# After tax returns, constant growth stock, NPV, cash budget,

1

EQ 2. (TCO D) After-tax returns

West Corporation has $50,000, which it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 6 percent; Exxon bonds yielding 9.5 percent; GM preferred stock with a dividend yield of 9 percent. West's corporate tax rate is 35 percent. What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)

2

EQ 2. (TCO D) After-tax returns

The XYZ Corporation has $1000,000 which it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Greenville County tax-free municipal bonds yielding 7 percent; AB corp. bonds yielding 11.5 percent; XZ corp. preferred stock with a dividend yield of 10 percent. XYZ's corporate tax rate is 35 percent. What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)

3

EQ 4. (TCO E) Constant growth stock

The last dividend paid by ABC Company was $2.00. ABC's growth rate is expected to be a constant 4 percent. ABC's required rate of return on equity (ks) is 9 percent. What is the current price of ABCs common stock?

4

EQ 4. (TCO E) Constant growth stock

The last dividend paid by XYZ Company was $1.00. XYZs growth rate is expected to be a constant 5 percent. XYZ's required rate of return on equity (ks) is 10 percent. What is the current price of XYZ's common stock?

5

EQ 4. (TCO E) Constant growth stock

The last dividend paid by Klein Company was $1.00. Klein's growth rate is expected to be a constant 4 percent. Klein's required rate of return on equity (ks) is 12 percent. What is the current price of Klein's common stock?

6

EQ 5. (TCO B, F) NPV

As the director of capital budgeting for Bingo Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

A B

-$150,000 -$225,000

1 $55,000 $85,000

2 $70,000 $55,000

3 $70,000 $65,000

4 $75,000 $55,000

5 $80,000 $65,000

If Bingo Corporation's cost of capital is 10 percent, defend which project would you choose.

7

EQ 5. (TCO B, F) NPV

As the director of capital budgeting for ABC Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

A B

-$200,000 -$125,000

1 $65,000 $60,000

2 $60,000 $40,000

3 $50,000 $40,000

4 $65,000 $35,000

5 $50,000 $45,000

8

EQ 5. (TCO B, F) NPV

As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

A B

-$100,000 -$125,000

1 $25,000 $25,000

2 $30,000 $35,000

3 $30,000 $35,000

4 $25,000 $35,000

5 $30,000 $45,000

If Denver's cost of capital is 15 percent, defend which project would you choose.

9

EQ 6. (TCO G) Cash budget

XYZ Corporation's budgeted monthly sales are $4,500. Forty percent of its customers pay in the first month and take the 1 percent discount. The remaining 60 percent pay in the month following the sale and do not receive a discount. XYZ's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $1,200. Other payments for wages, rent, and taxes are constant at $800 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for XYZ Corporation?

10

EQ 6. (TCO G) Cash budget

ABC Corporation's budgeted monthly sales are $4,000. Forty percent of its customers pay in the first month and take the 3 percent discount. The remaining 60 percent pay in the month following the sale and do not receive a discount. ABC's bad debts are very small and are excluded from this analysis. Purchases for next month's sales are constant each month at $2,000. Other payments for wages, rent, and taxes are constant at $500 per month. Construct a single month's cash budget with the information given. What is the average cash gain or (loss) during a typical month for ABC Corporation?

11

EQ 9. (TCO D)

Which of the following Treasury bonds will have the largest amount of interest rate risk (price risk) and why?

A. A 7% coupon bond which matures in 12 years.

B. A 9% coupon bond which matures in 10 years.

C. A 12% coupon bond which matures in 7 years.

D. A 7% coupon bond which matures in 9 years.

E. A 10% coupon bond which matures in 10 years.

12

EQ 9. (TCO D)

All treasury securities have a yield to maturity of 7%-- so the yield curve is flat. If the yield to maturity on all Treasuries were to decline to 6%, which of the following bonds would have the largest percentage increase in price and why?

A. 15 year zero coupon Treasury bond.

B. 12 year Treasury bond with a 10% annual coupon.

C. 15 year Treasury bond with a 12 percent annual coupon.

D. 2 year zero coupon Treasury bond.

E. 2 year Treasury bond with a 15% annual coupon.

13

EQ 9. (TCO D)

Which of the following statements is most correct and why?

A. If a bond sells for less than par, and then its yield to maturity is less than its coupon rate.

B. If a bond sells at par, and then its current yield will be less than its yield to maturity.

C. Assuming that both bonds are held to maturity and are of equal risk, a bond selling for more than par with ten years to maturity will have a lower current yield and higher capital gain relative to a bond that sells at par.

D. Answers A and C are correct.

E. None of the answers above is correct.

14

EQ 10. (TCO C) Payback period

The ABC Corporation is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $70,000 a year at the end of each of the next five years. The project's NPV is $90,000 and the company's WACC is 12 percent. What is the project's simple, regular payback?

15

EQ 10. (TCO C) Payback period

The Bingo Corporation is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $85,000 a year at the end of each of the next five years. The project's NPV is $100,000 and the company's WACC is 10 percent. What is the project's simple, regular payback?

16

EQ 10. (TCO C) Payback period

Haig Aircraft is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $60,000 a year at the end of each of the next five years. The project's NPV is $75,000 and the company's WACC is 10 percent. What is the project's simple, regular payback?

17

EQ 11. (TCO H) WACC

A company has determined that its optimal capital structure consists of 30 percent debt and 70 percent equity. Given the following information, calculate the firm's weighted average cost of capital.

Rd = 6%

Tax rate = 35%

P0 = $35

Growth = 0%

D0 = $3.00

18

EQ 11. (TCO H) WACC

A company has determined that its optimal capital structure consists of 50 percent debt and 50 percent equity. Given the following information, calculate the firm's weighted average cost of capital.

Rd = 7%

Tax rate = 40%

P0 = $30

Growth = 0%

D0 = $2.50

19

EQ 11. (TCO H) WACC

A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital.

rd= 6%

Tax rate = 40%

P0 = $25

Growth = 0%

D0 = $2.00

20

(12.3) Sunk costs

Which of the following statements is CORRECT?

a. A sunk cost is any cost that must be expended in order to complete a project and bring it into operation.

b. A sunk cost is any cost that was expended in the past but can be recovered if the firm decides not to go forward with the project.

c. A sunk cost is a cost that was incurred and expensed in the past and cannot be recovered if the firm decides not to go forward with the project.

d. Sunk costs were formerly hard to deal with, but once the NPV method came into wide use, it became possible to simply include sunk costs in the cash flows and then calculate the PV.

e. A good example of a sunk cost is a situation where a retailer opens a new store, and that leads to a decline in sales of some of the firm's existing stores.

21

(12.3) Externalities

Which of the following statements is CORRECT?

a. An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.

c. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.

d. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.

e. The identification of an externality can never lead to an increase in the calculated NPV.

22

(Comp: 12.1-12.4) Ann. op. CFs, depr'n and int. given

As a member of Midwest Corporation's financial staff, you must estimate the Year 1 operating cash flow for a proposed project with the following data. What is the Year 1 operating cash flow?

Sales revenues, each year $35,000

Depreciation $10,000

Other operating costs $17,000

Interest expense $4,000

Tax rate 35.0%

a. $12,380

b. $13,032

c. $13,718

d. $14,440

e. $15,200

23

(Comp: 12.1-12.4) Ann. op. CFs, depr'n and int. given

You work for the Sing Oil Company, which is considering a new project whose data are shown below. What is the project's operating cash flow for Year 1?

Sales revenues, each year $55,000

Depreciation $8,000

Other operating costs $25,000

Interest expense $8,000

Tax rate 35.0%

a. $21,185

b. $22,300

c. $23,415

d. $24,586

e. $25,815

24

(Comp: 12.1-12.4) NPV, SL, constant CFs, cannibalization

TexMex Products is considering a new salsa whose data are shown below. The equipment that would be used would be depreciated by the straight-line method over its 3-year life, would have zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project's 3-year life. However, this project would compete with other TexMex products and would reduce their pre-tax annual cash flows. What is the project's NPV? (Hint: Cash flows are constant in Years 1-3.)

WACC 10.0%

Pre-tax cash flow reduction in other products (cannibalization) $5,000

Investment cost (depr'ble basis) $65,000

Straight-line depr'n rate 33.333%

Sales revenues, each year $75,000

Annual operating costs, ex. depr'n $25,000

Tax rate 35.0%

a. $25,269

b. $26,599

c. $27,929

d. $29,325

e. $30,792

25

(14.3) Additional funds needed

Jefferson City Computers has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)?

a. A sharp increase in its forecasted sales.

b. A sharp reduction in its forecasted sales.

c. The company reduces its dividend payout ratio.

d. The company switches its materials purchases to a supplier that sells on terms of 1/5,

net 90, from a supplier whose terms are 3/15, net 35.

e. The company discovers that it has excess capacity in its fixed assets.

26 (14.3) Additional funds needed

Which of the following statements is CORRECT?

a. Since accounts payable and accrued liabilities must eventually be paid off, as these

accounts increase, AFN as calculated by the AFN equation must also increase.

b. Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.

c. If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.

d. Additional funds needed (AFN) are typically raised using a combination of notes payable,

Long-term debt and common stock. Such funds are non-spontaneous in the sense that they

require explicit financing decisions to obtain them.

e. If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.

27

(14.3) Additional funds needed--positive AFN

Clayton Industries is planning its operations for next year, and Ronnie Clayton, the CEO, wants you to forecast the firm's additional funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.

Last year's sales = S0 $350 Last year's accounts payable $40

Sales growth rate = g 30% Last year's notes payable (to bank) $50

Last year's total assets = A0 $500 Last year's accruals $30

Last year's profit margin = M 5% Target payout ratio 60%

a. $102.8

b. $108.2

c. $113.9

d. $119.9

e. $125.9

28

(14.5) Finding the target fixed assets/sales ratio

Last year Emery Industries had $450 million of sales and $225 million of fixed assets, so its FA/Sales ratio was 50%. However, its fixed assets were used at only 65% of capacity. If the company had been able to sell off enough of its fixed assets at book value so that it was operating at full capacity, with sales held constant at $450 million, how much cash (in millions) would it have generated?

a. $74.81

b. $78.75

c. $82.69

d. $86.82

e. $91.16

29

(14.5) Forecasting financial requirements

Which of the following statements is CORRECT?

a. When we use the AFN formula, we assume that the ratios of assets and liabilities to

sales (A*/S0 and L*/S0) vary from year to year in a stable, predictable manner.

b. When fixed assets are added in large, discrete units as a company grows, the

c. assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.

c. Firms whose fixed assets are 'lumpy' frequently have excess capacity, and this should be accounted for in the financial forecasting process.

d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.

e. A graph showing the relationship between assets and sales is always linear if economies of scale exist.

30

(14.3) AFN formula method

Which of the following statements is CORRECT?

a. Inherent in the basic, unmodified AFN formula are these two assumptions: (1) each asset item must grow at the same rate as sales, and (2) spontaneous liability accounts must also grow at the same rate as sales.

b. If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative.

c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN.

d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.

e. Dividend policy does not affect the requirement for external funds based on the AFN formula method.

https://brainmass.com/business/weighted-average-cost-of-capital/after-tax-returns-constant-growth-stock-npv-cash-budget-365178

#### Solution Summary

The solution computes After tax returns, constant growth stock, NPV, cash budget, payback, WACC in 30 problems

Comparing Mutually Exclusive Projects, Bond Price Movements, Capital Gains versus Income, Arithmetic and Geometric Returns, Interest Rate Risk, Profitability Index, EAC, NPV, Interest Rate Risk, Investment Returns, Project Analysis, Stock price with non constant growth in dividends, average return and standard deviation of return, Coupon Rates, Real Rates of Return, Stock Values

Question 1:

Comparing Mutually Exclusive Projects

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $1,910,000 and will last for 3 years. Variable costs are 38 percent of sales, and fixed costs are $139,000 per year. Machine B costs $4,390,000 and will last for 6 years. Variable costs for this machine are 32 percent and fixed costs are $79,000 per year. The sales for each machine will be $8,780,000 per year. The required return is 10 percent and the tax rate is 35 percent. Both machines will be depreciated on a straight-line basis. If the company plans to replace the machine when it wears out on a perpetual basis, the EAC for machine A is $_____Question 1: (6 points)

Question 2:

Bond Price Movements

Bond X is a premium bond making annual payments. The bond pays a 14 percent coupon, has a YTM of 11 percent, and has 20 years to maturity. Bond Y is a discount bond making annual payments. This bond pays a 11 percent coupon, has a YTM of 14 percent, and also has 20 years to maturity. If interest rates remain unchanged, you would expect that 4 years from now, Bonds X and Y will be priced at $ ____ and $_____ , respectively. And in 11 years: $ ____ and $____ . (Round answers to 2 decimal places.)

Question 3:

Capital Gains versus Income*

Consider four different stocks, all of which have a required return of 19 percent and a most recent dividend of $8.50 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 9 percent, 0 percent, and -9 percent per year, respectively. Stock Z is a growth stock that will increase its dividend by 22 percent for the next 2 years and then maintain a constant 10 percent growth rate, thereafter. The dividend yield for Stocks W, X, Y, and Z is percent, percent, percent, and percent, respectively. The expected capital gains yield for the respective stocks is ____ percent, _____ percent,_____ percent, ____and percent. (Input answers as a percent rounded to 2 decimal places, without the percent sign.) Discuss the relationship among the various returns that you find for each of these stocks.

Question 4:

P 12-16. Arithmetic and Geometric Returns

A stock had the following year-end prices and dividends:

Year Price Dividend

---------------------------------------------------------

1 $ 52.22 --

2 52.58 $ 0.55

3 50.56 0.6

4 51.27 0.63

5 62.46 0.72

6 68.53 0.73

The arithmetic and geometric returns for the stock are _____ percent and _____ percent, respectively. (Input answers as a percent rounded to 2 decimal places, without the percent sign.)

Question 5:

Interest Rate Risk

Bond J is a 6 percent coupon bond. Bond K is a 11 percent coupon bond. Both bonds have 11 years to maturity, make semiannual payments, and have a YTM of 8.5 percent. If interest rates suddenly rise by 3 percent, the percentage change in price of Bonds J and K is____ percent and ____ percent, respectively. (Input answers as a percent rounded to 2 decimal places, without the percent sign.)

Question 6:

Problems with Profitability Index

The Robb Computer Corporation is trying to choose between the following two mutually exclusive design projects:

Year Cash Flow (1) Cash Flow (2)

0 -$40,000 -$9,300

1 21,000 5,200

2 21,000 5,200

3 21,000 5,200

The required return is 19 percent.

a. The profitability index for Projects 1 and 2 is___ and ____ , respectively. If Robb Computer applies the profitability index decision rule, it should accept Project . (Round answers to 3 decimal places.)

b. The NPV for Projects 1 and 2 is $____ and $_____ , respectively. If Robb Computer applies the NPV decision rule, it should accept Project . (Round answers to 2 decimal places.)

c. Explain why your answers in (a) and (b) are different.

Question 7:

Calculating EAC

You are evaluating two different silicon wafer milling machines. The Techron I costs $187,000, has a 4-year life, and has pretax operating costs of $39,000 per year. The Techron II costs $328,000, has a 7-year life, and has pretax operating costs of $22,000 per year. For both milling machines, use straight-line depreciation to zero over the project's life and assume a salvage value of $20,000. Your tax rate is 34 percent and your discount rate is 13 percent. The Techron I has an EAC of $____ , while the Techron II has an EAC of $_____ (Round answers to 2 decimal places). You prefer Techron . Why?

Question 8:

Comparing Investment Criteria

Consider the following two mutually exclusive projects:

Year Cash Flow (A) Cash Flow (B)

0 -$194,601 -$28,058

1 12,894 11,999

2 27,237 8,872

3 29,159 13,767

4 388,500 13,767

Whichever project you choose. if any, you require a 15 percent return on your investment.

a. The payback period for Projects A and B is ___ and ___ years, respectively. If you apply the payback criterion, you will choose Project . (Round answers to 2 decimal places.)

b. The discounted payback period for Projects A and B is ___ and ___ years, respectively. If you apply the discounted payback criterion, you will choose Project . (Round answers to 2 decimal places.)

c. The NPV for Projects A and B is $___ and $____ , respectively. If you apply the NPV criterion, you will choose Project . (Round answers to 2 decimal places.)

d. The IRR for Projects A and B is percent and percent (Input these answers as a percent rounded to 2 decimal places, without the percent sign), respectively. If you apply the IRR criterion, you will choose Project .

e. The profitability index for Projects A and B is ___ and ____ , respectively. If you apply the profitability index criterion, you will choose Project . (Round answers to 3 decimal places.)

f. Based on your answers in (a) through (e), you finally choose Project . Why?

Question 9:

Interest Rate Risk

Both Bond Sam and Bond Dave have 8 percent coupons, make semiannual payments, and are priced at par value. Bond Sam has 5 years to maturity, wheareas Bond Dave has 12 years to maturity. If interest rates suddenly rise by 2 percent, the percentage change in the price of Bonds Sam and Dave is____ percent and ____ percent, respectively. (Input answers as a percent rounded to 2 decimal places, without the percent sign.)

Question 10:

Calculating Investment Returns

You bought one of Great White Shark Repellant Co.'s 7 percent coupon bonds one year ago for $870. These bonds make annual payments and mature 11 years from now. Suppose you decide to sell your bonds today, when the required return on the bonds is 11 percent. If the inflation rate was 4.3 percent over the past year, your total real return on this investment was ____ percent. (Input answer as a percent rounded to 2 decimal places, without the percent sign.)

Question 11:

Project Analysis

You are considering a new product launch. The project will cost $490,000, have a 3-year life, and have no salvage value; depreciation is straight- line to zero. Sales are projected at 230 units per year; price per unit will be $26,000, variable cost per unit will be $13,000, and fixed costs will be $220,000 per year. The required return on the project is 16 percent, and the relevant tax rate is 37 percent.

a. Based on your experience, you think the unit sales, variable cost, and fixed cost projections given here are probably accurate to within +/- 9 percent. Determine the upper and lower bounds for these projections. The base-case NPV is $___ . The best-case NPV is $____ and the worst-case NPV is $___ . (Round answers to 2 decimal places.)

Upper bound Lower bound

Unit sales

Variable cost per unit $

Fixed costs $

b. The sensitivity of your base-case NPV to changes in fixed costs is $ __ . (Round answer to 6 decimal places.)

c. The cash break-even level of output for this project (ignoring taxes) is units. (Round answer to nearest whole number.)

d. The accounting break-even level of output for this project is units (Round answer to nearest whole number). The degree of operating leverage at the accounting break-even point is (Round answer to 2 decimal places). Thus, for every 1 % increase in unit sales, OCF will change by percent (Input answer as a percent rounded to 2 decimal places, without the percent sign).

Question 12:

Nonconstant Growth

Storico Co. just paid a dividend of $3.50 per share. The company will increase its dividend by 24 percent next year and will then reduce its dividend growth rate by 6 percentage points per year until it reaches the industry average of 6 percent dividend growth, after which the company will keep a constant growth rate, forever. If the required return on Storico stock is 23 percent, a share of stock will sell for $ __ today. (Round answer to 2 decimal places.)

Question 13:

P 12-7. Calculating Returns and Variability

Using the following returns, calculate the arithmetic average returns, the variances, and the standard deviations for X and Y.

For average return and standard deviation: (Input answers as a percent rounded to 2 decimal places, without the percent sign.)

For variance: (Round answers to 4 decimal places.)

Returns

---------------------------------------------

Year X Y

-------------------------------------------------------------------------------

1 -7 % 29 %

2 1 41

3 19 -12

4 -6 25

5 8 16

X Y

Average Return

%

%

Variance

Standard Deviation

%

%

Question 14:

Coupon Rates

Rhiannon Corporation has bonds on the market with 15.5 years to maturity, a YTM of 11.2 percent, and a current price of $810.73. The bonds make semiannual payments. The coupon rate on these bonds must be ___ percent. (Input answer as a percent rounded to 2 decimal places, without the percent sign.)

Question 15:

Calculating Real Rates of Return

If Treasury bills are currently paying 8 percent and the inflation rate is 5 percent, the approximate real rate of interest is __ percent. The exact real rate is ___ percent. (Input answers as a percent rounded to 2 decimal places, without the percent sign.)

Question 16:

Stock Values

The Jackson-Timberlake Wardrobe Co., just paid a dividend of $1.22 per share on its stock. The dividends are expected to grow at a constant rate of 6 percent per year, indefinitely. If investors require a 10 percent return on The Jackson-Timberlake Wardrobe Co., stock, the current price is $___ . The price will be $___ in 19 years. (Round answers to 2 decimal places.)