ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all-equity financed with $680,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $340,000 and the interest rate on its debt is 7 percent. Both firms expect EBIT to be $67,000. Ignore taxes. a. Rico owns $41,500 worth of XYZ’s stock. What rate of return is he expecting? b. Show how Rico could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage. c. What is the cost of equity for ABC? What is it for XYZ? d. What is the WACC for ABC? For XYZ? What principle have you illustrated?
> Who benefits from subsidies to U.S. sugar producers? Who loses?
> One of the first actions of President Trump was to withdraw from negotiations on establishing the TTIP. Why do you think he did this? How does withdrawal benefit America? What are the opportunity costs of not pursuing the TTIP? Is Trump’s decision good f
> The Trans Pacific Partnership (TTP) met with significant political resistance in the United States when it was announced, (see the closing case to Chapter 6), while the TTIP did not. Why do you think this is the case?
> Two decades ago when the United States entered into the North American Free Trade Agreement with Canada and Mexico, there was significant opposition from organized labor and some politicians. There does not seem to be the same level of opposition to the
> Can you think of any drawbacks associated with the TTIP?
> What are the benefits of the proposed TTIP?
> The Flint, Michigan, water crisis highlighted a major issue in the United States regarding old lead-based pipes used to transport water to the community. This came to light in Flint due to the failure of applying corrosion inhibitors to the water when th
> With some 80 percent of the toys sold in the United States being manufactured in China, should the United States place greater emphasis on its toy-trading relationship with China? Could the United States control China’s manufacturing more than it does to
> On balance, do you think that the kind of outsourcing undertaken by American health care providers is a good thing or a bad thing for the American economy? Explain your reasoning.
> Should there be a global standard for toy manufacturing? What are some of the benefits and what are some of the drawbacks of a potential global quality and manufacturing standard?
> With Alibaba’s ownership of the very popular Tmall and Taobao online shopping systems (similar to eBay and Amazon) and its spread across the world, will a Western-based online shopping culture ultimately infiltrate China?
> If China will go from 17 million to 200 million middle- and upper-income people by the early 2020s, would the scenario presented by Best Buy not be applicable anymore? Would newly rich Chinese customers engage in this purchasing in the 2020s?
> Will China maintain its strong economic growth in the years to come? Some suggest it will until 2050. What do you think?
> In November 2015, the democratic opposition won a landslide victory in a general election. How do you think this will affect Myanmar’s economic growth trajectory going forward? What are the risks here?
> What potential impediments do you think might stand in the way of further improvements in Myanmar?
> How would you characterize the nature of the economic reforms now being implemented in Myanmar? What is the government trying to do here? What do you think the results will be?
> What do you think motivated the government of Myanmar to start undertaking political and economic reforms from 2010 onward?
> What explains the economic stagnation of Myanmar until very recently?
> By 2016, Venezuela’s economy appeared to be on the brink of total collapse. What do you think needs to be done to reverse this?
> What are the benefits to American medical providers of outsourcing certain well-defined tasks such as interpreting an MRI scan to foreign providers based in countries such as India? What are the costs?
> Your company is deciding whether to invest in a new machine. The new machine will increase cash flow by $485,000 per year. You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will
> Consider the following financial statement information for the Newk Corporation: Assume all sales are on credit. Calculate the operating and cash cycles. How do you interpret your answer?
> The Morning Jolt Coffee Company has projected the following quarterly sales amounts for the coming year: a. Accounts receivable at the beginning of the year are $335. The company has a 45-day collection period. Calculate cash collections in each of the
> Cori’s Corp. has an equity value of $14,735. Long-term debt is $8,300. Net working capital, other than cash, is $2,850. Fixed assets are $18,440. How much cash does the company have? If current liabilities are $2,325, what are current assets?
> Cheap Money Bank offers your firm a discount interest loan at 9.85 percent for up to $25 million and, in addition, requires you to maintain a 4.5 percent compensating balance against the amount borrowed. What is the effective annual interest rate on this
> In exchange for a $300 million fixed commitment line of credit, your firm has agreed to do the following: 1. Pay 1.93 percent per quarter on any funds actually borrowed. 2. Maintain a 4.5 percent compensating balance on any funds actually borrowed. 3. Pa
> A bank offers your firm a revolving credit arrangement for up to $75 million at an interest rate of 1.75 percent per quarter. The bank also requires you to maintain a compensating balance of 5 percent against the unused portion of the credit line, to be
> You’ve worked out a line of credit arrangement that allows you to borrow up to $50 million at any time. The interest rate is .37 percent per month. In addition, 4 percent of the amount that you borrow must be deposited in a non-interest-bearing account.
> Below are the most recent balance sheets for Country Kettles, Inc. Excluding accumulated depreciation, determine whether each item is a source or a use of cash and the amount:
> Here are some important figures from the budget of Nashville Nougats, Inc., for the second quarter of 2021: The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its sales will be collected in the month of the s
> The following is the sales budget for Lemonis, Inc., for the first quarter of 2021: Credit sales are collected as follows: 65 percent in the month of the sale. 20 percent in the month after the sale. 15 percent in the second month after the sale. The a
> You want to create a portfolio equally as risky as the market, and you have $1,000,000 to invest. Given this information, fill in the rest of the following table:
> In Problem 8, suppose the company instead decides on a 4-for-1 stock split. The firm’s 75-cent per-share cash dividend on the new (postsplit) shares represents an increase of 10 percent over last year’s dividend on the presplit stock. What effect does th
> The company with the common equity accounts shown here has declared a 15 percent stock dividend when the market value of its stock is $64 per share. What effects will the distribution of the stock dividend have on the equity accounts? Common stock ($1 p
> The market value balance sheet for Murray Manufacturing is shown here. The company has declared a 25 percent stock dividend. The stock goes ex dividend tomorrow (the chronology for a stock dividend is similar to that for a cash dividend). There are 11,00
> In Problem 5, suppose the company has announced it is going to repurchase $17,400 worth of stock. What effect will this transaction have on the equity of the firm? How many shares will be outstanding? What will the price per share be after the repurchase
> The balance sheet for Quinn Corp. is shown here in market value terms. There are 12,000 shares of stock outstanding. The company has declared a dividend of $1.45 per share. The stock goes ex dividend tomorrow. Ignoring any tax effects, what is the stoc
> Stockton Mineral Operations, Inc. (SMO), currently has 540,000 shares of stock outstanding that sell for $83 per share. Assuming no market imperfections or tax effects exist, what will the share price be after: a. SMO has a 5-for-3 stock split? b. SMO ha
> For the company in Problem 2, show how the equity accounts will change if: a. The company declares a 4-for-1 stock split. How many shares are outstanding now? What is the new par value per share? b. The company declares a 1-for-5 reverse stock split. How
> The owners’ equity accounts for Vulcano International are shown here: Common stock ($.50 par value) …………….. $ 20,000 Capital surplus …………………………………….. 210,000 Retained earnings ………………………………… 587,300 Total owners’ equity …………………………… $ 817,300 a. If the c
> After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 3 percent or paying the cash out to investors who would invest in the
> National Business Machine Co. (NBM) has $5 million of extra cash after taxes have been paid. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets. The resulting investment income will be paid out as a sp
> Consider the following information about three stocks: a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected return? The variance? The standard deviation? b. If the expected T-bill rate is 3.70
> As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not n
> The Gecko Company and the Gordon Company are two firms that have the same business risk but different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 2.9 percent. Suppose the capital gains tax rate is zero, whe
> Erna Corporation is evaluating an extra dividend versus a share repurchase. In either case, $53,500 would be spent. Current earnings are $1.79 per share, and the stock currently sells for $64 per share. There are 9,000 shares outstanding. Ignore taxes an
> In Problem 10, suppose you want only $1,500 total in dividends the first year. What will your homemade dividend be in two years? Problem 10: You own 1,000 shares of stock in Avondale Corporation. You will receive a $3.45 per share dividend in one year.
> You own 1,000 shares of stock in Avondale Corporation. You will receive a $3.45 per share dividend in one year. In two years, the company will pay a liquidating dividend of $62 per share. The required return on the company’s stock is 15 percent. What is
> Gatto, Inc., has declared a $5.85 per share dividend. Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be withheld at the time the dividend is paid. The company’s stock sells for $78.35 pe
> Finch, Inc., is debating whether to convert its allequity capital structure to one that is 30 percent debt. Currently, there are 6,500 shares outstanding, and the price per share is $51. EBIT is expected to remain at $41,000 per year forever. The interes
> Ignoring taxes in Problem 6, what is the price per share of equity under Plan I? Plan II? What principle is illustrated by your answers? Problem 6: Dickson Corp. is comparing two different capital structures. Plan I would result in 12,700 shares of stoc
> Dickson Corp. is comparing two different capital structures. Plan I would result in 12,700 shares of stock and $100,050 in debt. Plan II would result in 9,800 shares of stock and $226,200 in debt. The interest rate on the debt is 10 percent. a. Ignoring
> Ying Import has several bond issues outstanding, each making semiannual interest payments. The bonds are listed in the following table. If the corporate tax rate is 22 percent, what is the aftertax cost of the companyâ€™s debt?
> In Problem 4, use M&M Proposition I to find the price per share of equity under each of the two proposed plans. What is the value of the firm? Problem 4: Foundation, Inc., is comparing two different capital structures: an all-equity plan (Plan I) and a
> Foundation, Inc., is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 145,000 shares of stock outstanding. Under Plan II, there would be 125,000 shares of stock out
> Suppose the company in Problem 1 has a market-tobook ratio of 1.0 and the stock price remains constant. a. Calculate return on equity (ROE) under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in ROE
> In Problem 3, suppose instead that you assume the company has a market-to-book ratio of 1.0 before recapitalization and the stock price changes according to M&M. How would this affect your answer? Problem 3: Suppose the company in Problem 1 has a market
> Repeat parts (a) and (b) in Problem 1 assuming the company has a tax rate of 21 percent, a market-to-book ratio of 1.0, and the stock price remains constant. Problem 1: Fujita, Inc., has no debt outstanding and a total market value of $222,000. Earnings
> Repeat parts (a) and (b) in Problem 1 assuming the company has a tax rate of 21 percent, a market-to-book ratio of 1.0 before recapitalization, and the stock price changes according to M&M. Problem 1: Fujita, Inc., has no debt outstanding and a total ma
> The Day Company and the Knight Company are identical in every respect except that Day is not levered. Financial information for the two firms appears in the following table. All earnings streams are perpetuities, and neither firm pays taxes. Both firms d
> Tempest Corporation expects an EBIT of $37,700 every year forever. The company currently has no debt, and its cost of equity is 11 percent. The tax rate is 22 percent. a. What is the current value of the company? b. Suppose the company can borrow at 6 pe
> Tool Manufacturing has an expected EBIT of $57,000 in perpetuity and a tax rate of 21 percent. The firm has $134,000 in outstanding debt at an interest rate of 5.35 percent, and its unlevered cost of capital is 10.3 percent. What is the value of the firm
> In Problem 14, what is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision? Problem 14: Fields & Co. expects its EBIT to be $125,000 every year forever. The firm can borrow at
> Cookies ’n Cream, Inc., recently issued new securities to finance a new TV show. The project cost $45 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, wh
> Fields & Co. expects its EBIT to be $125,000 every year forever. The firm can borrow at 7 percent. The company currently has no debt, and its cost of equity is 12 percent. If the tax rate is 24 percent, what is the value of the firm? What will the value
> Navarro Corp. has no debt but can borrow at 5.9 percent. The firm’s WACC is currently 9.2 percent, and the tax rate is 21 percent. a. What is the company’s cost of equity? b. If the firm converts to 25 percent debt, what will its cost of equity be? c. If
> Solar Industries has a debt-equity ratio of 1.25. Its WACC is 7.8 percent, and its cost of debt is 4.7 percent. The corporate tax rate is 21 percent. a. What is the company’s cost of equity capital? b. What is the company’s unlevered cost of equity capit
> In Problem 10, suppose the corporate tax rate is 22 percent. What is EBIT in this case? What is the WACC? Explain. Problem 10: Sugar Skull Corp. uses no debt. The weighted average cost of capital is 7.9 percent. If the current market value of the equity
> Sugar Skull Corp. uses no debt. The weighted average cost of capital is 7.9 percent. If the current market value of the equity is $15.6 million and there are no taxes, what is EBIT?
> Fujita, Inc., has no debt outstanding and a total market value of $222,000. Earnings before interest and taxes, EBIT, are projected to be $18,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 25 percent
> Marker, Inc., wishes to expand its facilities. The company currently has 5 million shares outstanding and no debt. The stock sells for $64 per share, but the book value per share is $19. Net income is currently $12.2 million. The new facility will cost $
> Damron, Inc., has 250,000 shares of stock outstanding. Each share is worth $81, so the company’s market value of equity is $20,250,000. Suppose the firm issues 40,000 new shares at the following prices: $81, $76, and $68. What effect will each of these a
> The Telwar Co. has just gone public. Under a firm commitment agreement, the company received $25.11 for each of the 30 million shares sold. The initial offering price was $27 per share, and the stock rose to $32.49 per share in the first few minutes of t
> In Problem 5, if the SEC filing fee and associated administrative expenses of the offering are $1.9 million, how many shares need to be sold? Problem 5: The Meadows Corporation needs to raise $75 million to finance its expansion into new markets. The co
> A stock has a beta of 1.19 and an expected return of 12.4 percent. A risk-free asset currently earns 2.7 percent. a. What is the expected return on a portfolio that is equally invested in the two assets? b. If a portfolio of the two assets has a beta of
> The Meadows Corporation needs to raise $75 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $23 per share and the company’s underwri
> The Woods Co. and the Koepka Co. have both announced IPOs at $40 per share. One of these is undervalued by $12, and the other is overvalued by $5, but you have no way of knowing which is which. You plan to buy 1,000 shares of each issue. If an issue is u
> The Tennis Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the sha
> The Clifford Corporation has announced a rights offer to raise $25 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $5,000 per page. The stock c
> Nougat Corp. wants to raise $5.1 million via a rights offering. The company currently has 530,000 shares of common stock outstanding that sell for $55 per share. Its underwriter has set a subscription price of $30 per share and will charge the company a
> Bell Buckle Mfg. is considering a rights offer. The company has determined that the ex-rights price would be $71. The current price is $76 per share, and there are 29 million shares outstanding. The rights offer would raise a total of $95 million. What i
> In Problem 10, what would the ROE on the investment have to be if we wanted the price after the offering to be $75 per share? (Assume the PE ratio remains constant.) What is the NPV of this investment? Does any dilution take place? Problem 10: The Metal
> Hassinah, Inc., is proposing a rights offering. Presently there are 435,000 shares outstanding at $71 each. There will be 50,000 new shares offered at $64 each. a. What is the new market value of the company? b. How many rights are associated with one
> Ninecent Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 6 percent. The rele
> For the firm in Problem 7, suppose the book value of the debt issue is $75 million. In addition, the company has a second debt issue on the market, a zero coupon bond with eight years left to maturity; the book value of this issue is $30 million, and the
> In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced? Problem 18: Stock Y has a beta of 1.2 and an expected return of 11.5 percent. Stock Z has a beta of .80 and an expected return of 8.5 percent. I
> Jiminy’s Cricket Farm issued a 30-year, 4.5 percent semiannual bond three years ago. The bond currently sells for 104 percent of its face value. The company’s tax rate is 22 percent. a. What is the pretax cost of debt? b. What is the aftertax cost of d
> Sunrise, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 23 years to maturity that is quoted at 96 percent of face value. The issue makes semiannual payments and has an embedded cost of 5 percent annually. What i
> Savers has an issue of preferred stock with a stated dividend of $3.85 that just sold for $87 per share. What is the bank’s cost of preferred stock?
> Suppose Wacken, Ltd., just issued a dividend of $2.73 per share on its common stock. The company paid dividends of $2.31, $2.39, $2.48, and $2.58 per share in the last four years. If the stock currently sells for $43, what is your best estimate of the co
> Stock in Jansen Industries has a beta of 1.05. The market risk premium is 7 percent, and T-bills are currently yielding 3.5 percent. The company’s most recent dividend was $2.45 per share, and dividends are expected to grow at an annual rate of 4.1 perce
> Landman Corporation (LC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .60. It’s considering building a new $73 million manufacturing facility. This new plant is expected to generate aftertax cash flo
> In the previous problem, suppose you believe that sales in five years will be $45.5 million and the price-sales ratio will be 2.15. What is the share price now? Problem 26: You have looked at the current financial statements for J&R Homes, Co. The compa
> You have looked at the current financial statements for J&R Homes, Co. The company has an EBIT of $3.35 million this year. Depreciation, the increase in net working capital, and capital spending were $295,000, $125,000, and $535,000, respectively. You ex
> In the previous problem, instead of a perpetual growth rate in adjusted cash flow from assets, you decide to calculate the terminal value of the company with the price-sales ratio. You believe that Year 5 sales will be $23.7 million and the appropriate p
> Derry Corp. is expected to have an EBIT of $2.1 million next year. Increases in depreciation, the increase in net working capital, and capital spending are expected to be $165,000, $80,000, and $120,000, respectively. All are expected to grow at 18 perce
> In Problem 14, what is the break-even price per unit that should be charged under the new credit policy? Assume that the sales figure under the new policy is 3,310 units and all other values remain the same. Problem 14: The Branson Corporation is consid
> Ginger Industries stock has a beta of 1.08. The company just paid a dividend of $.85, and the dividends are expected to grow at 4 percent. The expected return on the market is 11.3 percent, and Treasury bills are yielding 3.4 percent. The most recent sto
> Lebleu, Inc., is considering a project that will result in initial aftertax cash savings of $2.9 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The firm has a target debt-equity ratio of .7
> The Swanson Corporation’s common stock has a beta of 1.07. If the risk-free rate is 3.4 percent and the expected return on the market is 11 percent, what is the company’s cost of equity capital?