1-6.You are a shareholder in a C corporation.

1-6.You are a shareholder in a C corporation. The corporation earns $2 per share before taxes.

Once it has paid taxes it will distribute the rest of its earnings to you as a dividend. The corporate tax rate is 40% and the personal tax rate on (both dividend andnon-dividend)income is 30%. How much is left for you after all taxes are paid?

2-10.See Table 2.5 showing financial statement data and share price data for Mydeco Corp.

a.What is Mydeco’s market capitalization at the end of each year?

b.What is Mydeco’smarket-to-bookratio at the end of each year?

c.What is Mydeco’s enterprise value at the end of each year?

Mydeco Stock Price $7.92 $3.30 $5.25 $8.71 $10.89

2-13.See Table 2.5 showing financial statement data and share 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?

2-15.See Table 2.5 showing financial statement data and share price data for Mydeco Corp. Suppose Mydeco had purchased additional equipment for $12 million at the end of 2010, and this equipment was depreciated by $4 million per year in 2011, 2012, and 2013. Given Mydeco’s tax rate of 35%, what impact would this additional purchase have had on Mydeco’s net income in years2010–2013?(Assume tha equipment is paid for out of cash and that Mydeco earns no interest on its cash balances).

The equipment purchase does not impact net income directly, however the increased depreciation expense and tax savings changes net income.

2-20.See Table 2.5 showing financial statement data and share 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?

2-21.See Table 2.5 showing financial statement data and share price data for Mydeco Corp.

a.In what year was Mydeco’s net income the lowest?

b.In what year did Mydeco need to reduce its cash reserves?

c.Why did Mydeco need to reduce its cash reserves in a year when net income was reasonably high?

2-22.See Table 2.5 showing financial statement data and share price data for Mydeco Corp. Use the data from the balance sheet and cash flow statement in 2009 to determine the following:

a.How much cash did Mydeco have at the end of 2008?

b.What were Mydeco’s accounts receivable and inventory at the end of 2008?

c.What were Mydeco’s total liabilities at the end of 2008?

d.Assuming goodwill and intangibles were equal in 2008 and 2009, what was Mydeco’s net property, plant, and equipment at the end of 2008?

2-31.See Table 2.5 showing financial statement data and share price data for Mydeco Corp.

a.How did Mydeco’s accounts receivable days change over this period?

b.How did Mydeco’s inventory days change over this period?

c.Based on your analysis, has Mydeco improved its management of its working capital during this time period?

Mydeco Corp.2009-2013 (All data as of fiscal year end; $ in millions)

Income Statement 2009 2010 2011 2012 2013
Revenue 404.3 363.8 424.6 510.7 604.1
Cost of Goods Sold (188.3) (173.8) (206.2) (246.8) (293.4)
Gross Profit 216.0 190.0 218.4 263.9 310.7
Sales and Marketing (66.7) (66.4) (82.8) (102.1) (120.8)
Administration (60.6) (59.1) (59.4) (66.4) (78.5)
Depreciation & Amortization (27.3) (27.0) (34.3) (38.4) (38.6)
EBIT 61.4 37.5 41.9 57.0 72.8
Interest Income (Expense) (33.7) (32.9) (32.2) (37.4) (39.4)
Pretax Income 27.7 4.6 9.7 19.6 33.4
Income Tax (9.7) (1.6) (3.4) (6.9) (11.7)
Net Income 18.0 3.0 6.3 12.7 21.7
Shares outstanding (millions) 55.0 55.0 55.0 55.0 55.0
Earnings per share $0.33 $0.05 $0.11 $0.23 $0.39

Balance Sheet 2009 2010 2011 2012 2013
Assets
Cash 48.8 68.9 86.3 77.5 85.0
Accounts Receivable 88.6 69.8 69.8 76.9 86.1
Inventory 33.7 30.9 28.4 31.7 35.3
Total Current Assets 171.1 169.6 184.5 186.1 206.4

Net Property, Plant & Equip. 245.3 243.3 309.0 345.6 347.0
Goodwill & Intangibles 361.7 361.7 361.7 361.7 361.7
Total Assets 778.1 774.6 855.2 893.4 915.1

Liabilities & Shareholders’ Equity
Accounts Payable 18.7 17.9 22.0 26.8 31.7
Accrued Compensation 6.7 6.4 7.0 8.1 9.7
Total Current Liabilities 25.4 24.3 29.0 34.9 41.4

Long-termDebt 500.0 500.0 575.0 600.0 600.0
Total Liabilities 525.4 524.3 604.0 634.9 641.4

Shareholders’ Equity 252.7 250.3 251.2 258.5 273.7
Total Liabilities & 778.1 774.6 855.2 893.4 915.1
Shareholders’ Equity

Statement of Cash Flows 2009 2010 2011 2012 2013
Net Income 18.0 3.0 6.3 12.7 21.7
Depreciation & Amortization 27.3 27.0 34.3 38.4 38.6
Chg. in Accounts Receivable 3.9 18.8 0.0 (7.1) (9.2)
Chg. in Inventory (2.9) 2.8 2.5 (3.3) (3.6)
Chg. in Payables & Accrued Co 2.2 (1.1) 4.7 5.9 6.5
Cash from Operations 48.5 50.5 47.8 46.6 54.0

Capital Expenditures (25.0) (25.0) (100.0) (75.0) (40.0)
Cash from Investing Activities (25.0) (25.0) (100.0) (75.0) (40.0)

Dividends Paid (5.4) (5.4) (5.4) (5.4) (6.5)
Sale (or purchase) of stock – – – – –
Debt Issuance (Pay Down) – – 75.0 25.0 –
Cash from Financing Activities (5.4) (5.4) 69.6 19.6 (6.5)
Change in Cash 18.1 20.1 17.4 (8.8) 7.5

Mydeco Stock Price $7.92 $3.30 $5.25 $8.71 $10.89
See Table 2.5 showing financial statement data and share 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?

2-34.See Table 2.5 showing financial statement data and share price data for Mydeco Corp.

a.How did Mydeco’s bookdebt-equityratio change from 2009 to 2013?

b.How did Mydeco’s marketdebt-equityratio change from 2009 to 2013?

c.Compute Mydeco’sdebt-to-enterprisevalue ratio to assess how the fraction of its business that is debt financed has changed over the period.

3-1.Honda Motor Company is considering offering a $2000 rebate on its minivan, lowering the vehicle’s price from $30,000 to $28,000. The marketing group estimates that this rebate will increase sales over the next year from 40,000 to 55,000 vehicles. Suppose

Honda’s profit margin with the rebate is $6000 per vehicle. If the change in sales is the only consequence of this decision, what are its costs and benefits? Is it a good idea?

The benefit of the rebate is that Honda will sell more vehicles and earn a profit on each additional vehicle sold:

Benefit = Profit of $6,000 per vehicle × 15,000 additional vehicles sold = $90 million.

The cost of the rebate is that Honda will make less on the vehicles it would have sold:

Cost = Loss of $2,000 per vehicle × 40,000 vehicles that would have sold without rebate = $80 million.

Thus, Benefit – Cost = $90 million – $80 million = $10 million, and offering the rebate looks attractive.

(Alternatively, we could view it in terms of total, rather than incremental, profits. The benefit as $6000/vehicle × 55,000 sold = $330 million, and the cost is $8,000/vehicle × 40,000 sold = $320 million.)

Suppose therisk-freeinterest rate is 4%.

a. Having $200 today is equivalent to having what amount in one year?

b.Having $200 in one year is equivalent to having what amount today?

c.Which would you prefer, $200 today or $200 in one year? Does your answer depend on when you need the money? Why or why not?

3-10.Your firm has identified three potential investment projects. The projects and their cash flows are shown here:

Suppose all cash flows are certain and therisk-freeinterest rate is 10%.

a.What is the NPV of each project?

b.If the firm can choose only one of these projects, which should it choose?

c.If the firm can choose any two of these projects, which should it choose?

3-11.Your computer manufacturing firm must purchase 10,000 keyboards from a supplier. One supplier demands a payment of $100,000 today plus $10 per keyboard payable in one year. Another supplier will charge $21 per keyboard, also payable in one year. Therisk-freeinterest rate is 6%.

a.What is the difference in their offers in terms of dollars today? Which offer should your firm take?

b.Suppose your firm does not want to spend cash today. How can it take the first offer and not spend $100,000 of its own cash today?

3-15.The promised cash flows of three securities are listed here. If the cash flows arerisk-free,and therisk-freeinterest rate is 5%, determine theno-arbitrageprice of each security before the first cash flow is paid.

3-19.Xia Corporation is a company whose sole assets are $100,000 in cash and three projects that it will undertake. The projects are risk free and have the following cash flows:

a.What is the NPV of each project? Which projects should Xia undertake and how much cash should it retain?

b.What is the total value of Xia’s assets (projects and cash) today?

c.What cash flows will the investors in Xia receive? Based on these cash flows, what is the value of Xia today?

d.Suppose Xia pays any unused cash to investors today, rather than investing it. What are the cash flows to the investors in this case? What is the value of Xia now?

e.Explain the relationship in your answers to parts (b), (c), and (d).

4-1.You have just taken out afive-yearloan from a bank to buy an engagement ring. The ring costs $5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments of $1000 at the end of each year. Show the timeline of the loan from your perspective. How would the timeline differ if you created it from the bank’s perspective?

0 1 2 3 4 5
4000–1000–1000–1000–1000–1000

From the bank’s perspective, the timeline is the same except all the signs are reversed.

4-4.What is the present value of $10,000 received:

a.Twelve years from today when the interest rate is 4% per year?

b.Twenty years from today when the interest rate is 8% per year?

c.Six years from today when the interest rate is 2% per year?

4-9.You are thinking of retiring. Your retirement plan will pay you either $250,000 immediately on retirement or $350,000 five years after the date of your retirement. Which alternative should you choose if the interest rate is:

a.0% per year?

b.8% per year?

c.20% per year?

Timeline: Same for all parts
0 1 2 3 4 5

PV = ? 350,000
4-10.Your grandfather put some money in an account for you on the day you were born. You are now 18 years old and are allowed to withdraw the money for the first time. The account currently has $3996 in it and pays an 8% interest rate.

a.How much money would be in the account if you left the money there until your 25th birthday?

b.What if you left the money until your 65th birthday?

c.How much money did your grandfather originally put in the account?

4-13.You have a loan outstanding. It requires making three annual payments at the end of thenext three years of $1000 each. Your bank has offered to allow you to skip making the next two payments in lieu of making one large payment at the end of the loan’s term in three years. If the interest rate on the loan is 5%, what final payment will the bank

require you to make so that it is indifferent between the two forms of payment?

4-14.You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1500 two years from now, and $10,000 ten years from now.

a.What is the NPV of the opportunity if the interest rate is 6% per year? Should you take the opportunity?

b.What is the NPV of the opportunity if the interest rate is 2% per year? Should you take it now?

4-21.When you purchased your house, you took out a30-yearannual-paymentmortgage with an interest rate of 6% per year. The annual payment on the mortgage is $12,000. You have just made a payment and have now decided to pay the mortgage off by repaying the outstanding balance. What is the payoff amount if:

a.You have lived in the house for 12 years (so there are 18 years left on the mortgage)?

b.You have lived in the house for 20 years (so there are 10 years left on the mortgage)?

c.You have lived in the house for 12 years (so there are 18 years left on the mortgage) and you decide to pay off the mortgage immediately beforethe twelfth payment is due?

4-24.A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $1000. Each year after that, you will receive a payment on the anniversary of the last payment that is 8% larger than the last payment. This pattern of payments will go on forever. If the interest rate is 12% per year,

a.What is today’s value of the bequest?

b.What is the value of the bequest immediately after the first payment is made?

4-33.You have just entered an MBA program and have decided to pay for your livingexpenses using a credit card that has no minimum monthly payment. You intend to

charge $1000 per month on the card for the next 21 months. The card carries a monthly interest rate of 1%. How much money will you owe on the card 22 months from now, when you receive your first statementpost-graduation?

4-40.You are thinking about buying a piece of art that costs $50,000. The art dealer is proposing the following deal: He will lend you the money, and you will repay the loan by making the same payment every two years for the next 20 years (i.e., a total of 10 payments). If the interest rate is 4% per year, how much will you have to pay every two years?

4-41.You are saving for retirement. To live comfortably, you decide you will need to save $2million by the time you are 65. Today is your 30th birthday, and you decide, starting today and continuing on every birthday up to and including your 65th birthday, that you will put the same amount into a savings account. If the interest rate is 5%, how much must you set aside each year to make sure that you will have $2 million in the account on

your 65th birthday?

4-50.You are considering purchasing a warehouse. The cost to purchase the warehouse is $500,000. Renting the equivalent space costs $20,000 per year. If the annual interest rate is 6%, at what rate must rental cost increase each year to make the cost of renting comparable to purchasing?

5-2.Which do you prefer: a bank account that pays 5% per year (EAR) for three years or: a. An account that pays 212%every six months for three years?

b.An account that pays 712%every 18 months for three years?

c. An account that pays12%per month for three years?

If you deposit $1 into a bank account that pays 5% per year for 3 years you will have after 3 years.

2
5-10.Your son has been accepted into college. This college guarantees that your son’s tuitionwill not increase for the four years he attends college. The first $10,000 tuition payment is due in six months. After that, the same payment is due every six months until you have made a total of eight payments. The college offers a bank account that allows you to withdraw money every six months and has a fixed APR of 4% (semiannual) guaranteed to remain the same over the next four years. How much money must you deposit today if you intend to make no further deposits and would like to make all the tuition payments

from this account, leaving the account empty when the last payment is made?

5-15.You have just sold your house for $1,000,000 in cash. Your mortgage was originally a30-yearmortgage with monthly payments and an initial balance of $800,000. The

mortgage is currently exactly 181?2 years old, and you have just made a payment. If the interest rate on the mortgage is 5.25% (APR), how much cash will you have from the sale once you pay off the mortgage?

First we need to compute the original loan payment

5-18.You have an outstanding student loan with required payments of $500 per month for thenext four years. The interest rate on the loan is 9% APR (monthly). You are considering making an extra payment of $100 today (that is, you will pay an extra $100 that you are not required to pay). If you are required to continue to make payments of $500 per month until the loan is paid off, what is the amount of your final payment? What effective rate of return (expressed as an APR with monthly compounding) have you earned on the $100?

:

5-23.The mortgage on your house is five years old. It required monthly payments of $1402, had an original term of 30 years, and had an interest rate of 10% (APR). In the intervening five years, interest rates have fallen and so you have decided torefinance—thatis, you will roll over the outstanding balance into a new mortgage. The new mortgage has a30-yearterm, requires monthly payments, and has an interest rate of 6 5?8% (APR).

a.What monthly repayments will be required with the new loan?

b.If you still want to pay off the mortgage in 25 years, what monthly payment should you make after you refinance?

c.Suppose you are willing to continue making monthly payments of $1402. How long will it take you to pay off the mortgage after refinancing?

d.Suppose you are willing to continue making monthly payments of $1402, and want to pay off the mortgage in 25 years. How much additional cash can you borrow today as part of the refinancing?

(

5-29.Suppose the term structure ofrisk-freeinterest rates is as shown below:

a.Calculate the present value of an investment that pays $1000 in two years and $2000 in five years for certain.

b.Calculate the present value of receiving $500 per year, with certainty, at the end of the next five years. To find the rates for the missing years in the table, linearly interpolate between the years for which you do know the rates. (For example, the rate in year 4 would be the average of the rate in year 3 and year 5.)

c.Calculate the present value of receiving $2300 per year, with certainty, for the next 20 years. Infer rates for the missing years using linear interpolation. (Hint:Use a spreadsheet.)

5-35.Your uncle Fred just purchased a new boat. He brags to you about the low 7% interest rate (APR, monthly compounding) he obtained from the dealer. The rate is even lower than the rate he could have obtained on his home equity loan (8% APR, monthly compounding). If his tax rate is 25% and the interest on the home equity loan is tax deductible, which loan is truly cheaper?

7-6.FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Developmentwill take six years and the cost is $200,000 per year. Once in production, the bike is expected to make $300,000 per year for 10 years. Assume the cost of capital is 10%.

a.Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make the investment?

b.By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the IRR.)

c.What is the NPV of the investment if the cost of capital is 14%?

7-9.You have been offered a very long term investment opportunity to increase your money one hundredfold. You can invest $1000 today and expect to receive $100,000 in 40 years. Your cost of capital for this (very risky) opportunity is 25%. What does the IRR rule say about whether the investment should be undertaken? What about the NPV rule? Do they agree?

7-17.Your firm has been hired to develop new software for the university’s class registration system. Under the contract, you will receive $500,000 as an upfront payment. You expect the development costs to be $450,000 per year for the next three years. Once the new system is in place, you will receive a final payment of $900,000 from the university four years from now.

a.What are the IRRs of this opportunity?

b.If your cost of capital is 10%, is the opportunity attractive?

Suppose you are able to renegotiate the terms of the contract so that your final payment in year 4 will be $1 million.

c.What is the IRR of the opportunity now?

d.Is it attractive at these terms?

 

7-20.You are considering making a movie. The movie is expected to cost $10 million upfront and take a year to make. After that, it is expected to make $5 million when it is released in one year and $2 million per year for the following four years. What is the payback period of this investment? If you require a payback period of two years, will you make the movie? Does the movie have a positive NPV if the cost of capital is 10%?

7-25.You are evaluating the following two projects:

Use the incremental IRR to determine the range of discount rates for which each project is optimal to undertake. Note that you should also include the range in which it does not make sense to take either project.

7-28.AOL is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid, from Huawei, will require a $20 million upfront investment and will generate $20 million in savings for AOL each year for the next three years. The second bid, from Cisco, requires a $100 million upfront investment and will generate $60 million in savings each year for the next three years.

a.What is the IRR for AOL associated with each bid?

b.If the cost of capital for this investment is 12%, what is the NPV for AOL of each bid? Suppose Cisco modifies its bid by offering a lease contract instead. Under the terms of the lease, AOL will pay $20 million upfront, and $35 million per year for the next three years. AOL’s savings will be the same as with Cisco’s original bid.

c.Including its savings, what are AOL’s net cash flows under the lease contract? What is the IRR of the Cisco bid now?

d.Is this new bid a better deal for AOL than Cisco’s original bid? Explain.

.

7-31.Kaimalino Properties (KP) is evaluating six real estate investments. Management plans to buy the properties today and sell them five years from today. The following table summarizes the initial cost and the expected sale price for each property, as well as the appropriate discount rate based on the risk of each venture.

KP has a total capital budget of $18,000,000 to invest in properties.

a.What is the IRR of each investment?

b.What is the NPV of each investment?

c.Given its budget of $18,000,000, which properties should KP choose?

d.Explain why the profitability index method could not be used if KP’s budget were $12,000,000 instead. Which properties should KP choose in this case?