What is the resulting total forecasted amount of the line

Question

Question 1:

Long-Term - Financing Needed

At year-end 2016, Wallace Landscaping's total assets were $2.17 million, and its accounts payable were $560,000. Sales, which in 2016 were $3.5 million, are expected to Increase by 35% in 2017. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Wallace typically uses no current liabilities other than accounts payable. Common stock amounted to $625,000 in 2016, and retained earnings were $395,000. Wallace has arranged to sell $195,000 of new common stock in 2017 to meet some of its financing needs. The remainder of its financing needs will be met by issuing new long-term debt at the end of 2017. (Because the debt is added at the end of the year, there will be no additional interest expense due to the new debt.) Its net profit margin on sales is 5%, and 45% of earnings will be paid out as dividends.

a. What were Wallace's total long-term debt and total liabilities in 2016?

b. How much new long-term debt financing will be needed in 2017?

Question 2:

Stevens Textile Corporation's 2016 financial statements are shown below:

Balance Sheet as of December 31, 2016 (Thousands of Dollars)

Cash	$1,080		Accounts payable	$4,320
Receivables	6,480		Accruals	2,880
Inventories	9,000		Line of credit	0
Total current assets	$16,560		Notes payable	2,100
Net fixed assets	12,600		Total current liabilities	$9,300
			Mortgage bonds	3,500
			Common stock	3,500
			Retained earnings	12,860
Total assets	$29,160		Total liabilities and equity	$29,160

Income Statement for December 31, 2016 (Thousands of Dollars)

Sales	$36,000
Operating costs	32,440
Earnings before interest and taxes	$3,560
Interest	460
Pre-tax earnings	$3,100
Taxes (40%)	1,240
Net income	$1,860
Dividends (45%)	$837
Addition to retained earnings	$1,023

a. Suppose 2017 sales are projected to increase by 15% over 2016 sales. Use the forecasted financial statement method to forecast a balance sheet and income statement for December 31, 2017. The interest rate on all debt is 10%, and cash earns no interest income.

Assume that all additional debt in the form of a line of credit is added at the end of the year, which means that you should base the forecasted interest expense on the balance of debt at the beginning of the year. Use the forecasted income statement to determine the addition to retained earnings. Assume that the company was operating at full capacity in 2016, that it cannot sell off any of its fixed assets, and that any required financing will be borrowed as notes payable. Also, assume that assets, spontaneous liabilities, and operating costs are expected to increase by the same percentage as sales. Determine the additional funds needed.

b. What is the resulting total forecasted amount of the line of credit?

c. In your answers to Pans a and b, you should not have charged any interest on the additional debt added during 2017 because it was assumed that the new debt was added at the end of the year. But now suppose that the new debt is added throughout the year. Don't do any calculations, but how would this change the answers to parts a and b?

Question 3:

External Equity Financing

Gardial GreenLights, a manufacturer of energy-efficient lighting solutions, has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $15 million investment in new machinery. Gardial plans to maintain its current 30% debt-total-assets ratio for its capital structure and to maintain its dividend policy in which at the end of each year it distributes 55% of the year's net income. This year's net income was $8 million. How much external equity must Gardial seek now to expand as planned?

Question 4:

Residual Distribution Policy

Harris Company must set its investment and dividend policies for the coaling year. It has three independent projects from which to choose, each of which requires a $3 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows:

Project A:     Cost of capital = 1796; IRR = 20%

Project B:     Cost of capital = 13%; IRR = 10%

Project C:     Cost of capital = 7%; IRR = 9%

Harris intends to maintain its 35% debt and 65% common equity capital structure, and its net income is expected to be $4,750,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be?

Question 5:

Alternative Dividend Policies

Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2016 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2017 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2017 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%.

a. Calculate Boehm's total dividends for 2017 under each of the following policies;

(1) Its 2017 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.

(2) It continues the 2016 dividend payout ratio.

(3) It uses a pure residual policy with all distributions in the form of dividends (35% of the 57.3 million investment is financed with debt).

(4) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy.

b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer.

c. Does a 2017 dividend of 59 million seem reasonable in view of your answers to Parts a and b? If not, should the dividend be higher or lower?

Question 6:

Nichols Corporation's value of operations is equal to $500 million after a recapitalization (the firm had no debt before the recap). It raised $200 million in new debt and used this to buy back stock. Nichols had no short-term investments before or after the recap. After the recap, w_d = 40%. What is S (the value of equity after the recap)?

Question 7:

Break-Even Point

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm's fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the firm's assets (all equity financed) are $5million. The firm estimates that it can change its production process, adding $4 million to assets and $500,000 to fixed operating costs. This change will reduce variable costs per unit by $10,000 and increase output by 20 units. However, the sales price on all units must be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt.

a. What is the incremental profit? To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment? Why or why not?

b. Would the firm's break-even point increase or decrease if it made the change?

c. Would the new situation expose the firm to more or less business risk than the old one?

Question 8:

Optimal Capital Structure with Hamada

Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero-growth firm and pays out all of its earnings as dividends. The firm's EBIT is $14.933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0.

a. What is BEA's unlevered beta? Use market value D/S (which is the same as wd/ws) when unlevering.

b. What are BEA's new beta and cost of equity if it has 40% debt?

c. What are BEA's WACC and total value of the firm with 40% debt?

Question 9:

WACC and Optimal Capital Structure

F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows:

Market Debt-to- Value Ratio (wd)	Market Equity-to- Value Ratio (ws)	Market Debt-to- Equity Ratio (D/S)	Before-Tax Cost of Debt (rd)
0.0	1.0	0.00	6.0%
0.2	0.8	0.25	7.0
0.4	0.6	0.67	8.0
0.6	0.4	1.50	9.0
0.8	0.2	4.00	10.0

F. Pierce uses the CAPM to estimate its cost of common equity, r5 and at the time of the analysis the risk-free rate is 5%, the market risk premium is 6%, and the company's tax rate is 40%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.8. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure?