Question1.
You are the manager of a pharmaceutical company and are considering what type of laptop computers to buy for your salespeople to take with them on their calls. Two alternatives have been proposed:
1. Purchase fairly inexpensive (and less powerful) older machines for about $2,000 each. These machines will be obsolete in three years and are expected to have an annual maintenance cost of $150.
2. Purchase newer and more powerful laptops for about $4,000 each. These machines will last five years and are expected to have an annual maintenance cost of $50.
If the cost of capital is 12%, and depreciation is straight-line, which option would you pick and why?
Question2
Cell Phone is a cellular firm that reported net income of $50 million in the most recent financial year. The firm had $1 billion in debt, on which it reported interest expenses of $100 million in the most recent financial year. The firm had depreciation of $100 million for the year, and capital expenditures were 200% of depreciation. The firm has a cost of capital of 11%. Assuming that there is no working capital requirement, and a constant growth rate of 4% in perpetuity, estimate the value of the firm.
Question3
Managers in a company that is currently in a high growth stage would like to raise external capital to help finance capital projects. They believe equity is undervalued and would like to issue debt. Managers have been informed that bondholder's might be concerned that they will invest in very risky projects that could result in large losses that will be borne by them. Investment bankers have advised management to issue convertible bonds to circumvent this problem.
1. Can convertible bonds be helpful in the situation? Why or why not?
2. Is there anything else management can do to alleviate the concerns of potential bondholders?
Question4
You have been asked by JJ Corporation, a California- based firm that manufacturers and services digital satellite TV systems, to evaluate its capital structure. They currently have 70 million shares outstanding trading at $10 per share. In addition, the company has 500,000 bonds, with a coupon rate of 8%, trading at $1000 per bond. JJ is rated BBB and the interest rate on BBB straight bonds is currently 10%. The beta for the company is 1.2, and the current risk-free rate is 6%, the market risk premium is 5%. The tax rate is 40%.
a. What is the firm's current debt/equity ratio?
b. What is the firm's current weighted average cost of capital?
JJ Corporation is proposing to borrow $250 million and use it for the following purposes:
• Buy back $100 million worth of stock OR
• Pay $100 million in dividends.
c. What will the firm's cost of equity be after this additional borrowing?
d. What will the firm's weighted average cost of capital be after this additional borrowing?
e. What will the value of the firm be after this additional borrowing? (with zero growth? with 2% growth in perpetuity)
f. Find the firm's optimal debt equity ratio
g. Why are capital structure choices important to a firm's strategic planning?
Question5
Please use the following financial statements to answer question 5.
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Income Statement 2014
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|
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Sales
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836,100
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Cost of Goods Sold
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650,700
|
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185,400
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Other Expenses
|
17,100
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Earnings Before Interest & Tax
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168,300
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Interest Expense
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12,600
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Taxable Income
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155,700
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Taxes
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54,495
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Net Income
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101,205
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Balance Sheet 2014
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Current Assets
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|
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Cash
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24,035
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Accounts Receivable
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38,665
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Inventory
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82,555
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Total
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145,255
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Fixed Assets
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Net Plant & Equipment
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392,350
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Total Assets
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537,605
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Liabilities & Owners Equity
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|
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Current Liabilities
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|
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Accounts Payable
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64,600
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Notes Payable
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16,150
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Total
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80,750
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Long-term debt
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150,000
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Owner's Equity
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|
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Common Stock and Paid-in Surplus
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130,000
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Retained Earnings
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176,855
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Total Liabilities & Owner's Equity
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537,605
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1. The company would like to grow at 20%. Assume that the dividend payout rate will remain constant, what, if any, is the company's external financing need? If the company plans to meet any external financing needs with debt and the interest rate on debt is 5% show how the income statement and balance sheet will be affected by the debt issue.
2. Why is financial planning crucial to a company's strategic management?