Reference no: EM131312112

Fundamentals of Corporate Finance

1. Suppose that you own 2,200 shares of Nocash Corp. and the company is about to pay a 25% stock dividend. The stock currently sells at $100 per share.

a. What will be the number of shares that you hold after the stock dividend is paid?

b. What will be the total value of your equity position after the stock dividend is paid?

c. What will be the number of shares that you hold if the firm splits five for four instead of paying the stock dividend?

2. Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 1.5 million shares that are outstanding. Shareholders require a 10% rate of return from Consolidated stock.

a. What is the price of Consolidated stock?

b. What is the total market value of its equity?

Consolidated now decides to increase next year's dividend to $20 a share, without changing its investment or borrowing plans. Thereafter the company will revert to its policy of distributing $10 million a year.

c. How much new equity capital will the company need to raise to finance the extra dividend payment? (Enter your answer in millions.)

d. What will be the total present value of dividends paid each year on the new shares that the company will need to issue? (Enter your answer in millions.)

e. What will be the transfer of value from the old shareholders to the new shareholders? (Enter your answer in millions.)

f. Is this figure more than, less than, or the same as the extra dividend that the old shareholders will receive?

3. The expected pretax return on three stocks is divided between dividends and capital gains in the following way:

Stock	Expected Dividend	Expected Capital Gain
A	$  0	$ 6
B	1	1
C	24	0

a. If each stock is priced at $100, what are the expected net percentage returns on each stock to (i) a pension fund that does not pay taxes,

(ii) a corporation paying tax at 35% (The effective tax rate on dividends received by corporations is 10.5%), and (iii) an individual with an effective tax rate of 15% on dividends and 10% on capital gains?

b. Suppose that investors pay 50% tax on dividends and 20% tax on capital gains. If stocks are priced to yield an after-tax return of 8%, what would A, B, and C each sell for? Assume the expected dividend is a level perpetuity.

4. The following is the financial statement of Executive Fruit Company for the year ended December 2014.

INCOME STATEMENT, 2014
(Figures in $ Thousands)
Revenue	$	5,500
Cost of goods sold		4,950
EBIT	$	550
Interest		110
Earnings before taxes	$	440
State and federal tax		176
Net income	$	264
Dividends		176
Additions to retained earnings	$	88

BALANCE SHEET (Year-End, 2014)
(Figures in $ Thousands)
Assets
Net working capital	$	550
Fixed assets		2,200
Total assets	$	2,750
Liabilities and shareholders' equity
Long-term debt	$	1,100
Shareholders' equity		1,650
Total liabilities and shareholders' equity	$	2,750

The following are the first stage and second stage pro forma financial statements of Executive Fruit Company for the year ended December 2015.

PRO FORMA INCOME STATEMENT, 2015
(Figures in $ Thousands)
Revenue	$	6,050
Cost of goods sold		5,445
EBIT	$	605
Interest		110
Earnings before taxes	$	495
State and federal tax		198
Net income	$	297
Dividends		198
Additions to retained earnings	$	99

PRO FORMA BALANCE SHEET (Year-End, 2015)
(Figures in $ Thousands)
Assets
Net working capital	$	605
Fixed assets		2,420
Total assets	$	3,025
Liabilities and shareholders' equity
Long-term debt	$	1,100
Shareholders' equity		1,749
Total liabilities and shareholders' equity	$	2,849
Required external financing	$	176

Second stage pro forma balance sheet:

PRO FORMA BALANCE SHEET (Year-End, 2015)
(Figures in $ Thousands)
Assets
Net working capital	$	605
Fixed assets		2,420
Total assets	$	3,025
Liabilities and shareholders' equity
Long-term debt	$	1,276
Shareholders' equity		1,749
Total liabilities and shareholders' equity	$	3,025

How would Executive Fruit's financial model change if the dividend payout ratio were cut to 1/3? Use the revised model to generate a new financial plan for 2015 assuming that debt is the balancing item. What would be the required external financing?

The right-hand side of the balance sheet becomes.

5. Find the sustainable and internal growth rates for a firm with the following ratios: asset turnover = 2.00; profit margin = 4%; payout ratio = 35%; equity/assets = .30.

6. Executive Fruit's financial manager believes that sales in 2015 could rise by as much as 20% or by as little as 5%. Assets and costs change in proportion to sales, debt remains constant, and no new equity financing occurs.

a. Recalculate the first-stage pro forma financial statements under these two growth assumptions and calculate the required external financing (All figures are in thousands). (Enter your answers in thousands.)

	Base Case			20% Growth		5% Growth
INCOME STATEMENT
Revenue	$	6,000		$		$
Cost of goods sold		5,400
EBIT	$	600		$		$
Interest		120
Earnings before taxes	$	480		$		$
State and federal tax		192
Net income	$	288		$		$
Dividends		192
Retained earnings	$	96		$		$
BALANCE SHEET
Assets
Net working capital	$	600		$		$
Fixed assets		2,400
Total assets	$	3,000		$		$
Liabilities and shareholders' equity
Long-term debt	$	1,200		$		$
Shareholders' equity		1,800
Total liabilities and shareholders' equity	$	3,000		$		$
Required external financing				$		$

b. Assume any required external funds will be raised by issuing long-term debt and that any surplus funds will be used to retire such debt. Prepare the completed (second-stage) pro forma balance sheet. (Enter your answers in thousands.)

BALANCE SHEET
	Base Case			20% Growth		5% Growth
Assets
Net working capital	$	600		$		$
Fixed assets		2,400
Total assets	$	3,000		$		$
Liabilities and shareholders' equity
Long-term debt	$	1,200		$		$
Shareholders' equity		1,800
Total liabilities and shareholders' equity	$	3,000		$		$

7. Plank's Plants had net income of $4,000 on sales of $70,000 last year. The firm paid a dividend of $1,480. Total assets were $200,000, of which $80,000 was financed by debt.

a. What is the firm's sustainable growth rate?

b. If the firm grows at its sustainable growth rate, how much debt will be issued next year?

c. What would be the maximum possible growth rate if the firm did not issue any debt next year? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

8. An all-equity-financed firm plans to grow at an annual rate of at least 24%. Its return on equity is 37%. What is the maximum possible dividend payout rate the firm can maintain without resorting to additional equity issues?

9. The 2015 financial statements for Growth Industries are presented below:

INCOME STATEMENT, 2015
Sales		$	270,000
Costs			185,000
EBIT		$	85,000
Interest expense			17,000
Taxable income		$	68,000
Taxes (at 35%)			23,800
Net income		$	44,200
Dividends	17,680
Addition to retained earnings	26,520

BALANCE SHEET, YEAR-END, 2015
Assets			Liabilities
Current assets			Current liabilities
Cash	$	3,000	Accounts payable	$	10,000
Accounts receivable		8,000	Total current liabilities	$	10,000
Inventories		29,000	Long-term debt		170,000
Total current assets	$	40,000	Stockholders' equity
Net plant and equipment		210,000	Common stock plus additional paid-in capital		15,000
			Retained earnings		55,000
Total assets	$	250,000	Total liabilities and stockholders' equity	$	250,000

Sales and costs in 2016 are projected to be 30% higher than in 2015. Both current assets and accounts payable are projected to rise in proportion to sales. The fixed assets of Growth Industries are operating at only 75% of capacity. Interest expense in 2016 will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of .40.

What is the required external financing over the next year?

Even if sales increase by 30%, the firm still has more than enough fixed assets to meet production. Only working capital will increase. Net working capital of the firm in 2015 was $ . The increase in net working capital will be $ , which is less than the increase in the retained earnings. Thus required external financing is $ . A negative external financing value indicates the firm will generate more cash than it needs to finance the projected growth. This extra cash can be used to reduce debt, repurchase shares, increase cash reserves, or fund future growth. This extra cash was primarily due to the firm's excess production capacity.

Income statement data:
Sales	$	6,000
Cost of goods sold		5,200
Balance sheet data:
Inventory	$	590
Accounts receivable		210
Accounts payable		370

 

10. Calculate the accounts receivable period, accounts payable period, inventory period, and cash conversion cycle for the above firm:

11. Complete the statement of sources and uses of cash from the following entries:

Net income	$2,000
Dividends	800
Additions to inventory	170
Additions to receivables	200
Depreciation	140
Reduction in payables	600
Net issuance of long-term debt	350
Sale of fixed assets	110

Sources
Issued long-term debt	$
Sale of fixed assets
Cash from operations:
Net income
Depreciation
Total sources	$
Uses
Additions to inventory	$
Increase in accounts receivable
Decrease in accounts payable
Payment of dividends
Total uses	$

12. Here is a forecast of sales by National Bromide for the first 4 months of 2015 (figures in thousands of dollars):

Month:	1			2			3			4
Cash sales		26			35			29			25
Credit sales		155			175			145			125

On average, 60% of credit sales are paid for in the current month, 20% in the next month, and the remainder in the month after that. What are the expected cash collections in months 3 and 4?

13. A firm sells its $1,090,000 receivables to a factor for $1,079,100. The average collection period is 1 month. What is the effective annual rate on this arrangement? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

14. Company X sells on a 1/10, net 60, basis. Customer Y buys goods with an invoice of $2,000.

a. How much can company Y deduct from the bill if it pays on day 10?

b. How many extra days of credit can company Y receive if it passes up the cash discount?

c. What is the effective annual rate of interest if Y pays on the due date rather than day 10?

15. Microbiotics currently sells all of its frozen dinners cash on delivery but believes it can increase sales by offering supermarkets 1 month of free credit. The price per carton is $80, and the cost per carton is $55. The unit sales will increase from 1,030 cartons to 1,090 per month if credit is granted. Assume all customers pay their bills and take full advantage of any credit period offered.

a. If the interest rate is 1% per month, what will be the change in the firm's total monthly profits on a present value basis if credit is offered to all customers?

b. If the interest rate is 1.5% per month, what will be the change in the firm's total monthly profits on a present value basis if credit is offered to all customers?

c. Assume the interest rate is 1.5% per month but the firm can offer the credit only as a special deal to new customers, while existing customers will continue to pay cash on delivery. What will be the change in the firm's total monthly profits on a present value basis under these conditions?

16. On each nondelinquent sale Cast Iron receives revenues with a present value of $1,280 and incurs costs with a present value of $1,130. Assume there is no possibility of repeat orders and that the probability of successful collection from the customer is p = .97.

a-1. What is the expected profit of granting credit?

a-2. Should Cast Iron grant or refuse credit?

b. What is the break-even probability of collection?

17. Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lock-box system. She forecasts that 450 payments a day will be made to lock boxes with an average payment size of $3,000. The bank's charge for operating the lock boxes is $.50 a check. The interest rate is .012% per day.

a-1. If the lock box makes the cash available 2 days earlier, calculate the net daily advantage of the system.

a-2. Is it worthwhile to adopt the system?

b. What minimum reduction in the time to collect and process each check is needed to justify use of the lock-box system?