Prince Sultan University Finance and Investment Decision Questions

 

Question 1:                                                                                                                                        

Cherry Creek Inc. is considering expanding to another city; the project will cost $50,000 and is expected to generate after-tax cash flows of $10,000 per year in perpetuity.

The firm has a target debt/equity ratio of 0.5 and the new equity has a flotation cost of 10% and a required return of 15%, while new debt has a flotation cost of 5% and a required return of 10%. The tax rate is 34%.

1. Calculate the cost of capital.
2. Calculate the flotation cost.
3. Calculate the initial investment.
4. Calculate the NPV for the project after adjusting for flotation costs.
5. What do you conclude?

 

Question 2:                                                                                                                                        

Wexler & Associates is considering the following projects:

 

Project	Beta	Project’s Expected Return
W	0.69	9.0%
X	0.88	11.0%
Y	1.32	12.8%
Z	1.74	14.9%

Assume that the T-bill rate is 4%, and the expected return on the market is 11%.

1. Which projects have a higher expected return than Wexler & Associates’ 11% cost of capital? And which projects have a higher expected return than Wexler & Associates’ 11% cost of capital?
2. So, based on the 11% cost of capital alone, which projects would you have accepted as the financial manager for Wexler & Associates?
3. Which projects should be accepted? You need to show your full calculations that enabled you to decide.
4. Now compare your answers in (a) and (b) and make a conclusion.
5. Which projects would be incorrectly accepted or rejected if the overall cost of capital were used to decide on accepting or rejecting the projects?

 

Question 3:                                                                                                                                        

Ali Baba & Co. is a small company engaged in the hospitality industry. The cost of debt capital is 10%; EBIT is $150; the amount of debt is $500; the cost of unlevered debt is 20%; and the tax rate is 34%.

1. Calculate the value of Ali Baba & Co’s equity.  (show your calculations in detail)
2. Calculate the cost of equity capital for Ali Baba & Co.
3. Calculate the WACC for Ali Baba & Co.
4. What do you conclude?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Question 4:                                                                                                                                          

Gentech Inc. expects its EBIT to be $90,000 every year forever. The firm can borrow at 9%. Gentech Inc. currently has no debt, and its cost of equity is 13%.

1. If the tax rate is 35%, what is the value of the firm?
2. What will the value be if the company borrows $125,000 and uses the proceeds to repurchase shares?
3. What is the cost of equity after recapitalization?
4. What is the WACC?
5. What are the implications for the firm’s capital structure decision?

Question 5:                                                                                                                                        

Lions Gate Inc., has declared a $4.18 per share dividend. If we suppose capital gains are not taxed, but dividends are taxed at 17%. New IRS regulations require that taxes be withheld at the time the dividend is paid. Lions Gate Inc. sells for $68 per share, and the stock is about to go ex-dividend.

 

• Calculate the ex-dividend price.

 

 

 

 

 

 

Question 6:                                                                                                                                        

Arvada Heights Inc. has projected the following quarterly sales amounts for the coming year: Q1 = $795 ; Q2 = $830  ; Q3= $955 ; Q4 = $1,100.

 

345. Assuming that accounts receivable at the beginning of the year are $345. Arvada Heights Inc. has a 45-day collection period. Calculate cash collections in each of the four quarters by completing the following:

 

Hint: ACP = 45 days implies that 1/2 of sales are collected in the quarter made and the remaining 1/2 are collected the following quarter.

 

 

 

You need to show your calculation of each item below the table.

 

	Q1	Q2	Q3	Q4
Beginning receivables
Sales
Cash collections
Ending receivables

 

 

1. Rework (a) assuming a collection period of 30 days.

Hint: ACP = 30 days implies that 2/3 of sales are collected in the quarter made and the remaining 1/3 are collected the following quarter

 

 

You need to show your calculation of each item below the table.

 

	Q1	Q2	Q3	Q4
Beginning receivables
Sales
Cash collections
Ending receivables

 

 

 

 

Question 7:                                                                                                                                        

 

Consider the following financial statement information for the Pamela & Wally Corp.:

 

Item	Beginning	Ending
Inventory	10,278	13,509
Accounts receivable	5,122	5,789
Accounts payable	7,314	7,927

 

Also assume that Credit sales are $111,382 and Cost of goods sold are $77,837.

 

Show your calculations of all the components involved in parts (a) and (b) for full credit.

 

1. Calculate the operating cycle.
2. Calculate the cash cycle.
3. How do you interpret your answer?

 

 

Question 8:                                                                                                                                       

 

The following are figures from the budget of Kinkos, Inc., for the Third quarter of 2000:

 

	July	August	September
Credit sales	374,400	349,500	420,500
Credit purchases	148,900	169,300	200,300
Cash disbursements:
Wages, taxes, and    expenses	54,340	70,300	75,170
Interest	12,580	12,580	12,580
Equipment purchases	88,800	135,000

 

The company predicts that 5% of its credit sales will never be collected, 35% of its sales will be collected in the month of the sale, and the remaining 60% will be collected in the following month. Credit purchases will be paid in the month following the purchase.

 

In June 2000, credit sales were $235,000 and credit purchases were $161,300

 

1. fill in this table based on the available information above:

 

Uncollected credit sales
Collected in the month of the sale
Collected in the following month
Previous month credit sales
Previous month credit purchases
Beginning cash

 

 

 

 

 

 

 

1.  Using the given information, complete the following cash budget:

 

	July	August	September
Beginning cash balance
Cash receipts
Cash collections from credit sales
Total cash available
Cash disbursements
Purchases
Wages, taxes, and expenses
Interest
Equipment purchases
Total cash disbursements
Ending cash balance

 

 

 

1. Comment on your results.

 

 

 

 

Question 9:                                                                                                                                        

 

Edith is college student; she has $5,000 in her bank account at Mesa Verde Bank. One day, she writes a check for $1,000 to pay for books, and she deposits $2,000. You need to show your calculation when needed and justify your answers. Answering with just a figure will earn only half the credit.

 

1. What is the initial available balance on her bank account?
2. Calculate her book value after she wrote the check.
3. Calculate her disbursement float.
4. Calculate her collection float.
5. Calculate her net floats.

 

 

 

 

 

Question 10:                                                                                                                                      

 

 

1. The Tanasbourne Warehouse is a large facility with thousands of consumers. It sells $145,000 of items on credit each day. Its average operating cycle is 38 days and it acquires and sells inventory, on average, every 15 days. What is the Tanasbourne Warehouse’s average accounts receivable balance?

 

 

 

500. DTC Brewers Inc. has an average collection period of 57 Its average daily investment in receivables is $47,500. What are the annual credit sales?

 

 

 

 

 

 

Section III: Short Answers                                                                                             

 

 

1. Select from the list the activity (or activities) that increase (s) cash and describe how that increase takes place:
2. Granting credit to a customer
3. Purchasing new machinery
4. Paying off a loan
5. Acquiring long-term debt
6. Accepting credit from a supplier

 

 

 

2. Changes in dividends may be important signals if the market anticipates that the change will be maintained through time. If the market believes that the change is just a rearrangement of dividends through time, then the impact will be small.
   • What do we call the reaction to the information contained in dividend changes?

 

• Define and describe that concept from (a) in detail.

 

3. As a financial manager, what do you need to be more concerned with? Net float? available balances? Book balances? All? Or none? Justify your answer.                                                                                                                                                                                  

 

 

 

 

 

 

4. Fill in the blank. Recall these concepts as we covered them in class this semester.
5. In finance, we call the fundamental value of a financial instrument or asset, independent of its market value, the ………………. of that asset.
6. The ………………………. refers to the return that equity investors require on their investment in the firm.
7. The ideal mixture of debt and equity for a firm may be referred to as …………………………
8. ……………., ………………., and ……………… are the three key financial management decisions that financial managers are in charge of.

 

5. Is it always appropriate to use WACC as the discount rate? Justify your answer.

 

 

 

 

 

 

                                               

 

 

 

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