Task1. Trevor Price bought 10-year bonds issued by the Harvest Foods 5 years ago for $986.61. The bonds make semi-annual coupon payments at a rate of 8.4 percent. When the current price of the bonds is $1,063.49, what is yield that Trevor would earn by selling the bonds today?
Task2. The Pettit Corporation has annual credit sales of $2 million. Current expenditures for the collection department are $30,000, bad debt losses are 2% and the day’s sales outstanding are 30 days. Pettit is considering easing its collection efforts so that collection expenditures will be reduced to $22,000 per year. The change is expected to raise bad debt losses to 3% and to raise the DSO to 45 days. In addition, sales are anticipated to rise to $2.2 million per year. Should Pettit relax collection efforts when the opportunity cost of funds is 12%, the variable cost ratio is 75% and its marginal tax rate is 40%? All costs associated with production and credit sales are paid on day of the sale.
Task3. Suppose that Firms U and L are in the same risk class and that both have EBIT = $500,000. Firm U uses no debt financing, and its cost of the equity is rsu = 14%. Firm L has $1 million of debt outstanding at a cost rd =8%. There are no taxes. Suppose that the MM (Miller and Modigliani) assumptions hold.
1. Find out V, S, rs, and WACC for Firms U and L.
2. Graph (a) the relationships between capital costs and leverage as evaluated by D/V and (b) the relationship between V and D.
Now suppose that Firms L and U are both subject to a 40% corporate tax rate. Using the data given repeat the analysis called for in (1) and (2) under MM model with taxes.