Carla Vista Security Company produces a cash flow of $160 per year and is expected to continue doing so in the infinite future. The cost of equity capital for Carla Vista is 16 percent, and the firm is financed entirely with equity. Management would like to repurchase $100 in shares by borrowing $100 at a 10 percent annual rate (assume that the debt will also be outstanding into the infinite future). Using Modigliani and Miller’s Proposition 1 answer the following questions.

What is the value of the firm today?

What is the value of equity after the repurchase?

What will be the rate of return on common stock required by investors after the stock repurchase? (Round answer to 2 decimal places, e.g. 17.54%.)

2) Vega Inc. expects earnings/dividends to grow at an annual rate of 20 percent for the next 2 years. This growth rate is expected to drop to 10 percent a year for a further three years after which the company settles into a constant growth pattern of 4 percent per year indefinitely. If current dividend is $1.10 per share and investors require a 15 percent annual return on Vega stock, what is a fair price for a share of Vega's stock today?

(Part 1)Which of the following IS NOT a way Management can control Return on Equity (ROE)?
a.Earnings produced out of each dollar of sales (Profit Margin)
b.How well a company is able to meet its current obligations (Current Ratio)
c.Sales generated from each dollar of assets employed (Asset Turnover)
d.Amount of equity used to finance the assets (Financial Leverage)

(Part 2)Which of the following ratios measure the amount of a company's operations that are financed from debt versus financed from equity?
a.Leverage ratios
b.Profitability ratios
c.Liquidity ratios
d.Operating ratios

St. Johns River Shipyards' welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. The new welder will cost $184,000 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $28,000 to $72,500 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 40%, and the project cost of capital is 11%. Should the old welder be replaced by the new one? Do not round intermediate calculations. Round your answer to the nearest cent. Negative value, if any, should be indicated by a minus sign. The NPV of the project is $ Old welder be replaced.

Problem 12-09
Financing Deficit

Garlington Technologies Inc.'s 2016 financial statements are shown below:

Balance Sheet as of December 31, 2016

Income Statement for December 31, 2016

Suppose that in 2017 sales increase by 20% over 2016 sales and that 2017 dividends will increase to $200,000. Forecast the financial statements using the forecasted financial statement method. Assume the firm operated at full capacity in 2016. Use an interest rate of 9%, and assume that any new debt will be added at the end of the year (so forecast the interest expense based on the debt balance at the beginning of the year). Cash does not earn any interest income. Assume that the all new-debt will be in the form of a line of credit. Round your answers to the nearest dollar. Do not round intermediate calculations.

Problem 10-21 Cost-Cutting Proposals [LO2]

Explain how each of the following affects corporate governance and whether the impact is positive or negative.

1. Block ownership

2. Greenmail

3. Stock options as part of compensation

4. High level of debt

5. Board of Directors comprised by majority of outsiders and compensation based in part on performance of company.

Shares of XYZ stock (which does not pay dividends) are trading at $460. The prices of European options on XYZ with 1 year to expiry are as follows: Strike Call Put 440 83.99 59.26 445 81.67 61.89 450 79.40 64.56 455 77.18 67.30 460 75.02 70.08 465 72.92 72.92 470 70.86 75.81 475 68.86 78.76 480 66.90 81.75

(a) What is the one-year forward price of XYZ?

(b) What is the riskless rate of interest?

(c) You become convinced that XYZ’s price will end up between 450 and 470 in a year’s time, and decide to put on a trade that pays you $100,000 if XYZ’s share price is between 450 and 470, and nothing if XYZ’s share price is less than 445 or more than 475. Draw the payoff diagram. (In the payoff diagram, join these payoffs by straight lines between 445 and 450, and between 470 and 475.) How much does it cost you to enter this position? If you wanted to do a zero-cost trade with the same profit diagram, how much would you stand to lose if you were wrong, and XYZ ended up above 475 or below 445?

Lourdes Corporation's 15% coupon rate, semiannual payment, $1,000 par value bonds, which mature in 30 years, are callable 3 years from today at $1,025. They sell at a price of $1,245.45, and the yield curve is flat. Assume that interest rates are expected to remain at their current level.

1. What is the best estimate of these bonds' remaining life? Round your answer to the nearest whole number.

     years

2. If Lourdes plans to raise additional capital and wants to use debt financing, what coupon rate would it have to set in order to issue new bonds at par?
   1. Since the bonds are selling at a premium, the coupon rate should be set at the going rate, which is the YTM.
   2. Since Lourdes wishes to issue new bonds at par value, the coupon rate should be set the same as that on the existing bonds.
   3. Since Lourdes wishes to issue new bonds at par value, the coupon rate should be set the same as the current yield on the existing bonds.
   4. Since interest rates have risen since the bond was first issued, the coupon rate should be set at a rate above the current coupon rate.
   5. Since the bonds are selling at a premium, the coupon rate should be set at the going rate, which is the YTC.

A two-month European put option on a non-dividend-paying stock is currently selling for $2.00. The stock price is $52, the strike price is $55, and the risk-free interest rate is 5% per annum. What opportunities are there for an arbitrageur?

what are the definitions of these financial ratios?
1. Quick Ratio
2. Current Ratio
3. Average Inventory Ratio Average Accounts Receivable Ratio

A pension fund manager is considering three mutual funds. The first is a stock fund, the second is a long-term government and corporate bond fund, and the third is a T-bill money market fund that yields a rate of 7%. The probability distribution of the risky funds is as follows:

The correlation between the fund returns is 0.12.

You require that your portfolio yield an expected return of 13%, and that it be efficient, on the best feasible CAL.

a. What is the standard deviation of your portfolio? (Round your answer to 2 decimal places.

b. What is the proportion invested in the T-bill fund and each of the two risky funds? (Round your answers to 2 decimal places.)

T-bill fund-?

Stocks-?

Bonds-?

Renegade Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2.92 million and will last for six years. Variable costs are 32% of sales, and fixed costs are $2,033,463 per year. Machine B costs $5.05 million and will last for nine years. Variable costs for this machine are 21% of sales and fixed costs are $1,281,839 per year. The sales for each machine will be $10.2 million per year. The required return is 11 %, and the tax rate is 38%. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Calculate the NPV for machine A. (Round answer to 2 decimal places. Do not round intermediate calculations)

Topic: Capital Budgeting Problem