Question 1: ABC Waterhouse's free cash flow next year will be $250 million and it is widely expected to grow at a 5 percent annual rate indefinitely.
The company's weighted average cost of capital is 11 percent, the market value of its liabilities is $2.5 billion, and it has 32 million shares outstanding.
a. Estimate the price per share of ABC's common stock.
b. A private equity firm believes that by selling the company 200 water towers, increasing the work day to eight hours, and instituting other cost savings, it can increase ABC's free cash flow next year to $260 billion and can add a full percentage point to ABC's growth rate without affecting its cost of capital. What is the maximum price per share the private equity firm can justify bidding for control of ABC?
Question 2: As the Financial vice president for Bear Enterprises, you have the following information:
Expected net income after tax next year before new financing $60,000,000
Sinking Fund payments due next year on existing debt 20,000,000
Interest due next year on existing debt 18,000,000
Conpany Tax rate 25%
Common Stock Price, per share 17
Common Shares outstanding 22,000,000
a. Calculate Bear's times-interest earned ratio for next year assuming the firm raises $60 Million of new debt at an
interest rate of 9 percent.
b. Calculate Bears times-burden covered ratio for the next year assuming annual sinking-fund payments on the new
debt will equal $5 Million
c. Calculate next years earnings per share assuming Bear raises the $60 Million of new debt.
d. Calculate next years times-interest earned ratio, times-burden-covered ratio, and earnings per share if Bear sells
$2 Million new shares at $17.00 per share instead of raising new debt.
Question 3:
An investment costing $70,000 promises an after tax cash flow of $28,000 per year for 7 years.
a. Find the investment's accounting rate of return and its payback period.
b. Find the investment's net present value at 20 percent discount rate.
c. Find the investment's profitability index at a 20 percent discount rate.
d. Find the investment's internal rate of return.
Question 4: A Company is consideri ng two alternative methods of producing a new product. The relevant data concerning thealterrnatives are presented below.
Alternative Alternative
I II
Initial Investment 50,000 110,000
Annual receipts 36,000 50,000
Annual disbursements 16,000 10,000
Annual depreciation 12,000 16,000
Expected Life 5 years 7 years
Salvage Value 0 0
At the end of the useful life of whatever equipment is chosen the product will be discontinued. The company's tax
rate is 50 percent, and its cost of capital is 11 percent.
a. Calculate the Net Present Value of each alternative
b. Calculate the internal rate of return for each alternative.
d. If the company is not under capital rationing, which alternative should be chosen? Why?