The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $17 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.9 million with a 0.2 probability, $3.2 million with a 0.5 probability, and $0.5 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.
Debt/Capital ratio is 0.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 10%, interest rate is 9%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 50%, interest rate is 11%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 60%, interest rate is 14%.
| RÔE = | % |
| σ = | % |
| CV = |
In: Finance
A British company BB Corp. enters into a 1-year interest rate swap with Sea Bank. The notional principle of the swap is £60 million. Payments will be made quarterly on the basis of 90/360 (90 days in the settlement period and 360 days per year). BB will receive a fixed rate of 3.5% and pay floating rate Euribor plus 1%. The 90-day Euribor rates are as below:
Current: 2.4% In 1 quarter: 3% In 2 quarters: 3.5% In 3 quarters: 3.7%
A. Determine the initial exchange of cash that occurs at the start of the swap.
B. Determine the quarterly payments (Q1, Q2)
C. Determine the final exchange of cash that occurs at the end of the swap.
In: Finance
Renter’s Dilemma
Adam's, Inc., a publicly traded corporation, plans to lease equipment from Jackson Co. (Jackson) on January 1, 2020, for a period of three years. Lease payments of $100,000 are due to Jackson each year. Other expenses (e.g., insurance, taxes, and maintenance) are also to be paid by Adams and amount to $2,000 per year. Jackson will not incur any initial direct costs. The lease contains no purchase or renewal options and the equipment reverts back to Jackson on the expiration of the lease. The remaining useful life of the equipment is four years. The fair value of the equipment at lease inception is $265,000. Adams has guaranteed $20,000 as the residual value at the end of the lease term. The $20,000 represents the expected value of the leased equipment to Adams at the end of the lease term. The salvage value of the equipment is expected to be $2,000 after the end of its economic life. Adam’s incremental borrowing rate is 11 percent (Jackson’s implicit rate is 10 percent and is calculable by Adams from the lease agreement).
The junior accountant of Adams analyzed the assets under lease, determined whether the lease was an operating lease or finance lease, and prepared the applicable journal entries. The senior accountant of Adams reviewed the junior accountant’s analysis and prepared a separate analysis. As the finance controller, you were given both analyses to determine the correct accounting treatment. Calculations and journal entries performed by your junior and senior accountant follow:
Present Value of the Lease Obligation
Using the rate implicit in the lease (10 percent), the present value of the guaranteed residual value would be $15,026 ($20,000 x 0.7513), and the present value of the annual payments would be $248,685 ($100,000 x 2.4869).
Using the incremental borrowing rate (11 percent), the present value of the guaranteed residual value would be $14,624 ($20,000 x 0.7312), and the present value of the annual payments would be $244,371 ($100,000 x 2.4437).
Junior accountant analysis:
Since the equipment reverts back to Jackson, it is an operating lease. 840
Entry to be posted in years 1, 2, and 3:
Dr. Rent expense $100,000
Dr. Insurance expense $2,000
Cr. Cash $102,000
(Operating lease rental paid to Jackson)
Senior accountant analysis:
Step 1 – Lease classification
The lease term is for three years. The useful life of the equipment is four years. Since the lease term is for a major part of the useful life of the equipment, it is a finance lease.
Step 2 – Computation of the lease asset and obligation
Since Adam’s incremental borrowing rate is greater than the implicit rate in the lease, compute the present value of the minimum lease payments using the 11 percent rate.
Present value of the minimum lease payments = $100,000 x 2.4437 = $244,371.
Step 3 – Allocation of payments between interest and lease obligation
Since interest has to be charged on the straight-line method, the following is the allocation of the interest and the reduction in the lease liability.
|
Year |
Cash Payment |
Interest Expense (11%) |
Reduction in Lease Obligation |
Balance of Lease Obligation |
|
0 |
$244,371 |
|||
|
1 |
$100,000 |
$26,881 |
$73,119 |
$171,252 |
|
2 |
$100,000 |
$26,881 |
$73,119 |
$98,133 |
|
3 |
$100,000 |
$26,881 |
$73,119 |
$25,014 |
Entry to be posted in year 1 for capitalization of equipment:
Db. Equipment $244,371
Cr. Lease obligation $244,371
Entry to be posted in years 1, 2, and 3 for payment:
Dr. Rent expense $2,000
Dr. Interest expense $26,881
Dr. Lease obligation $73,119
Cr. Cash $102,000
(Finance lease rental paid to Jackson)
Required:
Are either of the above analyses correct? If so, which one? If not, why not and what would need to be changed? Please provide appropriate codification support for your conclusions. ( Use answers according FASB Codifications)
In: Finance
The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.8 million with a 0.2 probability, $3.4 million with a 0.5 probability, and $0.6 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.
Debt/Capital ratio is 0.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 10%, interest rate is 9%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 50%, interest rate is 11%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 60%, interest rate is 14%.
| RÔE = | % |
| σ = | % |
| CV = |
In: Finance
You own a small networking startup. You have just received an offer to buy your firm from a large, publicly traded firm, JCH Systems. Under the terms of the offer, you will receive 1 million shares of JCH. JCH stock currently trades for $25.63 per share. You can sell the shares of JCH that you will receive in the market at any time. But as part of the offer, JCH also agrees that at the end of one year, it will buy the shares back from you for $25.63 per share if you desire. Suppose the current one-year risk-free rate is 5.95%, the volatility of JCH stock is 29.4%, and JCH does not pay dividends. Round all intermediate values to five decimal places as needed.
a. Is this offer worth more than $25.63 million? Explain.
b. What is the value of the offer?
In: Finance
A 15-year bond issue of 5,100,000 and bearing interest at 4% payable annually is sold to yield 4.4% compounded semi-annually. What is the issue price of the bonds?
In: Finance
FINANCIAL LEVERAGE EFFECTS The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $20 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4.2 million with a 0.2 probability, $3.1 million with a 0.5 probability, and $0.7 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations. Debt/Capital ratio is 0. RÔE = % σ = % CV = Debt/Capital ratio is 10%, interest rate is 9%. RÔE = % σ = % CV = Debt/Capital ratio is 50%, interest rate is 11%. RÔE = % σ = % CV = Debt/Capital ratio is 60%, interest rate is 14%. RÔE = % σ = % CV =
In: Finance
In one or two paragraphs, please discuss how Fed Reserve’s interest rate policy will influence Stock and Bond markets.
In: Finance
9..Consider the following data for a one-factor economy. All portfolios are well diversified.
Portfolio E(r) Beta
A 12% 1.2
F 6% 0.0
Suppose that another protfolio E is well diversified with a beta of 0.6 and expected return of 7%.
Construct an arbitrage strategy by investing $1 in the long position and $1 in the short position. What is the profit for the arbitrage strategy?
Your answer should be in dollars and accurate to the hundredth.
In: Finance
The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 9%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,103. The firm has 576 shares of common stock outstanding that sell for $4.00 per share.
Calculate Paulson's WACC using market-value weights. Round your answer to two decimal places. Do not round your intermediate calculations.
| Assets | Liabilities And Equity | |||
| Cash | $ 120 | Accounts payable and accruals | $ 10 | |
| Accounts receivable | 240 | Short-term debt | 43 | |
| Inventories | 360 | Long-term debt | $1,060 | |
| Plant and equipment, net | 2,160 | Common equity | 1,767 | |
| Total assets | $2,880 | Total liabilities and equity | $2,880 | |
In: Finance
A stock is trading ex-rights; the market price per share of common stock is $75; the number of rights needed to buy one new share is 3, and the value of a right is 5. Calculate the subscription price.
In: Finance
The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $15 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $5.2 million with a 0.2 probability, $2.4 million with a 0.5 probability, and $0.7 million with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places at the end of the calculations.
Debt/Capital ratio is 0.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 10%, interest rate is 9%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 50%, interest rate is 11%.
| RÔE = | % |
| σ = | % |
| CV = |
Debt/Capital ratio is 60%, interest rate is 14%.
| RÔE = | % |
| σ = | % |
| CV = |
In: Finance
Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $25.00 million. The plant and equipment will be depreciated over 10 years to a book value of $3.00 million, and sold for that amount in year 10. Net working capital will increase by $1.35 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.54 million per year and cost $1.59 million per year over the 10-year life of the project. Marketing estimates 11.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 21.00%. The WACC is 10.00%. Find the NPV (net present value).
Caspian Sea Drinks is considering the production of a diet drink. The expansion of the plant and the purchase of the equipment necessary to produce the diet drink will cost $28.00 million. The plant and equipment will be depreciated over 10 years to a book value of $1.00 million, and sold for that amount in year 10. Net working capital will increase by $1.38 million at the beginning of the project and will be recovered at the end. The new diet drink will produce revenues of $8.98 million per year and cost $2.33 million per year over the 10-year life of the project. Marketing estimates 17.00% of the buyers of the diet drink will be people who will switch from the regular drink. The marginal tax rate is 27.00%. The WACC is 15.00%. Find the IRR (internal rate of return).
In: Finance
Narelle borrows $600,000 on a 25-year property loan at 4 percent per annum compounding monthly. The loan provides for interest-only payments for 5 years and then reverts to principal and interest repayments sufficient to repay the loan within the original 25-year period. Assume rates do not change.
a) Calculate the monthly repayment for the first 5 years. (CLUE: it is INTEREST ONLY)
b) Calculate the new monthly repayment after 5 years assuming the interest rate does not change. (You need the repayment required to amortise the loan to $0 in remaining 20 years)
c) Calculate the total repayments over the life of the loan.
d) Has she paid more or less than she would have if she took a principal and interest loan at the outset? Demonstrate showing your workings.
e) Why might she choose interest-only loan terms?
PLEASE EXPLAIN ANSWER WITHOUT CALCULATING FROM EXCEL
In: Finance
How is it possible that dividends are so important, but, at the same time, dividend policy is irrelevant? Without taxes or any other imperfections, why doesn’t it matter how the firm distributes cash?
In: Finance