Fundaments of Cortporate Finance - Textbook Questions - Chapter 2,3&5 - 17 Sep PDF

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Contents Chapter 2 – Financial Statements, Taxes, and Cash Flows.....................................................................1 Chapter 3 – Working with Financial Statements....................................................................................3 Chapter 5 – Time Value of Money.........................................................................................................7 Chapter 6 – Discounted Cash Flow........................................................................................................8 Chapter 7 – Interest Rates and Bond Valuation...................................................................................10 Chapter 9 – Net Present Value and Other Investment Criteria............................................................11

Chapter 2 – Financial Statements, Taxes, and Cash Flows Chapter 2 – Question 14 1. Calculating Total Cash Flow – Volbeat Corp. shows the following information on its 2015 income statement:

Particulars Sales Costs Other Expenses Depreciation Expense Interest Expense Taxes Dividends

Amount ($) 267,000 148,000 8,200 17,600 12,400 32,620 15,500

In addition, you are told that the firm issued $6,400 in new equity during 2015 and redeemed $4,900 in the outstanding long-term debt. a. b. c. d.

What is the 2015 operating cash flow? What is the 2015 cash flow to creditors? What is the 2015 cash flow to stock holders? If net fixed assets increased by $25,000 during the year, what was the addition to NWC?

e. f. Chapter 2 – Problem 15 (Using Income Statements) g. Given the following information for Gandolfino Pizza Co., calculate the depreciation expense: Particulars Sales Costs Addition to Retained Earnings Dividends Paid

Amount ($) 61,000 29,600 5,600 1,950

Interest Expense 4,300 Tax Rate 35% h. i. Chapter 2 – Problem 16 (Preparing a Balance Sheet) j. Prepare a 2015 balance sheet for Cornell Corp. based on the following information: Particulars Amount ($) Cash 1,34,000 Patents and Copyrights 6,70,000 Accounts Payable 1,05,000 Tangible Net Fixed Assets 17,30,000 Inventory 2,93,000 Notes Payable 1,60,000 Accumulated Retained Earnings 14,53,000 Long-term Debt 8,45,000 k. l. Use the following information for Taco Swell, Inc., for Problems 25 and 26 (assume tax rate to be 34%) Particulars 2014($) 2015($) Sales 12,730 14,229 Depreciation 1,827 1,910 Cost of goods sold 4,377 5,178 Other expenses 1,041 906 Interest 854 1,019 Cash 6,674 7,113 Accounts Receivable 8,837 10,371 Short-term notes payable 1,288 1,262 Long-term debt 22,352 27,099 Net fixed assets 55,977 59,700 Accounts Payable 4,822 5,108 Inventory 15,711 16,817 Dividends 1,522 1,780 m. n. Problem 25 (Financial Statements)– Draw up an income statement and balance sheet for the company for 2014 and 2015. o. Problem 26 (Calculating Cash Flow)– For 2015, calculate the cash flow from assts, cash flow to creditors, and cash flow to stock holders.

Chapter 3 – Working with Financial Statements Some recent financial statements for Smolira Golf Corp. follow. Use this information to work Problems 26 through 30.

Assets ($) 2014 Current Assets Cash Accounts Receivable Inventory Total

26,450 13,693 27,931 68,074

SMOLIRA GOLD CORP. 2014 and 2015 Balance Sheets Liabilities and Owners' Equity ($) 2015 2014 Current Liabilities 29,106 Accounts Payable 30,602 18,282 Notes Payable 15,840 32,586 Other 15,280 79,974 Total 61,722 Long-term debt

Fixed Assets Net Plant and Equipment

357,165

Total Assets

425,239

2015 35,485 13,500 20,441 69,426

95,000

110,000

Owner's equity 398,346 Common stock and paid-in surplus Accumulated retained earnings Total

45,000 223,517 268,517

45,000 253,893 298,893

478,319 Total Liabilities and owners' equity

425,239

478,319

SMOLIRA GOLD CORP. 2015 Income Statement ($) Sales Cost of Goods Sold Depreciation

422,045 291,090 37,053

Earnings before interest and taxes Interest paid Taxable income

93,902 16,400 77,502

Taxes (35%)

27,126

Net income Dividends Retained Earnings

50,376 20,000 30,376

Chapter 3 – Question 26 - 30 2. Calculating Financial Ratios – Find the following ratios for Smolira Golf Corp. (use year-end figures rather than average values where appropriate): Short-term solvency ratios a. Current Ratio b. Quick Ratio c. Cash Ratio

Asset utilization ratios: d. Total asset turnover e. Inventory turnover f. Receivables turnover Long-term solvency ratios: g. h. i. j. k.

Total debt ratio Debt-equity ratio Equity multiplier Times interest earned ratio Cash coverage ratio

Profitability ratios: l. Profit Margin m. Return on Assets n. Return on Equity

3. DuPont Identity – Construct DuPont identity for Smolira Golf Corp. 4. Statement of Cash Flows – Prepare the statement of cash flows for Smolira Golf Corp. 5. Market Value Ratios – Smolira Golf Corp. has 25,000 shares of common stock outstanding, and the market price for a share of stock at the end of 2015 was $58. What is the priceearnings ratio? What are the dividends per share? What is the market-to-book ratio at the end of 2015? If the company’s growth rate is 9 percent, what is the PEG ratio? 6. Tobin’s Q - What is Tobin’s Q for Smolira Golf? What assumptions are you making about the book value of debt and the market value of debt? What about the book value of assets and the market value of assets? Are the assumptions realistic? Why or why not?

Chapter 3 – Chapter Review and Self-Test Problems 3.1 Sources and Uses of Cash Consider the following balance sheets for Philippe Corportaion. Calculate the changes in cvarious accounts and, where applicable, identify the chanse as a source or use of cash. What were the major sources and uses of cash? Did the company become more or less liquid during the year? What happened to the cash during the year?

3.2 Common-size Statements Here is the most recent income statement for Philippe. Prepare a common-size income statement based on this information. How do you interpret the standardized net income? What percentage of sales goes to cost of goods sold?

3.3 Financial Ratios – Based on the balance sheets and income statement in the previous two problems, calculate the following ratios for 2015:    

Current Ratio Quick Ratio Cash Ratio Inventory turnover

      

Recievables turnover Days’ sales in inventory Days’ sales in recievables Total debt ratio Long-term debt ratio Times interest earned ratio Cash coverage ratio

3.4 ROE and DuPont Identity – Calculate the 2015 ROE for the Philippe Corporation and then break down your answer into its component parts using the DuPont identity.

Chapter 5 – Time Value of Money Chapter 5 – Question 8 – Calculating Interest Rates According to the Census Bureau, in January 2013, the average house price in the United States was $ 306,900. In January 2000, the average price was $200,300. What was the annual increase in selling price? Chapter 5 – Question 9 – Calculating the Number of Periods You are trying to save a new $225,000 Ferrari. You have $45,000 today that can be invested at your bank. The bank pays 4.8% annual interest on its accounts. How long will it be before you have enough to buy the car? Chapter 5 – Question 10 – Calculating Present Values Imprudential, Inc., has an unfunded pension of $475 million that must be paid in 20 years. TO assess the value of the firm’s stock, financial analysts want to discount this liability back to the present. If the relevant discount rate is 6.1%, what is the present value of this liability. Chapter 5 – Question 12 – Calculating Future Values Your coin collection contains fifty 1952 silver dollars. If your grandparents purchased them for their face value when they were new, how much will your collection be worth when you retire in 2063, assuming they appreciate at an annual rate of 4.3%?

Chapter 5 – Question 14 – Calculating Rates of Return Although appealing to refined tastes, art as a collectible has not performed so profitably. During 2003, Sobethy’s sold the Edgar Degas bronze sculpture Petite Danseuse de Quatorze Ans at auction for a price of $10,311,500. Unfortunately for the previous owner, he had purchased it in 1999 at a price of $12,377,500. What was his annual rate of return on the sculpture?

Chapter 6 – Discounted Cash Flow Chapter 6 – Question 2 – Present value and multiple Cash Flows Investment X offers to pay you $4,700 per year for eight years, whereas Investment Y offers to pay you $6,700 per year for five years. Which of the cash flow streams has the higher present value if discount rate is 5%? If the discount rate is 15%? Chapter 6 – Question 4 – Calculating Annuity Present Values An investment offers $5,500 per year for 15 years, with the first payment occurring one year from now. If the required return is 6%, what is the value of investment? What would be the value if payments occurred for 40 years? For 75 years? Forever? Chapter 6 – Question 5 – Calculating Annuity Cash Flows If you put up $38,000 today in exchange for a 5.8%, 15-year annuity, what will the annual cash flow be? Chapter 6 – Question 8 – Calculating Annuity Values You want to have $50,000 in your savings account 12 years from now, and you’re prepared to make equal annual deposits into the account the end of each year. If the account pays 6.2% interest, what amount must you deposit each year? Chapter 6 – Question 14 – Calculating EAR

First National Bank charges 12.4% compounded monthly on its business loans. First United Bank charges 12.7% compounded semiannually. As a potential borrower, which bank would you go for a new loan? Chapter 6 – Question 15 – Calculating APR Tai Credit Corp. wants to earn an effective annual return on its consumer loans of 16.5% per year. The bank uses daily compounding on its loans. What interest rate is the bank required by law to report to potential borrowers? Explain why this rate is misleading to an uninformed borrower. Chapter 6 – Question 16 – Calculating Future Values What is the future value of $2,400 in 17 years assuming an interest rate of 7.9% compounded semiannually? Chapter 6 – Question 23 – Valuing Perpetuities Live Forever Life Insurance Co. is selling a perpetuity contract that pays $1400 monthly. The contract currently sells for %215,000. What is the monthly return on this investment vehicle? What is the APR? The effective annual return? Chapter 6 – Question 24 – Calculating Annuity Future Values You are planning to make monthly deposits of %450 into a retirement account that pays 10% interest compounded monthly. If your first deposit will be made one month from now, how large will your retirement account be in 40 years? Chapter 6 – Question 25 – Calculating Annuity Future Values In the previous problem, suppose you make $5,400 annual deposits into the same retirement account. How large will your account balance be in 30 years? Chapter 6 – Question 26 – Calculating Annuity Present Values Beginning three months from now, you want to be able to withdraw $2,200 each quarter from your bank account to cover college expenses over the next four years. If the account pays 0.43% interest per quarter, how much do you have in your bank account today to meet your daily expense needs over the next four years?

Chapter 7 – Interest Rates and Bond Valuation Chapter 7 – Question 3 – Valuing Bonds Even though most corporate bonds in the United States make coupon payments semiannually, bonds issued elsewhere often have annual coupon payments. Suppose a German company issues a bond with a par value of €1,000. 23 years to maturity, and a coupon rate of 5.8% paid annually. If the yield to maturity is 4.7%, what is the current price of the bond? Chapter 7 – Question 7 – Bond Yields Heginbotham Corp. issued 20-year bonds two years ago at a coupon rate of 5.3%. The bond makes semiannual payments. If these bonds currently sell for 105% of par value, what is the YTM? Chapter 7 – Question 8 – Coupon Rates DMA Corporation has bonds on the market with 14.5 years to maturity, a YTM of 5.3%, a par value of $1,000, and a current price of $965. The bonds make semiannual payments. What must be the coupon rate on these bonds? Chapter 7 – Question 9 – Zero Coupon Bonds You find a zero-coupon bond with a par value of $10,000 and 17 years to maturity. If the yield to maturity on this bond is 4.9%, what is the price of the bond? Assume semiannual compounding periods.

Chapter 7 – Question 22 – Bond Yields Chamberlain Co. wants to issue new 20-year bonds for some much-needed expansion projects. The company currently has 7% coupon bonds on the market that sell for $1,083, make semiannual payments, and mature in 20 years. What coupon rate should the company set on its new bonds if it wants them to sell at par? Chapter 7 – Question 33

Chapter 9 – Net Present Value and Other Investment Criteria Chapter 9 – Question 2 – Calculating Payback An investment project provides cash inflows of $675 per year for 8 years. What is the project payback period if the initial cost is $1,700? What if the initial cost is $3,300? What if it is $5,600?

Chapter 9 – Question 4 – Calculating Discounted Payback An investment project has annual cash inflows of $2,800, $3,700, %5,100 and $4,300, for the next four years, respectively. The discount rate is 14%. What is the discounted payback period for these cash flows if the initial cost is $5,200? What is the initial cost is $5,400? What if it is $10,400? Chapter 9 – Question 10 – Calculating IRR What is the IRR of the following cash flows? Year 0 1 2 3

Cash Flow ($) -13,900 6,400 8,700 5,900

Chapter 9 – Question 11 – Calculating NPV For the cash flows in the previous problem, what is the NPV at a discount rate of 0%? What if the discount rate is 10%? If it is 20%? If it is 30%? Chapter 9 – Question 14 – Problems with IRR Light Sweet Petroleum, Inc., is trying to evaluate a generation project with the following cashflows: Year 0 1

Cash Flow ($) -45,000,000 71,000,000

2

-15,000,000

a. If the company requires a return of 12% on its investments, should it accept this project? Why? b. Compute the IRR for this project. How many IRRs are there? Using the IRR decision rule, should the company accept the project? What is going on here?

Chapter 9 – Question 17 – Comparing Investment Criteria Consider the following two mutually exclusive projects: Year 0 1 2 3 4

Cash Flow ($) - A -4,55,000 58,000 85,000 85,000 5,72,000

Cash Flow ($) - B -65,000 31,000 28,000 25,500 19,000

Whichever project you choose, if any, you require a return of 11% on your investment. a. b. c. d. e. f.

If you apply the payback criterion, which investment will you choose? Why? If you apply the discounted payback criterion, which investment will you choose? Why? If you apply the NPV criterion, which investment will you choose? Why? If you apply the IRR criterion, which investment will you choose? Why? If you apply the profitability index criterion, which investment will you choose? Why? Based on your answers, which project will you finally choose? Why?

Chapter 9 – Question 23 – Payback and NPV An investment under consideration has a payback of seven years and a cost of $735,000. If the required return is 11%, what is the worst-case NPV? The best-case NPV? Explain. Assume the cash flows are conventional. Chapter 9 – Question 28 – NPV and IRR Anderson International Limited is evaluating a project in Erewhon. The project will create the following cash flows: Year 0 1 2 3 4

Cash Flow ($) -1,450,000 485,000 535,000 435,000 390,000

All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has declared that all cash flows created by a foreign company are “blocked” and must be reinvested with the government for one year. The reinvestment rate for these funds is 4%. IF Anderson uses a required rate of 11% on this project, what are the NPV and IRR of the project? Is the IRR you calculated the MIRR of the project? Why or why not?...