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Question 1
Felicia & Fred’s board has hired a new Chief Operating Officer (COO) to assist them in expanding their operations globally. A close friend of Fred’s from childhood, the new COO, has extensive experience in importing goods and maximizing value for shareholders through outsourcing activities, and recently left a large Fortune 500 company to join Felicia & Fred. Logistics and supply chain are of primary concern, as the demand for the company’s handbag product line has grown steadily. Rather than expanding the inventory as well as the need for additional warehousing space and working capital, the COO believes that inventory turnover may be increased through quicker replenishment and shipment directly to stores rather than to a centralized warehouse, and indicates that previously, he was able to take an approach with a manufacturer that was successful. He has not articulated the plan as yet, but assures Fred that it can be done.
A few weeks after the COO is hired, you meet a marketing department colleague in the cafeteria, who confides the following: “I read something unusual in the Financial Times today. It appears that the company from which our new COO hails is being investigated for potential violation of the Foreign Corrupt Practices Act. It is speculated that the company paid bribes to local officials in Hong Kong, classifying these as ‘commissions,’ in order to gain access to various manufacturing plants’ idle capacity at short notice. It seems to me that this would be a supply chain responsibility. It did not mention any names, but the investigation is ongoing.”
Do you have any concerns regarding the background of the new COO’s background, or questions regarding his potential approach to maximizing inventory turnover?
In the context of the CFA Institute Code and Standards, would there be any required action on your part to take to investigate further the potential plans of the COO? How might you assess whether the approach is legitimate?
Felicia & Fred’s board has hired a new Chief Operating Officer (COO) to assist them in expanding their operations globally. A close friend of Fred’s from childhood, the new COO, has extensive experience in importing goods and maximizing value for shareholders through outsourcing activities, and recently left a large Fortune 500 company to join Felicia & Fred. Logistics and supply chain are of primary concern, as the demand for the company’s handbag product line has grown steadily. Rather than expanding the inventory as well as the need for additional warehousing space and working capital, the COO believes that inventory turnover may be increased through quicker replenishment and shipment directly to stores rather than to a centralized warehouse, and indicates that previously, he was able to take an approach with a manufacturer that was successful. He has not articulated the plan as yet, but assures Fred that it can be done.
A few weeks after the COO is hired, you meet a marketing department colleague in the cafeteria, who confides the following: “I read something unusual in the Financial Times today. It appears that the company from which our new COO hails is being investigated for potential violation of the Foreign Corrupt Practices Act. It is speculated that the company paid bribes to local officials in Hong Kong, classifying these as ‘commissions,’ in order to gain access to various manufacturing plants’ idle capacity at short notice. It seems to me that this would be a supply chain responsibility. It did not mention any names, but the investigation is ongoing.”
Do you have any concerns regarding the background of the new COO’s background, or questions regarding his potential approach to maximizing inventory turnover?
In the context of the CFA Institute Code and Standards, would there be any required action on your part to take to investigate further the potential plans of the COO? How might you assess whether the approach is legitimate?
Fred and Felicia aside for a moment. If any students have an example from their professional experience that is directly applicable to the concepts Ethics and shareholders and stakeholders please feel free to share with us some of the insights you have observed and learned relative to this topic.
1. Dharma Supply has earnings before interest and taxes (EBIT) of $581000 interest expenses of
$305000 and faces a corporate tax rate of 35 percent.
a. What is Dharma Supply’s net income?
b. What would Dharma’s net income be if it didn’t have any debt (and consequently no interest expense)?
c. What are the firm’s interest tax savings?
a. Dharma Supply’s net income is
$
b. If it didn’t have any debt, Dharma Supply’s net income is
$
c. The firm’s interest tax savings are
$
2. (Common stock valuation) Gilliland Motor, Inc., paid a $3.58 dividend last year. If Gilliland’s return on equity is 31 percent, and its retention rate is 36 percent, what is the value of the common stock if the investors require a rate of return of 21 percent?
The value of the common stock is
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3.Moody’s to Put Bank Hybrids on Review for Downgrades
Source: McDonald, Sarah and John Glover, “Moody’s to Put Bank Hybrids on Review for Downgrades,” Bloomberg.com,
posted 11/17/2009.
The financial crisis and subsequent government intervention in the banking industry has created some uncertainty for bondholders. In many cases the government’s efforts to prop up troubled financial institutions has actually been harmful to bondholders. For example, in some countries financial institution bonds have skipped interest payments without defaulting due to government mandates.
Hybrid securities have been particularly problematic since they have characteristics of both debt and equity. Based on the way that some countries have treated these securities Moody’s has been forced to reevaluate some of the underlying assumptions used when the bonds were rated. The new model will likely result in a number of downgrades for many hybrids since the level of risk of these securities is higher than previously thought.
Thinking Critically Questions
1. All of the following are bond rating agencies except;
A.
NYSE Bond Raters
B.
Standard and Poors
C.
Moody’s
D.
Fitches
2. Companies with higher bond ratings can borrow money at a rate.
A.
higher
B.
Fed funds
C.
prime
D.
lower
3. Unrated debt typically carries a higher interest rate because investors assume it must be .
A.
higher risk
B.
lower risk
C.
a better investment
D.
risk free
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4 (Defining capital structure weights) In August of 2009 the capital structure of the Emerson Electric Corporation (EMR) (measured in book and market values) appeared as follows:
| (Thousands of dollars) | Book Values | Market Values | ||
| Short-term debt | $1217000 | $1217000 | ||
| Long-term debt | 11892000 | 11892000 | ||
| Common equity | 9123000 | 26092000 | ||
| Total capital | $ 22232000 | $ 39201000 |
What weights should Emerson use when computing the firm’s weighted average cost of capital?
The appropriate weight of debt, w Subscript d, is %.
(Round to one decimal place.)
The appropriate weight of common equity, w Subscript cs, is %.
(Round to one decimal place.)
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5 (Cost of preferred stock) Your firm is planning to issue preferred stock. The stock is expected to sell for
$98.76 a share and will have a $100 par value on which the firm will pay a
13.5 percent dividend. What is the cost of capital to the firm for the preferred stock?
The firm’s cost of capital for the preferred stock is %.
(Round to two decimal places.)
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6 (Discretionary financing needs) In the spring of 2013 the Caswell Publishing Company established a custom publishing business for its business clients. These clients consisted principally of small- to medium-size companies in Round Rock, Texas. However, the company’s plans were disrupted when they landed a large printing contract from Dell Computers Corp. (DELL) that they expected would run for several years. Specifically, the new contract would increase firm revenues by 100 percent. Consequently, Caswell’s management knew they would need to make some significant changes in firm capacity, and quickly. The following balance sheet for 2013 and pro forma balance sheet for 2014 reflect the firm’s estimates of the financial impact of the 100 percent revenue growth:
.
a. How much new discretionary financing will Caswell require based on the above estimates?
b. Given the nature of the new contract and the specific needs for financing that the firm expects, what recommendations might you offer to the firm’s CFO as to specific sources of financing the firm should seek to fulfill its DFN?
a. The discretionary financing needs are $
b. Given the nature of the new contract and the specific needs for financing that the firm expects, what recommendations might you offer to the firm’s chief financial officer as to specific sources of financing the firm should seek to fulfill its DFN? (Select all the choices that apply below.)
A.
Common stock.
B.
Retained earnings.
C.
Notes payable.
D.
Sale of fixed assets.
E.
Long-term debt.
Pioneer’s preferred stock is selling for $77 in the market and pays a $4.60 annual dividend.
a. If the market’s required yield is 7 percent, what is the value of the stock for that investor?
b. Should the investor acquire the stock?
a. The value of the stock for that investor is
$ per share. (Round to the nearest cent.)
b. Should the investor acquire the stock? (Select from the drop-down menus.)
The investor
▼
should not
should
acquire the stock because it is currently
▼
overpriced
underpriced
in the market.
7(Cost of debt) Belton Distribution Company is issuing a
$1000 par value bond that pays 7.0percent annual interest and matures in 15 years that is paid semiannually. Investors are willing to pay $958for the bond. The company is in the
18 percent marginal tax bracket. What is the firm’s after-tax cost of debt on the bond?
The firm’s after-tax cost of debt on the bond is
Measuring growth) If Pepperdine, Inc.’s return on equity is 19 percent and the management plans to retain 59 percent of earnings for investment purposes, what will be the firm’s growth rate?
The firm’s growth rate will be
8(Common stock valuation)
Header Motor, Inc., paid a $2.85 dividend last year. At a constant growth rate of 6
percent, what is the value of the common stock if the investors require a 11 percent rate of return?
The value of the common stock is
9)(Measuring growth) If Pepperdine, Inc.’s return on equity is 19 percent and the management plans to retain 59 percent of earnings for investment purposes, what will be the firm’s growth rate?
The firm’s growth rate will be
10) Zapatera Enterprises is evaluating its financing requirements for the coming year. The firm has only been in business for one year, but its CFO predicts that the firm’s operating expenses, current assets, net fixed assets, and current liabilities will remain at their current proportion of sales.
Last year Zapatera had $11.29 million in sales with net income of $1.19 million. The firm anticipates that next year’s sales will reach $14.92 million with net income rising to $2.07
million. Given its present high rate of growth, the firm retains all of its earnings to help defray the cost of new investments.
The firm’s balance sheet for the year just ended is as follows:
.
Estimate Zapatera’s total financing requirements (total assets) and its net funding requirements (discretionary financing needed) for 2014.
Use the percentage of sales given in Zapatera Enterprises’ balance sheet for 2013.
Hint: Make sure to round all intermediate calculations to at least five decimal places.
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The 2014 retained earnings are?
12) Thompson Trucking Company
Current Assets 10.48
Net Fixed Assets 14.04
Total 24.52
Accounts Payable 5.99
Notes Payable 0.00
Bonds Payable 10.69
Common Equity 7.84
Total 24.52
.
TTC had sales for the year ended 12/31/13 of $49.65 million. The firm follows a policy of paying all net earnings out to its common stockholders in cash dividends. Thus, TTC generates no funds from its earnings that can be used to expand its operations. (Assume that depreciation expense is just equal to the cost of replacing worn-out assets.). Hint: Make sure to round all intermediate calculations to at least five decimal places.
a. If TTC anticipates sales of $80.02 million during the coming year, develop a pro forma balance sheet for the firm for 12/31/14. Assume that current assets vary as a percent of sales, net fixed assets remain unchanged, and accounts payable vary as a percent of sales. Use notes payable as a balancing entry.
b. How much “new” financing will TTC need next year?
c. What limitation does the percent-of-sales forecast method suffer from? Discuss briefly.
a. If TTC anticipates sales of $80.02million during the coming year, develop a pro forma balance sheet for the firm for 12/31/14. Assume that current assets vary as a percent of sales, net fixed assets remain unchanged, and accounts payable vary as a percent of sales. Use notes payable as a balancing entry. (Round to the nearest dollar.)
| Thompson Trucking Company | ||
| Pro Forma Balance Sheet as of 12/31/14 | ||
| Current assets | $ | |
| Net fixed assets | ||
| Total assets | $ | |
| Accounts payable | ||
| Notes payable | ||
| Bonds payable | ||
| Common equity | ||
| Total liabilities and common equity | $ |
b. How much new financing will TTC need next year
c. What limitations does the percent of sales forecast method come from
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