FIN - Capital Budgeting Misc Problems

Problems

Directions:  Please complete the problems in Excel. Show all work.

There are five questions worth a total of 40 points.

Question 1:  (Cost of Capital)  8 points

 You are provided the following information on a company. The total market value is $40 million. The company’s capital structure, shown here, is considered to be optimal.

                                                                                                            Market Value

Bonds, $1000 par, 6% coupon, 4% YTM                                           $10,000,000

Preferred Stock, 3%, $100 par, 100,000 shares @ $70 per share         $7,000,000

Common Stock, 100,000 shares @ $230 per share                            $23,000,000

a.  What is the after-tax cost of debt?  (assume the company’s effective tax rate = 40%)

b.  Assuming a $3 dividend paid annually, what is the required return for preferred shareholders (i.e. component cost of preferred stock)?  (assume floatation costs = $0.00)

c.  Assuming the risk-free rate is 1%, the expected return on the stock market is 7%, and the company's beta is 1.1, what is the required return for common stockholders (i.e., component cost of common stock)?

d.  What is the company's weighted average cost of capital (WACC)?

Question 2:  (Capital Budgeting)  10 points

It's time to decide how to use the money your firm is expected to make this year.  Two investment opportunities are available, with net cash flows as follows:

                                    Year                Project X         Project Y

                                     0 (Now)         ($30,000)        ($30,000)

                                     1                      11,000              4,000

                                     2                       10,000             8,000

                                     3                         9,000           12,000

                                     4                         8,000           16,000

a.  Calculate each project's Net Present Value (NPV), assuming your firm's weighted average cost of capital (WACC) is 6%

b.  Calculate each project’s Internal rate of Return (IRR).

c.  Plot NPV profiles for both projects on a graph.

d.  Assuming that your firm's WACC is 6%:

            (1) If the projects are independent which one(s) should be accepted?

            (2) If the projects are mutually exclusive which one(s) should be accepted?

Question 3:  (Capital Structure)  8 points

Dick & Jane’s Children’s Books has asked you to help it determine its optimal capital structure.  The procedure it is using is to calculate the total value of the company with different blends of debt and equity financing in use. The blend that produces the highest value of the firm will be the blend selected.  Assume that Dick & Jane’s is zero-growth and it pays all its net income in dividends each year  Sales this year are expected to be $500,000 and operating costs are expected to be $400,000.  The company’s effective tax rate is 40%.

a. If Dick & Jane’s uses all equity financing and no debt its cost of equity (Rs) will be 10%. Under these conditions, what is the total value of the company?

b. If Dick & Jane’s uses $100,000 in debt financing it can borrow the money at an interest rate of 5%, but it’s cost of equity (Rs) will rise to 11%. Under these conditions, what is the total value of the company?

c. If Dick & Jane’s uses $200,000 in debt financing it can borrow the money at an interest rate of 6%, but it’s cost of equity (Rs) will rise to 13%. Under these conditions, what is the total value of the company?

d. If the capital structures in parts a, b, and c above are the only alternatives available, which blend is optimal for Dick & Jane’s Children’s Books?

Question 4:  (Forecasting)  8 points

A firm has the following balance sheet:

            Cash                          $  200     Accounts payable               $ 200

            Accounts receivable      200     Notes payable                       400

            Inventory                       200      Long-term debt                    800

            Fixed assets                1,800     Common stock                      800

                                                             Retained earnings                  200

            Total assets              $2,400     Total liabilities & Equity  $2,400

Sales for the year just ended were $5,000, and fixed assets were used at 80 percent of capacity.  Current assets and accounts payable vary directly with sales.  Sales are expected to grow by 20 percent next year, the expected net profit margin is 5 percent, and the dividend payout ratio is 50 percent.

How much additional funds (AFN) will be needed next year, if any?

Question 5:  Working Capital Management  6 points

a. It takes the Roosterman Corporation, a computer manufacturer, 10 days to build and sell computers.  Also suppose it takes the firm’s customers 30 days, on average, to pay for the computers after they have purchased them on credit.  Finally, suppose the firm is able to delay paying for the computer parts it uses in the manufacturing process for 20 days.  Given these conditions, how long is the firm’s cash conversion cycle?

b. If the Roosterman Corporation buys $100 worth of supplies on credit with terms 3/10 n20 and pays the bill on the 20th day after the  purchase:

   (1). What is the approximate, or “nominal,” cost of trade credit as an annual rate?

   (2). What is the exact cost of trade credit as an annual rate?