Question: Faraway Fabricators, Inc., is considering the
Faraway Fabricators, Inc., is considering the expansion of its welding and stamping division and estimates that this will require the firm’s accounts receivable to increase by 12 percent of the added sales. Moreover, Faraway estimates that inventories will be 15 percent of the added cost of goods sold, while accounts payable will be 10 percent of that added cost. The firm’s CFO estimates that its sales and cost of goods sold over the five-year estimated life of the investment are as follows:
a. What are the (operating) working-capital requirements of the project for Years 1 through 5?
b. How much additional money must Faraway invest annually because of its working-capital requirements?
Transcribed Image Text:
Year 2 3 Sales $150,000 $162,000 $174,960 $188,957 $204,073 $220,399 Cost of goods sold 90,000 97,200 104,976 113,374 122,444 132,240
> Should anticipated inflation be incorporated into project cash flow forecasts? If so, how?
> What are opportunity costs, and how should they affect an investment’s cash flows? Give an example.
> Should overhead expense ever be considered when evaluating investment cash flows?
> As you saw in the introduction, the Toyota Prius took some of its sales away from other Toyota products. Toyota has also licensed its hybrid technology to Ford Motor Company, which allowed Ford to introduce a Ford Fusion hybrid in 2010 that traveled 39 m
> The opening vignette on page 301 described Google first going public in 2004. Prior to going public, did Google’s stock have a market price? What principles would go into determining the value of a company that hadn’t gone public yet?
> As part of its planning for the coming Christmas season, Criswell Motorsports is considering whether to expand its product line that currently consists of skateboards to include gaspowered skateboards. The company feels it can sell 2,000 of these per yea
> The market’s required yield on preferred stock is actually a promised rate of return. Explain this statement.
> Compare the methods for valuing preferred stock and common stock.
> In Finance for Life: Herd Mentality on page 303, we learned that it is common for investors to follow the investment lead of others. If they are all investing in dotcom firms or biotech firms, you might be swayed to jump on the bandwagon and do the same.
> Why would a preferred stockholder want to have the cumulative dividend feature?
> Because preferred stock dividends must be paid before common stock dividends, should preferred stock be considered a liability and appear on the right side of the balance sheet alongside of the firm’s long-term debt?
> Why is preferred stock referred to as a hybrid security?
> Regardless of Your Major: Getting Your Fair Share on page 302 focuses on the valuation of a new business venture. If you were faced with the need to value this business, what would you want to know about the business?
> What is the difference between the expected return and the promised or contractual yield to maturity on a bond?
> Distinguish among a bond’s coupon interest rate, current yield, and yield to maturity.
> Why does a bond’s par or face value differ from its market value?
> The Heritage Farm Implement Company is considering an investment that is expected to generate revenues of $3 million per year. The project will also involve annual cash expenses (including both fixed and variable costs) of $900,000, while increasing depr
> In Finance for Life: Adjustable-Rate Mortgages on page 263, we learned the difference between fixed- and adjustable-rate mortgages. Why would you ever want to use an adjustable-rate mortgage (ARM)?
> Describe the relationship between yield to maturity and the value of a bond.
> What is the difference between a bond’s clean price and its dirty price, and what does the saying “buy clean, pay dirty” mean?
> What is a floating-rate bond?
> Distinguish between public and private corporate debt.
> In Finance in a Flat World: International Bonds on page 280, we learned about the bonds issued in financial markets outside of the United States. What are the potential benefits and costs of investing in foreign-issue bonds?
> How does inflation impact the rate of interest observed in financial markets?
> Is the price of a long-term (longer-maturity) bond more or less sensitive to changes in interest rates than that of a short-term bond? Why?
> Why does the market value of a bond differ from its par value when the coupon interest rate does not equal the market yield to maturity on a comparable-risk bond?
> Distinguish between the following: a. Debentures and mortgage bonds b. Eurobonds, zero-coupon bonds, and junk bonds c. Premium and discount bonds
> Killibrew Enterprises is considering a new project that is expected to generate added revenues $1,250,000 and incur added cash expenses (including both fixed and variable costs) of $650,000, while increasing depreciation by $200,000 per year. If the firm
> What does a bond rating reflect? Why is the rating important to the firm’s management?
> What is the equity risk premium, and how is it calculated?
> Describe the information contained in Figure 7.2, identifying which securities have performed the best over long periods of time. Some investors with long investment time horizons invest exclusively in bonds. Why do you think that is so? Figure 7.2:
> Describe the five-step process used to calculate the variance in the rate of return for an investment.
> Why is the volatility or variance in an investment’s rate of return a reasonable indication of the risk of the investment?
> Describe the concept of an expected rate of return as if you were explaining it to your 10-year-old niece.
> How does the expected rate of return concept differ from that of the realized rate of return?
> How do cash dividends affect the realized rate of return from investing in shares of common stock?
> Describe the concept of a realized rate of return as if you were explaining it to your grandfather, who has never had a finance class.
> What is the “behavioral view” of market efficiency?
> Visible Fences is introducing a new product and has an expected change in net operating income of $900,000. The company has a 34 percent marginal tax rate. This project will also produce $300,000 of depreciation per year. In addition, this project will c
> Compare and contrast the notions of weak-form, semi-strong-form, and strong-form market efficiency.
> What is the efficient markets hypothesis? Explain this concept in your own words.
> What is your tolerance for risk? Take the risk tolerance quiz referenced in Finance for Life: Determining Your Tolerance for Risk on page 206 and found at the website www.rce.rutgers.edu/money/riskquiz.
> Under what circumstances would you prefer to use the geometric average rate of return as opposed to the arithmetic average rate of return?
> What is the relationship between the geometric average rate of return and compound interest?
> What can you conclude about the relative risk of investing in the United States versus Japan from Figure 7.4? Figure 7.4: 50.00% | Compound annual rate of return | Standard Diviation 45.00% 40.00% Developed Markets Emerging Markets 35.00% 28.71% 3
> What does Figure 7.4 tell us about how the U.S. stock market has performed when compared to all the alternatives included in the figure over the period 1988–2015? Figure 7.4: 50.00% | Compound annual rate of return | Standard Divi
> In Regardless of Your Major: Using Statistics on page 194, we note that statisticians analyze data. Moreover, in your statistics class you learned how to describe random outcomes using statistical measures such as expected value and variance. How does ou
> How do you calculate the present value of an annuity? A perpetuity? A growing perpetuity?
> What is a level perpetuity? A growing perpetuity?
> Distinguish between an ordinary annuity and an annuity due.
> Assume you bought a home and took out a 30-year mortgage on it 10 years ago. How would you determine how much principal on your mortgage you still have to pay off?
> What is the relationship between the present value interest factor (from Chapter 5) and the annuity present value interest factor (from Equation [6–2])?
> How do you calculate the future value of an annuity?
> What is an annuity? Give some examples of annuities.
> In the Payday Loans feature on page 129, we examined these short-term, high-interest loans. Go to the Responsible Lending Organization website at www. responsiblelending.org/payday-lending/. What are some of their concerns about payday and other small do
> Compare some of the different financial calculators that are available on the Internet. Look at Kiplinger Online calculators (www.kiplinger.com/tools/index.html), which include how much you need to retire, the value of boosting your 401(k) contributions
> How would an increase in the interest rate (i) or a decrease in the number of periods until the payment is received (n) affect the present value (PV) of a sum of money?
> How would an increase in the interest rate (i) or a decrease in the number of periods (n) affect the future value (FVn) of a sum of money?
> What is the relationship between the number of times interest is compounded per year on an investment and the future value of that investment? What is the relationship between the number of times compounding occurs per year and the EAR?
> Morten Food Products, Inc., is a regional manufacturer of salty food snacks. The firm competes directly with the national brands including Frito-Lay—but only in the southeastern part of the United States. Next year Morten expects total revenues of $300 m
> What is the time value of money? Give three examples of how the time value of money might take on importance in business decisions.
> What can we learn about a firm from its price-earnings ratio and market-to-book ratio?
> What is the DuPont system of financial statement analysis, and how is it applied to the analysis of a company’s return on equity?
> What are the two determinants of a firm’s operating return on assets?
> What are the differences among gross profit margin, operating profit margin, and net profit margin?
> What two ratios are typically used to measure how a firm has financed its assets (i.e., its capital structure)?
> What does the term liquidity mean in the context of a firm’s financial condition, and what financial ratios can the analyst use to assess liquidity?
> List and describe the five basic questions used to discuss financial statement analysis.
> What are common-size financial statements, how are they constructed, and why are they useful to the financial analyst?
> In Finance in a Flat World on page 105, we noted that differences in accounting standards around the world can influence financial ratios. Describe how differences in the way goodwill is treated in the United States versus Hong Kong might influence finan
> Determine the IRR to the nearest percent for the following projects: a. An initial outlay of $10,000 resulting in cash inflows of $2,000 at the end of Year 1, $5,000 at the end of Year 2, and $8,000 at the end of Year 3 b. An initial outlay of $10,000 re
> In Finance for Life: Your Cash Budget and Personal Savings Ratio on page 102, we defined something called your personal savings ratio. What is this ratio, and how can you use it when thinking about gaining control over your personal finances?
> What are the limitations of industry-average ratios as a source of benchmarks for a firm’s financial condition? Discuss briefly.
> Analyzing a firm’s financial condition using its financial statements can be likened to performing a physical examination. A physician assesses a patient’s health by checking temperature, blood pressure, and other vital signs. What are the vital signs
> In Finance for Life: Your Personal Balance Sheet and Income Statement on page 56, we learned that individuals have financial statements just like firms. Prepare your personal balance sheet using the following items: (i) You have a 2003 Corolla that you b
> The cash flow statement is one of the four basic financial statements. Define the objective in preparing this statement, and discuss some of the types of questions that can be addressed using its content.
> In 2016, RubKing Barbeque Sauce, Inc., purchased a new bottling machine at a cost of $1.5 million. The new machine is expected to last for 10 years, and the firm plans to depreciate it using straight-line depreciation of $150,000 per year. What is the ca
> Appleby Southern Inc. had an accounts payable balance of $5 million at the end of 2015, and that balance rose to $7 million in 2016. What is the cash flow consequence of this change in accounts payable?
> Meri whether Chemicals experienced an increase in its accounts receivable balance for the year just ended. This will be reported as a use of cash in the firm’s cash flow statement. How is it that an increase in an asset such as accounts receivable repres
> When bank loan officers are evaluating the creditworthiness of a potential commercial borrower, they often look to the firm’s net working capital balance as an indicator of the firm’s overall liquidity. How is net working capital defined, and what does i
> From the firm’s perspective, how are cash dividends different from interest payments?
> East Coast Television is considering a project with an initial outlay of $X (you will have to determine this amount). It is expected that the project will produce a positive cash flow of $50,000 at the end of each year for the next 15 years. The appropri
> Firm income statements document the revenues earned and the expenses incurred in generating those revenues during the period covered. However, firm expenses are categorized into one of three groups: cost of goods sold, operating expenses, and interest ex
> In Finance in a Flat World: GAAP vs. IFRS on page 61, we learned that GAAP, the financial reporting system used in the United States, is not the same as that used throughout the rest of the world. However, the U.S. system is converging with the internati
> Describe the content of the balance sheet and the income statement.
> What makes preferred stock “preferred”?
> What is the difference between a debt security and an equity security?
> What is a mutual fund, and how does it differ from an exchange-traded fund (ETF)?
> Describe the difference between the primary market and the secondary market.
> What do investment banks do in the financial markets?
> What is a financial intermediary? List and describe the principal types of financial intermediaries in the U.S. financial markets.
> What are the three principal sets of players that interact in the financial markets?
> Determine the IRRs for the following projects: a. An initial outlay of $10,000 resulting in a cash inflow of $1,993 at the end of each year for the next 10 years b. An initial outlay of $10,000 resulting in a cash inflow of $2,054 at the end of each year
> Emily’s Soccer Mania is considering building a new indoor soccer facility for local soccer clubs to rent. This project will require an initial cash outlay of $10 million and will generate annual cash inflows of $3 million per year for Years 1 through 5.
> Go to the Motley Fool website (www.fool.com), and under the tab “Guides,” click on “Retirement.” Describe the information available here for planning for your retirement.
> Go to the Market Watch website (www.marketwatch.com), and click on “Sections” then on “Personal Finance.” This is a great resource for information and help in managing your personal finances. Find an article you like, read it, and write a summary of it.
> Go to Yahoo Finance (http://finance.yahoo.com), and enter “GOOG” (the ticker symbol for Alphabet, formerly Google) in the “Enter Symbol(s)” box at the top of the page. What is the price at which the stock last traded? What is the last trade time, and how
> What are the two types of private equity funds? What does each do with the money it raises from investors?
> What is a hedge fund, and how is it different from a mutual fund?
> The distribution of financial assets around the world is described in Finance in a Flat World: Where’s the Money Around the World on page 32. What country dominates in terms of the stock market and total financial assets? Of the United Kingdom, Germany,
