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Unformatted text preview: Arvo Corporation is trying to choose between three alternative investments. The three securities that the company is considering are as follows: · · · Tax-free municipalThe XYZ Corporation has of 8.8%. bonds with a return Wooli Corporation $1000,000 which it plans of 11.75%. bonds with a return to invest in marketable CFI Corp. preferred stock with a return of 8.5%. securities. The corporation 1. The XYZ Corporation has is choosing between the The company’s tax rate is 34%. What is the after-tax return on $1000,000 which it plans to following three equally invest in marketable securities. risky securities: Greenville The corporation is choosing County tax­free municipal Amount Tax bonds yielding 7 percent; between the following three PT Return Taxable Rate AB corp. bonds yielding equally risky securities: Muni Bond 8.80% 0% 34% 11.5 percent; XZ corp. Greenville County tax­free Corp Bond 11.75% 100% 34% preferred stock with a municipal bonds yielding 7 P. Stock (Div) 8.50% 30% 34% dividend yield of 10 percent; AB corp. bonds percent. XYZ's corporate yielding 11.5 percent; XZ corp. preferred stock with a dividend tax rate is 35 percent. What is the after­tax yield of 10 percent. XYZ's return on the best corporate tax rate is 35 percent. What is the after­tax investment alternative? return on the best investment (Assume the company chooses on the basis of alternative? (Assume the the best investment alterna AT Return 8.800% 7.755% 7.633% company chooses on the basis after­tax returns.) (Points: of after­tax returns.) 20) · Tax-free municipal bonds with a return of 7%. · AB bonds with a return of 11.5%. · XZ Corp. preferred stock with a return of 10%. The company’s tax rate is 35%. Amount Taxable PT Return Muni Bond AB Corp Bond XZ P. Stock (Div) 7.00% 11.50% 10.00% Tax Rate 0% 35% 100% 35% 30% 35% AT Return 7.000% 7.475% 8.950% municipal bonds yielding 8 percent; Ford bonds yielding 11.5 percent; GE preferred stock with a dividend yield of 12 percent. ABC's corporate tax rate is 35 percent. What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of aftertax returns.) · Tax-free municipal bonds with a return of 8%. · Wooli Corporation bonds with a return of 11.5%. · CFI Corp. preferred stock with a return of 12%. The company’s tax rate is 35%. What is the after-tax return on the best investment alterna The XYZ Corporation has PT $1000,000 which it plans to invest Muni Bond in marketable securities. The Corp Bond corporation is choosing between the following three equally risky P. Stock (Div) securities: Greenville County tax­ free municipal bonds yielding 7 percent; AB corp. bonds yielding 11.5 percent; XZ corp. preferred After­tax returns stock with a dividend yield of 10 percent. XYZ's corporate tax rate is 35 percent. What is the after­ tax return on the best investment alternative? (Assume the company chooses on the basis of after­tax returns.) (Points: 20) Amount Taxable Return 8.00% 11.50% 12.00% Tax Rate 0% 35% 100% 35% 30% 35% AT Return 8.000% 7.475% 10.740% est investment alternative? 4.0250000% 7.4750000% 1.0500000% 8.9500000% est investment alternative? 1. Bond value ­ semiannual payment Assume that you wish to purchase a 20­year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? d. $828 Bond value ­ semiannual payment Financial calculator solution: Inputs: N = 40; I = 5; PMT = 40; FV = 1,000. Output: PV = ­$828.41; VB÷ $828. Assume that you wish to purchase a 10­year bond that has a maturity value of $1,000 and makes semiannual interest payments of $50. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? Bond value ­ semiannual payment Assume that you wish to purchase a 20­year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? ($828.41) ($1,000.00) ($828.41) 1. Constant growth stock The last dividend paid by ABC Company was $2.00. ABC’s growth rate is expected to be a constant 4 percent. ABC's required rate of return on equity (ks) is 9 percent. What is the current price of ABCs common stock? D 0 = g = r s = P 0 = $2.00 4% 9.0% D 1 ( r s - g ) = D 0 (1+g) ( r s - g ) = D 0 (1+g) ( r s - g ) P 0 = $41.60 1. Constant growth stock The last dividend paid by XYZ Company was $1.00. XYZs growth rate is expected to be a constant 5 percent. XYZ's required rate of return on equity (ks) is 10 percent. What is the current price of XYZ's common stock? D 0 = $1.00 g = 5% r s = 10.0% P 0 = D 1 ( r s - g ) P 0 = $21.00 Constant growth stock The last dividend paid by Klein Company was $1.00. Klein's growth rate is expected to be a constant 4 percent. Klein's required rate of return on equity (ks) is 12 percent. What is the current price of Klein's common stock? D 0 = $1.00 g = 4% r s = 12.0% P 0 = D 1 ( r s - g ) = P 0 = $13.00 = $2.0800 0.0500 = $1.0500 0.0500 D 0 (1+g) ( r s - g ) = $1.0400 0.0800 1. As the director of capital budgeting for Bingo Corporation, you are evaluating two mutually exclusive projects with the following net cash flows: Cash flows A B ($150,000) ($225,000) 1 $55,000 $85,000 2 $70,000 $55,000 3 $70,000 $65,000 4 $75,000 $55,000 5 $80,000 $65,000 Panel B: Summary of Select If Bingo Corporation's cost of capital is 10 percent, defend which project would you choose. Year (t) 0 1 2 3 4 Cash flow X ($100,000) 25,000 30,000 30,000 25,000 Cash flow Y ($125,000) 25,000 35,000 35,000 35,000 5 30,000 45,000 Figure 11-1: Net Cash Flows and Selected Evaluation Criteria for Proje Project cost of capital = r = 15% Panel B: Summary of Selected Evaluation Criterion Project X $93,358.06 ­$6,641.94 Y $113,601.54 ­$11,398.46 1. 8.NPV As the director of capital budgeting for ABC Corporation, you are evaluating two mutually exclusive projects with the Cash Flows A B ($200,000) ($125,000) 1 $65,000 $60,000 2 $60,000 $40,000 3 $50,000 $40,000 4 $65,000 A $211,136.38 $11,136.38 $35,000 5 $50,000 $45,000 If ABC Corporation's cost of capital is 12 percent, defend which project would you choose. Cash flows 1 2 3 4 5 A ($150,000) $55,000 $70,000 $70,000 $75,000 $80,000 B ($225,000) $85,000 $55,000 $65,000 $55,000 $65,000 If Bingo Corporation's cost of capital is 10 percent, defend which project would you choose. $261,342.99 $111,342.99 Project cost of capital = r = 10% l B: Summary of Selected Evaluation Criterion Cash Flow X $261,342.99 $111,342.99 tion Criteria for Projects S and L (CFt) xclusive projects with the following net cash flows: Y $249,488.36 $24,488.36 B $161,707.73 $36,707.73 $249,488.36 $24,488.36 Cash Flow X Y 261342.99 ### 111342.99 24488.36 1. Cash budget XYZ Corporation's budgeted monthly sales are $4,500. Forty percent of its customers pay in the first month and take the 1 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. XYZ’s bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,200. Other payments for wages, rent, and taxes are constant at $800 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for XYZ Corporation? Input Data Collections during month of sale Collections during 2nd month after Discount on first month collections Purchases as a % of next month's sa wages, rent, taxes Target cash balance Sales adjustment factor THE CASH BUDGET Collections and purchases worksheet Sales (gross) Collections During month of sale During second month after sale Total collections Purchases 1500 of next months sales Payments on last month's purchases Cash gain or loss for month Collections Payments for purchases Wages and salaries Total payments Net cash gain (loss) during month 1. XYZ Corporation's budgeted monthly sales are $4,500. Forty percent of its customers pay in the first month and take the 1 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. XYZ’s bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,200. Other payments for wages, rent, and taxes are constant at $800 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for XYZ Corporation? Input Data Collections during month of sale Collections during 2nd month after Discount on first month collections Purchases as a % of next month's sa wages, rent, taxes THE CASH BUDGET Collections and purchases worksheet Sales (gross) Collections During month of sale During second month after sale Total collections Purchases 1500 of next months sales Payments on last month's purchases Cash gain or loss for month Collections Payments for purchases Wages and salaries Total payments Net cash gain (loss) during month ABC Corporation's budgeted monthly sales are $4,000. Forty percent of its customers pay in the first month and take the 3 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. ABC's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $2,000. Other payments for wages, rent, and taxes are constant at $500 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for ABC Corporation? ABC Corporation's budgeted monthly sales are $4,000. Forty percent of its customers pay in the first month and take the 3 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. ABC's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $2,000. Other payments for wages, rent, and taxes are constant at $500 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for ABC Corporation? (Points: 20) Input Data Collections during month of sale Collections during 2nd month after Discount on first month collections Purchases as a % of next month's sa wages, rent, taxes THE CASH BUDGET Collections and purchases worksheet Sales (gross) Collections 1552 During month of sale During second month after sale Total collections Purchases 1500 of next months sales Payments on last month's purchases Cash gain or loss for month Collections Payments for purchases Wages and salaries Total payments Net cash gain (loss) during month Cash budget ABC Corporation's budgeted monthly sales are $4,000. Forty percent of its customers pay in the first month and take the 3 percent discount. The remaining 60 percent pay in the month following the sale and don't receive a discount. ABC's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $2,000. Other payments for wages, rent, and taxes are constant at $500 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for ABC Corporation? (Points: 20) ollections during month of sale 40% Assumed constant. Don't change. ollections during 2nd month after sale iscount on first month collections urchases as a % of next month's sales ages, rent, taxes 60% Allow this value to change to reflect slower collections. 3% $2,000 $500 arget cash balance ales adjustment factor $10 0.00 HE CASH BUDGET May ollections and purchases worksheet ales (gross) August September October November $4,000 $4,000 $4,000 $4,000 uring month of sale uring second month after sale 1552 $2,400 1552 $2,400 1552 $2,400 1552 $2,400 1552 $2,400 otal collections $3,952 $3,952 $3,952 $3,952 $3,952 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 ayments for purchases ages and salaries otal payments $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 et cash gain (loss) during month $1,452 $1,452 $1,452 $1,452 $1,452 ayments on last month's purchases $4,000 July $4,000 500 of next months sales $3,000 June $2,000 ash gain or loss for month ollections during month of sale 40% Assumed constant. Don't change. ollections during 2nd month after sale iscount on first month collections urchases as a % of next month's sales ages, rent, taxes HE CASH BUDGET 60% Allow this value to change to reflect slower collections. 1% $1,200 $800 May ollections and purchases worksheet ales (gross) August September October November $4,500 $4,500 $4,500 $4,500 uring month of sale uring second month after sale 1782 $2,700 1782 $2,700 1782 $2,700 1782 $2,700 1782 $2,700 otal collections $4,482 $4,482 $4,482 $4,482 $4,482 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 ayments for purchases ages and salaries otal payments $4,482 1200 $800 $2,000 $4,482 1200 $800 $2,000 $4,482 1200 $800 $2,000 $4,482 1200 $800 $2,000 $4,482 1200 $800 $2,000 et cash gain (loss) during month $2,482 $2,482 $2,482 $2,482 $2,482 ayments on last month's purchases $4,500 July $4,500 500 of next months sales $4,500 June $1,200 ash gain or loss for month ollections during month of sale 40% Assumed constant. Don't change. ollections during 2nd month after sale iscount on first month collections urchases as a % of next month's sales ages, rent, taxes HE CASH BUDGET 60% Allow this value to change to reflect slower collections. 3% $2,000 $500 May ollections and purchases worksheet ales (gross) August September October November $4,000 $4,000 $4,000 $4,000 uring month of sale uring second month after sale 1552 $2,400 1552 $2,400 1552 $2,400 1552 $2,400 1552 $2,400 otal collections $3,952 $3,952 $3,952 $3,952 $3,952 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 $2,000 ayments for purchases ages and salaries otal payments $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 $3,952 2000 $500 $2,500 et cash gain (loss) during month $1,452 $1,452 $1,452 $1,452 $1,452 ayments on last month's purchases $4,000 July $4,000 500 of next months sales $4,000 June $2,000 ash gain or loss for month Cash budget Answer: c Diff: E Construct a simplified cash budget: Sales $3,000 Collections (same month's sales) 1,176 (0.98 ´ 0.40 ´ $3,000) Collections (last month's sales) 1,800 (1.00 ´ 0.60 ´ $3,000) Total collections 2,976 Purchases payments 1,500 December Other payments 700 Total payments 2,200 $4,000 Net cash gain (loss) $ 776 Net cash gain is $776.00. 1552 $2,400 $3,952 $2,000 $2,000 $3,952 2000 $500 $2,500 $1,452 December $4,500 1782 $2,700 $4,482 $1,200 $1,200 $4,482 1200 $800 $2,000 $2,482 December $4,000 1552 $2,400 $3,952 $2,000 $2,000 $3,952 2000 $500 $2,500 $1,452 Permanent assets financing Answer: c Diff: M xx. Wicker Corporation is determining whether to support $100,000 of its permanent current assets with a bank note or a short­term bond. The firm's bank offers a two­year note where the firm will receive $100,000 and repay $118,810 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Wicker can sell 8.5 percent coupon bonds with a 2­ year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument? a. 0%; the rates are equal. b. 1.2% c. 1.0% d. 1.8% e. 0.6% Wicker Corporation is determining whether to support $100,000 of its permanent current assets with a bank note or a short­term bond. The firm's bank offers a two­year note where the firm will receive $100,000 and repay $118,810 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Wicker can sell 8.5 percent coupon bonds with a 2­year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument? 1. Permanent assets financing Bingo Corporation is determining whether to support $150,000 of its permanent current assets with a bank note or a short-term bond. The firm's bank offers a two-year note where the firm will receive $150,000 and repay $175,000 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Bingo can sell 8.5 percent coupon bonds with a 2-year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument? ABC Corporation is determining whether to support $125,000 of its permanent current assets with a bank note or a short-term bond. The firm's bank offers a two-year note where the firm will receive $125,000 and repay $150,000 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Bingo can sell 9.5 percent coupon bonds with a 2-year maturity and $1,000 par value at a price of $950. How many percentage points lower is the interest rate on the less expensive debt instrument? Wicker Corporation is determining whether to support $100,000 of its permanent current assets with a bank note or a short­term bond. The firm's bank offers a two­year note where the firm will receive $100,000 and repay $118,810 at the end of two years. The firm has the option to renew the loan at market rates. Alternatively, Wicker can sell 8.5 percent coupon bonds with a 2­year maturity and $1,000 par value at a price of $973.97. How many percentage points lower is the interest rate on the less expensive debt instrument? Time lines: Note that the cash flows viewed from the firm's perspective involve inflows at time 0, and repayment of coupon and/or maturity value in the future. 2­year note: 0 100,000 1 9% 2­year bond: pmnt 0 1 ­85 $973.97 10% percentage points lower is the interest rate on the less expensive debt instrument Time lines: Note that the cash flows viewed from the firm's perspective involve inflows at time 0, and repayment of coupon and/or maturity value in the future. 1% 2­year note: 0 150,000 1 8% 2­year bond: 0 1 pmnt ­85 $973.97 10% percentage points lower is the interest rate on the less expensive debt instrument Time lines: Note that the cash flows viewed from the firm's perspective involve inflows at time 0, and repayment of coupon and/or maturity value in the future. 2% 2­year note: 0 125,000 1 10% 2­year bond: pmnt 0 1 95 $950.00 12.48% percentage points lower is the interest rate on the less expensive debt instrument 2.93% I=? 2 FV= ­118,810 2 ­85 FV= ­1000 I=? 2 FV= ­175000 2 ­85 FV= ­1000 I=? 2 FV= ­150000 2 95 FV= ­1000 1. Payback period Phoenix Aircraft is considering a project which has an upfront cost paid today at t = 0. The project will generate positive cash flows of $50,000 a year at the end of each of the next five years. The project’s NPV is $75,000 and the company’s WACC is 10 percent. What is the project’s simple, regular payback? The ABC Corporation is considering a project which has an up­ front cost paid today at t = 0. The project will generate positive cash flows of $70,000 a year at the end of each of the next five years. The project's NPV is $90,000 and the company's WACC is 12 percent. What is the project's simple, regular payback? (Points: 20) WACC 10% 0 ($114,539.34) 2.29 1 50000 1 ($189,539.34) 75000 ($114,539.34) 1. Haig Aircraft is considering a project which has an up­front cost paid today at t = 0. The project will generate positive cash flows of $60,000 a year at the end of each of the next five years. The project's NPV is $75,000 and the company's WACC is 10 percent. What is the project's simple, regular payback? The NPV represents the sum of the PV of the $60,000 cash inflows minus the initial cost The ABC Corporation is considering a project which has an up­ front cost paid today at t = 0. The project will generate positive cash flows of $70,000 a year at the end of each of the next five years. The project's NPV is $90,000 and the company's WACC is 12 percent. What is the project's simple, regular payback? (Points: 20) WACC 0.12 0 (162,334.33) 1 70,000.00 2.32 1.00 2.32 (2.32) (252,334.33) 90,000.00 ($162,334.33) 1. The Bingo Corporation is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $85,000 a year at the end of each of the next five years. The project's NPV is $100,000 and the company's WACC is 10 percent. What is the project's simple, regular payback? WACC 10% 0 ($222,216.88) 2.61 1 85,000.00 1 2.61 ($322,216.88) 100,000.00 ($222,216.88) The ABC Corporation is considering a project which has an up­ front cost paid today at t = 0. The project will generate positive cash flows of $70,000 a year at the end of each of the next five years. The project's NPV is $90,000 and the company's WACC is 12 percent. What is the project's simple, regular payback? (Points: 20) WACC 12% 0 ($162,334.33) 2.32 ($252,334.33) 90,000.00 ($162,334.33) 1 70,000.00 1 2.32 2 50000 1 3 50000 0.29 4 50000 5 50000 2 3 4 5 70,000.00 70,000.00 70,000.00 70,000.00 1.00 0.32 2 3 4 5 85,000.00 85,000.00 85,000.00 85,000.00 1 0.61 2 3 4 5 70,000.00 70,000.00 70,000.00 70,000.00 1 0.32 capital structure consists of 50 percent debt and 50 percent equity. Given the following information, calculate the firm's weighted average cost of capital. = 7% Rd Tax rate = 40% P0 = $30 Growth = 0% D0 = $2.50 WACC= (wd)(rd(1­T) + (wps)(rps)+ (wce)(rs) wd = 50% rp = 0.0% 50% ws = 7.0% 0% wp = rd = rs = 8.33% tax rate = 40% WACC = 6.267% A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital. rd = 6% Tax rate = 40% P0 = $25 Growth = 0% D0 = $2.00 a. b. c. d. e. 6.00% 6.20% 7.00% 7.20% 8.00% WACC= (wd)(rd(1­T) + (wps)(rps)+ (wce)(rs) wd = ws = 11. (TCO H) WACC 40% rd = 6.0% 60% rs = 8.00% tax rate = 40% WACC = 6.24000% A company has determined that its optimal capital structure consists of 30 percent debt and 70 percent equity. Given the following information, calculate the firm's weighted average cost of capital. = 6% Rd Tax rate = 35% P0 = $35 Growth = 0% D0 = $3.00 (Points: 25) Growth Stock price Expected dividend rs Growth Stock price Expected dividend rs 0.0% $30.00 $2.50 8.33% 0.0% $25.00 $2.00 8.00% 0.08 ...
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This note was uploaded on 06/15/2011 for the course FI515 FI515 taught by Professor Fi515 during the Spring '10 term at Keller Graduate School of Management.

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