Final Bus314

. How much debt is outstanding in a firm that has calculated the present value of a perpetual tax shield to be $300,000 if the tax rate is 35% and the debt carries a 10% rate of return?

$300,000 = (D × 0.35 ×10%)/10%; D = $857,143

What is the after-tax cost to a corporation in the 35% tax bracket of paying $50,000 in preferred stock dividends?

$50,000. Dividends are paid out of after-tax income.

What proportion of a firm is equity financed if the WACC is 14%, the before-tax cost of debt is 10.77%, the tax rate is 35%, and the required return on equity is 18%?

0.14 = (1 - x)(10.77%)(1 - 0.35) + x(18%); x = 63.64%

How much should an investor pay now for a stock expected to sell for $30 one year from now if the stock offers a $2 dividend, dividends are taxed at 40%, capital gains are taxed at 20%, and a 15% after-tax return is expected on the investment?

0.15 = [$2 × (1 - 0.40)]/P0 + [($30 - P0)/P0](1 - 0.20); P0 = $26.53

What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes

0.24 = 0.16 + D/E (0.16 - 0.12); D/E = 2 Debt financing % = 2/(2 + 1) = 0.667, or 66.7%

How much will a firm need in cash flow before tax and interest to satisfy debtholders and equityholders if the tax rate is 40%, there is $10 million in common stock requiring a 12% return, and $6 million in bonds requiring an 8% return?

2,480,000

A planner's percentage of sales model forecasts that sales will grow by 20% next year. If costs of goods sold are proportionate at 70% of sales, then what is the growth rate of costs of goods sold?

20% in dollar terms.

A firm currently has operating income of $4 million, interest expense of $2 million, and EPS of $2. How low can operating income drop before EPS are reduced by half, to $1? Ignore taxes

3m

. At what point does a customer's unpaid account become delinquent when the terms of sale are 2/10, net 60?

61 days after the sale

A firm has projected sales of $328,000, costs of goods sold equal to 68% of sales, interest of $18,500, a tax rate of 35%, and a dividend payout ratio of 60%. What will be the addition to retained earnings?

Add to RE = ({[$328,000(1 - 0.68)] - $18,500} × (1 - 0.35)) × (1 - 0.60) = $22,480

How much will be recorded as a firm's additional paid-in capital if the firm issues 1 million shares that have a $5 par value for $15 per share?

Additional paid-in capital = 1m($15 - 5) = $10m

Compare the after-tax returns for a corporation that invests in preferred stock with a 12% dividend versus a common stock with no dividend but a 16% capital gain. The corporation's tax rate is 35%. The:

After-tax returns: RP = 0.12 - (0.12 × 0.30 × 0.35) = 0.1074, or 10.74% RC = 0.16(1 - 0.35) = 0.1040, or 10.40% Difference = 10.74% - 10.40 = 0.34%

What is the amount of the annual interest tax shield for a firm with $3 million in debt that pays 12% interest if the firm is in the 35% tax bracket?

Annual interest tax shield = 0.12 × $3m × 0.35 = $126,000

What is the book value per share of equity for a firm with $1 million in net common equity, $50,000 in authorized share capital, 25,000 shares issued, and 20,000 shares outstanding?

Book value per share = $1m/20,000 = $50

For the period, a firm collected $38,200 on accounts receivable, paid $19,700 to suppliers on trade credit, paid $12,000 in cash expenses, purchased for cash a $42,000 piece of equipment that will be depreciated straight-line to zero over 4 years, and had $59,000 of sales of which 15% were cash sales. The firm also paid $13,500 in taxes and interest. The beginning cash balance was $11,300. How much must the firm borrow if it wishes to maintain a minimum cash balance of $10,000?

Cash balance = $11,300 + 38,200 - 19,700 - 12,000 - 42,000 + (0.15 × $59,000) - 13,500 - 10,000 = -$38,850; Thus, the firm needs to borrow $38,850.

What is the cash conversion cycle for a firm with $3 million average inventories, $1.5 million average accounts payable, a receivables period of 40 days, and an annual cost of goods sold of $18 million?

Cash conversion cycle = $3m/($18m/365) + 40 - $1.5m/($18m/365) = 70.42 days

A company's CFO wants to maintain a target debt-to-equity ratio of 1/4. If the WACC is 18.6%, and the pretax cost of debt is 9.4%, what is the cost of common equity assuming a tax rate of 34%?

D/V = 1/5 and E/V = 4/5; 0.186 = 1/5(0.094)(1 - 0.34) + 4/5(re); re = 21.70

. Assume a firm is financed with 60% debt on which it pays 7%. What is the expected return on equity if the expected return on assets is 12%?

E(Re) = 0.12 + [0.60/(1 - 0.60)](0.12 - 0.07) = 0.1950, or 19.50%

Assume a firm is financed with 30% debt on which it pays 9%. What is the expected return on equity if the expected return on assets is 14%?

E(Re) = 0.14 + [0.30/(1 - 0.30)](0.14 - 0.09) = 0.1614, or 16.14%

. A firm sells its $1,000,000 of receivables to a factor for $960,000. What is the effective annual rate on this arrangement if the average collection period is one month?

EAR = [1 + ($1m - 960,000)/960,000]^12 - 1 = 0.6321, or 63.21%

What effective annual rate of interest is being charged to a customer who is granted credit terms of 3/15, net 45 when the customer foregoes the discount and pays on the last date prior to being delinquent?

EAR = [1 + (0.03/(1 - 0.03))]365/(45 - 15) - 1 = 0.4486, or 44.86%

With terms of 4/15, net 60, what is the implied interest rate for forgoing a cash discount and paying at the end of the credit period?

EAR = [1 + (0.04/(1 - 0.04))]365/(60 - 15) - 1 = 0.3925, or 39.25%

If a firm uses external financing as a plug item, has a new capital budget of $2 million, a net income of $3 million, and a plowback ratio of 40%, how much should be raised in external funds?

EFN = $2m - ($3m × 0.40) = $800,000

A firm is expected to generate $1.5 million in operating income and pay $250,000 in interest. Ignoring taxes, this will generate $12.50 earnings per share. What will happen to EPS if operating income increases to $2.0 million?

EPS: $17.50

A firm had $2,800 cash at the beginning of the period. During the period, the firm collected $1,600 in receivables, paid $1,850 to supplier, had credit sales of $4,200, and incurred cash expenses of $2,300. What was the cash balance at the end of the period?

Ending cash - $2,800 + 1,600 - 1,850 - 2,300 = $250

A firm has current assets of $1.2 million, fixed assets of $3.6 million, and debt of $2.2 million. There are 250,000 shares of stock outstanding. What will be the book value of equity if the firm repurchases 10% of its outstanding shares for $10.40 a share?

Equity = $1.2m + 3.6m - 2.2m - (0.10 × 250,000 × $10.40) = $2,340,000

. If the pro forma balance sheet shows that total assets must increase by $400,000 while retaining a debt-equity ratio of 0.75, then what is the change of debt?

Increase in debt = $400,000 × 0.75/(0.75 + 1) = $171,429

Assume a corporation has cumulative voting and there are two directors up for election. What is the maximum number of votes a shareholder who owns 100 shares can cast for Candidate Jones if there are a total of 5 candidates?

Maximum votes = 100 × 2 = 200 votes

A firm has $4 million in total assets and $2.2 million in equity. How much of its $500,000 capital budget should be debt-financed to retain the same debt-equity ratio?

New debt = $500,000 × ($4m - 2.2)/$4m = $225,000

. What is the new share price for a corporation with a current share price of $4 that employs a 2-for-9 reverse split?

New price = 9/2 × $4 = $18

A firm has perpetual debt of $10 million at an interest rate of 7%. What is the present value of the interest tax shield if the tax rate is 35%?

PV tax shield = (0.07 × $10m × 0.35)/0.07 = $3.5m

Which will happen to the one-year after-tax return on the following stocks, assuming a 40% tax rate on dividends and a 20% tax rate on capital gains: Stock A is purchased for $50, offers a 5% dividend yield, and is sold for $56; stock B is purchased for $60, offers no dividend yield, but is sold after one year for $70.

RA = [0.05 × $50 × (1 - 0.40)]/$50 + [($56 - 50)/$50] (1 - 0.20) = 0.1260, or 12.60% RB = [($70 - 60)/$60] (1 - 0.20) = 0.1333, or 13.33% Difference = 13.33% - 12.60 = 0.73%

A firm that is located in New York receives on average 2,000 checks a day from its customers in the Twin Cities area. Average payment per check is $1,500. A bank in the Twin Cities is offering a lock-box arrangement for collection and processing of these checks at a cost of $0.50 per check. This arrangement will reduce the float by 2 days. The daily interest rate for the firm is 0.02%. What is the net saving from the lock-box arrangement?

Reduction in float = 2,000 × $1,500 × 2 days = $6m Daily interest savings = $6m × 0.0002 = $1,200 Daily processing cost = $0.50 × 2,000 = $1,000 Net daily savings = $1,200 - 1,000 = $200

Calculate the rate at which a firm can grow without changing its leverage if its payout ratio is 70%, equity outstanding at the beginning of the year is $940,000, and its net income for the year is $162,000.

Sustainable growth rate = (1 - 0.70) × ($162,000/$940,000) = 0.0517, or 5.17%

What tax liability is created by the receipt of $50,000 in preferred stock dividends by a corporation in the 35% tax bracket?

Tax liability = $50,000 × 0.30 × 0.35 = $5,250

A firm sells a product that it realizes is short-lived and thus the firm plans to close after 2 more years. The firm expects to have free cash flows of $398,000 next year and $211,000 in Year 2 after incurring the costs of closing. The firm's cost of equity is 14% and its cost of debt is 5.5%. What is the present value of the firm if its debt to value ratio is 40%?

WACC = 0.4(5.5%) + (1 - 0.4)(14%) = 10.6% PV = $398,000/1.106 + $211,000/1.106^2 = $532,349

The weighted-average cost of capital for a firm with a 65/35 debt/equity split, 8% pre-tax cost of debt, 15% cost of equity, and a 35% tax rate would be:

WACC = [0.65 × .08 × (1 - 0.35)] + (0.35 × 0.15) = 0.0863, or 8.63%

. A firm has 12,000 shares of common stock outstanding with a book value of $20 per share and a market value of $39. There are 5,000 shares of preferred stock with a book value of $10 and a market value of $26. There is a $400,000 face value bond issue outstanding that is selling at 87% of par. What weight should be placed on the preferred stock when computing the firm's WACC?

Weight of preferred = (5,000 × $26) / [(12,000 × $39) + (5,000 × $26) + ($400,000 × 0.87)] = 0.1374, or 13.74%

The yield-to-maturity of a firm's bond is 8.5%. The firm has a beta of 1.3 and a tax rate of 34%. The market risk premium is 8.4% and the risk-free rate is 3.8%. What is the firm's WACC if the firm has a capital structure that is 40% debt financed?

re = 3.8% + 1.3(8.4%) = 14.72% WACC = (1 - 0.40)(0.1472) + 0.40(.085)(1 - 0.34) = 0.1108, or 11.08%

. A firm paid out a dividend of $700,000 and repaid $1,000,000 of 6-month notes payable. The net effect of these transactions on the firm's net working capital is a decrease of $___:

ΔNWC = -($700,000 + 1m)(decreases in cash) + 1m(decrease in current liabilities) = -$700,000