BM-Corp Fin-Exercises L1 Solutions PDF

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Berk and DeMarzo’s Corporate Finance Solutions – Exercises listed on the syllabus Chapter 2 – Introduction to Financial Statement Analysis 2-10. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. What is Mydeco’s market capitalization at the end of each year? b. What is Mydeco’s market-to-book ratio at the end of each year? c. What is Mydeco’s enterprise value at the end of each year? 2009–2013 Financial Statement Data and Stock Price Data for Mydeco Corp.

2-13. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. By what percentage did Mydeco’s revenues grow each year from 2010 to 2013? b. By what percentage did net income grow each year? c. Why might the growth rates of revenues and net income differ?

c. Net Income growth rate differs from revenue growth rate because cost of goods sold and other expenses can move at different rates than revenues. For example, revenues declined in 2010 by 10%, however, cost of goods sold only declined by 7%.

2-14. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. Suppose Mydeco repurchases 2 million shares each year from 2010 to 2013. What would its earnings per share be in 2013? A repurchase does not impact earnings directly, so any change to EPS will come from a reduction in shares outstanding. 2013 shares outstanding = 55 – 4 × 2 = 47 million, EPS = 21.7/47 = $0.46.

2-20. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. From 2009 to 2013, what was the total cash flow from operations that Mydeco generated? b. What fraction of the total in (a) was spent on capital expenditures? c. What fraction of the total in (a) was spent paying dividends to shareholders? d. What was Mydeco’s total retained earnings for this period? a. Total cash flow from operations = 48.5 + 50.5 + 47.8 + 46.6 + 54 = $247.4 million.

b. Total fraction spent on capital expenditures = (25 + 25 + 100 + 75 + 40)/247.4 = 107.1%. c. Total fraction spent on dividends = (5.4 × 4 + 6.5)/247.4 = 11.4%. d. Retained earnings = Net Income – Dividends = (18 + 3 + 6.3 + 12.7 + 21.7) – (5.4 × 4 + 6.5) = $33.6 million. 2-26. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. What were Mydeco’s retained earnings each year? b. Using the data from 2009, what was Mydeco’s total stockholders’ equity in 2008? a. Retained earnings = Net Income – Dividends Paid

b. 2008 stockholders’ equity = 2009 stockholders’ equity – 2009 retained earnings = 252.7 – 12.6 = $240.1 million. 2-32 See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. Compare accounts payable days in 2009 and 2013. b. Did this change in accounts payable days improve or worsen Mydeco’s cash position in 2013? a. 2009 accounts payable days = 18.7 / (188.3 / 365) = 36.2 . 2013 accounts payable days = 31.7 / (293.4 / 365) = 39.4 . b. Accounts payable days increased from 2009 to 2013, which improved the cash position of Mydeco 2-33. See Table 2.5 showing financial statement data and stock price data for Mydeco Corp. a. By how much did Mydeco increase its debt from 2009 to 2013? b. What was Mydeco’s EBITDA/Interest coverage ratio in 2009 and 2013? Did its coverage ratio ever fall below 2? c. Overall, did Mydeco’s ability to meet its interest payments improve or decline over this period? a. Mydeco increased its debt from $500 million in 2009 to $600 million in 2013 (by $100 million). b. 2009 EBITDA/Interest coverage ratio = (61.4 + 27.3) / 33.7 = 2.6. 2013 EBITDA/Interest coverage ratio= (72.8 + 38.6)/ 39.4 = 2.8. Mydeco’s coverage ratio fell below 2 in 2010, where it was 1.96. c. Overall Mydeco’s ability to meet its interest payments improved over this period, although it experienced a slight dip in 2010.

Chapter 26 – Working Capital Management 26-4. The Greek Connection had sales of $32 million in 2009, and a cost of goods sold of $20 million. A simplified balance sheet for the firm appears below: a. Calculate The Greek Connection’s net working capital in 2009. b. Calculate the cash conversion cycle of The Greek Connection in 2009. c. The industry average accounts receivable days is 30 days. What would the cash conversion cycle for The Greek Connection have been in 2009 had it matched the industry average for accounts receivable days? a. Net working capital is current assets minus current liabilities. Using this definition, T The Greek Connection’s net working capital is $7,250 – $3,720 = $3,530. Some analysts calculate the net operating working capital instead, which is the non-interest earning current assets minus the noninterest bearing current liabilities. In this case, the notes payable would not be included in the calculation since they are assumed to be interest bearing. Net operating working capital for The Greek Connection is $7,250 – ($1,500 + $1,220) = $4,530. b. The cash conversion cycle (CCC) is equal to the inventory days plus the accounts receivable days minus the accounts payable days. The Greek Connection’s cash conversion cycle for 2004 was 41.4 days. CCC = inventory/ average daily COGS + accounts receivable/average daily sales - accounts payable/average daily COGS = 1,300/(20,000/365) + 3,950/(32,000/365) – 1,500/(20,000/365) = 23.7 days + 45.1 days - 27.4 days =41.4 days c. If The Greek Connection accounts receivable days had been 30 days, its cash conversion cycle would have been only 26.3 days: CCC = 23.7 days + 30 days – 27.4 days = 26.3 days 26-5. Assume the credit terms offered to your firm by your suppliers are 3/5, Net 30. Calculate the cost of the trade credit if your firm does not take the discount and pays on day 30. In this instance, the customer will have the use of $97 for an additional 25 days (30 – 5) if he chooses not to take the discount. It will cost him $3 to do so since he must pay $100 for the goods if he pays after the 5-day discount period. Thus, the interest rate per period is: $3/97 = 0.0309 = 3.09%. The number of 25-day periods in a year is 365/25 = 14.6 periods. So the effective annual cost of the trade credit is: EAR = (1.0309)14.6 – 1 = 55.94%.

26-11. The Mighty Power Tool Company has the following accounts on its books: The firm extends credit on terms of 1/15, Net 30. Develop an aging schedule using 15-day increments through 60 days, and then indicate any accounts that have been outstanding for more than 60 days. Mighty Power Tool Company Aging Schedule

26-15. Use the financial statements supplied below for International Motor Corporation (IMC) to answer the following questions. a. Calculate the cash conversion cycle for IMC for both 2009 and 2010. What change has occurred, if any? All else being equal, how does this change affect IMC’s need for cash? b. IMC’s suppliers offer terms of Net 30. Does it appear that IMC is doing a good job of managing its accounts payable? a. The cash conversion cycle (CCC) is equal to the inventory days plus the accounts receivable days minus the accounts payable days. IMC’s cash conversion cycle for 2003 was 35.2 days, and for 2004, it was 45.6 days. CCC = inventory/average daily COGS + accounts receivable/average daily sales - accounts payable/ average daily COGS CCC2003 = 6,200/(52,000/365)+2,800/(60,000/365)-3,600/(52,000/365) 43.5 days + 17.0 days - 25.3 days = 35.2 days CCC2004= $6,600/(61,000/365)+ $6,900/(75,000+365)- $4,600/(61,000+365) =39.5 days + 33.6 days 27.5 days = 45.6 days IMC’s cash conversion cycle has lengthened in 2004, due to an increase in its accounts receivable days. The number of days goods are held in inventory has decreased, and IMC is taking longer to pay its suppliers, both of which would decrease the cash conversion cycle, all else being equal.These changes were not enough to offset the increase in the amount of time it is taking IMC’s means that IMC will require more cash. b. If IMC’s suppliers are offering terms of net 30, IMC should consider waiting longer to pay for its purchases. In 2003, it paid nearly five days earlier than necessary, and in 2004, it paid 2.5 days earlier. IMC could, therefore, have kept the money working for it longer because there was no discount offered for early payment. The early payment may give IMC a preferred position with its suppliers, however, which may have benefits that are not presented here. IMC’s decision on whether to extend its accounts payable days would have to take these benefits into consideration.

Chapter 27 – Short-term financial planning 27-4. Quarterly working capital levels for your firm for the next year are included in the following table. What are the permanent working capital needs of your company? What are the temporary needs? The net working capital for each quarter is calculated below:

The minimum level of net working capital—$400,000 in Quarter 1—represents the firm’s permanent working capital. The difference between the higher net working capital levels in each quarter and the permanent working capital needs represents the firm’s temporary working capital needs. Thus the firm has temporary working capital needs of $200,000 in Quarter 2, $600,000 in Quarter 3, and $250,000 in Quarter 4. 27-6. The Hand-to-Mouth Company needs a $10,000 loan for the next 30 days. It is trying to decide which of three alternatives to use: Alternative A: Forgo the discount on its trade credit agreement that offers terms of 2/10, Net 30. Alternative B: Borrow the money from Bank A, which has offered to lend the firm $10,000 for 30 days at an APR of 12%. The bank will require a (no-interest) compensating balance of 5% of the face value of the loan and will charge a $100 loan origination fee, which means Hand-to-Mouth must borrow even more than the $10,000. Alternative C: Borrow the money from Bank B, which has offered to lend the firm $10,000 for 30 days at an APR of 15%. The loan has a 1% loan origination fee. Which alternative is the cheapest source of financing for Hand-to-Mouth? Alternative A: The effective annual cost of the trade credit is 44.6%, calculated as follows: Interest rate per period = $2/98 = 2.041%. The loan period is 20 (= 30 – 10) periods, and there are 18.25 periods in a year (365/20 = 18.25). EAR = 1.0204118.25 – 1 = 44.6% Alternative B: Hand-to-Mouth will need to borrow $10,100 just to cover its loan origination fee. Beyond that, it needs to have enough to meet the compensating balance requirement. So the total amount that Hand-to-Mouth must borrow is $10,632: Amount needed = $10,100/(1-0.05) = $10,632. At a 12% APR, the interest expense for the 30-day loan will be 0.01($10,632) = $106.32. Since the loan origination fee is simply additional interest, the total interest on the 30-day loan is $106.32 + $100 = $206.32. The firm’s usable proceeds from the loan is $10,000. So the interest rate per period is 2.063% = ($206.32/$10,000) The effective annual rate of alternative B is (1.02063)365/30 – 1 = 28.2%. Alternative C: Hand-to-Mouth will need to borrow $10,100 in order to cover the loan origination fee. An APR of 15% translates to an interest rate of 1.25% =15%/12 for 30 days. The interest expense for one month is 0.0125 × $10,100 = $126.25. This with the loan origination fee makes the total interest charge $226.25 for the 30-day loan. This amounts to 2.263% for 30 days: $226.25/$10,000 The effective annual rate is (1.02263)365/30 – 1 = 31.3%. Thus in Alternative A, the cost of trade credit is the most expensive at an effective annual rate of 44.6%. 27-7. Consider two loans with a 1-year maturity and identical face values: an 8% loan with a 1% loan origination fee and an 8% loan with a 5% (no-interest) compensating balance requirement. Which loan would have the higher effective annual rate? Why? The loan with the 1% loan origination fee would cost the most since the loan origination fee is just another form of interest, so on a $1,000 loan, the borrower is paying $90 in interest and will have the use of only $990 for the period, making the effective annual cost of the loan over 9% ($90/$990 = 9.1%). The

compensating balance requirement of 5% on a $1,000 loan reduces the usable proceeds of the firm by 5% to $950, but the interest rate is still 8%, so the effective annual cost of that arrangement is 8.4% = $80/$950 The effective annual rate is not increased by a full percentage....