# Financial management

1. A company has a return on equity of 20 percent and a profit margin of 13 percent. The company’s total debt equal \$450 million and total equity equal to \$550 million. Determine the level of sales for this company? (Hints: assume debt + equity = total assets. Think about DuPont equation).

2. Last year a company had \$365,000 of assets, \$28,275 of net income, and a debt-to-total-assets ratio of 42%. However, the president is convinced to increase the debt ratio to 54%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and therefore keep net income unchanged.

What was the original return on equity (ROE) for this company? Assuming the president of the firm allows the CFO to increase the debt ratio to 54%, what will be the new ROE’?

(Hints: in this case, we assume debt-to-total-assets ratio + equity-to-total-assets ratio = 100%)

3.You plan to deposit \$2,500 into a saving account at the beginning of every year  with the first deposit made today (on 9/07/2015). The bank account has a nominal annual interest rate of 4 percent and interest is compounded annually. How much will you have in the account (FV) at the end of 15 years (or by 9/07/2030)?

4. A new firm is asking your advice regarding its capital structure decisions.  It will require \$1,500,000 of total assets and expecting sales during its first year of operation to be \$950,000.  The operating costs and cost of goods sold will be 80% of sales.  The company can borrow funds at an interest rate of 7.3% however, because of its high-risk business plan, the lender will require the firm to maintain a TIE (times-interest-earned) ratio of at least 6.0x.  What is the maximum debt ratio the firm can use so as to meet its TIE ratio of 6.0x?  Note that by the term debt ratio I imply Debt/Total Assets from the 13th edition of our text, which in the 14th edition is called the Liabilities-to-assets ratio and is defined as Total liabilities/Total assets.

Hint:  To determine the annual interest paid, use the following:  INT(\$) = Debt x i

(where i = interest rate in %).  Also, EBIT = Sales – Operating costs – Cost of goods sold.

5. The firm had earnings per share (EPS) of \$6.22 in 2005 and \$13.48 at the end of 2014.  The company pays out 33 percent of its earnings as dividends per share (DPS), and the company’s stock price was \$39.50 (at the end of 2014). (hints: assume the firm has a constant growth)

(a)  Calculate the growth rate in dividends (g) over the given period.

Dividend Growth Rate (g) = _________________.

(b)  Calculate the expected dividend per share next year (what is D1 at the end of 2015, assuming the earnings and dividends of Mountain Fresh growth at a constant rate).

Expected Dividend (D2015) = __________________.

(c)  Based on the information given above, what is the cost of retained earnings common equity (rs) for Mountain Fresh Company?

Cost of Retained Earnings (rs) = __________________.

6.  (60 Points).  The firm has identified two mutually exclusive projects, A and B, with the following expected net cash flows:

Expected Net Cash Flows

Year                Project A                                 Project B

0                      (\$150)                                    (\$150)

1                          95                                      35

2                          75                                      80

3                          35                                      100

Both of the projects have a cost of capital of 14 percent.

(i)         What is Project A’s and Project B’s net present value (NPV)? (24 points)

NPV for A = ____________________.

NPV for B = ____________________.

(ii)  What is the profitability index (PI) for Project A? (18 points)

Profitability Index for A = ____________________.

(iii)       What is the modified internal rate of return for Project B? (18 points)

MIRR for Project B = ____________________.

7a.  (30 Points). The 9-year bond carries a coupon (legal) rate of 5.95 percent, payable semiannually, and has a maturity value of \$1,000.  If you require a 10.6 percent yield to maturity (rd = 0.106), what price should you expect to pay for the bond today (VB(2015))?  Also, if the yield to maturity holds constant over the next year and you think you might sell your investment at that point, what price would you expect to receive for this bond next year (VB(2016))?

Bond Price Today (VB(2015)) = ______________________.

Bond Price Next Year (VB(2016)) = ______________________.

7b. (30 Points). ABC Co. expects to earn \$3.65 per share during the current year, its

expected dividend payout ratio is 66%, its expected constant dividend growth rate (g) is 5.0%,

and its common stock currently sells for \$33.50 per share.  New stock can be sold to the public at

the current price, but a flotation cost of 10% would be incurred (F = 0.10).  What would be the

cost of retained earnings  common equity (rs) for ABC Co.?  What would be the cost of equity from new common stock (re) (Assume the new stocks issue at the same price as existing stock)?

Cost of Retained Earnings Common Equity (rs) = ____________________.

Cost of Newly Issued Common Stock (re) = ____________________.

8.  (30 Points).  BCD Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product.  Management expects earnings and dividends to grow at a rate of 28% for the next 3 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., g = 0.  The company’s last dividend, D0, was \$1.25, its beta is 1.50, the market risk premium is 4.50%, and the risk-free rate is 4.00% (Hint:  You will need this data to find the required return (CAPM or SML), rs, for BCD, Inc.).  What are the expected dividends during the high-growth period (D1, D2, D3,).  Also, what is the current price of the common stock today (P0)?

D1 = _______________.         D2 = _______________.       D3 = _______________.

Stock Price Today (P0) = ____________________.

9.  (60 Points).  CDE Co. plans to finance its capital budget for next year by selling \$60 million of 10 percent semiannual coupon rate bonds, with each bond having a maturity value (par value) of \$1,000 and a 15-year maturity.  Flotation costs (F) will be 4% of the maturity value of each bond.  The balance of its \$125 million capital budget will be financed with retained earnings (so that retained earnings will be at least \$65 million next year).  Next year CDE expects dividends will increase at a 9 percent rate from \$1.40 per share (so that D0 = \$1.40), and the CFO expects dividends and earnings to continue growing at the 9 percent rate for the foreseeable future. The current market value of CDE’s stock is \$40.  The firm has a marginal tax rate of 35 percent.  Given its flotation cost on newly issued debt what is the cost of debt for CDE (rd)?  What is the cost of retained earnings equity capital for CDE (rs)?  Finally, what is its weighted average cost of capital for the coming year?

Cost of Newly Issued Debt (rd) = ____________________.

Cost of Retained Earnings Equity Capital (rs) = ____________________.

Weighted Average Cost of Capital (WACC) = ____________________.

10. (60 points) Suppose a company has hired you to estimate the cash flows arising from a proposed capital project by replacing old equipment with a \$0 market value and a book value of \$21000, and you have been handed the relevant data below. The project being considered has a 5-year tax life, and at the end of year 5 the asset will be worthless (i.e. salvage value =0). The CFO suggests that you depreciate the asset by using the straight-line method over the 5 year life of the project. Revenues and other operating costs are as noted below, and will be constant over the period.

Equipment cost: \$160,000;     Book value of old equipment: \$21000

Delivery and installation cost of equipment and remove old equipment: \$60,000;

Straight-line depreciation rate: 20% (5-year);   Sales revenue for the first year: \$105,000;

COGS and Operating costs (excluding depreciation) for the first year: \$32,000;

Tax rate: 35%;             Inflation: 2%;

10a. What are annual cash flows for the next five years? (There is no requirement for working capital.) Hint: find CF0 to CF5

10b. Suppose CFO will borrow 40% of capital from a bank with 8.5% interest, and 60% of capital through equity with 19% of require rate of return. What is the cost of capital for this project?

10c. What is the internal rate of return of this project and should you convince the CFO to accept

or reject the new equipment?

10d. If the firm’s CEO want to use NPV to value the project, will NPV has the same suggestion as IRR? (please find NPV)

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