13.1 Seattle Health Plans currently uses zero-debt financing. Its operating income (earnings before interest and taxes, or EBIT) is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing bearing an interest rate of 8 percent. a. What impact would the new capital structure have on the firm’s net income, total dollar return to investors, and ROE? b. Redo the analysis, but now assume that the debt financing would cost 15 percent. c. Return to the initial 8 percent interest rate. Now, assume that EBIT could be as low as $500,000 (with a probability of 20 percent) or as high as $1.5 million (with a probability of 20 percent). There remains a 60 percent chance that EBIT would be $1 million. Redo the analysis for each level of EBIT, and find the expected values for the firm’s net income, total dollar return to investors, and ROE. What lesson about capital structure and risk does this illustration provide? d. Repeat the analysis required for Part a, but now assume that Seattle Health Plans is a not-for-profit corporation and pays no taxes. Compare the results with those obtained in Part a. (just need the answer to D.)

You are ready to buy a house and you have $85,000 for a down payment and closing costs. Closing costs are estimated to be 3.5% of the loan value.   You have an annual salary of $125,000. The bank is willing to allow your monthly mortgage payment to be equal to 28% of your monthly income.   The interest rate on the loan is 4.5% per year with monthly compounding for a 30-year fixed rate loan.

1. How much money will the bank loan you?
2. How much can you offer for the house?
3. Construct a loan amortization table for the mortgage. Please submit the actual Excel spreadsheet with formulas embedded in the spreadsheet.

The questions below are all based on the following assumptions:

1. Assume you are the CFO of a publicly traded corporation

2. Assume you are seeking to borrow and/or raise some money

3. Assume you have two options:

Option A: Sign with a bank for a 30-yr $100,000 bank loan at 3% APR

Option B: Issue a 30-yr $100,000 bond with a 3% coupon rate

Question 1) Which of the two options has the higher duration?

Question 2) In which of the options would you pay more interest over the full 30 years?

Question 3) Assuming that you knew interest rates were going to increase in the future, which of the two options would provide you with more free cash flow and flexibility to re-invest at the higher interest rate over the first 20 years?

You are asked to conduct a five-year economic feasibility study of an e-commerce site for a small office supply company. Due to construction time, the system will only be in operation for 6 months for the current year (Year 1). Once the system is in operation, you expect to reduce staff cost by $37,000 and to reduce printing/postage cost by $12,000 for a full year of operation between year 1 and year 3. The numbers will be $38,000 and $15,000, respectively, for year 4 and year 5.

New computer and software costs $6,000, and the cost of system development is estimated at $87,500. The software license and the cost of hiring/training a part-time operator is totaled $8,000 per full year of operation between year 1 and year 3. The same cost is estimated to be $9,000 for year 4 and 5.

1.) Calculate the NPV for the above project assuming a discount rate of 6%. Is there a break-even point in the first five years? If so, when? What is the ROI for the project? Make sure to prorate the appropriate system costs and benefits for Year 1. Make a spreadsheet showing all years.

2.) What is the impact on NPV if the discount rate is 9% instead? Does the NPV decreases with higher discount rate? Why or why not? Paste another copy of the spreadsheet.

3.) Use Goal Seek feature of Excel to find out the amount of the development cost that would make the NPV zero for the project.

Search case study “Orange County Bankruptcy”

a. What was the Orange County Governance Structure?

b. What was the Orange County Investment Pool and balance sheet (1994)?

c. What was Citrons Strategy?

d. How the Fed action affects the interest rate in 1994?

e. Describe the crisis following the Fed action.

f. Describe the outcomes?

Facebook (FB) currently trades at $194.00. You purchase a 16 month European $8.00 strike call option on a short futures contract on one share of FB. The futures delivery date is 29 months from now and the delivery price is $233.00. The risk-free rate is 5.1%. Compute the range of prices of FB 16 months from now that will make you want to exercise your option.

You own a wholesale plumbing supply store. The store currently generates revenues of $1.02 million per year. Next​ year, revenues will either decrease by 10.2% or increase by 4.6%​, with equal​ probability, and then stay at that level as long as you operate the store. You own the store outright. Other costs run $880,000 per year. There are no costs to shutting​ down; in that case you can always sell the store for $440,000. What is the business worth today if the cost of capital is fixed at 10.5%?  

​(​Hint: Make sure to round all intermediate calculations to at least four decimal places.​)

​  

Corporate bonds offer a series of fixed payments consisting of interest payments and face value at maturity. As so, managers of financial intermediaries like pension funds and insurance companies frequently utilize such instruments to achieve their financing objectives.

Questions for discussion:

What is assumed the interest payments can be reinvested at?

What is interest rate risk and what would happen to the price of a bond given interest rates increase?

Assume the manager of a $100 million portfolio of corporate bonds predicts interest rates will rise in the near future.

What adjustments should be made to the portfolio assuming the market has not already adjusted for this prediction?

Will a long-term zero coupon bond have more or less interest rate risk than a comparable coupon paying bond?

Give three reasons why an owner would wish to start a corporation rather than a proprietorship or partnership.

Problem 4-31 Non Annual Compounding It is now January 1. You plan to make a total of 5 deposits of $300 each, one every 6 months, with the first payment being made today. The bank pays a nominal interest rate of 8% but uses semiannual compounding. You plan to leave the money in the bank for 10 years.

How much will be in your account after 10 years? Round your answer to the nearest cent.

You must make a payment of $1,979.70 in 10 years. To get the money for this payment, you will make 5 equal deposits, beginning today and for the following 4 quarters, in a bank that pays a nominal interest rate of 8% with quarterly compounding.

How large must each of the 5 payments be? Round your answer to the nearest cent.

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 5%. The probability distribution of the risky funds is as follows:

The correlation between the fund returns is 0.10.

What is the Sharpe ratio of the best feasible CAL? (Do not round intermediate calculations. Enter your answers as decimals rounded to 4 places.)

Discuss the approaches currently used by retail investors to passively invest in equities markets, and consider how this may have changed over the past twenty years

Your firm is contemplating a capital investment in equipment that will enable a new product line. Last month you paid a consultant $50,000 to analyze the feasibility of the product line, but now you have tasked your financial analysis group with evaluating the product line. The equipment will cost $2,000,000 (payable today). The equipment will be depreciated straight line to $0 over the two year operating period. You believe that the equipment will have a $650,000 salvage value at the end of year 2. The expected annual revenues are $13,000,000, annual cash expenses will be $10,250,000. To start production, an upfront investment in net working capital of $50,000 will be required (assume full recovery at the end of the operating period). With a tax rate of 21% and a discount rate of 10%, should this expansion be undertaken?