| HOMEWORK SET 5 |
| Directions: Answer the following questions on this document. Explain how you reached the answer |
| or show your work if a mathematical calculation is needed, or both. Submit your assignment using |
| the assignment link in the course shell. This homework assignment is worth 100 points. |
| | | | | YOU MUST ENTER CORRECT INFORMATION IN THE YELLOW-CODED CELLS |
| | | | | DO NOT TOUCH THE NON-YELLOW-CODED CELLS |
| | | | | ANSWERS ARE IN THE RED-BORDERED CELLS |
| Use the following information for Questions 1 through 3: |
| Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 |
| Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 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 2014 Boehm will return |
| to its previous 8% earnings growth rate. Its target debt ratio is 35%. |
| Calculate Boehm's total dividends for 2014 under each of the following policies. |
| 1. Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. |
| | 6.00% | Boehm's stable earnings growth rate |
| | $2,000,000 | Boehm's 2013 dividends (amount) |
| | $2,120,000 | Dividends for 2014 |
| It continues the 2013 dividend payout ratio. |
| | $10,000,000 | Net income in 2013 |
| | $2,000,000 | Dividends paid in 2013 |
| | $15,000,000 | Net income in 2014 |
| | 20.00% | Dividend payout ratio in 2013 |
| | $3,000,000 | Dividends for 2014 |
| 2. It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million |
| investment is financed with debt). |
| | $8,000,000 | Cost of plant expansion |
| | 65.00% | Portion financed with equity (100% - 35%) |
| | $5,200,000.00 | Equity financing needed |
| | $13,000,000 | Net income for 2014 |
| | $7,800,000 | 2014 Dividends = Net income - equity financing |
| 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. |
| | $7,855,000 | Dividends required by residual policy (calculated in No. 3 above) |
| | $2,808,000 | Regular dividends based on long-run growth rate (1.08% times $2013 dividend) |
| | $5,047,000 | Extra dividend |
| Use the following information for Questions 5 and 6. |
| 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 $5 million. The firm estimates that it can change its production |
| process, adding $4 million to investment and $500,000 to fixed operating costs. The change will |
| (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on |
| all units will have to 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. |
| 3. 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? |
| | First, determine the variable cost per unit (V) at present: |
| | Profit = P (Q) - FC - V (Q) |
| | $400,000 | Annual profits |
| | $90,000 | Price per unit |
| | 50 | Units sold per year |
| | $2,000,000 | Fixed costs per year |
| | $42,000 | = Variable Cost per Unit |
| | Second, determine the new profit level if the change is made: |
| | New Profit - P2 * Q2 - FC2 - V2 (Q2) |
| | $80,000 | New Price per unit |
| | 70 | New Units sold per year |
| | $2,500,000 | New Fixed costs per year |
| | $32,000 | New Variable costs per year |
| | $860,000 | = New Profit Level |
| | Third, determine the incremental profit. |
| | $860,000 | New Profit Level |
| | $500,000 | Previous Annual Profit Level |
| | $360,000 | = Incremental Profit |
| | 9.00% | Return on the Investment |
| | 16.00% | Cost of capital (equity) |
| | Don't Make Investment | | Should the investment be made? |
| 4. Would the firm's breakeven point increase or decrease if it made the change? |
| | 42 | Old Breakeven Point |
| | 52.08 | New Breakeven Point |
| | Breakeven point increases |
Finisher07
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