Managerial Finance Problems

1. The Artful Dodger has decided to sell packages of firecrackers at an upcoming parade. The packages will cost the Dodger 50 cents each. He will pay a $500 to the city for a permit to sell the firecrackers. IN addition he must purchase insurance that will cost him $100. The Dodger does not want to sell the packages himself, so he hired 5 NYU students to sell for him. The students will receive $20 each and 10 cents for each package they sell. The dodger will sell the packages for $1 each.
a. How many packages will the Dodger have to sell to break even?
b. How many packages will the Dodger have to sell to have a profit of $500?
c. What is the degree of operating leverage at the level of sales that you calculated in B?
d. Clearly state the meaning of the term operating leverage?

2. Source of Capital
8% coupon first mortage bonds
Preferred stock 13% divided ($100 par)
Common stock equity

Amount
$4,000,000
$40,000
$1,060,000

Totals

$5,100,000

a. Calculate the weighted average cost of capital (WACC) assuming that the beta coefficient for the company is 1.5, the return on U.S. ten year treasury notes is 5 percent and the Market risk premium is 4 percent. You may assume that the marginal tax rate is 40%.
b. Clearly identify another method of calculating the cost of equity financing? That is, an acceptable method other than the one you used in “a” above?
c. What would be the cost of using cash funds “thrown off” by depreciation expenses?
3. The tiger corporation is considering two possible capital structure, A and B:
Source of capital
Long term debt
Preferred stock
Common Stock

Structure a
$75,000 at 16%
$10,000 at 18%
8,000 shares at $20

Structure b
$50,000 at 15%
$15,000 at 18%
10,000 shares at $20

Their expected EBIT is 30,000
a. calculate the financial breakeven point, and the earnings per share for each structure. Assume a 40 percent tax rate on ordinary income.
b. Graph the two capital structures on the same set of EBIT-EPS axes.
c. Compute the degree of financial leverage with each structure
d. Carefully explain what financial leverage is.

4. The DeerBuck Company was recently formed to manufacture a new product. It has the following capital structure
9% debnetures of 2002 ($1000 par)
7% preferred stock ($100 par)
Common stock (320,000 shares)
Total :

$6,000,000
$2,000,000
$8,000,000
$16,000,000

The company is expected to pay a $2 dividend next year. The dividend growth rate is 10%, the required rate of return on equity funds is 12%, and their common stock is presently selling for $50 per share. Assume a marginal tax rate of 40%.
a. Compute the weighted- average cost of capital
b. What would be the cost of using funds thrown off by depreciation expenses?
5. The gator corporation is financed by 50% debt, and 50% equity. Their debt has an
8.5% annual interest rate. Their published beta coefficient is 1.57. The risk free rate on U.S. treasury securities is 5% and the return on the market portfolio is 10%. Gator is not sure that they have the optimum mix of debt and equity. They are considering the following debt/equity capital structure. 1. Compute gators present weighted average cost of capital. 2. Compute the weighted average cost of capital for each potential structure.
Assume a 40% corporate tax rate. Should Gator change their capital structure? If so, to which of the following structures? Why? (you must show all work)
a. 40% debt with an 8% coupon rate, and 60% equity
b. 60% debt with a 9% coupon rate, and 40% equity.
c. 80% debt with a 10% coupon rate, and 20% equity.