# FUNDAMENTALS OF CORPORATE FINANCE

 1.     Suppose that you own 2,200 shares of Nocash Corp. and the company is about to pay a 25% stock dividend. The stock currently sells at \$100 per share.

 a. What will be the number of shares that you hold after the stock dividend is paid? (Do not round intermediate calculations.)

 Number of shares

 b. What will be the total value of your equity position after the stock dividend is paid? (Do not round intermediate calculations.)

 Total value \$

 c. What will be the number of shares that you hold if the firm splits five for four instead of paying the stock dividend?

 Number of shares hold

 2.     Consolidated Pasta is currently expected to pay annual dividends of \$10 a share in perpetuity on the 1.5 million shares that are outstanding. Shareholders require a 10% rate of return from Consolidated stock.

 a. What is the price of Consolidated stock?

 Stock price \$

 b. What is the total market value of its equity? (Enter your answer in millions.)

 Market value of equity \$ million

 Consolidated now decides to increase next year’s dividend to \$20 a share, without changing its investment or borrowing plans. Thereafter the company will revert to its policy of distributing \$10 million a year.

 c. How much new equity capital will the company need to raise to finance the extra dividend payment? (Enter your answer in millions.)

 New equity \$ million

 d. What will be the total present value of dividends paid each year on the new shares that the company will need to issue? (Enter your answer in millions.)

 Present value \$ million

 e. What will be the transfer of value from the old shareholders to the new shareholders? (Enter your answer in millions.)

 Transfer of value \$ million

f. Is this figure more than, less than, or the same as the extra dividend that the old shareholders will receive?

 More than Less than The same

 3.     The expected pretax return on three stocks is divided between dividends and capital gains in the following way:

 Stock Expected Dividend Expected Capital Gain A \$  0 \$ 6 B 1 1 C 24 0

 a. If each stock is priced at \$100, what are the expected net percentage returns on each stock to (i) a pension fund that does not pay taxes, (ii) a corporation paying tax at 35% (The effective tax rate on dividends received by corporations is 10.5%), and (iii) an individual with an effective tax rate of 15% on dividends and 10% on capital gains? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

 Stock Pension Investor Corporation Individual A % % % B % % % C % % %

 b. Suppose that investors pay 50% tax on dividends and 20% tax on capital gains. If stocks are priced to yield an after-tax return of 8%, what would A, B, and C each sell for? Assume the expected dividend is a level perpetuity. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

 Stock Price A \$ B \$ C \$

 4.     The following is the financial statement of Executive Fruit Company for the year ended December 2014.

 INCOME STATEMENT, 2014 (Figures in \$ Thousands) Revenue \$ 5,500 Cost of goods sold 4,950 EBIT \$ 550 Interest 110 Earnings before taxes \$ 440 State and federal tax 176 Net income \$ 264 Dividends 176 Additions to retained earnings \$ 88

 BALANCE SHEET (Year-End, 2014) (Figures in \$ Thousands) Assets Net working capital \$ 550 Fixed assets 2,200 Total assets \$ 2,750 Liabilities and shareholders’ equity Long-term debt \$ 1,100 Shareholders’ equity 1,650 Total liabilities and shareholders’ equity \$ 2,750

 The following are the first stage and second stage pro forma financial statements of Executive Fruit Company for the year ended December 2015. First stage pro forma statements:

 PRO FORMA INCOME STATEMENT, 2015 (Figures in \$ Thousands) Revenue \$ 6,050 Cost of goods sold 5,445 EBIT \$ 605 Interest 110 Earnings before taxes \$ 495 State and federal tax 198 Net income \$ 297 Dividends 198 Additions to retained earnings \$ 99

 PRO FORMA BALANCE SHEET (Year-End, 2015) (Figures in \$ Thousands) Assets Net working capital \$ 605 Fixed assets 2,420 Total assets \$ 3,025 Liabilities and shareholders’ equity Long-term debt \$ 1,100 Shareholders’ equity 1,749 Total liabilities and shareholders’ equity \$ 2,849 Required external financing \$ 176

 Second stage pro forma balance sheet:

 PRO FORMA BALANCE SHEET (Year-End, 2015) (Figures in \$ Thousands) Assets Net working capital \$ 605 Fixed assets 2,420 Total assets \$ 3,025 Liabilities and shareholders’ equity Long-term debt \$ 1,276 Shareholders’ equity 1,749 Total liabilities and shareholders’ equity \$ 3,025

 How would Executive Fruit’s financial model change if the dividend payout ratio were cut to 1/3? Use the revised model to generate a new financial plan for 2015 assuming that debt is the balancing item. What would be the required external financing? (Do not round intermediate calculations.)

 Dividends fall by \$ . Therefore, the requirement for external financing falls from \$ to \$ . On the other hand, shareholders’ equity will be increased by \$ .

 The right-hand side of the balance sheet becomes (Do not round intermediate calculations. Enter your answers in thousands.):

 Long-term debt \$ Shareholders’ equity Total \$

 5.     Find the sustainable and internal growth rates for a firm with the following ratios: asset turnover = 2.00; profit margin = 4%; payout ratio = 35%; equity/assets = .30. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

 Sustainable growth rate % Internal growth rate %

 6.     Executive Fruit’s financial manager believes that sales in 2015 could rise by as much as 20% or by as little as 5%. Assets and costs change in proportion to sales, debt remains constant, and no new equity financing occurs.

 a. Recalculate the first-stage pro forma financial statements under these two growth assumptions and calculate the required external financing (All figures are in thousands). (Enter your answers in thousands.)

 Base Case 20% Growth 5% Growth INCOME STATEMENT Revenue \$ 6,000 \$ \$ Cost of goods sold 5,400 EBIT \$ 600 \$ \$ Interest 120 Earnings before taxes \$ 480 \$ \$ State and federal tax 192 Net income \$ 288 \$ \$ Dividends 192 Retained earnings \$ 96 \$ \$ BALANCE SHEET Assets Net working capital \$ 600 \$ \$ Fixed assets 2,400 Total assets \$ 3,000 \$ \$ Liabilities and shareholders’ equity Long-term debt \$ 1,200 \$ \$ Shareholders’ equity 1,800 Total liabilities and shareholders’ equity \$ 3,000 \$ \$ Required external financing \$ \$

 b. Assume any required external funds will be raised by issuing long-term debt and that any surplus funds will be used to retire such debt. Prepare the completed (second-stage) pro forma balance sheet. (Enter your answers in thousands.)

 BALANCE SHEET Base Case 20% Growth 5% Growth Assets Net working capital \$ 600 \$ \$ Fixed assets 2,400 Total assets \$ 3,000 \$ \$ Liabilities and shareholders’ equity Long-term debt \$ 1,200 \$ \$ Shareholders’ equity 1,800 Total liabilities and shareholders’ equity \$ 3,000 \$ \$

 7.     Plank’s Plants had net income of \$4,000 on sales of \$70,000 last year. The firm paid a dividend of \$1,480. Total assets were \$200,000, of which \$80,000 was financed by debt.

 a. What is the firm’s sustainable growth rate? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

 Sustainable growth rate %

 b. If the firm grows at its sustainable growth rate, how much debt will be issued next year? (Do not round intermediate calculations.)

 New debt \$

 c. What would be the maximum possible growth rate if the firm did not issue any debt next year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

 8.     An all-equity-financed firm plans to grow at an annual rate of at least 24%. Its return on equity is 37%. What is the maximum possible dividend payout rate the firm can maintain without resorting to additional equity issues? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)

 Maximum dividend payout ratio %

 9.     The 2015 financial statements for Growth Industries are presented below:

 INCOME STATEMENT, 2015 Sales \$ 270,000 Costs 185,000 EBIT \$ 85,000 Interest expense 17,000 Taxable income \$ 68,000 Taxes (at 35%) 23,800 Net income \$ 44,200 Dividends \$ 17,680 Addition to retained earnings 26,520

 BALANCE SHEET, YEAR-END, 2015 Assets Liabilities Current assets Current liabilities Cash \$ 3,000 Accounts payable \$ 10,000 Accounts receivable 8,000 Total current liabilities \$ 10,000 Inventories 29,000 Long-term debt 170,000 Total current assets \$ 40,000 Stockholders’ equity Net plant and equipment 210,000 Common stock plus additional paid-in capital 15,000 Retained earnings 55,000 Total assets \$ 250,000 Total liabilities and stockholders’ equity \$ 250,000

 Sales and costs in 2016 are projected to be 30% higher than in 2015. Both current assets and accounts payable are projected to rise in proportion to sales. The fixed assets of Growth Industries are operating at only 75% of capacity. Interest expense in 2016 will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of .40.

 What is the required external financing over the next year?

 Even if sales increase by 30%, the firm still has more than enough fixed assets to meet production. Only working capital will increase. Net working capital of the firm in 2015 was \$. The increase in net working capital will be \$, which is less than the increase in the retained earnings. Thus required external financing is \$. A negative external financing value indicates the firm will generate more cash than it needs to finance the projected growth. This extra cash can be used to reduce debt, repurchase shares, increase cash reserves, or fund future growth. This extra cash was primarily due to the firm’s excess production capacity.

 Income statement data: Sales \$ 6,000 Cost of goods sold 5,200 Balance sheet data: Inventory \$ 590 Accounts receivable 210 Accounts payable 370

10.

 Calculate the accounts receivable period, accounts payable period, inventory period, and cash conversion cycle for the above firm: (Use 365 days in a year. Do not round intermediate calculations. Round your answers to 1 decimal place.)

 a. Accounts receivable period days b. Accounts payable period days c. Inventory period days d. Cash conversion cycle days

 11.  Complete the statement of sources and uses of cash from the following entries:

 Net income \$2,000 Dividends 800 Additions to inventory 170 Additions to receivables 200 Depreciation 140 Reduction in payables 600 Net issuance of long-term debt 350 Sale of fixed assets 110

 Sources Issued long-term debt \$ Sale of fixed assets Cash from operations: Net income Depreciation Total sources \$ Uses Additions to inventory \$ Increase in accounts receivable Decrease in accounts payable Payment of dividends Total uses \$

 12.  Here is a forecast of sales by National Bromide for the first 4 months of 2015 (figures in thousands of dollars):

 Month: 1 2 3 4 Cash sales 26 35 29 25 Credit sales 155 175 145 125

 On average, 60% of credit sales are paid for in the current month, 20% in the next month, and the remainder in the month after that. What are the expected cash collections in months 3 and 4? (Enter your answers in whole dollars.)

 Expected cash collections Month 3 \$ Month 4 \$

 13.  A firm sells its \$1,090,000 receivables to a factor for \$1,079,100. The average collection period is 1 month. What is the effective annual rate on this arrangement? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

 Effective annual rate %

 14.  Company X sells on a 1/10, net 60, basis. Customer Y buys goods with an invoice of \$2,000.

 a. How much can company Y deduct from the bill if it pays on day 10?

 Discount \$

 b. How many extra days of credit can company Y receive if it passes up the cash discount?

 Number of days days

 c. What is the effective annual rate of interest if Y pays on the due date rather than day 10? (Use 365 days in a year. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

 Effective annual rate %

 15.  Microbiotics currently sells all of its frozen dinners cash on delivery but believes it can increase sales by offering supermarkets 1 month of free credit. The price per carton is \$80, and the cost per carton is \$55. The unit sales will increase from 1,030 cartons to 1,090 per month if credit is granted. Assume all customers pay their bills and take full advantage of any credit period offered.

 a. If the interest rate is 1% per month, what will be the change in the firm’s total monthly profits on a present value basis if credit is offered to all customers? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 Change in total monthly profit \$

 b. If the interest rate is 1.5% per month, what will be the change in the firm’s total monthly profits on a present value basis if credit is offered to all customers? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 Change in total monthly profit \$

 c. Assume the interest rate is 1.5% per month but the firm can offer the credit only as a special deal to new customers, while existing customers will continue to pay cash on delivery. What will be the change in the firm’s total monthly profits on a present value basis under these conditions? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 16.  On each nondelinquent sale Cast Iron receives revenues with a present value of \$1,280 and incurs costs with a present value of \$1,130. Assume there is no possibility of repeat orders and that the probability of successful collection from the customer is p = .97.

 a-1. What is the expected profit of granting credit? (A negative amount should be indicated by a minus sign. Do not round intermediate calculations. Round your answer to 2 decimal places.)

 Expected profit \$ per sale

a-2. Should Cast Iron grant or refuse credit?

 Grant Refuse

 b. What is the break-even probability of collection? (Enter your answer as a percent rounded to 1 decimal place.)

 Break-even probability %

 17.  Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 450 payments a day will be made to lock boxes with an average payment size of \$3,000. The bank’s charge for operating the lock boxes is \$.50 a check. The interest rate is .012% per day.

 a-1. If the lock box makes the cash available 2 days earlier, calculate the net daily advantage of the system. (Do not round intermediate calculations.)

 Daily interest saved \$

a-2. Is it worthwhile to adopt the system?

 Yes No

 b. What minimum reduction in the time to collect and process each check is needed to justify use of the lock-box system? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 Minimum reduction in time days

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