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Solutions to Assigned Problems Chapter One 2.

Example One: An individual opens a savings account at a local commercial bank with a 2!! deposit. "he bank loans out the 2!! with other #unds #rom other savings accounts to a local business man who is expanding his business. "he local business man pa$s back the loan overtime with interest and the bank credits the savings account with interest. "he individual withdraws mone$ #rom the savings account to bu$ a new bike.
Example "wo: An individual deposits his monthl$ pa$check in a checking account. "he bank accumulates the #unds #rom man$ checking accounts and loans mone$ to an individual bu$ing a house. "he new homeowner makes monthl$ mortgage pa$ments to the bank. "he bank uses the mortgage pa$ments to cover the checks written b$ the person with the checking account. Example "hree: An individual bu$s a municipal bond #or an airport improvement pro%ect. "he individual usuall$ bu$s a municipal #rom a bond dealer& an investment banker marketing the bond& and the #unds #rom the sale o# the bond are delivered to the cit$ minus a #ee #rom the investment banker. "he cit$ uses the #unds to build new #acilities at the airport& #or example a new parking lot. Once #inished the #ees received #rom parking are used to pa$back the bu$er o# the bond with interest.

'. "he goal o# the #inancial manager is to maximi(e the current share price or
e)uit$ value o# the #irm. "his goal encompasses man$ good business practices such as a good working relationship with the surrounding communit$. *# the #irm pollutes local streams& abuses local #acilities such as roads& and in general does not participate in the economic advancement o# the local communit$ its share price or e)uit$ value will su##er. "he local communit$ ma$ sue the compan$ #or its damages and the best local work#orce members ma$ choose not to work #or the compan$. Emplo$ees ma$ not be lo$al to the compan$ causing high turnover and increased personal costs #or recruiting and training. +inall$& #acilities such as roads and utilities ma$ not be repaired or moderni(ed b$ the local communit$ impacting the compan$,s abilit$ to produce a pro#it. A good communit$ relationship is embedded in the goal o# maximi(ing current share price or the e)uit$ value o# the compan$.

-. Principal.Agent pair: Shareholder / Chie# Executive O##icer


Con#lict is the 0perk1 the CEO elects to take& a personal %et #or #l$ing to and #rom business activities instead o# #l$ing commercial carriers. "he cost o# the %et outweighs the expense o# commercial carriers so it hurts the compan$ pro#its. 2owever the CEO #eels that the private %et allows #or greater supervision o# the operations and hence a more

e##icient operation. "his con#lict could be reduced b$ the board o# directors reviewing the travel needs and #re)uenc$ o# the CEO and the inconvenience o# using commercial carriers. Once the pros and cons o# the di##erent travel options have been reviewed a compan$ polic$ can be issued so that shareholders understand the rationale i# a private %et is elected #or the CEO. Agent Pair: Supervisor / Emplo$ee. "he con#lict is over the overtime assignment o# the emplo$ee. "he emplo$ee wants su##icient lead time on overtime work while the supervisor assigns the work whenever the situation arises. "he emplo$ee is disgruntled when working overtime and does not produce )ualit$ work. "he cost o# this is rework on some o# the production items. Solution: a polic$ on overtime and selection #or overtime worked out between the supervisor and all emplo$ees sub%ect to selection #or overtime. Agent Pair: "eacher / Student "he con#lict is on grading o# individual student participation in group assignments. "he student #eels that student not pulling their weight in the group assignment should not receive #ull credit #or the work. Credit should be based on the contribution o# the individual to the assignment. "eacher has di##icult$ determining each student,s contribution on group assignment so minimi(es errors in assigning incorrect contribution levels b$ giving all individuals same grade. Solution: 2ave students grade their contribution and all group member contributions. 3hen the group is consistent in evaluating all group member contributions then grades are assigned. 3hen group is not consistent& group must re.evaluate individual contributions to come to agreement. *# second evaluation is not consistent then teacher talks to group. "his ma$ onl$ reduce some agenc$ problems and raise others. "he group d$namics ma$ be such that members are 0#orced1 to agree on all students contributed evenl$ when doing evaluations. Agent Pair: Parent / Child "he con#lict is on the appropriate driving o# the #amil$ car b$ the child. "he child does not alwa$s adhere to speed limits and does not use a sa#et$ belt when driving. "he parents want the child to obe$ the speed limits and alwa$s wear a sa#et$ belt. Agenc$ cost is the increased potential #or tra##ic tickets and increased potential #or personal in%ur$ to child. "here are a number o# potential solutions here& all the wa$ #rom removing driving privileges i# the child does receive a ticket to installing a new device that measures speed o# the car and i# seat belt is being worn b$ driver. 2ope#ull$ the agenc$ con#lict can be reduced with the least amount o# expense.

4!. Answer: "he #irst issue is wh$ do emplo$ees take #ort$.#ive minutes #or
lunch5 "he #ort$.#ive minutes ma$ be the time natural time re)uired to go through the line& purchase a lunch and then eat the lunch at an appropriate pace. *# this is the case

then it will be necessar$ to determine how to 0speed1 up the process to allow the emplo$ees to meet the 6! minute lunch time #rame. "he agenc$ cost here is the lost 47 minutes o# emplo$ee production time each da$. *n order to eliminate this agenc$ cost it ma$ be necessar$ to signi#icantl$ modi#$ the ca#eteria or the serving procedure. *# the management wants to maintain the thirt$ minute lunch period it ma$ have to look into the serving procedure in their ca#eteria to see how to shorten lines and speed up purchasing meals. An$ cost to redesign the ca#eteria process is an agenc$ cost. An$ additional emplo$ees added to the ca#eteria sta## to speed up the process is an agenc$ cost. Another possibilit$ is to extend the work da$ b$ #i#teen minutes. "he cost to negotiate a new work da$ schedule is an agenc$ cost. An$ turnover caused b$ the new workda$ is also an agenc$ cost. *t ma$ be more costl$ to en#orce the thirt$ minute lunch time than to accept the standard 87 minute break currentl$ used b$ emplo$ees. 9ot all agenc$ costs can be eliminated or reduced. "he norms o# the emplo$ees and the abilit$ o# current #acilities to support a polic$ need to be considered when setting policies and in this case lunch time in the #irst place. "hen again& i# the #acilities are su##icient to handle a 6! minute lunch it ma$ be as simple as rea##irming the lunch break time with the emplo$ees.

Chapter "wo 7. Answers:


a. +: ; '&!!! x <4.!=>2 ; '&!!! x 4.426= ; '&?=7.2! b. +: ; '&!!! x <4.!=>7 ; '&!!! x 4.66?2 ; -&6='.7? c. +: ; '&!!! x <4.!=>? ; '&!!! x 4.7-6? ; 44&47=.-8 d. +: ; '&!!! x <4.!=>47 ; '&!!! x 2.6-== ; 4=&''7.-4

'.

Answers: a. P: ; 2&7!! x 4@<4.!'>2 ; 2&7!! x !.?'68 ; 2&4?6.=! b. P: ; 2&7!! x 4@<4.!'>7; 2&7!! x !.'46! ; 4&'?2.8' c. P: ; 2&7!! x 4@<4.!'>- ; 2&7!! x !.786- ; 4&67-.?6 d. P: ; 2&7!! x 4@<4.!'>48 ; 2&7!! x !.6?'? ; -=-.78

e. P: ; 2&7!! x 4@<4.!'>4? ; 2&7!! x !.2-7- ; '6-.==

-. Answers:

a. r ; < '?=.?=@ 8!!>4@4! / 4 ; 4.!' / 4 ; '.!!A b. r ; < 4!&-2'.87@ 6&!!!>4@47 / 4 ; 4.!- / 4 ; -.!!A c. r ; < 4!!&!!!@ 64&4?!.8'>4@2! / 4 ; 4.!= / 4 ; =.!!A d. r ; < 4&!!!&!!!@ 64&62'.??>4@87 / 4 ; 4.!? / 4 ; ?.!!A

44. Spreadsheet Solution


*n Cells A4 through A4= put in the Present :alue o# the savings bond& 4!!.!!. *n Cells B4 through B4= put in the annual interest rate& !.!'7& C. *n Cells C4 through C4= put in the waiting time in $ears& 7 through 2!& 9. *n Cell D4 put in the +: #unction using the row value in A4 #or the P:& row value in B4 #or the interest rate& row value in C4 #or n. Cop$ #ormula #or cells D2 through D4=. "he displa$ed value will be the :alue o# the 4!! savings bond at '.7A annual interest. A .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! .4!!.!! B !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 !.!'7 C 7 = ' ? 4! 44 42 46 48 47 4= 4' 4? 42! D +: <P: ; A4& rate ; B4& n ; C4> ; 486.7= +: <P: ; A2& rate ; B2& n ; C2> ; 478.66 +: <P: ; A6& rate ; B6& n ; C6> ; 4=7.-! +: <P: ; A8& rate ; B8& n ; C8> ; 4'?.67 +: <P: ; A7& rate ; B7& n ; C7> ; 4-4.'2 +: <P: ; A=& rate ; B=& n ; C=> ; 2!=.4! +: <P: ; A'& rate ; B'& n ; C'> ; 224.7= +: <P: ; A?& rate ; B?& n ; C?> ; 26?.4? +: <P: ; A-& rate ; B-& n ; C-> ; 27=.!8 +: <P: ; A4!& rate ; B4!& n ; C4!> ; 2'7.28 +: <P: ; A44& rate ; B44& n ; C44> ; 2-7.?+: <P: ; A42& rate ; B42& n ; C42> ; 64?.!? +: <P: ; A46& rate ; B46& n ; C46> ; 684.-8 +: <P: ; A48& rate ; B48& n ; C48> ; 6='.7? +: <P: ; A47& rate ; B47& n ; C47> ; 6-7.47 +: <P: ; A4=& rate ; B4=& n ; C4=> ; 828.'-

the #uture

4 2 6 8 7 = ' ? 4! 44 42 46 48 47 4=

9ote the negative values in column A denote the cash out#low and produce a positive cash in#low in column D.

4-. "he disease is spreading at a growth rate o# nearl$ 7'A per da$.
r ; <=@4>4@8 / 4 ; 4.64=4 . 4 ; 7=.74A Esing the same growth rate #or the 4= da$ period& <two weeks and two da$s> the number o# patients in#ected will be: +: ; 4 x <4.747=>4= ; 4&2-= or 4&2-= patients Or $ou could reali(e that ever$ #our da$s the number o# people in#ected increases b$ six times and with #our periods o# #our da$s $ou have 4 x = x = x = x = ; 4 x <=>8 ; 4&2-=

Chapter Three
4!. Perpetuities. "he Canadian Fovernment has once again decided to issue a consul <bond with a never ending interest pa$ment and no maturit$ date>. "he bond will pa$ 7! each $ear interest <at the end o# the $ear> but never return the principal. "he current discount rate #or Canadian Fovernment bonds is =.7A. 3hat should this bond sell #or in the market5 3hat i# the interest rate should #all to 8.7A5 Cise to ?.7A5 3h$ does the price go up when interest rates #all5 3h$ does the price go down when interest rates rise5 Answer: at =.7A& 7! @ !.!=7 ; '=-.26 at 8.7A& 7! @ !.!87 ; at ?.7A& 7! @ !.!?7 ; 4&444.44 7??.28

"he price rises when interest rates #all because the present value o# each #uture interest pa$ment is worth more in present value due to the lower discount rate. "he price #alls when interest rates rise because the present value o# each #uture interest pa$ment is worth less in present value due to the higher discount rate.

47. +uture :alue. Gack and Gill are saving #or a rain$ da$ and decide to put 7! awa$ ever$ $ear #or the next 27 $ears. "he local bank EP."2E.2*HH Bank will pa$ Gack and Gill 'A on their account. *# Gack and Gill put the mone$ in the account #aith#ull$ at the end o# ever$ $ear& a. how much will the$ have in their account at the end o# 27 $ears5

b. En#ortunatel$ Gack #ell down& breaking his crown& a#ter onl$ 4! $ears o# savings. "he medical bill has come to '!!. *s there enough in the rain$ da$ #und to cover this medical bill5 Answers Part a. +: ; 7! x <4.!'27 .4>@!.!' ; 7! x =6.28-! ; 6&4=2.87 Part b. +: ; 7! x <4.!'4! .4>@!.!' ; 7! x 46.?4=8 ; =-!.?2 so the rain$ da$ #und is -.4? short o# being able to cover the medical bill.

4'. Present :alue. Count$ Canch *nsurance Compan$ wants to o##er a guaranteed annuit$ stream in units o# 7!! pa$able at the end o# each $ear #or twent$ #ive $ears. "he compan$ has a strong investment record and can consistentl$ earn 'A on its investments a#ter tax. *# the compan$ wants to make 4A on this contract what price should the compan$ set on this contract5 Ese =A as the discount rate& assume an ordinar$ annuit$ and price is the same thing as present value. Answer Price ; Present :alue ; 7!!.!! x <4 / 4@4.!=27> @ !.!= ; 7!! x 42.'?68 ; =&6-4.=? Pa$ments ; 6!&!!! @ I<4 / 4@<4.!?7>4!> @ .!?7J ; 6!&!!! @ =.7=46 ; 8&7'2.26 4-. Pa$ments. Coole$ Handscaping Compan$ needs to borrow 6!&!!! #or a new #ront. end dirt loader. "he bank is willing to loan the #unds at ?.7A interest with annual pa$ments at the end o# the $ear #or the next ten $ears. 3hat is the annual pa$ment on this loan #or Coole$ Handscaping5 Answer Pa$ments ; 6!&!!! @ I<4 / 4@<4.!?7>4!> @ .!?7J ; 6!&!!! @ =.7=46 ; 8&7'2.26

24. 9umber o# Pa$ments. Bugs$ Kalone is o##ering two repa$ment plans #or a long overdue loan to Fambling Bob. O##er one is two broken legs and the debt completel$ #orgiven. O##er two is to pa$ back 6&-!! per $ear at 2!A interest rate until the loan principal is paid o##. Fambling Bob owes Kr. Kalone 47&!!!. 2ow long will it take #or Fambling Bob to pa$o## the loan i# he takes o##er two5 Answer +irst remember to check i# the pa$ment is greater than the interest expense #or the period.

PK" L P: x C ; 6&-!! L 47&!!! x !.2 ; 6&!!! and now& 9umber o# Pa$ments ; ln I 6&-!! @ < 6&-!! . 47&!!! x !.2!>J @ ln <4.2!> ; ln I 6&-!!@ -!!J @ ln <4.2!> ; 4.8==6 @ !.4?26 ; ?.!82= M ? pa$ments or ? $earsN Or on the calculator *9PE" :ariables OE"PE" 5 9 ?.!82= 2!.! *@O 47&!!! P: . 6&-!! PK" ! +:

28. *nterest Cate with Annuit$. A local government is about to run a lotter$ but does not want to be involved in the pa$o## i# a winner picks an annuit$ stream pa$o##. "he government contracts with a trust to pa$ the lump sum pa$out to the trust and have the trust <probabl$ a local bank> pa$ the annual pa$ments. "he #irst winner o# the lotter$ chose the annual stream and will receive 47!&!!! a $ear #or the next twent$.#ive $ears. "he local government will give the trust 2&!!!&!!! to pa$ #or this annuit$. 3hat investment rate must the trust earn to break even on this arrangement5 Answer Esing a calculator ":K ke$s with P@$;4 and C@$ ; 4 in end mode: *9PE" :ariables OE"PE" 27 9 5 *@O 7.7=4-A 2&!!!&!!! P: . 47!&!!! PK" +: !

27. Amorti(ation. Hoan Consolidated *ncorporated is o##ering a special one.time package to reduce Custom Autos outstanding bills to one eas$ to handle pa$ment plan. HC* will pa$o## the current outstanding bills o# 282&!!! #or Custom Auto i# the$ will pa$ an annual pa$ment to HC* at a 4!A interest rate over the next 47 $ears. +irst& what is the annual pa$ment and what is the amorti(ation schedule #or this loan i# Custom Autos wants to pa$ o## the loan be#ore the loan maturit$ in 47 $ears5 3hen will the balance be hal# paid o##5 And what is the total interest expense on the loan over the 47 $ears5

Answer Pa$ment ; 282&!!! @ I<4 / 4@4.4!47> @ !.4!J ; 282&!!! @ '.=!=! ; 64&?4=.=7 Amorti(ation Schedule with *nterest per period based on beginning balance x !.47 Oear 4 2 6 8 7 = ' ? 4! 44 42 46 48 47 "otal Beg. Balance 282&!!!.!! 268&6?6.67 22=&!!7.!6 24=&'??.?= 2!=&=74.44 4-7&8--.7' 4?6&262.?' 4=-&'6-.7! 478&?-=.?! 46?&7=-.?2 42!&=4!.47 4!!&?78.74 '-&426.64 77&24?.-2?&-28.26 Pa$ment 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 64&?4=.=7 *nterest 28&2!!.!! 26&86?.66 22&=!!.7! 24&='?.?2!&==7.44 4-&78-.-= 4?&626.24=&-'6.-7 47&8?-.=? 46&?7=.-? 42&!=4.!4 4!&!?7.87 '&-42.66 7&724.-! 2&?-2.82 267&28-.?4 Principal Ceduction '&=4=.=7 ?&6'?.62 -&24=.47 4!&46'.'' 44&474.78 42&2==.'! 46&8-6&6' 48&?82.'! 4=&62=.-' 4'&-7-.=' 4-&'77.=8 24&'64.2! 26&-!8.62 2=&2-8.'= 2?&-28.26 Ending Balance 268&6?6.67 22=&!!7.!6 24=&'??.?= 2!=&=74.44 4-7&8--.7' 4?6&262.?' 4=-&'6-.7! 478&?-=.?! 46?&7=-.?2 42!&=4!.47 4!!&?78.74 '-&426.64 77&24?.-2?&-28.26 !.!!

"he loan balance will be hal#.wa$ paid o## at the end o# the tenth $ear or 2@6rds the wa$ through the contract. "he total interest expense over the contract is 267&28-.?4. "his can be determined b$ adding up the interest expenses or multipl$ing the pa$ment < 64&?4=.=7> times the number o# pa$ments <47> and subtracting the original principal < 282&!!!>. "his shows that the pa$ments go toward principal and interest onl$P *nterest Expense ; 64&?4=.=7 x 47 . 282&!!! ; 267&28-.'7 "he six cents di##erence is due to rounding.

Chapter Four
6. EAC. 3hat is the e##ective annual rate o# a mortgage rate that is advertised at '.'7A over the next twent$ $ears with monthl$ pa$ments5 A9S3EC Periodic Cate ; !.!''7 @ 42 ; !.!!=87?6666

EAC ; <4 Q Periodic Cate>C@O . 4 ; 4.!!=87?6642 / 4 ; 4.!?!6 / 4 ; !.!?!6 ; ?.!6A

7. Present :alue with Periodic Cates. Het,s revisit Sam 2ind,s the dentist #rom chapter three and his remodeling pro%ect <Problem 6.4?>. "he cost o# the e)uipment is 4?&!!! and the purchase will be #inanced with a '.7A loan over six $ears. Originall$ the loan called #or annual pa$ments. Cedo the pa$ments based on )uarterl$ pa$ments <#our per $ear> and monthl$ pa$ments <twelve per $ear>. Compare the annual cash out#low o# the two pa$ments. 3h$ does the monthl$ pa$ment plan have less total cash out#low each $ear5 A9S3EC Ruarterl$ Pa$ment ; 4?&!!! @ <4 / 4@I4 Q <!.!'7@8>J= x 8 > @ <!.!'7@8> Ruarterl$ Pa$ment ; 4?&!!! @ 4-.4?87 ; -6?.2= Konthl$ Pa$ment ; 4?&!!! @ <4 / 4@I4 Q <!.!'7@42>J= x 42 > @ <!.!'7@42> Konthl$ Pa$ment ; 4?&!!! @ 7'.?6=7 ; 644.22 Annual Cash Out#low Ruarterl$ Pa$ment ; -6?.2= x 8 ; 6&'76.!8 Annual Cash Out#low Konthl$ Pa$ment ; 6&'68.=8 Di##erence o# 4?.!8 *t is lower #or the monthl$ pa$ment because each pa$ment reduces some o# the principal and so over the three months between the )uarterl$ pa$ments the average borrowed amount is lower so that the accumulated interest expense is lower. '.+uture :alue with Periodic Cates. Katt Gohnson& a paper deliver$ bo$& is putting awa$ 47.!! ever$ month #rom his paper route collections. Katt is eight $ears old and will use the mone$ when he goes to college in ten $ears. 3hat will the value be in Katt,s account in ten $ears with his monthl$ pa$ments i# he is earning =A <APC>& ?A <APC> or 42A <APC>5 A9S3EC +: at =A APC ; 47.!! x I<4 Q !.!=@42>4! x 42 / 4J @ <!.!=@42>

+: at =A APC ; 47.!! x 4=6.?'-6 ; 2&87?.4-

+: at ?A APC ; 47.!! x I<4 Q !.!?@42>4! x 42 / 4J @ <!.!?@42> +: at ?A APC ; 47.!! x 4?2.-8=! ; 2&'88.4+: at 42A APC ; 47.!! x I<4 Q !.42@42>4! x 42 / 4J @ <!.42@42> +: at 42A APC ; 47.!! x 26!.!6?' ; 6&87!.7?

-. Pa$ments with Periodic Cates. 3hat pa$ment does Denise need to make at the end o# each month over the coming 88 $ears at =A to reach her retirement goal o# 4&!!!&!!!5 A9S3EC Pa$ment ; 4&!!!&!!! @ I<4 Q !.!=@42>88 x 42 .4 J @ <!.!=@42> Pa$ment ; 4&!!!&!!! @ 2&7?8.2=72 ; 6?=.-=

4!. Amorti(ation Schedule with Periodic Pa$ments. Koulton Kotors is advertising the #ollowing deal on a new 2onda Civic: Konthl$ Pa$ments o# 8!!.8! #or the next =! months and this beaut$ can be $ours. "he sticker price o# the car is 4?&!!!. +irst what is the interest rate $ou are pa$ing in both APC and EAC terms5 Second& what is the amorti(ation schedule o# these =! pa$ments5 A9S3EC "he periodic or monthl$ interest rate& r& is the solution to the e)uation P: ; Pa$ment x <4 / 4@<4Qr>n> @ r

4?&!!! ; 8!!.8! x <4 / 4@<4Qr>=!> @ r P:*+A ; <4 / 4@<4Qr>n> @ r ; P: @ Pa$ment ; 4?&!!! @ 8!!.8! ; 88.-77! <Hook up in Appendix A.6 the P:*+A tables& with 9 ; =!& and see 88.-77! #or 4A column. "he periodic or monthl$ interest rate is 4A. "he annual percentage rate is 42A& periodic rate times 42& 4A x 42 ; 42A and the EAC is EAC ; 4.!442 / 4 ; 42.=?A. Amorti(ation Schedule <Can be done e##ectivel$ on a spread sheet> Cell A4 is Beginning Balance #or month 4 Cell B4 is the Konthl$ Pa$ment Cell C4 is the Konthl$ *nterest Expense and is the periodic or monthl$ interest rate times the beginning balance: A4 S !.!4 <#ormula #or the cell> Cell D4 is the amount o# the monthl$ pa$ment that is applied to the principal and is the pa$ment minus the interest expense: B4 / C4 <#ormula #or the cell> Cell E4 is the ending balance a#ter the appl$ing o# the monthl$ pa$ment to interest and principal. *t is the beginning balance minus the principal reduction: A4 / D4 <#ormula #or the cell>. Cell A2 is the ending balance #rom the previous month or the value in Cell E4. "hen #or cells B2 through E2 cop$ the #ormulas down #rom the row above. Cepeat this #or the sixt$ monthsN 4 2 6 N 7' 7? 7=! A 4?&!!!.!! 4'&''-.=! 4'&77'.!! 4&7=2.67 4&4''.7' '??.-8 6-=.88 B 8!!.8! 8!!.8! 8!!.8! N 8!!.8! 8!!.8! 8!!.8! 8!!.8! C 4?!.!! 4''.?! 4'7.7' 47.=2 44.'? '.-! 6.-= D 22!.8! 222.=! 228.?6 6?8.'? 6??.=2 6-2.7! 6-=.88 E 4'&''-.=! 4'&77'.!! 4'&662.4' 4&4''.7' '??.-8 6-=.88 !.!!

Chapter Five
7. 2olding Period and Annual <*nvestment> Ceturns. Far$ Baker "rading Cards *ncorporated originall$ purchased the rookie card o# 2ammerin, 2ank Aaron #or 67.!!. A#ter holding the card #or #ive $ears& Baker "rading Cards auctioned o## the card #or 4?!.!!. 3hat are the holding period return and the annual return on this investment5 A9S3EC 2olding Period Ceturn ; < 4?! . 67> @ 67 ; 8.482- or 848.2-A Annual Ceturn ; <4 Q 8.482->4@7 / 4 ; 4.6?'7 / 4 ; !.6?'7 or 6?.'7A

?. Comparison o# Ceturns. 3ei Fuan *nvestors are looking at three di##erent investment opportunities. *nvestment One is a #ive $ear investment with a cost o# 427 and a promised pa$out o# 27! at maturit$. *nvestment "wo is a seven $ear investment with a cost o# 427 and a promised pa$out o# 67!. *nvestment "hree is a ten $ear investment with a cost o# 427 and a promised pa$out o# 77!. 3ei Fuan *nvestors can onl$ take one o# the three investments. Calculate the annual return #or each investment and select the best investment choice i# all three investment opportunities have the same level o# risk. A9S3EC 2olding Period Ceturn #or *nvestment One ; < 27! . 427> @ 427 ; 4.!! or 4!!.!!A Annual Ceturn *nvestment One ; <4 Q 4.!!>4@7 / 4 ; 4.48?' / 4 ; !.48?' or 48.?'A 2olding Period Ceturn #or *nvestment "wo ; < 67! . 427> @ 427 ; 4.?! or 4?!.!!A Annual Ceturn *nvestment "wo ; <4 Q 4.?!>4@' / 4 ; 4.47?7 / 4 ; !.47?7 or 47.?7A 2olding Period Ceturn #or *nvestment "hree ; < 77! . 427> @ 427 ; 6.8! or 68!.!!A Annual Ceturn *nvestment "hree ; <4 Q 6.8!>4@4! / 4 ; 4.47-= / 4 ; !.47-= or 47.-=A *nvestment "wo has the highest annual return rate o# the three choices. *# all choices have the same level o# risk& choose *nvestment "wo.

-. 2istorical Ceturns <#rom "able do some averaging>. Calculate the average return o# the E.S. "reasur$ Bills& Hong."erm Fovernment Bonds& and Harge Compan$ Stocks #or the -!s #rom "able 7.4. 3hich had the highest and which had the lowest return5 Answer #rom data is: Average Ceturn E.S. "reasur$ Bill #or -!s: 7.!2A Average Ceturn E.S. Hong."erm Fovernment Bonds #or -!s: -.26A Average Ceturn E.S. Harge Compan$ Stocks #or -!s: 4?.--A Average Ceturn E.S. Small Compan$ Stocks #or -!s: 47.?'A 2ighest was Harge Compan$ Stocks& Howest was 6 Konth ".Bills

=.

Standard Deviation. Calculate the standard deviation o# the E.S. "reasur$ Bills& Hong."erm Fovernment Bonds& and Harge Compan$ Stocks #or the -!s #rom "able 7.4. 3hich had the highest and which had the lowest variance5

Answer #rom data is: Standard Deviation #or E.S. "reasur$ Bill #or -!s: 4.6'A Standard Deviation #or E.S. Hong."erm Fovernment Bonds #or -!s: 42.6?A Standard Deviation #or E.S. Harge Compan$ Stocks #or -!s: 48.24A Standard Deviation #or E.S. Small Compan$ Stocks #or -!s: 24.'?A 2ighest was Small Compan$ Stocks& Howest was 6 Konth ".Bills

46. Expected Ceturn. Cob 2ull Consultants& a #amous think tank in the Kidwest& has provided probabilit$ estimates #or the #our potential economic states #or the coming $ear. "he probabilit$ o# a boom econom$ is 4!A& the probabilit$ o# a stable growth econom$ is 47A& the probabilit$ o# a stagnant econom$ is 7!A& and the probabilit$ o# a recession is 27A. Estimate the expected return on the #ollowing individual investments #or the coming $ear.

*9:ES"KE9" Stock Corporate Bond Fovernment Bond A9S3EC

Boom 27A -A ?A

+orecasted Ceturns #or Each Econom$ Stable Frowth Stagnant Cecession 42A 8A .42A 'A 7A 6A =A 8A 2A

Expected Ceturn Stock ; !.4! x !.27 Q !.47 x !.42 Q !.7! x !.!8 Q !.27 x <.!.42> ; !.!27! Q !.!4?! Q !.!2!! . !.!6!! ; !.!66! or 6.6A Expected Ceturn Corp. Bond ; !.4! x !.!- Q !.47 x !.!' Q !.7! x !.!7 Q !.27 x !.!6 ; !.!!-! Q !.!4!7 Q !.!27! Q !.!!'7 ; !.!72! or 7.2A Expected Ceturn Fov. Bond ; !.4! x !.!? Q !.47 x !.!= Q !.7! x !.!8 Q !.27 x !.!2 ; !.!!?! Q !.!!-! Q !.!2!! Q !.!!7! ; !.!82! or 8.2A

48. :ariance and Standard Deviation <expected>. Esing the data #rom problem 46& calculate the variance and standard deviation o# the three investments& stock& corporate bond& and government bond. *# the estimates #or both the probabilities o# the econom$ and the returns in each state o# the econom$ are correct& which investment would $ou choose considering both risk and return5 3h$5 A9S3EC :ariance o# Stock ; !.4! x <!.27 / !.!66>2 Q !.47 x <!.42 / !.!66>2 Q !.7! x <!.!8 / !.!66>2 Q !.27 x <.!.42 / !.!66>2 ; !.4! x !.!8'4 Q !.47 x !.!!'= Q !.7! x !.!!!! Q !.27 x !.!268 ; !.!!8' Q !.!!44 Q !.!!!! Q !.!!7- ; !.!44' or 4.4'A Standard Deviation o# Stock ; <!.!44'>4@2 ; !.4!?6 or 4!.?6A :ariance o# Corp. Bond ; !.4! x <!.!- / !.!72>2 Q !.47 x <!.!' / !.!72>2 Q !.7! x <!.!7 / !.!72>2 Q !.27 x <!.!6 / !.!72>2 ; !.4! x !.!!48 Q !.47 x !.!!!6 Q !.7! x !.!!!! Q !.27 x !.!!!7

; !.!!!4 Q !.!!!! Q !.!!!! Q !.!!!4 ; !.!!!64= or !.!!64=A Standard Deviation o# Corp. Bond ; <!.!!!64=>4@2 ; !.!4'''= or 4.'?A :ariance o# Fov. Bond ; !.4! x <!.!? / !.!82>2 Q !.47 x <!.!= / !.!82>2 Q !.7! x <!.!8 / !.!82>2 Q !.27 x <!.!2 / !.!82>2 ; !.4! x !.!!48 Q !.47 x !.!!!6 Q !.7! x !.!!!! Q !.27 x !.!!!7 ; !.!!!4 Q !.!!!! Q !.!!!! Q !.!!!4 ; !.!!!64= or !.!64=A Standard Deviation o# Fov. Bond ; <!.!!!64=>4@2 ; !.!4'''= or 4.'?A "he best choice is the corporate bond. +irst comparing the corporate bond and the stock& the corporate bond has a higher expected return and a lower variance <standard deviation>. Second comparing the corporate bond and the government bond the corporate bond has a higher return and the same variance <standard deviation>. "his result is due to the low probabilities o# 0good1 economic states where the stock per#orms best.

Chapter Six
Ese the #ollowing table #or problems 4 through 8. Par :alue $1,000.00 $1,000.00 $5,000.00 $5,000.00 Coupon Cate ?A =A -A 42A Oears to Katurit$ 4! 4! 2! 6! Oield to Katurit$ =A ?A 'A 7A Price 5 5 5 5

4. Price the bonds #rom the above table with annual coupon pa$ments. A9S3EC: Price ; 4&!!!.!! x 4@<4.!=>4! Q ?!.!! <4 / 4@<4.!=>4!>@ !.!= Price ; 4&!!!.!! x !.77?8 Q ?!.!! x '.6=!4

Price ; 77?.6- Q 7??.?4 ; 4&48'.2! Price ; 4&!!!.!! x 4@<4.!?>4! Q =!.!! <4 / 4@<4.!?>4!>@ !.!? Price ; 4&!!!.!! x !.8=62 Q =!.!! x =.'4!4 Price ; 8=6.4- Q 8!2.=! ; ?=7.?! Price ; 7&!!!.!! x 4@<4.!'>2! Q 87!.!! <4 / 4@<4.!'>2!>@ !.!' Price ; 7&!!!.!! x !.27?8 Q 87!.!! x 4!.7-8! Price ; 4&2-2.4! Q 8&'='.6! ; =&!7-.8! Price ; 7&!!!.!! x 4@<4.!7>6! Q =!!.!! <4 / 4@<4.!7>6!>@ !.!7 Price ; 7&!!!.!! x !.2648 Q =!!.!! x 47.6'27 Price ; 4&47=.?- Q -&226.8' ; 4!&6?!.6=

2. Price the bonds #rom the above table with semi.annual coupon pa$ments. A9S3EC: Price ; 4&!!!.!! x 4@<4.!6>2! Q 8!.!! <4 / 4@<4.!6>2!>@ !.!6 Price ; 4&!!!.!! x !.776' Q 8!.!! x 48.?''7 Price ; 776.=' Q 7-7.4! ; 4&48?.'' Price ; 4&!!!.!! x 4@<4.!8>2! Q 6!.!! <4 / 4@<4.!8>2!>@ !.!8 Price ; 4&!!!.!! x !.87=8 Q 6!.!! x 46.7-!6 Price ; 87=.6- Q 8!'.'4 ; ?=8.4! Price ; 7&!!!.!! x 4@<4.!67>8! Q 227.!! <4 / 4@<4.!67>8!>@ !.!67 Price ; 7&!!!.!! x !.272= Q 227.!! x 24.6774 Price ; 4&2=2.?= Q 8&?!8.?- ; =&!='.'7 Price ; 7&!!!.!! x 4@<4.!27>=! Q 6!!.!! <4 / 4@<4.!27>=!>@ !.!27 Price ; 7&!!!.!! x !.22'6 Q 6!!.!! x 6!.-!?' Price ; 4&46=.84 Q -&2'2.=! ; 4!&8!-.!4

7. 3hat is the $ield o# the above bonds i# interest <coupons> is paid semi.annuall$5 A9S3EC: <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 2! 5 .4!!!.!! 8!.!! 4!!!.!! TEOS 9 *@O P: PK" +: CP" ?.! <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2

*9PE" TEOS CP"

2! 9

5 *@O ?.26!!

.?7!.!! P:

6!.!! PK"

4!!!.!! +:

<":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 8! 5 .78!!.!! 227.!! TEOS 9 *@O P: PK" CP" ?.4?!' <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" =! 5 .86!!.!! 6!!.!! TEOS 9 *@O P: PK" CP" 46.--6= 4!. 3hat are the coupon rates #or the bonds listed below5 Coupon Cate 5 5 5 5 Oears to Katurit$ 6! 27 2! 4! Oield to Katurit$ =.!A 4!.!A -.!A ?.!A

7!!!.!! +:

7!!!.!! +:

Par :alue $1,000.00 $1,000.00 $1,000.00 $1,000.00

Price 4&842.-8 4&4?2.7= -!'.=6 ?=2.=6

Coupon +re)uenc$ Annual Semi.Annual Ruarterl$ Konthl$

A9S3EC: <":K Te$s> Set Calculator to P@O ; 4 and C@O ; 4 *9PE" 6! =.! .4842.-8 5 4!!!.!! TEOS 9 *@O P: PK" +: CP" -!.!! Coupon pa$ments are 7.!! ever$ $ear so coupon rate is: 4&!!! x rate ; -!.!! rate ; -! @ 4&!!! ; !.!- or -A <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 7! 4!.! .4&4?2.7= 5 4!!!.!! TEOS 9 *@O P: PK" +: CP" =!.!! Coupon pa$ments are 7.!! ever$ month so coupon rate is: 4&!!! x rate @ 2 ; =!.!! 4&!!! x rate ; 42!.!! rate ; 42! @ 4&!!! ; !.42 or 42A <":K Te$s> Set Calculator to P@O ; 8 and C@O ; 8 *9PE" ?! -.! .-!'.=6 5 4!!!.!!

TEOS 9 *@O P: PK" +: CP" 2!.!! Coupon pa$ments are 2!.!! ever$ #our months so coupon rate is: 4&!!! x rate @ 8 ; 2!.!! 4&!!! x rate ; ?!.!! rate ; ?! @ 4&!!! ; !.!? or ?A <":K Te$s> Set Calculator to P@O ; 42 and C@O ; 42 *9PE" 42! ?.! .?=2.=6 5 4!!!.!! TEOS 9 *@O P: PK" +: CP" 7.!!!! Coupon pa$ments are 7.!! ever$ month so coupon rate is: 4&!!! x rate @ 42 ; 7.!! 4&!!! x rate ; =!.!! rate ; =! @ 4&!!! ; !.!= or =A 44. Koore Compan$ is about to issue a bond with semi.annual coupon pa$ments& a coupon rate o# ?A and par value o# 4&!!!. "he $ield.to. maturit$ #or this bond is 4!A. A. 3hat is the price o# the bond i# the bond matures in 7& 4!& 47& or 2! $ears5 B. 3hat do $ou notice about the price o# the bond in relationship to the maturit$ o# the bond5 A9S3EC to A: At #ive $ears to maturit$ Price ; 4&!!!.!! x 4@<4.!7>4! Q 8!.!! <4 / 4@<4.!7>4!>@ !.!7 Price ; 4&!!!.!! x !.=46- Q 8!.!! x '.'24' Price ; =46.-4 Q 6!?.?' ; -22.'? <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 4! 4!.! 5 8!.!! TEOS 9 *@O P: PK" CP" .-22.'? 4!!!.!! +:

At ten $ears to maturit$ Price ; 4&!!!.!! x 4@<4.!7>2! Q 8!.!! <4 / 4@<4.!7>2!>@ !.!7 Price ; 4&!!!.!! x !.6'=- Q 8!.!! x 42.8=22 Price ; 6'=.?- Q 8-?.8- ; ?'7.6? <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 2! 4!.! 5 8!.!! TEOS 9 *@O P: PK" CP" .?'7.6? 4!!!.!! +:

At #i#teen $ears to maturit$ Price ; 4&!!!.!! x 4@<4.!7>6! Q 8!.!! <4 / 4@<4.!7>6!>@ !.!7

Price ; 4&!!!.!! x !.2648 Q 8!.!! x 47.6'27 Price ; 264.6? Q =48.-! ; ?8=.2? <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 6! 4!.! 5 8!.!! TEOS 9 *@O P: PK" CP" .?8=.2? 4!!!.!! +:

At twent$ $ears to maturit$ Price ; 4&!!!.!! x 4@<4.!7>8! Q 8!.!! <4 / 4@<4.!7>8!>@ !.!7 Price ; 4&!!!.!! x !.482! Q 8!.!! x 4'.47-4 Price ; 482.!7 Q =?=.6= ; ?2?.84 <":K Te$s> Set Calculator to P@O ; 2 and C@O ; 2 *9PE" 8! 4!.! 5 8!.!! TEOS 9 *@O P: PK" CP" .?2?.84 4!!!.!! +:

A9S3EC to B "he longer the maturit$ o# a bond selling at a discount& all else held constant& the lower the price o# the bondP

46. Addison Compan$ will issue a (ero coupon bond this coming month. "he pro%ected $ield #or the bond is 'A. *# the par value o# the bond is 4&!!! what is the price o# the bond using a semi.annual convention i# a. "he maturit$ is 2! $ears5 b. "he maturit$ is 6! $ears5 c. "he maturit$ is 7! $ears5 d. "he maturit$ is 4!! $ears5 A9S3EC to A: Price ; 4&!!! x 4 @ <4.!67>8! ; 4&!!! x !.272= ; 272.7' A9S3EC to B: Price ; 4&!!! x 4 @ <4.!67>=! ; 4&!!! x !.42=- ; 42=.-6 A9S3EC to A: Price ; 4&!!! x 4 @ <4.!67>4!! ; 4&!!! x !.!624 ; 62.!= A9S3EC to A: Price ; 4&!!! x 4 @ <4.!67>2!! ; 4&!!! x !.!!4!; 4.!6

4-.

*n Problem 4?& the conversion option is #or 7! shares o# Goe Phillips Kanu#acturing Compan$ #or ever$ bond. *# the current bond price is 4&28! at what share price would a bondholder be better o## converting to stock5

A9S3EC: An$ price above 4&28! @ 7! ; 28.?!.

Chapter 7
4. Kurph$ Kotors& *nc. has %ust set the compan$ dividend polic$ at !.7! per $ear. "he compan$ plans on being in business #orever. 3hat is the price o# this stock i# a. An investor wants a 7A return5 b. An investor wants an ?A return5 c. An investor wants a 4!A return5 d. An investor wants a 46A return5 e. An investor wants a 2!A return5 SOHE"*O9: Ese the constant dividend in#inite dividend stream model: Price ; Dividend @ r a. Price ; !.7! @ !.!7 ; 4!.!! b. Price ; !.7! @ !.!? ; =.27 c. Price ; !.7! @ !.4! ; 7.!! d. Price ; !.7! @ !.46 ; 6.?7 e. Price ; !.7! @ !.2! ; 2.7!

2. Cice Electronics wants its shareholders to earn a 47A return on their investment in the compan$. At what price would the stock need to be priced toda$ i# Cice Electronics had the #ollowing cash dividend polic$: a. b. c. d. !.27 constant annual dividend #orever5 4.!! constant annual dividend #orever5 4.'7 constant annual dividend #orever5 2.7! constant annual dividend #orever5

SOHE"*O9: Ese the constant dividend in#inite dividend stream model: Price ; Dividend @ r a. Price ; !.27 @ !.47 ; 4.=' b. Price ; 4.!! @ !.47 ; =.=' c. Price ; 4.'7 @ !.47 ; 44.=' d. Price ; 2.7! @ !.47 ; 4=.='

6. "rembla$ +ine +oods has a current annual cash dividend polic$ o# 2.27. "he price o# the stock is set to $ield a 42A return. 3hat is the price o# this stock i# the dividend will be paid #or: a. 4! $ears5 b. 47 $ears5 c. 8! $ears5 d. =! $ears5 e. 4!! $ears5 #. +orever5

SOHE"*O9: Ese the #inite constant dividend model except with # <use in#inite constant dividend model> Price ; Dividend x <4 / 4@<4Qr>n> @ r a. Price ; 2.27 x <4 / 4@<4.42>4! @ !.42 ; 2.27 x 7.=7!2 ; 42.'4 b. Price ; 2.27 x <4 / 4@<4.42>47 @ !.42 ; 2.27 x =.?4!- ; 47.62 c. Price ; 2.27 x <4 / 4@<4.42>8! @ !.42 ; 2.27 x ?.286? ; 4?.78 d. Price ; 2.27 x <4 / 4@<4.42>=! @ !.42 ; 2.27 x ?.628! ; 4?.'6 e. Price ; 2.27 x <4 / 4@<4.42>4!! @ !.42 ; 2.27 x 7.=7!2 ; 4?.'7 #. Price ; 2.27 @ !.42 ; 4?.'7 7. Ting 3aterbeds has an annual cash dividend polic$ that raises the dividend each $ear b$ 8A. Hast $ear,s dividend was !.8! per share. 3hat is the price o# this stock i# a. An investor wants a 7A return5 b. An investor wants an ?A return5 c. An investor wants a 4!A return5 d. An investor wants a 46A return5 e. An investor wants a 2!A return5 SOHE"*O9: Ese the constant growth dividend model with an in#inite dividend stream: Price ; Hast Dividend x <4 Q g> @ <r / g> a. Price ; !.8! x <4.!8> @ <!.!7 / !.!8> ; !.84=! @ !.!4 ; 84.=! b. Price ; !.8! x <4.!8> @ <!.!? / !.!8> ; !.84=! @ !.!8 ; 4!.8! c. Price ; !.8! x <4.!8> @ <!.4! / !.!8> ; !.84=! @ !.!= ; =.-6

d. Price ; !.8! x <4.!8> @ <!.46 / !.!8> ; !.84=! @ !.!- ; 8.=2 e. Price ; !.8! x <4.!8> @ <!.2! / !.!8> ; !.84=! @ !.4= ; 2.=! '. Kiles 2ardware has an annual cash dividend polic$ that raises the dividend each $ear b$ 6A. Hast $ear,s dividend was 4.!! per share. *nvestors want a 47A return on this stock. 3hat is the price o# this stock i# a. "he compan$ will be in business #or 7 $ears and not have a li)uidating dividend5 b. "he compan$ will be in business #or 47 $ears and not have a li)uidating dividend5 c. "he compan$ will be in business #or 27 $ears and not have a li)uidating dividend5 d. "he compan$ will be in business #or 67 $ears and not have a li)uidating dividend5 e. "he compan$ will be in business #or '7 $ears and not have a li)uidating dividend5 #. +orever5 SOHE"*O9: Ese the constant growth dividend model with a #inite dividend stream: Price ; Hast Dividend x <4 Q g> @ <r / g> x I4 / <<4Qg> @ <4Qr>>nJ a. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> x I4 / <<4.!6> @ <4.47>>7J ; 4.!6 @ !.42 x I4 . !.7'=8J ; ?.7? x I!.826=J ; 6.=8 b. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> x I4 / <<4.!6> @ <4.47>>47J ; 4.!6 @ !.42 x I4 . !.4-47J ; ?.7? x I!.?!?7J ; =.-8 c. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> x I4 / <<4.!6> @ <4.47>>27J

; 4.!6 @ !.42 x I4 . !.!=6=J ; ?.7? x I!.-6=8J ; ?.!6 d. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> x I4 / <<4.!6> @ <4.47>>67J ; 4.!6 @ !.42 x I4 . !.!244J ; ?.7? x I!.-'?-J ; ?.8! e. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> x I4 / <<4.!6> @ <4.47>>'7J ; 4.!6 @ !.42 x I4 . !.!!!6J ; ?.7? x I!.---'J ; ?.7? #. Price ; 4.!! x <4.!6> @ <!.47 / !.!6> ; 4.!6 @ !.42 ; ?.7? 44. 2uber Athletic Club is going to o##er pre#erred stock to its members with the #ollowing characteristicsU par value is 4!! and annual dividend rate o# =A. *# a member wants the #ollowing returns& what price should he be willing to pa$: a. Brad wants a 4!A return. b. Kike wants a 42A return c. Cick wants a 47A return d. Gulius wants a 4?A return SOHE"*O9: Ese the constant dividend model with #inite hori(on Price ; Dividend @ r a. Brad,s Price ; 4!! x !.!= @ !.4! ; =!.!! b. Kike,s Price ; 4!! x !.!= @ !.42 ; 7!.!! c. Cick,s Price ; 4!! x !.!= @ !.47 ; 8!.!! d. Gulius,s Price ; 4!! x !.!= @ !.4? ; 66.66

Chapter 8
Ese the in#ormation in the #ollowing to answer )uestions 4.8 below: State o# Econom$ Boom Probabilit$ o# State .6! Ceturn on G in State !.!7! Ceturn on T in State !.28! Ceturn on H in State !.6!!

Frowth Stagnant Cecession

.8! .2! .4!

!.!7! !.!7! !.!7!

!.42! !.!8! .!.4!!

!.2!! !.!=! .!.2!!

4. Expected Ceturn. 3hat are the expected returns o# the three di##erent assets5 A9S3EC Expected Ceturn G ; !.6! x !.!7 Q !.8! x !.!7 Q !.2! x !.!7 Q !.4! x !.!7 ; !.!47! Q !.!2!! Q !.!4!! Q !.!!7!; !.!!7! or 7.!A Expected Ceturn T ; !.6! x !.28 Q !.8! x !.42 Q !.2! x !.!8 Q !.4! x <.!.4!> ; !.!'2! Q !.!8?! Q !.!!?! . !.!4!! ; !.44?! or 44.?!A Expected Ceturn H ; !.6! x !.6! Q !.8! x !.2! Q !.2! x !.!= Q !.4! x <.!.2!> ; !.!-!! Q !.!?!! Q !.!42! Q !.!2!! ; !.4=2! or 4=.2!A

2. :ariance and Standard Deviation. 3hat are the variances and standard deviations o# each o# the three di##erent assets5 A9S3EC V2 <G> ; !.6! x <!.!8 / !.!8>2 Q !.8! x <!.!8 / !.!8>2 Q !.2! x <!.!7.!.!7>2 Q !.4! x <!.!8 / !.!8>2 ; !.6! x !.!!!! Q !.8! x !.!!!! Q !.2! x !.!!!! Q !.4! x !.!!!! ; !.!!!!Q !.!!!! Q !.!!!! Q !.!!!! ; !.!!!! or !.!!A Standard Deviation o# G ; <!.!!!!>4@2 ; !.!!!! or !.!!A V2 <T> ; !.6! x <!.28 / !.44?!>2 Q !.8! x <!.42 / !.44?!>2 Q !.2! x <!.!8 . !.44?!>2 Q !.4! x <.!.4! / !.44?!>2 ; !.6! x !.!48- Q !.8! x !.!!!! Q !.2! x !.!!=4 Q !.4! x !.!8'7 ; !.!!87 Q !.!!!! Q !.!!42 Q !.!!8? ; !.!4!8 or 4.!8A

Standard Deviation o# T ; <!.!4!8>4@2 ; !.4!22 or 4!.22A V2 <H> ; !.6! x <!.6! / !.4=2!>2 Q !.8! x <!.2! / !.4=2!>2 Q !.2! x <!.!= . !.4=2!>2 Q !.4! x <.!.2! / !.4=2!>2 ; !.6! x !.!4-! Q !.8! x !.!!48 Q !.2! x !.!4!8 Q !.4! x !.464! ; !.!!7' Q !.!!!= Q !.!!24 Q !.!464 ; !.!247 or 2.47A Standard Deviation o# H ; <!.!247>4@2 ; !.48=7 or 48.=7A

6. Port#olio. 3hat is the expected return o# a port#olio with 4!A in asset G& 7!A in asset T& and 8!A in asset H5 A9S3EC Expected Ceturn Port#olio ; !.4! x !.!7 Q !.7! x !.44? Q !.8! x !.4=2 ; !.!!7! Q !.!7-! Q !.!=8? ; !.42?? or 42.??A OC +irst determine the port#olio,s return in each state o# the econom$ with the allocation o# assets at 4!A in G& 7!A in T& and 8!A in H. Expected Ceturn Port#olio in Boom; !.4! x !.!7 Q !.7! x !.28 Q !.8! x !.6! ; !.!!7! Q !.42!! Q !.42!! ; !.287! or 28.7!A Expected Ceturn Port#olio in Frowth ; !.4! x !.!7 Q !.7! x !.42 Q !.8! x !.2! ; !.!!7! Q !.!=!! Q !.!?!! ; !.487! or 48.7!A Expected Ceturn Port#olio in Stagnant ; !.4! x !.!7 Q !.7! x !.!8 Q !.8! x !.!= ; !.!!7! Q !.!2!! Q !.!28! ; !.!8-! or 8.-!A Expected Ceturn Port#olio in Cecession ; !.4! x !.!7 Q !.7! x <.!.4!> Q !.8! x <.!.2!> ; !.!!7! . !.!7!! . !.!?!! ; .!.427! or .42.7!A 9ow take the probabilit$ o# each state times the port#olio outcome in that state:

Expected Ceturn Port#olio ; !.6! x !.287! Q !.8! x !.487! Q !.2! x !.!8-! Q !.4! x <.!.427!> ; !.!'67 Q !.!7?! Q !.!!-? . !.!427 ; !.42?? or 42.??A 9ote that either wa$ produces the same expected return but that #or the variance calculation the port#olio returns in the three economic states are needed. 8. :ariance and Standard Deviation o# a Port#olio. 3hat is the port#olio,s variance and standard deviation using the same asset weights #rom problem 65 A9S3EC :ariance o# Port#olio ; !.6! x <!.287! / !.42??>2 Q !.8! x <!.487! / !.42??>2 Q !.2! x <!.!8-! / !.42??>2 Q !.4! x <.!.427! / !.42??>2 ; !.6! x !.!467 Q !.8! x !.!!!6 Q !.2! x !.!!=8 Q !.4! x !.!=88 ; !.!!84 Q !.!!!4 Q !.!!46 Q !.!!=8 ; !.!44- or 4.4-A Standard Deviation o# Port#olio ; <!.!44->4@2 ; !.4!-! or 4!.-!A Ese the in#ormation in the #ollowing to answer )uestions 7.? below: State o# Econom$ Boom Frowth Stagnant Cecession Probabilit$ o# State .47 .27 .67 .27 Ceturn on C in State !.!8! !.!8! !.!8! !.!8! Ceturn on S in State !.2?! !.48! !.!'! .!.!67 Ceturn on " in State !.87! !.2'7 !.!27 .!.4'7

-. Bene#its o# Diversi#ication. Sall$ Cogers has decided to invest her wealth e)uall$ across the three #ollowing assets. 3hat is her expected return increase and the risk reduction bene#it b$ investing in the three assets versus putting all her wealth in asset K5 2*9": +ind the standard deviation o# asset K and o# the port#olio e)uall$ invested in K& 9& and O. States Boom Probabilit$ 6!A Asset K Ceturn 42A Asset 9 Ceturn 4-A Asset O Ceturn 2A

9ormal Cecession A9S3EC

7!A 2!A

?A 2A

44A .2A

?A 42A

+irst #ind the expected return o# the e)uall$ weighted port#olio in the three economic states: Ceturn o# Port#olio in Boom ; 4@6 <42A> Q 4@6 <4-A> Q 4@6 <2A> ; 44.!!A Ceturn o# Port#olio in 9ormal ; 4@6 <?A> Q 4@6 <44A> Q 4@6 <?A> ; -.!!A Ceturn o# Port#olio in Cecession ; 4@6 <2A> Q 4@6 <.2A> Q 4@6 <42A> ; 8.!!A 9ow #ind the expected returns o# Asset K and the Port#olio. Expected Ceturn Asset K ; !.6! x <42A> Q !.7! x <?A> Q !.2! <2A> E<rK> ; 6.=A Q 8.!A Q !.8A ; ?A Expected Ceturn Port#olio ; !.6! x <44A> Q !.7! x <'A> Q !.2! <8A> E<rK> ; 6.6A Q 8.7A Q !.?A ; ?.=A 9ow #ind the standard deviation o# Asset K and the Port#olio. Standard Deviation o# Asset K ; I!.6! x <!.42 / !.!?>2 Q !.7! x <!.!? / !.!?>2 Q!.2! x <!.!2 / !.!?>2J4@2 ; I!.6! x !.!!4= Q !.2! x !.!!6=J4@2 ; I!.!!!8? Q !.!!!'2J4@2 ; I!.!!42J4@2 ; !.!68= or 6.8=A Standard Deviation o# Port#olio ; I!.6! x <!.44 / !.!?=>2 Q !.7! x <!.!- / !.!?=>2 Q!.6! x <!.8 / !.!?=>2J4@2 ; I!.6! x !.!!!= Q !.7! x !.!!!! Q !.2! x !.!!24J4@2 ; I!.!!!2 Q !.!!!! Q !.!!!8J4@2 ; I!.!!!=J4@2 ; !.!28= or 2.8=A "he bene#it is an increase in return o# !.=A and a simultaneous reduction in total risk o# 4A.

44. Beta o# a Port#olio. "he beta o# #our stocks& F& 2& *& and G are respectivel$ !.87& !.?& 4.47& and 4.=. 3hat is the beta o# a port#olio with the #ollowing weights in each asset5 Port#olio 4 Port#olio 2 Port#olio 6 A9S3EC Beta o# Port#olio 4 ; !.27 x !.87 Q !.27 x !.? Q !.27 x 4.47 Q !.27 x 4.= Wport#olio . 4 ; !.4427 Q !.2 Q !.2?'7 Q !.8 ; 4.! Beta o# Port#olio 2 ; !.6! x !.87 Q !.8! x !.? Q !.2! x 4.47 Q !.4! x 4.= Wport#olio . 2 ; !.467 Q !.62 Q !.26 Q !.4= ; !.?87 Beta o# Port#olio 6 ; !.4! x !.87 Q !.2! x !.? Q !.8! x 4.47 Q !.6! x 4.= Wport#olio . 6 ; !.!87 Q !.4= Q !.8= Q !.8? ; 4.487 3eight in F 27A 6!A 4!A 3eight in 2 27A 8!A 2!A 3eight in * 27A 2!A 8!A 3eight in G 27A 4!A 6!A

42. Expected Ceturn o# a Port#olio using Beta. Esing the same #our assets #rom above <problem 44> in the same three port#olios. 3hat are the expected returns o# the #our individual assets and the three port#olios i# the current SKH is plotting with an intercept o# 8A <risk.#ree rate> and a market premium o# 4!A <slope o# the line>5 A9S3EC Expected Ceturn o# Asset F ; 8A Q !.87 <4!A> ; ?.7A Expected Ceturn o# Asset 2 ; 8A Q !.? <4!A> ; 42A Expected Ceturn o# Asset * ; 8A Q 4.47 <4!A> ; 47.7A Expected Ceturn o# Asset G ; 8A Q 4.= <4!A> ; 2!A Expected Ceturn o# Port#olio 4 ; 8A Q 4.! <4!A> ; 48A

Expected Ceturn o# Port#olio 2 ; 8A Q !.?87 <4!A> ; 42.87A Expected Ceturn o# Port#olio 2 ; 8A Q 4.487 <4!A> ; 47.87A

Chapter 9
1. Payback Period Fiven the cash #lows o# the #our pro%ects& A& B& C& and D& and
using the Pa$back Period decision model& which pro%ects do $ou accept and which pro%ects do $ou re%ect with a three $ear cut.o## period #or recapturing the initial cash out#low5 Assume that the cash #lows are e)uall$ distributed over the $ear #or Pa$back Period calculations. Pro%ects Cost Cash +low Oear One Cash +low Oear "wo Cash +low Oear "hree Cash +low Oear +our Cash +low $ear +ive Cash Flow Year Six Solution Pro%ect A: Oear One: . 4!&!!! Q 8&!!! ; =&!!! le#t to recover Oear "wo: . =&!!! Q 8&!!! ; 2&!!! le#t to recover Oear "hree: . 2&!!! Q 8&!!! ; #ull$ recovered Oear "hree: 2&!!! @ 8&!!! ; X $ear needed #or recover$ Pa$back Period #or Pro%ect A: 2 and X $ears& ACCEP"P Pro%ect B: Oear One: . 27&!!! Q 2&!!! ; 26&!!! le#t to recover Oear "wo: . 26&!!! Q ?&!!! ; 47&!!! le#t to recover Oear "hree: . 47&!!! Q 48&!!! ; 4&!!! le#t to recover A 4!&!!! 8&!!! 8&!!! 8&!!! 8&!!! 8&!!! 8&!!! B 27&!!! 2&!!! ?&!!! 48&!!! 2!&!!! 2=&!!! 62&!!! C 87&!!! 4!&!!! 47&!!! 2!&!!! 2!&!!! 47&!!! 4!&!!! D 4!!&!!! 8!&!!! 6!&!!! 2!&!!! 4!&!!! ! !

Oear +our: . 4&!!! Q 2!&!!! ; #ull$ recovered Oear +our: 4&!!! @ 2!&!!! ; 4@2! $ear needed #or recover$ Pa$back Period #or Pro%ect B: 6 and 4@2! $ears& CEGEC"P Pro%ect C: Oear One: . 87&!!! Q 4!&!!! ; 67&!!! le#t to recover Oear "wo: . 67&!!! Q 47&!!! ; 2!&!!! le#t to recover Oear "hree: . 2!&!!! Q 2!&!!! ; #ull$ recovered Oear "hree: 2!&!!! @ 2!&!!! ; #ull $ear needed Pa$back Period #or Pro%ect B: 6 $ears& ACCEP"P Pro%ect D: Oear One: . 4!!&!!! Q 8!&!!! ; =!&!!! le#t to recover Oear "wo: . =!&!!! Q 6!&!!! ; 6!&!!! le#t to recover Oear "hree: . 6!&!!! Q 2!&!!! ; 4!&!!! le#t to recover Oear +our: . 4!&!!! Q 4!&!!! ; #ull$ recovered Oear +our: 4!&!!! @ 4!&!!! ; #ull $ear needed Pa$back Period #or Pro%ect B: 8 $ears& CEGEC"P

3. Discou ted Payback Period / Fiven the #ollowing #our pro%ects and their cash
#lows& calculate the discounted pa$back period with a 7A discount rate& 4!A discount rate& and 2!A discount rate. 3hat do $ou notice about the pa$back period as the discount rate rises5 Explain this relationship. Pro%ects Cost Cash +low Oear One Cash +low Oear "wo Cash +low Oear "hree Cash +low Oear +our Cash +low $ear +ive Cash Flow Year Six A 4!&!!! 8&!!! 8&!!! 8&!!! 8&!!! 8&!!! 8&!!! B 27&!!! 2&!!! ?&!!! 48&!!! 2!&!!! 2=&!!! 62&!!! C 87&!!! 4!&!!! 47&!!! 2!&!!! 2!&!!! 47&!!! 4!&!!! D 4!!&!!! 8!&!!! 6!&!!! 2!&!!! 4!&!!! 4!&!!! !

Solution at 7A discount rate Pro%ect A: P: Cash #low $ear one .. 8&!!! @ 4.!7 ; 6&?!-.72 P: Cash #low $ear two .. 8&!!! @ 4.!72 ; 6&=2?.42 P: Cash #low $ear three .. 8&!!! @ 4.!76 ; 6&877.67 P: Cash #low $ear #our .. 8&!!! @ 4.!78 ; 6&2-!.?4 P: Cash #low $ear #ive .. 8&!!! @ 4.!77 ; 6&468.4! P: Cash #low $ear six .. 8&!!! @ 4.!7= ; 2&-?8.?= Discounted Pa$back Period: . 4!&!!! Q 6&?!-.72 Q 6&=2?.42 Q 6&877.67 ; ?-2.-and #ull$ recovered Discounted Pa$back Period is 6 $ears. Pro%ect B: P: Cash #low $ear one .. 2&!!! @ 4.!7 ; 4&-!8.'= P: Cash #low $ear two .. ?&!!! @ 4.!72 ; '&27=.28 P: Cash #low $ear three .. 48&!!! @ 4.!76 ; 42&!-6.'6 P: Cash #low $ear #our .. 2!&!!! @ 4.!78 ; 4=&878.!7 P: Cash #low $ear #ive .. 2=&!!! @ 4.!77 ; 2!&6'4.=? P: Cash #low $ear six .. 62&!!! @ 4.!7= ; 26&?'?.?Discounted Pa$back Period: . 27&!!! Q 4&-!8.'= Q '&27=.28 Q 42&!-6.'6 Q 4=&878.!7 ; 42&'!?.'? and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect C: P: Cash #low $ear one .. 4!&!!! @ 4.!7 ; -&726.?4 P: Cash #low $ear two .. 47&!!! @ 4.!72 ; 46&=!7.88 P: Cash #low $ear three .. 2!&!!! @ 4.!76 ; 4'&2'=.'7 P: Cash #low $ear #our .. 2!&!!! @ 4.!78 ; 4=&878.!7

P: Cash #low $ear #ive .. 47&!!! @ 4.!77 ; 44&'72.?P: Cash #low $ear six .. 4!&!!! @ 4.!7= ; '&8=2.47 Discounted Pa$back Period: . 87&!!! Q -&726.?4 Q 46&=!7.88 Q 4'&2'=.'7 Q 4=&878.!7 ; 44&?=!.!7 and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect D: P: Cash #low $ear one .. 8!&!!! @ 4.!7 ; 6?&!-7.28 P: Cash #low $ear two .. 67&!!! @ 4.!72 ; 64&'8=.!6 P: Cash #low $ear three .. 2!&!!! @ 4.!76 ; 4'&2'=.'7 P: Cash #low $ear #our .. 4!&!!! @ 4.!78 ; ?&22'.!2 P: Cash #low $ear #ive .. 4!&!!! @ 4.!77 ; '&?67.2= P: Cash #low $ear six .. ! @ 4.!7= ; ! Discounted Pa$back Period: . 4!!&!!! Q 6?&!-7.28 Q 64&'8=.!6 Q 4'&2'=.'7 Q ?&22'.!2 Q '&?67.2= ; 6&4?!.6! and #ull$ recovered. Discounted Pa$back Period is 7 $ears.

Solution at 4!A discount rate Pro%ect A: P: Cash #low $ear one .. 8&!!! @ 4.4! ; 6&=6=.6= P: Cash #low $ear two .. 8&!!! @ 4.4!2 ; 6&6!'.'P: Cash #low $ear three .. 8&!!! @ 4.4!6 ; 6&!!7.2= P: Cash #low $ear #our .. 8&!!! @ 4.4!8 ; 2&'62.!7 P: Cash #low $ear #ive .. 8&!!! @ 4.4!7 ; 2&8?6.=P: Cash #low $ear six .. 8&!!! @ 4.4!= ; 2&27'.-!

Discounted Pa$back Period: . 4!&!!! Q 6&=6=.6= Q 6&6!'.'- Q 6&!!7.2= Q 2&'62.!7 ; 2&=?4.8= and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect B: P: Cash #low $ear one .. 2&!!! @ 4.4! ; 4&?4?.4? P: Cash #low $ear two .. ?&!!! @ 4.4!2 ; =&=44.7' P: Cash #low $ear three .. 48&!!! @ 4.4!6 ; 4!&74?.84 P: Cash #low $ear #our .. 2!&!!! @ 4.4!8 ; 46&==!.2' P: Cash #low $ear #ive .. 2=&!!! @ 4.4!7 ; 4=&486.-7 P: Cash #low $ear six .. 62&!!! @ 4.4!= ; 4?&!=6.4' Discounted Pa$back Period: . 27&!!! Q 4&?4?.4? Q =&=44.7' Q 4!&74?.84 Q 46&==!.2' ; '&=!?.86 and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect C: P: Cash #low $ear one .. 4!&!!! @ 4.4! ; -&!-!.-4 P: Cash #low $ear two .. 47&!!! @ 4.4!2 ; 42&6-=.=P: Cash #low $ear three .. 2!&!!! @ 4.4!6 ; 47&!2=.6! P: Cash #low $ear #our .. 2!&!!! @ 4.4!8 ; 46&==!.2' P: Cash #low $ear #ive .. 47&!!! @ 4.4!7 ; -&646.?2 P: Cash #low $ear six .. 4!&!!! @ 4.4!= ; 7&=88.'8 Discounted Pa$back Period: . 87&!!! Q -&!-!.-4 Q 42&6-=.=- Q 47&!2=.2! Q 46&==!.2' ; 74'8.!' and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect D: P: Cash #low $ear one .. 8!&!!! @ 4.4! ; 6=&6=6.=8 P: Cash #low $ear two .. 67&!!! @ 4.4!2 ; 2?&-27.=2

P: Cash #low $ear three .. 2!&!!! @ 4.4!6 ; 47&!2=.6! P: Cash #low $ear #our .. 4!&!!! @ 4.4!8 ; =&?6!.46 P: Cash #low $ear #ive .. 4!&!!! @ 4.4!7 ; =&2!-.24 P: Cash #low $ear six .. ! @ 4.4!= ; ! Discounted Pa$back Period: . 4!!&!!! Q 6=&6=6.=8 Q 2?&-27.=2 Q 47&!2=.6! Q =&?6!.46 Q =&2!-.24 ; . =&=87.4! and never recovered. *nitial cash out#low is never recovered. Solution at 2!A discount rate Pro%ect A: P: Cash #low $ear one .. 8&!!! @ 4.2! ; 6&666.66 P: Cash #low $ear two .. 8&!!! @ 4.2!2 ; 2&'''.'? P: Cash #low $ear three .. 8&!!! @ 4.2!6 ; 2&648.?4 P: Cash #low $ear #our .. 8&!!! @ 4.2!8 ; 4&-2-.!4 P: Cash #low $ear #ive .. 8&!!! @ 4.2!7 ; 4&=!'7.4! P: Cash #low $ear six .. 8&!!! @ 4.2!= ; 4&66-.7Discounted Pa$back Period: . 4!&!!! Q 6&666.66 Q 2&'''.'? Q 2&648.?4Q 4&-2-.!4 ; 678.-6 and #ull$ recovered Discounted Pa$back Period is 8 $ears. Pro%ect B: P: Cash #low $ear one .. 2&!!! @ 4.2! ; 4&===.=' P: Cash #low $ear two .. ?&!!! @ 4.2!2 ; 7&777.7= P: Cash #low $ear three .. 48&!!! @ 4.2!6 ; ?&4!4.?7 P: Cash #low $ear #our .. 2!&!!! @ 4.2!8 ; -&=87.!= P: Cash #low $ear #ive .. 2=&!!! @ 4.2!7 ; 4!&88?.?2 P: Cash #low $ear six .. 62&!!! @ 4.2!= ; 4!&'4=.'8

Discounted Pa$back Period: . 27&!!! Q 4&===.=' Q 7&777.7= Q ?&4!4.?7 Q -&=87.!= Q 4!&88?.?2 ; 4!&84'.-= and #ull$ recovered Discounted Pa$back Period is 7 $ears. Pro%ect C: P: Cash #low $ear one .. 4!&!!! @ 4.2! ; ?&666.66 P: Cash #low $ear two .. 47&!!! @ 4.2!2 ; 4!&84=.=' P: Cash #low $ear three .. 2!&!!! @ 4.2!6 ; 44&7'8.!' P: Cash #low $ear #our .. 2!&!!! @ 4.2!8 ; -&=87.!= P: Cash #low $ear #ive .. 47&!!! @ 4.2!7 ; =&!2?.4= P: Cash #low $ear six .. 4!&!!! @ 4.2!= ; 6&68?.-' Discounted Pa$back Period: . 87&!!! Q ?&666.66 Q 4!&84=.=' Q 44&7'8.!' Q -&=87.!= Q =&!2?.4= ; --'.2- and #ull$ recovered Discounted Pa$back Period is 7 $ears. Pro%ect D: P: Cash #low $ear one .. 8!&!!! @ 4.2! ; 66&666.66 P: Cash #low $ear two .. 67&!!! @ 4.2!2 ; 28&6!7.7= P: Cash #low $ear three .. 2!&!!! @ 4.2!6 ; 44&7'8.!' P: Cash #low $ear #our .. 4!&!!! @ 4.2!8 ; 8&?22.76 P: Cash #low $ear #ive .. 4!&!!! @ 4.2!7 ; 8&!4?.'? P: Cash #low $ear six .. ! @ 4.2!= ; ! Discounted Pa$back Period: . 4!!&!!! Q 66&666.66 Q 28&6!7.7= Q 44&7'8.!' Q 8&?22.76 Q 8&!4?.'? ; . 24&-87.'6 and initial cost is never recovered. Discounted Pa$back Period is in#init$.

As the discount rate increases& the Discounted Pa$back Period also increases. "he reason is that the #uture dollars are worth less in present value as the discount rate increases re)uiring more #uture dollars to recover the present value o# the outla$.

7. !et Prese t "a#ue / Swanson *ndustries has a pro%ect with the #ollowing pro%ected
cash #lows: *nitial Cost& Oear !: 28!&!!! Cash #low $ear one: 27&!!! Cash #low $ear two: '7&!!! Cash #low $ear three: 47!&!!! Cash #low $ear #our: 47!&!!! a. Esing a 4!A discount rate #or this pro%ect and the 9P: model should this pro%ect be accepted or re%ected5 b. Esing a 47A discount rate5 c. Esing a 2!A discount rate5 Solution a. 9P: ; . 28!&!!! Q 27&!!!@4.4! Q '7&!!!@4.4!2 Q 47!&!!!@4.4!6 Q 47!&!!!@4.4!8 9P: ; . 28!&!!! Q 22&'2'.2' Q =4&-?6.8' Q 442&=-'.22 Q 4!2&872.!2 9P: ; 7-&?7-.-? and accept the pro%ect. b. 9P: ; . 28!&!!! Q 27&!!!@4.47 Q '7&!!!@4.472 Q 47!&!!!@4.476 Q 47!&!!!@4.478 9P: ; . 28!&!!! Q 24&'6-.46 Q 7=&'4!.'= Q -?&=2'.86 Q ?7&'=2.--

9P: ; 22&?8!.64 and accept the pro%ect. c. 9P: ; . 28!&!!! Q 27&!!!@4.2! Q '7&!!!@4.2!2 Q 47!&!!!@4.2!6 Q 47!&!!!@4.2!8 9P: ; . 28!&!!! Q 2!&?66.66 Q 72&!?6.66 Q ?=&?!7.7= Q '2&66'.-= 9P: ; . '&-6-.?2 and re%ect the pro%ect.

11. $ ter a# %ate o& %etur / 3hat are the *CCs o# the #our pro%ects #or
Swanson *ndustries in problem Y-5 Solution& this is an iterative process but can be solved )uickl$ on a calculator or spreadsheet. Enter the ke$s noted #or each pro%ect in the C+ o# a "exas BA ** Plus calculator Cash +lows C+O CO4& +4 CO2& +2 Oear three Oear #our Oear #ive CPT IRR Pro%ect K . 2&!!!&!!! 7!!&!!!& 4 7!!&!!!& 4 7!!&!!!& 4 7!!&!!!& 4 7!!&!!!& 4 '.-6A Pro%ect 9 . 2&!!!&!!! =!!&!!!& 4 =!!&!!!& 4 =!!&!!!& 4 =!!&!!!& 4 =!!&!!!& 4 47.28A Pro%ect O . 2&!!!&!!! 4&!!!&!!!& 4 ?!!&!!!& 4 =!!&!!!& 4 8!!&!!!& 4 2!!&!!!& 4 2!.2'A Pro%ect P . 2&!!!&!!! 6!!&!!!& 4 7!!&!!!& 4 '!!&!!!& 4 -!!&!!!& 4 4&4!!&!!!& 4 4'.'2A

1'. Pro&itabi#ity $ dex .. Fiven the discount rates and the #uture cash #lows o# each
pro%ect& which pro%ects should the$ accept using pro#itabilit$ index5

Cash +lows Oear (ero Oear one Oear two Oear three Oear #our

Pro%ect E . 2&!!!&!!! 7!!&!!! 7!!&!!! 7!!&!!! 7!!&!!!

Pro%ect : . 2&7!!&!!! =!!&!!! =!!&!!! =!!&!!! =!!&!!!

Pro%ect 3 . 2&8!!&!!! 4&!!!&!!! ?!!&!!! =!!&!!! 8!!&!!!

Pro%ect Z . 4&'7!&!!! 6!!&!!! 7!!&!!! '!!&!!! -!!&!!!

Oear #ive Discount Rate

7!!&!!! =A

=!!&!!! -A

2!!&!!! 47A

4&4!!&!!! 22A

Solution& #ind the present value o# bene#its and divide b$ the present value o# the costs #or each pro%ect. Pro%ect E,s P: Bene#its ; 7!!&!!!@4.!7 Q 7!!&!!!@4.!72 Q 7!!&!!!@4.!76 Q 7!!&!!!@4.!78 Q 7!!&!!!@4.!77 Pro%ect E,s P: Bene#its ; 8'=&4-!.8? Q 876&748.'8 Q 864&-4?.?! Q 844&674.28 Q 6-4&'=6.!? ; 2&4=8&'6?.68 Pro%ect E,s P: Costs ; 2&!!!&!!! Pro%ect E,s P* ; 2&4=8&'6?.68 @ 2&!!!&!!! ; 4.!?28 accept pro%ect. Pro%ect :,s P: Bene#its ; =!!&!!!@4.!- Q =!!&!!!@4.!-2 Q =!!&!!!@4.!-6 Q =!!&!!!@4.!-8 Q =!!&!!!@4.!-7 Pro%ect :,s P: Bene#its ; . 2&!!!&!!! Q 77!&87?.'2 Q 7!7&!!?.!! Q 8=6&664.!- Q 827&!77.46 Q 6?-&-7?.?6 ; 2&666&'-!.'' Pro%ect :,s P: Costs ; 2&7!!&!!! Pro%ect :,s P* ; 2&666&'-!.'' @ 2&7!!&!!! ; !.-667 and re%ect pro%ect. Pro%ect 3,s P: Bene#its ; 4&!!!&!!!@4.47 Q ?!!&!!!@4.472 Q =!!&!!!@4.476 Q 8!!&!!!@4.478 Q 2!!&!!!@4.477 Pro%ect 3,s P: Bene#its ; ?=-&7=7.22 Q =!8&-48.-6 Q 6-8&7!-.'8 Q 22?&'!4.6! Q --&867.68 ; 2&4-'&42=.76 Pro%ect 3,s P: Costs ; 2&8!!&!!! Pro%ect 3,s P* ; 2&4-'&42=.76 @ 2&8!!&!!! ; !.-477 and re%ect pro%ect.

Pro%ect Z,s P: Bene#its; . 2&!!!&!!! Q 6!!&!!!@4.22 Q 7!!&!!!@4.222 Q '!!&!!!@4.226 Q -!!&!!!@4.228 Q 4&4!!&!!!@4.227 Pro%ect Z,s P: Bene#its; . 2&!!!&!!! Q 287&-!4.=8 Q 667&-64.2! Q 6?7&8-8.?2 Q 8!=&27-.4? Q 8!=&---.4? ; 4&'?!&7?=.!2 Pro%ect Z,s P: Cost ; 4&'7!&!!! Pro%ect Z,s P* ; 4&'?!&7?=.!2 @ 4&'7!&!!! ; 4.!4'7 and accept pro%ect.

19. !P" Pro&i#e o& a Pro(ect / Fiven the #ollowing cash #lows o# Pro%ect H.2& draw
the 9P: pro#ile. 2int use a discount rate o# (ero #or one intercept <$.axis> and solve #or the *CC #or the other intercept <x.axis>. Cash #lows: Oear ! ; . 27!&!!! Oear 4 ; 87&!!! Oear 2 ; '7&!!! Oear 6 ; 447&!!! Oear 8 ; 467&!!! 9P: <discount rate ; !> ; . 27!&!!! Q 87&!!! Q '7&!!! Q 447&!!! Q 467&!!! ; 42!&!!! <$.axis intercept> 9P: <discount rate ; 7A> ; . 27!&!!! Q 87&!!!@4.!7 Q '7&!!!@4.!72 Q 447&!!!@4.!76 Q 467&!!!@4.!78 ; '4&2-!.74 9P: <discount rate ; 4!A> ; . 27!&!!! Q 87&!!!@4.4! Q '7&!!!@4.4!2 Q 447&!!!@4.4!6 Q 467&!!!@4.4!8 ; 64&7!!.7? 9P: <discount rate ; 47A> ; . 27!&!!! Q 87&!!!@4.47 Q '7&!!!@4.472 Q 447&!!!@4.476 Q 467&!!!@4.478 ; . 4&67'.'8

9P: <discount rate ; 2!A> ; . 27!&!!! Q 87&!!!@4.2! Q '7&!!!@4.2!2 Q 447&!!!@4.2!6 Q 467&!!!@4.2!8 ; . 2?&'=4.7' *CC ; 48.''A

9P: Dollars 42!&!!! -!&!!! =!&!!! 6!&!!! ! . 6!&!!! 7A 4!A Discount Cates 47A 2!A 9P: Pro#ile O# Pro%ect H.2

Chapter 1)
4. Fro* the ba#a ce sheet accou ts #isted be#o+: a.list all the working capital accounts& b. #ind the net working capital #or the $ears ending 2!!6 and 2!!8& and

c.calculate the change in net working capital #or the $ear 2!!8. Balance Sheet Accounts o# Comula Corporation Account Accumulated Depreciation Accounts Pa$able Accounts Ceceivable Balance 42@64@2!!6 2&!2! 4&?!! 2&8?! Balance 42@64@2!!8 2&='! 2&!=! 2&=-!

Cash Common Stock *nventor$ Hong."erm Debt Plant& Propert$ [ E)uipment Cetained Earnings Solution:

4&6!! 8&--! 7&?!! '&?!! ?&8!! 4&6'!

4&!-! 8&--! =&!6! ?&2!! -&2!! 4&!-!

a. "he 3orking Capital Accounts are: Cash& Accounts Ceceivable& *nventor$& and Accounts Pa$able b. "he 9et 3orking Capital #or 2!!6 and 2!!8: 9et 3orking Capital ; Cash Q Accounts Ceceivable Q *nventor$ / Accounts Pa$able 2!!6 9et 3orking Capital ; 4&6!! Q 2&8?! Q 7&?!! . 4&?!! ; '&'?! 2!!8 9et 3orking Capital ; 4&!-! Q 2&=-! Q =&!6! . 2&!=! ; '&'7!

c. "he Change in 9et 3orking Capital #or 2!!8 is& '&'7! . '&'?! ; . 6! or a decrease in 9et 3orking Capital o# 6!. d. 3. Fi d the operati , cash &#o+ &or the year &or Space#y Sprockets i# the$ had sales revenue o# 6!!&!!!&!!!& cost o# goods sold o# 48!&!!!&!!!& sales and administrative costs o# 8!&!!!&!!!& depreciation expense o# =7&!!!&!!! and a tax rate o# 8!A. Solution: Esing income statement #ormat we have& Sales 6!!&!!!&!!!

COFS SF[A Depreciation EB*" "axes <\ 8!A> 9et *ncome

48!&!!!&!!! 8!&!!!&!!! =7&!!!&!!! 77&!!!&!!! 22&!!!&!!! 66&!!!&!!!

Operating Cash +low ; EB*" Q Depreciation / "axes Operating Cash +low ; 77&!!!&!!! Q =7&!!!&!!! . 22&!!!&!!! ; -?&!!!&!!! For prob#e*s ' throu,h 1) use the data &ro* the &o##o+i , &i a cia# state*e ts: Partial *ncome Statement Oear Ending 2!!8 Sales Cevenue COFS +ixed Costs SF[A Expenses Depreciation 67!&!!! 48!&!!! 86&!!! 2?&!!! 8=&!!!

Partial Balance Sheet 42@64@2!!6 Assets: Cash Accounts Cec. *nventories +ixed Assets Acc. Depreciation 4=&!!! 2?&!!! 8?&!!! 6=?&!!! 482&!!! Hiabilities: 9otes Pa$able Accounts Pa$able Hong."erm Debt Owner,s E)uit$ Cetained Earnings 5555555 48&!!! 4-&!!! 4-!&!!!

*ntangible Assets

?2&!!!

Common Stock

46!&!!!

Partial Balance Sheet 42@64@2!!8 Assets: Cash Accounts Cec. *nventories +ixed Assets Acc. Depreciation *ntangible Assets 2=&!!! 4-&!!! 76&!!! 88?&!!! 5555555 ?2&!!! Hiabilities: 9otes Pa$able Accounts Pa$able Hong."erm Debt Owner,s E)uit$ Cetained Earnings Common Stock 555555 4?!&!!! 42&!!! 28&!!! 4=2&!!!

'. Co*p#ete the partia# i co*e state*e t and balance sheet i# the compan$ paid interest expense o# 4?&!!! #or 2!!8& dividends o# 6!&!!! and had an overall tax rate o# 8!A #or 2!!8. Solution: *ncome Statement #or the Oear Ending 42@46@2!!8 Sales Cevenue COFS +ixed Costs SF[A Expenses Depreciation EB*" *nterest Expense "axable *ncome 67!&!!! 48!&!!! 86&!!! 2?&!!! 8=&!!! -6&!!! 4?&!!! '7&!!!

"axes \ 8!A 9et *ncome

6!&!!! 87&!!!

And with a Dividend pa$ment o# 6!&!!! the remainder o# 9et *ncome goes to Cetained Earnings& 47&!!!. "o complete the balance sheet add up all the asset accounts and subtract o## the accumulated depreciation <contra asset account> #or a total o# 8!!&!!!. 9ow balance the balance sheet b$ determining the total liabilities and owner,s e)uit$ accounts < 676&!!!> and #illing in the di##erence between this total and total assets as the balance in Cetained Earnings& 8'&!!!. Balance Sheet 42@64@2!!6 Assets: Cash Accounts Cec. *nventories +ixed Assets Acc. Depreciation *ntangible Assets "otal Assets 4=&!!! 2?&!!! 8?&!!! 6=?&!!! 482&!!! ?2&!!! 8!!&!!! Hiabilities: 9otes Pa$able Accounts Pa$able Hong."erm Debt Owner,s E)uit$ Cetained Earnings Common Stock "otal Hiab. [ OE 8'&!!! 46!&!!! 8!!&!!! 48&!!! 4-&!!! 4-!&!!!

Do the same #or the $ear 2!!8 but now we must #irst #ind accumulated depreciation total. "he prior $ear was 482&!!! and the current $ear,s depreciation #rom the income statement is 8=&!!! so the accumulated depreciation #or 2!!8 is 4??&!!!. Also& Cetained Earnings went up b$ 9et *ncome minus dividends paid out so we have an increase o# 47&!!! < 87&!!! . 6!&!!!>. Balance Sheet 42@64@2!!8

Assets: Cash Accounts Cec. *nventories +ixed Assets Acc. Depreciation *ntangible Assets "otal Assets 2=&!!! 4-&!!! 76&!!! 88?&!!! 4??&!!! ?2&!!! 88!&!!!

Hiabilities: 9otes Pa$able Accounts Pa$able Hong."erm Debt Owner,s E)uit$ Cetained Earnings Common Stock "otal Hiab. [ O.E. =2&!!! 4?!&!!! 88!&!!! 42&!!! 28&!!! 4=2&!!!

-.Fi d the Cash F#o+ &ro* .ssets &or /))0 and break down into it its three parts& Operating Cash +low& Change in 9et 3orking Capital& and Capital Spending. Solution: +ind the three parts that make up Cash +low #rom Assets& Operating Cash +low& Change in 9et 3orking Capital and Capital Spending. Operating Cash +low is EB*" / "axes Q Depreciation so& OC+ ; -6&!!! . 6!&!!! Q 8=&!!! ; 4!-&!!! Change in 9et 3orking Capital is 2!!8 93C / 2!!6 93C 2!!6 9et 3orking Capital is Current Assets minus Current Hiabilities 2!!6 93C ; 4=&!!! Q 4?&!!! Q 8?&!!! . 48&!!! . 4-&!!! ; 7-&!!! 2!!8 93C ; 2=&!!! Q 4-&!!! Q 76&!!! . 42&!!! . 28&!!! ; =2&!!! Change in 93C ; =2&!!! . 7-&!!! ; 6&!!!

Capital spending #or 2!!8 is the Change in 9et +ixed Assets <+ixed Assets minus Depreciation> plus 2!!8 Depreciation Expense. 9ote there is no change in *ntangible Assets so we need onl$ +ixed Assets and Accumulated Depreciation. Capital Spending ; < 88?&!!! . 4??&!!!> / < 6=?&!!! . 482&!!!> Q 8=&!!! ; ?!&!!! And Cash +low #rom Assets is: C+ #rom Assets ; OC+ . *ncrease in 93C . *ncrease in Capital Spending C+ #rom Assets ; 4!-&!!! . 6&!!! . ?!&!!! ; 2=&!!! 7. Fi d the Cash F#o+ to Creditors &or /))0 b$ parts and total with the parts *nterest *ncome Paid and *ncreases in Borrowing. Solution: +irst the *nterest Paid to Creditors comes #rom the income statement and is 4?&!!! #or the $ear. Second& the change in Hong."erm Debt re#lects an increase or decrease in cash #lows to creditors. 2ere we have a decrease #rom 2!!6 to 2!!8 re#lecting a reduction or retirement o# debt& a cash #low to creditors: Decrease in Hong."erm Debt 2!!8 ; 4-!&!!! / 4=2&!!! ; 2?&!!! Cash +low to Creditors #or 2!!8 ; 4?&!!! Q 2?&!!! ; 8=&!!!

8. Fi d the Cash F#o+ to 1+ ers &or /))0 b$ parts and total with the parts being Dividends Paid and *ncrease in Borrowing. Solution:

Dividends Paid #or 2!!8 were 6!&!!! and the Common Stock account changed #rom 46!&!!! in 2!!6 to 4?!&!!! in 2!!8 #or an increase o# 7!&!!! so we have the #ollowing Cash +low to Owners: 2!!8 C+ to Owners ; 6!&!!! . 7!&!!! ; . 2!&!!! 9. "eri&y the Cash F#o+ $de tity& Cash +low #rom Assets ] Cash +low to Creditors Q Cash +low to Owners Solution: 2=&!!! ] 8=&!!! . 2!&!!!

1). Produce the Sources a d 2ses o& Cash 3State*e t o& Cash F#o+s4 &or the year /))0. Solution: Esing the in#ormation #rom )uestions 7 through - and noting that this Sources and Eses o# Cash ties out to the change in the cash balance #or the $ear& we have a target o# 4!&!!! increase in cash or source #or 2!!8. Sources and Eses o# Cash 2!!8 Sources and <Eses>: Operating Activities Operating Cash +lows Decrease in Current Assets <ex.Cash> *ncrease in Current Hiabilities Sources and <Eses>: *nvesting Activities Capital Spending Sources and <Eses>: +inancing Activities < ?!&!!!> 4!-&!!! 8&!!! 6&!!!

*nterest Expense Dividends Decrease in Hong."erm Debt *ncrease in Common Stock 9et Sources and <Eses> o# Cash

< < <

4?&!!!> 6!&!!!> 2?&!!!> 7!&!!! 4!&!!!

11. 5rosio Costs / +at "ire Bic$cle Compan$ currentl$ sells 8!&!!! bic$cles per $ear. "he current bike is a standard balloon tire bike& selling #or -!.!! with a production and shipping cost o# 67.!!. "he compan$ is thinking o# introducing an o##.road bike with a pro%ected selling price o# 84! and a production and shipping cost o# 6=!. "he pro%ected market is #or 42&!!! bikes in annual sales. 2owever& the$ will loose sales in the #at tire bikes o# ?&!!! per $ear i# the$ introduce the new bike. 3hat is the erosion cost #rom the new bike5 Should the$ start producing the o##.road bike5 Solution: Erosion Cost ; < -! . 67> x ?&!!! ; 72!&!!! 9et Annual Cash +low with one bike: < -! . 67> x 8!&!!! ; 2&=!!&!!! 9et Annual Cash +low with two bikes: < -! . 67> x <8!&!!! . ?&!!!> ; 2&!?!&!!! < 84! . 6=!> x 42&!!! ; =!!&!!! 9et Annual C+ ; 2&!?!&!!! Q =!!&!!! ; 2&=?!&!!! *ncrease o# ?!&!!! per $ear so add new o##.road bike to production.

1'. Depreciatio 5xpe se /Brock +lorist Compan$ bu$s a new deliver$ truck #or 2-&!!!. *t is classi#ied as a light dut$ truck. d. Calculate the depreciation schedule using a #ive $ear li#e and straight line depreciation and the hal# $ear convention #or the #irst and last $ear. e. Calculate the depreciation schedule using a #ive $ear li#e and KACCS depreciation. #. Compare the depreciation schedules #rom parts a and b be#ore and a#ter taxes with a 6!A tax rate #or Brock +lorists. 3hat do $ou notice about the di##erence in these two methods5 Solution a. Annual depreciation is cost o# truck divided b$ #iveU 2-&!!!@ 7 ; 7&?!! And #or the #irst and last $ear we have 7&?!! @ 2 ; 2&-!!. b. Depreciation schedule using KACCSU Oear One Depreciation ; 2-&!!! x !.2!!! ; 7&?!! Oear "wo Depreciation ; 2-&!!! x !.62!! ; -&2?! Oear "hree Depreciation ; 2-&!!! x !.4-2! ; 7&7=? Oear +our Depreciation ; 2-&!!! x !.4472 ; 6&68!.?! Oear +ive Depreciation ; 2-&!!! x !.4472 ; 6&68!.?! Oear Six Depreciation ; 2-&!!! x !.!7'= ; 4&='!.8! c. Comparing the two depreciation schedules be#ore and a#ter taxes <at 6!A>: Oear One "wo "hree +our +ive Straight Hine 2&-!! 7&?!! 7&?!! 7&?!! 7&?!! KACCS 7&?!! -&2?! 7&7=? 6&68!.?! 6&68!.?! ^ Be#ore "ax 2&-!! 6&8?! . 262 . 2&87-.2! . 2&87-.2! ^ A#ter "ax ?'! 4&!88 . =-.=! . '6'.'= . '6'.'=

Six "otal

2&-!! 2-&!!!

4&='!.8! 2-&!!!

. 4&22-.=! !

. 6=?.?? !

"he di##erence is that the KACCS moves up the tax shield to the earl$ $ears o# depreciation $et the total tax shield is the same under both depreciation schedules.

19. Pro(ect Cash F#o+s 6 !P" / "he managers o# Classic Autos *ncorporated plan to manu#acture classic ".Birds <4-7' replicas>. "he necessar$ #oundr$ e)uipment will cost a total o# 8&!!!&!!! and will be depreciated using a #ive.$ear KACCS li#e. Pro%ected sales in annual units #or the next #ive $ears are 3)) per year. *# sales price is 2'&!!! per car& variable costs are 4?&!!! per car& and #ixed costs are 4&2!!&!!! annuall$& what are the annual operating cash #lows i# the tax rate is 3)75 "he e)uipment is sold #or salvage #or 7!!&!!! at the end o# $ear #ive. 3hat is the a#ter tax cash #lows o# the salvage5 9et working capital increases b$ =!!&!!! at the beginning o# the pro%ect <Oear !> and is reduced back to its original level in the #inal $ear. 3hat is the incremental cash #lows o# the pro%ect5 Esing a discount rate o# 42A #or the pro%ect& should the pro%ect be accepted or re%ected with the 9P: decision model5

Solution Annual depreciation o# #oundr$ e)uipment is: Oear One& 8&!!!&!!! x !.2! ; ?!!&!!! Oear "wo& 8&!!!&!!! x !.62 ; 4&2?!&!!! Oear "hree& 8&!!!&!!! x !.4-2 ; '=?&!!!

Oear +our& 8&!!!&!!! x !.4472 ; 8=!&?!! Oear +ive& 8&!!!&!!! x !.4472 ; 8=!&?!! Operating Cash +lows are: Annual Sales& 6!! x 2'&!!! ; ?&4!!&!!! Annual COFS& 6!! x 4?&!!! ; 7&8!!&!!! *n thousands <rounded> Oear 4 Sales Cevenue . COFS . +ixed Costs . Depreciation EB*" . "axes 9et *ncome Q Depreciation Operating Cash +lows ?&4!! 7&8!! 4&2!! ?!! '!! 24! 8-! ?!! 4&2-! Oear 2 ?&4!! 7&8!! 4&2!! 4&2?! 22! == 478 4&2?! 4&868 Oear 6 ?&4!! 7&8!! 4&2!! '=? '62 22! 742 '=? 4&2?! Oear 8 ?&4!! 7&8!! 4&2!! 8=4 4&!6642 '2' 8=4 4&4?? Oear 7 ?&4!! 7&8!! 4&2!! 8=4 4&!6642 '2' 8=4 4&4??

"he e)uipment is sold #or salvage #or 7!!&!!! at the end o# $ear #ive. *t has a book value o# 8&!!!&!!! . ?!!&!!! . 4&2?!&!!! . '=?&!!! . 8=!&?!! . 8=!&?!! ; 26!&8!! Fain on Sale is 7!!&!!! . 26!&8!! ; 2=-&=!! "ax on Fain is 2=-&=!! x !.6! ; ?!&??! And a#ter.tax cash #low on disposal is 7!!&!!! . ?!&??! ; 84-&42!. *ncremental Cash +lows #or Pro%ect <Answer in "housands& !!!> Account@Activit$ *nvestment 93C OC+ Salvage :alue Oear ! Oear 4 . 8&!!! . =!! 4&2-! 4&868 4&2?! 4&44? Oear 2 Oear 6 Oear 8 Oear 7 =!! 4&44? 84-

"otal Cash +lows <*ncremental>

. 8&=!!

4&2-!

4&868

4&2?!

4&44?

2&46'

9P: \ 42A ; . 8&=!! Q 4&2-!@4.42 Q 4&868@4.422 Q 4&2?!@4.426 Q 4&44?@4.428 Q 2&46'@4.427 ; . 8&=!! Q 4&284 Q 4&4-- Q -44 Q '44 Q 4&246 ; 72Accept the pro%ect because 9P: is positive 72-&2!- <without an$ rounding>.

Chapter 11
1. 8.CC / Eric Cartman has another get rich )uick idea but needs #unding to support the idea. Eric will borrow 2&!!! #rom his mom and she will charge Eric =A on the loan. Eric will borrow 4&7!! #rom Che# and he will charge ?A on the loan. Eric will borrow ?!! #rom Kr. Farrison and he will charge Eric 48A on the loan. 3hat is the weighted average cost o# capital #or Eric5 Solution: "otal #unds borrowed ; 2&!!! Q 4&7!! Q ?!! ; 8&6!! 3ACC ; < 2&!!! @ 8&6!!> x !.!= Q < 4&7!! @ 8&6!!> x !.!? Q < ?!! @ 8&6!!> x !.48 3ACC ; !.8=74 x !.!= Q !.68?? x !.!? Q !.4?=! x !.48 3ACC ; !.!2'- Q !.!2'- Q !.!2=! ; !.!?4- or ?.4-A

'. Cost o& Debt +ith Fees .. Tenn$ Enterprises will issue the same debt in problem Y6 but now will use an investment banker that charges 27 per bond #or their services. 3hat is the new cost o# debt #or Tenn$ Enterprises at a market price o# -2!& 4!!!& and 4!?!5 Solution: A. *# the bond sells #or -2! and Tenn$ pa$s 27 per bond the net proceeds are ?-7

?-7 ; 4&!!! @ <4Q <O"K@2>>8! Q 8! x <4 / 4@<4 Q <O"K@2>>8!>@<O"K@2> And solving via a calculator we have: set P@O ; 2U C@O ;2 *9PE"S :ariables OE"PE" 8! 9 5 *@O -.47A .?-7 P: 8! PK" 4!!! +:

B. *# the bond sells #or 4!!! and Tenn$ pa$s 27 per bond the net proceeds are -'7 -'7 ; 4&!!! @ <4Q <O"K@2>>8! Q 8! x <4 / 4@<4 Q <O"K@2>>8!>@<O"K@2> And solving via a calculator we have: set P@O ; 2U C@O ;2 *9PE"S :ariables OE"PE" 8! 9 5 *@O ?.2=A .-'7 P: 8! PK" 4!!! +:

C. *# the bond sells #or 4!?! and Tenn$ pa$s 27 per bond the net proceeds are 4!77 4!77 ; 4&!!! @ <4Q <O"K@2>>8! Q 8! x <4 / 4@<4 Q <O"K@2>>8!>@<O"K@2> And solving via a calculator we have: set P@O ; 2U C@O ;2 *9PE"S :ariables OE"PE" 8! 9 5 *@O '.8'A .4!77 P: 8! PK" 4!!! +:

7. Cost o& 59uity: S;< / Stan is expanding his business and he will sell common stock #or the needed #unds. *# the current risk.#ree rate is 8A and the expected market return is 42A& what is the cost o# e)uit$ #or Stan i# the beta o# the stock is: A. !.'7 B. !.-!

C. 4.!7 D. 4.2! Solution: A. Esing the securit$ market line we have& E<ri> ; r# Q Wi <E<rm> / r#> Cost o# E)uit$ ; E<ri> ; !.!8 Q !.'7 <!.42 / !.!8> Cost o# E)uit$ ; !.!8 Q !.'7 <!.!?> ; !.!8 Q !.!= ; !.4! or 4!A B. Esing the securit$ market line we have& E<ri> ; r# Q Wi <E<rm> / r#> Cost o# E)uit$ ; E<ri> ; !.!8 Q !.-! <!.42 / !.!8> Cost o# E)uit$ ; !.!8 Q !.-! <!.!?> ; !.!8 Q !.!'2 ; !.442 or 44.2A C. Esing the securit$ market line we have& E<ri> ; r# Q Wi <E<rm> / r#> Cost o# E)uit$ ; E<ri> ; !.!8 Q 4.!7 <!.42 / !.!8> Cost o# E)uit$ ; !.!8 Q 4.!7 <!.!?> ; !.!8 Q !.!?8 ; !.428 or 42.8A D. Esing the securit$ market line we have& E<ri> ; r# Q Wi <E<rm> / r#> Cost o# E)uit$ ; E<ri> ; !.!8 Q 4.2! <!.42 / !.!8> Cost o# E)uit$ ; !.!8 Q 4.2! <!.!?> ; !.!8 Q !.!-= ; !.46= or 46.=A

9. Cost o& Pre&erred Stock / T$le is raising #unds #or his compan$ b$ selling pre#erred stock. "he pre#erred stock has a par value o# 4!! and a dividend rate o# =A. "he stock is selling #or ?! in the market. 3hat is the cost o# pre#erred stock #or T$le5 Solution:

"he dividend is 4!! x !.!= ; =.!! And with a price o# ?! the cost o# pre#erred stock is =@ ?! ; !.!'7 or '.7A

13. .d(usted 8.CC / Hewis runs an outdoor adventure compan$ and wants to know what impact a tax change will have on his 3ACC. Currentl$ Hewis has the #ollowing borrowing pattern: E)uit$ 67A and cost o# 48A Pre#erred Stock 47A and cost o# 44A Debt 7!A and cost o# 4!A be#ore taxes. 3hat is the ad%usted 3ACC #or Hewis i# the tax rate is a. 8!A b. 6!A c. 2!A d. 4!A e. !A5 Solution: a. Ad%usted 3ACC ; !.67 x 48A Q !.47 x 44A Q !.7! x 4!A x <4 / !.8!> ; Ad%usted 3ACC ; 8.-A Q 4.=7A Q 6.!A ; -.77A b. Ad%usted 3ACC ; !.67 x 48A Q !.47 x 44A Q !.7! x 4!A x <4 / !.6!> ; Ad%usted 3ACC ; 8.-A Q 4.=7A Q 6.7A ; 4!.!7A c. Ad%usted 3ACC ; !.67 x 48A Q !.47 x 44A Q !.7! x 4!A x <4 / !.2!> ; Ad%usted 3ACC ; 8.-A Q 4.=7A Q 8.!A ; 42.77A d. Ad%usted 3ACC ; !.67 x 48A Q !.47 x 44A Q !.7! x 4!A x <4 / !.4!> ; Ad%usted 3ACC ; 8.-A Q 4.=7A Q 8.7A ; 44.!7A

e. Ad%usted 3ACC ; !.67 x 48A Q !.47 x 44A Q !.7! x 4!A x <4 / !.!!> ; Ad%usted 3ACC ; 8.-A Q 4.=7A Q 7.!A ; 46.77A

1'. =eta o& a Pro(ect / Kagellan is adding a pro%ect to the compan$ port#olio and has the #ollowing in#ormation& the expected market return is 48A& the risk.#ree rate is 6A& and the expected return on the new pro%ect is 4?A. 3hat is the beta o# the pro%ect5 Solution: E<rpro%ect> ; 4?A ; 6A Q Wpro%ect x <48A . 6A> and Beta ; 4.6=6=

Chapter 1/
3. =e e&it o& =orro+i , / 3ilson Kotors is looking at expanding its operations b$ adding a second manu#acturing location. *# success#ul the compan$ will make 8!!&!!! but i# it #ails the compan$ will loose 27!&!!!. 3ilson Kotors has decided to borrow the 27!&!!! but the bank is charging 47A on the loan. Should 3ilson Kotors borrow the mone$ i# a. "he probabilit$ o# success is -!A5 b. "he probabilit$ o# success is ?!A5 c. "he probabilit$ o# success is '!A5 Solution: A. Ceturn on -!A success rate ; !.- x 8!!&!!! . 27!&!!! x 4.47 ; '2&7!!& so borrow the mone$. B. Ceturn on ?!A success rate ; !.? x 8!!&!!! . 27!&!!! x 4.47 ; 62&7!!& so borrow the mone$.

C. Ceturn on '!A success rate ; !.' x 8!!&!!! . 27!&!!! x 4.47 ; . '&7!!& So do not borrow the mone$. =. Pecki , 1rder >ypothesis / Cachel has the #ollowing places she can borrow: Source o# +unds Parents +riends Bank Hoan Credit Card *nterest Cate !A 7A -A 48.7A Borrowing Himit 4!&!!! 2&!!! 47&!!! 7&!!!

3hat is Cachel,s weighted average cost o# capital i# she needs to borrow a. b. c. Solution: a. #or 4!&!!! she would borrow all o# it #rom her parents and pa$ !A interest so her 3ACC is !. b. +or 2!&!!! she would borrow 4!&!!! #rom her parents& 2&!!! #rom her #riends and ?&!!! #rom the bank #or a 3ACC o#& 3ACC ; 4!&!!! @ 2!&!!! x !A Q 2&!!! @ 2!&!!! x 7A Q ?&!!! @ 2!&!!! x -A 3ACC ; !A Q .7A Q 6.=A ; 8.4A c. +or 6!&!!! she would borrow 4!&!!! #rom her parents& 2&!!! #rom her #riends& 47&!!! #rom the bank and 6&!!! against her credit card #or a 3ACC o#& 3ACC ; 4!&!!! @ 6!&!!! x !A Q 2&!!! @ 6!&!!! x 7A Q 47&!!! @ 6!&!!! x -A Q 6&!!! @ 6!&!!! x 48.7A 4!&!!! 2!&!!! 6!&!!!

3ACC ; !A Q .666A Q 8.7A Q 4.87A ; =.2?6A 9. Fi di , 8.CC / Konica is the C+O o# Cooking 3orld and uses Pecking Order 2$pothesis <PO2> philosoph$ when she borrows #or compan$ pro%ects. Currentl$ the she can borrow up to 8!!&!!! #rom her bank at a rate o# ?.7A& #loat a bond #or '7!&!!! at a rate o# -.27A& or issue additional stock #or 4&6!!&!!! at a cost o# 4'A. 3hat is the 3ACC #or Cooking 3orld i# Konica chooses to invest a. b. c. 4&!!!&!!! in new pro%ects 2&!!!&!!! in new pro%ects 6&!!!&!!! in new pro%ects5

Solution: a. 3ACC i# she borrows 4&!!!&!!! is 3ACC ; !.8 x ?.7A Q !.= x -.27A ; 6.8!A Q 7.77A ; ?.-7A b. 3ACC i# she borrows 2&!!!&!!! is 3ACC ; !.2 x ?.7A Q !.6'7 x -.27A Q !.827 x 4'A 3ACC ; 4.'!!!A Q 6.8=??A Q '.227!A ; 42.6-6?A c. She can not borrow 6&!!!&!!! her maximum borrowing is 2&87!&!!!. 3ACC at 2&87!&!!! is& 3ACC ; !.4=66 x ?.7A Q !.6!=4 x -.27A Q !.76!= x 4'A 3ACC ; 4.6?'?A Q 2.?64=A Q -.!2!8A ; 46.26-?A 11. ;6;? 8or#d o& !o Taxes / Air America is looking at changing its capital structure #rom an all e)uit$ #irm to a leveraged #irm with 7!A debt and 7!A e)uit$ #irm. Air America is a not #or pro#it compan$ and there#ore pa$s no taxes. *# the re)uired rate

on the assets o# Air America is 2!A <CA>& what is the current re)uired cost o# e)uit$ and what is the new re)uired cost o# e)uit$ i# the cost o# debt is 4!A5 Solution: CE ; CA Q <CA / CD> x <D@E> All E)uit$ +irm: CE ; CA Q <CA / CD> x <D@E>& where D ; ! All E)uit$ +irm: CE ; 2!A Q <2!A . 4!A> x !@4 ; 2!A 9ew Heveraged +irm at 7!.7! Debt to E)uit$ CE ; 2!A Q <2!A . 4!A> x 4@4 ; 6!A

Chapter 13
Problems and Solutions 4. Business Operating C$cle / Tolman Tampers has a production c$cle o# 67 da$s& an collection c$cle o# 24 da$s& and pa$ment c$cle o# 48 da$s. 3hat is Tolman,s business operating c$cle and cash conversion c$cle5 *# Tolman reduces the production c$cle b$ one week what is the impact on the cash conversion c$cle5 *# Tolman decreases the collection c$cle b$ one week what is the impact on the cash conversion c$cle5 *# Tolman increases the pa$ment c$cle b$ one week what is the impact on the cash conversion c$cle5 Solution: Business C$cle ; Production C$cle Q Collection C$cle Business C$cle ; 67 Da$s Q 24 Da$s ; 7= Da$s Cash Conversion C$cle ; Business C$cle / Pa$ment C$cle Cash Conversion C$cle ; 7= Da$s / 48 Da$s ; 82 Da$s

Ceducing Production C$cle b$ one week <' da$s> reduces cash conversion c$cle b$ one week <' Da$s> to 67 da$s. Ceducing Collection C$cle b$ one week <' da$s> reduces cash conversion c$cle b$ one week <' Da$s> to 67 da$s. *ncreasing Pa$ment b$ one week <' da$s> reduces cash conversion c$cle b$ one week <' Da$s> to 67 da$s.

2. Business Operation C$cle / Stewart and Compan$ currentl$ has a production c$cle o# 8! da$s& a collection c$cle o# 2! da$s& and a pa$ment c$cle o# 47 da$s. 3hat Stewart,s current business operating c$cle and cash conversion c$cle5 *# Stewart and Compan$ wants to reduce its cash conversion c$cle to 67 da$s what action can Stewart take5 Solution Business C$cle ; Production C$cle Q Collection C$cle Business C$cle ; 8! Da$s Q 2! Da$s ; =! Da$s Cash Conversion C$cle ; Business C$cle / Pa$ment C$cle Cash Conversion C$cle ; =! Da$s / 47 Da$s ; 87 Da$s Options on reducing the cash conversion c$cle to 67 da$s: 4> reduce production c$cle b$ 4! da$s 2> reduce collection c$cle b$ 4! da$s 6> increase pa$ment c$cle b$ 4! da$s 8> combination o# reductions to production c$cle and collection c$cle and increase o# pa$ment c$cle totaling 4! da$s.

Ese the #ollowing account in#ormation #or problems 6 through ?. 2!!6 Selected *ncome Statement *tems #or Cian Compan$ Cash Sales Credit Sales "O"AH SAHES COFS 2-?&!!! ='2&!!! -'!&!!! 7'!&!!!

2!!6 Selected Balance Sheet Accounts o# Cian Compan$ 42@64@!6 Accounts Ceceivable *nventor$ Accounts Pa$able 6?&!!! 77&!!! 2'&!!! 42@64@!2 8=&!!! 7-&!!! 27&!!! Change ?&!!! 8&!!! 2&!!!

6. Average Production C$cle / +ind the average production c$cle #or Cian Co. Solution Average *nventor$ ; <Beginning *nventor$ Q Ending *nventor$> @ 2 Average *nventor$ #or Corporate Seasonings ; < 77&!!! Q 7-&!!!> @ 2 ; 7'&!!! "he second step is to determine how )uickl$ we turn over the inventor$. "o do this& we take the cost o# goods sold #or the $ear& COFS& and divide b$ the average inventor$: *nventor$ "urnover ; COFS @ Average *nventor$ *nventor$ "urnover #or Corporate Seasonings ; 7'!&!!! @ 7'&!!! ; 4! times Average Production C$cle ; Da$s in Oear @ *nventor$ "urnover

Average Production C$cle ; 6=7@4! ; 6=.7 Da$s 8. Average Production C$cle / +or the coming $ear Cian Co. wants to reduce its average production c$cle b$ =.7 da$s to 6! da$s. *# the target ending inventor$ #or 2!!8 is =4&!!! what COFS will the compan$ need to reach their goal5 Solution 3orking backwards through the e)uations #or average production c$cle we have& Average Production C$cle ; 6=7@ x ; 6! Da$s where x is the inventor$ turnover. Z ; 42.4==' Average *nventor$ ; 42.4==' ; COFS @ I< 7-&!!! Q =4&!!!>@2J COFS ; 42.4==' x =!&!!! ; '6!&!!! 7. Average Collection C$cle / 3hat is the average collection c$cle #or Cian Co.5 Solution Average Accounts Ceceivable ; <Beginning A@C Q Ending A@C> @ 2 Average A@C #or Corporate Seasonings ; < 6?&!!! Q 8=&!!!> @ 2 ; 82&!!! Step two is to determine the Accounts Ceceivable turnover rate: Accounts Ceceivable "urnover Cate ; Credit Sales @ Average Accounts Ceceivable A@C "urnover #or Corporate Seasonings ; ='2&!!! @ 82&!!! ; 4= times "he third and #inal step is to estimate the collection c$cle b$ dividing the number o# da$s in a $ear b$ the Accounts Ceceivable turnover rate: Collection C$cle ; 6=7 @ Accounts Ceceivable "urnover Cate Cian,s Collection C$cle ; 6=7 @ 4= ; 22.?427 Da$s

=. Average Collection C$cle / Cian Compan$ had a target o# 2! Da$s #or collection c$cle #or the $ear 2!!6. *# total sales had remained at -'!&!!! how much o# the sales revenue would have needed to be cash sales #or Cian to meet the collection goal5 Solution 3orking backwards to #ind credit sales we have& Collection C$cle ; 2! Da$s ; 6=7 @ Average Ceceivable "urnover Average Ceceivable "urnover ; 6=7 @ 2! Da$s ; 4?.27 Da$s Average Ceceivable "urnover ; 4?.27 Da$s ; Credit Sales @ 82&!!! Credit Sales ; 82&!!! x 4?.27 ; '==&7!! Cash Sales ; "otal Sales / Credit Sales ; -'!&!!! . '==&7!! ; 2!6&7!!

'. Average Accounts Pa$able C$cle / Calculate Cian Co. average accounts pa$able c$cle. Solution Average Accounts Pa$able ; <Beginning o# the $ear A@P Q End o# Oear A@P> @ 2 Average A@P ; < 2'&!!! Q 27&!!!> @ 2 ; 2=&!!! "he second step is to determine the Accounts Pa$able "urnover and here we use the COFS as the cost o# production. Accounts Pa$able "urnover ; COFS @ Average A@P Cian,s A@P "urnover ; 7'!&!!! @ 2=&!!! ; 24.-264 times "he third and #inal step is to determine the number o# da$s that Corporate Seasonings takes to pa$ its suppliers:

Accounts Pa$able C$cle ; 6=7 @ Accounts Pa$able "urnover Cian,s A@P C$cle ; 6=7 @ 24.-264 ; 4=.=8-4 da$s

?. Average Accounts Pa$able C$cle / Cian Co. had a target o# 47 da$s #or pa$ment <accounts pa$able> c$cle. 3hat would the ending balance in the accounts pa$able account needed to be to reach this target holding all other accounts the same5 Solution 3orking backwards we have& Cian,s A@P c$cle ; 47 da$s ; 6=7 @ Accounts Pa$able "urnover Accounts Pa$able "urnover ; 6=7 @ 47 da$s ; 28.6666 da$s Accounts Pa$able "urnover ; 28.6666 da$s ; 7'!&!!! @ Average Accounts Pa$able Average Accounts Pa$able ; 7'!&!!! @ 28.6666 ; 26&828.== Average Accounts Pa$able ; 26&828.== ; I 2'&!!! Q Ending A@PJ @ 2 Ending A@P ; 26&828.== x 2 . 2'.!!! ; 4-&?8-.62

-. Cash +low o# Accounts Ceceivable / K$ers and Associates& a #amous law o##ice in Southern Cali#ornia bills it clients on the #irst o# each month. 2owever clients pa$ in the #ollowing #ashionU 8!A pa$ at the end o# the #irst month& 6!A pa$ at the end o# the second month& 2!A pa$ at the end o# the third month& 7A pa$ at the end o# the #ourth month and 7A de#ault on their bills. K$ers wants to know the anticipated cash #lows #or the #irst )uarter o# 2!!8 i# the past billings and anticipated billings #ollow this same pattern. +ourth Ruarter Actual Billings +irst Ruarter Anticipated Billings

Oct @39/?)))

9ov 626&!!!

Dec 2-=&!!!

Gan 68!&!! !

+eb 6=!&!!!

Kar 8!?&!!!

Solution End o# Ganuar$ Anticipated Cash +low #rom Billings ; 7A o# Oct Q 2!A o# 9ov Q 6!A o# Dec Q 8!A o# Gan ; !.!7 x 6-2&!!! Q !.2! x 626&!!! Q !.6! x 2-=&!!! Q !.8! x 68!&!!! ; 4-&=!! Q =8&=!! Q ??&?!! Q 46=&!!! ; 6!-&!!! End o# +ebruar$ Anticipated Cash +low #rom Billings ; 7A o# 9ov Q 2!A o# Dec Q 6!A o# Gan Q 8!A o# +eb ; !.!7 x 626&!!! Q !.2! x 2-=&!!! Q !.6! x 68!&!!! Q !.8! x 6=!&!!! ; 4=&47! Q 7-&2!! Q 4!2&!!! Q 488&!!! ; 624&67! End o# Karch Anticipated Cash +lows 7A o# Dec Q 2!A o# Gan Q 6!A o# +eb Q 8!A o# Kar ; !.!7 x 2-=&!!! Q !.2! x 68!&!!! Q !.6! x 6=!&!!! Q !.8! x 8!?&!!! ; 48&?!! Q =?&!!! Q 4!?&!!! Q 4=6&2!! ; 678&!!!

4!. Ageing Accounts Ceceivable / "homas Bic$cles has the #ollowing outstanding account receivables at the close o# the month. "he monthl$ late #ee is 4A o# the outstanding balance at the end o# the billing month #ollowing the sale <+ebruar$ sales receive a late #ee in April i# not paid b$ Karch 64& 2!!8>. Determine the current amount due #or each bill and age the receivables. "oda$ is Ka$ 64& 2!!8. *nvoice Y !4.4487 !2.!6-! Billing Date !4.44.!8 !2.!6.!8 Customer D2H TPK Original 427.!! 647.!! Hate +ees Current Due

!2.44!4 !6.488? !6.4''6 !8.!-?7 !8.24!8 !8.22!4 !7.!=-? 05-1143 Solution:

!2.44.!8 !6.48.!8 !6.4'.!8 !8.!-.!8 !8.24.!8 !8.22.!8 !7.!=.!8 !7.44.!8

GBB FHC 39T EC9 DHB RS: GKF BKK

2!!.!! 67!.!! ?7!.!! 64!.!! 28!.!! 7=7.!! 8!!.!! '27.!!

Hate +ees are #or invoices #rom Ganuar$ #or three months <Karch& April& and Ka$>& +ebruar$ #or two months <April and Ka$>& and invoices #rom Karch #or one month <Ka$>. "he April and Ka$ bills are not $et late enough #or late #ees. Hate +ees per billU !4.4487 Hate +ee ; 427.!! x 4.!46 . 427.!! ; 2.74 !2.!6-! Hate +ee ; 647.!! x 4.!42 . 647.!! ; =.66 !2.44!4 Hate +ee ; 2!!.!! x 4.4!2 . 2!!.!! ; 8.!2 !6.488? Hate +ee ; 67!.!! x 4.4! . 67!.!! ; 6.7! !6.4''6 Hate +ee ; ?7!.!! x 4.4! . ?7!.!! ; ?.7!

*nvoice Y !4.4487 !2.!6-! !2.44!4 !6.488? !6.4''6 !8.!-?7 !8.24!8 !8.22!4 !7.!=-? 05-1143

Billing Date !4.44.!8 !2.!6.!8 !2.44.!8 !6.48.!8 !6.4'.!8 !8.!-.!8 !8.24.!8 !8.22.!8 !7.!=.!8 !7.44.!8

Customer D2H TPK GBB FHC 39T EC9 DHB RS: GKF BKK

Original 427.!! 647.!! 2!!.!! 67!.!! ?7!.!! 64!.!! 28!.!! 7=7.!! 8!!.!! '27.!!

Hate +ees 2.74 =.66 8.!2 6.7! ?.7! !.!! !.!! !.!! !.!! !.!!

Current Due 42'.74 624.66 2!8.!2 676.7! ?7?.7! 64!.!! 28!.!! 7=7.!! 8!!.!! '27.!!

"he ageing o# accounts receivable b$ period and total amount due:

!.6! da$s <Y!7.!=-? and Y!7.4486> 4&427.!! 64.=! da$s <Y!8.!-?7& Y!8.24!8& and Y!8. 22!4> 4&447.!! =4.-! da$s <Y!6.488? and Y!6.4''6> 4&242.!! -4.42! da$s <Y!2.!6-! and Y!2.44!4> 727.67 Over 42! da$s <Y!4.4487> 42'.74

46.

Credit Screening / +red and Barne$ manu#acture kid peddle cars. "he$ currentl$ have 8&!!! cash pa$ing customers and make a pro#it o# =! per car. +red and Barne$ want to expand their customer base b$ allowing customers to bu$ on credit. "he$ estimate a credit sales will bring in an additional 42!! customers per $ear but that the$ will also have a de#ault rate on credit sales o# 7A. *t costs 2=! to make a peddle car and the$ retail #or 62!. *# all customers <old and new> bu$ on credit& what is the cost o# bad debt without a credit screen5 3hat is the most +red and Barne$ would pa$ #or a credit screen that accuratel$ identi#ies bad debt customers prior to the sale5 3hat are the increased pro#its b$ adding credit sales #or customers with and without a credit screen5 Should +red and Barne$ o##er credit sales i# credit screen costs 4! per customer5 Solution Cost o# bad debt is !.!7 x <8&!!! Q 4&2!!> x 2=! ; ='&=!! Kaximum cost o# Credit Screen: Old Pro#its ; 8&!!! x =! ; 28!&!!! 28!&!!! ; 72!! x !.-7 x =! / 7&2!! x Cost o# Screen per Customer Cost per Customer ; < 2-=&8!! . 28!&!!!> @ 72!! ; 4!.?7

9ew Pro#its o# Credit Screen without ; 7&2!! x !.-7 x =! / !.!7 x 7&2!! x 2=! ; 2-=&8!! . ='&=!! ; 22?&?!! 9ew Pro#its with Credit Screen ; 7&2!! x !.-7 x =! . 72!! x 4! ; 2-=&8!! . 72&!!! ; 288&8!! +red and Barne$ should o##er credit sales i# with credit screen cost o# 4! per customer.

47. Credit "erms .. As the manager o# +l$.B$.9ight Airlines $ou decide to allow customers -! da$s to pa$ their bills. 2owever& to encourage earl$ pa$ment $ou allow customers to reduce their bill b$ 4.7A i# paid within the #irst 6! da$s. At what implied e##ective annual interest rate <EAC> are $ou loaning mone$ to $our customers5 3hat i# $ou extend the discount to =! da$s and allow #ull pa$ment up to 4?! da$s5 Solution: 2olding Period <=! Da$> Ceturn ; !.!47 @ !.-?7 ; !.!4726 or 4.726A 9ow what is !.4726A interest over =! da$s stated on an annual basis5 E##ective Annual Cate ; <4 Q !.!4726> 6=7@=! . 4 ; !.!-=6 or -.=6A 2olding Period <42! Da$> Ceturn ; !.!47 @ !.-?7 ; !.!4726 or 4.726A 9ow what is !.4726A interest over 42! da$s stated on an annual basis5 E##ective Annual Cate ; <4 Q !.!4726> 6=7@42! . 4 ; !.!8'! or 8.'!A

4'. Economic Order Ruantit$ .. Economic Order Ruantit$ .. "$ler,s "inkering "o$s believes he will sell 8&!!!&!!! Bean$ Babies this coming $ear <note this is annual

sales>. 2e plans on ordering Bean$ Babies 8! times over the next $ear. "he carr$ing cost is !.!6 per bab$ per $ear. "he order cost is =!! per order. 3hat is the annual carr$ing cost o# the Bean$ Babies inventor$5 3hat is the annual ordering cost o# the Bean$ Babies5 3hat is the optimal order )uantit$ #or the Bean$ Babies5 :eri#$ $our answer b$ calculating the new total inventor$ cost. Solution Annual Carr$ing Cost ; average inventor$ x cost per unit per $ear Average inventor$ ; <8&!!!&!!! @ 8!> @ 2 ; 7!&!!! Annual Carr$ing Cost ; 7!&!!! x !.!6 ; 4&7!! Annual Ordering Costs ; 8! x =!! ; 28&!!! EOR ; I2 x 8&!!!&!!! x =!! @ !.!6J4@2 ; 8!!&!!! 9ew Carr$ing Costs ; 8!!&!!! @ 2 x !.!6 ; =&!!! 9ew Ordering Costs ; 8&!!!&!!! @ 8!!&!!! x =!! ; =&!!! EOR o# 8!!&!!! is optimal order )uantit$ <carr$ing costs ; ordering costs>.

Chapter 10
4. "imeline o# Cash Dividend / "iger Kanu#acturing *ncorporated has the #ollowing press release: 0"iger Kanu#acturing will pa$ a )uarterl$ dividend o# !.7! per share to record holders as o# the 4!th o# this month on the 2!th o# this month.1 "his announcement was made on Gul$ 6& 2!!7. Draw a time line o# the dates around this dividend pa$ment assuming a two da$ settlement #or stock trading. Solution

"iger Kanu#acturing Dividend Dates

Gul 6& 2!!7 Declaration

Gul ?& 2!!7 Ex.Date

Gul 4!& 2!!7 Cecord Date

Gul 2!& 2!!7 Pa$ment Date

6. Stock Price around Dividend / Esing the in#ormation in problem number 4& what will the stock price o# "iger Kanu#acturing be a#ter the cash dividend announcement i# the current price is 8'.42 per share <assume the price does not change between Sept. 6rd and Oct. 2!th> and on what da$ does the price change5 3hat is the cost to a bu$er a#ter the announcement5 3hat is the sales revenue to a seller a#ter the announcement5 Solution: "he price will drop b$ the si(e o# the cash dividend on the morning #ollowing the ex.date. "he new price will be 8'.42 . !.7! ; 8=.=2. A new bu$er a#ter the announcement e##ectivel$ pa$s 8=.=2 #or the stock regardless o# the date o# the purchase. *# the bu$er ac)uires the stock be#ore the ex. date the bu$er pa$s 8'.42 but is entitled to the !.7! dividend so the net price is 8=.=2. A#ter the ex.date the bu$er pa$s 8=.=2 but is not entitled to the !.7! dividend. "he seller receives a net o# 8'.42 i# the sale takes place be#ore the ex.date directl$ #rom the new bu$er. *# the sale takes place a#ter the ex.date the seller receives

8=.=2 directl$ #rom the bu$er and the !.7! dividend #rom the compan$ #or a net o# 8'.42. 7. Dividend Pattern / Ce#er to "able 47.2 in the text <PepsiCo Dividend 2istor$> and predict the next dividend using a percent change& a dollar change pattern& and $our expectation given the pattern change. Solution Esing a percentage change we see the #ollowing changes each Gune: Gune 2!!4 Gune 2!!2 Gune 2!!6 < !.487@ !.48!> . 4 ; 6.7'A < !.47!@ !.487> . 4 ; 6.87A < !.4=!@ !.47!> . 4 ; =.='A

Average percent change is <6.7'A Q 6.87A Q =.='A> @6 ; 8.7=A& so next change would be 4.!87= x !.4= ; !.4='6 3ith a dollar <cent> change we have the #ollowing average& < !.!!7 Q !.!!7 Q !.!4> @ 6 ; !.!!==' so the next change would be !.4= Q !.!!=' ; !.4===' Gust looking at the pattern one would probabl$ guess either !.4=7 #or a hal#.cent increase or !.4' with a #ull one.cent increase.

2. Creating Own Dividend Polic$ / Kicke$ owns 2&!!!&!!! shares o# 3isne$ Entertainment. 3isne$ %ust declared a cash dividend o# !.!7 per share. "he stock is currentl$ selling #or 7.!!. *# Kicke$ wants an annual 0dividend income1 #rom his stock holdings o# 7!&!!!& 4!!&!!!& or 27!&!!! what must he do to get these levels o# income5 3hat is his wealth in paper and cash #or each level o# desired dividend income level5

Solution "he cash dividend he will receive i# he does nothing is !.!7 x 2&!!!&!!! ; 4!!&!!! so i# he wants this dividend income he %ust waits #or the check. 2is wealth a#ter the distribution is: Paper 2&!!!&!!! x < 7.!! . !.!7> ; -&-!!&!!! Cash 2&!!!&!!! x !.!7 ; 4!!&!!! "otal 3ealth is -&-!!&!!! Q 4!!&!!! ; 4!&!!!&!!! *# Kicke$ wants onl$ 7!&!!! then he must use hal# o# the cash dividend to bu$ back shares. Shares purchased ; 7!&!!! @ 8.-7 ; 4!&4!4. 2is wealth a#ter dividend distribution and share purchase is: Paper 2&!4!&4!4 x < 7.!! . !.!7> ; -&-7!&!!! Cash 2&!!!&!!! x !.!7 . 7!&!!! ; 4!!&!!! . 7!&!!! ; 7!&!!! "otal 3ealth is -&-7!&!!! Q 7!&!!! ; 4!&!!!&!!! *# Kicke$ wants 27!&!!! then he must sell some o# his shares a#ter the cash dividend. Dividend is 4!!&!!! and he needs 47!&!!! more. Shares sold ; 47!&!!! @ 8.-7 ; 6!&6!6. 2is wealth a#ter dividend distribution and share purchase is: Paper <2&!!!&!!! / 6!&6!6> x < 7.!! . !.!7> ; -&'7!&!!! Cash 2&!!!&!!! x !.!7 Q 6!&6!6 x 8.-7 ; 4!!&!!! Q 47!&!!! ; 27!&!!! "otal 3ealth is -&'7!&!!! Q 27!&!!! ; 4!&!!!&!!!

44. Change Dividend Polic$ in 3orld o# "axes / Hooking back a problem Y- with Benn$U now assume that Benn$ is taxed 2!A on dividend distribution and 2!A on capital gains. Assume also that Benn$ originall$ paid 4? #or these shares. *# Benn$ onl$ wants to receive 2!! a#ter tax& is his wealth impacted b$ changing this dividend polic$ #rom a high pa$out polic$ to a low pa$out polic$5 Solution *# Benn$ did not change the polic$ he would receive a cash dividend o# 7!! x 2.!! ; 4!!! and pa$ taxes o# 2!! #or a net cash #low o# ?!!. 2is wealth would be: Paper wealth 7!! x <4?.!! . 2.!! x <4 . !.2!>> ; 7!! x 4=.8! ; ?&2!! Cash wealth 4&!!! . 2!! ; ?!! "otal wealth a#ter cash dividend ?&2!! Q ?!! ; -&!!! *# Benn$ onl$ wants 2!! in cash he will use the extra =!! to bu$ more shares o# 3estern +orest at 4=.8! per share& or 6=.7?78 shares < =!!@ 4=.8!>. 2is wealth is now: Paper wealth 767.7?78 x 4=.8! ; ?&?!! Cash wealth ?!! . =!! ; 2!! "otal wealth ?&?!! Q 2!! ; -&!!!

4'. Stock Cepurchase Plan / 9orthern Cailroad has announced it will bu$ back 4&!!!&!!! o# its 6!&!!!&!!! shares over the next $ear. *# the stock is selling #or 26.8! what is the e)uivalent cash dividend that the compan$ could pa$5 *# $ou

owned 6!! shares o# stock& how man$ would $ou need to sell to get this cash e)uivalent dividend5 Solution "he 4&!!!&!!! shares will cost 9orthern Cailroad 26&8!!&!!! and the e)uivalent cash dividend per share is: 26&8!!&!!! @ 6!&!!!&!!! ; !.'? per share. *# $ou own 6!! shares $ou would have received 268.!! i# a cash dividend had been declared instead o# the repurchase. So to get 268 $ou would need to sell 268@ 26.8! ; 4! shares o# stock. Stock Cepurchase Plan / Southern Cailroad

Chapter 1'
-. Pro +orma +inancial Statements / Prepare Pro +orma *ncome Statements #or 3al.Kart and Starbucks using the 2!!8 in#ormation provided in problems ' and ?. 3hich compan$ is doing a better %ob o# getting sales dollars to net income5 3here is the one compan$ having an advantage over the other compan$ in turning revenue into net income5 Solution Account Sales COFS Depreciation SF[A EB*" *nterest "axes 9et *ncome 3al.Kart Gan. 64& 2!!8 Percent 27?&=?4 4!!.!!A 4-?&'8' '=.?6A ! !.!!A 88&-!4'.6=A 47&!27 7.?4A ?62 !.62A 7&464.--A -&!78 6.7!A Starbucks Sep. 6!& 2!!8 Percent 7&2-8 4!!A 2&4-? 84.72A 2!= 6.?-A 2&2== 82.?!A =28 44.'-A ! !.!!A 262 8.6?A 6-2 '.8!A

Starbuck brings '.8 cents o# sales revenue to the bottom line compared to 6.7 cents #or 3al.Kart. "he advantage Starbuck,s has over 3al.Kart is in the cost o# goods sold and selling& general& and administrative expenses. Starbuck,s is able to generate nearl$ 42 cents on the sales dollar at EB*" whereas 3al.Kart is about = cents per sales dollar at EB*". 3h$ Starbucks en%o$s this advantage is a )uestion that will take more #inancial and economic investigation into the operations o# the two companies and the industries in which the$ operate. 44.:ariance Anal$sis / Fiven the #ollowing budget and per#ormance in#ormation on Kicrobrew *ncorporated& provide the #ollowing variances to the budget& sales price variance& sales volume variance& production price variance& production volume variance& overhead price variance and overhead volume variance. :eri#$ the variances b$ using the #orecast EB*" and the actual EB*". Kicrobrew *ncorporated Kanagement Ceport Y4 Budget Sales Ruantit$ Price per gallon Sales Dollars Production costs <material and labor> COFS Overhead EB*" Solution 48&8!! 4&2!! kegs =7.!! per keg '?&!!! 8?.!! per keg =?&!=8 42&-?! 7&664 ?=&6'7 Actual 4&6?2 kegs

Sales Price :ariance ; Actual Price x Actual Ruantit$ / +orecast Price x Actual Ruantit$ ; ?=&6'7 . =7.!! x 4&6?2 ; ?=&6'7 . ?-&?6! ; 6&887 un#avorable Sales :olume :ariance ; <4&6?2 / 4&2!!> x =7.!! ; 44&?6! #avorable 9et Sales :ariance ; 44&?6! #avorable . 6.887 un#avorable ; ?&6?7 #avorable

42. :ariance Anal$sis / +arbucks Co##ee is looking at their regional store managers, per#ormance reports to determine which managers are controlling the sales& material& labor& and overhead variances #or their individual co##ee shops. Each region has the same pro%ections& budgets& and standard costs and actual per#ormance b$ categor$ is listed #or each region: Categor$ Sales Ruantit$ Sales Dollars Habor Costs Habor Cate Katerials Katerial Cate SF[A EB*" +orecast Budget 8&!!! 4!&!!! 2&8!! !.=! 2&2!! !.77 8&2!! 4&2!! Actual Cegion Y4 6&?'? 4!&!?! 2&6'7 2&646 8&467 4&27' Actual Cegion Y2 8&268 4!&288 2&8-? 2&642 8&4?= 4&28? Actual Cegion Y6 6&-!2 -&'72 2&2?6 2&47' 8&2!= 4&4!= Actual CegionY 8 8&4=8 4!&6=2 2&742&4'' 8&76? 4&42?

3hich Kanager seems to be doing the best %ob based on #avorable and un#avorable variances in 9et Sales :ariance& 9et Katerial :ariance& 9et Habor :ariance& 9et Overhead :ariance and "otal :ariance5 Solution Sales :ariances #or the #our regions: +orecast Price ; 4!&!!! @ 8&!!! ; 2.7! Sales Price :ariance ; Actual Price x Actual Ruantit$ / +orecast Price x Actual Ruantit$

Cegion Y4 ; 4!&!?! . 2.7! x 6&?'? ; 4!&!?! . -&=-7 ; 6?7 +avorable Cegion Y2 ; 4!&288 . 2.7! x 8&268 ; 4!&288 . 4!&7?7 ; 684 En#avorable Cegion Y6 ; -&'72 . 2.7! x 6&-!2 ; -&'72 . -&'77 ; 6 En#avorable Cegion Y8 ; 4!&6=2 . 2.7! x 8&4=8 ; 4!&6=2 . 4!&84! ; 8? En#avorable Sales :olume :ariance ; +orecast Price x <Actual Ruantit$ / +orecast Ruantit$> Cegion Y4 ; 2.7! x <6&?'? . Cegion Y2 ; 2.7! x <8&268 . Cegion Y6 ; 2.7! x <6&-!2 . Cegion Y8 ; 2.7! x <8&4=8 . 9et Sales :ariance: Cegion Y4 ; 6?7 +avorable and 6!7 En#avorable ; ?! +avorable Cegion Y2 ; 684 En#avorable and 7?7 +avorable ; 288 +avorable Cegion Y6 ; 47 En#avorable and 287 En#avorable ; 28? En#avorable Cegion Y8 ; 8? En#avorable and 84! +avorable ; 6=2 +avorable Best Cegional Kanager on Sales is Cegional Kanager Y8 Katerial Price :ariance ; Actual Cost x Actual Production / Actual Production x Standard Cost Standard Katerial cost ; 2&2!! @ 8&!!! ; !.77 Cegion Y4 ; 2&646 . !.77 x 6&?'? ; 2&646 . 2&462.- ; 4?!.4 En#avorable Cegion Y2 ; 2&642 . !.77 x 8&268 ; 2&642 . 2&62?.' ; 4=.' +avorable Cegion Y6 ; 2&47' . !.77 x 6&-!2 ; 2&47' . 2&48=.4 ; 4!.- En#avorable Cegion Y8 ; 2&4'' . !.77 x 8&4=8 ; 2&4'' . 2&2-!.2 ; 446.2 +avorable Katerial Ruantit$ :ariance ; <Actual Ruantit$/ Standard Ruantit$> x Standard Costs 8&!!!> ; 6!7 En#avorable 8&!!!> ; 7?7 +avorable 8&!!!> ; 287 En#avorable 8&!!!> ; 84! +avorable

Cegion Y4 ; !.77 x <6&?'? . Cegion Y2 ; !.77 x <8&268 . Cegion Y6 ; !.77 x <6&-!2 . Cegion Y8 ; !.77 x <8&4=8 . 9et Katerial :ariance

8&!!!> ; ='.4 +avorable 8&!!!> ; 42?.' En#avorable 8&!!!> ; 76.- +avorable 8&!!!> ; -!.2 En#avorable

Cegion Y4 ; 4?!.4 En#avorable and ='.4 +avorable ; 446 En#avorable Cegion Y2 ; 4=.' +avorable and 42?.' En#avorable ; 442 En#avorable Cegion Y6 ; 4!.- En#avorable and 76.- +avorable ; 86 +avorable Cegion Y8 ; 446.2 +avorable and -!.2 En#avorable ; 26 +avorable Best Cegional Kanager on Katerial :ariance is Cegional Kanager Y2 Habor :ariance; Actual Cost x Actual Production / Actual Production x Standard Cost Standard Habor cost ; 2&8!! @ 8&!!! ; !.=! Cegion Y4 ; 2&6'7 . !.=! x 6&?'? ; 2&6'7 . 2&62=.? ; 8?.2 En#avorable Cegion Y2 ; 2&8-? . !.=! x 8&268 ; 2&8-? . 2&7!8.8 ; 82.8 +avorable Cegion Y6 ; 2&2?6 . !.=! x 6&-!2 ; 2&2?6 . 2&684.2 ; 7?.2 +avorable Cegion Y8 ; 2&74- . !.=! x 8&4=8 ; 2&74- . 2&8-?.8 ; 2!.= En#avorable Habor Ruantit$ :ariance ; <Actual Ruantit$/ Standard Ruantit$> x Standard Costs Cegion Y4 ; !.=! x <6&?'? . Cegion Y2 ; !.=! x <8&268 . Cegion Y6 ; !.=! x <6&-!2 . Cegion Y8 ; !.=! x <8&4=8 . 9et Habor :ariance Cegion Y4 ; 8?.2 En#avorable and '6.2 +avorable ; 27 +avorable 8&!!!> ; '6.2 +avorable 8&!!!> ; 48!.8 En#avorable 8&!!!> ; 7?.? +avorable 8&!!!> ; -?.8 En#avorable

Cegion Y2 ; 82.8 +avorable and 48!.8 En#avorable ; -? En#avorable Cegion Y6 ; 7?.2 +avorable and 7?.? +avorable ; 44' +avorable Cegion Y8 ; 2!.= En#avorable and -?.8 En#avorable ; 44- En#avorable Best Cegional Kanager on Habor :ariance is Cegional Kanager Y6 Overhead :olume :ariance ; Actual Overhead / Standard Cost x :olume Standard Overhead Cost ; 82!!@8&!!! ; 4.!7 Cegion Y4 ; 8&467 . 4.!7 x 6&?'? ; 8&467 . 8&!'4.- ; =6.4 En#avorable Cegion Y2 ; 8&4?= . 4.!7 x 8&268 ; 8&4?= . 8&887.' ; 27-.' +avorable Cegion Y6 ; 8&2!= . 4.!7 x 6&-!2 ; 8&2!= . 8&!-'.4 ; 4!?.- En#avorable Cegion Y8 ; 8&76? . 4.!7 x 8&4=8 ; 8&76? . 8&6'2.2 ; 4=7.? En#avorable Overhead Ruantit$ :ariance ; <Actual Ruantit$/ Standard Ruantit$> x Standard Costs Cegion Y4 ; 4.!7 x <6&?'? . Cegion Y2 ; 4.!7 x <8&268 . Cegion Y6 ; 4.!7 x <6&-!2 . Cegion Y8 ; 4.!7 x <8&4=8 . 9et Overhead :ariance Cegion Y4 ; =6.4 En#avorable and 42?.4 +avorable ; =7 +avorable Cegion Y2 ; 27-.' +avorable and 287.' En#avorable ; 48 +avorable Cegion Y6 ; 4!?.- En#avorable and 4!2.- +avorable ; = En#avorable Cegion Y8 ; 4=7.? En#avorable and 4'2.2 En#avorable ; 66? En#avorable Best Cegional Kanager on Overhead :ariance is Cegional Kanager Y4 "otal :ariance is the sum o# the #our areas and is the actual EB*" versus the budgeted EB*". 8&!!!> ; 42?.4 +avorable 8&!!!> ; 287.' En#avorable 8&!!!> ; 4!2.- +avorable 8&!!!> ; 4'2.2 En#avorable

Cegion Y4 ; 4&27' . 4&2!! ; 7' +avorable Cegion Y2 ; 4&28? . 4&2!! ; 8? +avorable Cegion Y6 ; 4&4!= . 4&2!! ; -8 En#avorable Cegion Y8 ; 4&42? . 4&2!! ; '2 En#avorable And Cegion Y4 Kanager is the overall 0variance1 winner #or the reporting period& but that does not mean Cegion Y4 Kanager did the best %ob. *t will take more in#ormation to come to that conclusion.

+or the problems thirteen through sixteen use the #ollowing data: Bu(( Beer *ncorporated *ncome Statement #or Period Ending Cevenue COFS SF[A Depreciation EB*" *nterest Expense "axes 9et *ncome 64 Dec 2!!6 48&48=&'!! ?&88-&4!! ---&62! 4&8-?&-?! 6&4--&6!! 6'7&!!! 4&!-6&6!! 2&!'7&-!! 64 Dec 2!!2 46&7==&8!! ?&464&6!! -?2&4=! 4&8'6&28! 2&-'-&'!! 67=&4!! 4&!84&7!! 4&-66&?!!

Balance Sheet #or Period Ending Assets 64 Dec 2!!6 64 Dec 2!!2

Current Assets Cash *nvestments Accts. Ceceivables *nventor$ "otal Current Assets Hong "erm Assets *nvestments Plant& Propert$ and E)uip. Foodwill *ntangible Assets "O"AH ASSE"S Hiabilities Current Hiabilities Accounts Pa$able Short "erm Debt "otal Current Hiabilities Hong."erm Hiabilities Debt Other Hiabilities "O"AH H*AB*H*"*ES Owner,s E)uit$ Common Stock 4&87'&-!! 4&876&8!! '&2?7&8!! 4&8=2&4!! 44&-''&?!! =&=!6&2!! 4&687&4!! 44&!='&2!! 4&787&'!! 644&7!! 4&?7'&2!! 4&877&4!! 662&=!! 4&'?'&'!! 6&!72&!!! ?&8-?&-!! 68-&!!! 4&47-&6!! 48&=?-&7!! 2&?2'&-!! ?&8?4&7!! 68?&'!! -7=&'!! 48&44-&7!! 4-4&!!! 4?2&6!! ==-&8!! 7?'&7!! 4&=6!&6!! 4??&-!! 424&?!! =6!&8!! 7=6&=!! 4&7!8&'!!

Cetained Earnings "O"AH O39ECS ERE*"O "O"AH H*AB. [ O39EC,S ER.

4&276&?!! 2&'44&'!! 48&=?-&7!!

4&7-?&-!! 6&!72&6!! 48&44-&7!!

46. +inancial Catios& Hi)uidit$ / Calculate the Current Catio& Ruick Catio& Cash Debt Coverage Catio and Cash Catio #or Bu(( Beer #or 2!!6 and 2!!2. Should an$ o# these ratios or the change in a ratio warrant concern #or the managers o# Bu(( Beer or the shareholders5 Solution Current Catio ; Current Assets @ Current Hiabilities 2!!6 is& 4&=6!&6!! @ 4&?7'&2!! ; !.?''? 2!!2 is& 4&7!8&'!! @ 4&'?'&'!! ; !.?84' Current Cash Debt Coverage Catio ; Cash Provided b$ Operations @ Average Current Hiabilities 2!!6 is& < 6&4--&6!! Q 4&8-?&-!! . 4&!-6&6!!> @ I< 4&?7'&2!! Q 4&'?'&'!!>@2J ; 6&=!8&-!! @ 4&?22&87! ; 4.-'?4 Ruick Catio <or Acid Catio "est> ; Current Assets / *nventories @ Current Hiabilities 2!!6 is& < 4&=6!&6!! . 7?'&7!!> @ 4&?7'&2!! ; !.7=47 2!!2 is& < 4&7!8&'!! . 7=6&=!!> @ 4&'?'&'!! ; !.72=8 Cash Catio ; Cash @ Current Hiabilities 2!!6 is& 4-4&4!! @ 4&?7'&2!! ; !.4!22!!2 is& 4??&-!! @ 4&'?'&'!! ; !.4!7'

"he ratios are look reasonable and the change is in the right direction #or better li)uidit$ #or all ratios except the cash ratio. 4'. DuPont *dentit$ / +or the #ollowing #irms #ind the Ceturn on E)uit$ using the three components o# the DuPont *dentit$& the operating e##icienc$ as measured b$ the pro#it margin <9et *ncome@Sales>& the asset management e##icienc$ as measured b$ asset turnover <Sales @ "otal Assets>& and #inancial leverage as measured b$ the e)uit$ multiplier <"otal Assets @ "otal E)uit$>. All Dollars in millions <2!!6> Compan$ Pepsi Coca.Cola Starbuck,s nh! "usch Solution: +irst #ind the e)uit$ o# each compan$: Pepsi,s E)uit$ ; 27&62' . 46&876 ; 44&?'8 Coca.Cola,s E)uit$ ; 2'&682 . 46&272 ; 48&!-! Starbuck,s E)uit$ ; 6&62? . ?84 ; 2&8?' Anheuser.Busch,s E)uit$ ; 48&=?- . 44&-'' ; 2&'42 9ext calculate the three components Compan$ Pepsi Coca.Cola Starbucks nh! "usch Operating E##icienc$ 6&7=?@ 2=&-'4 ; !.4626 8&68' @ 24&!88 ; !.2!== 6-2 @ 7&2-8 ; !.!'8! 2&!'= @ 48&48= ; !.48=? Kgmt. E##icienc$ 2=&-'4@ 27&62' ; 4.!=824&!88 @ 2'&682 ; !.'=-' 7&2-8 @ 6&62? ; 4.7-!' 48&48= @ 48&=?- ; !.-=6! +inancial Heverage 27&62' @ 44&?'8 ; 2.466! 2'&682 @ 48&!-! ; 4.-8!7 6&62? @ 2&8?' ; 4.66?2 48&=?- @ 2&'42 ; 7.84=6 Sales 2=&-'4 24&!88 7&2-8 48&48= 9et *ncome "otal Assets Hiabilities 6&7=? 27&62' 46&876 8&68' 2'&682 46&272 6-2 6&62? ?84 2&!'= 48&=?44&-''

Hast& take the three components to #ind the COE& Pepsi ; !.4626 x 4.!=8- x 2.466! ; !.6!!7 or 6!.!7A COE Coca.Cola ; !.2!== x !.'=-' x 4.-8!7 ; !.6!?7 or 6!.?7A COE Starbuck,s ; !.!'8! x 4.7-!' x 4.66?2 ; !.47'= or 47.'=A COE Anheuser.Busch ; !.48=? x !.-=6! x 7.84=6 ; !.'=77 or '=.77A COE 3hile Coca.Cola is the most operationall$ e##icient and Starbucks is the most e##icient in management& Anheuser.Busch is the best to its shareholders because it has e##ectivel$ utili(ed a ver$ high #inancial leverage strateg$& using debt and not shareholder earnings to #inance the pro#its o# the #irm. 4-. Compan$ Anal$sis / Fo to a web site such as Oahoo.com and #ind the #inancial statements o# Disne$& ticker s$mbol D*S& and KcDonalds& ticker s$mbol KCD. Compare these two companies using the #ollowing #inancial ratios: "imes *nterest Earned& Current Catio& Asset "urnover& +inancial Heverage& Pro#it Kargin& and Ceturn on E)uit$. 3hich compan$ would $ou invest in as either a bondholder or a stockholder5 Solution Hook up these values #or each compan$& Sales& EB*"& *nterest Expense& 9et *ncome& Current Assets& "otal Assets& Current Hiabilities& and E)uit$ Sales EB*" *nterest Expense 9et *ncome Disne$ 6!&'72 8&6=? =22&687 KcDonalds 4'&48! 2&'68 6?? 4&8'4

Current Assets "otal Assets Current Hiabilities #$uit%

-&6=76&-!2 44&7!2=&!?4

4&??7 27&727 2&8?= 44&-?2

"imes interest Earned ; EB*" @ *nterest Expense Disne$ is& 8&6=? @ =2- ; =.-888 KcDonalds is& 2&'68 @ 6?? ; '.!8=8 Current Catio ; Current Assets @ Current Hiabilities Disne$ is& -&6=- @ 44&!7- ; !.?8'2 KcDonalds is& 4&??7 @ 2&8?= ; !.'7?2 Asset "urnover ; Sales @ "otal Assets Disne$ is& 6!&'72 @ 76&-!2 ; !.7'!7 KcDonalds is& 4'&48! @ 27&727 ; !.='47 +inancial Heverage ; "otal Assets @ "otal E)uit$ Disne$ is& 76&-!2 @ 2=&!?4 ; 2.!==' KcDonalds is& 27&727 @ 44&-?2 ; 2.46!6 Pro#it Kargin ; 9et *ncome @ Sales Disne$ is& 2&687 @ 6!&'72 ; !.!'=6 KcDonalds is& 4&8'4 @ 4'&48! ; !.!?7? Ceturn on E)uit$ ; 9et *ncome @ "otal Owner,s E)uit$ Disne$ is& 2&687 @ 2=&!?4 ; !.!?-KcDonalds is& 4&8'4 @ 44&-?2 ; !.422? "he best compan$ to invest in appears to be KcDonalds with its higher COE and strong solvenc$ position as most o# the #inancial ratios are ver$ similar.