FV FV of Annuity PV of Annuity PV of Annuity Due PV of Unev Seri of Pym Terminal Value Effective Annual Rate Continuous Discounting Perpetuity

Bond

FVn=PV[1+k]n; PVIFk,n=1/FVIFk,n n PV=FV[1/1+k] FVA=[(1+k)nFV of Annuity Due FVAad= PMT(FVIFAk,n) 1]/k=PMT[FVIFAk,n] (1+k) PVAn=PMT[(1+k)n=PMT[1/k - 1/(k(1+k)n)]=PMT[PVIFAk,n] n] 1)/k(1+k) PVAn=PMT*[PVIFAk,n] (1+k) Sum of the PVs of the individual components of the stream. TVn =PMT*[1+k]n EAR=APY=(1+knom/m)m 1; FVn=PV(1+knom/ FVn=PV(ekn); e=2.7183 n FVn=PV(1+k) m)m*n kn -kn PVn=FVn/e =FVn (e ) PV=CF/r; Growing PV=CF0 (1+g)/(1Inflation: Perpetuity g)=CF1/(r-g); 1+rreal=1+rnominal/1+I Vb=INT[1/rd - 1/rd(1+rd)N] INT=cupn Vb=INT/2[2/rd - 2/rd(1+rd/2)2N] + M/ + M/(1+rd)N rate*M (1+rd/2)2N P0=Div / r P0=Div0(1+g)/(rscondition rs>g; P0=Div/rs P0=Div1/(rs-g) if g constant g)=Div1/(rs-g) if g=0 Horizon (Terminal) Value=PN=DN+1/(rs-g)=DN(1+g)/rs-g

Preferred Stock Valuing const grw stok Valu non-const grw stok Stok val by FCF V=FCF (1+g)/(WACC-g) Growth Rate=F(retaining Aprch earnings)=ROE*retention rate D-1: Equipment Purchase:Equipment 8,000,000+Delivery 300,000+Installation, fit-up 100,000=Total 8,400,000; Computation of tax on gain: Sale price 700,000- book value 504,000(Total-sumOfDeprec)=Gain/(loss)196,000*%40=TaxDecrease/(increase)(78,400); Equipment Disposition:Sale proceeds 700,000+Tax impact (78,400)=Net proceeds 621,600 Period 0 1 2 3 4 5 Revenues Units Sold 150,000 200,000 300,000 300,000 100,000 Price Inflation -1.0% -1.0% -1.0% -1.0% Price 75.00 74.25 73.51 72.77 72.04 Revenues 11,250,00 14,850,0 22,052,25 21,831,7 7,204,470 0 00 0 28 Production Cost Cost Inflation/production 2.0% 2.0% 2.0% 2.0% cost grows Unit Cost 55.00 56.10 57.22 58.37 59.53 Total Production 8,250,000 11,220,0 17,166,60 17,509,9 5,953,377 Costs 00 0 32 Operating Cash Flows Revenues 11,250,00 14,850,0 22,052,25 21,831,7 7,204,470 (Declining 1%) 0 00 0 28 (Variable (8,250,000 (11,220, (17,166,60 (17,509, (5,953,377) (Growing at 2%) Expense) ) 000) 0) 932) (Rent) (500,000) (500,000 (500,000) (500,000 (500,000) ) ) (Depreciation*) (1,680,000 (2,688,0 (1,596,000 (1,008,0 (924,000) ) 00) ) 00) Earnings before tax 820,000 442,000 2,789,650 2,813,79 (172,907) 6 (Tax at 40%) (328,000) (176,800 (1,115,860 (1,125,5 69,163 ) ) 18) After-tax earnings 492,000 265,200 1,673,790 1,688,27 (103,744) 7 Plus 1,680,000 2,688,00 1,596,000 1,008,00 924,000

Depreciation 0 0 Operating Cash 2,172,000 2,953,20 3,269,790 2,696,27 820,256 Flow 0 7 Non-operating Cash Flows (Equipment) (8,400,00 621,600 0) (Change in (300,000) (50,000) (50,000) 0 100,000 300,000 working capital**) TOTAL CASH FLOW (8,700,00 2,122,000 2,903,20 3,269,790 2,796,27 1,741,856 0) 0 7 PVIF @14.0% 1.0000 0.8772 0.7695 0.6750 0.5921 0.5194 PV (8,700,00 1,861,404 2,233,91 2,207,015 1,655,62 904,665 0) 8 1 NPV 162,623 * Basesd on MACRS 0.20 0.32 0.19 0.12 0.11 percentags: ** Working capitall 300,000 350,000 400,000 400,000 300,000 0 balance

D-3:(Standalone risk and return) E(r)=SUM{p(recession,average,boom)*r};2=SUM{p*[rE(r)]2};=2;A:preferred to C and B(higher return,lower cost);B,C:C has higher return and higher risk to B; depends on people perception of risk and return; D-4:(Protfolio risk and return) Portfolio:E(r)=SUM{p(recession,average,boom)*rA(1/3)+rB(1/3)+rC(1/3)}; 2=SUM{p*[(rA(1/3)+rB(1/3)+rC(1/3))-E(r)]2}; =2; STOCKA,B:COV=SUM{p(recession,average,boom)*[rA-E(rA)]*[rB-E(rB)]} D-5:(Beta and required return: according to CAPM) r=rRF+ [rM-rRF];c)The market risk premium is the extra return or reward which investors require in order to invest in stocks rather than risk-free investments. It is measured as the difference between the risk-free rate and the return which investors expect on the overall market. Currently it is 5 percentage points (the expected market return of 10% minus the risk free rate of 5%) If investors required a higher market risk premium such that the expected return on the market increased to 12% (which is the equivalent of saying that the market risk premium increased to 7 percentage points), the required return on the companys stock would be;d)If expected inflation increased by 1percent point, you would expect the risk-free rate to inc by the same amt. Assuming the mrkt risk premium didnt change, the exp return on the market would also inc by 1percent point (since it is based on the risk-free rate) and the cos required return would inc by 1perc point D-6(Beta;Evaluating a stock) STOCK:E(r)=SUM{p(recession,average growth,high, boom)*rSTOCK};2=SUM{p*[r-E(r)]2}; =2; Mrkt: SUM{p*rM};2=SUM{p*[rE(r)]2};=2;COVSTOK,M=SUM{p*[rSTOK-E(rSTOK)][rM-E(rM)]}; =COVSTOK,M/2M; r=rRF+ [rM-rRF]; E(r)<r:Reject D-7:(HistAndAdj ) ADJUSTED =.67( HISTORICAL)+.35(1.00);The rationale for calculating an adjusted beta is that research indicates betas tend to move toward 1 over time;an adjusted beta takes this tendency into account and is a better indicator of a companys future beta. r=rRF+ [rM-rRF]:valueLineMethod; (c) Co As beta reflects the betas of its component businesses; it is a weighted average of the betas of those businesses. If the company sells one of its component businesses, its beta will be the beta of the remaining busine. For example, half of the company might be in a business with a beta of 1.49 and the other half might be in a business with a beta of 1.09, yielding a weighted average of 1.29. If the company sold the business with a beta of 1.09, its beta would be that of the remaining business (1.49). The change in the companys beta would lead to a change in stock investors required return for the company. D-8(FrwrdLook ;Eval stok Inv)MRKT:r=SUM{p(resession,normal growth,high,boom)*r};2=SUM{p*[r-r]2};=2;CO:r=SUM{ p(resession,normal growth,high,boom)*r};2=SUM{p*[r-r]2};=2;Beta:COVCO,M=SUM{p*[rM-rM][rXYZ-

rXYZ]}; CO=COVCO,M/2M; r=rRF+ [rM-rRF]; r(exp return) > r (reqd return); >1 return react more strongly to changes in market (economic growth, interest rate) D-9:( of protfolio) =wSTOCK1 STOCK1+wSTOCK2 STOCK2+wSTOCK3 STOCK3+wSTOCK4 STOCK4;r=rRF+ [rMrRF]; D-10:(portfolio s & change in port holding) =wSTOCK1 STOCK1+wSTOCK2 STOCK2+wSTOCK3 STOCK3; D-11(changes in )rSTOCK=2*rM=> =2;r=rRF+ [rM-rRF];r=risk adj disc rate for CF; CO= %OldCo* OLD+%NewPlant* NEW PLANT; D-12:( & stock price)STOK:E(r)=SUM{p(low growth, normal, high, boom)*rSTOK};2=SUM{p*[r-r]2};=2;Mrkt:SUM{p*rM}; 2=SUM{p*[rr]2};=2;COVCO,M=SUM{p*[rM-rM][rXYZ-rXYZ]}; CO=COVCO,M/2M;r=rRF+ [rMrRF];PSP=P0=[DIV0(1+g)]/(r-g); D-13:( ; Eval a stock)MRKT:r=SUM{p(good,fair,poor)*r};2=SUM{p*[rr]2};=2;CO:r=SUM{p(good,fair,poor)*r};2=SUM{p* [r-r]2}; =2;Beta:COVCO,M=SUM{p*[rM-rM][rXYZ-rXYZ]}; CO=COVCO,M/2M;r=rRF+ [rMrRF];r(expected)<r(required) notOKInvest D-14:( & stock price)r=rRF+ [rM-rRF];PSP=P0=[div0(1+g)]/(r-g);NPV table by years (DONOT take the 0 year value); for values after 3rd year calculate horizon terminal value @ year 3: P3=[DIV3(1+g)]/(r-g); P/E D-15:(Evaluating returns)r=rRF+ [rMrRF];r<r=>Undervalued;r>r=>overvalued;r=r=>properly valued D-16:(WACC)Bonds:P=INT/2[2/rd - 2/rd(1+rd/2)2N] +M/ (1+rd/2)2N;PreferredStock:P0=Div/r;CS:rS=rRF+ [rM-rRF];PSP=P0=DIV0(1+g) /(r-g); Calculate Co capital structure and %ofTotal for each structure; rWACC=wSTDrSTD(1-T)+ wDrD(1-T)+ wPSrPS+wSrS; D-17:(WACC)allStok:rWACC=rS=rRF+ [rM-rRF];Bonds:P=INT/2[2/rd-2/rd(1+rd/2)2N]+M/ (1+rd/2)2N;PreferredStock:P0=Div/r;CS: rS=rRF+ [rM-rRF];Cos capital structure:STD,Bonds,PS,CS and %ofTotal for each structure;rWACC=wSTDrSTD(1-T)+wDrD(1-T)+ wPSrPS+wSrS; beta declined low business risk, high finance risk, added debt D-18:(WACC)Bonds:P=INT/2[2/rd-2/rd(1+rd/2)2N]+M/ (1+rd/2)2N;PreferredStock:P0=Div/r;CS:rS=rRF+ [rM-rRF];PSP=P0=DIV0(1+g)/(r-g);Calculate Co capital structure and %ofTotal for each structure; rWACC=wSTDrSTD(1-T)+ wDrD(1-T)+wPSrPS+ wSrS;Assets: VL= EBIT(1T)/rWACC,L;Liabilities/Equity:VSTD=CFSTD/rSTD;VD=CFD/rD;VPS=CFPS/rPS;VS=CFS/rSL;EBITinterest=taxableInc-tax= NetIncome-preferredDividents=Available to common shareholders; D-19:(CostOfCapital-EstimateCostOfEquity)a)using CAPM rS=rRF+ [rM-rRF];The assumptions in the CAPM are the companys beta and the market risk premium; the risk free rate is observable(b)divid discount model P0=DIV0(1+g)/(r-g); The main assumption in using this model is that the growth rate estimated by analysts is the growth rate which investors are using to value the stock. (There is also the implicit assumption that the stock is fairly valued by the market.)(c)The first step would be to revisit the assumptions in each model. When that doesnt resolve most of the difference, companies use judgment in deciding on a required return. Sometimes they average the differing results. D-20:(CC-multipleBusinesses)for each division calculate rS and rWACC;Value=EBIT(1T)/rWACC;TV=V1+V2+V3; CO= wDIV1 DIV1+ wDIV2 DIV2+wDIV3 DIV3; rS=rRF+ [rMrRF];rWACC=rS=wDrD(1-T)+wSrS;V=SUM{allEBITs}(1-T)/rWACC;EBIT=perpetual pretax cash flow= market value; D-21:(CC-multipleBusinesses) for each division calculate rS and rWACC;Value=EBIT(1T)/rWACC;TV=V1+V2+V3; CO=wDIV1 DIV1+ wDIV2 DIV2+wDIV3 DIV3; rS=rRF+ [rM-rRF];rWACC=wDrD(1-T) +wSrS;V=SUM{allEBITs}(1-T)/rWACC;EBIT=perpetual pretax cash flow= market value; D-22:(CC-newProducts)rS=rRF+ [rM-rRF];rWACC=wDrD(1-T)+wSrS;V=EBIT(1-T)/rWACC;for each product calculate rS and rWACC;Value= EBIT(1-T)/rWACC;NPV= -Cost+Value;

V=V1+V2+V3; CO=wOLD OLD+wPROD1 PROD1+wPROD2 PROD2; rS=rRF+ [rM-rRF];rWACC=wDrD(1-T)+wSrS; V=SUM{EBIT1+EBIT2+EBIT3}(1-T)/rWACC; D-23:(CC-multipleBusinesses) CO=wDIVA DIVA+wDIVB DIVB+wDIVC DIVC; rS=kRF+ [rM-rRF]; (b) For capital budgeting, the company should use required returns or discount rates that reflect the risk of each capital budgeting proposal. It should only use the 11.25% required return calculated in (a) for proposals with betas of 1.25. Generally, proposals in division A will be held to relatively higher required rates of return, with lower required returns in divisions B and C. D-24:(CC-aquisition)rS=rRF+ [rM-rRF]; CO=wOLD OLD+wAQUISITION AQUISITION;rS=rRF+ [rM-rRF]; D-25: (CCValue-acquisition)rS=rRF+ [rM-rRF];V=EBIT(1-T)/rWACC;TV=VOLD+VACQUISITION; CO=wOLD OLD+wAQUISITION ACQUISITION= (VOLD/TV) OLD+ ( VACQUISITION/TV) ACQUISITION;rS=rWACC=rRF+ [rM-rRF];V=SUM{EBIT1+EBIT2}(1-T)/rWACC; D-26:(CCV-stockDebt)rS=rRF+ [rM-rRF]; rWACC=wDrD(1-T)+wSrS;V=EBIT(1T)/rWACC;TV=VCO+VAQ; CO=wOLD OLD+wAQUISITION ACQUISITION= [VCO//VT]* OLD+[VAQ/VT]* ACQUISITION; rS=rRF+ [rM-rRF]; rWACC=wDrD (1-T)+wSrS;V=SUM{EBITOLD+EBITAQU}(1-T)/rWACC; D-27:(CC-newProductLineBusiness) CO=wOLD OLD+wNEWDIVISION NEWDIVISION; rS=rRF+ [rM-rRF]; (d) If the company uses its overall required rate of return (13.2%) to evaluate capital budgeting proposals:(1) It will not undertake software business capital budgeting proposals even if they meet the appropriate risk-based required return of 12%. (2) It will undertake internet access capital budgeting proposals even if they fall short of the appropriate riskbased required return for the internet business of 15.6%. (3) Over time, the company will invest only in higher risk projects. Some of these higher risk projects will earn a lower return than they should (e.g., an internet capital budgeting proposal promising a return of 14% would be accepted even though investors would want the company to earn 15.6% on such a project). Thus the companys risk (and its ) will increase and its returns will increasingly fall short of the returns that investors will expect based on its risk. D-28:(CC-newProduct) (a) We are given the companys overall weighted average cost of capital, its cost of debt, and the information needed to calculate the required return for the companys stock. First, calculate the cost of stock:rS=rRF+ [rM-rRF];Giventhis information, we can determine the companys capital structure:rWACC=wDrD(1-T)+wSrS =wDrD(1-T)+(1-wD)rS; The company is financed 50% by debt, 50% by stock.Calc rS&rWACC forEachProduct;We will now want to find the NPV for each product. Note that the cash flows for each product are level cash flows for a given period, so the products can be treated as annuities:PV=PV{CF}=AMT[1/r-1/(r(1+r)n)];NPV=-Cost+PV; Note that the value of the products, i.e., what they are worth, is the present value of their future cash flows, not their net present values. Net present value is the difference between what something is worth (the present value of its cash flows) and its cost:TV=VOLD+PV1+PV2+PV3; =wO O+wA A+wB B+wC C=(VO/TV) O+ (VA/TV) A+(VB/TV) B +(VC/TV) C;PVvsNPV; beta is lower; D-29:(CC-newProduct) The firms cost of capital is equal to its cost of stock: The firms cost of capital is equal to its cost of stock:rWACC =rS=rRF+ [rM-rRF]; The value of the company is the present value of its after-tax operating cash flows [EBIT(1-T)], which are assumed to be a perpetuity:V=EBIT(1-T)/rWACC;rWACC=rS=rRF+ [kM-kRF] forEachProd;PV=PV{CF}=EBIT(1-T)/rWACC NPV= -Cost+PV; Note that the value of the products, i.e., what they are worth, is the present value of their future cash flows, not their net present values. Net present value is the difference between what something is worth (the present value of its cash flows) and its cost. The value of the three new products (the present value of their cash flows) is 1,500,000 plus 1,500,000 plus 1,500,000 for a total of 4,500,000; Cos is weighted average of of comp; =wO O+wA A+wB B+wC C D-30:(CC-newProduct)Before it takes on any new products, the firms cost of capital is equal to its cost of stock: rWACC=rS=rRF+ [rM-rRF];The value of the company is the present value of its after-tax operating cash flows [EBIT(1-T)],which are assumed to be a perpetuity:V=EBIT(1-T)/rWACC;rWACC=rS forEachProd; We will now want to find the NPV for each

product. Note that the cash flows for each product are level cash flows for a given period, so the products can be treated as annuities: PV=PV{FutCF} =Annuity*PVIFA =AMT[1/r-1/(r (1+r)n)];NPV= -Cost+PV; with NPV>=0 yesUndertake;TV=VOLD+VA+VB; PricPerShare=(TVdebt)/ #Shares; Note that the value of the products, i.e., what they are worth, is the present value of their future cash flows, not their net present values. Net present value is the difference between what something is worth (the present value of its cash flows) and its cost. D-31:(Value Priv Held Co)table discounting CF by rWACC (0-5 years; CF at year 0 discarded); terminal value=VOps5=CF5(1+g)/r-g= CF6/r-g;TotValOfOps+marketableSec.+InvInOtherCoDebt-Preferred=ValOfStok/NumShares=PricePerShare D-32:(Co Val; treatmOfWorkCap&otherBalSheetAcc)VOps=FCF0(1+g)/rWACC-g=FCF1/rWACCg; The value of the company would be VOps (1,260 million) plus marketable securities (50 million) or 1,310 million. (Other than the marketable securities, the co doesnt appear to have any assets whose value would be added to the VOps, such as ownership of stock in another co.b)The total value of the companys stock would be equal to the value of the company (1,310mill) minus short-term debt/notes payable (75 million), long-term debt (200 million) and preferred stock (20 million): 1,3107520020=1,015.The value per share would be this amount divided by the number of shares (10mill): 1,015 / 10 = 101.50. (Note that the value of net working capital is captured in the Value of Operations (VOps). The components of net working capital are cash, accounts receivable, inventories, accounts payable and accrued expenses. Since these items are captured in VOps, the working capital assets are not added to VOps in determining the companys total value, and the working capital liabilities are not subtracted in determining the value of the stock.) D-33:(Cap Struct:w/&w/o tax)rWACC=rSU=rRF+ U[rM-rRF];VU=EBIT(1-T)/rWACC;VU=EBIT(1T)/rWACC;VL=VU+TD;VSL=VL-D;rSL=rSU+D/ S(1-T)(rSU-rD);rWACC,L=wDrD(1-T)+wSrSL;rSU=rRF+ U[rMrRF];VL=VU+TD;VSL=VL-D;rSL=rSU+D/S(1-T)(rSU-rD);rWACC,L=wDrD(1-T)+wSrSL; D-34:(Cap struct: varyingLevOfDebt)(a)If there are no corporate taxes, the Modigliani Miller model predicts that cap structure will have no impact on the value of a company or the price of its stock;rWACC=rSU=rRF+ U[rM-rRF];VU=EBIT(1-T)/rWACC; VL=VU+TD; VSL=VL-D; rSL=rSU+D/S(1-T)(rSU-rD); rWACC,L= wDrD(1-T)+wSrS;VL=VU+TD;VSL=VL-D;rSL=rSU+D/S(1-T)(rSUrD);rWACC,L=wDrD(1-T) +wSrSL;c)If there is a corporate tax and interest is tax deductible, using debt will increase the value of the company and the price of its stock. The company value will increase by a factor of TD, the tax rate times the amount of debt. D-35:(Cap struct caoncepts & extensions)(a)Assuming corporate taxes only (i.e., no personal taxes or financial distress costs), the Modigliani Miller model indicates that a company should use as much debt as possible. Its value increases by a factor of TD as the amount of debt increases.(b)No. At 100% debt, the bondholders would own the company and bear the full risk of the companys earnings stream (i.e., they would be shareholders). (c)(i)The relative levels of personal tax rates on stock income versus debt income would affect the benefit a company derives from borrowing. See discussion of the Miller model in the text. (ii)This would decrease the benefit a company derives from the use of debt at higher levels of borrowing. See discussion in the text.(iii)Investors would take into account the expected value of financial distress costs (i.e., estimated distress costs weighted by their probability) and reduce the value they attribute to the firm by this amount. See discussion in the text. D-36:(Beta L&U) L= u[1+D/S *(1-T) ]; D-37:(Reqd ret on stok: L&U)rS=rRF+ [rM-rRF]; L= u[1+D/S(1-T)];rS=rRF+ L[rMrRF];rSL=rSU+D/S(1-T)(rSU-rD);(Modigliani Miller proposition 2) D-38:(Beta L&U resulting CC) L= u[1+D/S(1-T)];rWACC=rS=rRF+ [rM-rRF]; L= u[1+D/S(1T)];rS=rRF+ [rM-rRF];rWACC,L=wDrD(1-T)+wSrSL; D-39:(Beta L&U: resulting CC) L= u[1+D/S(1-T)];rL=rRF+ L[rM-rRF];rWACC,L=wDrD(1-T)+wSrSL; rD=rRF, rSL=rL;

D-40:(Miller Model)a)With corporate taxes but no personal taxes:VL=VU+TD.The increase in company value from the use of debt is TD,or .4(50mill)=20mill. All of this increase will go to shareholders. (b) Use the Miller model, where TC is the corporate tax rate, TS is the tax rate investors pay on stock income and TD is the tax rate investors pay on bond income: VL=VU+[1-((1-TC)(1-TS))/(1-TD)]D;TC-taxRate;TS-stockIncomeTaxRate;TDbondIncomeTaxRate;Because the personal tax rate on stock income is less than that on bond income, the increase in value is lower (31.4% of the value of the debt versus 40% in part (a)). All of the increase in value will go to shareholders.c)Because the personal tax rate on stock income is the same as that on bond income, the increase in value is equal to . 4(50mill) or TD.When the personal tax rates are the same, the original Modigliani Miller proposition I applies. D-41:(CapStruct MrktVal BalSheet NewProdImpact)rWACC,U=rSU=rRF+ U[rM-rRF];VU=EBIT(1T)/rWACC;VL=VU+TD;VSL=VL-D;rSL=rSU+D/S (1-T)(rSU-rD);rWACC,L=wDrD(1-T) +wSrSLASSET:U:VU=EBIT(1-T)/rWACC,UL:VL=EBIT(1-T)/rWACC,LLIABILITIES/ EQUITY:U:VD=NO;VS=CFS /rSU=(EBIT-I)(1-T)/rSUL:VD=CFD/rD=I/rD;VS=CFS/rSU=(EBIT-I)(1T)/rSU;;rWACC=rSU=rRF+ U[rM-rRF]; VPROD=EBIT(1-T)/rWACC;NPV=PV(Cost)+ PV(Benefits);rSL=rSU+D/S(1-T)(rSU-rD);rWACC,L=wDrD(1-T)+wSrSL;VPROD=EBIT(1T) /rWACC;NPV=PV(Cost)+PV(Benefits);OR L= U[1+D/S(1-T)];rSL=rRF+ U[rMrRF];;rWACC=rSU=rRF+ U[rM-rRF];VU=EBIT(1-T) /rWACC;VL=VU+TD=VU+0D;VSL=VLD;;rWACC=rSU;rWACC,L=wDrD(1-T)+wSrSL D-42:(Lvs.U CC) Start byFinding the mrkt val of each of the cos outstanding securities:Bonds:PS:CS:r=rRF+ [rM-rRF]; P0=Div0 (1+g)/(rs-g); rWACC= wSTDrSTD(1-T)+wDrD(1-T) +wPSrPS+wSrS;rSL=rSU+D/S (1-T)(rSU-rD);OR L= U[1+D/S (1-T)]; rSU=rRF+ U[rM-rRF]; D-43:(Recapitalization)rWACC=rSU=rRF+ U[rM-rRF];VU=EBIT(1T)/rWACC;Pstock=VU/#shares;VL=VU+TD;Pstok=VL/#shares; shares2purch= purchAmt / priceFromB; shareOutstanding=total-shares2purch; Pstok= (VLpurchAmt) / shareOutstanding D-44:(Residual distribution amt)Since the company intends to maintain its target capital structure of 30% debt and 70% stock, it will finance 30% of the cost of the investment opportunities (30 million) by issuing debt and 70% (70 million) with stockholder funds. Although the total cost of the investment opportunities exceeds expected earnings, the company can undertake all of the opportunities because they will be partly funded by debt. (In addition, if earnings were less than the required stockholder funds, the company could issue new stock.) Since the company expects after-tax earnings available to shareholders to be 85 million, it will retain 70 million of earnings and pay out 15 million to shareholders via dividends and/or repurchase. D-45: (Cap budget & residual distr amt)(a) The capital budget should include those opportunities which have a net present value of 0 or greater, which is equivalent to saying an IRR equal to or greater than the cost of capital. New products 1 and 2 and the existing product expansion meet this criterion. New product 3 promises a high return but one which is less than its risk-adjusted cost of capital; the geographic expansion also falls short of its cost of capital. The capital budget will be 10 million (new product 1) + 5 million (new product 2) + 8 million (existing product expansion) = 23 million. (b) Assuming the company intends to maintain its target capital structure of 30% debt and 70% stock, it will finance 30% of the cost of the investment opportunities (6.9 million) by issuing debt and it will fund 70% (16.1 million) with stockholder funds. The company will retain 16.1 of the expected after-tax earnings available to common shareholders and pay out the rest (3.9 million) via dividends and/or repurchase.

Period Revenues Units Sold Price Inflation Price Revenues Production Costs Cost Inflation Unit Cost Total Production Costs Operating Cash Flows Revenues Variable expense Depreciation* Earnings before tax Tax at40% After-tax earnings Plus Depreciation Operating Cash Flow Non-operating Cash Flows Equipment Change in working capital TOTAL CASH FLOW PVIF@14.0% PV NPV

1 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000

2 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000

3 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000

4 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000 ) (6,000) 5,000 (2,000) 3,000 6,000 9,000

5 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000

6 20,000 0.0% 1.55 31,000 0.0% 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000

7 20,000 1.55 31,000 1.00 20,000 31,000 (20,000) (6,000) 5,000 (2,000) 3,000 6,000 9,000 0

(42,000 ) 0 (42,000 ) 1.0000 (42,000 ) (3,405)

0 9,000 0.8772 7,895

0 9,000 0.7695 6,925

0 9,000 0.6750 6,075

0 9,000 0.5921 5,329

0 9,000 0.5194 4,674

0 9,000 0.4556 4,100

0 9,000 0.3996 3,597