quiz3solw02

Quiz3solw02 - Third Quiz SOLUTIONS Finance 302 Winter 2002 Instructor Marlena L Akhbari Name_KEY Section I Problems Values are as marked Problem

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
Third Quiz SOLUTIONS Finance 302 Winter 2002 Instructor: Marlena L. Akhbari Name:____ KEY ________________ Section I. Problems. Values are as marked Problem 1. (25 Points) Country Textiles estimate that their EBIT is expected to be $240,000 for the foreseeable future. Country Textiles is considering the use of one of the following capital structures and would like to calculate which one might produce an optimal firm value. They have $1,000,000 in assets and no potential for growth and are 100% equity financed. Its common stock is currently valued at $25 per share and the firm is in the 40% tax bracket. The capital structures under consideration are as follows: Debt Interest Required Return on Equity $300,000 8% 12.53% $500,000 10% 14.63% $700,000 15% 17.58% Assuming the firm size will not change and all earnings will be paid out as dividends, what will be the stock price under each capital structure? Which capital structure would be optimal? DEBT $300,000 $500,000 $700,000 INTEREST 24,000 50,000 105,000 #SHARES 28,000 20,000 12,000 EBIT $240,000 $240,000 $240,000 INTEREST (24,000) (50,000) (105,000) EBT 216,000 190,000 135,000 TAXES 86,400 76,000 54,000 NET INCOME 129,600 114,000 81,000 EPS 4.63 5.70 6.75 STOCK PRICE 36.95 38.96 38.40 OPTIMAL NOTES: #SHARES ORIGINALLY = 1,000,000/$25 = 40,000; ADJUST BY THE AMOUNT OF DEBT RAISED THAT IS USED TO BUYBACK SHARES, SO FIRST COLUMN = 300,000 DEBT AND 700,000 EQUITY AND # SHARES = 700,000/25 = 28,000, ETC. STOCK PRICE = EPS/K AND THE Ke CHANGES FOR EACH NEW DEBT AMOUNT AS GIVEN.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Problem 2. (10 Points) Vanderheiden, Inc. is considering two average-risk alternative ways of producing its patented polo shirts. Process S has a cost of $8,000 and will produce net cash flows of $5,000 per year for 2 years. Process L will cost $11,500 and will produce cash flows of $4,000 per year for 4 years. Inflation is expected to be 0 for the foreseeable future. If Vanderheiden’s cost of capital is 10%, which process should they choose? Please solve using both the common life method and the Equivalent Annual Annuity method. PROJECT S
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 12/06/2011 for the course ECON 101 taught by Professor Adam during the Spring '06 term at Neumann.

Page1 / 7

Quiz3solw02 - Third Quiz SOLUTIONS Finance 302 Winter 2002 Instructor Marlena L Akhbari Name_KEY Section I Problems Values are as marked Problem

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online