Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 60% equity and 40% debt, it has 1,000,000 shares of common equity outstanding, and its net income is $8 million. The company forecasts that it will require $10 million to fund all of its profitable (that is, positive NPV) projects for the upcoming year. a. If Buena Terra follows the residual dividend model, how much retained earnings will it need to fund its capital budget? b. If Buena Terra follows the residual dividend model, what will be the company’s dividend per share and payout ratio for the upcoming year? c. If Buena Terra maintains its current $3.00 DPS for next year, how much retained earnings will be available for the firm’s capital budget? d. Can the company maintain its current capital structure, maintain the $3.00 DPS, and maintain a $10 million capital budget without having to raise new common stock? e. Suppose that Buena Terra’s management is firmly opposed to cutting the dividend; that is, it wants to maintain the $3.00 dividend for the next year. Also assume that the company was committed to funding all profitable projects and was willing to issue more debt (along with the available retained earnings) to help finance the company’s capital budget. Assume that the resulting change in capital structure has a minimal effect on the company’s composite cost of capital so that the capital budget remains at $10 million. What portion of this year’s capital budget would have to be financed with debt? f. Suppose once again that Buena Terra’s management wants to maintain the $3.00 DPS. In addition, the company wants to maintain its target capital structure (60% equity and 40% debt) and maintain its $10 million capital budget. What is the minimum dollar amount of new common stock that the company would have to issue to meet each of its objectives? g. Now consider the case where Buena Terra’s management wants to maintain the $3.00 DPS and its target capital structure, but it wants to avoid issuing new common stock. The company is willing to cut its capital budget to meet its other objectives. Assuming that the company’s projects are divisible, what will be the company’s capital budget for the next year? h. What actions can a firm that follows the residual dividend policy take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget?
> Bruner Aeronautics has perpetual preferred stock outstanding with a par value of $100. The stock pays a quarterly dividend of $2, and its current price is $80. a. What is its nominal annual rate of return? b. What is its effective annual rate of return?
> The Bouchard Company’s EPS was $6.50 in 2008, up from $4.42 in 2003. The company pays out 40% of its earnings as dividends, and its common stock sells for $36.00. a. Calculate the past growth rate in earnings. (Hint: This is a 5-year growth period.) b. T
> Wingler Communications Corporation (WCC) produces premium stereo headphones that sell for $28.80 per set, and this year’s sales are expected to be 450,000 units. Variable production costs for the expected sales under present production methods are estima
> Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 13%, a before-tax cost of debt of 10%, and a tax rate of 40%. The company’s retained earnings are
> Ballack Co.’s common stock currently sells for $46.75 per share. The growth rate is a constant 12%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio is 25%, and the expected return on equity (ROE) is 16%.
> a. What effect would each of the following events likely have on the level of nominal interest rates? (1) Households dramatically increase their savings rate. (2) Corporations increase their demand for funds following an increase in investment opportunit
> A bond has a $1,000 par value, 10 years to maturity, and a 7% annual coupon and sells for $985. a. What is its yield to maturity (YTM)? b. Assume that the yield to maturity remains constant for the next 3 years. What will the price be 3 years from today?
> What is the implied nominal interest rate on a Treasury bond ($100,000) futures contract that settled at 100’16.0 (or 100-160)? If interest rates increased by 1%, what would be the contract’s new value?
> Suppose you held a diversified portfolio consisting of a $7,500 investment in each of 20 different common stocks. The portfolio’s beta is 1.12. Now suppose you decided to sell one of the stocks in your portfolio with a beta of 1.0 for $7,500 and use the
> The Scampini Supplies Company recently purchased a new delivery truck. The new truck costs $22,500; and it is expected to generate after-tax cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected year-e
> Suppose interest rates on residential mortgages of equal risk are 5.5% in California and 7.0% in New York. Could this differential persist? What forces might tend to equalize rates? Would differentials in borrowing costs for businesses of equal risk loca
> Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 10% as long as it finances at its target capital structure, which calls for 45% debt and 55% common equity. Its last dividend was
> Klose Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $2 million of new retained earni
> Smith Technologies is expected to generate $150 million in free cash flow next year, and FCF is expected to grow at a constant rate of 5% per year indefinitely. Smith has no debt or preferred stock, and its WACC is 10%. If Smith has 50 million shares of
> It is a fact that the federal government (1) Encouraged the development of the savings and loan industry, (2) Virtually forced the industry to make long-term fixed-interest-rate mortgages, and (3) Forced the savings and loans to obtain most of their c
> Coleman Technologies is considering a major expansion program that has been proposed by the company’s information technology group. Before proceeding with the expansion, the company must estimate its cost of capital. Assume that you are an assistant to J
> A mutual fund manager has a $20 million portfolio with a beta of 1.5. The risk-free rate is 4.5%, and the market risk premium is 5.5%. The manager expects to receive an additional $5 million, which she plans to invest in a number of stocks. After investi
> Here is the condensed 2008 balance sheet for Skye Computer Company (in thousands of dollars): Skye’s earnings per share last year were $3.20, the common stock sells for $55.00, last year’s dividend was $2.10, and a flo
> Hart Enterprises recently paid a dividend, D0, of $1.25. It expects to have non constant growth of 20% for 2 years followed by a constant rate of 5% thereafter. The firm’s required return is 10%. a. How far away is the terminal, or horizon, date? b. What
> Assume that you have just been hired as a financial analyst by Tropical Sweets Inc., a midsized California company that specializes in creating exotic candies from tropical fruits such as mangoes, papayas, and dates. The firm’s CEO, Geo
> Suppose rRF = 9%, rM = 14%, and bi = 1.3. a. What is ri, the required rate of return on Stock i? b. Now suppose that rRF (1) Increases to 10% or (2) Decreases to 8%. The slope of the SML remains constant. How would this affect rM and ri? c. Now assume
> Warr Corporation just paid a dividend of $1.50 a share (that is, D0 = $1.50). The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for each of the next 5 years?
> A bond that pays interest forever and has no maturity is a perpetual bond. In what respect is a perpetual bond similar to a no-growth common stock? Are there preferred stocks that are evaluated similarly to perpetual bonds and other preferred stocks that
> Assume that it is now January 1, 2009. Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual gr
> a. Given the following graphs, calculate the total fixed costs, variable costs per unit, and sales price for Firm A. Firm B’s fixed costs are $120,000, its variable costs per unit are $4, and its sales price is $8 per unit. b. Which fir
> A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
> Assume that today is December 31, 2008, and that the following information applies to Vermeil Airlines: ● After-tax operating income [EBIT(1 – T)] for 2009 is expected to be $500 million. ● The depreciation expense for 2009 is expected to be $100 million
> Welch Company is considering three independent projects, each of which requires a $5 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here: Note that the projects’ cos
> You plan to invest in the Kish Hedge Fund, which has total capital of $500 million invested in five stocks: Kish’s beta coefficient can be found as a weighted average of its stocks’ betas. The risk-free rate is 6%, an
> Last year Clark Company issued a 10-year, 12% semiannual coupon bond at its par value of $1,000. Currently, the bond can be called in 4 years at a price of $1,060 and it sells for $1,100. a. What are the bond’s nominal yield to maturity and its nominal y
> What’s the difference between a call for sinking fund purposes and a refunding call?
> What are the key factors on which external financing depends, as indicated in the AFN equation?
> A company’s 5-year bonds are yielding 7.75% per year. Treasury bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate (r*) is 2.3%. The average inflation premium is 2.5%; and the maturity risk premium is estimated to be 0.1
> At the end of last year, Roberts Inc. reported the following income statement (in millions of dollars): Looking ahead to the following year, the company’s CFO has assembled this information: ● Year-end sales are expec
> Walter Industries has $5 billion in sales and $1.7 billion in fixed assets. Currently, the company’s fixed assets are operating at 90% of capacity. a. What level of sales could Walter Industries have obtained if it had been operating at full capacity? b.
> Austin Grocers recently reported the following 2008 income statement (in millions of dollars): This year the company is forecasting a 25% increase in sales; and it expects that its year-end operating costs, including depreciation, will equal 70% of sale
> Refer to Problem 17-1. What additional funds would be needed if the company’s year-end 2008 assets had been $4 million? Assume that all other numbers are the same. Why is this AFN different from the one you found in Problem 17-1? Is the company’s “capita
> Companies often have to increase their initial investment costs to obtain real options. Why might this be so, and how could a firm decide if it was worth the cost to obtain a given real option?
> Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech to begin paying dividends, beginning with a dividend of $1.00 coming 3 years from today. T
> Primrose Corp has $15 million of sales, $2 million of inventories, $3 million of receivables, and $1 million of payables. Its cost of goods sold is 80% of sales, and it finances working capital with bank loans at an 8% rate. What is Primrose’s cash conve
> McDowell Industries sells on terms of 3/10, net 30. Total sales for the year are $912,500; 40% of the customers pay on the 10th day and take discounts, while the other 60% pay, on average, 40 days after their purchases. a. What is the days’ sales outstan
> Dan Barnes, financial manager of Ski Equipment Inc. (SKI), is excited, but apprehensive. The company’s founder recently sold his 51% controlling block of stock to Kent Koren, who is a big fan of EVA (Economic Value Added). EVA is found
> Digital Inc. is considering production of a new cell phone. The project will require an investment of $20 million. If the phone is well-received, the project will produce cash flows of $10 million a year for 3 years; but if the market does not like the p
> Rework Problem 16-10 using a spreadsheet model. After completing Parts a through d, respond to the following: If Bowers’ customers began to pay late, collections would slow down, thus increasing the required loan amount. If sales declin
> Indicate whether each of the following actions will increase or decrease a bond’s yield to maturity: a. The bond’s price increases. b. The bond is downgraded by the rating agencies. c. A change in the bankruptcy code makes it more difficult for bondhold
> The cost of retained earnings is less than the cost of new outside equity capital. Consequently, it is totally irrational for a firm to sell a new issue of stock and to pay dividends during the same year. Discuss the meaning of those statements.
> Discuss the pros and cons of having the directors formally announce what a firm’s dividend policy will be in the future.
> Indicate whether the following statements are true or false. If the statement is false, explain why. a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are subject to capital gains taxes. b. If you own 100 shares
> Suppose you won the lottery and had two options: (1) Receiving $0.5 million or (2)Taking a gamble in which at the flip of a coin you receive $1 million if a head comes up but receive zero if a tail comes up. a. What is the expected value of the gamble?
> One alleged advantage of leasing voiced in the past was that it kept liabilities off the balance sheet, thus making it possible for a firm to obtain more leverage than it otherwise could have. This raised the question of whether the lease obligation and
> Distinguish between operating leases and financial leases. Would a firm be more likely to finance a fleet of trucks or a manufacturing plant with an operating lease? Explain.
> One often finds that a company’s bonds have a higher yield than its preferred stock even though an investor considers the bonds to be less risky than the preferred. What causes this yield differential?
> Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,175. The bonds may be called in 5 years at 109% of face value (Call price = $1,090)
> Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company’s common stock?
> You are told that one corporation just issued $100 million of preferred stock and another purchased $100 million of preferred stock as an investment. You are also told that one firm has an effective tax rate of 20%, whereas the other is in the 35% bracke
> For purposes of measuring a firm’s leverage, should preferred stock be classified as debt or equity? Does it matter if the classification is being made (a) By the firm’s management, (b) By creditors, or (c) By equity investors?
> Assume that you have just been hired as business manager of Campus Deli (CD), which is located adjacent to the campus. Sales were $1,100,000 last year, variable costs were 60% of sales, and fixed costs were $40,000. Therefore, EBIT totaled $400,000. Beca
> Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of 9% and $50 million of pure bonds with a coupon rate of 12%. Both bonds have the same maturity. Does the fact that the convertible issue has the lower coupon ra
> a. How would a firm’s decision to pay out a higher percentage of its earnings as dividends affect each of the following? (1) The value of its long-term warrants (2) The likelihood that its convertible bonds will be converted (3) The likelihood that its w
> What effect does the expected growth rate of a firm’s stock price (subsequent to issue) have on its ability to raise additional funds through (a) Convertibles and (b) Warrants?
> Suppose Congress changed the tax laws in a way that (1) Permitted equipment to be depreciated over a shorter period, (2) Lowered corporate tax rates, and (3) Reinstated the investment tax credit. Discuss how each of these changes would affect the rela
> Suppose there were no IRS restrictions on what constitutes a valid lease. Explain in a manner that a legislator might understand why some restrictions should be imposed.
> Pogue Industries Inc. has warrants outstanding that permit its holders to purchase 1 share of stock per warrant at a price of $21. (Refer to Chapter 18 for Parts a, b, and c.) a. Calculate the exercise value of Pogue’s warrants if the common stock sells
> Morris-Meyer Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the required amount. Alternatively, a Nevada investment banking firm that represents a group of investors believes that it ca
> Two textile companies, McDaniel-Edwards Manufacturing and Jordan-Hocking Mills, began operations with identical balance sheets. A year later both required additional manufacturing capacity at a cost of $200,000. McDaniel-Edwards obtained a 5-year, $200,0
> Look back at Table 7-4 and examine United Parcel Service and Telecom Italia Capital bonds that mature in 2013. a. If these companies were to sell new $1,000 par value long-term bonds, approximately what coupon interest rate would they have to set if they
> Gregg Company recently issued two types of bonds. The first issue consisted of 20-year straight (no warrants attached) bonds with an 8% annual coupon. The second issue consisted of 20-year bonds with a 6% annual coupon with warrants attached. Both bonds
> Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury
> Connors Construction needs a piece of equipment that can be leased or purchased. The equipment costs $100. One option is to borrow $100 from the local bank and use the money to buy the equipment. The other option is to lease the equipment. If Connors cho
> O’Brien Computers Inc. needs to raise $35 million to begin producing a new microcomputer. O’Brien’s straight, nonconvertible debentures currently yield 12%. Its stock sells for $38 per share, the last dividend was $2.46, and the expected growth rate is a
> The Howe Computer Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $150,000, carrying a 10% interest rate,
> As part of its overall plant modernization and cost reduction program, the management of Tanner-Woods Textile Mills has decided to install a new automated weaving loom. In the capital budgeting analysis of this equipment, the IRR of the project was found
> In the summer of 2008, the Hadaway Company was planning to finance an expansion with a convertible security. They considered a convertible debenture but feared the burden of fixed interest charges if the common stock did not rise enough to make conversio
> Martha Millon, financial manager of Fish & Chips Inc., is facing a dilemma. The firm was founded 5 years ago to develop a new fast-food concept; and although Fish & Chips has done well, the firm’s founder and chairman believes that an industry shake-out
> Martha Millon, financial manager for Fish & Chips Inc., has been asked to perform a lease versus- buy analysis on a new computer system. The computer costs $1,200,000; and if it is purchased, Fish & Chips could obtain a term loan for the full amount at a
> Storm Software wants to issue $100 million in new capital to fund new opportunities. If Storm raised the $100 million of new capital in a straight-debt 20-year bond offering, Storm would have to offer an annual coupon rate of 12%. However, Storm’s advise
> Use the spreadsheet model to rework Parts a and b of Problem 20-8. Then answer the following question. c. Accepting that the corporate WACC should be used equally to discount all anticipated cash flows, at what cost of capital would the firm be indiffere
> Last year Joan purchased a $1,000 face value corporate bond with an 11% annual coupon rate and a 10-year maturity. At the time of the purchase, it had an expected yield to maturity of 9.79%. If Joan sold the bond today for $1,060.49, what rate of return
> Would a failure to recognize growth options tend to cause a firm’s actual capital budget to be above or below the optimal level? Would your answer be the same for abandonment, timing, and flexibility options? Explain.
> Should firms require higher rates of return on foreign projects than on identical projects located at home? Explain.
> What is a Eurodollar? If a French citizen deposits $10,000 in Chase Manhattan Bank in New York, have Eurodollars been created? What if the deposit is made in Barclay’s Bank in London? Chase Manhattan’s Paris branch? Does the existence of the Eurodollar m
> Why might purchasing power parity fail to hold?
> Does interest rate parity imply that interest rates are the same in all countries?
> Six-month T-bills have a nominal rate of 7%, while default-free Japanese bonds that mature in 6 months have a nominal rate of 5.5%. In the spot exchange market, 1 yen equals $0.009. If interest rate parity holds, what is the 6–month forward exchange rate
> A currency trader observes that in the spot exchange market, 1 U.S. dollar can be exchanged for 3.50 Israeli shekels or for 104.00 Japanese yen. What is the cross exchange rate between the yen and the shekel; that is, how many yen would you receive for e
> Solitaire Machinery is a Swiss multinational manufacturing company. Currently, Solitaire’s financial planners are considering undertaking a 1-year project in the United States. The project’s expected dollar-denominated cash flows consist of an initial in
> After all foreign and U.S. taxes, a U.S. corporation expects to receive 3 pounds of dividends per share from a British subsidiary this year. The exchange rate at the end of the year is expected to be $2 per pound, and the pound is expected to depreciate
> You are the vice president of International InfoXchange, headquartered in Chicago, Illinois. All shareholders of the firm live in the United States. Earlier this month you obtained a loan of 5 million Canadian dollars from a bank in Toronto to finance th
> Chamberlain Canadian Imports has agreed to purchase 15,000 cases of Canadian beer for 4 million Canadian dollars at today’s spot rate. The firm’s financial manager, James Churchill, has noted the following current spot
> Explain in general terms what each of the following real options is and how it could change projects’ NPVs and their corresponding risk relative to what would have been estimated if the options had not been considered. a. abandonment b. timing c. growth
> You are considering a 10-year, $1,000 par value bond. Its coupon rate is 9%, and interest is paid semiannually. If you require an “effective” annual interest rate (not a nominal rate) of 8.16%, how much should you be willing to pay for the bond?
> Assume that interest rate parity holds and that 90-day risk-free securities yield 5% in the United States and 5.3% in Britain. In the spot market, 1 pound ¼ $2. a. Is the 90-day forward rate trading at a premium or a discount relative to the spot rate? b
> Assume that interest rate parity holds. In both the spot market and the 90-day forward market, 1 Japanese yen = 0.0086 dollar. And 90-day risk-free securities yield 4.6% in Japan. What is the yield on 90-day risk-free securities in the United States?
> Use the foreign exchange section of a current issue of The Wall Street Journal to look up the three currencies in Problem 19-8. What is the current exchange rate between Swedish kronas and pounds? Data from Problem 19-8 Suppose the exchange rate between
> Use the foreign exchange section of a current issue of The Wall Street Journal to look up the six currencies in Problem 19-5. a. What is the current exchange rate for changing dollars into 1,000 units of pounds, Canadian dollars, euros, yen, Mexican peso
> Table 19-1 lists foreign exchange rates for May 26, 2008. On that day, how many dollars would be required to purchase 1,000 units of each of the following: British pounds, Canadian dollars, EMU euros, Japanese yen, Mexican pesos, and Swedish kronas? Tabl
> Citrus Products Inc. is a medium-sized producer of citrus juice drinks with groves in Indian River County, Florida. Until now, the company has confined its operations and sales to the United States; but its CEO, George Gaynor, wants to expand into the Pa
> Yohe Telecommunications is a multinational corporation that produces and distributes telecommunications technology. Although its corporate headquarters are located in Maitland, Florida, Yohe usually buys its raw materials in several different foreign cou
> Discuss some of the techniques available to reduce risk exposure.
> Why do options typically sell at prices higher than their exercise values?
