Text Problem Sets 1

RUNNING HEAD: TEXT PROBLEM SETS

Text Problem Sets

Text Problem Sets 2

Text Problem Sets

Ch. 17: Problem B1 (p. 500)

B1. (Choosing financial targets) Bixton Company’s new chief financial officer is evaluating Bixton’s capital structure. She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here.

a. Bixton’s objective is to achieve a credit standing that falls, in the words of the chief financial officer, “comfortably within the ‘A’ range.” What target range would you recommend for each of the three credit measures?Answer: Being comfortably means to be off the low end of the ratings.Fixed Charge Coverage = 3.40 - 4.30Cash Flow / Total Debt = 55 - 65Long-Term Debt / Total Capitalization = 25 - 30

b. Before settling on these target ranges, what other factors should Bixton’s chief financial officer consider?Answer: Being able to use non-interest tax credits and debt management considerations such as issuance costs. The chief financial officer should also consider that the intangible assets and arguments lenders may use to determine loan levels.

c. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve?Answer: In some instances, additional tax shield from additional debt can have little effects. The financial officer should also consider the importance of foreign tax credits.

FUNDS FROMRATING FIXED CHARGE OPERATIONS/ LONG-TERM DEBT/CATEGORY COVERAGE TOTAL DEBT CAPITALIZATION

Aa 4.00–5.25x 60–80% 17–23%A 3.00–4.30 45–65 22–32Baa 1.95–3.40 35–55 30–41

Text Problem Sets 3

Ch. 18: Problems A10 & B2 (p. 542)

A10. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model, Equation (18.1), to calculate projected dividends per share for this year and the next four.

Answer

D1 = ADJ [POR(EPS1) - D0] + D0

D1 = 0.75 [0.25 x $8.00 - $1.00] + $1.00 = $1.75D2 = 0.75 [0.25 x $8.00 - $1.75] + $1.75 = $1.94D3 = 0.75 [0.25 x $8.00 - $1.94] + $1.94 = $1.985D4 = 0.75 [0.25 x $8.00 - $1.98] + $1.98 = $2.00D5 = 0.75 [0.25 x $8.00 - $2.00] + $2.00 = $2.00

B2. (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions.

a. Over the five-year period, what is the maximum overall payout ratio the firm could achieve without triggering a securities issue?

Total discretionary cash flow = $50 + $70 + $60 + $20 + $15 = $215Total earnings = $100 + $125 + $150 + $120 + $140 = $635Maximum Payout Ratio = $215 / $635 = 33.86%

b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years1 through 5.

1 2 3 4 5 THEREAFTEREarnings 100 125 150 120 140 150+ per yearDiscretionary cash flow 50 70 60 20 15 50+ per year

Current dividend = $1.50 x 20 million shares = $30 millionThe firm could gradually increase the dividend from $30 million to $50 million.D1 = $35 / 20 = $1.75D2 = $39 / 20 = $1.95D3 = $43 / 20 = $2.15

Text Problem Sets 4

D4 = $48 / 20 = $2.40D5 = $50 / 20 = $2.50Note that $35 + $39 + $43 + $48 + $50 = $215, the total discretionary cash flow and since large discretionary cash flows occur at the beginning, there is never a discretionary cash deficit.

Ch. 20: Problem A2 (p. 603)

A2. (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)?

Number of Periods (nper) 40(20) =Coupon Payments (pmt) 2,250,000 4,625,000 Net Proceeds of Bond (PV) 49,000,000 (option 1) 49,500,000 (option 2)

Face Value of Bond (FV) 50,000,000 (both option 1 & 2)Yield to Maturity 4.61% Bond Equivalent Yield 9.22% (option 1) 9.36% (option 2)

1. n = 40 r = ? PV = -($50 - $1) = -$49 PMT = 9% / 2 x $50 = $2.25 FV = $50 r = 4.61%

APY = (1 + 0.0461)2 -1 = 0.09432521 = 9.4334%2. n = 20 r = ? PV = -($50 - $0.5) = -$49.5 PMT = 9.25% x $50 = $4.625 FV = $50 r = 9.36%

APY = 9.36%

Choice 2 (9.36%) has the lower Annual Percentage Yield (APY).

Ch. 8: Problem A7 (p. 211)

A7. (Finding NPVs with differing project risks) Assume the expected return on the market portfolio is 15% and the riskless return is 9%. Also assume that all of the projects listed here are perpetuities with annual cash flows (in $) and betas as indicated. None of the projects requires or precludes any of the other projects, and each project costs $2,000.

a. What is the NPV of each project?

PROJECT A B C D E FAnnual cash flow 310 500 435 270 385 450Beta 1.00 2.25 2.22 0.65 1.37 2.36

Text Problem Sets 5

PROJECT A B C D E FAnnual cash flow

310 500 435 270 385 450

Beta 1 2.25 2.22 0.65 1.37 2.36Market return 15% 15% 15% 15% 15% 15%Riskless return 9% 9% 9% 9% 9% 9%Risk premium 6% 6% 6% 6% 6% 6%CAPM 15.00% 22.50% 22.32% 12.90% 17.22% 23.16%Project cost

2,000 2,000

2,000

2,000

2,000

2,000

NPV 66.67

222.22

(51.08)

93.02

235.77

(56.99)

b. Which projects should the firm undertake? The firm should undertake projects A, B, D, and E

Ch. 9: Problem A5 (p. 236)A5. (Investment criteria) Compute the NPV, IRR, and payback period for the following investment. The cost of capital is 10%.

YEAR 0 1 2 3

Cash flow -200,000 100,000 100,000 150,000

NVP= (10%(-200000,100000,100000,150000) = $78,409.94IRR= (-200000,100000,100000,150000) = 31.45%Payback Period: 2 years

Ch. 10: Problem B5 (p. 270)B5. (Cash flows and NPV for a new project) Syracuse Roadbuilding Company is considering the purchase of a new tandem box dump truck. The truck costs $95,000, and an additional $5,000 is needed to paint it with the firm logo and install radio equipment. Assume the truck falls into the MACRS three-year class. The truck will generate no additional revenues, but it will reduce cash operating expenses by $35,000 per year. The truck will be sold for $40,000 after its five-year life. An inventory investment of $4,000 is required during the life of the investment. Syracuse Roadbuilding is in the 45% income tax bracket.

a. What is the net investment?b. What is the after-tax net operating cash flow for each of the five years?c. What is the after-tax salvage value?d. Assuming a 10% cost of capital, what is the NPV of this investment?

(See attached spreadsheet for answer)

Text Problem Sets 6

Answer the following questions from your International Financial Management textbook in 100 to 150 words.

Ch. 12: Question 5 (p. 311)5. Discuss the process of bringing a new international bond issue to market.

Borrowers want money by issuing bonds to investors. They will get in touch with the bank and ask to increase to act as leader of a group of underwriters in securities. The leader is most likely to ask others to a management group to form and negotiate an agreement with the borrower, assess market conditions and program management. The management team and banks, insurers, and the problem, or use their own capital to acquire the number of borrowers. Most insurers/underwriters, will sell bonds to investors and each underwriter receives a percentage depending on the duties they performed.

Ch. 13: Question 2 (p.335) As an investor, what factors would you consider before investing in the emerging stock market of a developing country?An investor in emerging market stocks needs to be concerned with the depth of the market and the market’s liquidity.  Depth of the market shows investment opportunities in a country.  One measure of the depth of the market is the concentration ratio of a country’s stock market.  The concentration ratio frequently shows the market value of the top stocks traded.  A high concentration ratio indicates a shallow market.   

In terms of liquidity, an investor would be wise to examine the market turnover ratio of the country’s stock market.  Companies strive from day to day to make their business publicly strong, financially strong, and appealing and profitable for its shareholders. Financial ratios show market turnover rates. Ratios help measure a company's liquidity, activity, profitability, leverage and coverage. 

Other factors to consider include the country-risk analysis. For instances, political changes may change economic policies. During political, civil unrest, labor unrest, war or shear macroeconomic mismanagement there can be instances of expropriation (loss of assets, termination of operations), currency inconvertibility (inability to repatriate profits, import), higher taxes (less after tax revenues), higher tariffs (higher import costs), inflation (higher costs, difficult planning, currency depreciation), higher interest rates (higher borrowing costs in host country), and hard currency shortage.  

Text Problem Sets 7

References:

Douglas R.Emery, John D.Finnerty, and John D.Stowe (2007). Corporate Financial

Management (3rd ed.). New Jersey: Pearson-Prentice Hall.

Eun & Resnick. (2007). International Financial Management (4th ed.).New YorkMcGraw-Hill.