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Cash flow, payback method, IRR, secured debt, bond yields, z

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Text Questions and Exercises - WEEK 3

Prepare answers to the following questions and exercises from the text: Foundations of Financial Management -

Chapter 12: 1, 4, 8, 9
Chapter 16: 4, 5, 10
Chapter 12

Cash Flow
1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes ___
Depreciation ___
Earnings before taxes ___
Taxes @ 30% ___
Earnings after taxes ___
Depreciation ___
Cash flow ___

Payback Method
1. Assume a $40,000 investment and the following cash flows for two alternatives.
Year Investment X Investment Y
1 $ 6,000 $15,000
2 8,000 20,000
3 9,000 10,000
4 17,000 ?
5 20,000 ?
Which of the alternatives would you select under the payback method?

Internal Rate of return
8. You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the internal rate of return?

Internal Rate of Return
9. Warner Business Products is considering the purchase of a new machine at a cost of $11,070. The machine will provide $2,000 per year in cash flow for eight years. Warner's cost of capital is 13 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken.

Chapter 16
Secured vs. unsecured debt
2. Match the yield to maturity in column 2 with the security provisions (or lack thereof) in column 1. Higher returns tend to go with greater risk.

1. Security Provision 2. Yield to Maturity
a. Debenture a. 6.85%
b. Secured debt b. 8.20%
c. Subordinated debenture c. 7.76%

Bond Yields

3. The Southeast Investment Fund buys 70 bonds of the Hillary Bakery Corporation through its broker. The bonds pay 9 percent annual interest. The yield to maturity (market rate of interest) is 12 percent. The bonds have a 25-year maturity. Using an assumption of semiannual interest payments:
1. Compute the price of a bond (refer to "semiannual interest and bond prices" in Chapter 10 for review if necessary).
2. Compute the total value of the 70 bonds.

Zero coupon bond values

A 15-year, $1,000 par value zero-coupon rate bond is to be issued to yield 10 percent.
1. What should be the initial price of the bond? (Take the present value of $1,000 to be received after 15 years at 10 percent, using Appendix B at the back of the text.)
2. If immediately upon issue, interest rates dropped to 8 percent, what would be the value of the zero-coupon rate bond?
3. If immediately upon issue, interest rates increased to 12 percent, what would be the value of the zero-coupon rate bond?

Attachments

Solution Preview

See attached files.

Text Questions and Exercises - WEEK 3
Prepare answers to the following questions and exercises from the text: Foundations of Financial Management -

Chapter 12: 1, 4, 8, 9
Chapter 16: 4, 5, 10
Chapter 12
Cash Flow
1. Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and that it is in a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes 90,000
Depreciation 40,000
Earnings before taxes 50,000
Taxes @ 30% 15,000
Earnings after taxes 35,000
Depreciation 40,000
Cash flow 75,000

Payback Method
1. Assume a $40,000 investment and the following cash flows for two alternatives.
Year Investment X Investment Y
1 $ 6,000 $15,000
2 8,000 20,000
3 9,000 10,000
4 17,000 ?
5 20,000 ?
Which of the alternatives would you select under the payback method?
Payback method is to determine the amount of time that is used to match the amount of investment and cash inflows.
Investment X = 6,000 + 8,000 + 9,000 + 17,000 = 40,000
Payback for Investment X = 4 years
Investment Y = 15,000 + 20,000 + (5,000/10,000 amount left to make equal to 40,000 divided by the cash inflow for that year)
Payback for Investment Y = 2.5 years
I would select Investment Y due to shorter payback period.

Internal Rate of return
8. You buy a new piece of equipment for $16,980, and you receive a cash inflow of $3,000 per year for 12 years. What is the ...

Solution Summary

This solution is comprised of a detailed explanation to compute its cash flow and answer which of the alternatives would you select under the payback method.

$2.19