4. Cost of trade credit

Firms usually offer their customers some form of trade credit. This allowance comes with certain terms of credit, which will affect the actual cost of asset being sold for the buyer and the seller.

Consider this case:

Tasty Tuna Corporation buys most of its raw materials from a single supplier. This supplier sells to Tasty Tuna on terms of 1/15, net 60.

a. The cost per period of the trade credit extended to Tasty Tuna is __________? A. 0.81% B. 0.89% C.1.15% D. 1.01%

(Note: Round all intermediate calculations to four decimal places, and your final answer to two decimal places.).

b. Tasty Tuna’s trade credit has a nominal annual cost of _____________ , assuming a 365-day year. A. 5.73% B.7.37% C.9.66% D 8.19%

(Note: Round all intermediate calculations to four decimal places, and your final answer to two decimal places.)

c. If Tasty Tuna Corporation’s supplier shortens its discount period to five days, this will __________ the cost of the trade credit. Decrease or Increase

You are a US firm and expect to receive 10,000,000 Malaysian Ringitt (MR) from a customer for sure after six months. How would you achieve a complete hedge if you had the following: Spot rate $0.22/MR, six month US$ risk-free rate = 2.5 percent and six month MR risk-free rate is 3.5 percent. Describe the transactions in detail. 2 Suppose the payment in MR from your customer is not certain, and, in addition to the spot and risk-free rates mentioned above, you also have an options market in which MR calls trade. How would you construct the appropriate hedge in this case? Describe the transactions in detail.

Do you see value in the premise of resource dependency theory as an individual? How does resource dependency theory benefit an organization?

An asset used in a four-year project falls in the five-year MACRS class (MACRS Table) for tax purposes. The asset has an acquisition cost of $7,200,000 and will be sold for $1,620,000 at the end of the project.

A) What is the book value of the equipment at the end of Year 4?

B) If the tax rate is 24 percent, what is the aftertax salvage value of the asset?

Gary Levin is the chief executive officer of Mountainbrook Trading Company. The board of directors has just granted Mr. Levin 14,000 at-the-money European call options on the company’s stock, which is currently trading at $115 per share. The stock pays no dividends. The options will expire in five years and the standard deviation of the returns on the stock is 56 percent. Treasury bills that mature in five years currently yield a continuously compounded interest rate of 7 percent.

a. Use the Black-Scholes model to calculate the value of the stock options. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Value of option grant=?

Explain your opinion on Corporate Governance?

You are given the following information for Lightning Power Co. Assume the company's tax rate is 25 percent.

Debt: 15,000 6.4 percent coupon bonds outstanding$1,000 par value, 28 years to maturity, selling for 106 percent of par, the bonds make semiannual payments.

Common Stock: 480,000 shares outstanding, selling for $66 per share; beta is 1.17.

Preferred Stock: 21,000 shares of 4.2 percent preferred stock outstanding, currently selling for $87 per share. The par value is $100 per share.

5 percent market risk premium and 5.3 percent risk-free rate.

what is the companys WACC

1. Brooks Clinic is considering investing in new heart-monitoring equipment. It has two options. Option A would have an initial lower cost but would require a significant expenditure for rebuilding after 4 years. Option B would require no rebuilding expenditure, but its maintenance costs would be higher. Since the Option B machine is of initial higher quality, it is expected to have a salvage value at the end of its useful life. The following estimates were made of the cash flows. The company's cost of capital is 8%.

Instructions

a.  1.

Compute the (1) net present value, (2) profitability index, and (3) internal rate of return for each option.

b.  

Which option should be accepted? Explain your answer!

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.4 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $668,000. The firm believes that working capital at each date must be maintained at a level of 15% of next year’s forecast sales. The firm estimates production costs equal to $1.60 per trap and believes that the traps can be sold for $6 each. Sales forecasts are given in the following table. The project will come to an end in 6 years, when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 9%. Use the MACRS depreciation schedule.

Year: Sales (millions of traps)

Year 0 ---------------------0

Year 1----------------------0.6

Year 2----------------------0.8

Year 3----------------------1.0

Year 4----------------------1.0

Year 5----------------------0.9

Year 6----------------------0.6

Thereafter-----------------0

a. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

NPV-----------$

b.  By how much would NPV increase if the firm depreciated its investment using the 5-year MACRS schedule? (Do not round intermediate calculations. Enter your answer in whole dollars not in millions.)

The NPV increases by $

Assume these were the inflation rates and U.S. stock market and Treasury bill returns between 1929 and 1933:

1. What was the real return on the stock market in each year?

2. What was the average real return?

3. What was the risk premium in each year?

4. What was the average risk premium?

FuelSource Co (FuelSource) is a U.S. company with a December 31st year-end that prepares its financial statements in accordance with U.S. GAAP. FuelSource is planning to issue its financial statements on March 20, 2018. It is now March 18, 2018 and FuelSource management is evaluating new information regarding future contingencies and subsequent events to determine their impact (if any) on the December 31, 2017 financial statements. Environmental Clean-Up FuelSource operates in the oil industry, and its operations sometimes result in soil contamination. One of FuelSource’s subsidiaries is located outside of the U.S. in Dirty Country where there is no environmental legislation. However, FuelSource has a widely published environmental policy in which it undertakes to clean up all contamination that it causes, regardless of whether it occurs in a jurisdiction with no environmental regulations. FuelSource has a record of honoring this published policy. In November 2017, FuelSource contaminated land while operating in Dirty Country and anticipates that cleanup efforts will begin in May of 2018 and are estimated to cost approximately $1 million. Acquisition of an Oil Refinery Company Using the funds from a line of credit, FuelSource’s management drew $10 million on March 10, 2018, to acquire an oil refinery in the northeast United States. On the basis of its initial assessment from the Company’s due diligence (that started shortly before the balance sheet date), management’s best estimate of the allocation of the $10 million purchase price is as follows: $2 million of current assets and $8 million noncurrent assets (comprising $5 million of identifiable noncurrent assets, $2 million of intangible assets, and $1 million of goodwill). The estimated purchase price allocation has not been finalized, but is expected to be after the financial statements are issued. Required: Answer the following questions. Be sure to fully discuss the accounting options available to FuelSource for the above events and provide your recommendations for the best accounting treatments. Your responses should be supported by the FASB Codification and any other resources you find helpful (e.g., Conceptual Framework, real-world examples, etc.). 1. How do you think FuelSource should account for the environmental cleanup costs it anticipates incurring during 2018? Should Fuelsource record or disclosing anything about these costs in its December 31, 2017 financial statements? Explain why or why not.

17. a. Equity Risk Premium – the return that investors expect to receive above the return of the risk-free asset for investing into a risky asset. What does this mean?

b. How do we use the Expected Rate of Return from our investment to discount the expected cash flows from our investment to determine the present value (intrinsic value)? Please calculate the fair value of an investment with a dividend payout ratio of 40%, Next year’s dividend expectations of $2.40, growth rate of 3.0%, Risk-free rate is 2.4%, beta is 0.9 and ERP is 5.0%.

c. What is the difference between an Arithmetic Mean (Average) and a Geometric Mean (Average)? a. Why should investors know the difference?

d. Describe why a person must take risk to gain the potential for a higher return than they would receive for investing into the risk-free asset?

e. Be prepared to discuss which investment a reasonable person would choose to invest into over the next 5 years and why? a. Investment A has a mean return of 6% and a standard deviation of 12%. b. Investment B has a mean return of 5% and a standard deviation of 9%.

Pete and​ Jessica, on the advice of their​ next-door neighbor, recently purchased 600 shares of a​ small-capitalization Internet​ stock, trading at $ 78.91 per share. Their neighbor told them that the stock was a​ "real money​ maker" because it recently had a​ two-for-one stock split and would probably split again soon. Even​ better, according to the​ neighbor, the company was expected to earn $ 1.49 per share and pay a $ 0.27 dividend next year. Pete and Jessica have so far been less than impressed with the​ stock's performancelong dashthe stock has underperformed the​ S&P 500 Index this year. Pete and Jessica have come to you for some independent advice. Questions 1. Assuming that the stock actually splits two for​ one, how many shares will Pete and Jessica​ own? What will be the market value of their stock after the​ split? How will the split affect the value of their​ holdings? Was their neighbor correct in thinking that the stock split made the stock a​ "real money​ maker"? 2. Using the information​ provided, calculate the​ stock's P/E ratio. Would you classify this investment as a growth or value​ stock? 3. Since​ Pete, in​ particular, is worried about the price of the​ stock, explain to him how and why corporate earnings are so important in the valuation of common stocks. 4. Should Pete and Jessica be using the​ S&P 500 Index as a benchmark for this​ stock? Why or why​ not? What benchmark recommendation would you​ make? 5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a​ "no-lose guarantee." Should they invest with this type of​ broker? 6. Name at least five things Pete and Jessica need to look out for when making stock investments.

1. Assuming that the stock actually splits two for​ one, how many shares will Pete and Jessica​ own?

After the​ two-for-one split, they will own

nothing

shares.  ​(Round to the nearest​ integer.)

What will be the market value of their stock after the​ split?

The shares will be valued at

​$nothing.

​(Round to the nearest​ dollar.)

How will the split affect the value of their​ holdings?  ​(Select the best choice​ below.)

A.

The market value will double after the stock split since this is a​ two-for-one split.

B.

The market value will remain the same before and after the stock split.

C.

The market value will be cut in half after the stock split since this is a​ two-for-one split.

D.

None of the above.

Was their​ next-door neighbor correct in thinking that the stock split made the stock a​ "real money​ maker"?  ​(Select from the​ drop-down menu.)

Their neighbor was

▼

correct

incorrect

in thinking that a stock split will automatically increase the value of the stock.

2. Using the information​ provided, calculate the​ stock's P/E ratio.

The​ stock's P/E ratio is

nothing.

​(Round to two decimal​ places.)

Would you classify this investment as a growth or value​ stock?  ​(Select from the​ drop-down menu.)

By all measures​ (both dividend payout and​ P/E Ratio) this is a

▼

value stock

growth stock

.

3. Since​ Pete, in​ particular, is worried about the price of the​ stock, explain to him how and why corporate earnings are so important in the valuation of common stocks.  ​(Select all the choices that​ apply.)

A.

The​ long-term value of any stock is most closely aligned with a​ firm's earnings. The faster a firm can compound​ earnings, the greater the​ long-term value of the​firm's stock.

B.

Corporate earnings are important because analysts use earnings as a proxy for a​ company's ability to pay dividends in the future.​ Thus, Pete should pay close attention to the earnings outlook for the stock.

C.

The​ short-term value of any stock is most closely aligned with a​ firm's earnings. The faster a firm can compound​ earnings, the greater the​ long-term value of the​ firm's stock.

D.

Corporate earnings are important because analysts use earnings as proxy for a​ company's ability to pay its bills in the future.​ Thus, Pete should pay close attention to the earnings outlook for the stock.

4. Should Pete and Jessica be using the​ S&P 500 Index as a benchmark for this​ stock? Why or why​ not? What benchmark recommendation would you​ make?  ​(Select all the choices that​ apply.)

A.

The​ S&P 500 index is an inappropriate benchmark for Pete and Jessica because the​ make-up of the index does not include any Internet company.

B.

Pete and Jessica should consider tracking the performance of their stock to an index comprised of other Internet companies​ (e.g., NASDAQ​ index)

C.

The​ S&P 500 index is an inappropriate benchmark for Pete and Jessica because the​ make-up of the index does not represent the type of company they own.

D.

Pete and Jessica should consider tracking the performance of their stock to an index comprised of other Internet companies​ (e.g., FTSE 100​ index)

5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a​ "no-lose guarantee." Should they invest with this type of​ broker?  ​(Select the best choice​ below.)

A.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an​ investment, unless they can put the​ "no-lose guarantee" in writing.

B.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an​ investment, unless the investment opportunities involve initial public offerings.

C.

They should definitely not invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an investment.

D.

They should definitely invest with this or any other broker who makes cold calls promising unlimited returns or guarantees against losses for an investment. These opportunities​ don't come around very often.

6. Name at least five things Pete and Jessica need to look out for when making stock investments.

Before making any stock​ investment, Pete and Jessica need​ to:  ​(Select all that​ apply.)

A.

be prepared for the risks involved with broker​ "churning" when they employ an investment strategy and asset allocation model that meets or exceeds their risk beta.

B.

be aware of​ misrepresentation, telephone sales​ pitches, or recommendations based on​ "inside information" or other tips.

C.

be aware of​ "hot tips" and​ "insider information" that will help them choose the best stocks.

D.

be aware of psychological impacts on investment decisions.

E.

understand the types and potential impacts of the various risks they would be exposed to.

F.

understand the concept of beta and how the beta of a stock tells how much and in what direction an individual stock price has moved relative to the market. High beta stocks have much more volatile price swings than low beta stocks.

G.

be aware of excessive transactions undertaken by broker​ "churning", if they use a broker.

H.

be prepared for losses and be wary of claims for easy profit or​ "hot tips", if they use an online account.

I.

employ an appropriate investment strategy and asset allocaion model that meets their risk tolerance

Do you think companies can manipulate their Statement of Cash Flows? If so, what do you think are some of the top ways in which companies could manipulate it?