Problem 1. Pierre Imports is evaluating the proposed acquisition of new equipment at a cost of $95,000. In addition the equipment would require modifications at a cost of $10,000 plus shipping costs of $2,000. The equipment falls into the MACRS 3-year class, and will be sold after 3 years for $35,000. The equipment would require an increased inventory of 3,000. The equipment is expected to save the company $35,000 per year in before-tax operating costs. The company's marginal tax rate is 30 percent and its cost of capital is 10 percent.
a. What is the terminal year cash flow?
b. Calculate net present value. Should the machine be purchased?
Problem 2. Andrews Corporation plans a $6 million expansion. The firm wants to maintain a 35 percent debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 30 percent of last year's net income. Last year, net income was $4 million.
a. If the company changed to a residual dividend policy, how much external equity will it need?
b. Is the company likely to change to a residual policy? Why or why not?
Problem 3. Kern Corporation entered into an agreement with its investment banker to sell 10 million shares of the company's stock with Kern netting $210 million dollars from the offering. The expected price to the public was $25 per share.
The out-of-pocket expenses incurred by the investment banker were $2,000,000.
a. Is the agreement between the company and its investment banker an example of a negotiated or a best-efforts deal? Why? Which is riskier to the company? Why?
Problem 4. The Marcus Corporation's financial statements are shown below. Figures are in millions. The firm is in the 30% tax bracket.
Balance Sheet
2008 2007
Cash and equivalents 40 30
Marketable securities 10 15
Accounts receivable 60 50
Inventory 80 70
Total Current Assets 190 165
Net plant and equipment 230 190
Total Assets 420 355
2008 2007
Accounts payable 60 50
Notes payable 80 90
Accruals 20 15
Total current liabilities 160 155
Long-term debt 60 50
Common stock 200 150
Total liabilities and equity 420 355
Income Statement
2008 2007
Net sales 550 490
Costs other than depreciation 390 350
Depreciation 100 97
Total operating costs 490 447
Earnings before interest and taxes 60 43
Less interest 10 7
Earnings before taxes 50 36
Taxes 15 11
Net income 35 25
a. Calculate net operating income after taxes
b. Calculate net operating working capital for 2007 and 2008
c. Calculate total operating capital for 2007 and 2008?
d. Calculate free cash flow for 2008
e. Why is free cash flow important? Is it critical that the company always maintain positive free cash flow? Explain.