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Estimating Free Cash Flow, Return, Financial Leverage etc.

11-1 Meltzer Electronics estimates that its total financing needs for the coming year will be $34.5 million. During the coming fiscal year, the firm's required financing payments on its debt-and-equity financing will toal $12.9 million. The firm's financial manager estimates that operating cash flows for the coming year will total $33.7 million and that the following changes will occur in the accounts noted.

Account Forecast Change
Gross fixed assets $8.9 million
Change in current assets +2.3 million
Change in accounts payable +1.3 million
Change in accrued liabilities +0.8 million

Use the data provided to estimate Meltzer's free cash flow in the coming year.
How much of the free cash flow will the firm have available as a source of new internal financing in the coming year?
How much external financing will Meltzer require during the coming year to meet its total forecast financing need?

11-2 West Coast Manufacturing Company (WCMC) is executing an initial public offering with the following characteristics. The company will sell 10 million shares at an offer price of $25 per share, the underwriter will charge a 7 percent underwriting fee, and the shares are expected to sell for $32 per share by the end of the first-day's trading. Assuming this IPO is executed as expected, answer the following:

Calculate the initial return earned by investors who are allocated shares in the IPO.
How much will WCMC receive from this offering?
What is the total cost (underwriting fee and under pricing) of this issue to WCMC?

What is Financial Leverage and why do firms Use it?

12-1 As Chief Financial Officer of the Magnificent Electronics Corporation (MEC), you are considering a recapitalization plan that would convert MEC from its current all-equity capital structure to one including substantial financial leverage. MEC now has 500,000 shares of common stock outstanding, which are selling for $60 each, and you expect the firm's EBIT to be $2,400,000 per year, for the foreseeable future. The recapitalization proposal is to issue $15,000,000 worth of long-term debt, at an interest rate of 6.0 percent, and use the proceeds to repurchase 250,000 shares of common stock worth $15,000,000. Assuming there are no market frictions such as corporate or personal income taxes, calculate the expected return on equity for MEC shareholders, under both the current all-equity capital structure and under the recapitalization plan.

12-2 The ALL-Star Production Corporation (APC) is considering a recapitalization plain that would convert APC from its current all-equity capital structre to one including some financial leverage. APC now has 10,000,000 shares of common stock outstanding, which are selling for $40.00 each, and you expect the firm's EBIT to be $50,000,000 per year, for the foreseeable future. The recapitalization proposal is to issue $1000,000,000 worth of long-term debt, at an interest rate of 6.50 percent, and use the proceeds to repurchase as many shares as possible, at a price of $40.00 per share. Assume there are no market frictions such as corporate or personal income taxes. Calculate the expected return on equity for APC shareholders, under both the current all-equity capital structure and under the recapitalization plan.

a. Calculate the number of shares outstanding, the per-share price, and the debt-to-equity ratio for APC if the proposed recapitalization is adopted.
b. Calculate the earnings per share (EPS) and the return on equity for APC shareholders, under both the current all-equity capitalization and the proposed mixed debt/equity capital structure.
c. Calculate the breakeven level of EBIT, where earnings per share for APC stockholders are the same, under the current and proposed capital structures.
d. At what level of EBIT will APC shareholders earn zero EPS, under the current and the proposed capital structures?

Solution Preview

See the attached file for a hard copy of the solution (the text here may not be copied exactly as some of the symbols / tables may not print).

11-1 Meltzer Electronics estimates that its total financing needs for the coming year will be $34.5 million. During the coming fiscal year, the firm's required financing payments on its debt-and-equity financing will total $12.9 million. The firm's financial manager estimates that operating cash flows for the coming year will total $33.7 million and that the following changes will occur in the accounts noted.

Account Forecast Change
Gross fixed assets $8.9 million
Change in current assets +2.3 million
Change in accounts payable +1.3 million
Change in accrued liabilities +0.8 million

Use Equation 2.3 and the data provided to estimate Meltzer's free cash flow in the coming year.
How much of the free cash flow will the firm have available as a source of new internal financing in the coming year?
Operating cash flows = $33.7 million
Less: Increase in gross fixed assets = $8.9 million
Less: Increase in current assets = $2.3 million
Add: increase in accounts payable = $1.3 million
Add: Increase in accrued liabilities = $0.8 million
Free cash flow in coming year = $24.6 million

Less: Financing payments on debt and equity financing = $12.9 million
Free cash flow available as a source of internal financing = 11.7 million

How much external financing will Meltzer require during the coming year to meet its total forecast financing need?
External financing needed = 34.5 million - 11.7 million = $22.8 million

11-2 West Coast Manufacturing Company (WCMC) is executing an initial public offering with the following characteristics. The company will sell 10 million shares at an offer price of $25 per share, the underwriter will charge a 7 percent underwriting fee, and the shares are expected to sell for $32 per share by the end of the first-day's trading. Assuming this IPO is executed as expected, answer the ...

Solution Summary

Some of the concepts explained in this post include initial return, expected return, earnings per share (EPS), breakeven level of EBIT, number of shares outstanding, etc. There are four questions solved and it could be used as a good learning exercise. Full solution attached in Word for formatting reasons.

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