FIN322 Corporate Finance Homework Assignment I

Answer All Questions but my professor is picking two random to grade Show all your work (use of formula, etc.) in solving the problems. You still need to show your work even if you use the financial calculator to get the answers.

1. Suppose you wish to plan for your newborn’s college tuition payment. You intend to make equal semiannual deposits into an account offering 4% compounded semiannually on the child’s 3rd through 13th birthdays. You expect that tuition payments will be $50,000 semiannually by the time the child is ready to enter college. Therefore, your goal is to make eight semiannual withdrawals of $50,000 each starting on the child’s 18th birthday, each withdrawal to be used for semiannual tuition. Assume the account continues to offer 4 percent per year compounded semiannually throughout the entire period of deposits and withdrawals. How much must each of the semiannual deposits be such that there will be enough money accumulated in the account to exactly meet the goal? [Suggestion: Draw the cash flow diagram to aid you in solving this problem.]

2. You are planning to save for retirement over the next 40 years. To do this, you will invest $500 per month in a stock account and $2,500 semiannually in a bond account. The return of the stock account is expected to be 6 percent per year, and the bond account will pay 4 percent per year. When you retire, you will combine your money into an account with a 5 percent per year return. How much can you withdraw each month from your account assuming a 25-year withdrawal period?

3. You are taking out a four-year loan of $30,000 from your bank. The interest rate is 5 percent per year, and the loan calls for equal monthly payments. How much principle is paid in the second month? How much total interest is paid after five months? (Draw an amortization table to answer the questions. Use of excel is highly encouraged.)

4. Bond J is a 4 percent coupon bond. Bond K is a 7 percent coupon bond. Both bonds have 10 years to maturity, make semiannual payments, and have a YTM of 6 percent. If interest rate (YTM) changes from 6 percent to 8 percent, what is the percentage price change of these bonds? What if the YTM suddenly falls from 6 percent to 4 percent instead? What does this problem tell you about the interest rate risk of lower-coupon bonds?

5. Rizzi Co. is growing quickly. The company just paid a $2 per share dividend and dividends are expected to grow at a 15%, 8% and 4% rate respectively for the next three years, with the growth rate falling off to a constant 3 percent thereafter. If the required return is 10 percent, what is the current share price?

1. Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1,000 each. The preferred stock pays a dividend of $6 per share. The common stock currently sells for $32 per share and has a beta of 1.15, the preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par. The market risk premium is 10 percent, T-bills are yielding 5 percent, and Titan Mining’s tax rate is 35 percent.

1. If Titan Mining is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows?

Answer: Rate of return firm should use in 13.51%

You own a portfolio that has $1,500 invested in Stock A and $500 invested in Stock B. If the expected returns are 10% for Stock A and 14% for Stock B, what is the expected return on the portfolio?

You have just taken out a $15,000 car loan with a 6% APR, compounded monthly. The loan is for five years. When you make your first payment in one​ month, how much of the payment will go toward the principal of the loan and how much will go toward​ interest?  ​(Note: Be careful not to round any intermediate steps less than six decimal​ places.)

When you make your first​ payment,​$___will go toward the principal of the loan and ​$___ will go toward the interest. (Round to the nearest​ cent.)

Suspect Corp. issued a bond with a maturity of 30 years and a semiannual coupon rate of 8 percent 3 years ago. The bond currently sells for 93 percent of its face value. The book value of the debt issue is $50 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 13 years left to maturity; the book value of this issue is $50 million and the bonds sell for 54 percent of par. The company’s tax rate is 35 percent.

What is the company’s total book value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

What is the company’s total market value of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

What is your best estimate of the aftertax cost of debt? (Do not round intermediate calculations. Enter your answer in dollars, not millions of dollars, e.g., 1,234,567.)

A project has the following cash flows: Year Cash Flow 0 $ 42,000 1 – 21,000 2 – 32,000 What is the IRR for this project? (Round your answer to 2 decimal places. (e.g., 32.16)) IRR % What is the NPV of this project, if the required return is 12 percent? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) NPV $ What is the NPV of the project if the required return is 0 percent? (Negative amount should be indicated by a minus sign.) NPV $ What is the NPV of the project if the required return is 24 percent? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) NPV $

OceanGate sells external hard drives for $294 each. Its total fixed costs are $23 million, and its variable costs per unit are $191. The corporate tax rate is 32%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession, it will sell only half as many.

a. What will be the percentage decline in sales if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

b. What will be the percentage decline in profits if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

c. Calculate the operating leverage of this firm? (Round your answer to 2 decimal places.)

OceanGate sells external hard drives for $294 each. Its total fixed costs are $23 million, and its variable costs per unit are $191. The corporate tax rate is 32%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession, it will sell only half as many.

a. What will be the percentage decline in sales if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

b. What will be the percentage decline in profits if the economy enters a recession? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

c. Calculate the operating leverage of this firm? (Round your answer to 2 decimal places.)

1. Snow Man Inc. has accounts receivable of $4,500, inventory of $1,800, sales of $135,000, and cost of goods sold of $64,000. How many days does it take the firm to sell its inventory and collect the payment on the sale assuming that all sales are on credit? (i.e. Inventory Holding Period +  Days' sales in receivables)

   		10.27 days
   		18.67 days
   		14.50 days
   		22.43 days
   		12.17 days

NEW PROJECT ANALYSIS

You must evaluate the purchase of a proposed spectrometer for the R&D department. The base price is $280,000, and it would cost another $42,000 to modify the equipment for special use by the firm. The equipment falls into the MACRS 3-year class and would be sold after 3 years for $70,000. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The equipment would require a $8,000 increase in net operating working capital (spare parts inventory). The project would have no effect on revenues, but it should save the firm $48,000 per year in before-tax labor costs. The firm's marginal federal-plus-state tax rate is 40%.

1. What is the initial investment outlay for the spectrometer, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent. Negative amount should be indicated by a minus sign.
   $

2. What are the project's annual cash flows in Years 1, 2, and 3? Round your answers to the nearest cent.

   In Year 1 $

   In Year 2 $

   In Year 3 $

3. If the WACC is 11%, should the spectrometer be purchased?
   -Select-YesNo

You will be evaluating three projects for Hasbro Toys. Hasbro's cost of capital or discount rate is 8%.

The first project (A) will cost $25,000 initially. The project will then return cash flows of $10,000 for 5 years.

The second project (B) will cost $50,000 initially. The project will then return cash flows of $30,000 for the next 2 years and $10,000 for 2 years after that.

The third project (C) will cost $30,000 initially. The project will then return cash flows of $11,000 for 3 years.

Q1: What is Project A's Payback Period?

Q2: What is Project B's Payback Period?

Q3: What is Project C's Payback Period?

Q2

NEW PROJECT ANALYSIS

You must evaluate a proposal to buy a new milling machine. The base price is $118,000, and shipping and installation costs would add another $6,000. The machine falls into the MACRS 3-year class, and it would be sold after 3 years for $64,900. The applicable depreciation rates are 33%, 45%, 15%, and 7%. The machine would require a $9,500 increase in net operating working capital (increased inventory less increased accounts payable). There would be no effect on revenues, but pretax labor costs would decline by $44,000 per year. The marginal tax rate is 35%, and the WACC is 12%. Also, the firm spent $5,000 last year investigating the feasibility of using the machine.

1. How should the $5,000 spent last year be handled?
   1. Only the tax effect of the research expenses should be included in the analysis.
   2. Last year's expenditure should be treated as a terminal cash flow and dealt with at the end of the project's life. Hence, it should not be included in the initial investment outlay.
   3. Last year's expenditure is considered as an opportunity cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
   4. Last year's expenditure is considered as a sunk cost and does not represent an incremental cash flow. Hence, it should not be included in the analysis.
   5. The cost of research is an incremental cash flow and should be included in the analysis.
   
   -Select-IIIIIIIVV

2. What is the initial investment outlay for the machine for capital budgeting purposes, that is, what is the Year 0 project cash flow? Round your answer to the nearest cent.
   $

3. What are the project's annual cash flows during Years 1, 2, and 3? Round your answer to the nearest cent. Do not round your intermediate calculations.

   Year 1 $

   Year 2 $

   Year 3 $

4. Should the machine be purchased?
   -Select-YesNo

The pure expectations theory, or the expectations hypothesis, asserts that long-term interest rates can be used to estimate future short-term interest rates.

Based on the pure expectations theory, is the following statement true or false?

The pure expectations theory assumes that a one-year bond purchased today will have the same return as a one-year bond purchased five years from now.

False

True

The yield on a one-year Treasury security is 4.2300%, and the two-year Treasury security has a 5.7105% yield. Assuming that the pure expectations theory is correct, what is the market’s estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.)

7.212%

6.1302%

8.2217%

9.1592%

Recall that on a one-year Treasury security the yield is 4.2300% and 5.7105% on a two-year Treasury security. Suppose the one-year security does not have a maturity risk premium, but the two-year security does and it is 0.15%. What is the market’s estimate of the one-year Treasury rate one year from now? (Note: Do not round your intermediate calculations.)

7.8751%

6.908%

5.8718%

8.7732%

Suppose the yield on a two-year Treasury security is 5.83%, and the yield on a five-year Treasury security is 6.20%. Assuming that the pure expectations theory is correct, what is the market’s estimate of the three-year Treasury rate two years from now? (Note: Do not round your intermediate calculations.)

6.61%

6.53%

7.10%

6.45%

Orange Turtle Group buys on terms of 3.5/15, net 45 from its chief supplier.

If Orange Turtle receives an invoice for $1,545.78, what would be the true price of this invoice?

a. $1,491.68

b. $1,267.93

c. $1,118.76

d. $1,044.18

The nominal annual cost of the trade credit extended by the supplier is _____.

a. 43.29%

b. 36.66%

c. 39.75%

d. 44.17%

The effective annual rate of interest on trade credit is _______.

a. 63.72%

b. 44.82%

c. 54.00%

d. 55.08%

Suppose Orange Turtle does not take advantage of the discount and then chooses to pay its supplier late. On average, Orange Turtle will pay its supplier on the 50th day after the sale. As a result, Orange Turtle can decrease its nominal cost of trade credit by _____ by paying late.

a. 11.99

b. 7.26

c. 11.36

d. 6.31

Work in Process—Assembly Department
Bal., 3,000 units, 25% completed 8,625 / To Finished Goods, 69,000 units

Direct materials, 71,000 units @ $2 142,000 /

Direct labor 190,200 /

Factory overhead 73,900 /

Bal. ? units, 25% completed ? /

Based on the above data, determine the different costs listed below.

If required, round your interim calculations to two decimal places.