) by end of year
(EOY) 4

Question2

Three alternatives have been proposed
with the investment and forecasted annual cash flows shown below. Salvage
values should be ignored. A MARR of 12.5% and a four year time-span is to be
used. Resources are available for only
one of the three alternatives.

Determine
which one should be selected usingonly the internal rate of return
criterion.

Enhancement

Annual cash flow

Investment

A1

$17,50,000

$50,00,000

A2

$15,50,000

$44,00,000

A3

$13,00,000

$37,00,000

Enhancement

Annual
cash flow

Investment

A1

$17,50,000

$50,00,000

A2

$15,50,000

$44,00,000

A3

$13,00,000

$37,00,000

Question 3

Third-in-Line, LLC had sales and costs as shown below in
2012..

a What was
the profit in 2012

b What is
the break even quantity?

c If the
price, fixed cost and the variable cost
per unit stay the same as in 2012, what will the quantity sold have to be to increase profits to $1 million
in the coming year?

d If the
sales quantity, price, and fixed cost stay the same as in 2012, what would the
unit variable cost need to be to increase profits to $1 million in the coming
year?

2012

Sold
units 50,000

Total
Revenue $25,00,000

Total
Variable cost $12,00,000

Total
Fixed Cost $5,00,000

Question4

Anthony and Sons,
Inc. is evaluating a proposal for a new robotic assembly machine that is expected to need replacing after 6
years of use. The new machine will
reduce direct labor, and with the lower price that this enables, will increase
sales. The problem is that it is
expensive. Using the data below,
construct the Income statement part of a financial analysis. Show all
subtotals.

Purchase price of Robotic Assembly
Machine (RAM)

$100,00,000

year 0

Present annual sales

$100,00,000

constant for all years

Forecasted annual sales increase

20%

in year 1 and then constant at this
level for the remaining years

Present COGS

40%

of sales

Forecasted COGS

25%

of sales

S.G. & A without depreciation

$25,00,000

annually and not changed by proposal

Depreciation MACRS

5

years

Proposal life span

6

years

Income tax

18%

annually

MARR

10%

annually

1

2

3

4

5

6

MACRS 5-year

20.00%

32.00%

19.20%

11.52%

11.52%

5.76%

Question 5

Modern Medical Mechanics (M3) is going to replace a machines
that cannot be repaired economically with a new identical machine. They need to evaluate the alternatives of leasing versus buying.
The old machine is fully depreciated and will be discarded (no salvage
value on it). The replacement machine,
being identical , will not affect revenues nor
costs (all maintenance for both alternatives will be done in-house). The
new machine, with either option, will last four years and then be replaced. The
purchased machine only will have the salvage value listed below. From a financial perspective, document and
make a recommendation of which alternative should be adopted.

Purchase price

$42,000

year 0

Salvage value

$10,000

EOY 4

Lease expense

$12,000

annually paid at the beginning of
each year

Depreciation

5

MACRS years

Time span

4

years

Income tax rate

20.00%

Capital gains tax rate

10.00%

MARR

12.50%

Question 6

Josephine is trying to get a new company up and
running. She needs to prepare financial
documents to submit to a bank for a loan (line of credit) to cover the working
capital requirements. She has a
potential angel investor for the investment in machines and equipment so that
is not part of the line of credit loan amount.

The estimated working capital needed for each of the first
two years is shown below and the year 2 values are expected to be constant at
the year 2 level in the future.

Interest on this line of credit should be ignored.

The revenue COGS, Gross margin and S.G.& A. (does not
include depreciation) is shown below.

Prepare an Income Statement and Cash Flow Statement for years 0-2 that can be
submitted to the bank (meaning that all subtotals should be shown). All available data is shown below. Assume that the company will continue with
Josephine as the owner beyond year 2.

Investment
in year 0 $10,00,000 Assume this entire amount is
depreciable

Forecasted revenues, cost and expenses not including
depreciation.

0 1 2

Revenue $6,50,000 $13,00,000

COGS ($2,60,000) ($5,20,000)

SG&A ($1,80,000) ($2,40,000)

Depreciation
(MACRS) 5 year 20.00% 32.00% 19.20% 11.52% 11.52% 5.76%

Accounts
Receivable $0 $2,50,000 $4,00,000

Accounts
Payable $20,000 $1,80,000 $1,80,000

Wages
Payable$5,000 $50,000 $65,000

Inventory $10,000 $1,00,000 $1,50,000

Income
Tax rate 20%

Capital
Gains Tax rate 12%

Question 7

Below is an Income and cash flow statements that management
has approved. (If there are errors or
oversights, that is their problem, not yours).
Column E contains the original starting values in case you need to get
back to them.

a Determine
the sensitivity of the present worth to four changes in COGS: a 20% decrease, a
10% decrease, a 10% increase, and a 20% increase.

b Determine
the Unit Price that would achieve the MARR (PW = 0) when the unit COGS is
$16.00 . Explain how you determined this.

c If the investment was increased to $2,000,000 to
reduce the COGS each to $12.50, what would the unit price have to be to achieve
a cash flow of $500,000 in year 1?
Explain how you determined this.

Question 8

The Town of Greenburg has spent $1.5 million in the past
year making its facilities more energy efficient. The next step is to evaluate alternative
methods of heating. They presently use
coal. The alternatives being evaluated
are to switch to either natural gas, solar, or geothermal. The forecasted data below has been gathered
for one building to make an evaluation.
(Data are fictitious)

Perform a financial analysis to determine and indicate which
one is preferred over coal.

Time span 10 years

MARR 7%

Investment Annual Fuel Cost Annual Operating Cost

Coal $0 $80,000 $18,000

Natural Gas $35,000
$80,000 $3,000

Solar $1,00,000 $2,000 $5,000

Geothermal $90,000
$1,000 $7,000

Question 9

The Retired Entrepreneurs Association for People (REAP) is
funding projects for improving the grain supply in countries with food
shortages. Their staff has obtained
proposals as follows. Each proposal has
a upfront investment, estimated costs per year, and an estimated tons of food
that would be produced. Using a 10 year
time span and a discount rate (MARR) of 7%, create a priority order in which
the proposals should be funded. REAP
will then attempt to raise funds for as many as possible.

Proposal

Upfront
Investment

Annual
Costs

Annual
Tons of food produced

P1

$140,00,000

$24,00,000

1,50,000

P2

$200,00,000

$27,00,000

1,40,000

P3

$170,00,000

$23,00,000

1,64,000

P4

$250,00,000

$22,40,000

1,55,000

P5

$100,00,000

$19,00,000

1,30,000

P6

$120,00,000

$20,00,000

1,44,000

Question 10

Your company was bought by a large corporation and you are
now one of seven plants vying for investment funds. You are preparing a
financial analysis for the adoption of a
complex proposal to submit to a corporate investment committee. Prior to being purchased, your plant just
summed the estimated labor savings and divided investment by it. The corporate policy states that a 5-year
present worth analysis of cash flow is needed for investment proposals, of
which your plant manager knows nothing.
There will be other competing proposals at the corporate level , and
your plant manager’s support and signature are needed. Write an explanation to the busy plant
manager as to why the present worth approach should be used. This can be posted below or in a word
document. Limit your answer to 300
words.

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Homework chapter 6

1-Zane Perelli currently has $100 that he can spend today on polo shirts
costing $25 each. Alternatively, he could invest the $100 in a risk-free U.S.
Treasury security that is expected to earn a 9% nominal rate of interest. The
consensus forecast of leading economists is a 5% rate of inflation over the
coming year.

a. How many polo shirts can Zane
purchase today?
b. How much money will Zane have at
the end of 1 year if he forgoes purchasing the polo shirts today?
c. How much would you expect the polo
shirts to cost at the end of 1 year in light of the expected inflation?
d. Use your findings in parts b and c
to determine how many polo shirts (fractions are OK) Zane can purchase at the end
of 1 year. In percentage terms, how many more or fewer polo shirts can Zane buy
at the end of 1 year?
e. What is Zane’s real rate of return
over the year? How is it related to the percentage change in Zane’s buying
power found in part d? Explain.

2-Bond interest payments before and after taxes Charter
Corp. has issued 2,500 debentures with a total principal value of $2,500,000.
The bonds have a coupon interest rate of 7%.

a. What dollar amount of interest
per bond can an investor expect to receive each year from Charter?

b. What is Charter’s total
interest expense per year associated with this bond issue?

c. Assuming that Charter is in a
35% corporate tax bracket, what is the company’s net after-tax interest cost
associated with this bond issue?

3 – Valuation Fundamentals: Imagine that you are trying
to evaluate the economics of purchasing an automobile. You expect the car to
provide annual after-tax cash benefits of $1,200 at the end of each year and
assume that you can sell the car for after tax proceeds of $5,000 at the end of
the planned 5-year ownership period. All funds for purchasing the car will be
drawn from your savings, which are currently earning 6% after taxes.

A. Identify the cash flows, their timing, and
the required return applicable to valuing the car.

B. What is the maximum price you would be
willing to pay to acquire the car? Explain.

4- Midland Utilities has outstanding a bond issue that
will mature to its $1,000 par value in 12 years. The bond has a coupon interest
rate of 11% and pays interest annually.
a. Find the value of the bond if the required return is
(1) 11%,
(2) 15%, and
(3) 8%.
b. Plot your findings in part a on a set of “required return (x axis)–market
value of bond (y axis)” axes.
c. Use your findings in parts a and b to discuss the relationship between the
coupon interest rate on a bond and the required return and the market value of
the bond relative to its par value.
d. What two possible reasons could cause the required return to differ from the
coupon interest rate?

5-The Salem Company bond currently
sells for $955, has a 12% coupon interest rate and a $1,000 par value, pays
interest annually, and has 15 years to maturity.

a.
Calculate the yield to maturity(YTM) on this bond.

b. Explain the relationship that exists
between the coupon interest rate and yield to maturity and the par value and
market value of a bond.

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Problem 15-23 Return on investment
Soto Corporation’s balance sheet indicates that the company has $300,000 invested in
operating assets. During 2011, Soto earned operating income of $45,000 on $600,000 of
sales.
Required
a. Compute Soto’s profit margin for 2011.
b. Compute Soto’s turnover for 2011.
c. Compute Soto’s return on investment for 2011.
d. Recompute Soto’s ROI under each of the following independent assumptions.
(1) Sales increase for $600,000 to $750,000, thereby resulting in an increase in
operating income for $45,000 to $60,000.
(2) Sales remain constant, but Soto reduces expenses resulting in an increase in
operating income from $45,000 to $48,000.
(3) Soto is able to reduce its invested capital from $300,000 to $240,000 without
affecting operating income.

Problem 16-23 Postaudit evaluation
Ernest Jones is reviewing his company’s investment in a cement plant. The company
paid $15,000,000 five years ago to acquire the plant. Now top management is
considering an opportunity to sell it. The president wants to know whether the plant has
met original expectations before he decides its fate. The company’s discount rate for
present value computations is 8 percent. Expected and actual cash flows follow.
Expected
Actual

Year 1
$3,300,000
2,700,000

Year 2
$4,920,000
3,060,000

Year 3
$4,560,000
4,920,000

Year 4
$4,980,000
3,900,000

Year 5
$4,200,000
3,600,000

Required
a. Compute the net present value of the expected cash flows as of the beginning of the
investment.
b. Compute the net present value of the actual cash flows as of the beginning of the
investment.
c. What do you conclude from this postaudit?

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