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C O U RSE O U TL I N E
SU M M ER Q U A RTER 2 0 1 1
F I N A N C I A L A N A L YSI S
M B A ( Ev e n i n g ) P RO G RA M
Sr . C h a p t e r F i n a l Ex a m C h a p t e r H e a d i n q
N o . N o . Q . N o .
1 . 6 1 F i n a n c i a l St a t e m e n t A n a l y s i s
2 . 7 2 F u n d s A n a l y s i s , C a s h - F l o w A n a l y s i s a n d F i n a n c i a l
P l a n n i n g
3 . 1 2 3 C a p i t a l B u d g e t i n g a n d Es t i m a t i n g C a s h F l o w s
4 . 1 3 4 C a p i t a l B u d g e t i n g Te c h n i q u e s
5 . 1 4 5 Ri s k a n d M a n a g e r i a l O p t i o n s in C a p i t a l B u d g e t i n g
6 . 1 5 6 Re q u i r e d Re t u r n s a n d t h e C o s t o f C a p i t a l
7 . 1 6 7 O p e r a t i n g a n d F i n a n c i a l L e v e r a g e
8 . 1 7 8 C a p i t a l St r u c t u r e D e t e r m i n a t i o n
Re c o m m e n d e d Te x t B o o k :
. F u n d a m e n t a l s o f F i n a n c i a l M a n a g e m e n t : 1 2
t h
Ed i t i o n
b y H o m e & W a c h o w i c z ; P r e n t i c e H a l l i n t e r n a t i o n a l
D I STRI B U TI O N O F M A RK S
In t e r n a l Se s s i o n a l Ev a l u a t i o n Ex t e r n a l Ev a l .
A s s i g n m e n t s /
P r o j e c t
Q u i z z e s C l a s s P a r t i .
A t t e n d a n c e
M i d - Te r m
Te s t
To t a l
Se s s i o n a l
Te r m i n a l
Ex a m
F i n a l
Ev a l u a t i o n
1 0 . 1 0 5 2 5 5 0 5 0 1 0 0
F i n a l Ex a m i n a t i o n Q u e s t i o n P a p e r Re q u i r e d : 5 P r o b l e m s o u t o f 8
UNIVERSITY EXAMI NATI ON.
^ s s i r s s s ^ ' student Name:
Islamabad - Kohat - Peshawar Lahore
_ _. Reg. Nos.
Course Code; \ 446 7
Course Title: m nancial Anal ysis
Program: E3 tecutive MBA/ MBA (Evening)
Quarter: ill 2010
Thi s is a t hr ee- hour exami nat i on and consists of pr obl ems only.
You may at t empt not mor e t han live pr obl ems.
Q.l Cordillera Carson.Company has the following balance sheet and income statement f or 2003
(in thousands):

BALANCE SHEET INCOME STATEMENT
Cash $ 400 Net sales (all credit) $1 2,6.80
Accounts receivable 1,300 Cost of goods sold 8.930
Gross profit $ 3,750
Inventories - 2.100 Selling, general and
Current assets $3,800 administration expenses 2,230
Net fixed assets .. 3,320 .Interest expense 46 0
Total assets $7,120 Profit before taxes $ 1,060
Taxes 390
Accounts payable $ 320 Profit after taxes $ 6 70
Accruals 26 0
Short-term loans 1.100 Notes:(i) current period' s depreciation is $480
Current liabilities $1,6 80 (ii) ending inventory for 19x1 was $1,800.
Long-teriti debt 2,000
. Net worth 3.440
Total liabilities and net worth $ 7,120
Q.2
On the basis of this information, compute (a) the current ratio, (b) the acid test ratio, (c) the average
collection period, (d) the inventory turnover ratio, (e) the debt-to-net worth ratio, Of) the long-term debt
to-total-capitalization ratio, (g) the gross profit margin, (h) the net profit margin, (j) die return on
equity and (k) Times Interest Earned.
Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for
May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20.000.
Determine whether or not borrowing will be necessary during the period, and if it is, when and for
how much. As of April 30, the firm had a balance of Rs.20,000 in cash.
ACTUAL SALES
FORECASTED SALES
January
February
March
April
Rs.50,000
50,000
6 0,000
6 0,000
May
June
July
August
Rs. 70,000
80,000
100,000
100,000
Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be collected
equally during the following 2 months (assume no bad-debt loss).
Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month
and 10% in the second month. . ,
Selling, general, and administrative expenses: Rs. 10,000 per month pins 10 percent of sales. All of
these expenses are paid during the month of incurrence.
Interest payments: A semi-annual interest payment on Rs.l 50,000 of bonds outstanding (12 percent
coupon) is paid during July. An annual Rs.50,000 sinking-fund payment is also made at that time.
Dividends: A Rs. 10,000 dividend payment will be declared and made in July.
Capital expenditures: Rs.40,000 will be invested in plant and equipment in June.
Taxes: Income-tax payments of Rs. l , 000 will be made in July.
Q.3 Thoma Pharmaceutical Company may buy an equipment costing $6 0,000. This equipment is expected
to reduce labor costs by $20,000 annually. The equipment has a useful life of 5 years but depreciation
will be charged according to the following rates:
Year-1 33. 33% . '
Year-2 44.45 .
Year-3 . . 14.81 . .
Year-4
1
7.41
No salvage value is expected at the end. The corporate tax rate for Seema is 38 percent, and its
required rate of return is 15 percent. (If profits alter taxes on the project are negative in any year, the
firm will offset the loss against other firm income for that year).
REQUIRED:
What are the relevant cash flows'?
Q. 4 Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is
in 34% tax bracket. Assuming a required rate of return of 14 percent, calculate;
i. Pay Back Period ii. Net Present Value . iii. IRR of the project if the cash inflows are as under:
End of years 1
2
4 5 6 7
Cash Inflows
(Rs)
5,000 5,000 6 ,000 6 ,000 7,000 7,000 7,000
Depreciation
Rate
20% .32% 19.20% 11.52% 11.52% 5.76 % -
Q.5 The probability distribution of possible, net present values for project X has an expected value of
Rs 20,000 arid standard deviation of Rs.l 0,000. Assuming a normal distribution, calculate the
probability that the net present value will be zero or less, that it will be greater than Rs.30,000, and
that it will be less than Rs.5,000.
Q.6 The Mana Company was recently formed to manufacture a new product. It has the following capital
structure in market value terms:
13% Debentures of 2005 Rs.6 ,000,000
. 12% Preferred stock 2,000,000
Common stock (320,000 shares) 8,000,000
. .. ' MJ-6JL0_Q,M)
The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line
of business suggests that the required rate of equity is about 1.7 percent. The Manna Company' s debt
is currently yielding 13% while its preferred stock is yielding 12%. Compute the firm' s present
weighted average cost of capital.
Pagc2ol'3
Q.7 The Fazio Pump Corporation presently has 1.1 million shares of common stock outstanding and
$S million in debt bearing an interest rate of 10 percent on average. It is considering a $5 million
expansion program financed with either common stock at $20 per share being realized(option 1), debt
at an interest rate of 1 I percent (option 2), or preferred stock with a 10 percent dividend rate (option
3). Earnings before, interest and taxes (EBIT) after the new funds are raised expected to be $ 6 mi|lion,
and the company' s tax rate is 35 percent.
REQUIRED:
a. Determine likely earnings per share after financing for each of the three alternatives.
b. What would happen if EBIT were $3 million, $4 million? $8million?
Q.S Stinton Company is presently family owned and has no debt. The Stinton family is considering going
public by sel l i ngsome of their stock in the company. Investment bankers tell them the total market
value of t he company is $10 million if no debt is employed. In addition t o selling stock, the family
wishes to consider issuing debt that, for computational purposes, would be perpetual. The debt would
then be used to purchase and retire common stock, so that the size of company would stay the same.
Based on various valuation studies, the present value of tax-shield benefits is estimated at 22 percent
of the amount borrowed when both corporate and personal taxes are taken into account. The
company' s investment banker has estimated t he following present values for bankruptcy costs
.. associated with various levels of debt:
Debt Present Value of Bankruptcy Costs
$1,000,000 $ 0
2,000.000 50,000
3,000,000 100,000
4.000,000 200,000
5,000,000 400,000
6 ,000,000 700,000
7,000,000 1,100,000
8,000,000
1,6 00,000
Given this information, what amount, of debt should the family choose?
Pope 3 on
This is a three-hour examination and consists of problems only.
You may attempt not more than five problems.
Q. 1 Cordillera Carson Company has the following balance sheet and income statement for 2006
(in thousands): "... .
BALANCE SHEET INCOME STATEMENT
Cash $ 400 Net sales (all credit) $ 12,6 80
Accounts receivable 1,300 Cost of goods sold 8,930
Gross profit $ 3,750
Inventories 2.100 Selling, general and
Current assets $3,800 administration expenses 2,230
Net fixed assets 3,320 Interest expense 46 0
Total assets $7,120 Profit before taxes $ 1,06 0.
Taxes 390
Accounts payable $ 320 Profit after taxes $. 6 70
Accruals 26 0 -
Short-term loans 1,100 Notes:(i) current period' s depreciation is $480
Current liabilities $1,6 80 (ii) ending inventory for 2005 was $1,800
Long-term debt 2,000
Net worth 3..440
Total liabilities and net worth $ 7,120
On the basis of this information, compute (a) the current ratio, (b) the acid test ratio, (c) the average
cojlection period, (d) the inventory turnover ratio, (e) the debt-to-net worth ratio, (f) the long-term debt
to-total-capitalization ratio, (g) the gross profit margin, (h) t he net profit margin, (j) the return on .
equity and (k) Ti mes Interest Earned.
Q.2 Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for
May, June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20,000.
Determine whether or not borrowing will be necessary during the period, and if it is, when and for
how much. As of April 30, the firm had. a balance of Rs.20,000 in cash.
ACTUAL SALES FORECASTED SALES
January. . Rs.50,000 May Rs. 70,000
February . 50,000 June 80,000
March 6 0,000 July
1
100,000
April 6 0,000 August 100,000
o Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be
collected equally during the following 2 months (assume no bad-debt loss). *
Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10%
. in the second month.
Paue I oH
Selling, general, and administrative expenses: Rs. l 0,000 per month plus 10 percent of sales. All of
these expenses are paid during the month of incurrence.
Interest payments: A semi-annual interest payment on Rs.150,000 of bonds outstanding (12 percent coupon)
is paid during July. An annual Rs.50,000 sinking-fund payment is also made at that time.
Dividends: A Rs.10,000 dividend payment will be declared and made in July,
o Capital expenditures: Rs.40,000 will be invested in plant and equipment in June,
a Taxes: Income tax payments of Rs. 1,000 will be made in July.
Thoma Pharmaceutical Company may buy an equipment costing $6 0,000. This equipment is expected
to reduce labor costs by $20,000 annually. The equipment has a useful life of 5 years but depreciation
will be charged according to the following rates:
Year-1 33. 33%
Year-2 44.45
Year-3 14.81
Year-4 7.41
"No salvage va.lue is expected at the end. The corporate tax rate for Seema is 38 percent, and its
required rate of return is 15 percent. (If profits after taxes on the project are negative in any year, the
firm will offset the loss against other firm income for that year).
REQUIRED: .
On the basis of this information, what are the relevant cash flows?
Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. TJie company is
in 34% tax bracket. Assuming a required rate of return of 14 percent, calculate;
i. Pay Back Period ii. Net Present Value iii. IRR of the project if the cash inflows are as under:
End of years 1 2 j 4 5 6 7
Cash Inflows
(Rs)
5,000 5,000 6 ,000 6 ,000 7,000 7,000 7,000
Depreciation
Rate
20% 32% 19.20% 11.52% 11.52% 5.76 % -
The probability distribution of possible net present values for project X has an expected value of
Rs 20,000 and standard deviation of Rs.10,000. Assuming a normal distribution, calculate the
probability that the net present value will be zero or less, that it will be greater than Rs.30,000, and
that it will be less than Rs.5,000.
The Mana Company was recently formed to manufacture a new product. It has the following capital
structure in market value terms:
13% Debentures of 2005 Rs.6 ,000,000
12% Preferred stock 2,000,000
Common stock (320,000 shares) 8,000,000
; Rs.l 6 .000.000
The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of
business suggests that the required rate of equity is about 17 percent. The Manna Company' s debt is
currently yielding 13% while its preferred stock is yielding 12%. Compute the firm' s present weighted
average cost of capital.
Page 2 of 3
The Fazio Pump Corporation presently has 1.1 million shares of common stock outstanding and
$8 million in debt bearing an interest rate of 10 percent on average. It is considering a $5 million
expansion program financed with either common stock at $20 per share being realized(option 1), or
debt at an interest rate of 11 percent (option 2), or preferred stock with a 10 percent dividend rate
(option 3). Earnings before interest and taxes (EBIT) after the new funds are raised expected to be
$6 million, and t he company' s tax rate is 35 percent.
REQUIRED:
a. Determine likely earnings per share after financing for each of the three alternatives.
b. What would happen if EBIT were $3 million, $4 million? $8million?
Stinton Company is presently family owned and has no debt. The Stinton family is considering going
public by selling some of their stock in the company. Investment bankers tell them the total market
value of the company is $10 million if no debt is employed. In addition to selling stock, the family
wishes to consider issuing debt that, for computational purposes, would be perpetual. The debt would
then be used to purchase and retire common stock, so that the size of company would stay the same.
Based on various valuation studies, the present value of tax-shield benefits is estimated at 22 percent
of the amount borrowed when both corporate and personal taxes are taken into account. The
company' s investment banker has estimated the following present values for bankruptcy costs
associated with various levels of debt:
Debt Present Value of Bankruptcy Costs
$1,000,000
2,000,000
3,000,000
4,000,000
5,000,000
6 ,000,000
7,000,000
8,000,000
$ 0
50,000
100,000
200,000
400,000
700,000
1,100,000
1,600,000
Given this information, what amount of debt should the family choose?
Page J of
n
- Lahore
Course Code; FA
Course Title:- F
. Program:
TERMIN'AI,'
EXAB/IfNATION
'csiiitwaf
This is a (hree-hour examination and consists of problems only.
You may attempt not more t han five problems*
Q. I The following information is available for a Company: - ;
BALANCE SHEET AS OF DECEMBER 31,2001 (JN THOUSANDS)
Q.2
Cash and marketable securities $500 Accounts payable. $ 'i00
Accounts receivable ? Bank loan 7
Inventories ? Accruals 200
Current assets ? Current liabilities
?
Net fixed assets . ' ? .. Long term debt 2,650
Common stock & retained ea nings
Total assets
?
Total liabilities & equity
INCOME STATEMENT FOR 2001 (IN THOUSANDS)
Credit sates $8,000
:
;
Cost of goods sold . , ' ?
Gross profit ?
Selling & administrative expenses '?
Interest expense . 400
Profit before taxes ?
Taxes (44% rate) ___?
Profit after taxes ?
OTHER INFORMATION
Current.ratio 3 to 1
. Depreciation Rs. 500 ;
Net profit margin 7 %
. Total liabilities/shareholders' equity . 1 to 1
Average collection period . 4 5 days
. Inventory turnover ratio 3 to 1
REQUIRED:
Assuming that sates and production are steady throughout a 360-day year, complete the balance sheet and
income statement for the Company. Necessary working must be shown.
Prepare a cash budget for the Ace Manufacturing Company, indicating receipt? and disbursements for May,
June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs..'A 000. Determine
whether or not borrowing will be necessary during the period, and if it is, when and for haw much. As of
April 30, the firm had a balance of Rs. 20,000 in cash;
ACTUAL SALES
FORECASTED SALES
January
'February
March
April
Rs.50,000
50,000
60,000
60,000
May
June
July
August
Rs. 70,000
80,000
100,000
100.001)
Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent wiH'.U collected
equally during the following 2 months (the firm incurs a negligible bad-debt lo.js).
i
Paget of3
Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and
10% in the second month. ,
Selling, general, and administrative expenses: Rs.10,000 per month plus 10 percent of sales. All of these
expenses are paid during the month of incuixence.
Interest payments: A semi-annual interest payment on Rs.150,000 of bonds outstanding (12 percent
coupon) is paid during July. An annual Rs,50,000 sinking-fund payment is also made at that time.
Dividends: A Rs.10,000 dividend payment will be declared and made in July.
Capilal expenditures! Rs.40,000 will be invested in plant and equipment in June.
Taxes: Income tax payments of Rs. 1,000 will be made in July.
The City of San Jose must replace a number of its concrete-mixer trucks with new trucks. It has received
two bids and has evaluated closely die performance characteristics of the various trucks. The Rockbuilt
truck, which costs $74,000, is top-of-the-line equipment. The truck has a life of eight years, assuming that
the engine is rebuilt: in the fifth year. Maintenance costs of $2000 a year are expected in the first four years,
followed by total maintenance and rebuilding costs of $13,000 in the fifth year. During the last three years,
maintenance costs arc expected to be $4,000 a year. At the end of eight years the truck will have an
estimated scrap value of $9,000.
A bid front Bulldog Trucks, Inc. is for $59,000 a truck. Maintenance costs for the truck will be higher. In
the fust year, they are expected to be $ 3 ,000, and this amount is expected to increase by $1,50.0 a year
through the eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company
$15,000 in addition to maintenance costs in that year. At the end of eight years the Bulldog truck will have
an estimated scrap value of $5,000.
REQUIRED: .
a. What are the relevant cash flows related to the trucks of each bidder?.
b. What are the cash-floAV savings each year that can be obtained by going with the more expensive
truck rather than the less expensive one?
Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is in.
3 * 1 % tax bracket. Assuming a required rale of return of 14 percent, calculate;
i. Pay Back Period ii. Net Present Value iii. !RR of the project if the cash inflows arc as under:
End of years . 1 2 3 4 5 6 7
Cash Inflows (Rs) 5,000 5,000 0,000 6,000 7,000 7,000 7,000
Depreciation Rate ' 20% 32% 19.20% 11.52% 11.52% 5.76%
-
Xonics Graphics, Inc., is evaluating a new technology for ils reproduction equipment. The technology will
have a three-year life, will cost $ 1,000, and will have an impact on cash flows that is subject to risk.
Manngement estimates that there is a fifty-fitly chance that the technology will either save the company
$1,000 in the Erst year or save it nothing at all. If nothing at all, savings in the last two years would be zero
as well. Even here there is some possibility that in the second year an additional outlay of $300 would be
required to convert back to the original process, for the new teclinology may decrease efficiency.
Management attaches a 40 percent probability to this occurrence if the hew technology "Bombs out" in the
first year. If the technology proves itself in the first year, it is felt that second-year cash flows will be
$1,800,1,400, and $1,000, with probabilities of 0.20, 0.60, and 0.20, respectively, hi .the third year, cash
flows are expected to be either $200 greater or $200 less than the cash flow in period 2, with an equal
chance of occurrence. (Again, these cash flows depend on the cash flow in period 1 being $1,000)
i. Set up a tabular version of a probability tree to depict the cash-flow possibilities, and the initial,
conditional, and joint probabilities,
if Calculate a net present value for each of the tluee-year possibilities (that is, for each of (he eight
complete branches in the probability tree) using a risk-free rate of 5 percent,
iii. Calculate the expected value of net present value for the project represented in the probability tree.
IV; What is the risk of the project?
Page 2 of.i
The Manna Company was recently formed to manufacture a new product. It has the R>f!f<whijg capital
structure in market value terms:
J 3% Debentures of2005 Rs.6,000.000
12% Preferred stock 2.000,000
. Common stock mQfiJJQfi
Ra.U8iwft.nno
The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of
business suggests (hat. the required rate of equity is about 17 percent. Compute the firm's fireseul
weighted average cost of capital.
Cybernauts, Limited is a new firm dint wishes to determine an appropriate capital Mmpture. It can issue
16% debt or 15% preferred stock. The total caphatization of the company will be $ 5 million and
common stock can be sold at $20 per share. The company is expected to have a 50% lax rate (federal
plus state). Four possible capital structures being considered are as follows:
EQUITY >%)
'. 100
70 .
50
30
I. Construct an EOIT-EPS chart for the four plans. (EBIT is expected to be $ 1 mllJicnj. Which plan is
best? Why?
ii. Calculate the indifference point between plans 1 and 3.
The WB Company and the GH Company are identical in every respect except that the \VB Company is not
financially levered, while the GH Company has Rs.2 million in 12 percent bonds ouMtaJiiiR. There are no
(axes, and capital markets are assumed to be perfect. The valuation of the two firms is shown as follows:
PLAN DEBT(%) PREFERRED(%)
1 .0 0
2 30 0
3 50 o
4 50 20
WG Company GH Company
Net operating income Rs. 600,000 Rs. 600,000
Interest on debt 0 Rs. 240.000
Earnings to common shareholders(O-l) Rs. 600,000 Rs. 360,000
Required equity return +.15 + J 6
Market value of stock Rs.4,000,000 Rs.2,250,000
Market value of debt 0 2,000,000
Total value of firm Rs.4,000,000 Us.4,250,000
Implied overall capitalization Rate k
0
.15 .1412
bebl-to-equity ratio B/S 0 .89
a. You own Rs.22,500 worth of GH stock. Show the process and the amount by which you
could reduce your outlay through the use of arbitrage.
b. When will this arbitrage process cease? .
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fIVERSITY , .;
Maraatoad Kofeat' - Peshawar - Lahore
Reg. N<o:
TERMI NAL
. EXAMI NATI ON
Course Code; FA 446 7
This 3s a tjbires-hour examaraatioin and consists of problems only.
Y O M may attenpt act more than, fivs problems.
Q. 1 The following information is avaiiabie for a Company:
BALANCE SHEET AS OF DECEMBER 31,201.0 (IN THOUSAND^)"'
Casa and marketable secur ities $ 500 Accounts payable S 400
Accounts receivable ? Bank loan
?
Inventories
9
J -
Accruals 200
Current assets .'? Current liabilities
?
Nat fixed assets
9
Long term debt 2,650
Common stock & retained earnings 3,750
Total assets
9
Total liabilities & .equity
?
INCOME STATEMENT FOR 2010 (IN THOUSANDS)
Credit sales. $ 8,000
Cost of goods sold :
9
Gross profit 7
Selling & administrative expenses
9
Interest expense 400
Profit before taxes ?
Taxes (44% rate) ?
Profit after taxes
:
'
9
OTHER INFORMATION
Current ratio 3to.l
Depreciation Rs. 500
Net profit margin - 7 %
Total liabilities/shareholders' equity 1 to 1
Average collection period 45 days
Inventory turnover ratio 3 to 1
REQUIRED:
Assuming that sales and production are steady throughout a 360-day year, complete the balance sheet and
income statement-for the Company, Necessary working must be shown.
Q.2 Prepare a cash budget for the Ace Manufacturing Company, indicating receipts and disbursements for May,
June, and July. The firm wishes to maintain at all times a minimum cash balance of Rs.20,000. Determine
whether or not borrowing will be necessary during the period, and if it is, when and for how much. As of April
30, the firm had a balance of Rs. 20,000 in cash.
ACTUAL SALES FORECASTED SALES
January Rs.50,000 May Rs. 70,000
February 50,000 June 80,000
March 60,000 . - July 100,000
April ' 60,000 August 100,000
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Accounts receivable: 50 percent of total sales are for cash. The remaining 50 percent will be collected equally
during the following 2 months (the firm incurs a negligible bad-debt loss).
Cost of goods manufactured: 70 percent of sales. 90 percent of this cost is paid the following month and 10%
in the second month.
Selling, general, and administrative expenses: Rs: 10,000 per month plus 10 percent of sales. All of these
expenses are paid during the month of incurrence.
Interest payments: A semi-annual interest payment on Rs. 150,000 of bonds outstanding (12 percent coupon) is
paid during July. An annual Rs,50,000 sinking-fund payment is also made at that time.
Dividends: A Rs. 10,000 dividend payment will be declared and made in July.
Capital expenditures: Rs.40,000 will be invested in plant and equipment in June.
Taxes: Income tax payments of Rs,1,000 will be made in July.
The City of San Jose must replace a number of its concrete-mixer trucks with new trucks. It has received two
bids and has evaluated closely the performance characteristics of the various trucks. The Rockbuilt truck,
which costs $74,000, is top-of-the-Iine equipment. The truck has a life of eight years, assuming that the engine
is rebuilt in the fifth year. Maintenance costs of $2000 a year are expected in the first four years, followed by
total maintenance and rebuilding costs of $ 1.3,000 in the fifth year. During the last three years, maintenance
costs are expected ro be $4,000 a year. At the end of eight years the truck wili have an estimated scrap value of
$9,000.
A bid from Bulldog Trucks, Inc. is for $59,000 a truck. Maintenance costs for the truck will be higher. In the
first year, they are expected to be $3,000, and this amount is expected to increase by $1,500 a year through the
eighth year. In the fourth year the engine will need to be rebuilt, and this will cost the company $15,000 in
addition to maintenance costs in that year. At the end of eight years the Bulldog truck will have an estimated
scrap value of $5,000.
REQUIRED:
a. What are the relevant cash flows related to the trucks of each bidder?
b. What are the cash-flow savings each year that can be obtained by going with the more expensive
truck rather than the less expensive one?
Zaire Electronic is considering investment of Rs.20,000 in new equipment at time 0. The company is in 34%
tax bracket. Assuming a required rate of return of 14 percent, calculate;
i. Pay Back',Period ii. Net Present Value iii. IRR of the project if the cash inflows are as under:
End of years 1 2 3 4 5 6 7
Cash Inflows (Rs) 5,000 5,000 6,000 6,000 7,000 7,000 7,000
Depreciation Rate 20% 32% 19.20% 11.52% 11.52% 5.76% -
The probability distribution of possible net present values for project X has an expected value of Rs 20,000 and
standard deviation of Rs 10,000. Assuming a normal distribution, calculate the probability that the net present
value will be zero or less, that it will be greater than Rs 30,000, and that it will be less than Rs 5,000.
The Manna Company was recently formed to manufacture a new product. It has the following capital structure
in market value terms:
Rs.6,000,000
2,000,000
8,000,000
The company has a marginal tax rate of 40 percent. A study of publicly held companies in this line of
business suggests that the required rate on equity is about 17 percent. Compute the firm's present weighted
average cost of capital.
13% Debentures of 2005
12% Preferred stock
Common stock
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Cyberaauts, Limited is a new firm that wishes to determine an appropriate capital structure. It can issue
16% debt or 15% preferred stock. The total capitalization of the company will be $ 5 million and common
stock can be sold at $20 per share. The company is expected to have a 50% tax rate (federal plus state).
Four possible capital structures being considered are as follows:
PLAN DEBT(%) PRFERRED(%) EQUITY(%)
1 0 0 100
2 30 0 70
3 50 6 50
4 50 . 2 0 30
i. Construct an EBIT-EPS chart for the four plans. (EBIT is expected to be $ 1 million), Which plan is
best? Why?
ii. Calculate the indifference point between plans 1 and 3.
The WB Company and the GH Company are identical in every respect except i a t the WB Company is not
financially levered, while the GH Company has Rs.2 million in 12 percent bonds outstanding. There are no
taxes, and capital markets are assumed to be perfect. The valuation of the two firms is shown as follows:
WB Company - GH Company
Net operating income Rs. 600,000 Rs. 600,000
Interest on debt Q Rs. 240.000
Earnings to common shareholders(O-I) Rs. 600,000 Rs. 360,000
Required equity return + .15 +
Market value of stock Rs.4,000,000 Rs.2,250,000
Market value of debt ' 0 2,000,000
Total value of firm Rs.4,000,000 Rs.4,250,000
Implied overall capitalization Rate k .15 .1412
Debt-to-equity ratio B/S 0 .89
REQUIRED:
a. You own Rs.22,500 worth of GH stock. Show the process and the amount by which you could reduce your
outlay through the use of arbitrage. . .
b. When will this arbitrage process cease?
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