221-f2005-ex2-sol
7 Pages

221-f2005-ex2-sol

Course Number: BUS 221, Fall 2009

College/University: Charleston Law

Word Count: 1088

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R: n: g: PVIFGA: FVIFGA: NI/S: TA/S: D/E: R: g*: 10.0% 10 0.0% 6.14 15.94 0.14 4 3 0.79 12.36% APR: m: EAR: #DIV/0! EBIT T D E ROIC 34 35.00% 100 100 11.05% Scores Problem 1: Problem 2: Problem 3: Problem 4: Problem 5: Problem 6: Total: 0 0 0 0 0 0 0 1. [30 points total] You are evaluating a company that has the income statement and balance sheet shown below. You believe the company's Sales will grow at 10%...

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n: R: g: PVIFGA: FVIFGA: NI/S: TA/S: D/E: R: g*: 10.0% 10 0.0% 6.14 15.94 0.14 4 3 0.79 12.36% APR: m: EAR: #DIV/0! EBIT T D E ROIC 34 35.00% 100 100 11.05% Scores Problem 1: Problem 2: Problem 3: Problem 4: Problem 5: Problem 6: Total: 0 0 0 0 0 0 0 1. [30 points total] You are evaluating a company that has the income statement and balance sheet shown below. You believe the company's Sales will grow at 10% next year. You also believe that the company's core efficiencies will not change from its current state. (a) [16 points] Forecast the company's income statement and balance sheet for next year. (b) [4 points] How much additional long-term financing must the company raise so that it can grow Sales by 10%? (c) [10 points] Would the company prefer to issue additional debt or additional equity if it wants to grow Sales by 10% next year? Justify your answer. SCORE: Last Year Next Year Sales $100.00 $110.00 Costs $66.00 $72.60 Interest $18.00 $18.00 Taxable Income $16.00 $19.40 Taxes $5.60 $6.79 Net Income $10.40 $12.61 Dividends $7.00 $8.49 Retained Earnings $3.40 $4.12 Current Assets $30.00 Net PPE $170.00 Total Assets $200.00 Long-Term Debt $100.00 Equity $100.00 Total L&E $200.00 External Financing Required $33.00 $187.00 $220.00 $100.00 $104.12 $204.12 $15.88 Answer: EBIT T D E ROIC Rd Rd(1-T) $34.00 0.35 $100.00 $100.00 11.05% 0.18 11.70% (a) See left. (b) $15.88 (c) ROIC < after-tax interest rate on debt. The company would therefore prefer equity to debt. 2. [14 points total] A straight bond has a face value of $1,000, pays 8% annual coupons, and has 10 years to maturity. The bond currently sells for $1,060. (a) [6 points] What is the yield-to-maturity of the bond? (b) [4 points] Suppose that another bond is identical to the straight bond except that it is convertible. What can you conclude about the yield-to-maturity on that bond? (For example, could you conclude that the yield must be above some specific rate?) BRIEFLY explain. (c) [4 points] Suppose that another bond is identical to the straight bond except that it is callable. What can you conclude about the yield-tomaturity on that bond? BRIEFLY explain. SCORE: (a) 7.14% (b) The convertible bond would have a yield-to-maturity that is less than 7.14%. Investors would be willing to accept a lower yield because they might benefit from converting the bond at a later date. (b) The callable bond would have a yield-to-maturity that is greater than 7.14%. Investors would require a higher yield so that they would be compensated for the risk they face that the bond might be called. This would only occur when the bond cash flows are worth more than the call price, so the call provision can only hurt investors. ytm: value: 7.14% $1,060.01 3. [10 points] A straight bond has a face value of $1,000, pays 7% coupons (paid semi-annually), has 8 years to maturity, and has a yield-tomaturity of 11%. What is the value of the bond today? SCORE: Value: $790.76 4. [12 points] An oil producer is relatively certain that it will be able to sell 20 million barrels next year, and believes that it might be able to sell another 5 million barrels. Suppose that the producer wants to hedge the price risk it faces on its production. What specific strategy/strategies do you recommend? BRIEFLY explain your logic. SCORE: The company could sell 20 million barrels forward and buy put options on 5 million barrels, both with maturities next year. Because the 20 million barrels of production is relatively certain, the company can completely hedge the risk using forwards. The producer would not want to use forwards to hedge the 5 millions barrels because it is uncertain. If forwards were used and for some reason the company did want not to produce those barrels, it would be obligated to trade under the forward contract. Hence, the forward contract could create price risk rather than reduce it. 5. [14 points total] The most recent annual income statement and balance sheet for a company are shown below. Assume that you expect the financial condition of the company to remain relatively unchanged over the coming years. (a) [6 pts] What is your best estimate of the level of maximum level of growth the company can generate without improving efficiency, issuing new equity, or changing its capital structure? (b) [8 pts] Suppose that company managers do not believe that there is sufficient demand for their products to support that level of growth. BRIEFLY discuss how the company's financial statements are likely to change over the coming years. [Note: a general discussion is all you need. You need not get into specific predictions concerning individual accounts]. SCORE: (a) NI/S = 0.14; TA/S = 4; D/E = 3; R = 11/14 = 0.7857 g* = 12.36% (b) If the company cannot generate 12.36% sales growth, the basic assumptions behind sustainable growth must change in some way. One or more of the following must happen: (1) the profit margin must decrease (the company might choose to invest more in R&D, for example), (2) the asset turnover must decrease (the company might choose to hold more cash, for example), (3) the company must retain more earnings, (4) the company must change its capital structure (the company might buy back shares or repay debt, for example). Income Statement Sales $100 Cost of Sales $45 SG&A Expenses $25 Depreciation $5 Interest $5 Taxable Income $20 Taxes $6 Net Income $14 Dividends $3 Retained Earnings $11 0.79 Balance Sheet Current Assets $100 Net Fixed Assets $300 Current Liabilities Long-Term Debt Equity $150 $150 $100 6. [20 points total] Today is April 30. Your task is to prepare and evaluate a cash budget for a company that sells boating equipment. Selected XX. [XX points total] balance sheet items for the company are shown below, as are the company's Sales forecasts for the next few months. In addition, note that the company buys nothing on credit, but sells half of its goods for cash, 30% on receivables to be paid in one month, and 20% on receivables to be paid in two months. Finally, note that each month, the company purchases precisely the amount of inventory it expects to sell during the following month. The gross margin on goods is 50%. (a) Prepare an initial cash budget. (b) Analyze that cash budget and make recommendations for changes. [Note that there is no need to redo the cash budget. Just explain your recommendations]. SCORE: May Cash Receivables due in May due in June Inventory $200 $75 $75 $250 Sales (cash) (1 mo rec) (2 mo rec) Receipts Expenses Inventory Disbursements Current Assets Cash Receivables Inventory Current Liabilities Payables June July August $1,000 $2,200 $1,600 $800 $500 $1,100 $800 $400 $300 $660 $480 $240 $200 $440 $320 $160 $575 $1,475 $1,660 $1,320 Sales Forecast May $1,000 June $2,200 July $1,600 August $800 $1,100 $1,100 $800 $800 $400 $400 -$325 $575 $850 $350 $1,300 $550 $1,610 $1,240 $150 (a) See left. (b) The inventory level looks quite low at the end of July. If sales are higher than expected in July, the company could lose sales by not having enough inventory available. This suggests that the company should acquire more inventory in July and perhaps less in later months when sales are expected to be lower. The cash budget shows that the company will have a cash deficit in May and a large surplus in July. This suggests that the company should arrange a short term (2 month) loan to cover the expected deficit. $0 $0 $0
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