FIN 323 - Exam 3 Study

Katlin Markets is debating between a levered and an unlevered capital structure. The all-equity capital structure would consist of 75,000 shares of stock. The debt and equity option would consist of 40,000 shares of stock plus $320,000 of debt with an interest rate of 6.25 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes.

EBIT / 75,000 = [EBIT - ($320,000 ×.0625)] / 40,000 Breakeven EBIT = $42,857.14

Which one of the following is the equity risk related to a firm's capital structure policy?

Financial

Which one of the following represents the level of output where a project produces a rate of return just equal to its requirement?

Financial break-even

The dividend growth model cannot be used to compute the cost of equity for a firm that:

Has a retention ratio of 100 percent.

Sixx AM Manufacturing has a target debt—equity ratio of 0.51. Its cost of equity is 21 percent, and its cost of debt is 10 percent. If the tax rate is 34 percent, what is the company's WACC?

Here we need to use the debt-equity ratio to calculate the WACC. Doing so, we find: WACC = 0.21(1/1.51) + 0.1(0.51/1.51)(1 - 0.34) = 0.1614 or 16.14%

You've worked out a line of credit arrangement that allows you to borrow up to $70 million at any time. The interest rate is 0.63 percent per month. In addition, 2 percent of the amount that you borrow must be deposited in a non-interest-bearing account. Assume that your bank uses compound interest on its line of credit loans. What is the effective annual interest rate on this lending arrangement?

If you borrow $70,000,000 for one month, you will pay interest of: Interest = $70,000,000(0.0063) Interest = $441,000 However, with the compensating balance, you will only get the use of: Amount received = $70,000,000 - 70,000,000(0.02) Amount received = $68,600,000 This means the periodic interest rate is: Periodic interest = $441,000/$68,600,000 Periodic interest = 0.006429 or 0.643% So, the EAR is: EAR = [1 + ($441,000/$68,600,000)]12 - 1 EAR = 0.0799 or 7.99%

Which one of these combinations must increase the contribution margin?

Increasing the sales price and decreasing the variable cost per unit

A firm with a flexible short-term financial policy will:

Invest heavily in inventory

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 103 percent of face value. The issue makes semiannual payments and has an embedded cost of 12 percent annually. What is the pretax cost of debt?

N = 8* 2 = 16 PV = -1,000* 1.03 = -1,030 PMT = 1,000 * (.12/2) = 60 FV = 1,000 CPT I/Y = 5.709% YTM = 2 * 5.709% = 11.42%

By definition, which one of the following must equal zero at the accounting break-even point?

Net Income

By definition, which one of the following must equal zero at the cash break-even point?

Operating Cash Flow

The length of time between the purchase of inventory and the receipt of cash from the sale of that inventory is called the:

Operating Cycle

DM Electronics has projected sales of $900, $980, $1,040, and $1,200 for quarters 1 to 4, respectively. Sales in the following year are projected to be 12 percent greater in each quarter. Assume the firm places orders during each quarter equal to 40 percent of projected sales for the next quarter. How much will the firm pay to its suppliers in quarter 2 if its accounts payable period is 60 days?

Payments Q2 = (60 / 90)(.40)($980) + (30 / 90)(.40)($1,040) = $400

A project has the following estimated data: price = $71 per unit; variable costs = $29.11 per unit; fixed costs = $6,600; required return = 16 percent; initial investment = $14,000; life = three years. Ignore the effect of taxes. What is the accounting break-even quantity?

Q = (FC + D)/ (P-v) QA = [6,600 + (14,000/3)] / (71 - 29.11) =269

A project has the following estimated data: price = $71 per unit; variable costs = $29.11 per unit; fixed costs = $6,600; required return = 16 percent; initial investment = $14,000; life = three years. Ignore the effect of taxes. What is the cash break-even?

Q = FC / ( P - v) = 6,600/ ( 71 - 29.11) = 158

Waller, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 8 years to maturity that is quoted at 103 percent of face value. The issue makes semiannual payments and has an embedded cost of 12 percent annually. What is the aftertax cost of debt?

RD = YTM(1-t) = .1142 (1-0.36) = 0.0731 or 7.31%

The Down and Out Co. just issued a dividend of $2.66 per share on its common stock. The company is expected to maintain a constant 5 percent growth rate in its dividends indefinitely. If the stock sells for $50 a share, what is the company's cost of equity?

RE = D0 (1 + g)/P0 + g = 2.79/50 + 0.05 = 10.59

What is the formula for required return on stock?

RE = D0 (1+g)/P0 + g

A project has the following estimated data: price = $71 per unit; variable costs = $29.11 per unit; fixed costs = $6,600; required return = 16 percent; initial investment = $14,000; life = three years. Ignore the effect of taxes. What is the financial break-even?

Sales level at 0 NPV Initial cost must equal PV OCF = Initial Cost/annuity factor = 14,000/2.2459 =6,233.61 Q = (FC + OCF)/(P-v) = (6,600 + 6,233.61)/41.89 = 306

Eastern Markets has no debt outstanding and a total market value of $154,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 27 percent higher. If there is a recession, then EBIT will be 55 percent lower. The firm is considering a $20,000 debt issue with an interest rate of 6.5 percent. The proceeds will be used to repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes. What will be the percentage change in EPS if the economy enters a recessionary period?

Share price = $154,000 / 2,000 = $77 Shares repurchased = $20,000 / $77 = 259.74 Annual interest = $20,000 × .065 = $1,300 EPS Normal = ($12,000 - 1,300) / (2,000 - 259.74) = $6.15 EPS Recession = {[$12,000 × (1 - .55)] - $1,300} / (2,000 - 259.74) = $2.36 Percentage change = ($2.36 - 6.15) / $6.15 = -.62, or -62 percent

Saunders Corp. has a book net worth of $13,950. Long-term debt is $2,850. Net working capital, other than cash, is $3,700. Fixed assets are $3,450 and current liabilities are $1,900. How much cash does the company have?

The total liabilities and equity of the company are the net book worth, or market value of equity, plus current liabilities and long-term debt, so: Total liabilities and equity = $13,950 + 2,850 + 1,900 Total liabilities and equity = $18,700 This is also equal to the total assets of the company. Since total assets are the sum of all assets, and cash is an asset, the cash account must be equal to total assets minus all other assets, so: Cash = $18,700 - 3,450 - 3,700 Cash = $11,550

The flotation cost for a firm is computed as:

The weighted average of the flotation costs associated with each form of financing.

You've worked out a line of credit arrangement that allows you to borrow up to $70 million at any time. The interest rate is 0.63 percent per month. In addition, 2 percent of the amount that you borrow must be deposited in a non-interest-bearing account. Assume that your bank uses compound interest on its line of credit loans. Suppose you need $19 million today and you repay it in 4 months. How much interest will you pay?

To end up with $19,000,000, you must borrow: Amount to borrow = $19,000,000/(1 - 0.02) Amount to borrow = $19,387,755.10 The total interest you will pay on the loan is: Total interest paid = $19,387,755.10(1.0063)4 - 19,387,755.10 Total interest paid =$493,207.85

Saunders Corp. has a book net worth of $13,950. Long-term debt is $2,850. Net working capital, other than cash, is $3,700. Fixed assets are $3,450 and current liabilities are $1,900. What is the value of the current assets?

We have Net working capital other than cash, so the total Net working capital is: Net working capital = $11,550+ 3,700 Net working capital = $15,250 We can find total current assets by using the Net working capital equation. Net working capital is equal to: Net working capital = Current asset - Current liabilities $15,250 = Current asset - $1,900 Current asset = $17,150

What is WACC?

Weighted Average Cost of Capital

The average of a firm's cost of equity and after tax cost of debt that is weighted based on the firm's capital structure is called the:

Weighted average cost of capital.

Contribution margin formula

variable costs/revenue

You are in charge of a project that has a degree of operating leverage of 1.09. What will happen to the operating cash flows if the number of units you sell increase by 6.2 percent?

%∆OCF = DOL * %∆Q = 1.09 * 6.2% = 6.76% increase

WACC formula

(E/V) × RE + (D/V) × RD × (1 − TC)

The length of time between the sale of inventory and the collection of the payment for that sale is called the:

Accounts receivable period

Which one of the following statements is correct concerning the relationship between a levered and an unlevered capital structure? Ignore taxes.

At the break-even point, there is no advantage to debt.

The operating cycle is the inventory period plus the receivables period. The inventory turnover and inventory period are: Inventory turnover = COGS/Average inventory Inventory turnover = $58,110/{[$9,254 + 11,358]/2} Inventory turnover =5.6385 times Inventory period = 365 days/Inventory turnover Inventory period = 365 days/5.6385 Inventory period = 64.73 days And the receivables turnover and receivables period are: Receivables turnover = Credit sales/Average receivables Receivables turnover = $90,871/{[$5,619 + 6,896]/2} Receivables turnover = 14.5219 times Receivables period = 365 days/Receivables turnover Receivables period = 365 days/14.5219 Receivables period = 25.13 days So, the operating cycle is: Operating cycle = 64.73 days + 25.13 days Operating cycle = 89.86 days

Calculate the operating cycle

Steve has estimated the cash inflows and outflows for his hardware store for next year. The report that he has prepared recapping these cash flows is called a:

Cash budget

Money deposited by a borrower with the bank in a low or non-interest-bearing account as a condition of a loan agreement is called a:

Compensating balance

Holdup Bank has an issue of preferred stock with a $6 stated dividend that just sold for $86 per share. What is the bank's cost of preferred stock?

Cost = D/P RP = $6/$86 = 0.0698 or 6.98%

At an output level of 30,000 units, you calculate that the degree of operating leverage is 2.10. If output rises to 36,900 units, what will the percentage change in operating cash flow be?

DOL = %∆OCF / %∆Q Solving for %∆OCF, we get %∆OCF = (DOL)(%∆Q) =2.10[(36,900 - 30,000)/30,000] =0.4830 or 48.30%

A project has the following estimated data: price = $71 per unit; variable costs = $29.11 per unit; fixed costs = $6,600; required return = 16 percent; initial investment = $14,000; life = three years. Ignore the effect of taxes. What is the degree of operating leverage at the financial break-even level of output?

DOL = 1 + (FC/OCF) = 1 + (6,600/6,233.61) = 2.0588

Which one of the following is the relationship between the percentage change in operating cash flow and the percentage change in quantity sold?

Degree of operating leverage

What does the D stand for in accounting break-even?

Depreciation = Initial Investment/years