Section 1:
Problem 1. A firm has $30,000 of inventory. If this represents 30 days’ sales, what is the annual cost of goods sold? What is the inventory turnover ratio?
Problem 2. On average, it takes Microlimp’s customers 60 days to pay their bills. If Microlimp has annual sales of $500 million, what is the average value of unpaid bills?
Problem 3. How would the following actions affect a firm’s current ratio?
a. Inventory is sold.
b. The firm takes out a bank loan to pay its suppliers.
c. A customer pays its overdue bills.
d. The firm uses cash to purchase additional inventories.
Problem 4. If a firm pays its bills with a 30-day delay, what fraction of its purchases will be paid in the current quarter? In the following quarter? What if the delay is 60 days?
Section 2:
Problem 1. Acetate, Inc. has common stock with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14%. The current Treasury-bill rate is 8 percent, and the expected market premium is 10%. The beta on Acetate’s equity is 0.9.
a. What is Acetate’s debt-equity ratio?
b. What is the firm’s overall required return?
Problem 2. Rayburn Manufacturing is currently an all-equity firm. The firm’s equity is worth $2 million. The cost of that equity is 18%. Rayburn pays no taxes. Rayburn plans to issue $400,000 in debt and to use the proceeds to repurchase stock. The cost of debt is 10%.
a. After Rayburn repurchases the stock, what will the firm’s overall cost of capital be?
b. After the repurchase, what will the cost of equity be?
c. Explain your result in (b).
Problem 3. Andahl Corporation stock, of which you own 500 shares, will pay a $2-per-share dividend one year from today. Two years from now Andahl will close its doors; stockholders will receive liquidating dividends of $17.5375 per share. The required rate of return on Andahl stock is 15%.
a. What is the current price of Andahl stock?
b. You prefer to receive equal amounts of money in each of the next two years. How will you accomplish this?
Problem 4. What is the present value of a 10-year, pure discount bond that pays $1,000 at maturity and is priced to yield the following rates?
a. 5%
b. 10%
c. 15%
Problem 5. Consider the stock of Davidson Company that will pay an annual dividend of $2 in the coming year. The dividend is expected to grow at a constant rate of 5% permanently. The market requires a 12% return on the company.
a. What is the current price of a share of the stock?
b. What will the stock price be 10 years from today?
Problem 6. KIC, Inc. plans to issue $5 million of perpetual bonds. The face value of each bond is $1,000. The annual coupon on the bonds is 12%. Market interest rates on one-year bonds are 11%. With equal probability, the long-term market interest rate will be either 14% or 7% next year. Assume investors are risk-neutral.
a. If KIC bonds are noncallable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their price be greater than or less than the price you computed in part (a)? Why?
Problem 7. Present Value Lease Problem—Calculating Annual Payments
Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly Hills (RBH) to provide lease financing for a machine that would assist in automating a large part of their current assembly line. Annual lease payments will start at the beginning of each year. The purchase price of this machine is $200,000, and it will be leased by RBH for a period of 5 years. LRU will utilize straight-line depreciation of $40,000 per year with a zero book salvage value. However, salvage value is estimated to actually be $35,000 at the end of 5 years. LRU is required to earn a 14%, after-tax rate of return on the lease. LRU uses a marginal tax rate of 40%. Calculate the annual lease payments. (Remember, these payments are to be considered at the beginning of each year—annuity due.)
Section 3:
Problem 1. Here is recent financial data on Pisa Construction.
Stock Price: $40 Market value of firm: $400,000
# of Shares: 10,000 Earnings per share: $4
Book net worth: $500,000 Return on Investment: 8%
Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $80,000 to finance expansion into a promising market. Pisa’s financial advisers think a stock issue is a poor choice because, among other reasons, “sale of stock at a price below book value per share can only depress the stock price and decrease shareholders’ wealth.” To prove the point they construct the following example: “Suppose 2,000 new shares are issued at $40 and the proceeds are invested. (Neglect issue costs.) Suppose return on investment doesn’t change. Then
Book net worth = $580,000
Total earnings = .08(580,000) = $46,400
Earnings per share = 46,400/12,000 = $3.87
Thus, EPS declines, book value per share declines, and share price will decline proportionately to $38.70” Evaluate this argument with particular attention to the assumptions implicit in the numerical example.
Problem 2. Do you think that there could be a shortage of finance for new ventures? Should the government help to provide such finance and, if so, how?
Problem 3. Pick a company that had an initial public offering in the past 5-10 years. Identify the IPO terms and answer the following questions:
Did this company need to go public to in order to meet its financial needs?
As an investor, would you have been willing to purchase the company’s stock at the offering price? Why or why not?