CHAPTER TWO PROBLEMS

1. Last year Rattner Robotics had $5 million in operating income (EBIT). The company
had net depreciation expense o $1 million and an interest expense o $1 million! its
corporate tax rate "as #$ percent. The company has $1# million in c%rrent assets and
$# million in non&interest&bearing c%rrent liabilities! it has $15 million in net plant and
e'%ipment. It estimates that it has an ater&tax cost o capital o 1$ percent. (ss%me
that Rattner)s only non&cash item is depreciation.
a. *hat "as the company)s net income or the year+
$,.# million
b. *hat "as the company)s net cash lo"+
$-.# million
c. *hat "as the company)s net operating proit ater taxes (./0(T)+
$-.$ million
d. *hat "as the company)s operating cash lo"+
$#.$ million
e. I operating capital in the pre1io%s year "as $,# million2 "hat "as the
company)s ree cash lo" (343) or the year+
$,.$ million
. *hat "as the company)s economic 1al%e added+
$5$$2$$$
,. (s an instit%tional in1estor paying a marginal tax rate o #562 yo%r ater&tax di1idend
yield on preerred stoc7 "ith a 156 beore&tax di1idend yield "o%ld be8
1#.96
-. ( :6 co%pon bond iss%ed by the state o .e" ;or7 sells or $12$$$ and th%s pro1ides
a :6 yield to mat%rity. 3or an in1estor in the #$6 tax brac7et2 "hat co%pon rate on a
4arter 4hemical 4ompany bond that also sells at its $12$$$ par 1al%e "o%ld ca%se the
t"o bonds to pro1ide the in1estor "ith the same ater&tax rate o ret%rn+
11.5:6
#. ( corporation "ith a marginal tax rate o #56 "o%ld recei1e "hat (3TER&T(< ;IEL=
on a 1,6 co%pon rate preerred stoc7 bo%ght at par+
(ns"er8 11.1:,6
5. ;o% ha1e >%st recei1ed inancial inormation or the past t"o years or 0o"ell 0anther
4orporation8
1
Income ?tatements Ending =ecember -1
(millions o dollars)
,$$$ 1999
?ales $12,$$.$ $12$$$.$
/perating 4osts (excl%ding depreciation) 12$,$.$ @5$.$
=epreciation -$.$ ,5.$
Earnings beore interest and taxes $ 15$.$ $ 1,5.$
Less Interest expense ,1.: ,$.,
Earnings beore taxes $ 1,@.- $ 1$#.@
Less taxes (#$6) 51.- #1.9
.et income a1ailable to common e'%ity $ ::.$ $ 5,.9
4ommon di1idends $ $.5$5 $ $.#5#
Balance ?heets Ending =ecember -1
(millions o dollars)
,$$$ 1999
4ash and mar7etable sec%rities $ 1,.$ $ 1$.$
(cco%nts recei1able 1@$.$ 15$.$
In1entories 1@$.$ ,$$.$
.et plant and e'%ipment -$$.$ ,5$.$
Total (ssets $ 5:,.$ $ 51$.$
(cco%nts payable $ 1$@.$ $ 9$.$
.otes payable 5:.$ 51.5
(ccr%als :,.$ 5$.$
Long&term bonds $ 15$.$ $ 15$.$
4ommon stoc7 (5$ million shares) 5$.$ 5$.$
Retained earnings ,,5.$ ,$@.5
Total liabilities and e'%ity $ 5:,.$ $ 51$.$
a. *hat is the net operating proit (./0(T) or ,$$$+
$9$2$$$2$$$
b. *hat are the amo%nts o net operating "or7ing capital or 1999 and ,$$$+
$,1$2$$$2$$$ and $19,2$$$2$$$
c. *hat are the amo%nts o total operating capital or 1999 and ,$$$+
$#5$2$$$2$$$ and $#9,2$$$2$$$
d. *hat is ree cash lo" or ,$$$+
$5@2$$$2$$$
e. Ao" m%ch did the irm rein1est in itsel o1er the acco%nting period+
$1525$$2$$$
. (t the present time (1,B-1B,$$$)2 ho" large a chec7 co%ld the irm "rite "itho%t
it bo%ncing+
$1,2$$$2$$$
5. ( irmCs operating income (EBIT) "as $#$$ million2 their depreciation expense "as $#$
million2 and their increase in net in1estment in operating capital "as $:$ million.
(ss%ming that the irm is in the #$6 tax brac7et2 "hat "as their ree cash lo"+
2
$1:$ million
:. In its recent income statement2 ?mith ?ot"are Inc. reported $,- million o net income2
and in its year&end balance sheet2 ?mith reported $#$1 million o retained earnings.
The pre1io%s year2 its balance sheet sho"ed $-@9 million o retained earnings. *hat
"ere the total di1idends paid to shareholders d%ring the most recent year+
$11.$ million
@. 4ox 4orporation recently reported an EBIT=( o $5@ million and $: million o net
income. The company has $1, million interest expense and the corporate tax rate is
#$.$6 percent. *hat "as the companyCs depreciation and amortiDation expense+
$-#.-- million
9. Ra1ings Incorporated recently reported net income o $5.# million. Its operating income
(EBIT) "as $15 million2 and its tax rate "as #$ percent. *hat "as the company)s
interest expense+
$5 million
1$. In its recent income statement2 ?mith ?ot"are Inc. reported paying $1$ million in
di1idends to common shareholders2 and in its year&end balance sheet2 ?mith reported
$#19 million o retained earnings. The pre1io%s year2 its balance sheet sho"ed $#$#
million o retained earnings. *hat "as the irm)s net income d%ring the most recent
year+
$,5.$ million
11. 4asey Eotors recently reported net income o $19 million. The irmCs tax rate "as
#$.$6 and interest expense "as $5 million. The companyCs ater&tax cost o capital is
1#.$6 and the irmCs total in1estor s%pplied operating capital employed e'%als $95
million. *hat is the companyCs EF(+
$9.-$ million
1,. Broo7s ?istersC operating income (EBIT) is $19# million. The companyCs tax rate is
#$.$62 and its operating cash lo" is $1#@.# million. The companyCs interest expense is
$-9 million. *hat is the companyCs net cash lo"+ ((ss%me that depreciation is the
only non&cash item in the irmCs inancial statements.)
$1,5.$ million
1-. Fal%able Incorporated)s stoc7 c%rrently sells or $#5 per share. The irm has ,$ million
share o common o%tstanding. The irm)s total debt e'%als $5$$ million and its common
e'%ity e'%als $#$$ million. *hat is the irm)s mar7et 1al%e added+
$5$$ million
CHAPTER THREE PROBLEMS

1. (B42 Inc.2 sells all its merchandise on credit. It has a proit margin o #62 an a1erage
3
collection period o 5$ days2 recei1ables o $15$2$$$2 total assets o $- million and a
debt ratio o $.5#. *hat is the irmCs ret%rn on e'%ity+
-.-- percent
,. The ?mythe 4orporationCs common stoc7 is c%rrently selling at $1$$ per share "hich
represents a 0BE ratio o 1$. I the irm has 1$$ shares o common stoc7 o%tstanding2
a ret%rn on e'%ity o $.,$2 and a debt ratio o $.5:2 "hat is its ret%rn on total assets+
5.: percent
-. I *in7ler2 Inc.2 has sales o $, million per year (all credit) and an a1erage collection
period o -5 days2 "hat is its a1erage amo%nt o acco%nts recei1able o%tstanding
(ass%me a -5$ day year)+
$19#2###
#. I a irm has total interest charges o $1$2$$$ per year2 sales o $1 million2 a tax rate o
#$62 and a net proit margin o 562 "hat is the irmCs times interest earned ratio+
11 times
5. ( irm that has an e'%ity m%ltiplier o #.$ "ill ha1e a debt ratio o8
$.:5.
5. Gi1en the ollo"ing inormation2 calc%late the mar7et price per share o *(E2 Inc.8
Earnings ater interest and taxes H $,$$2$$$
Earnings per share H $,.$$
?toc7holdersC e'%ity H $,2$$$2$$$
Ear7etBBoo7 ratio H $.,$
$#.$$
:. ( ire has destroyed a large percentage o the inancial records o Aanson (ssociates.
;o% are charged "ith piecing together inormation in order to release a inancial report.
;o% ha1e o%nd the ret%rn on e'%ity to be 1@6. I sales "ere $# million2 the debt ratio
$.#$2 and total liabilities $, million2 "hat "as the ret%rn on assets+
1$.@6
@. (ss%me 4onser1ati1e 4orporation is 1$$6 e'%ity inanced. 4alc%late the ret%rn on
e'%ity gi1en the ollo"ing inormation8
1. Earnings beore taxes H $,2$$$
,. ?ales H $52$$$
-. =i1idend payo%t ratio H 5$6
#. Total asset t%rno1er H ,.$
5. (pplicable tax rate H 5$6
#$ percent
9. ;o% are considering a ne" prod%ct or yo%r irm to sell. It sho%ld ca%se a 156 increase
in yo%r proit margin b%t it "ill also re'%ire a 5$6 increase in total assets. ;o% expect
to inance this asset gro"th entirely by debt. I the ollo"ing ratios "ere comp%ted
4
beore the change2 "hat "ill be the ne" R/E i the ne" prod%ct is sold b%t sales
remain constant+
0roit margin H $.1$
Total asset t%rno1er H ,.$
E'%ity m%ltiplier H ,
#5 percent
1$. Iohnsto"n 4hemicals2 Inc.2 has a c%rrent ratio o -.$2 a '%ic7 ratio o ,.#2 and an
in1entory t%rno1er o 5. Iohnsto"nCs total assets are $1 million and its debt ratio is $.,$.
(The irm has no long&term debt.) *hat is Iohnsto"nCs sales ig%re+
$:,$2$$$
11. 4alc%late the mar7et price o a share o (B42 Inc.2 gi1en the ollo"ing inormation8
?toc7holdersC e'%ity H $12,5$! priceBearnings ratio H 5! shares o%tstanding H ,5!
mar7etBboo7 ratio H 1.5.
$:5.$$
1,. Iamesto"n2 Inc.2 has earnings ater interest ded%ctions b%t beore taxes o $-$$. The
companyCs beore&tax times interest earned ratio is :.$$. 4alc%late the companyCs
interest charges.
$5$.$$
1-. The G. Aobbs 4ompany has determined that its ret%rn on e'%ity is 156. Eanagement
is interested in the 1ario%s components that "ent into this calc%lation. Ao"e1er2 one o
the acco%ntants has misplaced the proit margin ratio. (s a inance "iDard2 yo% 7no"
ho" to calc%late the proit margin2 gi1en the ollo"ing inormation8 total debtBtotal
assets H $.-52 and total asset t%rno1er H ,.@. *hat is the proit margin+
-.#@ percent
1#. Lo"e J 4ompany has a debt ratio o $.52 a capital intensity ratio o #2 and a proit
margin o 1$6. The Board o =irectors is %nhappy "ith the c%rrent ret%rn on e'%ity
(R/E)2 and they thin7 it co%ld be do%bled. This co%ld be accomplished (1) by
increasing the proit margin to 1,6 and (,) by increasing debt %tiliDation. Total asset
t%rno1er "ill not change. *hat ne" debt ratio2 along "ith the 1,6 proit margin2 is
re'%ired to do%ble the R/E+
:$ percent
15. The Local 4ompany is a relati1ely small2 pri1ately o"ned irm. In 19@1 Local had an
ater&tax income o $152$$$2 and 1$2$$$ shares "ere o%tstanding. The o"ners "ere
trying to determine the e'%ilibri%m mar7et 1al%e or LocalCs stoc72 prior to ta7ing the
company p%blic. ( similar irm that is p%blicly traded had a priceBearnings ratio o 5.$.
Ksing only the inormation gi1en2 estimate the mar7et 1al%e o one share o LocalCs
stoc7.
$:.5$
15. Epsilon 4o.Cs records ha1e recently been destroyed by ire. Gi1en the ollo"ing bits o
inormation sa1ed rom the inerno2 determine EpsilonCs net income or 1999.
Ret%rn on e'%ity ,,6
5
(ssetsBnet "orth ,.15:
0roit margin 5.56
Total assets $55$ million
$ 55.$$ million
1:. =elta 4orp. has sales o $-$$2$$$2 a proit margin o 5.5 percent2 a tax rate o 15
percent2 and ann%al interest charges o $:25$$. *hat is =eltaCs times interest earned+
#.$5
1@. 4oastal 0ac7aging Ls R/E last year "as only - percent2 b%t its management has
de1eloped a ne" operating plan designed to impro1e things. The ne" plan calls or a
total debt ratio o 5$ percent2 "hich "ill res%lt in interest charges o $-$$ per year.
Eanagement pro>ects an EBIT o $12$$$ on sales o $1$2$$$2 and it expects to ha1e a
total asset t%rno1er ratio o ,.$. Knder these conditions2 the a1erage tax rate "ill be -$
percent. I the changes are made2 "hat ret%rn on e'%ity "ill 4oastal earn+
,#.5 percent
19. ;ohe Inc. has an R/( o 1-.#6 and a 1$6 proit margin. The company has sales
e'%al to $5 million. *hat are the companyCs total assets+
$-.:- million
,$. ;ohe Inc. has a c%rrent ratio o ,2 and a '%ic7 ratio o 1.#. 3%rthermore2 the irm has
$1.5 million in c%rrent liabilities. Based %pon this inormation2 ho" m%ch in1entory is
;ohe holding+
$9$$2$$$
,1. K M./2 Inc. %ses only debt and common e'%ity %nds to inance its assets. This past
year the irmCs ret%rn on total assets "as 1-6. The irm inanced #,6 percent o its
assets %sing debt. *hat "as the irmCs ret%rn on common e'%ity+
,,.#16
,,. 4le1eland 4orporation has 1:2#9$2$$$ shares o common stoc7 o%tstanding2 its net
income is $19# million2 and its 0BE ratio is 15.1. *hat is the company)s stoc7 price+
$15:.#9
,-. (((Cs in1entory t%rno1er ratio is 11.$9 based on sales o $152,$$2$$$. The
irmCs c%rrent ratio e'%als -.,, "ith c%rrent liabilities e'%al to $9:$2$$$. *hat is
the irmCs '%ic7 ratio+
1.@1
CHAPTER FOUR PROBLEMS
6
1. Interest rates on one&year Treas%ry sec%rities are c%rrently 5.5 percent2 "hile t"o&year
Treas%ry sec%rities are yielding 5 percent. I the p%re expectations theory is correct2
"hat does the mar7et belie1e "ill be the yield on one&year sec%rities one year rom
no"+
5.# percent
,. Interest rates on o%r&year Treas%ry sec%rities are c%rrently : percent2 "hile interest
rates on six&year Treas%ry sec%rities are c%rrently :.5 percent. I the p%re expectations
theory is correct2 "hat does the mar7et belie1e that t"o&year sec%rities "ill be yielding
o%r years rom no"+
@.5 percent
-. The real ris7&ree rate o interest is - percent. Inlation is expected to be , percent this
year and # percent d%ring the next t"o years. (ss%me that the mat%rity ris7 premi%m is
Dero. *hat is the yield on -&year Treas%ry sec%rities+
5.-- percent
#. ( Treas%ry bond that mat%res in 1$ years has a yield o 5 percent. ( 1$&year corporate
bond has a yield o @ percent. (ss%me that the li'%idity premi%m on the corporate
bond is $.5 percent. *hat is the dea%lt ris7 premi%m on the corporate bond+
1.5 percent
5. /ne&year Treas%ry sec%rities yield 5 percent. The mar7et anticipates that 1 year rom
no"2 one&year Treas%ry sec%rities "ill yield 5 percent. I the p%re expectations theory is
correct2 "hat sho%ld be the yield today or ,&year Treas%ry sec%rities+
5.5 percent
5. The real ris7&ree rate is - percent2 and inlation is expected to be - percent or the next
, years. ( ,&year Treas%ry sec%rity yields 5., percent. *hat is the mat%rity ris7
premi%m or the ,&year sec%rity+
$., percent
:. The real ris7&ree rate is - percent. Inlation is expected to be - percent this year2 #
percent next year2 and then -.5 percent thereater. The mat%rity ris7 premi%m is
estimated to be $.$$$5 < (t&1)2 "here t H n%mber o years to mat%rity2 *hat is the
nominal interest rate on a :&year Treas%ry note+
5.@ percent
@. (ss%me that the real ris7&ree rate is , percent and that the mat%rity ris7 premi%m is
Dero. I the nominal rate o interest on 1&year bonds is 5 percent and that on
comparable ris7 ,&year bonds is : percent2 "hat is the 1&year interest rate that is
expected or year t"o+
7
: percent
9. ;o% see that the c%rrent -$&day T&bill rate is #.56. ;o% are told by a riend "ho
"or7s or an in1estment irm that the best estimates o the c%rrent interest rate
premi%ms or relati1ely sae corporate irms is as ollo"s8 inlation premi%m H
,.16! dea%lt ris7 premi%m H 1.#6. Based on this data2 "hat is the real ris7&ree
rate o ret%rn+
,.#6
1$. The real ris7&ree rate o interest is - percent. Inlation is expected to be 5 percent this
coming year2 >%mp to 5 percent next year2 and increase to : percent the ollo"ing year
(;ear -). (ccording to the expectations theory2 "hat sho%ld be the interest rate on -&
year2 ris7&ree sec%rities today+
9 percent
11. =rongo 4orporation)s #&year bonds c%rrently yield @.# percent. The real ris7&ree rate o
interest2 7N2 is ,.: percent and is ass%med to be constant. The mat%rity ris7 premi%m
(ER0) is estimated to be $.16(t & 1)2 "here t is e'%al to the time to mat%rity. The
dea%lt ris7 and li'%idity premi%ms or this company)s bonds total $.9 percent and are
belie1ed to be the same or all bonds iss%ed by this company. I the a1erage inlation
rate is expected to be 5 percent or years 52 52 and :2 "hat is the yield on a :&year
bond or =rongo 4orporation+
@.91 percent
1,. /ne&year Treas%ry sec%rities yield 5 percent2 ,&year Treas%ry sec%rities yield 5.5
percent2 and -&year Treas%ry sec%rities yield : percent. (ss%me that the expectations
theory holds. *hat does the mar7et expect "ill be the yield on 1&year Treas%ry
sec%rities t"o years rom no"+
@ percent
1-. (ss%me that a -&year Treas%ry note has no mat%rity ris7 premi%m2 and that the real
ris7&ree rate o interest is - percent. I the T&note carries a yield to mat%rity o 1$
percent2 and i the expected a1erage inlation rate o1er the next , years is @ percent2
"hat is the implied expected inlation rate d%ring ;ear -+
5 percent
CHAPTER FIVE PROBLEMS
1. (n in1estor holds a di1ersiied portolio consisting o a $52$$$ in1estment in each o ,$
dierent common stoc7s. The portolio beta is e'%al to 1.1,. The in1estor has decided
to sell a lead mining stoc7 (beta H 1.$) at $52$$$ net and %se the proceeds to b%y a
li7e amo%nt o a steel company stoc7 (beta H ,.$). *hat is the ne" beta or the
8
portolio+
1.1:
,. 4onsider the ollo"ing inormation and calc%late the re'%ired rate o ret%rn or the
*in7ler In1estment 3%nd. The total in1estment %nd is $, million.
?toc7 In1estment Beta
&&&&& &&&&&&&&&& &&&&
( $ ,$$2$$$ 1.5$
B -$$2$$$ &$.5$
4 5$$2$$$ 1.,5
= 12$$$2$$$ $.:5
The mar7et re'%ired rate o ret%rn is 156 and the ris7&ree rate is : percent.
1-.1 percent
-. The ?andy 4ompany has de1eloped the ollo"ing data regarding a pro>ect to add ne"
distrib%tion acilities8
?T(TE 0R/B(BILIT; 0R/IE4T RETKR. E(RMET RETKR.
1 .- $.$1 $.1$
, .: $.15 $.1#
(. *hat is the expected ret%rn on the pro>ect+ 1$.@6
B. *hat is the standard de1iation o the pro>ect ret%rns+ $.$5#,
4. *hat is the coeicient o 1ariation o pro>ect ret%rns+ $.59#
=. *hat is the co1ariance o pro>ect ret%rns "ith mar7et ret%rns+ $.$$1,
E. *hat is the correlation coeicient bet"een the pro>ect ret%rns and the mar7et
ret%rns+ 1.$$
#. 4alc%late the re'%ired rate o ret%rn or Eanagement2 Inc.2 ass%ming that in1estors
expect a 56 rate o inlation in the %t%re. The real rate is e'%al to -6 and the mar7et
ris7 premi%m is 56. Eanagement has a beta o ,.$ and has historically ret%rned an
a1erage o 156.
1@ percent
5. 3irst In1estment Tr%st is a m%t%al %nd in1esting in the common stoc7 o six irms. The
irms2 mar7et 1al%e o shares held2 and the beta o each stoc7 are as ollo"s8
E(RMET F(LKE /3
3IRE ?A(RE? AEL= BET(
(ce Electronics $ 9$ million $.5
BobCs Ind%stries 11$ million 1.,
4BE International 5$ million $.:
=a1eCs 4en 1-$ million 1.@
EdCs Eatery :$ million $.9
9
?pace =eli #$ million ,.5
Total 5$$ million
(. 4alc%late the beta o the m%t%al %nd. 1.,5
B. ?%ppose R
m
H 15 percent and R

H 5 percent! "hat is the expected portolio

ret%rn+ 1@.5 percent
5. The ollo"ing data pertains to the next o%r '%estions. ?toc7s ( and B ha1e ret%rns
and probability distrib%tions as gi1en belo".
0R/B(BILIT; ?T/4M ( ?T/4M B
$.,5 56 @6
$.-$ 1$6 ,6
$.,5 #6 56
$.,$ @6 @6
(. 4alc%late the expected ret%rns or ?toc7s ( and B.
:.16 and 5.:6
B. *hat are the standard de1iations o expected ret%rns or ?toc7s ( and B+
,.-,6 and ,.556
4. The co1ariance bet"een ?toc7s ( and B is8
&$.$$$-5:
=. The correlation coeicient bet"een ?toc7s ( and B is8
&$.5,
E. ?%ppose yo% "ant to hold a portolio composed o 5$6 o ?toc7 ( and 5$6 o
?toc7 B. *hat "ill be the expected ret%rn (mean) and ris7 (standard de1iation)
o yo%r portolio+
5.#6 and 1.$:6
:. ;o% are managing a portolio o 1$ stoc7s "hich are held in e'%al amo%nts. The
c%rrent beta o the portolio is 1.5#2 and the beta o ?toc7 ( is ,.$. I ?toc7 ( is sold2
"hat does the beta o the replacement stoc7 ha1e to be to ha1e a ne" portolio beta o
1.55+
1.1$
@. Gi1en the ollo"ing inormation concerning (??ET? < and ;8
0ossible Ret%rns o (ssets
/%tcomes 0robability < ;
10
1 $.1$ $.$$ &$.$#
, $.,$ $.$@ $.1$
- $.#$ $.1, $.1,
# $.,$ $.-$ $.1#
5 $.1$ $.5$ $.15
(. *hat are the expected ret%rns or (??ET? < and ; gi1en the abo1e
probabilities+
1@.#$ percent and1$.@$ percent
B. *hat is the expected ret%rn o a portolio comprised o #$ percent o an
in1estorCs "ealth in1ested in (??ET < and 5$ percent in1ested in (??ET ;+
1-.@# percent
4. *hat are the standard de1iations o the ret%rns o the t"o sec%rities+
15.# percent and 5., percent
=. *hat is the 4/F(RI(.4E bet"een the t"o sec%rities+
$.$$5#@@
E. *hat is the 4/RREL(TI/. bet"een these t"o sec%rities+
$.5-5
3. *hat is the standard de1iation o a portolio comprised o #$ percent o an
in1estorCs "ealth in1ested in (??ET < and 5$ percent in1ested in (??ET ;+
@.9- percent
CHAPTER SIX PROBLEMS
1. I yo% b%y a actory or $,5$2$$$ and the terms are ,$6 do"n2 the balance to be paid
o o1er -$ years at a 1,6 rate o interest on the %npaid balance2 "hat are the -$
e'%al ann%al payments+
11
$,#2@,9
,. (n in1estor is considering the p%rchase o ,$ acres o land. Ais analysis is that i the
land is %sed or cattle graDing2 it "ill prod%ce a cash lo" o $12$$$ per year indeinitely.
I the in1estor re'%ires a ret%rn o 1$6 on in1estments o this type2 "hat is the most he
"o%ld be "illing to pay or the land+
$1$2$$$
3. /n Ian%ary 12 19952 a grad%ate st%dent de1eloped a inancial plan "hich "o%ld
pro1ide eno%gh money at the end o his grad%ate "or7 (Ian%ary 12 ,$$$) to open a
b%siness o his o"n. Ais plan "as to deposit $@2$$$ per year2 starting immediately2 into
an acco%nt paying 1$6 compo%nded ann%ally. Ais acti1ities proceeded according to
plan except that at the end o his third year he "ithdre" $52$$$ to ta7e a 4aribbean
cr%ise2 at the end o the o%rth year he "ithdre" $52$$$ to b%y a %sed 4amaro2 and at
the end o the ith year he had to "ithdra" $52$$$ to pay to ha1e his dissertation
typed. Ais acco%nt2 at the end o the ith year2 "ill be less than the amo%nt he had
originally planned on by ho" m%ch+
$15255$
#. ;o% ha1e been gi1en the ollo"ing cash lo"s. *hat is the present 1al%e (t H $) i the
disco%nt rate is 1,6+
$ 1 , - # 5 5
&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&O&&&&
$$ $1 $,$$$ $,$$$ $,$$$ $$ &$,$$$
$-2,:5
5. (B4 4orporation has been en>oying a phenomenal rate o gro"th since its inception
one year ago. 4%rrently assets total $1$$2$$$. I gro"th contin%es at the c%rrent rate
o 1,6 compo%nded '%arterly2 "hat "ill be total assets in , 1B, years+
$1-#2-9$
5. 4harter (ir is considering the p%rchase o an aircrat to s%pplement its c%rrent leet. In
estimating the impact o adding this crat to their leet2 they ha1e de1eloped the
ollo"ing cash lo" analysis8
End o year 1 &$12$$$
, $1$$2$$$
- $1$$2$$$
# $1$$2$$$
12
5 $1$$2$$$
5 $1$$2$$$
: &$-$$2$$$
I the disco%nt rate is 1$62 "hat is the present 1al%e o these estimated lo"s+
$1@92:5,
:. 3ind the present 1al%e or the ollo"ing income stream i the interest rate is 1, percent.
;E(R? 4(?A3L/*
1&# $ 52$$$
5&1$ $ :25$$
11&15 $ 1$2$$$
$-121#@.5$
@. ;o% are thin7ing abo%t b%ying a car2 and a local ban7 is "illing to lend yo% $,$2$$$ to
b%y the car. Knder the terms o the loan2 it "ill be %lly amortiDed o1er i1e years (5$
monthly payments) and the nominal interest "ill be 1, percent. *hat "o%ld be the
monthly payment on the loan+
$###.@9
9. ;o% ha1e been sa1ing money or the last t"o years. ;o% made deposits o $1$$ on
Ian%ary 12 ,$$12 and I%ly 12 ,$$12 in a sa1ings acco%nt paying 1$6 compo%nded
semi&ann%ally. /n Ian%ary 12 ,$$,2 the ban7 increased the interest rate paid on
sa1ings acco%nts to 1,62 ann%al compo%nding. ;o% made a third $1$$ deposit on
(pril 12 ,$$,. Ao" m%ch "ill be in yo%r acco%nt on Ian%ary 12 ,$$-+
$-#9.95
1$. ;o% plan on "or7ing or 1$ years and then lea1ing or the (las7an Pbac7 co%ntryQ. ;o%
ig%re yo% can sa1e $12$$$ a year or the irst 5 years and $,2$$$ a year or the last 5
years. In addition2 yo%r amily has gi1en yo% a $52$$$ grad%ation git. I yo% p%t the
git and yo%r %t%re sa1ings in an acco%nt paying @ percent compo%nded ann%ally2 "hat
"ill yo%r Psta7eQ be "hen yo% lea1e or the "ilderness 1$ years hence+
$-121#@
11. I $1$$ is placed in an acco%nt that earns a nominal #62 compo%nded '%arterly2 or 5
years2 "hat "ill it be "orth in 5 years+
$1,,.$,
1,. Aess =istrib%tors is inancing a ne" tr%c7 "ith a loan o $1$2$$$ to be repaid in 5
ann%al installments o $,25$5. *hat ann%al interest rate is the company paying+
@6
1-. ;o% ha1e decided to deposit yo%r scholarship money ($12$$$) in a sa1ings acco%nt
paying @6 interest2 compo%nded '%arterly. Eighteen months later2 yo% decide to go to
the mo%ntains rather than school and yo% close o%t yo%r acco%nt. Ao" m%ch money
13
"ill yo% recei1e+
$121,5
1#. The present 1al%e (t H $) o the ollo"ing cash lo" stream is $529:9.$# "hen
disco%nted at 1-6 ann%ally. *hat is the 1al%e o the EI??I.G (t H ,) cash lo"+
$ 1 , - #
&&&O&&&&&&&&&&&&O&&&&&&&&&&O&&&&&&&&&&&O&&&&&&&&&&&O&&&&&
$$ $ 9$$ $+ $,21$$ $12@$$
$ #25,:
15. ;o% "ant to set %p a tr%st %nd. I yo% ma7e a payment at the end o each year or
t"enty years and earn 1$6 per year2 ho" large m%st yo%r ann%al payments be so that
the tr%st is "orth $1$$2$$$ at the end o the t"entieth year+
$12:#5.95
15. T"el1e years ago yo% bo%ght a $,5 stoc7 "hich is no" "orth $:@.#:. (ss%ming that
the stoc7 paid no di1idends2 the rate o ret%rn on yo%r in1estment "as8
1$6
1@. ?tarting on Ian%ary 12 19912 and then on each Ian%ary 1 %ntil ,$$$ (1$ payments)2
yo% "ill ma7e payments o $12$$$ into an in1estment "hich yields 1$ percent. Ao"
m%ch "ill yo%r in1estment be "orth on =ecember -1 in the year ,$1$+
$#52#5@.,5
19. ;o%r 59&year old a%nt has sa1ings o $-52$$$. ?he has made arrangements to enter a
home or the aged on reaching the age o @$. ;o%r a%nt "ants to decrease at a
constant amo%nt each year or ten years2 "ith a Dero balance remaining. Ao" m%ch
can she "ithdra" each year i she earns 5 percent ann%ally on her sa1ings+ Aer irst
"ithdra"al "o%ld be one year rom today.
8. $#2:55
,$. ( rich a%nt promises yo% $-52$$$ exactly 5 years ater yo% grad%ate rom college.
*hat is the 1al%e o the promised $-52$$$ i yo% co%ld negotiate payment %pon
grad%ation+ (ss%me an interest rate o 1, percent.
$192@5$.$5
,1. In planning to b%y a home yo% are p%tting $,25$$ o yo%r end o year bon%s in an
acco%nt that earns 1$ percent. I yo%r irst payment begins in exactly one year2 ho"
m%ch o a do"n payment "ill yo% be able to aord at the end o # years+
$1125$,.5$
,,. 3red Iohnson is retiring one year rom today. Ao" m%ch sho%ld 3red c%rrently ha1e in
a retirement acco%nt earning 1$ percent interest to g%arantee "ithdra"als o $,52$$$
per year or 1$ years+
14
$15-2515
,-. I yo% "ere promised 1$ ann%al payments o $#2$$$ starting "ith the irst payment
today2 comp%te the present 1al%e o these lo"s i yo%r opport%nity cost is : percent.
$-$2$5$.@$
,#. ;o% place $52$$$ in yo%r credit %nion at an ann%al interest rate o 1, percent
compo%nded monthly. Ao" m%ch "ill yo% ha1e in , years i all interest remains in the
acco%nts+
$52-#@.5$
,5. ;o% ha1e >%st had yo%r thirtieth birthday. ;o% ha1e t"o children. /ne "ill go to college
@ years rom no" and re'%ire o%r beginning&o&year payments or college expenses o
$1,2$$$2 $1-2$$$2 $1#2$$$2 and $152$$$. The second child "ill go to college 1# years
rom no" and re'%ire o%r beginning&o&year payments o $152$$$2 $1:2$$$2 $1@2$$$2
and $192$$$. In addition2 yo% plan to retire in ,5 years. ;o% "ant to be able to
"ithdra" $5$2$$$ per year (at the end o each year) rom an acco%nt thro%gho%t yo%r
retirement. ;o% expect to li1e ,5 years beyond retirement. The irst "ithdra"al "ill
occ%r on yo%r ity&sixth birthday. *hat e'%al2 ann%al2 end&o&year amo%nt m%st yo%
sa1e or each o the next ,5 years to meet these goals2 i all sa1ings earn a 1- percent
ann%al rate o ret%rn+
$ 525#5
,5. 3ind the present 1al%e o the cash lo"s sho"n %sing a disco%nt rate o 9 percent.
;E(R 4(?A3L/*
1&5 $15$Byr.
5 ,$$
: ,5$
@&15 15$Byr.
1:&,$ -$$Byr.
$ 125:5.,$
,:. (ccording to a local department store2 the store charges c%stomers 16 per month on
the o%tstanding balances o their charge acco%nts. *hat is the eecti1e ann%al rate
on s%ch c%stomer credit+ (ss%me the store recalc%lates yo%r acco%nt balance at the
end o each month.
1,.5@6
,@. ;o%r ban7 has oered yo% a $152$$$ loan. The terms o the loan re'%ire yo% to pay
bac7 the loan in i1e e'%al ann%al installments o $#2151.$$. The irst payment "ill be
made a year rom today. *hat is the eecti1e rate o interest on this loan+
8 1,6
,9. ;o% ha1e p%rchased a ne" sailboat and ha1e the option o paying the entire $@2$$$
no" or ma7ing e'%al2 ann%al payments or the next # years2 the irst payment d%e one
year rom no". I yo%r time 1al%e o money is : percent2 "hat "o%ld be the largest
15
amo%nt or the e'%al2 ann%al payments that yo% "o%ld be "illing to %nderta7e+
$,2-5,.$$
-$. ( irm p%rchases 1$$ acres o land or $,$$2$$$ and agrees to remit t"enty e'%al
ann%al installments o $#12$5: each. *hat is the tr%e ann%al interest rate on this
loan+
,$ percent
-1. Thirty years ago2 Iessie Iohnson bo%ght ten acres o land or $5$$ per acre in "hat is
no" do"nto"n Ao%ston. I this land gre" in 1al%e at a 1$ percent per ann%m rate2
"hat is it "orth today+
$ @:2,#5
-,. I yo% p%t yo%r money in a ban7 oering 1, percent compo%nded '%arterly2 ho" m%ch
"ill $12$## gro" to in i1e years+
8 $12@@5.5@
--. *hat is the %t%re 1al%e o $12,5$ compo%nded at an @ percent rate or ten years+
$,259@.5-
-#. Iames ?treetsC son Aarold is i1e years old today. Aarold is already ma7ing plans to go
to college on his eighteenth birthday and his ather "ants to start p%tting a"ay money
no" or that p%rpose. ?treet estimates that Aarold "ill need $1#2$$$2 $152$$$2
$152$$$2 and $1:2$$$ or his reshman2 sophomore2 >%nior2 and senior years. Ae plans
on ma7ing these amo%nts a1ailable to Aarold at the beginning o each o these years.
?treet "o%ld li7e to ma7e t"el1e deposits (the irst o "hich "o%ld be made on AaroldCs
sixth birthday2 1 year rom no") in an acco%nt earning 1, percent. Ae "ants the
acco%nt to e1ent%ally be "orth eno%gh to pay or AaroldCs college expenses. (ny
balances remaining in the acco%nt "ill contin%e to earn 1, percent. Ao" m%ch "ill
?treet ha1e to deposit in this planning acco%nt each year to pro1ide or AaroldCs
ed%cation+
$,155
-5. In yo%r analysis o =BE 4orporation yo% ind that the c%rrent earnings per share are
$5.$$ per share and most analysts are pro>ecting the earnings per share to gro" at a
1, percent rate ann%ally. *hat can yo% expect the earnings per share o this irm to be
in : years+
$11.$5
-5. ;o%r grandmother is thrilled that yo% are going to college and plans to re"ard yo% at
grad%ation "ith a 0orsche T%rbo a%tomobile. ?he "o%ld li7e to set aside an e'%al
16
amo%nt at the completion o each o yo%r college years rom her meager pension. I
her acco%nt earns 1, percent and a ne" 0orsche "ill cost $5$2$$$2 ho" m%ch "ill she
deposit each year+ (ss%me her irst deposit is in exactly one year.
$1$2#5,.##
-:. ?ellDar 4orporation c%rrently has sales o $1$$ million and its mar7eting department is
pro>ecting sales to be $@$$ million in # years. *hat rate o gro"th in sales are the
mar7eting people pro>ecting+
5@6
-@. ?%ppose that a local sa1ings and loan association ad1ertises a 5 percent ann%al rate o
interest on reg%lar acco%nts2 compo%nded monthly. *hat is the eecti1e ann%al
percentage rate o interest paid by the sa1ings and loan+
5.156
-9. Greg 0erry2 KTE0Cs reno"ned comp%ter >oc72 is grad%ating in one year and plans to
start his o"n comp%ter irm2 namely 0erryCs 0eriphals2 Inc. Being a science iction b%2
Greg is planning to start his irm %sing $5$2$$$ he earned as a trombone player in the
Bits and =iscs IaDD Band d%ring college and retire in ,$ years in order to ta7e the irst
Intergalactic ?pace ?h%ttle trip at an estimated cost o $1$.5 million. *hen Greg
ret%rns to earth 1$ years thereater2 he plans to li1e o an ann%ity o $-$$2$$$ per
year2 starting on the day o his ret%rn. This ann%ity "as %nded "hen he let on his
space >o%rney and is earning interest at 1, percent per year. B%t one o the side
eects o the space sh%ttle program has been that e1ery tra1eler dies exactly ,$ years
rom the day o ret%rn. 4alc%late the gro"th rate o 0erryCs 0eriphals that "ill ma7e
GregCs long&range plans possible.
-1.1 percent
#$. Iason and Bryan Ec.%tt are presently - and 5 years old. Their parents are planning to
send them to college at age 1@ at a cost o $1$2$$$ per year or each. Ao" m%ch m%st
the parents contrib%te ann%ally to a college %nd to ens%re the boysC college ed%cation
i the interest rate is 1, percent compo%nded ann%ally+ The payments start in one year
and end "hen the yo%nger brother starts college.
$,2$5:
#1. I yo% ha1e $52#-5 in an acco%nt that has been paying an ann%al rate o 1$62
compo%nded contin%o%sly2 since yo% deposited some %nds 1$ years ago2 ho" m%ch
"as the original deposit+
$,2$$$
#,. Ao" m%ch sho%ld yo% be "illing to pay or an acco%nt today that "ill ha1e a 1al%e o
$12$$$ in 1$ years %nder contin%o%s compo%nding i the nominal rate is 1$6+
$-5@
#-. ;o%r irm has recently borro"ed $1$$2$$$ rom a local ban7 at an interest rate o 1$
percent. The loan is to be repaid in 5 e'%al2 end&o&year payments. The ollo"ing is a
partial amortiDation sched%le or the loan.
17
0rincipal
;ear 0ayment Interest Red%ction Balance
$ $ 1$$2$$$
1 $ ,52-@$ $ 1$2$$$ $ 152-@$ $ @-25,$
, $ ,52-@$ $ @2-5, $ ( $ 5525$,
- $ ,52-@$ $ B $ 192@,$ $ #52:@-
# $ ,52-@$ $ #25:@ $ ,12@$1 $ ,-29@1
5 $ ,52-@$ $ ,2-9@ $ ,-29@1 $ $
(. The missing 1al%e or the 0rincipal Red%ction in the second year (labeled () is8
$ 1@2$1@
B. The missing 1al%e or the Interest 0ayment in the third year (labeled B) is8
$ 5255$
##. ;o% are 1al%ing an in1estment that "ill pay yo% $,#2$$$ per year or the irst 5 years2
$,@2$$$ per year or the next 1$ years2 and $5#2$$$ per year the ollo"ing 1# years (all
payments are at the end o each year). I the appropriate ann%al disco%nt rate is
5.$$62 "hat is the 1al%e o the in1estment to yo% today+
$#5$2@:@
CHAPTER SEVEN PROBLEMS
1. 4alc%late the price o a 1$ year bond paying a 5 percent ann%al co%pon (hal o the 5
percent semiann%ally) on a ace 1al%e o $12$$$ i in1estors can earn @ percent on
similar ris7 in1estments.
$@5-.:$
,. ( ma>or a%to man%act%rer has experienced a mar7et re&e1al%ation lately d%e to a
n%mber o la"s%its. The irm has a bond iss%e o%tstanding "ith 15 years to mat%rity
and a co%pon rate o @6 (paid semiann%ally). The re'%ired rate has no" risen to 156.
(t "hat price can these sec%rities be p%rchased on the mar7et+
$5#9.:1
-. The c%rrent mar7et price o a IonesC 4ompany bond is $12,9:.5@. ( 1$6 co%pon
interest rate is paid semi&ann%ally2 and the par 1al%e is e'%al to $12$$$. *hat is the
;TE (on an ann%al basis) i the bonds mat%re 1$ years rom today+
5 percent
#. 4ommon"ealth 4ompany has 1$$ bonds o%tstanding (mat%rity 1al%e H $12$$$). The
re'%ired rate o ret%rn on these bonds is c%rrently 1$62 and interest is paid
semiann%ally. The bonds mat%re in 5 years2 and their c%rrent mar7et 1al%e is $:5@ per
bond. *hat is the ann%al co%pon interest rate+
#6 percent
5. ;o% ha1e >%st been oered a bond or $@#:.@@. The co%pon rate is @62 payable
ann%ally2 and interest rates on ne" iss%es o the same degree o ris7 are 1$6. ;o%
18
"ant to 7no" ho" many more interest payments yo% "ill recei1e2 b%t the party selling
the bond cannot remember. 4an yo% help him o%t+
15
5. 3ord and GE ha1e similar bond iss%es o%tstanding. The 3ord bond has interest
payments o $@$ paid ann%ally and mat%res in the year ,$$, (,$ years rom today).
The GE bond has interest payments o $@$ paid semiann%ally and also mat%res in the
year ,$$,. I the re'%ired rate o ret%rn (7
d
) is 1,62 "hat is the dierence in c%rrent
selling price o the t"o bonds+
$,.1@
:. (cme 0rod%cts has a bond o%tstanding "ith @ years remaining to mat%rity and a
co%pon rate o 56 paid semiann%ally. I the c%rrent mar7et price is $:,9.$52 "hat is
the yield to mat%rity+
1$ percent
@. Recently2 TLE2 Inc.2 iled ban7r%ptcy papers. The irm "as reorganiDed as =L2 Inc.2 and
the co%rt permitted a ne" indent%re on an o%tstanding bond iss%e to be p%t into eect.
The iss%e has 1$ years to mat%rity and a co%pon rate o 1$62 paid ann%ally. The ne"
agreement allo"s the irm to pay no interest or 5 years and then at mat%rity to repay
principal and any %npaid interest (no interest on the %npaid interest). I the re'%ired
ret%rn is ,$62 "hat sho%ld s%ch bonds sell or in the mar7et today+
$-5,.##
9. In order to assess acc%rately the capital str%ct%re o a irm2 it is necessary to con1ert
the balance sheet to a mar7et 1al%e basis. The c%rrent balance sheet is as ollo"s8
Long&term debt (bonds) $1$2$$$2$$$
0reerred stoc7 ,2$$$2$$$
4ommon stoc7 ($1$ par) 1$2$$$2$$$
Retained earnings #2$$$2$$$
&&&&&&&&&&&
Total debt and e'%ity $,52$$$2$$$
The bonds mat%re in 1$ years. Interest is payable semiann%ally and the yield to mat%rity
is 1,6. The co%pon rate is # percent. *hat is the c%rrent mar7et 1al%e o the irmCs
debt+
$5.#1, million
1$. 4alc%late the yield to mat%rity (on an ann%al basis) o an @ percent co%pon2 1$&year
bond that pays interest semiann%ally i its price is no" $::$.5$.
1, percent
11. ;o% are the o"ner o 1$$ bonds iss%ed by Eidterm 4orporation. These bonds ha1e @
years remaining to mat%rity2 an ann%al co%pon payment o $@$2 and a par 1al%e o
$12$$$. Knort%nately2 Eidterm is on the brin7 o ban7r%ptcy2 and the creditors2
19
incl%ding yo%rsel2 ha1e agreed to a postponement o the next # interest payments.
The remaining interest payments "ill be made as sched%led. The postponed payments
"ill accr%e interest at an ann%al rate o 56 and "ill be paid as a l%mp s%m at mat%rity @
years hence. The re'%ired rate o ret%rn on these bonds2 considering their s%bstantial
ris72 is no" ,@6. *hat is the present 1al%e o each bond+
$,55.@9
1,. The <;R 4ompany recently iss%ed a ,$&year2 : percent semiann%al co%pon bond at
par. (ter three months2 the mar7et interest rates on similar bonds increased to @
percent. (t "hat price sho%ld the bonds sell+
$91@.@@
1-. IB< has a bond iss%e o%tstanding that is callable in three years at a 5 percent call
premi%m. The bond pays a 1$ percent ann%al co%pon and has a remaining mat%rity o
,- years. I the c%rrent mar7et price is $1$$$2 than "hat is the yield to call+
11.#@ percent
CHAPTER EIGHT PROBLEMS
1. The =(0 4ompany has decided to ma7e a ma>or in1estment. The in1estment "ill
re'%ire a s%bstantial early cash o%t&lo"2 and inlo"s "ill be relati1ely late. (s a res%lt2
it is expected that the impact on the irmCs earnings or the irst , years "ill be a
negati1e gro"th o 56 ann%ally. 3%rther2 it is anticipated that the irm "ill then
experience , years o Dero gro"th ater "hich it "ill begin a positi1e ann%al s%stainable
gro"th o 56. I the irmCs cost o capital is 1$6 and its c%rrent di1idend (=
$
) is $, per
share2 "hat sho%ld be the c%rrent price per share+
$-@.#:
,. The Radley 4ompany has decided to %nderta7e a large ne" pro>ect. 4onse'%ently2
there is a need or additional %nds. The inancial manager decides to iss%e preerred
stoc7 "hich has a stated di1idend o $5 per share and a par 1al%e o $-$. I the
re'%ired ret%rn on this stoc7 is c%rrently ,$62 "hat sho%ld be the stoc7Cs c%rrent mar7et
1al%e+
$,5
-. ?.GCs stoc7 is selling or $15 per share. The irmCs income2 assets2 and stoc7 price
ha1e been gro"ing at an ann%al 156 rate and are expected to contin%e to gro" at this
rate or - more years. .o di1idends ha1e been declared as yet2 b%t the irm intends to
declare a $,.$$ di1idend at the end o the last year o its s%pernormal gro"th. (ter
that2 di1idends are expected to gro" at the irmCs normal gro"th rate o 56. The irmCs
re'%ired rate o ret%rn is 1@6. ;o% sho%ld8
?ell the stoc7! it is o1er1al%ed by $-.$-.
20
#. BB02 Inc.2 has experienced a recent res%rgence in b%siness as it has gained ne"
national identity. Eanagement is orecasting rapid gro"th o1er the next # years
(ann%al rate o 156). (ter that2 it is expected that the irm "ill re1ert to its historical
gro"th rate o ,6 ann%ally. The last di1idend paid "as $1.5$ per share2 and the
re'%ired ret%rn is 1$6. *hat is the c%rrent price per share2 ass%ming e'%ilibri%m+
$,9.51
5. The 4l%b (%to 0arts 4ompany has >%st recently been organiDed. It is expected to
experience no gro"th or the next , years as it identiies its mar7et and ac'%ires its
in1entory. Ao"e1er2 4l%b "ill gro" at an ann%al rate o 56 in the third and o%rth years
and2 beginning "ith the ith year2 sho%ld attain a 1$6 gro"th rate "hich it "ill s%stain
thereater. The last di1idend paid "as $$.5$ per share. 4l%b has a cost o capital o
1,6. *hat sho%ld be the present price per share o 4l%b common stoc7+
$,$.@#
5. ( share o =RF2 Inc.2 stoc7 paid a di1idend o $1.5$ last year2 and the di1idend is
expected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rn
on this stoc7 is belie1ed to be 1,6. *hat sho%ld the stoc7 sell or today+
$19.5$
:. The 0et 4ompany has recently disco1ered a type o roc7 "hich2 "hen cr%shed2 is
extremely absorbent. It is expected that the irm "ill experience (beginning no") an
%n%s%ally high gro"th rate (,$6) d%ring the period (- years) "hen it has excl%si1e
rights to the property "here this roc7 can be o%nd. Ao"e1er2 beginning "ith the o%rth
year the irmCs competition "ill ha1e access to the material2 and rom that time on the
irm "ill ass%me a normal gro"th rate o @6 ann%ally. =%ring the rapid gro"th period2
the irmCs di1idend payo%t ratio "ill be relati1ely lo" (,$6)2 to conser1e %nds or
rein1estment. Ao"e1er2 the decrease in gro"th "ill be accompanied by an increase in
di1idend payo%t to 5$6. Last yearCs earnings "ere $,.$$ per share (E
$
) and the irmCs
cost o e'%ity is 1$6. *hat sho%ld be the c%rrent price o the common stoc7+
$:1.5@
@. ITJE2 Inc.2 a large conglomerate2 has decided to ac'%ire another irm. (nalysts are
orecasting that there "ill be a period (, years) o extraordinary gro"th (,$6) ollo"ed
by another , years o %n%s%al gro"th (1$6)2 and that inally the pre1io%s gro"th
pattern o 56 ann%ally "ill res%me. I the last di1idend "as $1 per share and the
re'%ired ret%rn is @62 "hat sho%ld the mar7et price be today+
$:-.:#
9. ( share o =RF2 Inc.2 stoc7 paid a di1idend o $1.5$ last year2 and the di1idend is
expected to gro" at a constant rate o #6 in the %t%re. The appropriate rate o ret%rn
on this stoc7 is belie1ed to be 1,6. ?%ppose =RF stoc7 "ere selling or $,5 today.
*hat "o%ld be the implied 1al%e o 7
s
2 ass%ming the other data remain the same+
1$.,# percent
1$. The 4anning 4ompany has been hit hard d%e to increased competition. The
companyCs analysts predict that earnings (and di1idends) "ill decline at a rate o 56
21
ann%ally into the oreseeable %t%re. (ss%me that 7
s
H 116 and =
$
H $,.$$. *hat "ill
be the price o the companyCs stoc7 in three years+
$1$.19
11. IBE is c%rrently selling at $55 per share. .ext yearCs di1idend is expected to be $,.5$.
I in1estors on this partic%lar day expect a ret%rn o 1,6 on their in1estment2 "hat do
they thin7 IBECs gro"th rate "ill be+
@ percent
1,. The EE 4ompany has allen on hard times. Its management expects to pay no
di1idends or the next , years. Ao"e1er2 the di1idend or ;ear - (=
-
) "ill be $1.$$ per
share2 and it is expected to gro" at a rate o -6 in ;ear #2 56 in ;ear 52 and 1$6 in
;ear 5 and thereater. I the re'%ired ret%rn or EE 4o. is ,$62 "hat is the c%rrent
e'%ilibri%m price o the stoc7+
$5.-#
1-. ;o%r brother&in&la"2 a stoc7bro7er at In1est2 Inc.2 is trying to sell yo% a stoc7 "ith a
c%rrent mar7et price o $,$. The stoc7 had a last di1idend (=
$
) o $,.$$ and a
constant gro"th rate o @6. ;o%r re'%ired ret%rn on this stoc7 is ,$6. 3rom a strict
1al%ation standpoint2 yo% sho%ld8
.ot b%y the stoc7! it is o1er1al%ed by $,.$$.
1#. .egati1e Limited is expected to gro" or o%r years at a rate o 5$ percent. (ter o%r
years2 the prod%ct ad is expected to decline2 and .egati1e "ill gro" at a negati1e
gro"th rate o 5 percent. .egati1e c%rrently pays a di1idend o $1.$$ per share and
stoc7holders ha1e a re'%ired rate o ret%rn o 1@ percent. *hat sho%ld be the mar7et
1al%e or a share o .egati1e Limited stoc7+
$1@.-#
15. (ss%me the irm has been gro"ing at a 156 ann%al rate and is expected to contin%e to
do so or - more years. (t that time2 gro"th is expected to slo" to a constant #6 rate.
The irm maintains a -$6 payo%t ratio2 and this yearCs retained earnings "ere $1.#
million. The irmCs beta is 1.,52 the ris7&ree rate is @62 and the mar7et ris7 premi%m is
#6. I the mar7et is in e'%ilibri%m2 "hat is the mar7et 1al%e o the irmCs common
e'%ity (1 million shares o%tstanding)+
$9.15 million
15. =exter2 Inc.2 has >%st paid a di1idend o $,.$$. Its stoc7 is no" selling or $#@ per share.
The irm is hal as 1olatile as the mar7et. The expected ret%rn on the mar7et is 1#6
and the yield on K.?. Treas%ry bonds is 116. I the mar7et is in e'%ilibri%m2 "hat rate
o gro"th is expected+
@ percent
1:. Gi1en the ollo"ing inormation2 calc%late the expected capital gains yield or Bimlo
Bottle 4aps! beta H $.5! 7
m
H 156! R

H @6! =
1
H $,.$$! 0
$
H $,5.$$. (ss%me the
stoc7 is a constant gro"th stoc7 and is in e'%ilibri%m.
22
#., percent
1@. <;R stoc7 is c%rrently paying a di1idend o $,.$$ per share (=
$
H $,) and is in
e'%ilibri%m. The company has a gro"th rate o 56 and beta e'%al to 1.5. The
re'%ired rate o ret%rn on the mar7et is 1562 and the ris7&ree rate is :6. <;R is
considering a change in policy that "ill increase its beta coeicient to 1.:5. I mar7et
conditions remain %nchanged2 "hat ne" gro"th rate "ill ca%se the common stoc7 price
o <;R to remain %nchanged+
5.:5 percent
19. Knion 0aperCs stoc7 is c%rrently in e'%ilibri%m selling at $-$ per share. The irm has
been experiencing a 56 ann%al gro"th rate. Earnings per share (E
$
) "ere $#.$$ and
the di1idend payo%t ratio is #$6. The ris7&ree rate is @6 and the mar7et ris7 premi%m
is 56. I systematic ris7 increases by 5$62 all other actors remaining constant2 the
stoc7 price "ill increaseBdecrease by8
&$:.-1
,$. 4harter /il 4ompany is c%rrently selling at its e'%ilibri%m price o $1$$ per share. The
beta coeicient c%rrently is ,. The ris7&ree rate is 1$6. The ollo"ing e1ents "ill soon
occ%r8 (1) top management "ill lo"er 4harterCs beta to 1., by in1esting in se1eral lo"
ris7 pro>ects! (,) the 3ederal Reser1e Board "ill red%ce the money s%pply ca%sing the
inlation premi%m to be red%ced by - percentage points! and (-) decreased "orld
stability d%e to global politics "ill ca%se the mar7et ris7 premi%m to increase ,
percentage points to 56. The company has a constant gro"th rate o 56. *hat "ill
be the ne" e'%ilibri%m price or a share o 4harter /il common stoc7 ater the abo1e
e1ents ha1e ta7en place+ ((ss%me the expected di1idend "ill not change.)
$1-:.5$
,1. *heeler2 Inc.2 is presently in a stage o abnormally high gro"th beca%se o the excess
demand or "idgets. The company expects earnings and di1idends to gro" at a rate o
,$6 or the next # years2 ater "hich time there "ill be no gro"th in earnings and
di1idends. The companyCs last di1idend "as $1.5$. *heeler has a beta o 1.52 the
ret%rn on the mar7et is c%rrently 1,.:562 and the ris7&ree rate is #6. *hat sho%ld be
the c%rrent price per share o common stoc7+
$15.1:
,,. ;o% are gi1en the ollo"ing data8
1. The ris7&ree rate is $.$5.
,. The re'%ired ret%rn on the mar7et is $.$@.
-. The expected gro"th rate or the irm is $.$#.
#. The last di1idend paid "as $$.@$ per share.
5. Beta is 1.-.
.o" ass%me the ollo"ing changes occ%r8
23
1. The inlation premi%m decreases by the amo%nt o $.$1.
,. (n increased degree o ris7 a1ersion ca%ses the re'%ired ret%rn on the
mar7et to go to $.1$ ater ad>%sting or the changed inlation premi%m.
-. The expected gro"th rate increases to $.$5.
#. Beta rises to 1.5.
*hat "ill be the change in price per share ass%ming the stoc7 "as in e'%ilibri%m
beore the changes+
&$#.@:
,-. ;o% are considering b%ying common stoc7 in Gro" /n2 Inc. ;o% ha1e calc%lated that
the irmCs ree cash lo" "as $:.5$ million last year. ;o% pro>ect that ree cash lo" "ill
gro" at a rate o 5.$6 per year indeinitely. The irm c%rrently has o%tstanding debt and
preerred stoc7 "ith a total mar7et 1al%e o $,,.,- million. The irm has ,.9# million
shares o common stoc7 o%tstanding. I the irmCs cost o capital is 19.$62 "hat is the
most yo% sho%ld pay per share or the stoc7 no"+
$11.@-
,#. =%e to the highly specialiDed nat%re o the electronic ind%stry2 Borrett Ind%stries in1est
a lot o money in RJ= on prospecti1e prod%cts. 4onse'%ently2 it retains all o its
earning and rein1ests them into the irm. (t this time2 Borrett does not any plans to pay
di1idends in the near %t%re. ( ma>or pension %nd is interested in p%rchasing BorrettCs
stoc72 "hich is traded on the .;?E. The treas%rer or the pension %nd has done
research on the company and has estimated BorrettCs ree cash lo" or the next o%r
years as ollo"s8 $- million2 $5 million2 $1$ million and $15 million. (ter the o%rth
year2 ree cash lo" is pro>ected to gro" at a constant : percent. BorrettCs *(44 is 1,
percent2 it has $5$ million o total debt and preerred stoc7 and 1$ million shares o
common stoc7.
(. *hat is the present 1al%e o BorrettCs ree cash lo"s d%ring the next o%r
years+
$,#211,2-$@
B. *hat is the companyCs terminal 1al%e+
$-,12$$$2$$$
4. *hat is the total 1al%e o the irm today+
$,,@211-251,
=. *hat is BorrettCs price per share+
$15.@1
,5. (ss%me that today is =ecember -12 ,$$$ and that the ollo"ing inormation applies to
Fermeil (irlines8
(. (ter&tax operating income SEBIT(1&t)T or ,$$1 is expected to be $5$$ million.
B. The companyCs depreciation expense or ,$$1 is expected to be $1$$ million.
4. The companyCs capital expendit%res or ,$$1 are expected to be $,$$ million
=. .o change is expected in the companyCs net operating "or7ing capital.
E. The companyCs ree cash lo" is expected to gro" at a constant rate o 5
percent per year.
24
3. The companyCs cost o e'%ity is 1# percent.
G. The companyCs *(44 is 1$ percent.
A. The mar7et 1al%e o the companyCs debt is $- billion.
I. The company has ,$$ million shares o stoc7 o%tstanding.
Ksing the ree cash lo" approach2 "hat sho%ld the companyCs stoc7 price be today+
$-5.$$ per share
CHAPTER NINE PROBLEMS
1. The chie inancial oicer o 0ortland /il has gi1en yo% the assignment o determining
the irmCs marginal cost o capital. The present capital str%ct%re "hich is considered
optimal2 is8
Boo7 Fal%e Ear7et Fal%e
=ebt $ 5$ million $ #$ million
0reerred ?toc7 1$ million 5 million
4ommon E'%ity -$ million 55 million
Total $ 9$ million $ 1$$ million
The anticipated inancing opport%nities are these8 =ebt can be iss%ed "ith a 15 percent
beore&tax cost. 0reerred stoc7 "ill be $1$$ par2 carry a di1idend o 1- percent2 and
can be sold to net the irm $95 per share. 4ommon e'%ity has a beta o 1.,$2 the
ret%rn on the mar7et is 1: percent2 and the ris7&ree rate is 1, percent. I the irmCs tax
rate is #$ percent2 "hat is its marginal cost o capital+
1#., percent
,. ?ilicon 4orp. recently iss%ed 1$&year2 1, percent co%pon bonds at par 1al%e. ?iliconCs
beta is $.5! the optimal capital str%ct%re contains #5 percent debtB55 percent e'%ity!
and the marginal tax rate is #$ percent. I the expected ret%rn on the mar7et is 15
percent and the treas%ry bill rate is 9 percent2 estimate ?iliconCs "eighted a1erage cost
o capital.
1$.5 percent
-. Ieerson re'%ires $15 million to %nd its c%rrent year)s capital pro>ects. Ieerson "ill
inance part o its needs "ith $9 million in internally generated %nds. The irms)
common stoc7 mar7et price is $1,$ per share. The irm)s last di1idends "as $5 per
share and is expected to gro" at a rate o 11 percent ann%ally or the oreseeable
%t%re. (nother portion o the re'%ired %nds "ill come rom the iss%e o 92-:5 shares
o 1, percent $1$$ par preerred stoc7 that "ill be pri1ately placed. The irm "ill net
$95 per share rom the sale o these shares. The remainder o the %nding needs "ill
be met "ith debt. 3i1e tho%sand 1$&year $12$$$ par bonds "ith a co%pon rate o 15
percent "ill be iss%es to net the irm $12$,$ each. Interest "ill be paid ann%ally on the
25
bonds. The irm)s tax rate is -$ percent.
1-.51 percent
#. (1erage 4orporationCs stoc7 c%rrently sells or $#5.$$ per share2 it is expected
to pay a di1idend o $-.1$ next year2 its gro"th rate is a constant :.$62 and the
company "ill inc%r a lotation cost o 1,.$6 o the mar7et 1al%e i it sells ne"
common stoc7. The irmCs tax is #$6. *hat is the irmCs cost o retained
earnings+
1-.@96
5. ;o% are determining <;R2 Inc.Cs optimal capital b%dget or the next year. ;o% ha1e
identiied the ollo"ing possible I.=IFI?IBLE capital pro>ects8
0R/IE4T 4/?T IRR
( $ 1$$2$$$ 15 6
B @$$2$$$ 1# 6
4 5$$2$$$ 1@ 6
= -$$2$$$ 15 6
E #$$2$$$ 1, 6
3 :$$2$$$ 1: 6
G 5$$2$$$ ,$ 6
<;RCs marginal cost o capital is8
.E* 4(0IT(L REUKIRE= E(RGI.(L 4/?T
$ $ & 5$$2$$$ 1-.$ 6
$ 5$$2$$1 & 9992999 1#., 6
$ 12$$$2$$$ & 12#992999 15.$ 6
$ 125$$2$$$ & 129992999 15.5 6
$ ,2$$$2$$$ & ,2#992999 1:.$ 6
$ ,25$$2$$$ & -2$$$2$$$ 1:.5 6
(B/FE $ -2$$$2$$$ 1@.$ 6
*hat is <;RCs optimal capital b%dget or the %pcoming year+
$1.9 million
5. Earginal Incorporated has determined that its beore&tax cost o debt is 1$.$6. Its cost
o preerred stoc7 is 11.$6. Its cost o internal e'%ity is 15.$62 and its cost o external
e'%ity is 15.96. 4%rrently2 the irmCs capital str%ct%re consists o -,6 debt2 1#6
preerred stoc72 and 5#6 common e'%ity. The irmCs marginal tax rate is -96. *hat is
the irmCs "eighted a1erage cost o capital i it "ill ha1e to iss%e ne" common stoc7 to
%nd the e'%ity portion o its capital b%dget+
1,.5, percent
26
CHAPTER TEN PROBLEMS
1. Gi1en the ollo"ing net cash lo"s2 determine the IRR o the pro>ect8
Time .et cash lo"
&&&& &&&&&&&&&&&&&
$ $ 125,$
1 &12$$$
, &125$$
- 5$$
,#6
,. (cme 0rod%cts2 Inc.2 re'%ires a ne" machine to prod%ce a part or a heat generator.
T"o companies ha1e s%bmitted bids2 and yo% ha1e been assigned the tas7 o
choosing one o the machines. 4ash lo" analysis indicates the ollo"ing8
;ear Eachine ( Eachine B
&&&& &&&&&&&&& &&&&&&&&&
$ &$12$$$ &$12$$$
1 $ #1:
, $ #1:
- $ #1:
# 129-@ #1:
(. *hat is the internal rate o ret%rn or each machine+
IRR
(
H $.1@! IRR
B
H $.,#
B. I the cost o capital or (cme 0rod%cts is 562 "hich o the ollo"ing is tr%e+
The .0F
(
V .0F
B
2 thereore accept Eachine (.
-. 0ro>ects 4 and * are m%t%ally excl%si1e2 and they ha1e the ollo"ing net cash lo"s8

;ear 0ro>ect 4 0ro>ect *
&&&& &&&&&&&&& &&&&&&&&&
$ &$5$2$$$ &$1$$2$$$
1 -$2$$$ #$2$$$
, #$2$$$ #$2$$$
- 5$2$$$ #$2$$$
# $ #$2$$$
5 $ #$2$$$
27
;o% are to %se the e'%i1alent ann%al ann%ity method or comparing these pro>ects
since they ha1e %ne'%al li1es. The cost o capital is 1$6. *hich pro>ect sho%ld be
chosen+
0ro>ect 4 since it has a higher e'%i1alent ann%al ann%ity.
#. The ?mith 4ompany is considering t"o m%t%ally excl%si1e in1estments that "o%ld
increase its capacity to ma7e stra"berry tarts. The irm %ses a 1, percent cost o
capital to e1al%ate potential in1estments. The pro>ects ha1e the ollo"ing costs and
cash lo" streams8
;E(R (LTER.(TIFE ( (LTER.(TIFE B
$ $ &-$2$$$ $ &-$2$$$
1 1$25$$ 525$$
, 1$25$$ 525$$
- 1$25$$ 525$$
# 1$25$$ 525$$
5 && 525$$
5 && 525$$
: && 525$$
@ && 525$$
*hat are the respecti1e EUKIF(LE.T (..K(L (..KITIE? or alternati1es ( and B+
(LTER.(TIFE ( (LTER.(TIFE B
8 $ 5,1.-5 $ #51.-5
5. *hat is the paybac7 period2 the .0F at a disco%nt rate o 1$ percent2 and the IRR or a
pro>ect "ith the ollo"ing cash lo"s+
;E(R 4(?A /KT3L/* 4(?A I.3L/*
$ $ 1$$$ &&
1 && $ 5$$
, && 5$$
- && 1$5
0(;B(4M .0F IRR
1 5B5 yrs -$ 1, 6
5. ( pro>ect has an initial cost o $92#,:. I it ret%rns a net cash lo" o $12$$$ at the end
o each year or the next -$ years2 the internal rate o ret%rn m%st be8
1$ 6
:. *hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+
TIEE 4(?A /KT3L/* 4(?A I.3L/*?
$ $ #-2,95 &&
1 && $ 1$2$$$
, && 1$2$$$
- && 1$2$$$
# && 1$2$$$
5 && 1$2$$$
28
5 6
@. ;o%r company is considering t"o m%t%ally excl%si1e pro>ects2 < and ;2 "hose costs
and cash lo"s are sho"n belo"8
;ear < ;
$ &$12$$$ &$12$$$
1 1$$ 12$$$
, -$$ 1$$
- #$$ 5$
# :$$ 5$
The pro>ects are e'%ally ris7y2 and their cost o capital is 1, percent. *hat is
the modiied IRR o each pro>ect+
< ;
1-.596 1-.1$6
9. 4onglomerates2 Inc.2 is considering the p%rchase o ?mall J 4ompany. The ac'%isition
"o%ld re'%ire an initial in1estment o $19$2$$$2 b%t 4onglomeratesC net cash lo"s
"o%ld increase by $-$2$$$ per year and remain at the ne" le1el ore1er. ?ho%ld
4onglomerates b%y ?mall+ (ss%me a cost o capital o 156.
;es2 beca%se the .0F H $1$2$$$.
1$. I the re'%ired rate o ret%rn is 1, percent2 "hat is the net present 1al%e o the pro>ect
described belo"8
4/?T /3 .E* EUKI0EE.T $ 5$2$$$
LI3E /3 EUKI0EE.T 5 ;E(R?
?(LF(GE F(LKE $ 52$$$
(..K(L .ET 4(?A 3L/* $ 1,2$$$
$ &:25,#
11. *hat is the IRR o a pro>ect "ith the ollo"ing cash lo"s+
;E(R 4(?A3L/*
$ $ $
1 $ $
, $ &,5$$
- $ 1$$$
# $ 1$$$
5 $ 1$$$
9&1$ 6
1,. *hat is the net present 1al%e o this in1estment+
I.ITI(L 4/?T $ 152$$$
0R/IE4T LI3E 5 years
?(LF(GE F(LKE $ $
(..K(L .ET 4(?A 3L/*? $ 52$$$
=I?4/K.T R(TE 1$ 6

$ -295#.$$
29
1#. I a capital b%dgeting pro>ect has an initial o%tlay o $125$$ and an .0F o $52$$$2 "hat
is its proitability index+
#.--
15. 4%mmings 0rod%cts 4ompany is considering t"o m%t%ally excl%si1e in1estments. The
pro>ectCs expected net cash lo"s are as ollo"s8
Expected .et 4ash 3lo"s
;ear 0ro>ect ( 0ro>ect B
$ ($-$$) ($#$5)
1 (-@:) 1-#
, (19-) 1-#
- (1$$) 1-#
# 5$$ 1-#
5 5$$ 1-#
5 @5$ 1-#
: (1@$) $
(. I the cost o capital or each pro>ect is 1, percent2 "hat is the .0F or each
pro>ect+ *hich pro>ect sho%ld be accepted+
$,$$.#1 and $1#5.9- 0ro>ect (
B. I the cost o capital or each pro>ect is 1@ percent2 "hat is the .0F or each
pro>ect+ *hich pro>ect sho%ld be accepted+
$,.55 and $5-.5@ 0ro>ect B
4. *hat is the internal rate o ret%rn or each pro>ect+
1@.16 and ,#.$6
=. *hat is the crosso1er rate+
1#.5-6
CHAPTER ELEVEN PROBLEMS
1. The capital b%dgeting director is e1al%ating a pro>ect that costs $,$$2$$$2 is expected
to last or 1$ years and to prod%ce ater&tax income o $,925$- per year. =epreciation
applicable to this pro>ect "o%ld be $,$2$$$ per year. I the cost o capital o the irm is
1#62 "hat is the pro>ectCs IRR (tax rate H #$6)+
,1.1 percent
30
,. EJE Inc.2 is considering the p%rchase o a ne" machine "hich "ill red%ce
man%act%ring costs by $52$$$ ann%ally. EJE "ill %se the straight&line method to
depreciate the machine2 and it expects to sell the machine at the end o its 5 year lie
or $1$2$$$. The irm expects to be able to red%ce "or7ing capital by $152$$$ "hen
the machine is installed. The irmCs marginal tax rate is #$6 and it %ses a 1,6 cost o
capital to e1al%ate pro>ects o this nat%re. I the machine costs $5$2$$$2 "hat is the
.0F o the pro>ectCs cash lo"s+
&$,,25$#
-. Bla7e 4orporationCs ne" pro>ect calls or an in1estment o $1$2$$$. It has an estimated
lie o 1$ years. The IRR has been calc%lated to be 156. I cash lo"s are e1enly
distrib%ted and the tax rate is #$62 "hat is the ann%al BE3/RE&T(< cash lo" each
year+ ((ss%me depreciation is a negligible amo%nt.)
$-2-,1
#. G Eart2 Inc.2 is considering the ac'%isition o e'%ipment to expand its sales. The initial
cost o the e'%ipment is $1$$2$$$. Ao"e1er2 the prod%ction manager has estimated
the expansion program "ill increase cash operating costs by $,$2$$$. (ss%me straight
line depreciation to a Dero sal1age 1al%e2 a tax rate o #$62 and a cost o capital o
1$6. Ao" m%ch "ill the additional cash re1en%e d%ring the 1$ year lie o the asset
ha1e to be to ca%se the IRR o the pro>ect to be e'%al to 7+
$#$2#5:
5. Blain 4orporation is considering the p%rchase o a machine "hich has an expected @
year lie and costs $,$2$$$. The ann%al expected .ET 4(?A 3L/* rom the machine
is $52$$$ or the irst : years and $92$$$ in year @2 excl%ding sal1age 1al%es. The
asset "ill be depreciated on a straight line basis to a $#2$$$ sal1age 1al%e. It is eligible
or a :6 in1estment tax credit. I the disco%nt rate is 1$62 "hat is the machineCs .0F+
$112@$:
5. 0recision Eetals2 Inc. is considering the replacement or its existing lathe2 "hich cost
$,$$2$$$ at the time o p%rchase i1e years ago2 and "hich no" has a remaining lie o
i1e years "ith no sal1age 1al%e. It can be sold c%rrently or $1$$2$$$. ( ne"2 more
operationally eicient lathe costs $-$$2$$$ and has a %se%l lie o i1e years "ith a
sal1age 1al%e o $5$2$$$. It is expected to red%ce operating costs by $552$$$ ann%ally.
(n in1estment tax credit o 1$ percent o the p%rchase price can be %sed i the lathe is
ac'%ired. The irmCs re'%ired rate o ret%rn or replacement decisions is 1, percent.
(ss%me straight&line depreciation and a tax rate o #$ percent. The net present 1al%e
o this capital b%dgeting decision is8
$ ##2-@$
:. 4=B J (ssociates is considering the p%rchase o a ne" piDDa o1en. The original cost
o the old o1en "as $-$2$$$. The machine is no" 5 years old and has a c%rrent
mar7et 1al%e o $52$$$. The o1en is being depreciated o1er a 1$&year lie to"ard a
Dero estimated sal1age 1al%e on a straight&line basis. Eanagement is contemplating
the p%rchase o a ne" o1en "hose cost is $,52$$$ and "hose estimated sal1age 1al%e
is Dero. Expected cash sa1ings rom the ne" o1en are $,2$$$ a year (beore tax).
=epreciation is on a straight&line basis o1er a 5 year lie2 and the cost o capital is 1$6.
(ss%me a 5$6 tax rate. *hat is the net present 1al%e o the ne" machine+
31
&$:2#1@
@. ?andals2 Inc.2 is considering the p%rchase o a ne" leather&c%tting machine to replace
an existing machine that has a boo7 1al%e o $-2$$$ and can be sold or $125$$. The
estimated sal1age 1al%e o the old machine in # years is Dero. The ne" machine "ill
red%ce costs (beore tax) by $:2$$$ per year! that is2 $:2$$$ cash sa1ings o1er the old
machine. The ne" machine has a # year lie2 cost $1#2$$$2 and can be sold or an
expected $,2$$$ at the end o the o%rth year. (ss%ming straight line depreciation or
both machines2 a #$6 tax rate2 and a cost o capital o 1562 ind the .0F.
$-2#:5
9. Gi1en the ollo"ing inormation2 "hat is the eecti1e cost o the ne" machine! that is2
"hat is the cash lo" at t H $+
0%rchase price o ne" machine $@2$$$
Installation charge ,2$$$
Ear7et 1al%e o old machine ,2$$$
Boo7 1al%e o old machine 12$$$
In1entory decrease i ne" machine is installed 12$$$
(cco%nts payable increase i ne" machine is installed 5$$
Tax rate #@6
4ost o capital 156
$529@$
1$. U%i72 Inc.2 is a ast&ood establishment that needs to p%rchase ne" ryolators. I the
machines are p%rchased2 they "ill replace old machines p%rchased 1$ years ago or
$1$$2$$$2 being depreciated on a straight line basis to a Dero sal1age 1al%e (,$ years
depreciable lie). The old machines can be sold or $1,$2$$$. The ne" machines "ill
cost $,$$2$$$ installed and "ill be depreciated on a straight&line basis to a Dero
sal1age 1al%e in 1$ years. It is expected that there "ill be increased re1en%es o
$1@2$$$ per year and increased cash expenses o $,25$$ per year. I the irmCs cost o
capital (7) is 1$62 the tax rate on ordinary income is #$62 and the tax rate on capital
gains is -$62 "hat is the .0F o the machine+
&$529@@
11. 042 Inc.2 has a stamping machine "hich is 5 years old and "hich is expected to last
another 1$ years. It has a boo7 1al%e o $1$$2$$$ and is being depreciated by the
straight&line method to Dero. Tri&?tate Ind%stries has demonstrated a ne" machine "ith
an expected %se%l lie o 1$ years (scrap 1al%e $5$2$$$) that sho%ld sa1e 04 $152$$$
a year in labor and maintenance costs. I 04Cs cost o capital is 1$62 sho%ld the
replacement be made+ 04Cs tax rate is #$62 the ne" machine "ill cost $,$$2$$$2 and
an in1estment tax credit o 1$6 applies. The mar7et 1al%e o the old machine is
$1$2$$$ and a $1$2$$$ increase in "or7ing capital "ill be needed to s%pport the ne"
machine.
32
.o! .0F H &$5-2,:@
1,. GIG/2 Inc.2 is considering replacing its c%rrent comp%ter "ith a ne" generation model.
The (BE salesperson has demonstrated a model "hich "o%ld cost GIG/ $:5$2$$$2
sho%ld last 1$ years2 and red%ce costs $1552$#- per year. (BE estimates that this
ne" comp%ter can be sold or $1$2$$$ at the end o its %se%l lie. The comp%ter GIG/
c%rrently %ses has a boo7 1al%e o $#5$2$$$ (remaining lie o 1$ years2 a sal1age
1al%e o $1$2$$$2 and a c%rrent mar7et 1al%e o $1$2$$$. I an in1estment tax credit o
1$6 is applicable to the ne" comp%ter2 and the ne" machine "ill permit a $1$2$$$
decrease in "or7ing capital "hen the comp%ter is installed2 "hat is the .0F (7 H 1562 t
H #$62 depreciation is straight line)+
$:@2:5-
1-. ;o% ha1e been as7ed by the irmCs president to e1al%ate the proposed ac'%isition o a
ne" machine. The machineCs price is $5$2$$$2 and it "ill cost $1$2$$$ to transport and
install. It "ill be depreciated by the straight&line method o1er its 5&year %se%l lie to a
$1$2$$$ sal1age 1al%e. The machine "ill increase re1en%es by $1$2$$$ per year2 and
it "ill decrease operating costs by $,$2$$$ per year. (lso2 the machine "ill allo" the
irm to red%ce in1entories by $52$$$. The ne" machine (incl%ding deli1ery and
installation costs) '%aliies or a 1$6 in1estment tax credit. I the irmCs cost o capital is
1,62 and its marginal tax rate is #$62 "hat is the ne" machineCs .0F+
$--21#-
1#. Knion Bric72 Inc.2 has an electric 7iln "hich is 5 years old and is expected to last
another 1$ years. It has a boo7 1al%e o $1$$2$$$2 and it is being depreciated by the
straight&line method to a Dero sal1age 1al%e. (s =irector o 4apital B%dgeting2 yo% are
e1al%ating a ne" gas 7iln that sho%ld sa1e KBI $,52$$$ a year in %el costs. The ne"
7iln "o%ld cost $,$$2$$$2 and it is eligible or a 1$6 in1estment tax credit. It "o%ld be
depreciated o1er 1$ years by the straight&line method to a $,$2$$$ sal1age 1al%e. The
mar7et 1al%e o the old 7iln is $1$2$$$. KBICs marginal tax rate is #$62 and the irmCs
cost o capital is 1$6. *hat is the .0F o the replacement pro>ect+
&$1#2#5@
W
15. ( company is planning to in1est $5$2$$$ (beore tax) in a personnel training program.
The $5$2$$$ o%tlay "ill be charged o as an expense by the irm this year (time $). the
ret%rns rom the program2 in the orm o greater prod%cti1ity and a red%ction in
employee t%rno1er2 are estimated as ollo"s (on an ater&tax basis)8
;E(R? 1&1$ $ 52$$$ per year
;E(R? 11&,$ $ 152$$$ per year
33
The company has estimated its cost o capital to be 15 percent. (ss%me that the entire
$5$2$$$ is paid at time $ (the beginning o the pro>ect). The marginal tax rate or the
irm is #$ percent. *hat is the in1estmentCs .0F+
$ 1-259$
15. The *R(.GLER 4orporation is considering the ac'%isition o a ne" splicing machine
to impro1e the eiciency o its clothing operations. The ne" machine "ill cost $5$2$$$
pl%s installation costs o $52$$$. The machineCs eiciency "ill create additional o%tp%t!
th%s2 re1en%es "ill increase by $52$$$ ann%ally. The amo%nt o "asted material "ill
decline2 so operating costs "ill decline by $,2$$$ ann%ally. The machine "ill re'%ire a
$,2$$$ increase in in1entory and spare parts. The machineCs estimated sal1age 1al%e
(at the end o its 5 year lie) is $5$$. (Kse this 1al%e or depreciation p%rposes.) The
irmCs marginal tax rate is #$ percent and its re'%ired rate o ret%rn is 1$ percent.
(ss%me that the irm %ses straight&line depreciation or analysis o this type.
(. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash
o%tlo"+)
$ &5:2$$$
B. *hat are the net operating cash lo"s or ;ear 1 thro%gh 5+
$ 92-5$
4. *hat is the total 1al%e o the additional considerations at the end o the i1e
years+
$ ,25$$
=. *hat is the .et 0resent Fal%e o the decision+
$ &,92955
34
1:. The .elson E'%ipment 4ompany p%rchased a machine 5 years ago at a cost o
$,$$2$$$. The machine had an expected lie o 1$ years at the time o the p%rchase
and an expected sal1age 1al%e o $5$2$$$ at the end o the 1$ years. It is being
depreciated by the straight&line method to"ard a sal1age 1al%e o $5$2$$$2 or by
$152$$$ per year.
( ne" machine can be p%rchased or $#$$2$$$ and re'%ire an additional
$152$$$ in installation costs. The ne" machine "ill re'%ire $,$2$$$ in additional spare
parts. =%ring its 5&year lie2 it "ill red%ce cash operating expenses by $15$2$$$ per
year. ?ales are not expected to change. (t the end o its %se%l lie2 the machine is
estimated to be "orth $5$2$$$. (4R? depreciation "ill be %sed2 and the machine "ill
be depreciated o1er its -&year class lie rather than its 5&year economic lie.
The old machine can be sold today or $1:52$$$. The irmCs tax rate is #$
percent and the appropriate disco%nt rate is 1, percent. (The reco1ery allo"ance
percentages or -&year property are --62 #562 1562 and :6.)
(. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash
o%tlo"+)
$ &,@$2$$$
B. *hat are the net operating cash lo"s or ;ear 1 and ,+
;ear 1 ;ear ,
$ 1-@2:@$ $ 15@2:$$
4. *hat is the total 1al%e o the additional considerations at the end o the i1e
years+
$ $
=. *hat is the .et 0resent Fal%e o the replacement decision+
$ 1552-:$
35
1@. Eac=o%galCs is a ast&ood establishment that needs to p%rchase ne" ryolators. I the
ne" ryolators are p%rchased2 they "ill replace old machines p%rchased 1$ years ago
or $15$2$$$. The old machines are being depreciated on a straight&line basis to a
Dero sal1age 1al%e. The original estimated lie o the old machines "as iteen years.
(The old machines ha1e i1e years o estimated lie remaining.) The old ryolators can
c%rrently be sold to another irm in the ind%stry or $#$2$$$.
The ne" machines "ill cost $,5$2$$$ pl%s an additional $,$2$$$ or installation.
The ne" ryolators ha1e an estimated %se%l lie o i1e years and ha1e an estimated
sal1age 1al%e (?4R(0) at the end o i1e years o $1$2$$$. The ne" ryolators ha1e
extra capacity and "ill2 th%s2 increase re1en%es by $5$2$$$ ann%ally. The machines
"ill also red%ce operating expenses (electricity) by $1$2$$$ ann%ally. The irm "ill
re'%ire $52$$$ in additional "or7ing capital to s%pport the increased o%tp%t.
Eac=o%galCs depreciates their capital impro1ements at the maxim%m rate
allo"ed by the IR?. 3or property o this type (-&year)2 the E(4R? rates are --62 #562
156 and :6. The irmCs marginal tax rate is #$ percent and their re'%ired rate on
pro>ects o this nat%re is 1, percent.
(. *hat is the .ET 4/?T o the machine+ (That is2 "hat is the initial cash
o%tlo"+)
$ &,-12$$$
B. *hat are the net operating cash lo"s or ;ear 1 and ,+
;ear 1 ;ear ,
$ :-25#$ $ @525$$
4. *hat is the total 1al%e o the additional considerations at the end o the i1e
years+
$ 112$$$
=. *hat is the .et 0resent Fal%e o the machine+
$ &@:5
36
19. .at%ral Be1erages is contemplating the replacement o one o its bottling machines
"ith a ne"er and more eicient one. The old machine has a boo7 1al%e o $#$$2$$$
and a remaining %se%l lie o i1e years. The sal1age 1al%e o the old machine (or
depreciation and cash lo" p%rposes) is $5$2$$$. The irm can sell it no" to another
irm in the ind%stry or $,$$2$$$. The ne" machine has a p%rchase price o $1.,
million2 an estimated %se%l lie o i1e years2 and an estimated sal1age 1al%e in i1e
years o $,$2$$$. (dditional costs o installation "ill be $,52$$$. It is expected to
economiDe on operating costs and to red%ce the n%mber o deecti1e bottles. In total2
an ann%al sa1ing o $,5$2$$$ "ill be realiDed i the ne" machine is installed. The ne"
machine "ill re'%ire an additional $152$$$ in in1entory (spare parts). The company is
in the #$ percent marginal tax brac7et and has a 1, percent re'%ired rate o ret%rn.
The machine '%aliies as a -&year property %nder E(4R? (--62 #562 1562 :6).
(. *hat is the initial in1estment re'%ired or this replacement decision+
&$95$2$$$
B. *hat are the net operating cash lo"s or years one and t"o+
$,@-2:$$ $-#,25$$
4. *hat is the 1al%e o the additional considerations in year 5+
&$,-2$$$
=. *hat is the .ET 0RE?E.T Fal%e o this replacement decision+
&$1-@299@
37
,$. A%ang Ind%stries is considering a proposed pro>ect or its capital b%dget. The company
estimates that the pro>ectCs .0F is $1, million. This estimate ass%mes that the
economy and mar7et conditions "ill be a1erage o1er the next e" years. The
companyCs 43/2 ho"e1er2 orecasts that there is only a 5$ percent chance that the
economy "ill be a1erage. RecogniDing this %ncertainty2 she has perormed the
ollo"ing scenario analysis8
Economic 0robability
?cenario o /%tcome .0F
Recession $.$5 ($:$ million)
Belo" (1erage $.,$ ($,5 million)
(1erage $.5$ $1, million
(bo1e (1erage $.,$ $,$ million
Boom $.$5 $-$ million
*hat is the pro>ectCs expected .0F2 its standard de1iation2 and its coeicient o
1ariation+
E(.0F) H $-.$ million
.0F H $,-.5 million
4F H :.@:#
38
CHAPTER TWELVE PROBLEMS
1. U%ic7 La%nch Roc7et 4ompany2 a satellite la%nching irm2 expects its sales to increase
by 5$ percent in the coming year as a res%lt o .(?(Cs recent problems "ith the space
sh%ttle. The irmCs c%rrent E0? is $-.,5. Its degree o operating le1erage is 1.52 "hile
its degree o inancial le1erage is ,.1. *hat is the irmCs pro>ected E0? or the coming
year %sing the =TL approach+
$ @.:1
,. ( irm expects to ha1e a 15 percent increase in sales o1er the coming year. I it has
operating le1erage e'%al to 1.,5 and inancial le1erage e'%al to -.52 then "hat "ill be
the percentage change in E0?+
55 percent
-. The 4ongress 4ompany has identiied t"o method o prod%cing playing cards. /ne
method in1ol1es a machine ha1ing a ixed cost o $1$2$$$ and 1ariable costs o $1.$$
per dec7 o cards. The other method "o%ld %se a less expensi1e machine (ixed costs
H $52$$$)2 b%t it "o%ld re'%ire greater 1ariable costs ($1.5$ per dec7 o cards). I the
selling price per dec7 o cards "ill be the same %nder each method2 at "hat le1el o
o%tp%t "ill the t"o methods prod%ce the same net operating income+
1$2$$$ dec7s
#. (ss%me that a irm c%rrently has EBIT o $,2$$$2$$$2 =TL o :.52 and =3L o 1.@:5. I
sales decline by ,$ percent next year2 then "hat "ill be the irmCs expected EBIT in one
year+
$#$$2$$$
5. (ss%me that a irm has a =3L o 1.,5. I sales increase by ,$ percent2 the irm "ill
experience a 5$ percent increase in E0?2 and it "ill ha1e an EBIT o $1$$2$$$. *hat
"ill be the EBIT or this irm i sales do not increase+
(ns"er8 $5:255@
5. 4alc%late the c%rrent price per share (0
$
) or /lson 4orporation2 gi1en the ollo"ing
inormation. The data all pertain to the year >%st ended.
?ales H 1$2$$$ %nits
?ales price per %nit H $1$.$$
Fariable cost per %nit H $ 5.$$
3ixed cost H $1$2$$$
=ebt o%tstanding H $152$$$
Interest rate on debt H 5 percent
Tax Rate H -$ percent
4ommon stoc7 shares o%tstanding H 1$2$$$ shares
Beta H 1.5
7
R3
H 5 percent
7
E
H 9 percent
0ayo%t ratio H #$ percent
Gro"th rate in earnings and di1idends H : percent
$ ,9.#-
39
:. ( company c%rrently has assets o $5 million. The irm is 1$$ percent e'%ity inanced.
The company c%rrently has net income o $1 million2 and it pays o%t #$ percent o its
net income as di1idends. Both net income and di1idends are expected to gro" at a
constant rate o 5 percent per year. There are ,$$2$$$ shares o stoc7 o%tstanding2
and it is estimated that the c%rrent cost o capital is 1-.#$ percent.
The company is considering a recapitaliDation "here it "ill iss%e $1 million in
debt and %se the proceeds to rep%rchase stoc7. In1estment ban7ers ha1e estimated
that i the company goes thro%gh "ith the plan2 its beore tax cost o debt "ill be 11
percent2 and the cost o e'%ity "ill rise to 1#.5 percent. The company has a #& percent
ederal&pl%s&state tax rate.
(. *hat is the c%rrent share price (beore recapitaliDation)+
$,5.$$
B. (ss%ming that the irm maintains the same payo%t ratio2 "hat "ill be its stoc7
price ollo"ing the recapitaliDation+
$,5.@1
@. The (4E *ine 4ompany o El 0aso prod%ces a pop%lar2 lo"&cost "ine. The irm has
ixed costs o $1$$2$$$ ann%ally and 1ariable costs per bottle o $-.$$. The di1ision
has $15$2$$$ in debt o%tstanding at an ann%al interest rate o 1, percent.
(. I the price per bottle is $:.$$2 "hat is the di1isionCs brea7e1en re1en%e+.
$ 1:52$$$
B. I the irm expects to sell 1$$2$$$ bottles2 at "hat price m%st it sell each bottle in
order to brea7 e1en+
$ #.$$
4. I the irm sells 5$2$$$ bottles at a price o $:.$$2 "hat is the irmCs degree o
operating le1erage+
,.$$
=. I the irm sells 5$2$$$ bottles at a price o $:.$$2 "hat is the irmCs degree o
inancial le1erage+
1.,,
E. *hat is the degree o total le1erage at this le1el o o%tp%t and sales price+
,.##
9. The irms AL and LL are identical except or their le1erage ratios and interest rates on
40
debt. Each has $,$ million in assets2 earned $# million beore interest and taxes in
,$$$2 and has a #$ percent ederal&pl%s&state tax rate. 3irm AL2 ho"e1er2 has a
le1erage ratio (=B() o 5$ percent and pays 1, percent interest on its debt2 "hereas LL
has a -$ percent le1erage ratio and pays only 1$ percent interest on its debt.
(. *hat is the ret%rn on e'%ity or each irm+
R/E or LL8 1#.5 percent
R/E or AL8 15.@ percent
B. I LL raises its debt ratio to 5$ percent and the interest rate on all o its debt
increases to 15 percent2 "hat "o%ld its ne" R/E be+
R/E or LL at 5$ percent =B(8 15.5 percent
1$. The <;R 4ompany man%act%res and sells only one prod%ct2 a "idget. The irm sells
e1ery %nit that it prod%ces or a sales price o $5.$$ a %nit. The irmCs 1ariable cost per
%nit is $,.$$2 and the ixed operating cost is $-$2$$$. <;R has c%rrent interest costs o
$152$$$ ann%ally and a marginal tax rate o #$ percent. I the irm prod%ces and sells
,$2$$$ %nits8
(. *hat is the irmCs brea7e1en '%antity and re1en%e+
1$2$$$ %nits and $5$2$$$
B. *hat is the irmCs degree o operating le1erage+
,.$
4. *hat is the irmCs degree o inancial le1erage+
,.$
=. *hat is the irmCs degree o total le1erage+
#.$$
11. ( gro%p o retired college proessors has decided to orm a small man%act%ring
41
corporation. The company "ill prod%ce a %ll line o traditional oice %nit%re. T"o
inancing plans ha1e been proposed by in1estors. 0lan ( is an all&e'%ity alternati1e.
Knder this agreement2 one million shares "ill be sold to net the irm $,$ per share.
0lan B in1ol1es the %se o inancial le1erage. ( debt iss%e "ith a ,$&year mat%rity "ill
be pri1ately placed. The debt iss%e "ill carry an interest rate o 1$ percent2 and the
principal borro"ed "ill amo%nt to $5 million. (ss%me a corporate tax rate o -#
percent.
(. 3ind the EBIT indierence le1el associate "ith the t"o inancing alternati1es.
$,2$$$2$$$
B. *hat is the E0? at this indierence le1el o EBIT+
$1.-,
4. The a1erage ann%al EBIT has been estimated at $-2$$$2$$$! "hat is the
expected E0? o each plan at this le1el o EBIT+ *hich plan sho%ld be selected+
0lan (8 $1.9@ 0lan B8 $-.#-
42
1,. 3o%r recent liberal arts grad%ates ha1e interested a gro%p o 1ent%re capitalists in
bac7ing a ne" enterprise. The proposed operation "o%ld consist o a series o retail
o%tlets to distrib%te and ser1ice a %ll line o 1ac%%m cleaners and accessories. These
stores "o%ld be located in Ao%ston2 =allas and ?an (ntonio. T"o inancing plans ha1e
been proposed by the grad%ates. 0lan ( is an all&common e'%ity str%ct%re. T"o
million dollars "o%ld be raised by selling @$2$$$ shares o common stoc7. 0lan B
"o%ld in1ol1e the %se o long&term debt inancing. /ne million dollars "o%ld be raised
mar7eting bonds "ith an eecti1e interest rate o 1, percent. Knder this alternati1e2
another million dollars "o%ld be raised by selling #$2$$$ shares o common stoc7.
*ith both plans2 then $, million is needed to la%nch the ne" irm)s operations. The
debt %nds raised %nder 0lan B are tho%ght to be part o the irm)s permanent capital
str%ct%re. (ss%me a -# percent marginal tax rate or the analysis.
(. 3ind the EBIT indierence le1el bet"een the t"o proposals.
$,#$2$$$
B. *hat is the E0? at this indierence le1el o EBIT+
$1.9@
4. The a1erage ann%al EBIT has been estimated at $5$$2$$$! "hat is the
expected E0? o each plan at this le1el o EBIT+ *hich plan sho%ld be
selected+
0lan (8 $#.1,5 0lan B8 $5.,:
1-. The *ingler 4orporation s%pplies headphones to airlines or %se "ith mo1ie and stereo
programs. The headphones %se the latest in electronic components and sell or $,@.@$
per set. This yearCs sales are expected to be #5$2$$$ %nits. Fariable prod%ction costs
or the expected sales %nder present prod%ction methods are estimated at
$1$2,$$2$$$2 and ixed prod%ction costs at present are $1255$2$$$. *ingler has
$#2@$$2$$$ o debt o%tstanding at an interest rate o @ percent. There are ,#$2$$$
shares o common stoc7 o%tstanding2 and there is no preerred stoc7. The di1idend
payo%t ratio is :$ percent2 *ingler is in the #$ percent ederal&pl%s&state tax brac7et.
The company is considering in1esting $:2,$$2$$$ in ne" e'%ipment. ?ales
"o%ld not increase2 b%t 1ariable costs per %nit "o%ld decline by ,$ percent. (lso2 ixed
operating costs "o%ld increase rom $1255$2$$$ to $12@$$2$$$. *ingler co%ld raise
the re'%ired capital by borro"ing $:2,$$2$$$ at 1$ percent or by selling ,#$2$$$
additional shares at $-$ per share.
(. *hat "o%ld be *inglerCs E0? %nder (1) the old prod%ction process! (,) %nder
the ne" process i it %ses debt2 and (-) the ne" process i it %ses e'%ity+
/ld8 $,.$# .e" debt8 $#.:# .e" e'%ity8 $-.,:
B. (t "hat %nit sales le1el "o%ld *ingler ha1e the same E0? i the ne" prod%ction
process is implemented+ *hat is the E0? at this le1el+
--92:5$ %nits and $1.@$
43
CHAPTER THIRTEEN PROBLEMS
1. 4ra1en 4orp. has retained earnings o $1.:5 million and 1$$2$$$ shares o stoc7
o%tstanding "ith a mar7et 1al%e o $,5 per share. I 4ra1en declares a 15 percent
stoc7 di1idend2 "hat "ill 4ra1enCs retained earnings be ater the di1idend+
$ 1.-:5 million
, ( company has a net income o $1$$ million and a policy o paying o%t 5$ percent o its
earnings in di1idends. Ao" m%ch total inancing can be accomplished beore the
company has to sell common stoc7+ (ss%me a debtBe'%ity ratio o 55.5 percent.
$ 55.55 million
-. (lton 4orp. has earnings o $1.5 million and a policy o paying o%t 5$ percent o
earnings. (lton has $1.@ million in acceptable in1estments b%t is %nable to iss%e ne"
e'%ity. (ss%ming a =BE o $.#2 ho" m%ch "ill (lton be able to spend on capital
b%dgeting i it "ishes to stic7 "ith the 5$ percent payo%t+
$ $.@# million
#. Beore a ,&or&1 stoc7 split2 =ean 4ompany sold or $5$ a share2 earning $15 and
paying $@ di1idend per share. (ter the split2 the di1idend per share becomes $5.,$. By
"hat percentage has the payo%t ratio risen+
-$6
5. B%tler 4orporation has declared a 1$ percent stoc7 di1idend. B%tler has , million
shares o%tstanding "ith a c%rrent mar7et price o $:. Its capital stoc7 acco%nt is $1
million2 and the irmCs retained earnings are $@ million. *hat balances "ill the retained
earnings and capital stoc7 acco%nts sho" ater the distrib%tion o the stoc7 di1idend+
4(0IT(L ?T/4M RET(I.E= E(R.I.G?
$ 121$$2$$$ $ 525$$2$$$
5. The ?herman ?teel 4ompany has an order bac7log o $5 million. It desires to expand
prod%ction capacity by ,$ percent2 "hich "ill in1ol1e a $15 million in1estment in plant
and e'%ipment. Eanagement desires to maintain #$ percent debt in its capital
str%ct%re. The di1idend policy has been to distrib%te ,5 percent o their ater&tax
earnings2 "hich this year "ere $5 million. I management "ishes to maintain its
di1idend policy2 ho" m%ch external e'%ity m%st the irm see7 at the beginning o the
year+
$ #25$$2$$$
:. /n Earch 152 the directors o Gl%t /il 4ompany met and declared the reg%lar di1idend
o #@ cents a share to holders o record on Earch -12 payment to made on Eay 15. /
the 1$$ shares o Gl%t /il yo% no" o"n2 ,5 shares at a time "ere p%rchased on each
o the ollo"ing dates8 Ian%ary 12 3ebr%ary 152 Earch 152 and (pril 1. *hat total
di1idends "ill yo% recei1e+ ((ss%me ex&di1idend o%r days prior to record date.)
$ -5.$$
44
@. *ilbert 4ompany expects next yearCs ater&tax income to be $1$ million. The irmCs
c%rrent debt&e'%ity ratio is 1$$ percent. I *ilbert has $1, million o proitable
in1estment opport%nities and "ishes to maintain its c%rrent debt ratio "ith no external
e'%ity inancing2 ho" m%ch sho%ld it pay o%t in di1idends next year+
$ #2$$$2$$$
9. Iacobs 4orporation earned $, million ater&tax. The irm has 1.5 million shares
o%tstanding. I IacobsC di1idend policy calls or a #$ percent payo%t ratio2 "hat are the
di1idends per share+
$ $.5$
1$. 4hampo%x Aair 3actory2 Inc. has earnings beore interest and taxes o $1$$2$$$.
(nn%al interest amo%nts to $#$2$$$2 and the ann%al depreciation is $#$2$$$. Taxes are
comp%ted at the #$ percent rate. Existing bond obligations re'%ire the payment o
$,$2$$$ into a sin7ing %nd. 4hampo%x "ishes to pay $1 per share di1idend on the
existing ,$2$$$ shares o%tstanding. The irmCs bond indent%re prohibits the payment o
di1idends %nless the cash lo" (beore tax and sin7ing %nd payments) is greater than
the total di1idend2 interest2 and sin7ing %nd obligations. *hat is the maxim%m di1idend
per share that 4hampeo%x can pay+
$ $.@$
11. /ne share o Fan Aorn =istrib%tors2 Inc. has a mar7et price o $1,$. The irm lists the
ollo"ing on its ann%al report (dollars in tho%sands)8
4ommon ?toc72 $,.5$ par!
a%thoriDed2 52$$$2$$$ shares!
iss%ed and o%tstanding2 #2$$$2$$$ shares $ 1$2$$$
(dditional 0aid&In 4apital -2$$$
Retained Earnings 5$2$$$
(. The irm is considering a 5&or&1 stoc7 split. *hich o the ollo"ing "o%ld be
expected+
(pproximate
0ar Fal%e ?hares Iss%ed Ear7et 0rice
$ $.5$ ,$2$$$2$$$ $ ,#.$$
B. *hat "o%ld the balances in the e'%ity acco%nts be i the irm iss%ed a one
percent stoc7 di1idend+
4ommon (dditional Retained
?toc7 0aid&In Earnings
$ 1$21$$ $ :2:$$ $ #52,$$
45
1,. (ber"ald Aeating2 Inc. has a six&month bac7log o orders or its patented solar heating
system. Eanagement plans to expand prod%ction capacity by 5$ percent2 "ith an $1,
million in1estment in plant machinery2 to meet this demand. The irm "ants to maintain
a -$ percent debt&to&asset ratio in its capital str%ct%re! it also "ants to maintain its past
di1idend policy o distrib%ting -$ percent o last yearCs ater&tax earnings. In 199$2
ater&tax earnings "ere $, million.
(. I the irm has 12$$$2$$$ shares o%tstanding2 "hat "ill be the irmCs di1idends
per share (=0?) i it contin%es the c%rrent policy+
$ $.5$
B. *hat "o%ld the di1idend per share be i the irm employs the resid%al theory o
di1idends+ (ss%me 1 million shares o%tstanding.
$ $.$$
4. I (ber"ald is to meet both capital %nding and di1idend re'%irements2 ho"
m%ch external %nding "ill be re'%ired+
$ :2$$$2$$$
1-. Iacobs 4orporation earned $, million in ater&tax net income last '%arter. The irm has
1.5 million shares o%tstanding. I IacobsC di1idend policy calls or a #$ percent payo%t
ratio2 "hat are the di1idends per share+
$$.5$ per share
1#. Eaxi&Trac7Cs proit margin and sales are expected to be 1$ percent and $5$ million2
respecti1ely2 or the %pcoming '%arter. The irmCs traditional payo%t ratio is #$ percent
o net income. =%e to mar7et conditions2 the irm does not "ish to raise any ne" e'%ity
at this time. Eaxi&Trac7Cs optimal capital str%ct%re contains #$ percent debtB5$ percent
e'%ity.
(. *hat is the irmCs expected net income+
$52$$$2$$$
B. *hat is the irmCs expected le1el o retained earnings+
$-2$$$2$$$
4. *hat is the largest capital b%dget that Eaxi&Trac7 select "itho%t changing the
irmCs payo%t policy or capital str%ct%re "eights+
$52$$$2$$$
46