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Residual Dividend Policy: Maximum Capital Budget

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2. Banerjee Inc. wants to maintain a target capital structure with 30% debt and 70% equity. Its forecasted net income is $550,000, and its board of directors has decreed that no new stock can be issued during the coming year. If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure?

$673, 652

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The target capital structure has 30% debt and 70% equity. If no new ...

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The solution explains the mutiple choice question in relation to residual dividend policy

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1) Options 2) Capital Budgeting 3) Free Cash Flow 4) Dividend Policy 5) Exchange Rate 6) Leasing 7) Financing

See attached file for 7 finance problems.
Please answer in xlsx and be sure to show how you do all calculations.

Question 1. a) NORREL Corporation's stock is selling for $35 per share. An investor is considering buying a call option with an exercise price of $40. The investor is willing to pay the premium of 50 cents per option.
b) Why is an investor willing to pay 50 cents an option when the stock is going for $35?
c) Calculate the exercise value if the price of the stock increases to $42 per share.
d) What is the difference between a put option and a call option?

Question 2. Your company is evaluating new equipment that will cost $1,000,000. The equipment is in the MACRS 3-year class and will be sold after 3 years for $100,000. Use of the equipment will increae net working capital by 100,000. The equipment will save $450,000 per year in operating costs. The company's tax rate is 30 percent and its cost of capital is 10%.
Part a. Calculate the cash flow in Year 0.
Part b. Calculate the incremental operational cash flows .
Reference: MACRS Depreciation Percentages for three-year class life assets:
33% 45% 15% 7% 100%
Part c. Calculate the non-operating terminal year cash flow.
Part d. Calculate the project's payback period.
Part e. Calculate the project's NPV.
Part f. Calculate the project's IRR.
Part g. Calculate the project's MIRR.
Part h. Investment Decision: Should the project be accepted or rejected? Why or why not?

Question 3. A company generated free cash flow of $1 million last year and expects it to grow at a constant rate of 8 percent indefinitely. The company's weighted average cost of capital is 10 percent.
a. Calculate the company's free cash flow for next year.
b. Calculate the value of the company's operations.
c. How much would the value of operations change if expected growth is 5 percent?

Question 4. Reynolds company is evaluating its dividend policy. Selected data for the company are shown below.

Capital budget: $10,000,000
Desired capital structure: 40% Debt, 60% Equity
Expected net income $7,000,000
Outstanding shares 5,000,000
Last annual dividend per share $0.50

a. If the company follows a residual policy, how much will it pay out in dividends?
b. If the company decides to maintain last year's dividend, how much will it pay out in dividends this year?
c. What are the company's options for raising the equity needed for the capital budget?
d. Should the company follow the residual dividend policy? Why or why not?
e. Which is better for the stockholder--cash dividends or stock repurchases? Why?

Question 5. The exchange rate between the Japanese yen and the U.S. dollar is 105 yen = 1U.S$. A U.S. company agrees to purchase goods for 40 million yen, with payment due in 6 months.
a. How many U.S. dollars would the company need to purchase the goods and pay for them today?
b. Has the yen appreciated or depreciated against the dollar If the exchange rate is 100 yen to 1$US in 6 months? Why?
c. How many U.S. dollars will be needed to pay for the goods if the exchange rate is 110 yen to 1$US?
d. Does the Japanese exporter or the U.S. importer bear the risk if payment is due in yen? Why?
e. How can a company protect itself against exchange rate risk?

Question 6. Kemp Corporation is evaluating whether to lease or purchase equipment. The equipment will cost $500,000 if purchased, and the entire amount will be financed by a bank loan at an annual interest rate of 10 percent. At the end of 4 years, the company expects to sell the equipment for $60,000. The equipment falls in the MACRS 3-year class. The firm's tax rate is 30 percent. The lease terms call for payments of $100,000 for 4 years, payable at the beginning of the year.
a. Calculate the cost of purchasing the equipment.
b. Calculate the cost of leasing the equipment.
c. Calculate the NAL. Should the firm purchase or lease the equipment? Why?

Question 7. ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to increase total assets by $1,400,000. The bank loan bears an interest rate of 10 percent. The company's president owns 57.5% percent of the 1,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percent. Balance sheet information is shown below.

The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share.

Current Balance Sheet
Current Liabilities $900,000
Common Stock, Par $1 1,000,000
Retained earnings 700,000
Total Assets $2,600,000 Total claims $2,600,000

a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants.
b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares.
c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets.
d. Calculate the debt ratio under both alternatives
e. Which alternative do you recommend and why?

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