Corp Finance - Part I
The capital structure weights used in computing a firm's weighted average cost of capital:
are based on the market values of the firm's debt and equity securities.
P.A. Petroleum just purchased some equipment at a cost of $67,000. The equipment is classified as MACRS 5-year property. The MACRS rates are .2, .32, .192, .1152, .1152, and .0576 for years 1 to 6, respectively. What is the proper methodology for computing the depreciation expense for year 2.
$67,000 x (1-.20) x .32
Stellar Plastics is analyzing a proposed project with annual depreciation of $19,500 and a tax rate of 34 percent. The company expects to sell 12,000 units, plus or minus 5 percent. The expected variable cost per unit is $3.20 plus or minus 4 percent, and the expected fixed costs are $30,000 plus or minus 2 percent. The sales price is estimated at $7.50 a unit, plus or minus 4 percent. What is the operating cash flow for a sensitivity analysis using total fixed costs of $31,000?
$20,226
The Lunch Counter is expanding and expects operating cash flows of $32,500 a year for seven years as a result. The expansion requires $28,000 in new fixed assets. These assets will be worthless at the end of the project. In addition, the project requires an initial investment of $2,800 in net working capital at the beginning of the project which will be recovered at the end of the project. What is the net present value of this expansion project at a required rate of return of 14 percent?
$109,688.89
The Fluffy Feather sells customized handbags. Currently, it sells 18,000 handbags annually at an average price of $89 each. It is considering adding a lower-priced line of handbags that sell for $59 each. The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so. What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags?
$146,000
Pre-Fab purchased some machinery two years ago for $337,600. These assets are classified as five-year property for MACRS. The MACRS rates are .2, .32, .192, .1152, .1152, .0576 for years 1 to 6, respectively. The company is currently replacing this equipment with newer models at a cost of $528,000. The old equipment is being sold for $149,000. What is the aftertax salvage value from this sale is the tax rate is 35 percent?
$153,566.80
You are working on a bid to build two apartment buildings a year for the next three years. This project requires the purchase of $1,089,000 of equipment that will be depreciated using straight-line depreciation to a zero book value over the project's life. The equipment can be sold at the end of the project for $815,000. You will also need $280,000 in net working capital over the life of the project. The fixed costs will be $528,000 a year and the variable costs will be $1,640,000 per building. Your required rate of return is 18 percent for this project and your tax rate is 35 percent. What is the minimal amount, rounded to the nearest $100, you should bid per building?
$2,116,200
Cool Comfort currently sells 300 Class A spas, 450 Class C spas, and 200 deluxe model spas each year. The firm is considering adding a mid-class spa and expects that if it does it can sell 375 of them. However, if the new spa is added, Class A sales are expected to decline to 225 units while the Class C sales are expected to decline to 200. The sales of the deluxe model will not be affected. Class A spas sell for an average of $12,000 each. Class C spas are priced at $6,000 and the deluxe model sells for $17,000 each. The new mid-range spa will sell for $8,000. What is the value of the erosion?
$2,400,000
A project has base-case earnings before interest and taxes of $11,444, fixed costs of $38,000, a selling price of $26 a unit, and a sales quantity of 14,200 units. All estimates are accurate withing a plus/minus range of 2 percent. Depreciation is $11,900. What is the base-case variable cost per unit?
$21.68
Dependable Motors just purchased some MACRS 5-year property at a cost of $216,000. The MACRS rates are .2, .32, and .192 for years 1 to 3, respectively. Which one of the following will correctly give you the book value of this equipment at the end of year 2?
$216,000 x (1-.2-.32)
At the accounting break-even point, Swiss Mountain Gear sell 22,940 ski masks at a price of $19 each. At this level of production, the depreciation is $67,000 and the variable cost per unit is $6. What is the amount of the fixed costs at this production level?
$231,220
A company is considering a project with a cash break-even point of 31,422 units. The selling price is $39 a unit, the variable cost per unit is $27, and deprecation is $14,000. What is the projected amount of fixed costs?
$377,064
The Daily Brew has a debt-equity ration of .64. The firm is analyzing a new project that requires an initial cash outlay of $420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs?
$456,328
LC Delivery has decided to sell 1,500 shares of stock through a Dutch auction. The bids received are as follows: 300 shares at $36 a share, 500 shares at $35, 1,000 shares a $34, 1,200 shares at $33, and 1,800 shares at $32 a share. How much will LC Delivery receive in total from selling the 1,500 shares? Ignore all transactions and flotation costs.
$51,000
Nelson Paints recently went public by offering 65,000 shares of common stock to the public. The underwriters provided their services in a best efforts underwriting. The offering price was set at $16 a share and the gross spread was $2. After completing their sales efforts, the underwriters determined that they sold a total of 57,500 shares. How much cash did Nelson Paints receive from its IPO?
$805,000
A project will produce an operating cash flow of $31,200 a year for 7 years. The initial fixed asset investment in the project will be $204,900. The net aftertax salvage value is estimated at $62,000 and will be received during the last year of the project's life. What is the net present value of the project if the required rate of return is 11 percent?
-$28,016.66
Wilson's Market is reviewing a project with sales of 6,200 units plus or minus 2 percent at a sales price of $29 plus or minus 1 percent per unit. The expected variable cost per unit is $11 plus or minus 3 percent and the expected fixed costs are $87,000 plus or minus 1 percent. The depreciation expense is $68,000 and the tax rate is 35 percent. What is the net income under the worst-case scenario?
-$32,674.93
ALUM, Inc. uses high-tech equipment to produce specialized aluminum products for its customers. Each one of these machines costs $1,520,000 to purchase plus an additional $48,000 a year to operate. The machines have a five-year life after which they are worthless. What is the equivalent annual cost of one these machines if the required return is 15.5 percent?
-$506,819.32
High Breeze currently produces boat sails and is considering expanding into awnings for homes and travel trailers. The company owns land that could be used for the expansion. This land was purchased fiveat a cost of $319,000 and is valued today at $395,000. The company has some unused equipment that it currently owns valued at $38,000. This equipment could be used for producing awnings if $12,000 is spent for equipment modifications. Other equipment costing $138,000 will also be required. What is the amount of the initial cash flow for this expansion project?
-$583,000
Richard has an outstanding order with his stock broker to purchase 1,000 shares of every IPO. The next three IPOs are each priced at $30 a share and will all start trading on the same day. Richard is allocated 1,000 shares of IPO A, 400 shares of IPO B, and 100 shares of IPO C. On the first day of trading IPO A opened at $31.50 a share and ended the day at $26 a share. IPO B opened at $31 a share and finished the day at $32 a share. IPO C opened at $36.50 a share and ended the day at $40.25 a share. What is Richard's total profit or loss on these three IPOs as of the end of the first day of trading?
-$75
A project has cash flows of -$152,000, $60,800, $62,300, and $75,000 for years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value?
1.02; accept
The Market Outlet is an all-equity financed firm with a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25?
13.94 percent
High Mountain Mining wants to expand its current operations and requires $2.7 million in additional funding to do so. After discussing this with key shareholders, the firm has decided to raise the necessary funds through a rights offering at a subscription price of $20 a share. The current market price of the firm's stock is $22.70 a share. How many shares of stock will the firm need to sell through the rights offering to fund the expansion plans? (Round up to the next whole share)
135,000
The Motor Plant wants to raise $28.6 million through a rights offering so it can modernize its facilities. The subscription price for the offering is set at $25 a share. Currently, the company has 2.6 million shares of stock outstanding at a market price of $29.50 a share. Each shareholder will receive one right for each share of stock they own. How many rights will a shareholder need to purchase one new share of stock in this offering?
2.27 rights
Steele Insulators is analyzing a new type of insulation for interior walls. The initial fixed asset requirement is $1.3 million, which would be depreciated straight-line to zero over the 12-year life of the project. Projected fixed costs are $314,800 and the anticipated operating cash flow is $206,300. What is the degree of operating leverage for this project?
2.53
A project has an initial cost of $6,700. The cash inflows are $850, $2,400, $3,300, and $4,100 over the next four years, respectively. What is the payback period?
3.04 years
Wear Ever is expanding and needs $12.6 million to help fund this growth. The firm estimates it can sell new shares of stock for $32.50 a share. It also estimates it will cost an additional $340,000 for filing and legal fees related to the stock issue. The underwriters have agreed to a 7.5 percent spread. How many shares of stock must Wear Ever sell if it is going to have $12.6 million available for its expansion needs?
397,543 shares
The outstanding bonds of Tech Express are priced at $989 and mature in 10 years. These bonds have a face value of $1,000, a coupon rate of 6 percent, and pay interest annually. The firm's tax rate is 35 percent. What is the firm's after tax cost of debt?
4.00 percent
Florida Groves has a $250,000 bond issue outstanding that is selling at 102 percent of face value. The firm also has 2,000 shares of preferred stock valued at $38 a share and 45,000 shares of common stock valued at $24 a share. What weight should be assigned to the preferred stock when computing the firm's weighted average cost of capital?
5.39 percent
The Downtowner has 950,000 shares of common stock outstanding valued at $38 a share along with 40,000 bonds selling for $1,020 each. What weight should be given to the debt when the firm computes its weighted average cost of capital?
53.06 percent
The Coffee Express has computed its fixed costs to be $.48 for every cup of coffee it sells given annual sales of 145,000 cups. The sales price is $1.29 per cup while the variable cost per cup is $.07. How many cups of coffee must it sell to break even on a cash basis?
57,049
Theresa's Flower Garden has 750 bonds outstanding that are selling for $989 each, 2,500 shares of preferred stock with a market price of $47 a share, and 30,000 shares of common stock valued at $56 a share. What weight should be assigned to the common stock when computing the firm's weighted average cost of capital?
66.16 percent
The Pet Market has $1,000 face value bonds outstanding with 18 years to maturity, a coupon rate of 9 percent, annual interest payments, and a current price of $835. What is the after tax cost of debt if the tax rate is 34 percent?
7.37 percent
Deep Hollow Markets has a target capital structure of 30 percent debt, 10 percent preferred stock, and 60 percent common stock. The flotation costs are 10.5 percent for common stock, 8.2 percent for preferred stock, and 5.8 percent for debt. The corporate tax rate is 35 percent. What is the weighted average flotation cost?
8.86 percent
Sweet Treats common stock is currently priced at $17.15 a share. The company just paid $1.22 per share as its annual dividend. The dividends have been increasing by 2.4 percent annually and are expected to continue doing the same. What is the firm's cost of equity?
9.68 percent
The articles of incorporation: I. Describe the purpose of the firm. II. Are amended periodically. III. Set forth the number of shares of stock that can be issued. IV. Detail the method that will be sued to elect corporate directors.
ANSWER: I and III only.
What is the definition of syndicate?
A group of underwriters sharing the risk of selling a new issue of securities.
Which of the following help convince managers to work in the best interest of the stockholders? Assume there are no golden parachutes. I. Compensation based on the value of the stock. II. Stock option plans. III. Threat of a company takeover. IV. Threat of a proxy fight.
ANSWER: I, II, III, IV.
What is the net present value of a project that has an initial cash outflow of $36,000 and cash inflows of $11,500, $21,700, $0, and $10,400 in Years 1 through 4, respectively? The required return is 15 percent.
ANSWER: -$3,945.45 (see Calculators NPV)
The relevant discount rate is 14 percent for a project with cash flows of -$9,800, $4,600, $3,300 and $3,800 for Years 0 to 3, respectively. What is the profitability index?
ANSWER: .93 (See Calculators Profitability Index)
Which one of the following terms is defined as a conflict of interest between the corporate shareholders and the corporate managers?
Agency problem.
Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm's overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:
Assign appropriate, but differing discount rates to each project and then select the projects with the high net present values.
Which of the following statements is generally correct?
Auction markets match buy and sell orders.
Which one of the following best describes pro forma financial statements?
Financial statements showing projected values for future time periods.
Mutually exclusive projects are best defined as competing projects that:
Both require the total use of the same limited resource.
Which one of the following is a key goal of the aftermarket period?
Supporting the market price for a new securities issue.
The operating cash flow of a cost-cutting project:
Can be positive even though there are no sales.
Tedder Mining has analyzed a proposed expansion project and determined that the internal rate of return is lower than the firm desires. Which one of the following changes to the project would be most expected to increase the project's internal rate of return?
Condensing the firm's cash inflows into fewer years without lowering the total amount of those inflows.
A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?
Cost of equity
When a firm announces an upcoming seasoned stock offering, the market price of the firm's existing shares tends to:
Decrease
Which one of these is a working capital management decision?
Determining the minimum level of cash to be kept in a checking account
Which one of the following is a working capital management decision?
Determining whether to pay cash for a purchase or use the credit offered by the supplier.
Roy owns 200 shares of R.T.F., Inc. He has opted not to participate in the current rights offering by this firm. As a result, Roy will most likely be subject to:
Dilution
Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm is currently considering making handmade wreaths as well. Which one of the following is the best example of an incremental operating cash flow related to the wreath project?
Hiring additional employees to handle the increased workload should the firm accept the wreath project.
Which one of the following is an agency cost?
Hiring outside accountants to audit the company's financial statements?
Which of the following are cash flows from a corporation into the financial markets?
I. Repayment of long-term debt. III. Payment of loan interest. IV. Payment of quarterly dividend.
In actual practice, managers most frequently use which two types of investment criteria?
IRR and NPV
Forecasting risk is defined at the possibility that:
Incorrect decisions will be made due to erroneous cash flow projections.
Which one of the following best illustrates that the management of a firm is adhering to the goal of financial management?
Increase in the market value per share.
Sally and Alicia currently are general partners in a business located in Atlanta, Georgia. They are content with their current tax situation but are both very uncomfortable with the unlimited liability to which they are each subjected. Which form of business entity should they consider to replace their general partnership assuming they wish to remain the only two owners of their business? Whichever organization they select, they wish to be treated equally.
Limited liability company.
Decisions made by financial managers should primarily focus on increasing which one of the following?
Market value per share of outstanding stock
Which one of the following best states the primary goal of financial management?
Maximize the current value per share.
Southern Chicken is considering two projects. Project A consists of creating an outdoor eating area on the unused portion of the restaurant's property. Project B would use that outdoor space for creating a drive-thru service window. When trying to decide which project to accept, the firm should rely most heavily on which one of the following analytical methods?
Net present value
You are considering two mutually exclusive projects. Project A has cash flows or -$87,000, $32,600, $35,900, and $43,400 for years 0 to 3, respectively. Project B has cash flows of -$85,000, $14,700, $21,200, and $89,800 for years 0 to 3, respectively. Project A has a required return of 9 percent while Project B;s required return is 11 percent. Which project(s), if either, should you accept based on net present value?
Reject Project A and accept Project B
The Securities and Exchange Commission:
Reviews registration statements to ensure they comply with current laws and regulations.
Shareholder A sold shares of Maplewood Cabinets stock to Shareholder B. The stock is listed on the NYSE. This trade occurred in which one of the following?
Secondary, auction market.
Lamar has been experimenting in his garage and now has a product he feels could be successfully marketed. A venture capitalist has offered to finance the development of this product until it reaches the manufacturing and marketing stage. Which type of financing is being offered?
Seed money
An analysis that combines scenario analysis with sensitivity analysis is called _______________ analysis.
Simulation
Which one of the following characteristics applies to a limited liability company?
Taxed similar to a partnership.
A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project?
The cash flow in year two is valued just as highly as the cash flow in year one.
You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 104, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information?
The discount rate used in computing the net present value was less than 11.63 percent.
The bid price always assumes which one of the following?
The net present value of the project is zero.
Which one of the following statements concerning a sole proprietorship is correct?
The owner of a sole proprietorship is personally responsible for all of the company's debts.
If a project has a net present value equal to zero, then:
The project earns a return exactly equal to the discount rate.
Which one of the following statements concerning venture capital financing is correct?
Venture capitalists often require at least a 40 percent equity position as a condition of financing.
The equivalent annual cost method is useful in determining:
Which one of two machines should be purchased when the machines are mutually exclusive, have different lives, and will be replaced at the end of their lives.
You are considering an investment that costs $152,000 and has projected cash flows of $71,800, $86,900, and -$11,200 for years 1 to 3, respectively. If the required rate of return is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?
You cannot apply the IRR rule in this case.
When the operating cash flow of a project is equal to zero, the project is operating at the:
cash break-even point.
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.
Brubaker & Goss has received requests for capital investment funds for next year from each of its five divisions. All requests represent positive net present value projects. All projects are independent. Senior management has decided to allocate the available funds based on the profitability index of each project since the company has insufficient funds to fulfill all of the requests. Management is following a practice known as:
soft rationing
Uptown Promotions has three divisions. As part of the planning process, the CFO requested that each division submit its capital budgeting proposals for next year. These proposals represent positive net present value projects that fall within the long-range plans of the firm. The requests from the divisions are $4.2 million, $3.1 million, and $6.8 million, respectively. For the firm as a whole, the management of Uptown Promotions has limited spending to $10 million for new projects next year. This is an example of:
soft rationing.
The flotation cost for a firm is computed as:
the weighted average of the flotation costs associated with each form of financing.
