Reference no: EM131261802

Assignment 1 -

Question 1: The Rivoli Company has no debt outstanding, and its financial position is given by the following data:

Assets (market value = book value)	$3,000,000
EBIT	$500,000
Cost of equity	10%
Stock price	$15
Shares outstanding	200,00
Tax rate	40%

The firm wants to sell bonds and simultaneously repurchase some of its stock. If t moves to a capital structure with 30% debt, its cost of equity rises to 11% to reflect the increased risk. Bonds can be sold at a cost of 7%. Rivoli is a no-growth firm. Hence all its earnings are paid out as dividends. Earnings are expected to be constant over time.

a) What effect would this use of leverage have on the value of the firm?

b) What would be Rivoli's stock price?

c) What happens to the firm's earnings per share after the recap?

Question 2: Peterson Company has a capital budget of $1.2 million. It wants to maintain its 60% debt and 40% equity target capital structure. It forecasts its net income next year will be $600,000. If it follows a residual distribution policy and pays all distributions as dividends, what will be its payout ratio?

Assignment 2 -

Question 1: Bynum and Crumpton Inc. (B&C), a small jewelry manufacturer, has been successful. Now B&C is planning to go public with an issue of common stock, and faces the problem of setting a price for it. The company and its investment banks believe it should conduct a valuation based on a comparison of several similar companies that are publicly traded.

Of these companies, Abercrombe Jewelers and Gunther Fashions are most similar to B&C in terms of product mix, asset composition, and debt/equity proportions. Here's some data:

Company Data	Abercrombe	Gunther	B&C
Shares outstanding	5 million	10 million	1,000
Price per share	$35	$47	?
Earnings per share	$2.20	$3.75	$1,332.50
Free cash flow per share	$1.54	$2.25	$976.00
Book value per share	$16.00	$21.00	$7,500.55
Total assets	$115 million	$260 million	$11.5 million
Total debt	$35 million	$50 million	$4 million

a) B&C has 1,000 shares outstanding. Free cash flows have been low and in some years negative due to its recent high sales growth rates, but as its expansion phase comes to an end B&C's cash flows should increase. B&C anticipates the following cash flows for the next 5 years: Year 1 $1,025,000; Year 2 $1,076,000; Year 3 $1,237,000; Year 4 $1,361,000; Year 5 $1,497,000.

After Year 5, free cash flows grow at 7% a year. Currently B&C has no non-operating assets, has $4 million in debt, and its WACC is 12%. Calculate the value of its equity and per share value using the corporate valuation model.

b) Calculate debt to total assets, P/E, market to book, P/CF, and ROE for all 3 companies. For B&C's price, use the answer from part a).

c) Based on your answers from parts (a) and (b), do you think that B&C stock would sell in the same ballpark as that of Abercrombe and Gunther - that is in the $25 to $100 per share range?

d) Using Abercrombe's and Gunther's P/E, Market/Book, and Price/FCF ratios, calculate the range of prices for B&C's stock. For example, if you multiply B&C's earnings per share by Abercrombe's P/E ratio you get a price. How does this compare to your answer from part b)?

e) Assuming B&C's management can split the stock so that 1,000 shares could be changed to 10,000 shares, 100,000 shares, or any other number, would such an action make sense?

f) Should B&C split the stock and at what price do you think B&C's shares should be offered to the public?

Question 2: Maese Industries Inc. has warrants outstanding that permit the bondholders to purchase 1 share of stock per warrant at a price of $25.

a) Calculate the exercise value of the warrants if the common sells at each of the following prices: (1) $20, (2) $25, (3) $30, (4) $100. (Hint: A warrant's exercise value is the difference between the stock price and the exercise price.)

b) Assume the firm's stock now sells for $20 per share. The company wants to sell some 20-year, $1,000 par value bonds with interest paid annually.

Each bond has 50 warrants attached with a $25 exercise price for each share. The firm's straight bonds yield 12%. Each warrant has a market value of $3 when the stock is $20. What coupon rate, and dollar coupon, must the company set on the bonds with warrants? (Hint: The convertible bond has an initial price of $1,000.)

Question 3: The Tsetsekos Company was planning to finance an expansion by means of common stock rather than debt. However, management felt the current $42 per share is too low so they decided to issue a convertible preferred stock which would pay a dividend of $2.10 per share.

a) The conversion ratio will be 1.0, that is, one share of convertible preferred can be converted to one share of common. Therefore, the convertible's par value (and also the issue price) will be equal to the conversion price, which in turn will be determined as a premium (i.e. the percentage by which the conversion price exceeds the stock price) over the current market price of the common stock. What will the conversion price be if it is set at a 10% premium? At a 30% premium?

b) Should the preferred stock include a call provision? Why?

Assignment 3 -

Question 1: Strickler Technology is considering changes in its working capital policies to improve its cash flow cycle. Strickler's sales last year were $3,250,000 (all on credit), and its net profit margin was 7%. Its inventory turnover was 9.0 times during the year and its DSO was 41 days. Its annual cost of goods sold was $1,895,000. The firm had fixed assets totaling $535,000. Strickler's payables deferral period is 45 days.

a) Calculate Stricker's cash conversion cycle.

b) Assuming Strickler holds negligible amounts of cash and marketable securities, calculate its total assets turnover and ROA.

c) Suppose Strickler's managers believe the annual inventory turnover can be raised to 12 times without affecting sales. What would Strickler's cash conversion cycle, total assets turnover, and ROA have been if the inventory had been 12 for the year?

Question 2: Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industry wide credit terms have recently been lowered to net 30 days. On annual credit sales $2.5 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,375,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit.

Vinson's variable cost ratio is 85% , and taxes are 40%. If the interest rate on funds invested in receivable is 18%, should the change in credit terms be made?

Question 3: Del Hawley, owner of Hawley's Hardware, is negotiating with First City Bank for a 1-year loan of $50,000. First City has offered Hawley the alternatives listed below. Calculate the effective annual interest rate for each alternative. Which alternative has the lowest effective annual interest rate?

a) A 12% annual rate on a simple interest loan, with no compensating balance required and interest due at the end of the year.

b) A 9% annual rate on a simple interest loan, with a 20% compensating balance required and interest due at the end of the year.

c) An 8.75% annual rate on a discounted loan, with a 15% compensating balance.

d) Interest figured as 8% of the $50,000 amount, payable at the end of the year, but with the loan amount repayable in monthly installments during the year.

Assignment 4 -

Question 1: Andria Mullins, financial manager of Webster Electronics, has been asked by the firm's CEO, Fred Weygandt, to evaluate the company's inventory control techniques and to lead a discussion of the subject with the senior executives. Andria plans to use as an example one of Webster's "big ticket" items, a customized computer microchip which the firm uses in its laptop computer. Each chip costs Webster $200, and in addition it must pay its supplier a $1,000 setup fee on each order. Further, the minimum order size is 250 units; Webster's annual usage forecast is 5,000 units; and the annual carrying cost of this item is estimated to be 20 percent of the average inventory value.

Andria plans to begin her session with the senior executives by reviewing some basic inventory concepts, after which she will apply the EOQ model to Webster's microchip inventory. As her assistant, you have been asked to help her by answering the following questions:

a) What is the EOQ for custom microchips? What are total inventory costs if the EOQ is ordered?

b) What is Webster's added cost if it orders 400 units at a time rather than the EOQ quantity? What if it orders 600 per order?

c) Suppose it takes 2 weeks for Webster's supplier to set up production, make and test the chips, and deliver them to Webster's plant. Assuming certainty in delivery times and usage, at what inventory level should Webster reorder? (Assume a 52-week year, and assume that Webster orders the EOQ amount.)

d) Of course, there is uncertainty in Webster's usage rate as well as in delivery times, so the company must carry a safety stock to avoid running out of chips and having to halt production. If a 200-unit safety stock is carried, what effect would this have on total inventory costs? What is the new reorder point? What protection does the safety stock provide if usage increases, or if delivery is delayed?

e) Now suppose Webster's supplier offers a discount of 1 percent on orders of 1,000 or more. Should Webster take the discount? Why or why not?

Question 2: Carter Enterprises can issue floating-rate debt at LIBOR+2% or fixed rate debt at 10%. Brence Manufacturing can issue floating-rate debt at LIBOR+3.1% or fixed-rate debt at 11%. Suppose Carter issues floating-rate debt and Brence issues fixed-rate debt. They are considering a swap in which Carter makes a fixed-rate payment of 7.95% to Brence and Brence makes a payment of LIBOR to Carter. What are the net payments of Carter and Brence if they engage in the swap?

Would Carter be better off if it issued fixed-rate debt or if it issued floating-rate debt and engaged in the swap? Would Brence be better off if it issued floating-rate debt or if it issued fixed-rate debt and engaged in the swap?

Assignment 5 -

Question 1: Marston Marble Corporation is considering a merger with the Conroy Concrete Company. Conroy is a publicly traded company, and its beta is 1.30. Conroy has been barely profitable, so it has paid an average of only 20% in taxes during the last several years. In addition, it uses little debt: its target ratio is just 25%, with the cost of debt 9%.

If the acquisition were made, Marston would operate Conroy as a separate, wholly owned subsidiary. Marston would pay taxes on a consolidated basis, and the rate would therefore increase to 35%. Marston also would increase the debt capitalization in the Conroy subsidiary to w = 40%, for a total of $22.27 million in debt by the end of Year 4, and pay 9.5 % on the debt. Marston's acquisition department estimates that Conroy, if acquired, would generate the following free cash flows and interest expenses (in millions of dollars) in Years 1-5:

Year	Free Cash Flows	Interest Expense
1	$1.30	$1.2
2	1.50	1.7
3	1.75	2.8
4	2.00	2.1
5	2.12	?

In Year 5, Conroy's interest expense would be based on its beginning-of-year (that is, the end-of-Year 4) debt, and in subsequent years both interest expense and free cash flows are projected to grow at a rate of 6%.

These cash flows include all acquisition effects. Marston's cost of equity is 10.5%, its beta is 1.0, and its cost of debt is 9.5%. The risk-free rate is 6%, and the market risk premium is 4.5%.

a) What is the value of Conroy's unlevered operations, and what is the value of Conroy's tax shields under the proposed merger and financing arrangements?

b) What is the dollar value of Conroy's operations? If Conroy has $10 million in debt outstanding, how much would Marston be willing to pay for Conroy?

Question 2: The South Korean multinational manufacturing firm, Nan Sung Industries is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 13%. The current exchange rate is 1,050 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are:

	1 - Year	2 - Year
United States	4.0%	4.25%
S. Korea	3.0%	3.25%

a) If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return of this project?

b) What is the expected forward exchange rate 1 year from now and 2 years from now?

c) If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Nam Sung?