3 assignments
Example 1
| Workshop Five Practice Exercises | |||||
| Example 1: Calculating Holding Period Return | |||||
| Information about five securities is listed below: | |||||
| Security | Beginning of Year Price | End of Year Price | Interest or Dividend Paid During Year | ||
| Common A | $38.50 | $37.90 | $0.75 | ||
| Common B | $12.00 | $18.70 | $0.00 | ||
| Preferred A | $100.00 | $100.00 | $5.00 | ||
| Bond A | $968.00 | $995.00 | $30.00 | ||
| Bond B | $1,035.00 | $950.00 | $78.00 | ||
| Use the information provided above to answer the following questions for EACH security. | |||||
| a) What is the Capital Gain (loss) in dollar terms? What is the Capital Gain Yield (%)? | |||||
| b) What is the Dividend or Current Yield (%)? | |||||
| c) What is the total Holding Period Return (%)? | |||||
| Use the space below to create your solution. If you get stuck, or when you are ready to check your answer, go to the next worksheet tab for the solution. | |||||
Ex # 1 Solution
| Workshop Five Practice Exercises | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Example 1: Calculating Holding Period Return | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Information about five securities is listed below: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Security | Beginning of Year Price | End of Year Price | Interest or Dividend Paid During Year | ||||||||||||||||||||||||||||||||||||||||||||||||
| Common A | $38.50 | $37.90 | $0.75 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Common B | $12.00 | $18.70 | $0.00 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Preferred A | $100.00 | $100.00 | $5.00 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Bond A | $968.00 | $995.00 | $30.00 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Bond B | $1,035.00 | $950.00 | $78.00 | ||||||||||||||||||||||||||||||||||||||||||||||||
| Use the information provided above to answer the following questions for EACH security. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) What is the Capital Gain (loss) in dollar terms? What is the Capital Gain Yield (%)? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) What is the Dividend or Current Yield (%)? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) What is the total Holding Period Return (%)? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Check below for a detailed solution to this problem. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Input / Output area: | Take it one step at a time… | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Security | Starting Price ($) | Ending Price ($) | Income ($) | Change in Price | Capital Gain (loss) | + Income Yield | = Holding Period Return | Holding Period Return = Dividend Yield + Capital Gains (loss) Yield | |||||||||||||||||||||||||||||||||||||||||||
| Common A | $ 38.50 | $ 37.90 | $ 0.75 | $ (0.60) | -1.56% | 1.95% | 0.39% | This is a Common Stock with a loss in price (Capital Loss) but enough income (Dividend Yield) it has a net positive return (Holding Period Return) | |||||||||||||||||||||||||||||||||||||||||||
| Common B | $ 12.00 | $ 18.70 | $ - | $ 6.70 | 55.83% | 0.00% | 55.83% | This Common Stock has no dividend at all, but very high Capital Gains. This is common with new, quickly growing companies. | |||||||||||||||||||||||||||||||||||||||||||
| Preferred A | $ 100.00 | $ 100.00 | $ 5.00 | $ - | 0.00% | 5.00% | 5.00% | This Preferred Stock has no Capital Gain or Loss, but pays a steady dividend. This is typical for preferred stock. | |||||||||||||||||||||||||||||||||||||||||||
| Bond A | $ 968.00 | $ 995.00 | $ 30.00 | $ 27.00 | 2.79% | 3.10% | 5.89% | Here we have a bond that has both a small Capital Gain and income from interest payments (Current Yield) | |||||||||||||||||||||||||||||||||||||||||||
| Bond B | $ 1,035.00 | $ 950.00 | $ 78.00 | $ (85.00) | -8.21% | 7.54% | -0.68% | Finally this bond has a large Capital Loss and a large interest payment (Current Yield), but the interest is not enough to offset the capital loss. | |||||||||||||||||||||||||||||||||||||||||||
| Remember capital gains are calculated based on the starting point… | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Remember, there are two ways to earn money on an investment asset: | Capital Gain (loss) = (Ending Price - Starting Price) / Starting Price | ||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) Sell it for more than you bought it for, and | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (2) Hold on to it and earn income from it. | Also, Dividend Yield and Current Yield are calculated based on the starting point… | ||||||||||||||||||||||||||||||||||||||||||||||||||
| The change in value (price) of an asset is called the "Capital Gain" (or loss) | Income Yield = Income / Starting Price | ||||||||||||||||||||||||||||||||||||||||||||||||||
| The income component is either called the Dividend Yield (for a stock) or the Current Yield (for a bond) | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Stocks pay dividends, while bonds pay interest | |||||||||||||||||||||||||||||||||||||||||||||||||||
| These two pieces together create the total Holding Period Return | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This is the student Practice Problem file, provided in the assignment instructions October 2019 | |||||||||||||||||||||||||||||||||||||||||||||||||||
Example 2
| Workshop Five Practice Exercises | |
| Example 2: Calculating Return Components | |
| An investor purchased a bond at the beginning of the year for $1,085. At the end of the year, they sell it for $1,045. During the year, they collected two interest payments of $35 each. | |
| a) What was the current yield, in percentage terms? | |
| b) What was the capital gain on the bond, in percentage terms? | |
| c) What was the total return in dollars? What was the total return, in percentage terms? | |
| Use the space below to create your solution. If you get stuck, or when you are ready to check your answer, go to the next worksheet tab for the solution. | |
Ex # 2 Solution
| Workshop Five Practice Exercises | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Example 2: Calculating Return Components | |||||||||||||||||||||||||||||||||||||||||||||||||||
| An investor purchased a bond at the beginning of the year for $1,085. At the end of the year, they sell it for $1,045. During the year, they collected two interest payments of $35 each. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) What was the current yield, in percentage terms? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) What was the capital gain on the bond, in percentage terms? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) What was the total return in dollars? What was the total return, in percentage terms? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Check below for a detailed solution to this problem. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Input area: | The formula needed for this problem is given at the bottom of page 151 of the textbook. | ||||||||||||||||||||||||||||||||||||||||||||||||||
| The key is understanding the components of return. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (1) Capital Gains (or loss), and | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Purchase Price ($) | $ 1,085.00 | (2) Income | |||||||||||||||||||||||||||||||||||||||||||||||||
| Selling Price ($) | $ 1,045.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividends Received ($) | $ 70.00 | Capital Gains (loss) comes from a change in value (price) of an asset over time. | |||||||||||||||||||||||||||||||||||||||||||||||||
| For a bond, income comes in the form of interest payments and is measured by Current Yield. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| If this was a share of stock, income comes in the form of dividend payments and is measured by Dividend Yield | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Output area: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) | Current Yield | 6.5% | Current Yield = Income / Purchase Price | ||||||||||||||||||||||||||||||||||||||||||||||||
| Note you need to know the total income during the period. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) | Capital Gain ($) | $ (40.00) | |||||||||||||||||||||||||||||||||||||||||||||||||
| Capital Gain (%) | -3.7% | The Capital Gain (or loss) is also calculated with the initial / purchase price as the denominator. | |||||||||||||||||||||||||||||||||||||||||||||||||
| Using the ending / sale price is a common student error. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) | Total Return ($) | $ 30.00 | |||||||||||||||||||||||||||||||||||||||||||||||||
| Total Return (%) | 2.8% | Total return is Income plus Capital Gains | |||||||||||||||||||||||||||||||||||||||||||||||||
| Note in this case, we lose money by selling the bond for less than we bought it for… | |||||||||||||||||||||||||||||||||||||||||||||||||||
| However, the income from interest payments more than offsets this loss, resulting in a net gain. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Capital Gains and Income often work in opposite directions! | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This is the student Practice Problem file, provided in the assignment instructions October 2019 | |||||||||||||||||||||||||||||||||||||||||||||||||||
Example 3
| Workshop Five Practice Exercises | |
| Example 3: Calculating Returns with Exchange Rates | |
| An enterprising young investor has a friend in Japan with a hot tip on a new technology company. Through his friend, the investor purchases 50 shares of the company for 2,300 Yen per share. At the time of the purchase, the exchange rate is $1 US Dollar per 93 Yen. Fortunately, the friend's information is good. After one year, the share price increases to 3,080 Yen per share! The investor decides to take his profits and sell the shares. The exchange rate at the time of sale has also increased, rising to $1 US Dollar per 127 Yen. The company didn't pay any dividends during the year. | |
| a) What was the total purchase price in US Dollars? | |
| b) How much money did the investor earn due to the increase in the stock's price, in US Dollars? How much did they gain or lose from the change in the exchange rate, in US Dollars? | |
| c) What was the stock's selling price, in US Dollars? | |
| d) What was the investor's total earnings during the year, in US Dollars? | |
| Use the space below to create your solution. If you get stuck, or when you are ready to check your answer, go to the next worksheet tab for the solution. | |
Ex # 3 Solution
| Workshop Five Practice Exercises | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Example 3: Calculating Returns with Exchange Rates | |||||||||||||||||||||||||||||||||||||||||||||||||||
| An enterprising young investor has a friend in Japan with a hot tip on a new technology company. Through his friend, the investor purchases 50 shares of the company for 2,300 Yen per share. At the time of the purchase, the exchange rate is $1 US Dollar per 93 Yen. Fortunately, the friend's information is good. After one year, the share price increases to 3,080 Yen per share! The investor decides to take his profits and sell the shares. The exchange rate at the time of sale has also increased, rising to $1 US Dollar per 127 Yen. The company didn't pay any dividends during the year. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) What was the total purchase price in US Dollars? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) How much money did the investor earn due to the increase in the stock's price, in US Dollars? How much did they gain or lose from the change in the exchange rate, in US Dollars? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) What was the stock's selling price, in US Dollars? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| d) What was the investor's total earnings during the year, in US Dollars? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Check below for a detailed solution to this problem. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Input area: | There isn't a great deal about these types of calculations in the textbook, so it was done as a simple template problem. | ||||||||||||||||||||||||||||||||||||||||||||||||||
| There is one example in the text, at the top of page 145. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Unlike the previous problem, the math here can be difficult. However, in this case all the math is done for the students as a demonstration. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Purchase Price per Share (yen) | ¥ 2,300.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Number of Shares Purchased | 50 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Exchange Rate at Purchase (USD/YEN) | 93.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Dividend Paid (yen) | ¥ - 0 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Selling Price (yen) | ¥ 3,080.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Exchange Rate at Sale (USD/YEN) | 127.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Output area: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| It is easiest to walk through this step by step, coverting everything to US Dollars as a common basis… | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) | Purchase Price per Share (dollars) | $ 24.73 | To convert Yen into Dollars, divide the Yen amount by the USD/YEN exchange rate. | It is easy to get this backwards. Remember in this case $1 buys 103 Yen, so there should be much more Yen than Dollars. | |||||||||||||||||||||||||||||||||||||||||||||||
| Total Purchase Price (dollars) | $ 1,236.56 | Then to find the total purchase price, just multiply the cost per share times the number of shares. | |||||||||||||||||||||||||||||||||||||||||||||||||
| b) | Total Dividend Earned (dollars) | $ - | This example didn't have dividends, but if it did, you could convert that income earned back from Yen into Dollars. Divide by the USD/YEN exchange rate at the time of the dividend. | ||||||||||||||||||||||||||||||||||||||||||||||||
| Capital Gain (dollars) | $ 6.14 | To find the Capital Gain, take the difference between the ending and starting price and divide by the ENDING exchange rate. | |||||||||||||||||||||||||||||||||||||||||||||||||
| Gain from Exchange Rate (dollars) | $ (6.62) | There are a number of ways to calculate this, but the easiest it to recognize the value of the original purchase price changed by the proportion of the exchange rates. | |||||||||||||||||||||||||||||||||||||||||||||||||
| You could also simply calculate the sales price (like below), and then split the difference into its components. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) | Sale Price (dollars) | $ 24.25 | The Sale price is simply the ending price in Yen divided by the ending exchange rate of USD/YEN. | ||||||||||||||||||||||||||||||||||||||||||||||||
| d) | Total Earnings per Share (dollars) | $ (0.48) | Oh no! How did we lose money here? This is an example of a common risk with international investing. | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total Earnings (dollars) | $ (23.96) | While the value of the investment increase in terms of the local currency (Yen), this currency also lost its value relative to the Dollar. | |||||||||||||||||||||||||||||||||||||||||||||||||
| Total Earnings (%) | -1.94% | At the beginning of the year, $1 could be only 93 Yen. By the end, it could buy 127 Yen. | |||||||||||||||||||||||||||||||||||||||||||||||||
| We would say the Yen "grew weaker" or lost value. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| So when we convert the Yen-denominated investment back to US Dollars, we actually go backwards! | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This is the student Practice Problem file, provided in the assignment instructions October 2019 |
Example 4
| Workshop Five Practice Exercises | |
| Example 4: Determining Issue Costs | |
| A young, rapidly-growing company is looking to raise $50,000,000 in order to enter a new market. The company has hired an investment banker to advise them in this transaction. Their advisor suggests selling new shares of stock at $15 per share to fund the venture. However, because of the risky nature of the enterprise, they are demanding a 15% spread. In addition, the company anticipates it will cost them $500,000 in executive time, legal fees, and other expenses to conduct the transaction. The company's current stock price is $17 per share. | |
| a) What price per share will the company actually receive? | |
| b) How many shares must the company sell to raise the desired funds? | |
| c) How much money will the investment banking syndicate earn on the sale? | |
| d) What is the total cost of raising the funding, including all costs? | |
| Use the space below to create your solution. If you get stuck, or when you are ready to check your answer, go to the next worksheet tab for the solution. | |
Ex # 4 Solution
| Workshop Five Practice Exercises | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Example 4: Determining Issue Costs | |||||||||||||||||||||||||||||||||||||||||||||||||||
| A young, rapidly-growing company is looking to raise $50,000,000 in order to enter a new market. The company has hired an investment banker to advise them in this transaction. Their advisor suggests selling new shares of stock at $15 per share to fund the venture. However, because of the risky nature of the enterprise, they are demanding a 15% spread. In addition, the company anticipates it will cost them $500,000 in executive time, legal fees, and other expenses to conduct the transaction. The company's current stock price is $17 per share. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) What price per share will the company actually receive? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) How many shares must the company sell to raise the desired funds? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| c) How much money will the investment banking syndicate earn on the sale? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| d) What is the total cost of raising the funding, including all costs? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Check below for a detailed solution to this problem. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Input area: | This problem is again similar to Problem # 7 in Chapter 5 from the Higgins textbook, and also Problem # 8. | ||||||||||||||||||||||||||||||||||||||||||||||||||
| The solution to Problem # 7 is given in the back of the Higgins textbook, which could be used as an additional guide. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Desired Funds ($) | $ 50,000,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Current Stock Price ($ per share) | $ 17.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| New Issue Price ($ per share) | $ 15.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Investment Banker's Spread (%) | 15.0% | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Adminstrative and Legal Costs ($) | $ 500,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Output area: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) | Net price company will receive: | $ 12.75 | Public issue price minus 15% for spread | ||||||||||||||||||||||||||||||||||||||||||||||||
| b) | Shares that must be issued: | 3,921,569 | Desired funds / Net price to company | ||||||||||||||||||||||||||||||||||||||||||||||||
| c) | Investment bank earnings: | $ 8,823,529 | Number of shares issued multiplied by spread per share | ||||||||||||||||||||||||||||||||||||||||||||||||
| d) | Cost of underpricing: | $ 7,843,137 | Difference between current price and issue price on all issued shares | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total cost of raising funds: | $ 17,166,667 | Total of underpricing, investment bank spread, and administrative costs | |||||||||||||||||||||||||||||||||||||||||||||||||
| Cost as percentage of funds raised: | 34.33% | This was an expensive way to raise the money! | |||||||||||||||||||||||||||||||||||||||||||||||||
| This is the student Practice Problem file, provided in the assignment instructions October 2019 |
Example 5
| Workshop Five Practice Exercises | |
| Example 5: Impact of Financial Leverage | |
| Midlin Co. needs to raise $25 million in order to purchase manufacturing equipment for a new production line. To raise the funding, the company is considering whether to borrow the money or to issue new shares of stock. Today, the company has $15 million in debt and is already paying 9% annual interest on this debt. They also must pay $300,000 in principal payments on this existing debt. If they borrowed the needed money, they would have to pay 11% on the new debt, plus an additional $500,000 annually in principal payments. The current price of the company's stock is $63 per share, and there are 1.6 million shares outstanding. In they issued new shares of stock to raise the money they need, their investment banker predicts they will be able to sell the new stock for $55 per share. Once the project is completed, the new production line is anticipated to raise the company's Earnings Before Interest and Taxes to $14.3 million. The company's tax rate is 21%. | |
| a) If the company raises the funding with equity, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share? | |
| b) If the company raises the funding with debt, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share? | |
| Use the space below to create your solution. If you get stuck, or when you are ready to check your answer, go to the next worksheet tab for the solution. | |
Ex # 5 Solution
| Workshop Five Practice Exercises | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Example 5: Impact of Financial Leverage | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Midlin Co. needs to raise $25 million in order to purchase manufacturing equipment for a new production line. To raise the funding, the company is considering whether to borrow the money or to issue new shares of stock. Today, the company has $15 million in debt and is already paying 9% annual interest on this debt. They also must pay $300,000 in principal payments on this existing debt. If they borrowed the needed money, they would have to pay 11% on the new debt, plus an additional $500,000 annually in principal payments. The current price of the company's stock is $63 per share, and there are 1.6 million shares outstanding. In they issued new shares of stock to raise the money they need, their investment banker predicts they will be able to sell the new stock for $55 per share. Once the project is completed, the new production line is anticipated to raise the company's Earnings Before Interest and Taxes to $14.3 million. The company's tax rate is 21%. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) If the company raises the funding with equity, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| b) If the company raises the funding with debt, what will be its times-interested earned ratio? What will be its times-burden-covered ratio? What will be its earnings per share? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Check below for a detailed solution to this problem. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Input area: | This problem is very similar to Problem # 7 in Chapter 6 from the Higgins textbook. | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Note the solution to Problem # 7 is given in the back of the Higgins textbook, which can provide additional guidance. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Expected EBIT After Project ($) | $ 14,300,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Funding Needed ($) | $ 25,000,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Existing Debt ($) | $ 15,000,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest Rate on Existing Debt (%) | 9.0% | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest Rate on New Debt (%) | 11.0% | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Principal Fund Payments on Existing Debt ($) | $ 300,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Principal Fund Payment on New Debt ($) | $ 500,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Price ($ per share) | $ 63.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Price of New Issue of Stock ($ per share) | $ 55.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Common Shares Outstanding (# of shares) | 1,600,000 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Effective Tax Rate (%) | 21.0% | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Output area: | |||||||||||||||||||||||||||||||||||||||||||||||||||
| a) | Equity Funding | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Times-Interest-Earned Ratio | 10.59 | EBIT / Interest on existing debt | |||||||||||||||||||||||||||||||||||||||||||||||||
| Times-Burden-Covered Ratio | 8.27 | EBIT / [ Interest + Principal / (1 - Tax rate) ] | |||||||||||||||||||||||||||||||||||||||||||||||||
| New Shares to Issue (shares) | 454,545.45 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Earnings per Share | $ 4.98 | (EBIT - Interest) X (1 - Tax rate) / (Old shares + New shares) | |||||||||||||||||||||||||||||||||||||||||||||||||
| b) | Debt Funding | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest Payments on New Debt ($) | $ 2,750,000.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Times-Interest-Earned Ratio | 3.49 | EBIT / Interest | |||||||||||||||||||||||||||||||||||||||||||||||||
| Times-Burden-Covered Ratio | 2.80 | EBIT / [ Interest + Principal / (1 - Tax rate) ] | |||||||||||||||||||||||||||||||||||||||||||||||||
| Earnings per Share | $ 5.04 | (EBIT - Interest) X (1 - Tax rate) / Shares | |||||||||||||||||||||||||||||||||||||||||||||||||
| Note the Earnings per Share is higher with debt than with equity. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This results primarily from the fact debt creates a tax shield (debt payments are tax-deductible). | |||||||||||||||||||||||||||||||||||||||||||||||||||
| While equity raises the number of shares, causing earnings to be spread across more shares. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| However, the coverage ratios are substantially lower with debt. | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This creates a difficult decision! Which is better? | |||||||||||||||||||||||||||||||||||||||||||||||||||
| This is the student Practice Problem file, provided in the assignment instructions October 2019 |