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Essentials of Corporate Finance

Essentials of Corporate Finance. Ross Westerfield Jordan. Third Edition. Problem List Click on a Problem number to jump to the slide. Click on Return to Problem List to select a different Problem. Chapter 13 Problem 1 Problem 9 Problem 10 Problem 15. Chapter 14 Problem 3 Problem 6

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Essentials of Corporate Finance

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  1. Essentials of Corporate Finance Ross Westerfield Jordan Third Edition

  2. Problem ListClick on a Problem number to jump to the slide. Click on Return to Problem List to select a different Problem. Chapter 13 Problem 1 Problem 9 Problem 10 Problem 15 Chapter 14 Problem 3 Problem 6 Problem 13 Problem 16 Chapter 15 Problem 1 Problem 2 Problem 3 Problem 4 Chapter 16 Problem 5 Problem 7 Problem 9 Problem 10 Chapter 17 Problem 4 Problem 6 Problem 11 Problem 16 Chapter 18 Problem 2 Problem 7 Problem 8 Problem 11

  3. Chapter 13 Leverage and Capital Structure

  4. Problem 13-1 Big Apple, Inc., has no debt outstanding and a total market value of $80,000. Earnings before interest and taxes, EBIT, are projected to be $10,000 if economic conditions are normal. If there is a strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 60 percent lower. Big Apple is considering a $35,000 debt issue with a 5 percent interest rate. There are currently 4,000 shares outstanding. The proceeds will be used to repurchases shares of stock. Ignore taxes for this problem.

  5. a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS when the economy expands or enters a recession. b. Repeat part (a) assuming that Big Apple goes through with the recapitalization. What do you observe.

  6. a.

  7. b.MV $80,000/4,000 shares = $20 per share $35,000/$20 = 1,750 shares bought back Return to Problem List

  8. Problem 13-9 Buffett Enterprises is considering a change from its current capital structure. Buffett currently has an all equity capital structure and is considering a capital structure with 30 percent debt. There are currently 1,000 shares outstanding at a price per share of $120. EBIT is expected to remain constant at $19,000. The interest rate on new debt is 8% and there are no taxes.

  9. a. Rebecca owns $12,000 worth of stock in the company. If the firm has a 100 percent payout ratio what is her cash flow? b. What would her cash flow be under the new capital structure assuming that she keeps all of her shares? c. Suppose that the company does convert to the new capital structure. Show how Rebecca can maintain her current cash flow. d. Under you answer to part (c), explain why Buffett’s choice of capital structure is irrelevant.

  10. a. EPS = $19,000 / 1,000 = $19.00 Rebecca’s cash flow = $19.00(100 shares) = $19,000 b. V = $120(1,000) = $120,000 D = .30($120,000) = $36,000 $36,000 / $120 = 300 shares are repurchased NI = $19,000 – .30($36,000) = $16,120 EPS = $16,120 / 700 = $23.03 Rebecca’s cash flow = $23.03(100) = $2,303

  11. c. Sell 30 shares of stock and lend the proceeds at 8% Interest cash flow = 30($120)(.08) = $288 Cash flow from stock = 70($23.02) = $1,612 Total cash flow = $1,612 + 288 = $1,900 d. The capital structure is irrelevant because shareholders can create their own leverage or unlever the stock to create the payoff they desire, regardless of the capital structure the firm actually chooses. Return to Problem List

  12. Problem 13-10 Angstrom Corp. uses no debt. The weighted average cost of capital is 14 percent. The current market value of the company is $30 million. The corporate tax rate is 40 percent. What is the value of the company if Angstrom converts to a debt-equity ratio of 1? What if the debt-equity ratio is 2?

  13. D/E = 1 implies 50% debt: VL = VU + TCD = $30,000,000 + .40($15,000,000) = $36,000,000 D/E = 6 implies 67% debt: VL = VU + TCD = $30,000,000 + .40($20,000,000) = $38,000,000 Return to Problem List

  14. Problem 13-15 Diamond Co. has a 38 percent tax rate. Its total interest payment for the year just ended was $42 million. What is the interest tax shield. How do you interpret this amount? Interest tax shield = $42,000,000(.38) = $15,960,000 The interest tax shield represents the tax savings in current income due to the deductibility of a firm’s qualified debt expenses. Return to Problem List

  15. Chapter 14 Dividends and Dividend Policy

  16. Problem 14-3 What If, Inc., has declared a $3.00 per share dividend. Suppose capital gains are not taxed, but dividends are taxed at 34 percent. New IRS regulations require that taxes be withheld at the time the dividend is paid. What If sells for $70 per share, and the stock is about to go ex-dividend. What do you think the ex-dividend price will be? Aftertax dividend = $3.00(1 – .34) = $1.98 Ex-dividend price = $70.00 – 1.98 = $68.02 Return to Problem List

  17. Problem 14-6 Bermuda Triangle Corporation (BTC) currently has 300,000 shares of stock outstanding that sell for $80 per share. Assuming no market imperfections or tax effects exist, what will the share price be after: a. BTC has a five-for-three stock split? b. BTC has a 15 percent stock dividend? c. BTC has a 42.5 percent stock dividend? d. BTC has a four-for-seven reverse stock split? e. Determine the number of shares outstanding in parts (a) through (d).

  18. a. $80(3/5) = $48.00 b. $80(1/1.15) = $69.57 c. $80(1/1.425) = $56.14 d. $80(7/4) = $140.00 e. 300,000(5/3) = 500,000 300,000(1.15) = 345,000 300,000(1.425) = 427,500 300,000(4/7) = 171,429 Return to Problem List

  19. Problem 14-13 Key West Corporation has just declared an annual dividend of $2.00 per share. For the year just ended, earnings were $9.00 per share. a.What is Key West’s payout ratio? b.Suppose Key West has seven million shares outstanding. Borrowing for the coming year is planned at $13 million. What are planned investment outlays assuming a residual dividend policy? What target capital structure is implicit in these calculations?

  20. a. Payout ratio = DPS/EPS = $2.00 / $9.00 = .22 b. Equity portion of investment = 7,000,000($9 – $2) = $49,000,000 D/E ratio = $13,000,000 / $49,000,000 = .265 Return to Problem List

  21. Problem 14-16 You own 1,000 shares of stock in Edsel Communications. You will receive a $1 per share dividend in one year. In two years, Edsel will pay a liquidating dividend of $40 per share. The required return on Edsel stock is 15 percent. What is the current share price of your stock (ignoring taxes). If you would rather have equal dividends in each of the next two years, show how you can accomplish this by creating homemade dividends. Hint: Dividends will be in the form of an annuity.

  22. P0 = $1.00/1.15 + $40.00/1.152 = $31.12 $31.12 = D[1 – 1/1.152]/.15 D = $19.14 You want $19.14(1,000) = $19,140 in one year and will receive only $1.00(1,000) = $1,000 P1 = $40.00/1.15 = $34.78

  23. In one year, you will sell: ($19,140 – 1,000) / $34.78 = 521.56 shares Cash flow at time 1: $1,000 + $34.78(521.56) = $19,140 Cash flow at time 2: $40(1,000 – 521.56) = $19,140 Return to Problem List

  24. Chapter 15 Raising Capital

  25. Problem 15-1 The Wren Co. and the Stumpy Co. have both announced IPOs at $30 per share. One is undervalued by $4, and the other is overvalued by $4, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. If you could get 1,000 shares in Wren and 1,000 shares in Stumpy, what would your profit be? What profit do you actually expect? What principle have you illustrated?

  26. If you receive 1,000 shares of each: Profit = 1,000($4) – 1,000($4) = $0 Expected Profit = 500($4) – 1,000($4) = –$2,000 This is an example of the winner’s curse. Return to Problem List

  27. Problem 15-2 The Lambert Corporation needs to raise $42 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $75 per share and the company’s underwriters charge an 8 percent spread, how many shares need to be sold?

  28. Total proceeds(1 – .08) = $42,000,000 Total proceeds = $45,652,174 Shares offered = $45,652,174 / $75 = 608,696 Return to Problem List

  29. Problem 15-3 In the previous problem, if the SEC filing fees and associated administrative expenses of the offering are $500,000, how many shares need to be sold now? Total proceeds(1 – .08) = $42,000,000 + $500,000 Total proceeds = $46,195,652 Shares offered = $46,195,652 / $75 = 615,942 Return to Problem List

  30. Problem 15-4 The Taylor Co. has just gone public. Under a firm commitment agreement, Taylor received $22 for each of the 2.5 million shares sold. The initial offering price was $24 per share, and the stock rose to $29 per share in the first few minutes of trading. Taylor paid $300,000 in direct legal and other costs, and $150,000 in indirect costs. What was the floatation cost as a percentage of the funds raised?

  31. Net amount raised = 2,500,000($24) = $60,000,000 Total direct costs = $300,000 + ($24 – $22)(2,500,000) = $5,3000,000 Total indirect costs = $150,000 + ($29 – $24)(2,500,000) = $12,650,000 Total costs = $5,300,000 + $12,650,000 = $17,950,000 Floatation percentage costs $17,950,000 / $60,000,000 = 29.92% Return to Problem List

  32. Chapter 16 Short-Term Financial Planning

  33. Problem 16-5 The Belle Meade Company has produced the following quarterly sales amounts for the coming year: Q1 Q2 Q3 Q4   Sales $450 $600 $750 $900 a.Accounts receivable at the beginning of the year are $500. Belle Meade has a 45-day collection period. Calculate cash collections in each of the following four quarters by completing the following:

  34. Q1 Q2 Q3 Q4   Beginning receivables Sales Cash collections Ending receivables b. Rework (a) assuming a collection period of 60 days. c. Rework (a) assuming a collection period of 30 days.

  35. a. 45-day collection period implies all receivables outstanding from previous quarter are collected in the current quarter, and (90-45)/90 = 1/2 of current sales are collected. Q1 Q2 Q3 Q4   Beginning receivables $500 $225 $300 $375 Sales 450 600 750 900 Cash collections (725)(525)(675)(825) Ending receivables $225 $300 $375 $450

  36. b.60-day collection period implies all receivables outstanding from previous quarter are collected in the current quarter, and (90-60)/90 = 1/3 of current sales are collected. Q1 Q2 Q3 Q4   Beginning receivables $500 $300 $400 $500 Sales 450 600 750 900 Cash collections (650)(500)(650)(800) Ending receivables $300 $400 $500 $600

  37. c.30-day collection period implies all receivables outstanding from previous quarter are collected in the current quarter, and (90-30)/90 = 2/3 of current sales are collected. Q1 Q2 Q3 Q4   Beginning receivables $500 $150 $200 $250 Sales 450 600 750 900 Cash collections (800)(550)(700)(850) Ending receivables $150 $200 $250 $300 Return to Problem List

  38. Problem 16-7 Your firm has an average collection period of 42 days. Current practice is to factor all receivables immediately at a 2 percent discount. What is the effective cost of borrowing in this case? Assume that default is extremely unlikely. number of periods = 365/42 = 8.690 EAR = (1 + .02/.98)8.690 – 1 = 19.19% Return to Problem List

  39. Problem 16-9 The Thunder Dan’s Corporation’s purchases from suppliers in a quarter are equal to 75 percent of next quarter’s forecast sales. The payables period is 60 days. Wages, taxes and other expenses are 30 percent of sales, and interest and dividends are $70 per quarter. No capital expenditures are planned. Projected quarterly sales are: Q1 Q2 Q3 Q4   Sales $900 $700 $950 $600

  40. Sales for the first quarter of the following year are projected at $1,040. Calculate Thunder’s cash outflows. Q1 Q2 Q3 Q4   Payment of accounts Wages, taxes, other Long-term financing expenses Total

  41. Since the payables period is 60 days, payables in each period = 2/3 of last quarter’s orders, and 1/3 of this quarter’s orders, or 2/3(.75) times current sales + 1/3(.75) next period sales. Q1 Q2 Q3 Q4   Pmt. of accts. $625.00 $587.50 $625.00 $560.00 Wages, taxes 270.00 210.00 285.00 180.00 LT financing 70.00 70.00 70.00 70.00 Total $965.00 $867.50 $980.00 $810.00 Return to Problem List

  42. Problem 16-10 The following is the sales budget for Golden Parachute, Inc., for the first quarter of 2000: January FebruaryMarch   Sales budget $140,000 $170,000 $145,000 Credit sales are collected as follows: 60 percent in the month of the sale 20 percent in the month after the sale 15 percent in the second month after the sale

  43. The accounts receivable balance at the end of the previous quarter was $60,000 ($32,000 of which was uncollected December sales). a. Compute the sales for November. b. Compute the sales for December. c. Compute the cash collections from sales for each month from January through March.

  44. a. November sales = ($60,000 – 32,000)/0.15 = $186,667 b. December sales = $32,000/0.35 = $91,429 c. January collections = .15($186,667) + .20($91,429) + .65($140,000) = $137,285.85 February collections = .15($91,429) + .20($140,000) + .65($175,000) = $155,464.35 March collections = .15($140,000) + .20($175,000) + .65($145,000) = $150,250.00 Return to Problem List

  45. Chapter 17 Working Capital Management

  46. Problem 17-4 You place an order for 800 units of Good X at a unit price of $90. The supplier offers terms of 2/30, net 70. a. How long do you have to pay before the account is overdue? If you take the full period, how much should you remit? b. What is the discount being offered? How quickly must you pay to get the discount? If you do take the discount, how much should you remit? c. If you don’t take the discount, how much interest are you paying implicitly? How many days’ credit are you receiving?

  47. a. You have 70 days until the account is overdue. Remittance = 800($900) = $72,000 b. 2% discount; 30 day discount period Remittance = .98($72,000) = $70,560 c. Implicit interest = $72,000 – 70,560 = $1,440 70 – 30 = 40 days credit Return to Problem List

  48. Problem 17-6 Each business day, on average, a company writes checks totaling $21,000 to pay its suppliers. The usual clearing time for checks is five days. Meanwhile, the company is receiving payments from its customers each day, in the form of checks, totaling $38,000. The cash from the payments is available to the firm after two days. a. Calculate the company’s disbursement float, collection float, and net float. b. How would your answer in (a) change if the collected funds were available in one day instead of two days?

  49. a. Disbursement float = 5($21,000) = $105,000 Collection float = 2($28,000) = $76,000 Net float = $105,000 – 76,000 = $29,000 b. Collection float = 1($38,000) = $38,000 Net float = $105,000 – 38,000 = $67,000 Return to Problem List

  50. Problem 17-11 A firm offers terms of 1/10, net 45. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to this effective rate if: a. The discount is changed to 2 percent. b. The credit period is increased to 60 days. c. The discount period is increased to 15 days. d. What is the EAR for each scenario?

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