Question

1. Linus Industries has the following profile as it introduces its latest smoothie blender. The new blender will produce incremental Earnings Before Interest and Taxes (EBIT) of $900,000.
   Linus Industries has a 34% marginal tax rate and the project will produce $300,000 of depreciation per year. Additionally, in Year 1 the project will also cause the following changes:

Accounts Receivable will increase by $10,000

Inventory will increase by $15,000

Accounts Payable will increase by $14,000

               

1. What is the change in EBIT?                                        ___________________________________

2. What is the change in Taxes?                                     ___________________________________

3. What is the change in Depreciation?                      ___________________________________

4. What is the change in Working Capital?                 ___________________________________

5. What is the 1^st Year Free Cash Flow?*                    ___________________________________

N.B. Assume no change in Capital Expenditures

2. Peanuts Industries is starting a new project to develop tiger logo pink slippers for the Clemson football team. This project will generate revenues of $300,000 annually. Annual cash expenses including Fixed and Variable Costs equal $190,000 --- in addition to the cash expenditures depreciation will be $20,000. The marginal tax rate is 40%. Calculate the operating cash flow for Peanuts Industries.

1. $54,000
2. $64,000
3. $74,000
4. $84,000

3. Lucy Inc. has a bond with a $1,000 face value, and a coupon rate of 10%. A new issue would have a flotation cost of 5% of the $1,125 market value. The bond will mature in 40 years. Lucy’s marginal tax rate is 34%. What is the approximate after tax cost of this capital?

1.    6.1%
2.    7.1%
3.    8.1%
4.    9.1%

4. The common stock of Lucy Inc. sells for $27.50 per share. If a new issue was to be sold the flotation costs would be 5%. Last year’s dividend was $1.80 and the anticipated growth for Lucy Inc. is 7%. What is the approximate cost of this anticipated new common stock?

        

1.    7.4%
2. 14.4%
3. 18.4%
4. 21.4%

5. Lucy Inc. issued new preferred stock paying a 9% dividend on a $300.00 par value. The flotation costs will be 12% of the current price of $1700. What is the cost of this capital?

1. 12.5%
2. 14.5%
3. 17.5%
4. 19.5%

6. The amount of capital held by Lucy Inc. is: Bonds $6,000,000, Common Stock-new of $9,600,000 and Preferred Stock of $8,400,000. Using the answers to Questions 10, 11, and 12 above what is the approximate weighted average cost of capital for Lucy Inc.?

1.    10.4%
2.    11.4%
3.    12.4%
4.    13.4%

7. Woodstock Inc. is a high fashion designer company located in Paris, France. The company specializes in wedding gowns for the famous. Sales last year were $40,000,000 with Fixed Costs of $6,000,000 and EBIT of $24,000,000. Calculate Woodstock Inc.’s breakeven point in dollars.

1. $   8 Million
2. $10 Million
3. $14 Million
4. $24 Million

Answer 1

Answer to Question 1:

Change in EBIT = Incremental EBIT
Change in EBIT = $900,000

Change in Taxes = Change in EBIT * Tax Rate
Change in Taxes = $900,000 * 0.34
Change in Taxes = $306,000

Change in Depreciation = $300,000

Change in Working Capital = Increase in Accounts Receivable + Increase in Inventory - Increase in Accounts Payable
Change in Working Capital = $10,000 + $15,000 - $14,000
Change in Working Capital = $11,000

Free Cash Flows = Change in EBIT - Change in Taxes + Change in Depreciation - Change in Working Capital
Free Cash Flows = $900,000 - $306,000 + $300,000 - $11,000
Free Cash Flows = $883,000

Answer to Question 1:

Change in EBIT = Incremental EBIT
Change in EBIT = $900,000

Change in Taxes = Change in EBIT * Tax Rate
Change in Taxes = $900,000 * 0.34
Change in Taxes = $306,000

Change in Depreciation = $300,000

Change in Working Capital = Increase in Accounts Receivable + Increase in Inventory - Increase in Accounts Payable
Change in Working Capital = $10,000 + $15,000 - $14,000
Change in Working Capital = $11,000

Free Cash Flows = Change in EBIT - Change in Taxes + Change in Depreciation - Change in Working Capital
Free Cash Flows = $900,000 - $306,000 + $300,000 - $11,000
Free Cash Flows = $883,000