Problem 1
Lowell Inc. has no debt and its financial position is given by the following data:
Assets (book = market) $3,000,000
EBIT $500,000
Cost of equity (Ks) 10%
Stock price (P0) $15
Shares outstanding n0 200,000
Tax rate T 40%
The firm is considering selling bonds and simultaneously repurchasing some of its stock. It if moves to capital structure with 30 percent debt based on market values, its cost of equity, Ks, will increase to 11 percent to reflect the increased risk.
Bonds can be sold at a cost (Kd) of 7 percent. Lowell Inc. is a no-growth firm. Hence, all its earnings are paid out as dividends, and earnings are exceptionally constant over time.
A. What would be the new WACC?
B. What effect would this use of leverage have on the value of thefirm (Va)?
C.What would be Lowell Inc. s stock price?
D.What happens to the firm s earnings per share after therecapitalization?
Problem 2
Mass Inc. is trying to estimate its optimal capital structure. Right now, Mass Inc. has a capital structure that consists of 50 percent debt and 50 percent equity, based on market values. (Its D/S ratio is 1.00) The riskfree rate is 6 percent and the market risk premium, K M K RF, is 5 percent. Currently the company s cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. What would be Mass Inc. s estimated cost of equity if it were to change its capital structure to 60 percent debt and 40 percent equity?
Problem 3
23,104 32,562
Cost of goods sold
8,195 14,176
BALANCE SHEET COCA-COLA PEPSI
Assets
Cash and Cash Equivalents 4,701 1,716
Short-term Investments 66 3,166
Accounts Receivables 2,281 3,261
Inventory 1,424 1,693
Other Current Assets 1,778 618
Total Current Assets
10,250 10,454
Total Assets
29,427 31,727
Financed by: COCA-COLA PEPSI
Accounts Payable 5,290 5,357
Short-term debt 4,546 2,889
Other Current Liabilities 0 1,160
Total Current Liabilities
9,836 9,406
Problem 4
In-tech Corporation s sales and purchases for the last three months are as following:
Sales ($) Purchases ($)
October 100,000 80,000
November 90,000 100,000
December 120,000 75,000
For the next three months, it estimates sales and purchases to be as following:
Sales ($) Purchases ($)
January 90,000 70,000
February 80,000 70,000
March 80,000 70,000
It pays 40 percent of purchases in cash and gets a 4 percent discount. Another 40 percent of purchases are paid the next month, and the final 20 percent of purchases are paid in the second month after the purchase (for example, 40 percent of October purchases are paid in October, 40 percent October purchases are paid in November, and 20 percent October purchases are paid in December). Half of the sales are made in cash, and the balance is collected the next month. Cash sales are given a two percent discount, and five percent of credit sales end up as bad debt. The monthly operating expenses for In-tech Corporation s are $10,000. In-tech expects to sell one of its machinery in March for $25,000. It will buy the replacement in April for $50,000. The cash balance as on December 31 was $50,000. In-tech has a target cash balance of $50,000. Prepare a monthly cash budget for the next three months.