1. Absolute Corporation has a capital structure that consists of 65% equity and 35% debt.

The company
expects to report P100 million in net income this year, and 67.5% of the net income will be paid out as
dividends. How large can the firm's capital budget be this year without it having to include the cost of
new common stock in its cost of capital analysis?

2. How much will a firm need in cash flow before tax and interest to satisfy debt holders and equity
holders if the tax rate is 40%, there is P10 million in common stock requiring a 12% return, and P6
million in bonds requiring an 8% return?

3. The Dumaguete Co. has an equity cost of capital of 17%. The debt to equity ratio is 1.5 and a cost of
debt is 11%. What is the weighted average cost of capital of the firm? (Assume a tax rate of 33%)

4. Calculate the DFL for a firm with EBIT of P6,000,000, fixed cost of P3,000,000, interest expense of
P1,000,000, preferred stock dividends of 800,000, and a 40 percent tax rate.

5. A firm is expected to generate P1.5 million in operating income and pay P250,000 in interest. Ignoring
taxes, this will generate P12.50 earnings per share. What will happen to EPS if operating income
increases to P2.0 million?

6. Every 15 days a company receives P10,000 worth of raw materials from its suppliers. The credit terms
for these purchases are 2/10, net 30, and payment is made on the 30th day after each delivery. Thus,
the company is considering a 1-year bank loan for P9,800 (98% of the invoice amount). If the effective
annual interest rate on this loan is 12%, what will be the net peso savings over the year by borrowing
and then taking the discount on the materials?

7. Corbin Inc. can issue three-month commercial paper with a face value of $1,000,000 for
$980,000. Transaction costs would be $1,200.
The effective annualized percentage cost of the financing, based on a 360-day year,
would be:

8. XYZ Corporation borrowed P100,000 for six months from the bank. The rate is prime plus
2 percent. The prime rate was 8.5 percent at the beginning of the loan and changed to 9
percent after two months. This was the only change. How much interest must XYZ
corporation pay?

9. A bank lends a firm P1000000 for one year at 12 percent on a discounted basis and
requires compensating balances pf 10 percent of the face value of the loan. The effective
annual interest rate associated with this loan is:

10. Tangshan Mining borrowed P100, 000 for one year under a line of credit with a stated interest rate of
7.5 percent and a 15 percent compensating balance. Normally, the firm keeps almost no money in its
checking account. Based on this information, the effective annual interest rate on the loan is:
1. Net income 100.0M
Deduct dividends (0.675 x 100M) 67.5M
Increase in retained earnings 32.5M
Capital budget supported by retained earnings 32.5M ÷ 0.65 50.0M
2. Interest (6M x 0.08) P 480,000
Before-tax dividends (10M x 0.12 ÷ 0.6) 2,000,000
Total cash flow requirements to cover dividends and interest P2,480,000

3. Capital structure:
Debt: 1.5 ÷ (1 + 1.5) 60.0%
Equity: 100% - 60% 40.0%
WCCD (0.6 x 11%) 6.6%
WCCE (0.4 x 17%) 6.8%
Weighted average cost of capital 13.4%

4. Earnings before interest P6,000,000

Interest 1,000,000
Preferred Dividends (800,000/0.6) 1,333,333 2,333,333
Earnings after preferred dividends (before taxes) P3,666,667
DFL (6M ÷ 3,666,667) 1.64
For every 10 percent change in EBIT, EPS changes by 16.4 percent (10% x 1.64). Adding financial

leverage to operating leverage increases the total risk of a company.

5. Increase in Earnings after tax: (1,750,000 – 1,250,000) 500,000

Percentage increase: (500,000  1,250,000) 40 percent
New EPS: 12.50 + (12.50 x 0.40) 17.50%

6. Purchase discount 10,000 x 0.02 x 24 purchases 4,800

Interest on borrowed money 9,800 x 0.12 1,176
Savings 3,624
Number of purchases: 360 days/15-day interval 24

7.