Northwest Entertainment Inc. operates a multiplex cinema that has nine small theaters in one building. Business has been good lately and management is considering a project that will add five screens at an estimated cost of $3 million. The success of the expansion depends on whether local demand over the next two years will support the additional capacity. Demand is believed to depend on the local economy. An economist at a nearby university has predicted a 90% probability of continued prosperity in the area and a 10% chance of a moderate downturn. Management feels that if prosperity continues the new theaters will generate a profit margin of $2 million in the first year and $3 million in the second. A moderate downturn would produce contributions of $1.5 and $2 million. Northwest’s cost of capital is 12%. a. Draw a decision tree for the project. b. Calculate the NPV along each path. c. Develop the probability distribution of the project’s NPV. d. Calculate the project’s expected NPV. e. Make a recommendation on the project with an appropriate comment on risk.
> Newrock Manufacturing Inc. has the following target capital structure Investment bankers have advised the CFO that the company could raise up to $5 million in new debt financing by issuing bonds at a 6.0% coupon rate, beyond that amount new debt would
> Taunton Construction Inc.'s capital situation is described as follows: Debt: The firm issued 10,000 25-year bonds10 years ago at their par value of $1,000. The bonds carry a coupon rate of 14% and are now selling to yield 10%. Preferred Stock: 30,000
> The Maritime Engineering Corp sold 1,500 convertible bonds two years ago at their $1,000 par value. The 20-year bonds carried a coupon rate of 8% and were convertible into stock at $20 per share. At the time, the firm’s stock was selling for $15, and s
> Whitley Motors Inc. has the following capital. Debt: The firm issued 900, 25-year bonds five years ago which were sold at a par value of $1,000. The bonds carry a coupon rate of 7%, but are currently selling to yield new buyers 10%. Preferred Stock:3
> Consider two mutually exclusive projects, A and B. Project A requires an initial cash outlay of $100,000 followed by five years of $30,000 cash inflows. Project B requires an initial cash outlay of $240,000 with cash inflows of $40,000 in the first two
> Compare the implications of the MM model with taxes and bankruptcy costs to the things we discovered by studying the Arizona Hot Air Balloon Corporation.
> Hammell Industries has been using 10% as its cost of retained earnings for a number of years. Management has decided to revisit this decision based on recent changes in financial markets. An average stock is currently earning 8%, treasury bills yield 3
> Griffin Ross Construction Inc. (GRC) builds upscale homes in several New England cities. The firm is subject to the ups and downs of the construction industry and has a historical beta of 2.1. GRC has traditionally operated with a capital structure of
> Assume Schoen Industries of the last problem is subject to income tax at a rate of 40%. a. Recalculate the value of the firm assuming there is no tax shield associated with debt and compare it to the value calculated in the last problem. That is, assu
> Illinois Fabrics Inc. makes upholstery that’s used in high-quality furniture, largely chairs and sofas. Illinois has traditionally sold their fabric to manufacturers who use it to cover furniture frames they produce. These manufacturers then wholesale
> The Singleton Metal Stamping Company is planning to buy a new computer controlled stamping machine for $10 million. The purchase will be financed entirely with borrowed money that will change Singleton's capital structure substantially. It will also ch
> The stock market is generally depressed, and the price of Westin Metals Inc.’s common shares has been below its historic average value for some time. The shares are trading at $35 which represents a P/E of 19 on earnings of $7,000,000. Before the curren
> Tydek Inc. just lost a major lawsuit and its stock price dropped by 40% to $6. There are 3.5 million shares outstanding with a book value per share of $10. The company has $5 million in cash readily available. The CFO feels the decline in price is temp
> The Featherstone Corp. has $8M in cash for its next dividend but is considering a repurchase instead. Featherstone has 10M shares outstanding, currently selling at $40 per share. The P/E is 20 on EPS of $2. a. If the dividend is paid how large will it
> You're a financial analyst at Pinkerton Interactive Graphic Systems (PIGS), a successful entrant in a new and rapidly growing field. As in most new fields, however, rapid growth is anything but assured, and PIGS's future performance is uncertain. The fi
> Algebraically derive EPS = ROE [Book value per share]. (Hint: Write the definitions of ROE, EPS, and book value, and then start substituting.)
> In another short paragraph, describe the effect of adding bankruptcy costs to the MM model with taxes.
> Balfour Corp has the following operating results and capital structure ($000). The firm is contemplating a capital restructuring to 60% debt. Its stock is currently selling for book value at $25 per share. The interest rate is 9%, and combined state a
> Referring to Willerton Industries of the previous problem, the company’s long-term debt is comprised of 20-year $1,000 face value bonds issued seven years ago at an 8% coupon rate. The bonds are now selling to yield 6%. Willerton’s preferred is from a
> Assume Connecticut Computer Company of the last two problems is earning an EBIT of $15,000. Once again, calculate the chart showing the implication of adding more leverage. Verbally rationalize the result.
> Reconsider the Connecticut Computer Company of the previous problem assuming the firm has experienced some difficulties, and its EBIT has fallen to $8,000. a. Reconstruct the three-column chart developed in problem 1 assuming Connecticut’s EBIT remains a
> The Spitfire Model Airplane Company has the following modified income statement ($000) at 100,000 units of production. a. What are Spitfire's contribution margin and dollar breakeven point? b. Calculate Spitfire's current DFL, DOL, and DTL. c. Calculat
> Use the information from the previous two problems. Calculate BWP’s breakeven point in units and dollars, with and without the purchase of the new machine. Problem 13: BWP intends to purchase a machine that will result in a major improvement in produc
> If Spitfire elects to do the project, what is an abandonment option at the end of year 1 worth if Spitfire can recover $8M of the initial investment into other uses at that time? If the recovery is $13M?
> BWP intends to purchase a machine that will result in a major improvement in product quality along with a small increase in manufacturing efficiency. The machine will cost $1 million, which will be borrowed at 9%. The quality improvement is expected to
> Referring to the Cranberry Company of the previous problem: a. Calculate the DOL when sales are 20%, 30% and 40% above breakeven. b. Suppose automated equipment is added which increases fixed costs by $20,000 per month. How much will total variable co
> Cranberry Wood Products Inc. spends an average of $9.50 in labor and $12.40 in materials on every unit it sells. Sales commissions and shipping amount to another $3.10. All other costs are fixed and add up to $140,000 per month. The average unit sells
> In a short paragraph, describe the result of adding taxes to the MM model.
> The Connecticut Computer Company has the following selected financial results. The company is considering a capital restructuring to increase leverage from its present level of 10% of capital. a. Calculate Connecticut’s ROE and EPS
> The market price of Albertson Ltd.’s common stock is $5.50, and 100,000 shares are outstanding. The firm's books show common equity accounts totaling $400,000. There are 5,000 preferred shares outstanding that originally sold for their par value of $50
> The Wall Company has 142,500 shares of common stock outstanding that are currently selling at $28.63. It has 4,530 bonds outstanding that won’t mature for 20 years. They were issued at a par value of $1,000 paying a coupon rate of 6%. Comparable bonds
> Five years ago Hemingway Inc. issued 6,000 thirty-year bonds with par values of $1,000 at a coupon rate of 8%. The bonds are now selling to yield 5%. The company also has 15,000 shares of preferred stock outstanding that pay a dividend of $6.50 per sha
> A relatively young firm has capital components valued at book and market and market component costs as follows. No new securities have been issued since the firm was originally capitalized. a. Calculate the firm's capital structures and WACCs based on
> Again, referring to Willerton of the two previous problems, assume the firm’s cost of retained earnings is 11% and its marginal tax rate is 40%, calculate its WACC using its book value-based capital structure ignoring floatation costs.
> Calculate the NPV for the following projects. a. An outflow of $7,000 followed by inflows of $3,000, $2,500 and $3,500 at one-year intervals at a cost of capital of 7%. b. An initial outlay of $35,400 followed by inflows of $6,500 for three years and the
> The Ebitts Field Corp. manufactures baseball gloves. Charlie Botz, the company's top salesman, has recommended expanding into the baseball bat business. He has put together a project proposal including the following information in support of his idea. &
> If Glendale’s management in the last problem attaches a probability of .7 to the better outcome, what is the project’s most likely (expected) NPV? Comment on the result of your calculations.
> The Brown Owl Corporation manufactures high quality outdoor equipment for adventurous people who enjoy hiking, hunting, climbing, and trekking under extreme conditions. The firm has been very successful with things like cold weather clothing, boots, mou
> Every company should take full advantage of the sophisticated cash management services offered by today's banking industry. Right or wrong? Explain.
> After World War II, the United States was the world's dominant economic power. We're still the largest economy, but the rest of the world has caught up significantly. In some areas we've lost the lead. The production of consumer electronic equipment,
> Crest Concrete Inc. has been building basements and slab foundations for new homes in La Crosse, Wisconsin for more than 20 years. However, new home sales have slowed recently and residential construction work is hard to get. As a result, management is c
> New buyers of Simmonds Inc. stock expect a return of about 22%. The firm pays flotation costs of 9% when it issues new securities. What is Simmonds’ cost of equity (Hint: This problem is very simple since we don’t have to estimate the investors’ return
> The New England Brewing Company produces a super-premium beer using a recipe that’s been in the owner’s family since colonial times. Surprisingly, the firm doesn’t own its own brewing facilities, but rents time on the equipment of large brewers who have
> Spitfire Aviation Inc. manufactures small, private aircraft. Management is evaluating a proposal to introduce a new high-performance plane. High performance aviation is an expensive sport undertaken largely by people who are both young and wealthy. Spit
> Vaughn Clothing of the previous problem has a real option possibility. Carlson Flooring has expressed an interest in trading buildings with Vaughn after Vaughn’s is refurbished. Carlson has offered to reimburse Vaughn for 70% of its refurbishment costs
> Vaughn Clothing is considering refurbishing its store at a cost of $1.4 million. Management is concerned about the economy and whether a competitor, Viola Apparel, will open a store in the neighborhood. Vaughn estimates that there is a 60% chance that V
> Resolve the last problem assuming Work Station Inc has an abandonment option at the end of the first year under which it will recover $5 million of the initial investment in year 2. What is the value of the ability to abandon the project? How does your
> The Glendale Corp. is considering a real estate development project that will cost $5M to undertake and is expected to produce annual inflows between $1M and $4M for two years. Management feels that if the project turns out really well the inflows will
> Work Station Inc. manufactures office furniture. The firm is interested in “ergonomic” products that are designed to be easier on the bodies of office workers’ who suffer from aliments such as back a
> Outline the arbitrage process proposed by MM that supports the operating income argument. What is the arbitrage between?
> Tyler Inc.'s most recent annual dividend was $3.55 a share. The firm has been growing at a consistent 4% rate for several years, but analysts generally believe that better times are ahead, and that future growth will be in the neighborhood of 5%. The sto
> The Sampson Company issued a $1,000 bond 5 years ago with an initial term of 25 years and a coupon rate of 6%. Today’s interest rate is 10%. a. What is the bond’s current price if interest is paid semiannually as it is on most bonds? b. What is the pric
> The Blazingame Corporation is considering a three-year project that has an initial cash outflow (C0) of $175,000 and three cash inflows that are defined by the independent probability distributions shown below. All dollar figures are in thousands. Blazi
> Assume Keener Clothiers of the last problem assigns the following probabilities to production cost as a percent of revenue Sketch a probability distribution (histogram) for the project’s NPV, and compute its expected NPV. % of Rev
> Weisman Electronics just paid a $1.00 dividend, the market yield is yielding 10%, the risk-free rate is 4%, and Weisman’s beta is 1.5. How fast do investors expect the company to grow in the future if its stock is selling for $27.25.
> Cassidy and Sons is reviewing a project with an initial cash outflow of $250,000. An additional $100,000 will have to be invested after the first year, followed by an additional investment of $50,000 at the end of the second year. Beginning at the end
> Why does it make sense to finance net working capital separately from fixed assets?
> You work in the finance department of a manufacturing company. Over lunch, a friend in the engineering department said she'd heard that the firm used a lot of temporary working capital. Because temporary equipment is usually of lower quality than perma
> The Blivitt Company has been losing money and experiencing serious cash flow problems lately. The main problem is a large debt to the First National Bank, which was used to purchase a computer that's now obsolete. Bill Blivitt, the firm's owner has stat
> Clarington Corp has a division that's been performing well but doesn't fit into the company's long-term strategic plans. Describe the methods through which it can divest the operation.
> Sally Johnson lives in Baltimore, and does business with a large, national brokerage firm. When she sends the broker a check, she mails it to a local address in Baltimore. However, when she receives a check, from the broker, it comes from San Francisco
> Suppose an industry is dominated by three firms, one of which is twice as large as the others, which are about the same size. Could a merger of the two smaller firms actually increase competition in the industry?
> The central issue underlying the study of leverage is whether or not it influences stock price and whether there's an optimal structure. But the whole idea seems kind of fuzzy and uncertain. Why are people so interested? (Hint: Think of management's g
> Explain the difference between pledging and factoring receivables. Which is likely to be more a more expensive source of financing? Is factoring the same kind of financing as pledging?
> What's the difference between a promissory note, a line of credit, and a revolving credit agreement? Are they mutually exclusive? That is, might one be part of the other?
> What are the advantages and disadvantages of stretching payables? If you owned your own business, would you do it? Why or why not?
> You work in the finance department of HiTech Inc. The firm's owner and CEO, Charlie Dollars, is very profit oriented. He understands that short-term interest rates are quite low at the moment, and has suggested that the firm finance all of its working c
> Explain the different circumstances under which firms should use short-term or long-term financing.
> How does a firm's operating cycle differ from its cash conversion cycle? Explain fully.
> Support or challenge each of the following statements individually: a. Because accounts receivables aren't purchased like inventory or fixed assets, they don't require financing. b. Cash represents a pool of available money, so it actually reduces fina
> Working capital is generally defined as the difference between current assets and current liabilities. Is this definition precisely correct? Why?
> The Medco Supply Co. operates out of Waco, Texas, and has a number of customers around Portland, Maine. It seems to take a particularly long time for the Portland customers' payment checks to reach Medco. What can the company do to speed things up? Ex
> Describe the maturity matching principle. What are the risks of not matching maturities? How would you characterize a firm that ignores the principle? Can you think of situations in which it would be advisable for an otherwise prudent firm to deviate
> Describe generally how leverage affects stock prices. What forces are at work, driven by what effects?
> How do repurchases help firms manage the signaling effect of dividends.
> Explain how the two methods of cash distribution work, and describe their impact on shareholders. Does everyone always receive cash? If not, are some stockholders left out?
> You're a financial analyst for a large mutual fund. You're doing an analysis of the Truebright Apparel Company, which makes stylish cotton clothes for teenagers. The company has recently been under attack by foreign competition, and seems to have lost
> You're an investment advisor, and have several well-off older people among your clients. One of these individuals, Charlie Haverty, steadfastly refuses to invest in companies that pay significant dividends. A successful investment counselor advised him
> There is said to be a controversy over dividends. What is it and why is it important?
> Fully explain the choices implied by the dividend decision. Are the results of the choices known or uncertain?
> Leveraged leases offer tax advantages to unprofitable companies. a. Why are they called leveraged? b. Briefly, how do they work?
> Leasing is generally more expensive than borrowing to buy, and FASB 13 has reduced the availability of off-balance sheet financing. Why then is leasing popular?
> Outline the reasons for holding cash and the big cost associated with it. How do these lead to the objective of cash management? How do marketable securities help or hinder achievement of the objective?
> Explain in words how the tax system favors debt financing.
> Briefly summarize the operating income argument that was supported by the original MM result.
> Briefly describe the result of MM's original restrictive model. Why was it important in spite of its serious restrictions?
> Explain the idea of bankruptcy costs. Why are they important to investors? When do investors start to worry about them?
> The Braithwaite Tool Co. is considering a major modernization and automation of its plant using borrowed funds. Fully discuss a serious financial negative that could result from the project.
> Show that the profitability index (PI), the initial outlay (C0), and the net present value (NPV) of a project are related by the following equation: NPV = C0 (1 PI) (Hint: State both the NPV and the PI in terms of C0 and the sum of all other cash flows
> Why is the profitability index more appropriately described as a variation on the NPV technique than on the IRR technique?
> Why do labor-intensive processes involve less operating leverage than automated processes? What fixed costs are associated with automation? Why can't those costs be eliminated by just selling the machinery?
> Explain the difference between a fixed and a variable cost. How do these concepts change as the time horizon lengthens? In other words, are the same things fixed over a 5-year planning period that are fixed in a typical 1-year period? What about a 10-
> Dividends are said to be the basis for the value of stocks. If that's true, how do we explain the fact that companies that pay no dividends often have substantial market value? (Such companies are usually relatively young and in high growth fields.) F
> What is the biggest problem associated with financing secured by inventory? How is it addressed in practice?
> Retained earnings are generated by the firm's internal operations and are immediately reinvested to earn more money for the company and its shareholders. Therefore, such funds have zero cost to the company. Is that statement true or false? Explain.
> Explain in words the ROCE test for the advisability of adding leverage. That is, what is the test really telling us? When will it indicate a company is doing the wrong thing?
> Briefly explain the pros and cons of financial leverage. In other words, what are its benefits, and what are the costs that come along with those benefits?
> Both business risk and financial risk would exist with or without either type of leverage. Leverage just makes them more significant. Are these statements true or false? Explain.
> Why are ROE and EPS such important measures of performance to investors?
> Relate business and financial risk as defined in this chapter to the risks described in Chapter 9.
