Problem 1
Lowell Inc. has no debt and its financial position is given by the following data:
|
Assets (book = market)
|
$3,000,000
|
|
EBIT
|
$500,000
|
|
Cost of equity (Ks)
|
10%
|
|
Stock price (P0)
|
$15
|
|
Shares outstanding n0
|
200,000
|
|
Tax rate T
|
40%
|
The firm is considering selling bonds and simultaneously repurchasing some of its stock. It if moves to capital structure with 30 percent debt based on market values, its cost of equity, Ks, will increase to 11 percent to reflect the increased risk. Bonds can be sold at a cost (Kd) of 7 percent. Lowell Inc. is a no-growth firm. Hence, all its earnings are paid out as dividends, and earnings are exceptionally constant over time.
a. What would be the new WACC?
b. What effect would this use of leverage have on the value of the firm (Va)?
c. What would be Lowell Inc.'s stock price?
d. What happens to the firm's earnings per share after the recapitalization?
Problem 2
Mass Inc. is trying to estimate its optimal capital structure. Right now, Mass Inc. has a capital structure that consists of 50 percent debt and 50 percent equity, based on market values. (Its D/S ratio is 1.00) The risk- free rate is 6 percent and the market risk premium, KM - KRF, is 5 percent. Currently the company's cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. What would be Mass Inc.'s estimated cost of equity if it were to change its capital structure to 60 percent debt and 40 percent equity?
Problem 3
Use the following information to:
a. Calculate the cash conversion cycle, and interpret the numbers
|
INCOME STATEMENT
|
COCA-COLA
|
PEPSI
|
|
Sales
|
23,104
|
32,562
|
|
Cost of goods sold
|
8,195
|
14,176
|
|
BALANCE SHEET
|
COCA-COLA
|
PEPSI
|
|
Assets
|
|
|
|
Cash and Cash Equivalents
|
4,701
|
1,716
|
|
Short-term Investments
|
66
|
3,166
|
|
Accounts Receivables
|
2,281
|
3,261
|
|
Inventory
|
1,424
|
1,693
|
|
Other Current Assets
|
1,778
|
618
|
|
Total Current Assets
|
10,250
|
10,454
|
|
Total Assets
|
29,427
|
31,727
|
|
Financed by:
|
COCA-COLA
|
PEPSI
|
|
Accounts Payable
|
5,290
|
5,357
|
|
Short-term debt
|
4,546
|
2,889
|
|
Other Current Liabilities
|
0
|
1,160
|
|
Total Current Liabilities
|
9,836
|
9,406
|
Problem 4
In-tech Corporation's sales and purchases for the last three months are as following:
|
|
Sales ($)
|
Purchases ($)
|
|
October
|
100,000
|
80,000
|
|
November
|
90,000
|
100,000
|
|
December
|
120,000
|
75,000
|
For the next three months, it estimates sales and purchases to be as following:
|
|
Sales ($)
|
Purchases ($)
|
|
January
|
90,000
|
70,000
|
|
February
|
80,000
|
70,000
|
|
March
|
80,000
|
70,000
|
It pays 40 percent of purchases in cash and gets a 4 percent discount. Another 40 percent of purchases are paid the next month, and the final 20 percent of purchases are paid in the second month after the purchase (for example,
40 percent of October purchases are paid in October, 40 percent October purchases are paid in November, and 20 percent October purchases are paid in December). Half of the sales are made in cash, and the balance is collected the next month. Cash sales are given a two percent discount, and five percent of credit sales end up as bad debt. The monthly operating expenses for In-tech Corporation's are $10,000. In-tech expects to sell one of its machinery in March for $25,000. It will buy the replacement in April for $50,000. The cash balance as on December 31 was $50,000. In-tech has a target cash balance of $50,000. Prepare a monthly cash budget for the next three months.