Examine the key reasons why a business may not want to hold too much or too little working capital. Provide examples that illustrate the consequences of either situation.

You have looked at the current financial statements for Reigle Homes, Co. The company has an EBIT of $2,850,000 this year. Depreciation, the increase in net working capital, and capital spending were $225,000, $90,000, and $415,000, respectively. You expect that over the next five years, EBIT will grow at 16 percent per year, depreciation and capital spending will grow at 21 percent per year, and NWC will grow at 11 percent per year. The company has $15,100,000 in debt and 345,000 shares outstanding. You believe that sales in five years will be $22,600,000 and the price-sales ratio will be 2.4. The company’s WACC is 8.5 percent and the tax rate is 21 percent.

The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current capital structure calls for 40 percent debt, 5 percent preferred stock, and 55 percent common equity. Initially, common equity will be in the form of retained earnings (K_e) and then new common stock (K_n). The costs of the various sources of financing are as follows: debt, 5.6 percent; preferred stock, 11.0 percent; retained earnings, 8.0 percent; and new common stock, 9.4 percent.

a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, K_e.) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

  
  b. If the firm has $22.0 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

Capital Structure Size (X) _______ million

c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 55 percent of the capital structure, but will all be in the form of new common stock, K_n.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Marginal Cost of Capital ______%

d. The 5.6 percent cost of debt referred to above applies only to the first $40 million of debt. After that, the cost of debt will be 7.6 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)

Capital Structure Size _____ million

e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Marginal Cost of Capital _____%

The table provides the prices of 5 zero-coupon bonds:

Determine the value of the annual effective forward rate applicable from time 2 to time 3.

A. 12.3%

B. 11.9%

C. 23.7%

D. 19.2%

E. 17.8%

J.D. Dorian just finished a residency in internal medicine and wants to go into practice with Dr. Gregory House, Dr. John Zoidberg, Dr. Nick, Dr. Julius Hibbert, and Dr. Leonard “Bones” McCoy. J.D. tells you that while he needs to practice with other physicians for call coverage and for other reasons, he does not want to be personally liable should the other physicians be found guilty of malpractice (and he is particularly worried about this due to their reputation). You discuss various incorporation options with him, but he tells you that he would like to form a partnership. What business form would you recommend to him and why?

Problem # 2

Each of two mutually exclusive projects involves an investment of $ 75,000.  

The cash flows for the projects are as follows:

                                         Year              Project “A”                  Project "B"

                                            1                      29,000                        42,000

                                            2                      29,000                        42,000

                                            3                      29,000                        42,000

                                            4                      29,000

               Note: Project "A" covers 4 years and project "B" covers 3 years.                              

        A.   Calculate each project's payback period.          1 point        

                    B.   Compute the IRR of each project. 1 Point

Problem 1- Schedule of Cash Receipts

Watt’s Lighting Stores made the following sales projection for the next six months. All sales are credit sales.

March……. $35,000 June……. $34,000

April…… $42,000 July……. $42000

May……. $25,000 August…. $48,000

Sales in January and February were $32,000 and $36,000, respectively. Experience has shown that of total sales, 10 percent are uncollectible, 30 percent are collected in the month of sale, 40 percent are collected in the following month, and 20 percent are collected two months after sale.

Prepare a monthly cash receipts schedule for the firm for March through August. Of the sales expected to be made during the six months from March through August, how much will still be uncollected at the end of August? How much of this is to be collected later?

(Related to Checkpoint 13.2 and Checkpoint​ 13.3) ​ (Comprehensive risk​ analysis) Blinkeria is considering introducing a new line of hand scanners that can be used to copy material and then download it into a personal computer. These scanners are expected to sell for an average price of ​$105 each, and the company analysts performing the analysis expect that the firm can sell 101,000 units per year at this price for a period of five​ years, after which time they expect demand for the product to end as a result of new technology. In​ addition, variable costs are expected to be $19 per unit and fixed​ costs, not including​ depreciation, are forecast to be ​$1,060,000 per year. To manufacture this​ product, Blinkeria will need to buy a computerized production machine for $9.3 million that has no residual or salvage​ value, and will have an expected life of five years. In​ addition, the firm expects it will have to invest an additional $306000 in working capital to support the new business. Other pertinent information concerning the business venture is provided​ here: 

a.  Calculate the​ project's NPV.

b.Determine the sensitivity of the​ project's NPV to​ a(n) 8 percent decrease in the number of units sold.

c.Determine the sensitivity of the​ project's NPV to​ a(n) 8 percent decrease in the price per unit.

d.Determine the sensitivity of the​ project's NPV to​ a(n) 8 percent increase in the variable cost per unit.

e.Determine the sensitivity of the​ project's NPV to​ a(n) 8 percent increase in the annual fixed operating costs.

f.  Use scenario analysis to evaluate the​ project's NPV under​ worst- and​ best-case scenarios for the​ project's value drivers. The values for the expected or​ base-case along with the​ worst- and​ best-case scenarios are listed​ here: 

a. A newly issued bond has a maturity of 10 years and pays a 7% coupon rate (with coupon payments coming once annually). The bond sells at par value. What is the duration of the bond?

b. Find the actual price of the bond assuming that its yield to maturity immediately increases from 7% to 8% (with maturity still 10 years)

1. Why do firms set upper and lower limits on their cash balance? What factors affect these limits?

2. How is WACC different from the expected rate of return calculated using CAPM?

3. Firm A and Firm B have the same betas but Firm A has a much higher total risk (standard deviation of returns) than the Firm B. The dividends and dividend growth rates for both firms are the same. Do we expect Firm A’s price to be greater or less than Firm B’s price?

4. What is the relationship between the expected rate of return and the rate used to discount cash flows? Re-write the formula for stock price P=D/(r-g) to provide an expression for the expected rate of return.

5. Is it true that if a stock possesses a higher expected rate of return then it must be a better investment?

Stock 1: The Binkelman Corporation has just announced that it plans to introduce a new solar panel that will greatly reduce the cost of solar energy. As a result, analysts now expect the company’s earnings, currently $5 per share to grow by 50 percent per year for the next two years, by 25 percent per year for the following two years, and by 8 percent per year, thereafter. Blinkelman does not currently pay a dividend, but it expects to pay out 20 percent of its earnings beginning two years from now and to continue to pay dividends at the same level. The required rate of return for this company is 20 percent for now. Analysts think that it will stay at that level for the next five years and then it decreases to 15%.

Stock 2: Sports Novalties, Inc. has experienced an explosion in demand for its featured football novelties. The firm currently pays a dividend of $0.25 per share. This dividend is expected to increase to $0.75 per share one year from now. It is expected to grow at a rate of 15% per year for the following three years and then growth rate is expected to decrease to 10% and stay at that level. The required return for Sports Novalties is 16% and estimated to stay at that level for three more years and it will be 12% thereafter.

a)Calculate the price of Stock 1 today.

b)Calculate the price of Stock 2 today.

c) Suppose Stock 1 is selling for $25 in the market right now. Decide whether Mary should include Stock 1 in the portfolio of her clients or not and briefly justify your decision.

d)Suppose Mary purchased Stock 2 today with an intention of selling it a year later. Suppose a year has passed and Mary is getting ready to sell her shares. Today, the company announced experiencing some financial difficulties and the required rate of return on company shares suddenly changed to 15% indefinitely. Calculate the new price for Stock 2. Calculate the return she earned on her investment during her 1-year holding period and decompose this return into dividend yield and capital gains yield components.

5. Santa Corp. has 5,000 zero-coupon bonds outstanding. The bonds have a face value of $1,000, 4 years to maturity, and are currently trading at $822.70. The firm also has 750,000 common shares outstanding. The shares are currently priced at $21.75 each and yesterday paid a dividend of $2.24. The firm’s most recent annual financial statements show net income of $2.80 mln, shareholders’ equity of $26.67 mln, and a marginal tax rate of 26%.

   1. What are the weights of debt and equity in Santa Corp.’s capital structure? [2 points]

   2. What is Santa Corp.’s required return on equity? [4 points]

   3. What is Santa Corp.’s weighted average cost of capital? [4 points]

Most publicly traded companies are examined by numerous analysts. Locate analysts’ ratings about a company of your choice by visiting a website such as Yahoo Finance (Links to an external site.). Provide a comparison over time and across companies in the same industry by answering the following questions:

• How many analysts rated the company?
• What are analysts predicting in terms of earnings and revenues?
• How do the estimates compare against historical results?
• How do the growth projections for the company compare with the average projections for the S&P 500?

General Electric has 10 million shares of common stock with a book value of $1 per share and a current market price of $25 per share. The company’s beta is 1, the risk free rate is 3% and the market rate is 9%. The firm’s outstanding bonds have a total face value of $75 million, a maturity of 10 years, a 4% annual coupon, and are selling currently for 101% of par value. The marginal tax rate is 35%. What discount rate should General Electric use to evaluate its projects? (You MUST show all your work) 21. What is the weight of equity? A) 57.3% B) 42.7% C) 76.7% D) 23.3% 22. What is the weight of debt? A) 57.3% B) 42.7% C) 76.7% D) 23.3% 23. What is the rate of equity? A) 9% B) 3% C) 12% D) 4.5% 24. What is the rate of debt? A) 4.0% B) 3.8% C) 1.9% D) 7.6% 25. What is the discount rate for the firm? A) 7.5% B) 4.1% C) 3.8% D) 2.8%