The Paxton Homes Co. is a successful builder of moderate to high-priced houses. The firm is currently considering an expansion into light commercial construction in which it would build shopping centers and small office buildings. Management considers the idea a new venture because of the major differences between commercial and residential construction. Getting into the new line of business will require an investment of $12.5M in equipment and $3M in expenses. The equipment will be depreciated over five years. Part of the start-up money will come from the sale of some old trucks and cranes. These have a total market value of $1.8M and an NBV of $600K. Selling the equipment will result in a depreciation reduction of $200K per year for three years. Revenue from the commercial line is expected to be $6M in the first year and to grow by $2M in each succeeding year until it reaches $20M. After that growth is uncertain and may be anywhere from 0 to 6% per year. Costs and expenses, including incremental overhead, will be 110% of revenues in the first year, 85% in the next two years, and 70% thereafter. Economies of scale in materials purchasing are expected to save the residential business about $250K per year but not until the fourth year. Net working capital requirements are estimated at 10% of revenue. The combined federal and state tax rate on the incremental business will be 40%. Losses can be offset against other profits and can therefore be viewed as earning a tax credit at the same rate. Paxton's cost of capital is 12%. You are a financial analyst assigned to evaluate the commercial construction proposal. Use the CAPBUD program to analyze the project and prepare a presentation in which you will make a recommendation either favoring or opposing its undertaking. Here are some ideas for approaches to your presentation: a. Establish a base case using the information given. Forecast into the future until the numbers stop changing (eight years). Assume a terminal value based on a continuation of the eighth year's cash flows with no further growth. Is the project acceptable based on NPV and IRR given these assumptions? b. Test the sensitivity of the base case analysis to the terminal value assumption by varying the growth rate to 3% and 6%. 1) Comment on the difference the terminal growth rate assumption makes. 2) Construction is a cyclical industry in that it is very subject to the ups and downs of the economy. In good times growth is enormous, but in bad times the industry and the firms in it shrink rapidly. Given that fact, how do you feel about the terminal value assumption? 3) Evaluate the project's NPV and IRR assuming a ten-year planning horizon. That is, assuming zero cash flows after the tenth year. Does this approach make more or less sense to you than the terminal value assumptions used in part a.? c. Test the sensitivity of the analysis to changes in revenue growth. For example, suppose revenue grows by only $1M per year instead of two until the eighth year. Is the project a good idea then? What if cost/expense is a higher percentage of revenue than anticipated?
> The Framingham Company expects to grow at 4% indefinitely. Economists are currently asserting that investment opportunities in short term government securities (treasury bills) are readily available at a risk-free rate of 5%. The stock market is returni
> What is interest rate or price risk? Why is it sometimes called maturity risk? Explain fully.
> The Longlife Insurance Company of the preceding problem has several bonds outstanding that are currently selling to yield 9%. What does this imply about the cost of the firm's equity?
> Grandma's Cookies Inc. is considering acquiring Mother's Baked Goods Inc. After consideration of all benefits, synergies and tax effects, Grandma (originally a finance major) has estimated that the incremental cash flows from the acquisition will be abo
> The Longlife Insurance Company has a beta of .8. The average stock currently returns 15% and short-term treasury bills are offering 6%. Estimate Longlife's cost of retained earnings.
> Schoen Industries pays interest of $3 million each year on bonds with an average coupon rate of 7.5%. The firm has 4.5 million shares of stock outstanding and pays out 100% of earnings in dividends. Earnings per share (EPS) is $3.50. Schoen’s cost of
> Klints Inc. paid an annual dividend of $1.45 last year. The firm’s stock sells for $29.50 per share, and the company is expected to grow at about 4% per year into the foreseeable future. Estimate Klints’ cost of retained earnings.
> Assume that Meade Metals Inc of the previous problem is replacing an old truck with a new one instead of replacing an outside delivery service. The old truck was purchased 8 years ago for $120,000. It has been depreciated straight line based on a ten-y
> A few years ago Hendersen Corp issued preferred stock paying 8% of its par value of $50. The issue is currently selling for $38. Preferred stock flotation costs are 15% of the proceeds of the sale. What is Hendersen's cost of preferred stock?
> The York Company has an average receivables balance of $55,000, which turns over once every 30 days. It offers all of its receivables to its bank as collateral for short-term borrowing (pledging). The bank generally accepts 60% of the accounts offered
> Harris Inc.’s preferred stock was issued five years ago to yield 9%. Investors buying those shares on the secondary market today are getting a 14% return. Harris generally pays flotation costs of 12% on new securities issues. What is Harris’s cost of
> Jenkins Appliances has cash flow problems and needs to borrow between $50,000 and $60,000 for approximately sixty (60) days. Because the business is small and relatively new, unsecured loans are very hard to get and are expensive when they are available.
> What is valuation, and why are we interested in the results?
> Calculate the effective interest rate on loans with the following minimum compensating balance requirements: Compensating Balance 20% Loan Rate a. 6.5% b. 12.0% 10% с. 10.5% 15% d. 14.0% 25% е. 8.5% 30%
> Hampshire Motors Ltd., a British manufacturing company, wants to buy a production machine that isn’t available in England. Comparable products are made by an American company and a French firm. The Americans have quoted Hampshire a price of $175,000 whil
> An American importer owes vendors the following sums a. 140,560 Canadian dollars b. 392,000 Australian dollars c. 1,362,000 Mexican pesos d. 680,540 British (U.K.) pounds e. 14,673 Euros State each debt in U.S. dollars.
> In the situation at Wachusett Window outlined in the last question, do you think a higher prompt payment discount alongside the new sales program would have kept receivables down? Why?
> You're interested in investing in the Peters Company, which has shown a remarkable increase in EPS over the last three years. You investigate and find that the company's debt-to-equity ratio has increased dramatically over the same period and is now fou
> The Cranston Company would like to acquire the Lamont Company, but overtures made to management have been emphatically rebuffed. Five investors who were involved in the company's founding and continue to be active in its management own 45% of Lamont's st
> Shelton Pharmaceuticals Inc. is planning to introduce a new drug for pain relief. Management expects to sell 3 million units in the first year at $8.50 each, and anticipates 10% growth in sales per year thereafter. Operating costs are estimated at 70%
> The Grass Ridge Company has the following current asset accounts Its current ratio is 2.5:1. The bank is willing to lend the company enough to finance its working capital needs under a $10 million revolving credit arrangement at a base rate of 12% wi
> Using the information from the previous problem, randomly select four NPV outcomes from the data. (Select one cash flow from each year and compute the project NPV and the probability of that NPV implied by those selections.) Do your selections give a sen
> The Montauk Company has a dividend reinvestment plan in which shareholders owning 25% of its common stock participate. Last year the firm’s EPS was $4.20 and its payout ratio was 50%. There are 2 million shares of common stock outstanding. How much ne
> The amount formulas share a closer relationship than the annuity formulas. Explain and interpret this statement.
> Calculate the effective interest rate implied by the following terms of sale, using a 365-day year. 2/10, net 30 1/5, net 15 .5/10, net 30 2.5/10, net 25 1/5, net 20
> Moser Materials Inc. is considering acquiring Newkirk Products, which produces a number of products that would enhance Moser’s product line. Last year Newkirk reported a $30 million loss. Moser has estimated that Newkirk will break even in the fourth y
> What is the effective interest rate on a $750,000 loan at 8% for 120 days if a 20% minimum compensating balance is required?
> Scherbert Industries has the following balance sheet accounts as of 12/31/x3 (not a complete balance sheet): Calculate gross and net working capital. Accounts Payable. $650,000 Accounts Receivable 845,000 Accruals. 257,500 Cash .. 137,200 Common S
> Willerton Industries Inc. has the following balances in its capital accounts as of 12/31/x3: Calculate Willerton’s capital structure based on book values. Long Term Debt $65,000,000 Preferred Stock $15,000,000 Common Stock $40,000
> Southport Inc. has an inventory turnover of 10X, an ACP of 45 days, and turns over its payables once a month. How long are Southport's operating and cash conversion cycles? (Use a 360-day year.)
> The Manning Company's stock is currently selling for $23. It has the following prospects for next year: Calculate Manning's expected return for a one-year holding period. Next year's Stock Price Dividend $1.00 $1.50 $2.00 Probability $25 $30 $35 .
> Watson Waterbed Works Inc. has an EBIT of $2.75 million, can borrow at 15% interest, and pays combined state and federal income taxes of 40%. It currently has no debt and is capitalized by equity of $12 million. The firm has 1.5 million shares of common
> What interest rate would you need to get to have an annuity of $7,500 per year accumulate to $279,600 in 15 years?
> The Aztec Corporation has the following capital components and costs. Calculate Aztec's WACC. Value $23,625 $ 4,350 $52,275 Component Debt Cost 12.0% Preferred Stock Common Equity 13.5% 19.2%
> What is a sinking fund? How is it related to time value?
> Calculate BWP’s DFL and DTL before and after the acquisition of the new machine
> The Alligator Lock Company is planning a two-for-one stock split. You own 5,000 shares of Alligator's common stock that is currently selling for $120 a share. a. What is the value of your Alligator stock now, and what will it be after the split? b. Alli
> The Dentite Corporation’s bonds are currently selling to yield new buyers a 12% return on their investment. Dentite’s marginal tax rate including both federal and state taxes is 38%. What is the firm’s cost of debt?
> Asbury Corp. issued 30-year bonds 11 years ago with a coupon rate of 9.5%. Those bonds are now selling to yield 7%. The firm also issued some 20-year bonds two years ago with an 8% coupon rate. The two bond issues are rated equally by Standard and Poor
> Blazingame Inc.'s capital components have the following market values: Calculate the firm's capital structure and show the weights that would be used for a weighted average cost of capital (WACC) computation. Debt . $35,180,000 Preferred Stock.
> Sanville Quarries is considering acquiring a new drilling machine which is expected to be more efficient than their current machine. The project is to be evaluated over four years. The initial outlay required to get the new machine operating is $675,000
> The Olson Company plans to replace an old machine with a new one costing $85,000. The old machine originally cost $55,000, and has six years of its expected 11-year life remaining. It has been depreciated straight line assuming zero salvage value, and
> Kleig Inc.'s bonds are selling to yield 9%. The firm plans to sell new bonds to the general public and will therefore incur flotation costs of 6%. The company's marginal tax rate is 42%. a. What is Kleig's cost of debt with respect to the new bonds? (H
> Mitech Corp’s stock has been growing at approximately 8% for several years and is now $30. Based on past growth rate performance, what would you expect the stock’s price to be in five years?
> The Pepperpot Company's stock is selling for $52. Its last dividend was $4.50, and the firm is expected to grow at 7% indefinitely. Flotation costs associated with the sale of common stock are 10% of the proceeds raised. Estimate Pepperpot's cost of e
> What's an opportunity cost interest rate?
> Fuller, Inc. issued $100, 8% preferred stock five years ago. The shares are currently selling for $84.50. Assuming Fuller has to pay floatation costs of 10%, what is Fuller’s cost of preferred stock?
> Keener Clothiers Inc. is considering investing $2 million in an automatic sewing machine to produce a newly designed line of dresses. The dresses will be priced at $200, and management expects to sell 12,000 per year for six years. There is, however, so
> Haley Motors is considering a maintenance contract for its heavy equipment. One firm has offered Haley a four-year contract for $100,000 to be paid in advance. Another firm has offered an eight-year contract for $165,000 also to be paid in advance. Both
> Calculate IRRs for the projects in the previous problem. Problem 19: Initial Outlay (C) Project Length (in years) Annual Cost of NPV Cash Flow Сapital ($100,000) ($200,000) ($300,000) ($400,000) ? 5 $35,000 8% ? $35,000 $15,000 $20,000 $25,000 4
> Auburn Concrete Inc. is considering the purchase of a new concrete mixer to replace an inefficient older model that is completely worn out. If purchased, the new machine will cost $90,000 and is expected to generate savings of $40,000 per year for five
> Blue & Noble is a small law firm that does all of its business through billings (no cash sales). Historically the firm has collected 40% of its revenue in the month of billing, 50% during the first month after billing and 8% during the second month after
> Fox Woodworking Inc. issued preferred shares at a face value of $50 to yield 9% 10 years ago. The shares are currently selling at $60. What return are they earning for investors who buy them today?
> Olson-Jackson Corp. (OJC) is considering replacing a machine that was purchased only two years ago because of dramatic improvements in new models. The old machine has been depreciated straight line anticipating a ten years life based on a cost of $240,0
> Meade Metals Inc plans to start doing its own deliveries instead of using an outside service for which it has been paying $150,000 per year. To make the change Meade will purchase a $200,000 truck that it will depreciate straight line over ten years to
> Deferred payment terms are equivalent to a cash discount. Discuss and explain this idea.
> Harrington Inc. is introducing a new product in its line of household appliances. Household products generally have ten-year life cycles and are viewed as capital budgeting projects over that period. Harrington’s working capital forecast for the projec
> How many years will it take for $850 per year to accumulate to $20,000 if the interest rate is 8%?
> Softek has two potentially big-selling products under development. Alpha, the first new product, seems very likely to catch on and is expected to drive the firm's growth rate to 25% for the next two years. However, software products have short lives, a
> Laurel Wilson has a portfolio of five stocks. The stocks’ actual investment performance last year is given below along with an estimate of this year’s performance. Compute the actual return on Laurelâ€&
> Harry and Flo Simone are planning to start a restaurant. Stoves, refrigerators, other kitchen equipment, and furniture are expected to cost $50,000 all of which will be depreciated straight line over five years. Construction and other costs of getting
> A project that is expected to last six years will generate a profit and cash flow contribution before taxes and depreciation of $23,000 per year. It requires the initial purchase of equipment costing $60,000, which will be depreciated straight line over
> Voxland Industries purchased a computer for $10,000, which it will depreciate straight line over five years to a $1,000 salvage value. The computer will then be sold at that price. The company’s marginal tax rate is 40%. Calculate the cash flows assoc
> A four-year project has cash flows before taxes and depreciation of $12,000 per year. The project requires the purchase of a $50,000 asset that will be depreciated over five years, straight line. At the end of the fourth year the asset will be sold for
> Flextech Inc. is considering a project that will require new equipment costing $150,000. It will replace old equipment with a book value of $35,000 that can be sold on the second-hand market for $75,000. The company’s marginal tax rate is 35%. Calcula
> Imagine making choices in the following situation to test your degree of risk aversion. Someone offers you the choice between the following game and a sure thing. The Game: A coin is tossed. If it turns up heads, you get a million dollars. If tails,
> Write a brief, verbal description of the logic behind the development of the time value formulas for annuities.
> Why might the government be interested in influencing exchange rates from time to time? How would it go about moving the exchange rate?
> Calculate the IRR for the following projects. a. An initial outflow of $15,220 followed by inflows of $5,000, $6,000, and $6,500. b. An initial outflow of $47,104 followed by inflows of $16,000, $17,000, and 18,000.
> Calculate an IRR for the project in problem 2 using an iterative technique. (Hint: Start by guessing 15%.)
> Conestoga Ltd. has the following estimated probability distribution of returns. Calculate Conestoga’s expected return, the variance and standard deviation of its expected return and the return’s coefficient of variat
> Fred Tibbits has made a detailed study of the denim clothing industry. He's particularly interested in a company called Denhart Fashions that makes stylish denim apparel for children and teenagers. Fred has done a forecast of Denhart's earnings and look
> The Habender Company just issued a two-year bond at 12%. Inflation is expected to be 4% next year and 6% the year after. Habender estimates its default risk premium at about 1.5% and its maturity risk premium at about .5%. Because it's a relatively sma
> A project has the following cash flows a. What is the project’s payback period? b. Calculate the projects NPV at 12%. c. Calculate the project’s PI at 12%. Co ($700) Ca $244 $200 $500
> Blackstone Corporation's $7 preferred was issued five years ago. The risk-appropriate interest rate for the issue is currently 11%. What is this preferred stock selling for today?
> What will a deposit of $4,500 left in the bank be worth under the following conditions? a. Left for nine years at 7% interest? b. Left for six years at 10% compounded semiannually? c. Left for five years at 8% compounded quarterly? d. Left for 10 years
> Pam Smith just inherited a $1,000 face value K-S Inc. bond from her grandmother. The bond clearly indicates a 12% coupon rate, but the maturity date has been smudged and can’t be read. Pam called a broker and determined that similar bonds are currently
> A four-stock portfolio is made up as follows Calculate the portfolio's beta. Current Value $4,500 Stock Beta .8 .6 2,900 6,800 1,200 1.3 1.8 D ABCA
> Calculate the present value of one dollar 30 years in the future at 10% interest. What does the result tell you about very long-term contracts?
> Grand Banks Mining Inc. plans a project to strip mine a wilderness area. Setting up operations and initial digging will cost $5 million. The first year's operations are expected to be slow and net a positive cash flow of only $500,000. Then there will
> The Duncan Company's stock is currently selling for $15. People generally expect its price to rise to $18 by the end of next year. They also expect that it will pay a dividend of $.50 per share during the year. (Hint: Apply Equation 9.2 page 395.) a.
> Calculate the expected return on an investment in Delta Inc.'s stock if the probability distribution of returns is as follows. Plot the distribution on the axis with Omega Inc. of the previous problem. Based on the graph, which company has the lower r
> The probability distribution of the return on an investment in Omega Inc.'s common stock is as follows: Graph the probability distribution. Calculate the expected return, the standard deviation of the return, and the coefficient of variation. Re
> The Wintergreens are planning ahead for their son's education. He's eight now and will start college in 10 years. How much will they have to set aside each year to have $65,000 when he starts if the interest rate is 7%?
> The Aldridge Co. is expected to grow at 6% into the indefinite future. Its latest annual dividend was $2.50. Treasury bills currently earn 7% and the S&P 500 yields 11%. a. What price should Aldridge shares command in the market if its beta is 1.3? b.
> You are a junior treasury analyst at the Palantine Corporation. The treasurer believes the CAPM gives a good estimate of the company's return to equity investors at any time, and has asked you to prepare an estimate of that return using the SML. Treasu
> The stock of Sedly Inc. is expected to pay the following dividends: At the end of the fourth year its value is expected to be $37.50. What should Sedly sell for today if the return on stocks of similar risk is 12%? Year Dividend 3. 1 2 4 $2.25 $3.
> A portfolio consists of the following four stocks. What is the expected return of the portfolio? Еxpected Current Market Value Return $180,000 $145,000 $452,000 $223,000 $1,000,000 Stock 8% 10% 12% 5% ABCA
> Longly Trucking is issuing a 20-year bond with a $2,000 face value tomorrow. The issue is to pay an 8% coupon rate, because that was the interest rate while it was being planned. However, rates have increased suddenly and are expected to be 9% when the
> Why is it important that physical assumptions precede financial results in the planning process? For example, what's wrong with assuming that you want a business that sells $50 million a year earning a profit of $5 million, and then building a revenue an
> At what interest rate will $750 grow into $3,132.83 in 15 years?
> How long will it take $5,000 invested at 14% to double?
> The Pancake Corporation recently paid a $3 dividend, and is expected to grow at 5% forever. Investors generally require an expected return of at least 9% before they'll buy stocks similar to Pancake. a. What is Pancake's intrinsic value? b. Is it a ba
> The Spinnaker Company has paid an annual dividend of $2 per share for some time. Recently the board of directors voted to grow the dividend by 6% from now on. What is the most you would be willing to pay for a share of Spinnaker if you expect a 10% ret
> Broxholme Industries has sales of $40 million, equity totaling $27.5 million and an ROS of 12%. The sustainable growth rate has been calculated at 10.9%. What dividend payout ratio was assumed in this calculation?
> Refer to the Microsoft stock quotation on page 194. Demonstrate that the price earnings (P/E) ratio is consistent with other information in the listing.
> Snyder Mfg. issued a $1,000 face value 30-year bond 5 years ago with an 8% coupon. The bond is subject to call after 10 years, and the current interest rate is 7%. What call premium will make a bondholder indifferent to the call? (Hint: Equate the for
> What would you pay for an annuity paying $3,000 per year for 12 years if the interest rate is 10%?
> Softek has two potentially big-selling products under development. Alpha, the first new product, seems very likely to catch on and is expected to drive the firm's growth rate to 25% for the next two years. However, software products have short lives, a
> How much will $650 per year deposited at 12% be worth in 8 years?
