# Successful Finance for a Company

1. How does expertise in finance help a company become successful? Be specific and explain at least three ways. (TCO A)

2. Answer all five questions. Explain how you determined the answer and show your work. (TCO B)

Questions:

a. You want to borrow $1,000 from a friend for one year, and you propose to pay her $1,120 at the end of the year. She agrees to lend you the $1,000, but she wants you to pay her $10 of interest at the end of each of the first 11 months plus $1,010 at the end of the 12th month. How much higher is the effective annual rate under your friend's proposal than under your proposal?

b. You are considering buying a new car. The sticker price is $15,000 and you have $2,000 to put toward a down payment. If you can negotiate a nominal annual interest rate of 10 percent and you wish to pay for the car over a 5-year period, what are your monthly car payments?

c. Suppose you put $100 into a savings account today, the account pays a nominal annual interest rate of 6 percent, but compounded semiannually, and you withdraw $100 after 6 months. What would your ending balance be 20 years after the initial $100 deposit was made?

d. Terry Austin is 30 years old and is saving for her retirement. She is planning on making 36 contributions to her retirement account at the beginning of each of the next 36 years. The first contribution will be made today (t = 0) and the final contribution will be made 35 years from today (t = 35). The retirement account will earn a return of 10 percent a year. If each contribution she makes is $3,000, how much will be in the retirement account 35 years from now (t = 35)?

e. You can earn 8 percent interest, compounded annually. How much must you deposit today to withdraw $10,000 in 6 years?

3. Alpha-Omega Corporation had the following cash flows last year

(TCO C)

:

Operating income $250,000

Interest received 10,000

Interest paid 45,000

Dividends received 20,000

Dividends paid 50,000

Alpha-Omega was profitable last year, and its income taxes were paid using the following tax table:

Taxable Income Rate

0 - 50,000 15%

50,000 - 75,000 25%

75,000 - 100,000 34%

100,000 - 335,000 39%

over - 335,000 34%

Calculate A-O's tax liability for last year.

a. $ 57,530

b. $ 65,350

c. $ 69,440

d. $ 88,350

e. $100,280

Please show all work.

4. Zero coupon bonds (TCO D)

a. are issued only by corporations.

b. can be used to finance new projects that will take years to produce major cash inflows.

c. are priced at $1,000 when issued.

d. produce no tax-deductible interest charge.

e. have a lower after-tax cost than regular coupon bonds.

Discuss fully the reasons for your choice.

5. Which one of the following factors does NOT influence a firm's long-term financing decisions? (TCO D) (Points: 10)

a. Its target capital structure.

b. Maturity matching considerations.

c. Comparative costs of financing alternatives.

d. Availability of collateral.

e. All of the above factors may influence a firm's long-term financing decisions.

Discuss fully the reasons for your choice.

6. A share of common stock has just paid a dividend of $3.00. If the expected long-run growth rate for this stock is 5 percent, and if investors require an 11 percent rate of return, what is the price of the stock?

Show your work.

7. A share of preferred stock pays a quarterly dividend of $2.50. If the price of this preferred stock is currently $50, what is the nominal annual rate of return? (TCO D) (Points: 10)

Show your work.

8. The real risk-free rate is 2 percent. The rate of inflation is expected to be 3 percent a year for the next three years and then 4 percent a year thereafter. Assume that the default risk premium and liquidity premium on all Treasury securities equals zero. You observe that 10-year bonds yield 1 percent more than the yield on 5-year bonds. What is the difference in the maturity risk premium on the two bonds? (That is, what is MRP10 - MRP5?) (TCO A) (Points: 10)

Discuss fully the reasons for your choice. .

9. Assume that you wish to purchase a bond with a 10-year maturity, an annual coupon rate of 10 percent, a face value of $1,000, and semiannual interest payments. If you require a 9 percent nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? (TCO C, D) (Points: 10)

Show your work.

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#### Solution Summary

The solution examines successful finance for a company. The target capital structure is determined.