Purchase Solution

# Cost of Loan, Net Credit Position, PV, YTM, Cost of Debt

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1) Talmud Book Company borrows \$16,000 for 30 days at 9% interest. What is the dollar cost of the loan?

Dollar cost of loan = Amount Borrowed X interest Rate X Days loan is Outstanding/ Days in the year (360)

2) McGriff Dog Food Company normally takes 20 days to pay for average daily credit purchases of \$9,000. Its average daily sales are \$10,000 and it collects accounts in 25 days.

a) What is its net credit position? That is compute its accounts receivable and accounts payable and subtract the latter from the former.

Account receivable = average daily credit sales X average collection period.
Account payable = average daily credit purchase X average payment period.

b) If the firm extend its average payment period from 20 days to 32 days (and all else remains the same). What is the firmâ??s new net credit position? Has it improved its cash flow?

3) A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned \$200,000 a year for the next 40 years. The attorney for the plaintiffâ??s estate argues that the lost income should be discounted back to the present at 4%. The lawyer for the defendantâ??s insurance company argues for a discount rate of 12%. What is the difference between the present value of the settlement at 4% and 12%? Compute each one separately.

4) Royal Jewelers Inc. has an after-tax cost of debt of 6%. What tax rate of 40%. What can you assume the yield on the debt is?

5) Russell Container Corporation has a \$1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of \$95 and is currently selling for \$920 per bond. Russell Corp. is in a 25% tax bracket. The firms wishes to known what the after tax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

a) Compute the approximate yield to maturity.
b) Make the appropriate tax adjustment to determine the after-tax cost of debt.

6) Delta Corp has the following capital structure.
Cost after tax weight weight cost
Debt 61% 25% 1.53%
Preferred stock (kp) 7.6% 10 .76
Common equity (ke)
Retained earnings 15.1 65 9.82
Weighted average cost of capital (ka) 12.11%

A) If the firm has \$26 million in retained earnings, at what size capital structure will the firm run out of retained earnings?
B) The 7.1 % cost of debt referred to above applies only to the first \$13 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt?

##### Solution Summary

Solution is comprised of detailed calculation of the following questions: 1) Talmud Book Company borrows \$16,000 for 30 days at 9% interest. What is the dollar cost of the loan?

2) McGriff Dog Food Company normally takes 20 days to pay for average daily credit purchases of \$9,000. Its average daily sales are \$10,000 and it collects accounts in 25 days.

a) What is its net credit position?

b) If the firm extend its average payment period from 20 days to 32 days (and all else remains the same). What is the firmâ??s new net credit position? Has it improved its cash flow?

3) A brilliant young scientist is killed in a plane crash. It was anticipated that he could have earned \$200,000 a year for the next 40 years. The attorney for the plaintiffâ??s estate argues that the lost income should be discounted back to the present at 4%. The lawyer for the defendantâ??s insurance company argues for a discount rate of 12%. What is the difference between the present value of the settlement at 4% and 12%? Compute each one separately.

4) Royal Jewelers Inc. has an after-tax cost of debt of 6%. What tax rate of 40%. What can you assume the yield on the debt is?

5) Russell Container Corporation has a \$1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of \$95 and is currently selling for \$920 per bond. Russell Corp. is in a 25% tax bracket. The firms wishes to known what the after tax cost of a new bond issue is likely to be. The yield to maturity on the new issue will be the same as the yield to maturity on the old issue because the risk and maturity date will be similar.

a) Compute the approximate yield to maturity.
b) Make the appropriate tax adjustment to determine the after-tax cost of debt.

6) Delta Corp has the following capital structure.
Cost after tax weight weight cost
Debt 61% 25% 1.53%
Preferred stock (kp) 7.6% 10 .76
Common equity (ke)
Retained earnings 15.1 65 9.82
Weighted average cost of capital (ka) 12.11%

A) If the firm has \$26 million in retained earnings, at what size capital structure will the firm run out of retained earnings?
B) The 7.1 % cost of debt referred to above applies only to the first \$13 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt?

##### Solution Preview

Please see the attachment for proper format of formulas.

1) Talmud Book Company borrows \$16,000 for 30 days at 9% interest. What is the dollar cost of the loan?

Dollar cost
Of loan = Amount Borrowed X interest Rate X Days loan is Outstanding/ Days in the year (360)
Dollar cost of loan = \$16,000 * 0.09 * (30/360)
= \$120

2) McGriff Dog Food Company normally takes 20 days to pay for average daily credit purchases of \$9,000. Its average daily sales are \$10,000 and it collects accounts in 25 days.

a) What is its net credit position? That is compute its accounts receivable and accounts payable and subtract the latter from the former.

Account receivable = average daily credit sales X average collection period.
= \$10,000 * 25 = \$250,000

Account payable = average daily credit purchase X average payment period.
= \$9,000 * 20 = \$180,000

Net credit position: \$250,000 - \$180,000 = \$70,000

b) If the firm extend its average payment period from 20 days to 32 days (and all else remains the same). What is the firmâ??s new net credit position? Has it improved its cash flow?
New account payable = \$9,000 * 32 = \$288,000
Same ...

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