Chapter 08 Questions and Problems

# Chapter 08 Questions and Problems - ENTREPRENEURIAL FINANCE...

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E NTREPRENEURIAL F INANCE : Strategy Valuation and Deal Structure Chapter 8. Assessing Financial Needs Questions and Problems 1. Use the sustainable growth template in Figure 8.1 and the following data to answer the questions below: Factor Definition and Value 1. Asset Turnover Sales / Total Assets = 2.0 2. Financial Leverage Total Assets / Equity = 4.0 3. Return on Sales (ROS) Net Income / Sales = 7% 4. Dividend Retention (R) Fraction of Net Income Retained = 1/4 a. What is the sustainable growth rate, g*? b. What level of initial equity investment is required if Year 2 sales are to reach \$2,500? c. What is the new g* if the firm pays no dividend? d. If the firm would like to achieve a g* of 25% with no change in dividend policy, what level of financial leverage would be required? 2. EBIT/Sales = 15 percent, Sales/Assets = 2.0, Assets/Equity = 2.0, the dividend payout ratio = 10 percent, the interest rate on debt = 10 percent, and the tax rate = 40 percent. a. What is the sustainable growth rate? b. How does the sustainable growth rate change in response to reducing any of the above ratios or percentages by one-half (e.g., EBIT/Sales = 7.5 percent)? c. How does the sustainable growth rate change in response to increasing any of the above ratios or percentages by one-half (e.g., EBIT/Sales = 22.5 percent)? d. Do some changes have greater impacts on the sustainable growth rate than others? Are the effects linear or nonlinear? Explain your findings. 3. SIM Refer back to Problem 2. Suppose EBIT/Sales has an expected value of 15 percent with a standard deviation of 10 percent, Sales/Assets has an expected value of 2 with a standard deviation of 0.3, the interest rate is expected to be 10 percent with a standard deviation of 1 percent, and the tax rate is 40 percent if net taxable income is positive but zero if taxable income is negative. a. Build a simulation model of the sustainable growth rate. Set up the model so the leverage ratio and payout ratio are policy choices and dividend yield (the ratio of dividend payout to equity investment) is the objective. b. Simulate the model with the initial assumptions to determine the expected sustainable growth rate and its standard deviation.

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c. Assume the company has targets for g* and dividend yield of 20% and 5% respectively. Given the base case values for the leverage and payout ratios, i.e., 2.0 and 10%, what percentage of the time should they expect to achieve their targets? Using the financial leverage and payout ratios as policy choices, try to design a policy that increases the likelihood of them achieving their targets for g* and dividend yield. 4. A new software start-up, Lutoj, Inc., is developing a new smart home software product. Lutoj believes revenue must reach \$5 million in Year 3 for the product to be viable. Lutoj’s operating margin (EBIT/Sales) is 20%, the tax rate is 30%, and asset turnover is 5X. The founders have \$200,000 between them for initial equity funding. Assume Lutoj will pay no dividend.
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Chapter 08 Questions and Problems - ENTREPRENEURIAL FINANCE...

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