CHAPTER 3 RATIO ANALYSIS 3-1

$200 = 1.0 $200 $200 $80 Quick Ratio = = 0.6 $200 $300 Debt Ratio = = 0.6 $500 $150 Times interest earned = = 3.0 $50 $600 Inventory turnover = = 7.5 $80 $1 ,000 Account Receiveable Turnover = = 50.0 $20 365days Average collection Period = = 7.3days 50 $1 ,000 Asset turnover = = 2.0 $500 $50 Profit margin on sales = = 0.05 $1,000 $50 Return on Equity (ROE) = = 0.25 $200 $50 Return on Total Assets (ROA) = = 0.10 $500 Current Ratio =

3-2
$ 2 0 , 0 0 0 $ 2 , 0 0 0 ( a ) C u r r e n tr a t i o = = 2 . 2 5 $ 1 0 , 0 0 0 $ 2 0 0 0 $ 2 0 , 0 0 0 + $ 5 , 0 0 0 ( b ) C u r r e n tr a t i o= = 1 . 6 7 $ 1 0 , 0 0 0 + $ 5 , 0 0 0 $ 2 0 , 0 0 0 + $ 4 , 0 0 0 ( c ) C u r r e n tr a t i o= = 2 . 4 $ 1 0 , 0 0 0

(d) (e)

No effect No effect

3-3
total debt current liabilities + long term debt = net worth net worth
= current liabilities + 20,000 = 1 )' $40,000

Quick ratio =

cash + accounts receivable =1 $40,000

Current liabilities = $40,000 Cash + accounts receivable = $40,000

Asset turnover = sales =2 $100,000

Sales = $200,000
Average collection period = receivables 3+' = 1*)2' days $200,000

Receivables = $10,000 Quick assets = cash + receivables = cash + $10,000 = $40,000 Cash = $30,000
$ 2 0 0 , 0 0 0 I n v e n t o r y T u r n o v e r= = 1 0 i n v e n t o r y

Inventor = $20,000 Cash Receivables Inventories !et "lant (otal assets $ 30,000 10,000 20,000 40,000 $100,00 !otes "a able #on$-ter% &ebt Co%%on stock Retaine& earnin$s (otal clai%s $ 40,000 20,000 1',000 2',000 $100,00

3-4 , 3 7 /b0

,sset /a0 ,ssets 3)00 1)'3 C 6 2)14

-ro.it Co%"an 10)02 12)1 2)33 1)40 13)3

Return on (urnover 30)02 1*)' 4)5 4)5 2*)+

1ar$in

1*)3 13)4

(he .ive co%"an avera$es are8

6 0 0 + 6 1 0 + 7 0 0 + 8 5 0 + 6 0 0 3 , 3 6 0 T u r n o v e r= = = 2 t i m e s 2 0 0 + 4 0 0 + 3 0 0 + 5 0 0 + 2 8 0 1 , 6 8 0 6 0 + 7 4 + 5 5 + 6 7 + 8 0 3 3 6 M a r g i n= = = 1 0 % 3 ,3 6 0 3 ,3 6 0

Return on assets = 2 9 102 = 202 (he .ive-co%"an avera$es are 2)00, 102, an& 202) Co%"an 6 has turnover, %ar$in, an& Return on ,ssets "roble%s) Co%"an 3 has turnover an& Return on ,ssets "roble%s) Co%"an C has %ar$in an& Return on ,ssets "roble%s) Co%"an 7 is ver $oo& on all counts) 3-) Cost o. $oo&s sol& = *02 9 sales = *02 9 $100,000 = $*0,000 :ross "ro.it = sales - cost o. $oo&s sol& = $100,000 - $*0,000 = $20,000 o p e r a t i n g P r o f i t ( E B I T ) T i m e s i n t e r e s te a r n e d = i n t e r e s t( 2 % o f _ s a l e s )
= EBI = ' times 22 $100,000

73I( = $10,000 :ross "ro.it = - o"eratin$ e9"enses = 73I( $20,000 - o"eratin$ e9"enses = $10,000 ;"eratin$ e9"enses = $10,000 !et inco%e be.ore ta9es = 73I( - interest = $10,000 - $2,000 = $*,000 (a9es = ta9 rate 9 net inco%e be.ore ta9es = 402 9 $*,000 = $3,200 !et inco%e a.ter ta9es = net inco%e be.ore ta9es - ta9es
3

= $*,000 - $3,200 = $4,*00

C,1I##7 (;< C;1-,!< Inco%e State%ent Sales Cost o. $oo&s sol& :ross "ro.it ;"eratin$ e9"enses ;"eratin$ "ro.it /73I(0 Interest e9"enses !et inco%e be.ore ta9es (a9es at 402 !et inco%e a.ter ta9es 3-+ /a0 =I##I,1S C;1-,!< Co%%on-si>e ?inancial State%ents 6ece%ber 31, 200+ an& 2004 Cash ,ccounts receivable Inventories (otal current assets !et "lant an& e@ui"%ent (otal assets ,ccounts "a able !otes "a able ,ccrue& "a able (otal current &ebts #on$-ter% &ebt (otal liabilities Co%%on stock Retaine& earnin$s (otal stockhol&erAs e@uit (otal clai%s !et sales Cost o. $oo&s sol& :ross "ro.it ;"eratin$ e9"enses 6e"reciation char$es Interest e9"ense (otal e9"enses !et inco%e be.ore ta9es Inco%e ta9es at 302 !et inco%e a.ter ta9es
'

$100,000 *0,000 $ 20,000 10,000 $ 10,000 2,000 $ *,000 3,200 $ 4,*00

200+ 4)02 11)4 1')4 34)12 +')5 100)02 11)42 *)4 3)' 23)+2 2+)2 45)*2 43)4 +)' '0)22 100)02 100)02 +0)5 35)12 1*)' 3)3 2)0 23)*2 1')32 4)+ 10)42

2004 12)'2 13)2 14)' 43)22 '+)* 100)02 13)22 4)4 4)3 24)52 21)4 4+)32 42)4 11)3 '3)42 100)02 100)02 +2)4 34)+2 14)2 2)' 1)4 1*)12 15)'2 ')5 13)42

/b0

(he co%%on-si>e state%ents are the .inancial state%ents in "ercent .or% an& "rovi&e a co%%on basis .or anal sis) Co%"arisons can be %a&e Bithin the co%"an an& other co%"anies o. about the sa%e si>e in the sa%e in&ustr ) (he co%%on-si>e balance sheet shoBs that total current assets .or 2004 have increase& b al%ost 10 "ercent over 200+ an& that total current liabilities .or 2004 have increase& b onl 1)3 "ercent) (he net result is that the Borkin$ ca"ital "osition &i& not %ake an invest%ent in "lant an& e@ui"%entC the &ecreases in .i9e& assets are because o. &e&uctions .or &e"reciation char$es) (he &ecreases in the ratio o. total &ebt to total assets have resulte& in the corres"on&in$ increase in the ratio o. sharehol&ersA e@uit to total assets) (he co%%on-si>e inco%e state%ent shoBs 1)' "ercent increase in cost o. $oo&s sol& an& a corres"on&in$ &ecrease in the $ross %ar$in) (his relativel %o&est chan$e %a in&icate an increase in %ark&oBns .ro% ori$inal sales "rices) (he "ro.it %ar$in on sales .or 2004 has increase& b 3 "ercent over 200+) (his is because the co%"an has increase& its o"eratin$ e..iciencies b increasin$ &ollar sales Bithout a corres"on&in$ increase in o"eratin$ e9"enses) In su%%ar , increases in net inco%e a.ter ta9es an& "rocee&s .ro% the sale o. co%%on stock are re.lecte& b increases in each current asset ite%) Increases in &ollar &ecrease in $ross %ar$in %a in&icate an over invest%ent in inventories) (he overall .inancial con&ition an& the o"eratin$ results o. the Sunshine Co%"an have i%"rove&) DoBever, the co%"arison o. "ercenta$e chan$es on .inancial state%ents that occur .ro% "erio& to "erio&, &oes not alloB the .inancial anal st to &eter%ine i. too %an &ollars are bein$ investe& in a s"eci.ic cate$or as co%"are& to the in&ustr )

3-4

/a0 Current ratio Quick ratio 6ebt to total assets (i%es interest earne& Inventor turnover

=I##I,1S '','00E32,000=1)4 33,000E32,000=1)0 '5,'00E12*,000=4+)32 20,+00E1,34'=1')0 +1,'00E22,'00=2)4

In&ustr 2)0 1)0 4')'2 14)0 3)'

Co%"arison Fn.avorable In #ine In #ine Fn.avorable Fn.avorable

Collection "erio& ,sset turnover

/14,000 9 3+'0 E 5*,'00 = +3 +3)0 5*,'00 E 12*,'00 = 0)44 4)0 1*)02 24)02 3')02

In #ine Fn.avorable Fn.avorable Fn.avorable Fn.avorable

-ro.it %ar$in on sales 13,4'4 E 5*,'00 = 13)42 Return on total assets Return on e@uit /b0 13,4'4 E 12*,'00 = 10)'2 13,4'4 E +5,000 = 15)'2

3oth the current ratio an& the @uick ratio in&icate that the co%"an As li@ui&it "osition is relativel satis.actor b co%"arison Bith the in&ustr avera$es) (he ratio o. &ebt to total assets an& the ti%es-interest-earne& ratio .or the Sunshine Co%"an are reasonabl $oo& Bhen co%"are& to the in&ustr ) =ith satis.actor levera$e ratios acco%"anie& b a .avorable li@ui&it "osition, the co%"an %a be able to ac@uire %ore &ebt .inancin$ in the near .uture) (he inventor turnover an& the avera$e collection "erio& both in&icate that the co%"an As current assets are in line Bith the in&ustr avera$es) DoBever, the loB .i9e& asset turnover un&erscores a "ossible over invest%ent in "lant an& e@ui"%ent) It is clear .ro% this anal sis that to i%"rove the turnover ratios an& "ro.itabilit "osition o. the .ir%, sales %ust increase Bithout a corres"on&in$ increase in invest%ent on .i9e& assets or so%e o. its assets shoul& be &is"ose&) (he "ro.it %ar$in on sales is loBC it in&icates that e9"enses are too hi$h or that "rices are too loB or both) (he "oor return on total assets is &irectl attributable to the loB "ro.it %ar$in on sales an& the loB .i9e& asset turnover)

CHAPTER 4 LEVERAGE AND RISK ANALYSIS 4-1

Q= # $3,000 = = +00 units " ! $* $3

4-2
$%& = Q/ " ! 0 *00/$* $30 = =4 Q/ " ! 0 # *00/$* $30 $3,000

4-3

/a0 73I( #ess8 interest 7arnin$s be.ore ta9es #ess8 ta9es at '02 7arnin$s a.ter ta9es !u%ber o. co%%on shares 7arnin$s "er share /b0 Co%%on Stock 6ebt ,ll Co%%on Stock ,ll 6ebt $2,400 $2,400 - +00 $2,400 $1,*00 1,200 500 $1,200 $ 500 300 200 $4)00 $4)'0

( EBI

$0 )(1 0)'0 ) $0 ( EBI $+00 )(1 0)'0 ) $0 = 300 200 3I( = $1,*00

/c0 4-4 /a0

7-S = /$1,*00 - $00/1 - 0)'0 - $0 300

$%& =

=3

4,000/$'0 $300 =4 4,000/$'0 $300 $+0,000 Q/ " ! 0 # Q/ " ! 0 # I

/b0
$#& = =

4,000/$'0 $300 $+0,000 =2 4,000/$'0 $300 $+0,000 $10,000

/c0 4-' /a0

6C# = 6;# 9 6?# = 4 9 2 = *

Q=

$10,000 =1,000 units at $20 each or $20,000 $20 $10

*

/b0

Sales /$20 9 1,'000 ?i9e& costs Gariable costs /$10 9 1,'000 7arnin$s be.ore interest an& ta9es

$30,000 10,000 1',000 $ ',000

/c0
Q= $10,000 = '00 units at $30 each or $1',000 $30 $10

(hus, the break-even "oint is re&uce& .ro% 1,000 units to '00 units as a result o. the "rice increase .ro% $20 to $30 "er unit) -ro.its are $10 "er unit $reater than .or each level o. sales volu%e) /&0
$%& = $%& = 4,000/$20 $100 = 1)33 at 4,000 units 4,000/$20 $100 $10,000

2,000/$20 $100 = 2 H at H 2,000units 2,000/$20 $100 $10,000

4-+ 73I( Interest -ro.it be.ore ta9es (a9es at 4*2 -ro.it a.ter ta9es -re.erre& &ivi&en&s 7arnin$s available to sharehol&ers Shares outstan&in$ 7-S

Co%%on $ 12',000 0 $ 12',000 +0,000 $ +',000 0 $ +',000 12,000 $ ')41

-re.erre& $ 12',000 0 $12',000 +0,000 $ +',000 4,000 $ '*,000 10,000 $ ')*0

6ebt $ 12',000 +,000 $ 115,000 '4,120 $ +1,**0 0 $ +1,**0 10,000 $ +)15

(he in&i..erence 73I( "oint is co%"ute& as .olloBs8 6ebt ,lternative

/ EBI

Stock ,lternative
$00/1 0)4*0 $0 12,000

$+,0000/1 0)4*0 $0 / EBI = 10,000

73I( = $3+,000 -re.erre& Stock ,lternative

/ EBI

Stock ,lternative
$00/1 0)4*0 $0 12,000

$00/1 0)4*0 $4,000 / EBI = 10,000

73I( = $*0,4+5 (he 7-S in&i..erence "oint is $3+,000 in 73I( .or the &ebt an& co%%on stock alternatives8 beloB that level o. 73I( the co%%on stock alternative Bill "ro&uce hi$her 7-S an& above that level o. 73I( the &ebt alternative Bill "ro&uce hi$her 7-S) (he 7-S in&i..erence "oint is $*0,4+5 in 73I( .or the "re.erre& stock an& co%%on stock alternative8 beloB that "oint the co%%on stock alternative Bill result in hi$her 7-S an& above that "oint the "re.erre& stock alternative Bill "ro&uce hi$her 7-S) I. o"eratin$ "ro.its /73I(0 are in&ee& $12',000, the &ebt alternative is the best o"tion) 4-4 /a0
$%& = '0,000/$' $30 = 2)' '0,000/$' $30 $+0,000

/b0
$#& = '0,000/$' $30 $+0,000 = 1)33 '0,000/$' $30 $+0,000 $10,000 '0,000/$' $30 = 3)33 '0,000/$' $30 $+0,000 $10,000

/c0
$'& =

4-*

/a0

,vera$e "rice "er unit = /$12 + $*0E2 = $10 ,vera$e variable cost "er unit = /$+ + $40E2 = $'
$ 8 0 , 0 0 0 Q = = 1 6 , 0 0 0 _ u n i t s _ o r _ $ 1 6 0 , 0 0 0 $ 1 0 $ 5

/b0

=ei$hte& avera$e "rice "er unit

= 12 3 + * 2 '

= $10)40 =ei$hte& avera$e variable cost "er unit

= + 3 + 4 2 '
$*0,000 =1',3*' $10)4 $')2
10

= $')20
Q=

(he sales volu%e .or -ro&uct , is 5,231 /1',3*' 9 3E'0 units an& the sales volu%e .or -roIect 3 is +,1'4 /1',3*' 9 2E'0)

11

CHAPTER 5 FINANCIAL PLANNING AND FORECASTING '-1 DF:D7S C;1-,!< Cash 3u&$et ?or Si9 1onths 7n&in$ June 200* Januar $20,000 $20,000 $10,000 ?ebruar $20,000 $20,000 $10,000 $10,000 3,000 1,000 1,'00 '00 1arch $20,000 $20,000 $10,000 $10,000 3,000 1,000 1,'00 '00 ',000 10,000 $1+,000 $ 4,000 14,000 $1*,000 /10,0000 $ *,000 $31,000 /$11,0000 1*,000 $ 4,000 /10,0000 $ 3,000 $1+,000 $ 4,000 4,000 $11,000 /10,0000 $ 1,000 $2+,000 /$ +,0000 11,000 $ ',000 /10,0000 $ ',000 1,000 $14,000 $ 3,000 ',000 $ *,000 /10,0000 $ 2,000 ,"ril $20,000 $20,000 $10,000 $10,000 3,000 1,000 1,'00 '00 1a $20,000 $20,000 $10,000 $10,000 3,000 1,000 1,'00 '00 10,000 June $20,000 $20,000 $10,000 $10,000 3,000 1,000 1,'00 '00

Cre&it sales Collection Cre&it "urchases

-a %ents $10,000 =a$es an& salaries 3,000 ?actor overhea& 1,000 Sellin$ e9"enses 1,'00 ,&%inistrative e9"ense '00 Ca"ital e9"en&itures Inco%e ta9es 6ivi&en& "a %ents Interest char$es (otal e9"enses $1+,000 !et cash $ain /loss0 $ 4,000 3e$innin$ cash balance 10,000 Cu%ulative cash balance$14,000 1ini%u% cash balance /10,0000 Cash sur"lus 4,000 Cash &e.icit

12

'-2

DF:D7S C;1-,!< Inco%e State%ent ?or Si9 1onths 7n&in$ June 30, 200* Sales Cost o. $oo&s sol& 3e$innin$ inventor RaB %aterials "urchase& 6irect labor ?actor overhea& 6e"reciation (otal 7n&in$ inventor :ross "ro.it Sellin$ e9"enses ,&%inistrative e9"enses ;"eratin$ "ro.it Interest e9"ense 7arnin$s be.ore ta9es (a9es at '02 7arnin$s a.ter ta9es $ 1,000 +0,000 1*,000 +,000 3,000 $**,000 *,000 $ 5,000 3,000 $120,000

*0,000 $ 40,000 12,000 $ 2*,000 1,000 $ 24,000 13,'00 $13,'00

'-3

DFD7S C;1-,!< 3alance Sheet ?or Si9 1onths 7n&in$ June 30, 200* Cash $10,000 ,ccounts "a able ,ccounts receivable 20,000 Inventor *,000 (otal current assets $3*,000 :ross .i9e& assets $*4,000 ,ccu%ulate& &e"reciation 30,000 !et .i9e& assets $'4,000 (otal assets $5',000 $10,000 !otes "a able ,ccrue& inco%e ta9es (otal current &ebts 3on&s /1020 Co%%on stock Retaine& earnin$s (otal clai%s 2,000 23,'00 $3','00 $20,000 10,000 25,'00 $5',000

'-4

DF:D7S C;1-,!< Sources an& Fses o. ?un&s State%ent ?or Si9 1onths 7n&in$ June 30, 200* 7arnin$s a.ter ta9es 6e"reciation !otes "a able ,ccrue& inco%e ta9es (otal sources $13,'00 3,000 3,000 *,'00 $2*,000
13

,ccounts receivable Inventor :ross .i9e& assets 6ivi&en& "a %ents (otal uses

$ 1,000 4,000 10,000 10,000 $2*,000

'-'

=7##I!:(;! C;1-,!< 3alance Sheet Ite%s as -ercent o. Sales 6ece%ber 31, 2004 Cash ,ccounts receivable Inventor (otal current assets ')02 30)0 20)0 '')02 ,ccounts "a able ,ccrue& e9"enses (otal current &ebts '')02 -32)' 22)'2 30)02 2)' 32)'2

,ssets as "ercent o. sales #ess8 s"ontaneous liabilities ,&&itional .inancin$ as "ercent o. incre%ental sales

Sales are sche&ule& to increase b $40,000 .ro% $200,000 to $240,000) (he $40,000 increase in sales necessitates $5,000 /22)' "ercent o. sales0 in a&&itional .un&s) (he co%"an As earnin$s a.ter ta9es are * "ercent on sales or $15,200 /$240,000 9 0)0*0) 3ecause the co%"an Bill retain 30 "ercent o. its earnin$s, its retaine& earnin$s Bill increase b $',4+0 /$15,200 9 0)300) I. Be subtract these retaine& earnin$s o. $',4+0 .ro% $5,000 that %ust be .inance&, Be .in& that the co%"an Bill nee& an a&&itional a%ount o. $3,240 /$5,000 - $',4+00) '-+ /a0 Sales Cre&it sales /5020 Cash /1020 Collections8 1st %onth /+020 2n& %onth /4020 (otal recei"ts /b0 ?ebruar $+0,000 $'4,000 $ +,000 1arch $40,000 $+3,000 $ 4,000 34,*00 21,+00 ,"ril $4',000 +4,'00 $ 4,'00 40,'00 2',200 $++,500 1a $5',000 $*','00 $ 5,'00 '1,300 24,000 $4',200 June $110,000 $ 55,000 $ 11,000

$ *5,300

,ccounts receivable at the en& o. June 502 o. June sales 402 o. 1a cre&it sales (otal accounts receivable $ 55,000 34,200 $133,200

14

'-4

-roIecte& sales = $3,000,000 !et inco%e = +2 o. sales = $3,000,000 9 0)0+ = $1*0,000 3alance Sheet Ite%s ,ssu%"tions Cash $ 50,0001ini%u% cash balance ,ccounts "a able 4'0,000 1'2 o. sales Inventor 300,000 102 o. sales ?i9e& assets 1,24',000 !o chan$e (otal assets $2,11',000

?inancin$ re@uire&$ 43',000 ,ccounts "a able 120,000 #on$-ter% &ebt 3+0,000 Co%%on stock 300,000 Retaine& earnin$s 500,000 (otal clai%s $2,11',000 '-* Sources ,ccounts receivable 6e"reciation Retaine& earnin$s (otal sources $11,000 3,000 ',000 $15,000

-lu$ ite% 42 o. sales $420,000 + $1*0,000 /net inco%e0

Fses 1arketable securities $ 3,000 Inventories 10,000 !otes "a able +,000 (otal uses $15,000

(hus, retaine& earnin$s increase b $',000) '-5 /a0 CDRIS(;-D7R C;1-,!< 3alance Sheet Ite%s o. -ercent o. Sales ,s o. 6ece%ber 31, 2004 2)02 14)0 20)0 30)0 +5)02 ,ccounts "a able ,ccruals 1ort$a$e bon&s Co%%on stock Retaine& earnin$s (otal clai%s 10)02 ')0 !ot a""licable !ot a""licable !ot a""licable 1')02 +5)02 1')0 '4)02

Cash ,ccounts receivable Inventories ?i9e& assets /net0 (otal assets

,ssets as "ercent o. sales #ess8 s"ontaneous &ebts ,&&itional .inancin$ as "ercent o. incre%ental sales

1'

/b0

Sales are sche&ule& to increase b $+0,000) ,""l in$ the '4 "ercent &evelo"e& in /a0, the Christo"her Co%"an Bill nee& $32,400 /$+0,000 9 0)'40) So%e o. that nee& Bill be %et b retaine& earnin$sC its retaine& earnin$s Bill increase b $3,200 /22 o. $1+0,0000) (hus, the co%"an Bill nee& an a&&itional a%ount o. $25,200 .ro% neB sources)

1+

CHAPTER 6 AN OVERVIEW OF WORKING CAPITAL MANAGEMENT +-1 /a0 Sales 73( /102 o. sales0 #ess8 ta9es at 402 7,( $'00,000 '0,000 20,000 $ 30,000

/b0
E A T $ 3 0 , 0 0 0 R e t u r n o n t o t a la s s e t s = = = 1 5 % t o t a la s s e t s $ 2 0 0 , 0 0 0

/c0

!eB total assets = $200,000 + $'0,000 = $2'0,000 7arnin$s #ess8 interest /'2 o. $'0,0000 7arnin$s be.ore ta9es #ess8 ta9es at 402 7arnin$s a.ter ta9es Return on total assets
= $2*,'00 = 11)42 $2'0,000

$'0,000 2,'00 $44,'00 15,000 $2*,'00

+-2

Current ,ssetsESales Sales 7arnin$s a.ter ta9es Current assets ?i9e& assets (otal assets Rate o. return on assets

302 $200,000 $ 20,000 $ +0,000 '0,000 $110,000 1*)22

'02 $200,000 $ 20,000 $100,000 '0,000 $1'0,000 13)32 1o&erate $200,000 $100,000 $ '0,000 $ '0,000 $ 40,000 *,'00 $ 31,'00 1',4'0 $ 1',4'0 1')4'2

402 $200,000 $ 20,000 $140,000 '0,000 $150,000 10)'2 ,$$ressive $200,000 $100,000 $100,000 $ 40,000 4,000 $ 33,000 $ 1+,'00 $ 1+,'00 1+)'02

+-3

/a0 Conservative (otal assets $200,000 7@uit $100,000 Short-ter% &ebt /420 #on$-ter% &ebt /1020 $100,000 73( /202 o. assets0 $ 40,000 #ess8 interest 10,000 $ 30,000 #ess8 ta9es at '02 1',000 7,( $ 1',000 Return on e@uit 1')002

14

/b0 Current assets Short-ter% &ebt Current ratio +-4 ?i9e& assets Current assets (otal assets Short-ter% &ebt /'20 #on$-ter% &ebt /1020 (otal &ebt 7@uit (otal &ebt K net Borth 73I( #ess8 interest 73( #ess8 ta9es at '02 7,( Rate o. return on e@uit Current ratio +-' /a0 /b0

Conservative $100,000 0 In.inite ,lternative , $1,000,000 1,000,000 $2,000,000 $ 100,000 500,000 $1,000,000 1,000,000 $2,000,000 $ 200,000 5',000 $ 10',000 '2,'00 $ '2,'00 ')2'2 10 to 1

1o&erate $100,000 '0,000 2 to 1 ,lternative 3 $1,000,000 400,000 $1,400,000 $ '00,000 200,000 $ 400,000 400,000 $1,400,000 $ 200,000 4',000 $ 1'',000 44,'00 $ 44,'00 11)042 0)* to 1

,$$ressive $100,000 100,000 1 to 1

$20,000 - $1+,000 = $4,000 !eB level o. current assets /$1+,000E$40,0000/$'2,0000 = $20,*00 $1+,000 + 0)2'/$12,0000 = $15,000 (hus, $20,*00 - $15,000 = $1,*00 Boul& be raise& b other sources o. current liabilities, an& $12,000 - $4,*00 = $4,200 Boul& be raise& b lon$-ter% sources o. .un&s)

/c0 +-+ /a0

?inance the entire $12,000 Bith short-ter% .inancin$) 7arnin$s = $100,000 9 0)20 = $20,000 (otal assets = $20,000 + $30,000 = $'0,000 ,sset turnover = SalesE(otal ,ssets = $100,000E$'0,000 = 2)0 ti%es Return on assets = 73(E(otal ,ssets =$20,000E$'0,000 = 0)40
1*

/b0 /c0 +-4

$20,000E/$'0,000 - $20,0000 = 0)+4 $20,000E/$'0,000 + $20,0000 = 0)25 a&&itional current assets re@uire& "ro.its e9ternal .inancin$ re@uire&

$100,000E' = $20,000 $200,000 9 0)10 = $20,000 $20,000 - $20,000 = $0)00

+-*

$100,000 9 0)40 + $40,000 9 0)10 + $'0,000 9 0)'0 = $42,000

15

CHAPTER 7 CURRENT ASSET MANAGEMENT 4-1 /a0 /b0 Cash c cle = +0 &a s + *0 &a s L '0 &a s = 50 &a s Cash turnover
3 6 0 d a y s = = 4 t i m e s 9 0 d a y s

/c0

1ini%u% cash
= $2,000,000 = $'00,000 4

/&0

Cash c cle = +0 &a s + *0 &a s - +* &a s = 42 &a s Cash turnover

= 3+0 days = ' times 42 days

1ini%u% cash E !eB Cash turnover

= $2,000,000 = $400,000 '

Savin$s = 0)20/$'00,000 - $400,0000 = $20,000 4-2 /a0 (he a&o"tion o. a lock-bo9 s ste% Boul& save a total o. 3 &a s) (he a%ount o. re&uction in cash balance = 3 9 $1,000,000 = $3,000,000 /b0 /c0 4-3 (he o""ortunit cost in $ = $3,000,000 9 0)0' = $1'0,000 (he s ste% shoul& be a&o"te& because the o""ortunit cost o. the current s ste% /$1'0,0000 is $reater than the cost o. the lock-bo9 s ste% /$'0,0000)

Cre&it sales = $12,'00,000 9 *02 = $10,000,000 Current receivable turnover

= 3+0 days = 10 3+ days

!eB receivable turnover

= 3+0 days =' 42 days

Increase in unit sales volu%e

20

$10,000,000 0)20 = 2,000 units $1,000

1ar$inal "ro.it on sales !eB level o. receivables Current level o. receivables ,&&itional receivables Cost o. %ar$inal invest%ent 3a&-&ebt lossesOneB "olic 3a&-&ebt lossesOcurrent "olic Cost o. %ar$inal ba& &ebt losses !et $ain .ro% neB cre&it "olic

/2,0000/$1,000 - $*000 M$10,000,000/1 + 0)200NE' $10,000,000E10 $1,400,000 9 0)10 $12,000,000 9 0)02 $10,000,000 9 0)01

$400,000 $2,400,000 1,000,000 $1,400,000 140,000 $ 240,000 100,000 140,000 $120,000

3ecause the %ar$inal "ro.it on sales o. $400,000 e9cee&s the %ar$inal cost o. $2*0,000 /$140,000 + $140,0000, Corner Creations b 6ana shoul& a&o"t the "ro"ose& cre&it "olic ) 4-4 Cre&it -olic , 3 C 6 7 1ar$inal -ro.it ,&&itional on Sales Receivables $',000 $1*,000 4,000 1',000 3,000 1',000 2,000 1+,000 1,000 14,000 1ar$inal Invest%ent $3,+00 3,000 3,000 3,200 2,*00 :ain $1400 1000 0 P1200Q P1*00Q

(o "ro&uce the $reatest $ain, the co%"an shoul& select -olic ,) 4-' /a0
E%Q = 2 40,000 $100 = 2,000 units $2

/b0

;"ti%u% R o. or&ers =
4 0 , 0 0 0 = 2 0o r d e r s 2 , 0 0 0

/c0

(otal inventor cost

= $2 2,000 40,000 $100 + 2 2,000

= $2,000 + $2,000 = $4,000 /&0 3ecause the co%"an Bill have to "lace an or&er o. 2,000 units ever ten &a s 200 &a sE20 or&ers0, the &ail rate o. use is 200 units /2,000 unitsE10 &a s0)
21

Reor&er "oint = '00 + 2 9 200 = 500 units /e0 (otal inventor cost at 3,000 bo9es
= $2 3,000 40,000 $100 + 2 3,000

= $4,333 3ecause the total inventor cost at 2,000 bo9es Bas $4,000, the total inventor cost Boul& increase b $333 /$4,333 - $4,0000) Savin$ = $0)02 9 40,000 = $*00 (he savin$s e9cee& the total inventor cost increase an& conse@uentl the co%"an shoul& take the @uantit &iscount) 4-+
$2 *00 1,+00 $100 + = $1,000 2 *00 $2 '33 1,+00 $100 /b0 + = $*33 2 '33 $2 400 1,+00 $100 /c 0 + = $*00 2 400 $2 320 1,+00 $100 /d 0 + = $*20 2 320 $2 2+4 1,+00 $100 /e 0 + = $*++ 2 2+4 /a 0

Since the or&er si>e o. 400 Batches $ives us the loBest total inventor cost, it is the econo%ic or&er @uantit )

22

4-4
$100 $98 360 = 7.91% $100 91 $100 $98 365 (b) = 8.19% $98 91 7.50 (c)Bond yield = = 8.33% 90 (a)

(hus, the bon& has a hi$her iel& than the (reasur bill) 4-* /a0 ,&&itional sales ,ccounts un-collectible /102 o. sales0 Incre%ental revenue -ro&uction an& sellin$ cost /*02 o. sales0 Inco%e be.ore ta9es (a9es at 402 Incre%ental inco%e a.ter ta9es Incre%ental return on sales = $12,000E$200,000 = +2 (otal inventor cost = M$1)'0/',000E2 + 2000N + $1' 9 4 = $4,110 $200,000 20,000 $1*0,000 1+0,000 $ 20,000 *,000 $ 12,000

/b0 4-5 /a0 /b0

E%Q =

2 20,000 $1' = +32 units $1)'0

/c0

(otal inventor cost

+32 20,000 $1' = $1)'0 + 200 + +32 2

= $1,24*)+* 4-10 -ro.it = $'00,000 9 0)1' - $+0,000 = $1',000

23

CHAPTER 8 SOURCES OF SHORT-TERM FINANCING *-1 /a0

2 360 = 36.73% 98 20 4 360 (2) = 37.50% 96 40 3 360 (3) = 111.34% 97 10 2 360 (4) = 12.24% 98 60 (1)

/b0

/10 1arch 208 $450 /20 1arch 308 $3,3+0 /30 ,"ril 108 $1,4'' /40 1arch 208 $4,312

*-2
2 3+0 = 24)'2 5* 30 4 /b0 = *)*2 *0 * /c 0 = *)52 100 * 2 /a0

(he bank loan shoul& be chosen because it is chea"er than the other tBo alternatives) *-3 /a0 ?ace value o. account #ess8 reserve /0)20 9 $10,0000 .actorin$ .ees /0)03 9 $10,0000 ?un&s available .or a&vance #ess8 interest on a&vance /0)01 9 $4,4000 !et "rocee&s .ro% a&vance 7..ective annual cost
= $300 + $44 12 = 1+)0+2 $4,+23

$10,000 2,000 300 $ 4,400 44 $ 4,+23

/b0

*-4
10 = 11)12 50 10 /b 0 = 14)32 100 20 10 10 /c 0 = 13)32 4' / a0
24

*-'

(he interest char$e in &ollars over the entire cre&it li.e is the %onthl "a %ent ti%es the total nu%ber o. "a %ents %inus the a%ount borroBe& /cash "rice - &oBn "a %ent0) ?or e9a%"le, the interest char$e in &ollars .or Cre&itor , is $+,000 /$300 9 +0 - $12,0000)
24 $+,000 = 15)42 $12,000/+0 +10 24 $1,320 /b0 = 2*)'2 $3,000/3+ +10 24 $24 /c 0 = 3)42 $1,200/12 +10 24 $10 /d 0 = 4)42 $'00/10 +10 24 $20 / e0 = 32)02 $300/4 +10 /a0

3 .inancial calculator8 /a0 14)32 /b0 2')42 /c0 3)+42 /&0 3)432 /e0 31)+2 *-+ ?actorin$ co%%ission /0)02 9 $3,+00,0000 #ess8 savin$s /$3,000 9 120 !et .actorin$ .ee
0)05 $2,**0,000 + $3+,000 = 10)32 $2,**0,000

$42,000 3+,000 $3+,000

*-4

/a0 /b0 /c0

6ollar cost = /$3',00000)10 + /$1',00000)01 = $3,+'0 -ercenta$e cost = $3,+'0E$3',000 = 10)422 6ollar cost = /$20,00000)10 + /$30,00000)01 = $2,300 -ercenta$e cost = $2,300E$20,000 = 11)'2 Citi>ens 3ank an& (rust8 4'00 4'000 L 4'00 9 3+0 3+0 = )111 = 11)12

*-*

3ench%ark Co%%unit 3ank 45'0 9 3+0 = 45'0

2'

= )124

= 12)42

4'000 L 4'00 *-5 /a0 /b0 /c0 *-10 10 = 12)'2 100-20 10 = 11)12 100-10 10 100 = 10)02

3+0

400'0

3ench%ark Co%%unit 3ank 10E/100-200 = 12)'2

Citi>ens 3ank an& (rust 132

(hus, the 3ench%ark Co%%unit 3ank is %akin$ the better o..er)

2+

CHAPTER 9 TIME VALUE OF MONEY 5)1 (o .in& the .uture value o. a current "resent value, use ?Gn = -G 9 ?GI?n,i) 3< (,3#7 /a0 ?G10 = $2,000 9 ?GI?10,*2 = $2,000 9 2)1'5 = $4,31* /b0 ?G40 = $2,000 9 ?GI?40,22 = $2,000 9 2)20* = $4,41+ /c0 ?G40 = $2,000 9 ?GI?40,32 = $2,000 9 3)2+2 = $+,'24 3< ?I!,!CI,# C,#CF#,(;R /a0 $4314)*' /b0 $441+)04 /c0 $+'24)04 /&0 $++3*)52 /e0 $++40)00 5-2 (o .in& the .uture value o. an annuit , use ?G, = C? 9 ?G,I?n,i) /a0 /b0 /c0 5-3 ?G, = $3,000 9 ?G,I?10,*2 = $3,000 9 14)4*4 = $43,4+1 ?G, = $1,'00 9 ?G,I?20,42 = $1,'00 9 25)44* = $44,++4 ?G, = $ 100 9 ?G,I?120,)++42 = $ 1*254)+0 /b .inancial calculator0

(o .in& the "resent value o. a .uture value, use -G = ?G 9 -GI?n,i) /a0 /b0 /c0 -G = $1,000 9 -GI?10,+2 = $1,000 9 0)''* = $ ''* -G = $2,000 9 -GI?10,32 = $2,000 9 0)444 = $1,4** $121')'* /b .inancial calculator0

5-4

(o .in& the "resent value o. an annuit , use -G, = C? 9 -G,I?n,i) /a0 /b0 /c0 -G, = $2,000 9 -G,I?10,*2 = $2,000 9 +)41 = $13,420 an& b .inancial calculator, $13420)1+ -G, = $2,000 9 -G,I?20,'2 = $2,000 9 12)4+2 = $24,524 an& b .inancial calculator, $24524)42 -G, = $3,000 9 -G,I?4*,12 or b .inancial calculator, $113521)**)
24

5)'

,!!F,# C;1-;F!6I!: (o solve this "roble%, use either ?Gn = -G 9 ?GI?n,i or -G = ?Gn 9 -GI?n,i) $3 = $1 9 ?GI?n,+2C ?GI?n,+2 = 3C (able , shoBs that to tri"le $1 at + "ercent, it takes sli$htl less than 15 ears) $1 = $3 9 -GI?n,+2C -GI?n,+2 = 0)333C (able C shoBs that to tri"le $1 at + "ercent, it takes sli$htl less than 15 ears) ;r b .inancial calculator, 1*)*' ears C;1-;F!6I!: /b .inancial calculator0 Se%iannual 1*)'* ears Quarterl 1*)44 ears 1onthl 1*)3+ ears 6ail 1*)31 ears

5-+

(o solve this "roble%, use C? = -G, S -G,I?n,i) C? = $20,000 S -G,I?20,22 = $20,000 S 1+)3'1 = $1,223 ;r b .inancial calculator, $1223)13 )

5-4

(o &eter%ine the interest rate o. the note, use -G,I?n,i = -G, E C?) -G,I?4,i = $10,1+1 S $3,000 = 3)3*4C (able 6 shoBs that the interest rate o. the note is 4 "ercent) ;r, b .inancial calculator, 4)002*2)

5-* 5-5

-GI?n,12 = $1',000 S $3*3 = 35)1+4C (able 6 shoBs that it Bill take '0 %onths to "a the balance an& the interest) ;r b .inancial calculator8 45)5' 1onths 3on& Galue = C? 9 -G,I?n,i + ?Gn 9 -GI?n,i = $+0 9 -G,I?40,'2 + $1,000 9 -GI?40,'2 = $+0 9 14)1'5 + $1,000 9 0)142 = $1,141)'4 ;r, b .inancial calculator, $1141)'5) -G = $200 9 0)505 + $300 9 0)*2+ + $400 9 0)4'1 = $430 -G, = $20,000 9 -G,I?10,102 9 -GI?1',102 = $20,000 9 +)14' 9 0)235 = $25,343 ;r b .inancial calculator8 $25,415)21

5-10 5-11

2*

5-12

-G, = $10,000 9 -G,I?5,102 = $10,000 9 ')4'5 = $'4,'50 ;r b .inancial calculator8 $'4,'50)24 a0 $1,330)+1 "er %onth b0 1onth 1 2 3 3alance $155*35)0+ $155+41)14 $155'0')31 -rinci"al $1+3)54 $1+4)*5 $1+')*+ Interest $11++)+4 $11+')40 $11+4)4'

5-13

c0 -rinci"al = $43'24)+4C Interest = $220'35)03 &0 $4+4)0' = neB "a %ent o. $1454)++ less ol& "a %ent o. $1330)+1 Savin$s8 30 ear loan cost /$1330)+1 9 3+00 or $445015)+0 1' ear loan cost /$1454)++ 9 1*00 or $323'4*)*0 6I??7R7!C7 $1''440)*0 5-14 -G, = $100,000 9 /1 + -G,I?5,1220 = $100,000 9 /1 + ')32*0 = $+32,*00 ;r solvin$ .or the annuit &ue b .inancial calculator8 $+32*24)5* 6an shoul& take the $400,000 because it is $reater than the "resent value o. the $100,000 annuit /$+32,*24)5*0) 5-1' <ou have to solve this "roble% in tBo ste"s) ?irst, ou %ust &eter%ine hoB %uch ou nee& to have at a$e +' to "rovi&e a 20- ear %onthl "a %ent o. $3,000, $iven the 10 "ercent rate o. return) 3 .inancial calculator, solve .or the "resent value o. the annuit or $310*43)*+ Secon&, ou %ust calculate hoB %uch ou nee& to set asi&e %onthl so that our savin$s Bill $roB to the nee&e& $310*43)*+ b a$e +' to .un& the 20 ear %onthl retire%ent "a %ent o. $3000) 3 .inancial calculator, solve .or the 1' ear %onthl "a %ent necessar to "ro&uce the .uture value o. the annuit o. $310*43)*+) ,n& the %onthl "a %ent is $4'0)0') I. 1r) #iles invests $4'0)0' ever %onth at the en& o. each %onth at 10 "ercent, he Bill have accu%ulate& $*10,*43)*+ at a$e +') (his Bill alloB hi% to Bith&raB $3,000 a %onth .or 20 ears a.ter retire%ent)
25

5-1+

3on& -rice = $100 9 -G,I?10,*2 + $1,000 9 -GI?10,*2 = $100 9 +)410 + $1,000 9 0)4+3 = $1,134 or b .inancial calculator, $1134)20) 3 .inancial calculator, solve .or the rate o. return $ive -G, ?G, an& !) ,nsBer = *)452 /a0 :roBth rate at the en& one ear8
$1)102' 1 = '2 $1)0'

5)14 5-1*

:roBth rate at the en& o. tBo ears8

$1)1'4+ 1 = '2 $1)102'

/b0 /c0 5-15 5)20

Current &ivi&en& iel& = $1)0'E20 = ')2'2 (otal rate o. return $1)0'E20 + '2 = 10)2'2

3 .inancial calculator, solvin$ .or "a %ent re@uire& = $'*')00) (otal "rinci"al + interest "ai& = $'*' 9 +0 = $3',100)45) 3 .inancial calculator8 /a0 /b0 1onthl "a %ent = $1,++3)2+ $ 1,++3)2+ 9 3+0 $'5*,442)2' - 2'0,000)00 $ 34*,442)2' %onthl "a %ents %onths total "rinci"al interest "a %ent

/c0

,.ter 1' ears, #illianTs loan balance is $1*',044)1* /b .inancial calculator an& usin$ the a%orti>ation sche&ule0) ,t the neB rate o. '2 on the balance o. $1*',044)1*, #illianTs neB "a %ent Boul& &ro" to $14+3)34 "er %onth .or the re%ainin$ 1' ears) 6i..erence betBeen ol& an& neB "a %ents8 $1++3)2+ - $14+3)34 = $155)52) ,n& the "resent value o. $155)52 "er %onth .or 1' ears or 1*0 %onths is $2',2*0)53 so she Boul& save this %uch b re.inancin$)

30

CHAPTER 1 VALUATION 10)1 3 .inancial calculator8 /a0 $*43)'2 /?G=1000C-1(=110C!=10CI<=14C-<=1CC-( -G0 /b0 $10+1)4' /c0 $1000)00 /&0 $112*)3' 3 .inancial calculator8 /a0 $134+)'4 /?G=1000C-1(=40C!=40CI<='C-<=2CC-( -G0 /b0 $1000)00 /c0 $*2*)41 3 .inancial calculator8 /a0 $5*1)*2 /?G=1000C-1(=50C!=1CI<=11C-<=1CC-( -G0 /b0 $52+)0* /c0 $**2)22 /&0 $*40)43 /e0 $*2+)12 ,nnual cou"on interest = Cou"on interest rate 9 "ar value o. $1000 = )05 9 $1000 = 50 Since the iel& to %aturit on the bon& e@uals the cou"on interest rate, the bon&Ts "resent value or current "rice %ust e@ual its "ar value o. $1000) 3 .inancial calculator, the correct %arket "rice is8 ! = 40 /or 4 @uarters "er ear ti%es 10 ears0 I< = 13 /or the re@uire& %arket iel& to %aturit o. the bon&0 -1( = $2' /or cou"on interest rate o. 102 ti%es "ar value o. $1000 = $100 "er ear an& $2' "er @uarter since interest is "ai& @uarterl 0 ?G = $1000 /"rinci"al or "ar to be receive& b the bon&hol&er at %aturit 0 -< = 4 /or the nu%ber o. co%"oun&in$ "erio&s "er ear0 C-(, -G = $*33)44

10)2

10)3

10)4

10)' 10)+

So the Sall Ruth Cor"orate bon& is over"rice& b /**4 L *33)440 or $'0)'+) I. =illia% bu s this bon& at the $**4 "rice, he Bill not earn the %arket iel& to %aturit o. 132) Instea&, his iel& to %aturit /b .inancial calculator, solvin$ .or I< Bith a -G o. $**40 Boul& be 122) 10-4 -" or -rice o. -re.erre& Stock = 6"EU" or annual $ &ivi&en& &ivi&e& b the investorTs re@uire& return) -" = $3)00 E )05' = $31)'* "er share o. "re.erre& stock
31

10-*

?in& the "rice o. "re.erre& stock as shoBn in "roble% 10-4 above) /a0 $4')00 or $+)00 E )0* /b0 $+0)00 /c0 $'0)00 -o = 6c Ue -o = $3)'0 E )12 -o = $25)14 -o = Current -rice o. Co%%on Stock 6c = Constant 6ivi&en& "er share /since no $roBth0 Ue = Co%%on stockhol&erTs re@uire& return

10)5

=here8

10-10 -0 = 61 E /Ue - $0 -0 = $4)30 E /)1' - )0'0 -0 = $43)00 "er co%%on share =here8 -0 61 Ue $ 10-11 /a0 /b0 /c0 /&0 10)12 -0 61 61 -0 -0 10-13 -0 61 61 -0 -0 = = = = = = = = = = = = = = Current co%%on stock "rice 79"ecte& &ivi&en& "er co%%on share ne9t ear InvestorTs re@uire& return co%%ensurate Bith risk ?ir%Ts e9"ecte& constant $roBth rate in earnin$s -0 -0 -0 -0 = = = = $3)10 E /)13 - )030 $3)10 E /)1* - )030 $3)10 E /)13 - )0+0 $3)*0 E /)13 - )030 = = = = $31 "er share /see 10-100 $20)+4 "er share /see 10-100 $44)25 "er share /see 10-100 $3* "er share /see 10-100

61 E /Ue - $0 #ast earTs &ivi&en& or 60 ti%es /1 + $0 $')00 9 /1 + )0+0 = $')30 &ivi&en& "er share ne9t ear $')30 E /)1' - )0+0 $'*)*5 "er co%%on share 61 E /Ue - $0 /see "roble% 10-120 #ast earTs &ivi&en& or 60 ti%es /1 + $0 $0)'0 9 /1 + )030 = $0)'2 &ivi&en& "er share ne9t ear $0)'1' E /)12 - )030 $')42 "er co%%on share

32

10-14 -0 = 61 E /Ue - $0 /see "roble% 10-100 -0 = $2)30 E /)15 - )040 -0 = $15)14 "er co%%on share 10-1' /a0 /b0 /c0 Co%%on stock "rice increases) Co%%on stock "rice &ecreases) Co%%on stock "rice &ecreases)

10-1+ (=; S(,:7 :R;=(D ' -0 = V 3)00 /1+ )2'0t + -' ) t=1 /1 + )130t /1 + )130' =here8 -' = 6+ = 120)2' an& 6+ = 6' /1+ $n0 = 5)1+ /1 +)0'01 = 5)+2 /)13 L)0'0 -resent value o. &ivi&en&s &urin$ su"ernor%al $roBth "erio& -0 = 3)00/1+)2'01 + 3)00/1+)2'02 + 3)00/1+)2'03 + 3)00/1+)2'04 + 3)00/1+)2'0' /1+)1301 /1+)1302 /1+)1303 /1+)1304 /1+)130' -resent value o. stock "rice at en& o. su"ernor%al $roBth "erio& + =here8 -' = /3)00/1+)2'0'0 /1+)0'01 an& 6+ = /3)00/1+)2'0'0 /1+)0'01 /)13 -)0' 0 -0 = 3)4'E/1+)1301 + 4)+5E/1+)1302 + ')*+E/1+)1303 + 4)32E/1+)1304 + 5)1+E/1+)130' + 5)1+ /1 + )0'0 /)13 - )0'0 /1+ )120' ) /3)00/1+)2'0'0 /1+)0'01 /)13 -)0' 0 /1+ )130' )

= 3)32 + 3)+4 + 4)0+ + 4)45 + 4)54 + 120)2'E/1)130' = 20)'1 + +')24 = $*')4* or the Ca%illeTs JeBelr Cor"oration co%%on stock "rice Bith tBo-sta$e $roBth)

33

CHAPTER 11 COST OF CAPITAL 11)1 k6 = < /1 L t0 k6 = 0)124 /1 - 0)400 = 4)42 11-2 U" = 6" E /-" L ?0 =here8 U" = InvestorTs re@uire& return on "re.erre& stock 6" = 6ivi&en& in $ "er share on "re.erre& stock ? = ?lotation cost in $ "er share U" = $4)20 E $40 = 10)'2 11-3 Ue = 61E-0 + $ =here8 Ue = InvestorTs re@uire& return on co%%on stock 61 = 79"ecte& &ivi&en& in $ "er share ne9t ear -0 = Current co%%on stock "rice in $ "er share $ = ?ir%Ts e9"ecte& constant $roBth rate in earnin$s Ue = /$ 4 E $'40 + 0)05 = 1+)42 11-4 Ca"ital 6ebt -re.erre& stock Co%%on stock (otal 11-' Ca"ital 6ebt -re.erre& stock Co%%on stock (otal 11-+ /a0 1arket Galue $ 50,000 +0,000 1'0,000 $300,000 =ei$ht 0)30 0)20 0)'0 1)00 Co%"onent Cost 4)42 10)' 1+)4 =ei$hte& Cost 2)222 2)10 *)20 12)'22 3ook Galue $100,000 '0,000 '0,000 $200,000 =ei$ht 0)'0 0)2' 0)2' 1)00 Co%"onent Cost 4)42 10)' 1+)4 =ei$hte& Cost 3)4002 2)+2' 4)100 10)42'2

(o %aintain its current ca"ital structure, the .ir% %ust .inance '0 "ercent o. its $1 %illion e9"ansion "ro$ra% throu$h co%%on e@uit ) 3ecause retaine& earnin$s are esti%ate& to be $200,000, the .ir% %ust obtain an e9ternal e@uit o. $300,000)

34

/b0

U6 = 4)442 U" = 5)22 Cost o. retaine& earnin$s or Ue ;r Ue = 61E -0 + $ = $2/1 + 0)0'0 E $'0 + 0)0' = 5)22 Cost o. neB co%%on stock or Un ;r Un = $2/1 + 0)0'0 E /$'0-$100 + 0)0' = 10)2'2

Ca"ital (ar$et ,%ount 6ebt $ 300,000 -re.erre& stock 200,000 Retaine& earnin$s 200,000 Co%%on stock /neB0 300,000 (otal $1,000,000 11-4

=ei$ht 0)3 0)2 0)2 0)3 1)0

Co%"onent Cost 4)442 5)20 5)20 10)2'

=ei$hte& Cost 1)4222 1)*40 1)*40 3)04' *)1442

/a0 (o co%"ute the annual $roBth rate o. &ivi&en&s, use -G = ?Gn 9 -GI?n,$, Bhere $ = i) 1555 &ivi&en& = 2004 &ivi&en& E /1 + $0' = 155 &ivi&en& 9 -GI?',$ $1)'0 = $2 9 -GI?',$C -GI?',$ = $1)'0 E $2 = 0)4'

I. ou look across the .ive- ear roB in (able C at the en& o. this book, the &iscount .actor 0)4' is a""ro9i%atel un&er the + "ercent colu%n) (his + "ercent is the $roBth rate o. &ivi&en&s) O! "# $%&'&(%') (')(*)'+,!8 -G = -1)'0 ! = ' ?G = 2)00 C-(C I< = ')522 /b0 /c0 Ue = $2)10 E $2' + 0)0'52 = 14)322 Cost o. !eB Co%%on Stock = $2)10 E /$2' - $'0 + 0)0'52 = 1+)3'2 =here ? = ?lotation cost in $ "er share

3'

11-*

/a0

73I( #ess8 interest /*2 o. $',0000 7arnin$s be.ore ta9es #ess8 ta9es at '02 7arnin$s a.ter ta9es 1arket value o. stock /$''0E0)100 1arket value o. &ebt (otal value o. the .ir% /b0 ;R UB UB UB UB UB = = = = =

$1,'00 400 $1,100 ''0 $ ''0 $ ','00 ',000 $10,'00

;verall Cost o. Ca"ital = 7,( + Interest E Galue o. ?ir% = $''0 + $200 E $10,'00 = 4)142

</1-t0 /=60 + Ue /=e0 *2/1-)'0 /',000E10'000 + 102 /','00E10,'000 42 /)44+0 + 102 /)'240 1)52 + ')242 4)142 un&ervalue& un&ervalue& overvalue& un&ervalue& overvalue&

11-5

R, = 0)0' + /0)10 - 0)0'0/1)'0 = 12)'2 P 1'2 R3 = 0)0' + /0)10 - 0)0'0/1)30 = 11)'2 P 202 RC = 0)0' + /0)10 - 0)0'0/0)*0 = 5)02 Q *2 R6 = 0)0' + /0)10 - 0)0'0/0)40 = *)'2 P 102 R7 = 0)0' + /0)10 - 0)0'0/1)10 = 10)'2 Q 52

3+

CHAPTER 1CAPITAL .UDGETING UNDER CERTAINTY 12-1 /a0 !et Cash Invest%ent $ ',000 2,000 $ 3,000 9 0)'0 $ 1,'00 $20,000 $1,'00 2,000 3,'00 $1+,'00

3ook value o. ol& e@ui"%ent #ess8 %arket value o. ol& e@ui"%ent ;"eratin$ loss &ue to sale 9 (a9 rate (a9 savin$s -rice o. neB e@ui"%ent #ess8 ta9 savin$s %arket value o. ol& e@ui"%ent !et cash invest%ent /b0 ,nnual !et Cash ?loBs

Cash savin$s ,&&itional sales ,&&itional revenues #ess8 a&&itional &e"reciation &e"reciation o. neB e@ui"%ent &e"reciation o. ol& e@ui"%ent (a9able inco%e #ess8 ta9es at '02 7arnin$s a.ter ta9es ,&&8 a&&itional &e"reciation ,nnual net cash .loBs 12)2 /a0 <ear 1 Revenues #ess8 o"eratin$ cost 6e"reciation (a9able inco%e #ess8 ta9es at 402 7arnin$s a.ter ta9es ,&&8 &e"reciation ,nnual net cash .loBs

$ 2,000 4,000 $ +,000 $4,000 /1,0000 3,000 $ 3,000 1,'00 $ 1,'00 3,000 $ 4,'00 <ear 3 $20,000 4,'00 3,000 $12,'00 ',000 $ 4,'00 3,000 $10,'00 $20,000 4,'00 1,'00 $14,000 ',+00 $ *,400 1,'00 $ 5,500

<ear 2 $20,000 4,'00 4,'00 $11,000 4,400 $ +,+00 4,'00 $11,100

34

/b0

Revenues #ess8 o"eratin$ cost &e"reciation (a9able inco%e #ess8 ta9es at 402 7arnin$s a.ter ta9es ,&&8 &e"reciation ,nnual net cash .loBs !et Cash Invest%ent 3ook value o. ol& %achine #ess8 %arket value o. ol& %achine ;"eratin$ loss &ue to sale 9 (a9 rate (a9 savin$s -urchase "rice o. neB %achine ?rei$ht an& installation cost (otal cost o. neB %achine #ess8 ta9 savin$s $ 400 %arket value o. ol& %achine 4,000 !et cash invest%ent

$20,000 4,'00 +,000 $ 5,'00 3,*00 $ ',400 +,000 11,400

$20,000 4,'00 2,000 $13,'00 ',400 $ *,100 2,000 $10,100

$20,000 4,'00 1,000 $14,'00 ',*00 $ *,400 1,000 $ 5,400

12-3

/a0

$ ',000 4,000 $ 1,000 9 0)40 $ 400 $ *,000 2,000 $10,000 4,400 $ ',+00

/b0

Incre%ental !et Cash ?loBs ;#6 1,CDI!7 Revenues #ess8 o"eratin$ cost 6e"reciation (a9able inco%e #ess8 ta9es at 402 7arnin$s a.ter ta9es ,&&8 &e"reciation ,nnual net cash .loBs <ears 1-' $2,000 '00 1,000 $ '00 200 $ 300 1,000 $1,300

3*

!7= 1,CDI!7 <ear 1 Revenues ;"eratin$ cost 6e"reciation (a9able inco%e (a9es at 402 7,( 6e"reciation !et cash .loBs $10,000 3,'00 2,000 $ 4,'00 1,*00 $ 2,400 2,000 $ 4,400 <ear 2 $5,000 3,'00 2,000 $3,'00 2,400 $2,100 2,000 $4,100 <ear 3 $*,000 3,'00 2,000 $2,'00 1,000 $1,'00 2,000 $3,'00 <ear 4 $4,000 3,'00 2,000 $1,'00 +00 $ 500 2,000 $2,500 <ear ' $+,000 3,'00 2,000 $ '00 200 $ 300 2,000 $2,300 <ear + $','00 3,'00 HHHHHH $2,000 *00 $1,200 $1,200

Incre%ental !et Cash ?loBs o. the -roIect <ear 1 !eB %achine ;l& %achine !et cash .loBs 12-4 $ 4,400 1,300 $ 3,400 <ear 2 $4,100 1,300 $2,*00 <ear 3 $3,'00 1,300 $2,200 <ear 4 $2,500 1,300 $1,+00 <ear ' $2,300 1,300 $1,000
H

<ear + $1,200 1,300 - $100

!et Cash Invest%ent = $3',000 !et cash .loBs Savin$s in o"eratin$ costs #ess8 &e"reciation (a9able inco%e #ess8 ta9es at 4+2 7arnin$s a.ter ta9es ,&&8 &e"reciation ,nnual net cash .loBs /a0 /b0 /c0 <ears 1-4 $*,000 ',000 $3,000 1,3*0 $1,+20 ',000 $+,+20

-a back "erio& = $3',000 $ +,+20 = ')25 ears ,vera$e rate o. return = $1,+20 /$3',000 E 20 = 5)2+2 !et "resent value = $+,+20 9 -G,I?4,'2 - $3',000 = $+,+20 9 ')4*+ - $3',000 = $3,303 ,! "# $%&'&(%') (')(*)'+,!/ CF 0 -35 C 1 0 66F 1 0 7 NPV1 I 0 51 CPT NPV 0 233 5379

35

/&0 /e0

-ro.itabilit in&e9 = $3*,30')45 $3',000 = 1)05 (o &eter%ine the internal rate o. return .or a "roIect Bith an even series o. net cash .loBs, use -G,I?n,i = -G, S C?) -G,I?4,i = $3',000 S $+,+20 = ')2*4 I. Be look across the 4 ear roB o. (able 6, Be .in& that the &iscount .actor ')2*4 is betBeen 4 "ercent an& * "ercent) (hus, Be can inter"olate betBeen these tBo rates as .olloBs8 Interest Rate *2 IRR------------- --------------42 ) ) 6iscount ?actor ')20+ ')2*4 ')3*5
y= ')3*5 ')2*4 12 = 0)+2 ')3*5 ')20+

IRR = 42 +

= 42 + 0)+2 = 4)+2

,! "# $%&'&(%') (')(*)'+,!/ IRR AND COMPUTE1 IRR 0 73554 12-' -roIect ,8 $1,000 $400 = 2)' ears -roIect 38 2 + /$1,000 - $'00 - $4000 '00 = 2)2 ears ;r ears 1 an& 2 /$'00 + $4000 + $100 o. ear 3 or $100E'00 = 2)2 ears 12-+ -roIect C8 $'00 /$2,000E20 = '02 -roIect 68 M/$+00 + $400 + $2000E3N /$2,000E2 0 = $400 $1,000 = 402 12-4 /a0 -roIect 78 !-G = $4,100 9 -G,I?4,102 - $10,000 = $4,100 9 3)140 - $10,000 = $2,554 ,! "# $%&'&(%') (')(*)'+,!/ CF 0 -1 C 1 0 41 F 1 0 4 NPV1 I 0 1 1 CPT NPV 0 2-996345

40

-roIect ?8

<ear 1 2 3 -G o. net cash .loBs #ess8 net cash invest%ent !et "resent value

Cash .loBs $',000 +,000 2,000

6iscount ?actor 0)505 0)*2+ 0)4'1

-G $4,'4' 4,5'+ 1,'02 $11,003 -10,000 $ 1,003

,! "# $%&'&(%') (')(*)'+,!/ CF 0 -1 C 1 0 5 1C - 0 6 1 C 3 0 F 1 0 1 FOR EACH CF NPV1 I 0 1 1 CPT NPV 0 21 6376 /b0 -roIect 78 -ro.itabilit in&e9 = $12,554 10,000 = 1)255 -roIect ?8 -ro.itabilit in&e9 = $11,00+ 10,000 = 1)1 /c0 12-* -roIect 78 IRR = 23)212 -roIect ?8 IRR = 1+)3'

-roIect :8 $4,300)00 9 -G,I?',r - $10,000 = 0 -G,I?',r = $10,000 S $4300)00 = 2)32'+ I. ou rea& across the .ive- ear roB o. (able 6, ou Bill .in& that the &iscount .actor 2)32'+ is betBeen the 322 an& the 332 colu%ns) (hus, the "roIectTs IRR is betBeen 322 an& 332) ,! "# $%&'&(%') (')(*)'+,!/ ENTER/ CF 0 -1 1 C 1 0 43 1 F 1 0 5 IRR AND COMPUTE1 IRR 0 3-3454 -roIect D8 =e nee& a trial an& error a""roach to co%"ute the internal rate o. return .or -roIect ?) =e Bill be$in Bith the -G,I?3,r that corres"on&s Bith the avera$e cash .loB or /5000 + 3000 + 10000 E 3 = 4333)33) -G,I?3,r = 10000 E 4333)33 = 2)3044 an& in (able 6, lookin$ across RoB 3, Be .in& the a""ro9i%ate IRR betBeen 14 an& 1' 2) 3ut since the "roIect "ro&uces hi$h earl cash .loBs, the true rate Bill be hi$her than the a""ro9i%ate IRR)
41

(r in$ 1+2 an& lookin$ in (able C8 -G at 1+2 = $5,000 9 0)*+2 + $3000 9 0)443 + $1,000 9 0)+41 = $10,+2* ,t 1+ "ercent, the "resent value o. the net cash .loBs e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 14 "ercent) -G at 142 = $5,000 9 0)*'' + $3,000 9 0)431 + $1,000 9 0)+24 = $10,'12 ,t 14 "ercent, the "resent value o. the net cash .loBs still e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 1* "ercent) -G at 1*2 = $5,000 9 0)*44 + $3,000 9 0)41* + $1,000 9 0)+05 = $10,3*+ ,t 1* "ercent, the "resent value o. the net cash .loBs still e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 15 "ercent) -G at 152 = $5,000 9 0)*40 + $3,000 9 0)40+ + $1,000 9 0)'53 = $10,241 ,t 15 "ercent, the "resent value o. the net cash .loBs still e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 20 "ercent) -G at 202 = $5,000 9 0)*33 + $3,000 9 0)+54 + $1,000 9 0)'45 = $10,1'* ,t 20 "ercent, the "resent value o. the net cash .loBs still e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 21 "ercent) -G at 212 = $5,000 9 0)*2+ + $3,000 9 0)+*3 + $1,000 9 0)'+4 = $10,044 ,t 21 "ercent, the "resent value o. the net cash .loBs still e9cee&s $10,000) =e there.ore use a hi$her &iscount rate, sa 22 "ercent) -G at 222 = $5,000 9 0)*20 + $3,000 9 0)+42 + $1,000 9 0)''1 = $5,544 ,t 22 "ercent, the "resent value o. the net cash .loBs is less than $10,000) (hus, the &iscount .actor o. 22 "ercent is too hi$h) (he ansBer %ust .all betBeen 21 "ercent an& 22 "ercent) 222 $5,544 r $10,000 212 $10,044

r = 212 + $10044 - $10000 9 /222 - 2120 = 21)442 $10044 - $5544

42

,! "# $%&'&(%') (')(*)'+,!/ ENTER/ CF 0 -1 1C 109 1 F 1 0 11 C - 0 3 C 301 1F 301 IRR AND COMPUTE1 IRR 0 -1347374 12-5 /a0 /b0 /c0 /&0 -a back "erio&8 I is better than J) ,vera$e rate o. return8 J is better than I) !et "resent value8 I is better than J) Internal rate o. return8 I is better than J) I = 2 earsC J = 4)33 ears I = 24)'2C J = 32)'2 I = $42'C J = $3*2)*4 I = 14)252C J = 13)342

1 F - 0 11

43

CHAPTER 13 OTHER ISSUES IN CAPITAL .UDGETING 13-1 /a0 /b0 ,nnual &e"reciation char$es are $2,000 or /$20,000E100) (hus, the book value o. the ol& %achine is $10,000 or /$2,000 9 ' ears0) 3ook value o. ol& %achine #ess8 %arket value o. ol& %achine ;"eratin$ loss &ue to sale 9 (a9 rate (a9 savin$s 3ook value o. ol& %achine #ess8 %arket value o. ol& %achine ta9 savin$s Sunk cost 13-2 /a0 /b0 $10,000 +,000 $ 4,000 9 0)40 $ 1,+00 $10,000 +,000 1,+00 $ 2,400

$2,000 /1 - )4+0 = $1,0*0 I. the %achine is sol& be.ore it is .ull &e"reciate&, the ta9 treat%ent is &i..erent) Initial cost o. the %achine #ess8 accu%ulate& &e"reciation 3ook value o. the %achine 1arket value o. the %achine #ess8 book value o. the %achine (a9able $ain #ess8 ta9es at 4+2 :ain a.ter ta9es $14,000 4,000 $10,000 $13,000 10,000 $ 3,000 1,3*0 $ 1,+20

/c0

I. the %achine is sol& .or %ore than its initial cost, so%e o. the $ain is subIect to the ca"ital $ains ta9 treat%ent) 3ecause the %achine Bas sol& .or $1',000, the total $ain Boul& be $',000 or /$1',000 - $10,0000) (he $ain over the initial cost o. the %achine or $1,000 /$1',000 - $14,0000 is subIect to the ca"ital $ains ta9, Bhile the re%ainin$ $4,000 /$14,000 - $10,0000 is ta9e& at the re$ular ta9 rate o. 4+2) 1arket value o. the %achine #ess8 book value o. the %achine :ain 1arket value o. the %achine #ess8 ca"ital $ains ta9 /$1,000 9 0)2*0 re$ular ta9 /$4,000 9 0)4+0 !et cash "rocee&s
44

$1',000 10,000 $ ',000 $1',000 2*0 1,*40 $12,**0

13-3

(he net "resent value is $10,330 .or -roIect : an& $4,++2 .or -roIect D) ,nnuali>e& !-G o. -roIect : = $10,330 E -G,I?4,102 = $10,330 3)140 = $3,2'5 ,! "# $%&'&(%') (')(*)'+,!/ CF 0 -3 C 1 0 15 1C - 0 1 1 C 3 0 F 1 0 1 FOR EACH C NPV1 I 0 1 1 CPT NPV 0 21 34-319

1 C 4 0 5

,nnuali>e& !-G o. -roIect D = $ 4,+22 E -G,I?2,102 = $ 4,+22 1)43+ = $2,++2 -roIect : is %ore &esirable than -roIect D because it has a hi$her annuali>e& !-G than -roIect D) ,! "# $%&'&(%') (')(*)'+,!/ CF 0 -C 1 0 18 1C - 0 1 F 1 0 1 FOR EACH C NPV1 I 0 1 1 CPT NPV 0 246-831 13-4 (o &eter%ine the annual e@uivalent o. the "roIectAs initial cost, use C? = -G, S ,6?n,i8 C? = $400,000 -G,I?4,102 = $400,000 3)140 = $12+,1*3 ,! "# $%&'&(%') (')(*)'+,!/ PV 0 -4 N 0 4 IY 0 1 CPT PMT 0 CF 0 21-6518833-31 C? = $400,000 -G,I?4,102 = $400,000 4)*+* = $143,45+ ,! "# $%&'&(%') (')(*)'+,!/ PV 0 -7 N 0 7 IY 0 1 PT PMT 0 CF 0 21435783385 (he annuali>e& cost o. 1achine , = $12+,1*3 + $10,000 = $13+,1*3 (he annuali>e& cost o. 1achine 3 = $143,45+ + $+,000 = $145,45+ 1achine , shoul& be acce"te& because it has the loBer cost than 1achine 3)

4'

13-'

Cost o. =arehouse Cost o. ?urnace Cost o. #i$htin$ S ste% (otal ,nnuali>e& Cost

= $2,000,000 ,6?30,102 = $212,1'4 = $ '00,000 ,6?20,102 = $ '*,424 = $ 200,000 ,6?1',102 = $ 2+,25' $254,145

,! "# $%&'&(%') (')(*)'+,!/ PV 0 --5 5 N 0 3 IY 0 1 CPT PMT 0 CF 0 2-1-515835 ,! "# $%&'&(%') (')(*)'+,!/ PV 0 -5 5 N 0 IY 0 1 CPT PMT 0 CF 0 25857-9381 ,! "# $%&'&(%') (')(*)'+,!/ PV 0 -- 5 N 0 15 IY 0 1 CPT PMT 0 CF 0 2-65-94376 13-+ /a0 !-G = $2,000 -G,I?',102 - $4,'00 = $2,000 9 3)451 - $4)'00 = $*2

,! "# $%&'&(%') (')(*)'+,!8 CF 0 -755 C 1 0 -5 1F 1 0 5 NPV1 I 0 1 1 CPT NPV 0 281357 Dol&in$ -erio& 1 2 3 4 ' -G o. !et Cash ?loBs at 102 $4,4'4 4,4+' 4,54* 4,*43 4,'*2 Cash ;utla s $4,'00 4,'00 4,'00 4,'00 4,'00 !et -resent Galue -$ 4+ 2+' 44* 343 *2 3 ?ina Cal -$4')4' $2+*)+0 $44*)5+ $342)3+ $*1)'4

4+

3ecause the "roIect has the hi$hest net "resent value at the en& o. three ears, the co%"an can %a9i%i>e the "roIectAs net "resent value b retirin$ it at the en& o. three ears) ,! "# $%&'&(%') (')(*)'+,!/ CF 0 -755 C 1 0 -5 1 F 1 0 -1 C - 6 6,! '&&*') CF ,$ NPV1 I 0 1 1 CPT NPV 0 2478396 13-4 /a0 ,nnual cash savin$s #ess8 &e"reciation (a9able inco%e #ess8 ta9es at 7arnin$s a.ter ta9es -lus8 &e"reciation !et cash .loBs !-G = $*,000 9 -G,I?4,102 - $24,000 = $1*,000 9 3)140 - $24,000 = $1,3+0 ,! "# $%&'&(%') (')(*)'+,! $,! P;!%,= 3/ CF 0 --4 C 1 0 85 1F 1 0 4 NPV1 I 0 1 1 CPT NPV 0 2135839/b0 I. annual cash savin$s increase at an in.lation rate o. 4 "ercent, the Bill be $10,400, $11,445, $12,2'0, an& $13,10* .or the ne9t .our ears) <ear 1 Cash savin$s $10,400 #ess8 &e"reciation +,000 (a9able inco%e $ 4,400 #ess8 ta9 savin$s /'020 2,3'0 7arnin$s a.ter ta9es $ 2,3'0 -lus8 &e"reciation +,000 !et cash .loBs $ *,3'0 $*,3'0 !-G = /1)1401 + /1)140 +
2

7 8')9':; ,$ 4

<

$10,000 +,000 $ 4,000 2,000 $ 2,000 +,000 $ *,000

<ear 2 $11,445 +,000 $ ',445 2,42' $ 2,424 +,000 $ *,424

<ear 3 $12,2'0 +,000 $ +,2'0 3,12' $ 3,12' +,000 $ 5,12'

<ear 4 $13,10* +,000 $ 4,10* 3,''4 $ 3,''4 +,000 $ 5,''4

$*,424 $5,12' $ 5,''4 3 4 /1)140 + /1)140 - $24,000 = $312

,! "# $%&'&(%') (')(*)'+,! $,! P;!%,= 3/ CF 0 --45 C 1 0 835 1 F 1 0 11 87-41 F 1 0 11 91-51 F 1 0 11 95541 F 1 0 1 NPV1 I 0 171 CPT NPV 0 23 53644

13-*

/a0

!-G = $4,000 9 -G,I?4,102 - $10,000 = $4,000 9 3)140 - $10,000 = $2,+*0 ,! "# $%&'&(%') (')(*)'+,! $,! P;!%,= 3/ CF 0 -1 5 C 1 0 4 1F 1 0 4 NPV1 I 0 1 1 CPT NPV 0 2-679346

/b0

(he initial cost o. the "roIect Boul& increase b $2,000C the total cost o. the "roIect is $12,000) (he net cash .loB o. the last ear Boul& increase b $2,000C the total net cash .loB o. the last ear is $+,000) $ 4 , 0 0 0 $ 4 , 0 0 0 $ 4 , 0 0 0 $ 6 , 0 0 0 N P V = + + + $ 1 2 , 0 0 0 1 2 3 4 ( 1 . 1 0 ) ( 1 . 1 0 ) ( 1 . 1 0 ) ( 1 . 1 0 ) = $2,04+ (hus, the net "resent value Boul& &ecrease b $+34 or /$2,+*0 - $2,04+0) ,! "# $%&'&(%') (')(*)'+,! $,! P;!%,= 3/ CF 0 -1-5 C 104 1F 104 NPV1 I 0 1 1 CPT NPV 0 2- 45349

4*

CHAPTER 14 CAPITAL .UDGETING UNDER UNCERTAINTY 14-1 /a0 R, = /5000/0)'00 + /'000/0)300 + /3'00/0)200 = $+40 R3 = /4000/0)'00 + /4000/0)300 + /''00/0)200 = $+40 , = M/500 - +4002/0)'00 + /'00 - +4002/0)300 + /3'0 - +4002/0)200N1E2 = $23+ 3 = M/400- +4002/0)'00 + /400 - +4002/0)300 + /''0 - +4002/0)200N1E2 = $+0 CG, = 23+ S +40 = 0)3' CG3 = +0 S +40 = 0)05 /b0 (he tBo "roIects have the sa%e e9"ecte& value, but -roIect 3 has a s%aller &e$ree o. risk as %easure& b the stan&ar& &eviation an& the coe..icient o. variation) Dence, -roIect 3 is better than -roIect ,) R = 1,000/0)200 + 2,000/0)100 + 3,000/0)300 + 4,000/0)400 = $2,500 $ 2 , 9 0 0 $ 2 , 9 0 0 $ 2 , 9 0 0 N P V = + + $ 2 , 8 0 0 = $ 4 , 4 1 2 1 2 3 ( 1 . 1 0 ) ( 1 . 1 0 ) ( 1 . 1 0 ) or b .inancial calculator8 Dit C?C ke in 2*00 .or C?o, then +E-, then hit enter an& scroll &oBnC ke 2500 .or C;1, hit enter, scroll &oBnC ke in 3 .or ?01, hit enterC hit !-G, ke in 10 .or I an& hit enterC scroll &oBn to !-G screen an& hit co%"ute = !-G = $4411)*4 /c0 = M/1,000 - 2,50002/0)200 + /2,000 - 2,50002/0)100 + 3,000 - 2,50002/0)300 + /4,000 - 2,50002/0)400N1E2 = $1,13+ -roIect ,$1,400 3 C 6 7 /b0 Stan&ar& 6eviation $4,000 +,300 2,*00 4,500 2,100 !et -resent Galue 0)20 40,000 21,000 3',000 21,000 Coe..icient o. Gariation 0)05 0)13 0)14 0)10 Rank ' 1 3 4 2

14-2

/a0 /b0

14-3

/a0

-roIect C an& 7 have an e@ual net "resent value o. $21,000, but -roIect 7 has the s%aller stan&ar& &eviation than -roIect C) (his lea&s us to conclu&e that -roIect 7 is

45

better than -roIect C) (hus, to choose betBeen -roIects C an& 7 onl , Be &o not nee& to use the coe..icient o. variation) 14)4 /a0!-G = $*000E/1)1201 + $5000E/1)1202 + $10000E/1)1203 + $11000E/1)1204 - $1'000 = $13433 or b .inancial calculator8 Dit C?C ke in 12000 .or C?o, then +E-, then hit enter an& scroll &oBnC ke *000 .or C;1, hit enter, scroll &oBn to C;2C ke in 5000, hit enterC scroll &oBn to C03, ke in 10000, hit enterC scroll &oBn to C04, ke in 11000, hit enterC hit !-G, ke in 12 .or I an& hit enterC scroll &oBn to !-G screen an& hit co%"ute = !-G = 1342+)10 /b0 $ 8 , 0 0 0 $ 9 , 0 0 0 $ 1 0 , 0 0 0 $ 1 1 , 0 0 0 N P V = + + + $ 1 5 , 0 0 0 = $ 9 , 0 0 2 1 2 3 4 ( 1 . 2 0 ) ( 1 . 2 0 ) ( 1 . 2 0 ) ( 1 . 2 0 ) or b .inancial calculator8 !-G = $500*)45 14)' !-G = $500/0)4'0E/1)0+01 + $1000/0)''0E/1)0+02 + $1400/)03'0E/1)0+03 - $1400 = $13* or b .inancial calculator8 !-G = $134)40 14-+ /a0 3ecause the e9"ecte& net cash .loBs .or both "roIects are $4,000 or /$*,000 9 0)'0 + $0 9 0)'00, their net "resent values are co%"ute& as .olloBs8 !-G? = $4,000 E /1)100 - $3,000 = $+3+)3+ -G: = $4,000 E /1)100 - $4,000 = -$3+3)+4 /b0 (he stan&ar& &eviation o. these tBo "roIects can be co%"ute& usin$ 7@uation /14-208 ? = M/*,000 - 4,000002/0)'00 + /0 - 4,00002/0)'00N1E2 = $4,000 : = M/0 - 4,00002/0)'00 + /*,000 - 4,00002/0)'00N1E2 = $4,000 /c0 -ort.olio !-G = $+3+ + /-$3+40 = $242 (he "ort.olio stan&ar& &eviation is >ero /00 because the "ort.olio "ro&uces a net "resent value o. $242) CHAPTER 15
'0

INVESTMENT .ANKERS AND CAPITAL MARKETS 1'-1 /a0 Current %arket value o. .ir% /'0,000 shares 9 $210 ,&&itional .un&s to be raise& /10,000 ri$hts 9 $50 Galue o. .ir% a.ter ri$hts issue (otal shares a.ter ri$hts issue (heoretical "rice o. one share a.ter ri$hts issue !u%ber o. ri$hts to bu a neB share = '0,000 shares 10,000 shares = ' Ro = $21 - $5 /'+10 = $2 R9 = $15 - $5 ' = $2 Ro = $30 - $2' / '+10 = $0)*3 (heoretical value o. one share a.ter ri$hts issue is obtaine& b subtractin$ theoretical value o. one ri$ht /$0)*30 .ro% "rice o. share be.ore ri$hts o..erin$ /$300) (hus, the theoretical value o. one share o. stock Bhen it sells e9-ri$hts is $30 - $0)*3 = $25)14 /c0 /&0 R9 = /$30 - $2'0 ' = $1 $1,*00 S $30 = +0 shares +0 shares 9 $40 Return on $1,*00 = $2,400 - $1,*00 = $+00 or 332 Ri$ht ;..erin$ (otal nu%ber o. shares = current shares + neB shares = 10,000 + 2,000 = 12,000 shares 7-S = $3+,000 S 12,000 = $3 6ivi&en& "er share = $1*,000 S 12,000 = $1)'0 -rice = --7 ratio 9 7-S = 10 9 $3 = $30 $1,0'0,000 50,000 $1,140,000 S +0,000 $15

/b0

/c0 1'-2 /a0 /b0

1'-3

/a0

'1

/b0

-ublic ;..erin$ !et "rocee&s "er share = $25 - $2 = $24 !u%ber o. shares to be issue& = $'0,000 24 = 1,*'2 7-S = $3+,000 S 11,'*2 = $3)04 6ivi&en& "er share = $1*,000 11,*'2 = $1)'2 -rice = 10 9 $3)04 = $30)4

1'-4

/a0 /b0 /c0

--7 ratio = closin$ "rice S 7-S = $'3)' S $4)'0 = 11)*5 ;r&inaril , loB --7 ratios su$$est a lack o. .uture $roBth "ossibilities) Di$h --7 ratios in&icate si$ni.icant $roBth "otential) 3ecause $roBth co%"anies Bith hi$h --7 ratios $enerall reinvest %ost o. their earnin$s, these stock "rices a""reciate consi&erabl ) In contrast, stocks Bith loB --7 ratios usuall "a lar$e &ivi&en&s because the &o not have $oo& invest%ent o""ortunities) (hus, the choice betBeen loB --7 stocks an& hi$h --7 stocks &e"en& on the investorAs "re.erence betBeen current inco%e /&ivi&en&s0 an& the .uture inco%e /ca"ital $ains0) (he closin$ "rice o. the "revious &a = $'3 - $1 = $'2 (he are sellin$ at a "re%iu% over the .ace value) I. interest earnin$s are .i9e&, the hi$her the bon& "rice, the loBer the current iel&) 2'0 9 100 = 2',000 shares

/&0 /e0 1'-' /a0 /b0

$40 $

3 3 = $35 * *

/c0
$40 $40 = $10C E"( = = $4 E"( 10

'2

/&0
$2)'0 = +2)'2 $4

1'-+ /b0

/a0

6ollar s"rea& = $20 - $14 = $3 -ercenta$e s"rea& = $3 S$20 = 1'2 100,000 shares 9 $3 = $300,000S"rea& 2',000 Re$istration .ees $32',000

/c0

$2,120,000 !ee&e& 2',000 Re$istration .ees $2,14',000 (otal nee&e& to en& u" Bith $2,120,000 $2,14',000 S $14 = 12',000 shares to be sol&

1'-4

/a0

7-S be.ore stock issue = $200,000 S 4',000 = $2)+4 - 7-S a.ter stock issue = $200,000 S 5',000 = $2)11 -otential &ilution $0)'+ $40 9 0)0* = $3)20 S"rea& $40)00 -ublic "rice - 3)20 S"rea& $3+)*0!et "rice be.ore re$istration .ees 9 20,000 Shares $43+,000 (otal "rocee&s be.ore re$istration .ees - 1',000 Re$istration .ees $421,000 !et "rocee&s

/b0

'3

CHAPTER 16 FI>ED INCOME SECURITIES/ .ONDS AND PREFERRED STOCK 1+-1 (o solve this "roble%, use (able C at the en& o. this book an& 7@uation /5-'0 -G = ?G 9 -GI?n,i $10* = $1,000 9 -GI?1',iC -GI??1',i = $10* S $1,000 = 0)10* I. ou look across the 1'- ear roB, ou Bill .in& the &iscount .actor 0)10* un&er the 1+ "ercent colu%n) (hus, the iel& o. the bon& to %aturit is 1+ "ercent) or b .inancial calculator8 1')552) 1+-2 /a0 -G = $1,000 9 -GI??10,102 = $1,000 9 0)3*+ = $3*+, or b .inancial calculator8 $3*')'4 /b0 -G = $1,000 9 -GI?10,*2 = $1,000 9 0)4+3 = $4+3, or b .inancial calculator8 $4+3)15 /c0 -G = $1,000 9 -GI??10,122 = $1,000 9 0)322 = $322, or b .inancial calculator8 $321)54 1+-3 /a0 /10 !et Cash ;ut.loB = :ross Cash ;ut.loB - (a9 Savin$s :ross Cash ;ut.loB Call "re%iu% /$'0 9 1,'000 ?lotation cost o. neB bon&s ;verla""in$ interest on ol& bon&s /$1,'00,000 9 0)05 9 4E120 :ross cash outla (a9 Savin$s ;verla""in$ interest on ol& bon&s Call "re%iu% Fna%orti>e& .lotation cost o. ol& bon&s /$1*,000 9 2'E300 Fna%orti>e& &iscount on ol& bon&s /$4',000 9 2'E300 (otal ta9 &e&uctible e9"ense 9 ta9 rate at '02 (a9 savin$s
'4

$ 4',000 22,000 4',000 $142,000 $ 4',000 4',000 1',000 34,'00 $142,'00 9 '02 $ *+,2'0

/20

/30 /b0 !et /10

!et Cash ;ut.loB = $142,000 - $*+,2'0 = $'',4'0 ,nnual Interest Savin$s = ,nnual !et Cash ;ut.loB on ;l& 3on&s - ,nnual Cash ;ut.loB on !eB 3on&s) ,nnual !et Cash ;ut.loB on ;l& 3on&s Interest e9"ense /$1,'00,000 9 0)050 #ess8 (a9 savin$s interest e9"ense a%orti>ation o. .lotation cost /$1*,000E300 a%orti>ation o. &iscount /$4',000E300 total ta9 &e&uctible e9"ense 9 ta9 rate at '02 ta9 savin$s ,nnual net cash out.loB $13',000 13',000 +00 1,'00 $134,100 9 '02 $ +*,''0 $ ++,4'0 $10',000 10',000 **0 $10',**0 9 '02 $ '2,540 $ '2,0+0

/20

,nnual !et Cash ;ut.loB on !eB 3on&s Interest e9"ense /$1,'00,000 9 0)040 #ess8 ta9 savin$s interest e9"ense a%orti>ation o. .lotation cost /$22,000E2'0 total ta9 &e&uctible e9"ense 9 ta9 rate ta9 savin$s ,nnual net cash out.loB

/30 /c0

,nnual Interest Savin$s = $++,4'0 - $'2,0+0 = $14,350 -resent Galue = $14,350 9 -G,I?2','2 = $14,350 9 14)054 = $14,350 9 14)054 = $202,*13 !-G = $202,*13 - $'',4'0 = $144,0+3

/&0

3ecause the net "resent value o. the re.un&in$ &ecision is "ositive, the issue shoul& be re.un&e&)

''

/e0

$'',4'0 = $14,350 9 -G,I?2',r -G,I?2',r $'',4'0 S $14,350 = 3)*44 2+2 r-------------------) 3)*34 3)*44
y= 3)5*' 3)*44 /2+2 2'20 = 0)442 3)5*' 3)*34

---------------- 2'2 ) 3)5*'

r = 2'2 + 0)442 = 2')442 or b .inancial calculator8 2')432 3ecause the internal rate o. return .or the re.un&in$ &ecision /2')4420 e9cee&s the .ir%As re@uire& rate o. return /'20 a.ter ta9es0, the issue shoul& be re.un&e&) 1+-4 Increase in co%%on stock Increase in "re.erre& stock /$100,000 9 0)'0 !et Borth Increase in subor&inate& &ebt /$1'0,000 9 0)+0 !et Borth "lus subor&inate& &ebt Increase in bon&s /$240,000 9 0)40 (otal increase ,8 $'0 9 '0,000 9 /1 - 0)40 = $1,'00,000 38 $30 9 10,000 9 /1 - 0)40 = $1*0,000 C8 $100 9 2',000 9 /1 - 0)40 = $1,'00,000 68 $40 9 1',000 9 /1 - 0)40 = $3+0,000 1+-+ 1ort$a$e hol&ers :eneral cre&itors Subor&inate& &ebenture (otal $2' %illion $10 %illion 14 %illion 1 %illion 1002 402 '+ 4 $100,000 '0,000 $1'0,000 50,000 $240,000 1+*,000 $40*,000

1+-'

(he $' %illion .ro% the sale o. %ort$a$e assets $oes to the %ort$a$e hol&ers, leavin$ $' %illion o. their clai%s unsatis.ie&) ?ort /400 "ercent o. the $5 %illion .ro% the sale o. other assets or $3)+ %illion $oes to the %ort$a$e hol&ers .or a total recover o. $*)+ %illion) 3ecause the $eneral cre&itors are entitle& to receive $4)*4 %illion /$14 %illion 9 0)'+0, the re%ainin$ $')4/5 %illion - $3)+ %illion0 $oes to the $eneral cre&itors) 1+-4 /a0 $10 "er share 9 200,000 shares 9 3 ears = $+,000,000
'+

/b0 /c0

$+,000,000 + /$10 9 200,000 shares0 = $*,000,000 - $',000,000 = $3,000,000 !o co%%on stock &ivi&en&s can be "ai& until all the "re.erre& &ivi&en&s in arrears are "ai& to the cu%ulative "re.erre& stockhol&ers)

'4

CHAPTER 17 COMMON STOCK 14-1 /a0 /b0

1 200,000 +1 = 20,001 shares 5 +1

100,001 shares

/c0
/*0,001 10/5 +10 *00,000 = = 4 directors 200,000 200,000

/&0
+ 200,000 +1 = 120,001 shares 5 +1

(hus, the &issi&ent stockhol&ers nee& 40,000 shares %ore to elect si9 &irectors) 14-2 /a0 ,nnual "re.erre& &ivi&en&s = 20,000 9 $4 = 6ivi&en&s in arrears -re.erre& &ivi&en&s &ue Current earnin$s #ess8 "re.erre& &ivi&en&s &ue Co%%on &ivi&en&s /b0 Current earnin$s #ess8 "re.erre& &ivi&en&s 7arnin$s available to co%%on stockhol&ers 9 -a out ratio /*020 Co%%on &ivi&en&s -rice "er share -re%iu% /4020 Conversion "rice $ *0,000 240,000 $320,000 $3'0,000 320,000 $ 30,000 $420,000 320,000 $100,000 9 *02 $ *0,000 $2' 10 $3'

14-3

/a0

/b0 /c0

?ace value "er bon&EConversion "rice = $1,000 $3' = 2*)'4 Conversion value = 2*)'4 9 $2' = $414)2'

'*

/&0 e

200 bon&s 9 2*)'4 shares "er bon& = ',414 neB shares /e0 (he neB conversion value = 2*)'4 9 $40 = $1,142)*0

$ 1 , 1 4 2 . 8 $ 1 , 0 5 0 P r e m i u m = = 8 . 8 % $ 1 , 0 5 0

I. investors re@uire a *)* "ercent "re%iu% o. conversion "rice over call "rice or less, the call %a .orce the% to convert their bon&s into co%%on stock) 14-4 /a0 !eB shares = $100,000E$'0 = 2,000 (otal shares a.ter conversion = '0,000 + 2,000 = '2,000 3e.ore Conversion $'00,000 +,000 454,000 244,000 $244,000 S '0,000 $4)54 ,.ter Conversion $'00,000 0 $'00,000 2'0,000 $2'0,000 S '2,000 $4)*1

73I( #ess8 interest /+20 7arnin$s be.ore ta9es #ess8 ta9es at '02 7arnin$s a.ter ta9es W !u%ber o. co%%on shares 7arnin$s "er share /b0

(he e9istin$ co%%on stockhol&ers Boul& control 5+)1' "ercent a.ter conversion /'0,000E'2,0000) (hus, the conversion Boul& &ilute the votin$ control o. the .ir% b 3)*' "ercent) Galue o. one ri$ht = /$3' - $200 E /2+10 = $' Galue o. one Barrant = /$3' - $300/20 = $10 (heoretical value o. one co%%on share = $3' - $' = $30 (he Barrant hol&ers are "rotecte& a$ainst the &ilution e..ect o. the ri$hts o..erin$ onl i. the .or%ula value o. the Barrants re%ain the sa%e a.ter the stock sells e9-ri$hts) (hus, the neB subscri"tion "rice o. the Barrant as .olloBs8 $10 = /$30 - 0 9 2 = $2'

14-'

/a0 /b0 /c0 /&0

'5

CHAPTER 18 DIVIDEND POLICY AND RETAINED EARNINGS 1*-1 6ivi&en& "a out ratio = / 7arnin$s - Retaine& ?un&s0 7arnin$s = / $40,000 - $21,0000 $40,000 = 0)40 Co%%on stock /1,3*0 shares at $10 "ar0 Ca"ital sur"lus M$4,000 + /$1* - $100/1*00N Retaine& earnin$s M$23,000 - /$1*0/1*00N !et Borth /a0 /b0 1*-4 $13,*00 *,440 15,4+0 $42,000

1*-2

1*-3

=ei$hte& avera$e cost o. ca"ital = 0)4 9 2)'2 + 0)' 9 +2 + 0)1 9 102 = '2 6ivi&en&s shoul& not be "ai& because the .ir%As "ro.itable invest%ent o""ortunities re@uire %ore %one than its current earnin$s)

HHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHH Cash $'2,000Co%%on stock /1,100 shares at $10 "ar0 $11,000 Ca"ital sur"lus 21,000 Retaine& earnin$s 20,000 /a0 7arnin$s available .or &ivi&en&s = $200,000 9 0)' = $100,000 6ivi&en&s "er share = $100,000 S 2',000 = $4 /b0 /c0 (he %arket "rice o. the stock = $10 + $4 = $14 (he .un&s re@uire& to bu ',000 shares = ',000 9 $10 = $'0,000 6ivi&en& "er share = /$100,000 - $'0,0000 S 20,000 = $2)' /&0 !eB earnin$s "er share = $200,000 S 20,000 = $10 1arket "rice = $10 9 1)2' = $12)' "er share (otal value to re%ainin$ stockhol&ers = $12)' + $2)' = $1' a share (he re"urchase o. =alkerAs shares Boul& increase the "rice o. the stock b $1 an& thus the shares shoul& be re"urchase&)

1*-'

+0

1*-+

/a0 /b0 /c0

-ai&-in sur"lus + retaine& earnin$s = $2',000 + $1',000 = $40,000 $10,000 Cash an& accounts receivable Bill &ecrease b $',000 each an& retaine& earnin$s Bill &ecrease b $10,000) (hus, the co%"an Bill have the .olloBin$ balance sheet a.ter the $10,000 &ivi&en& "a %ent) Cash Receivables Inventor ?i9e& assets (otal assets $10,000 20,000 40,000 20,000 $50,000 ,ccounts "a able Co%%on stock -ai&-in sur"lus Retaine& earnin$s (otal clai%s $2',000 3',000 2',000 ',000 $50,000

1*-4

It is obvious that the %arket "rices o. these tBo stocks &e"en& on &ivi&en& "a %ents) It is i%"ortant to note that the avera$e &ivi&en& "er share .or both co%"anies is $1)4') DoBever, the avera$e %arket "rice .or Co%"an ,As stock /$13)*0 a share0 has been a""ro9i%atel 31 "ercent loBer that .or Co%"an 3As stock /$1*)20 a share0) Co%"an , has "ai& a constant "ercenta$e o. its earnin$s /'020C this in&icates Bh its &ollar &ivi&en& has .luctuate& &irectl Bith earnin$s) In contrast, Co%"an 3 has "ai& $1)4' "er share ever ear) ,s Cha"ter 1* "ointe& out, investors ten& to "lace a "ositive utilit on &ivi&en& stabilit ) 3ecause such a "olic re&uces the investorAs uncertaint , it conse@uentl increases the stock "rice)

+1

CHAPTER 19 TERM LOANS AND LEASES 15-1 /a0 (he "resent value o. the a.ter-ta9 cash out.loBs .or the bu in$ alternative is co%"ute& as .olloBs8 /10 ,nnual #oan -a %ent /,0 $200,000 = C? 9 -G,I?',1+2 /3)2440
A= $200,00 = $+1,0*4 3)244

or b .inancial calculator8 $+1,0*1)** /20 <ear 0 1 2 3 4 ' /30 <ear 1 2 3 4 ' /40 <ear 1 2 3 4 ' (er% #oan ,%orti>ation Sche&ule ,nnual Interest -a %ent at 1+2 Re"a %ent $200,000 $+1,0*4 $32,000 $25,0*4 +1,0*4 24,34+ 33,441 +1,0*4 21,54* 35,135 +1,0*4 1',+*' 4',402 +1,0*4 *,421 '2,+++ ,.ter-(a9 Cash ;ut.loBs ,nnual -a %ent Interest $+1,0*4 $32,000 +1,0*4 24,34+ +1,0*4 21,54* +1,0*4 1',+*' +1,0*4 *,421

3alance 140,513 134,142 5*,033 '2,+31 (a9 Shiel& $3+,000 33,+43 30,544 24,*42 24,210 Re%ainin$ 3alance $2',0*4 24,414 30,113 33,24' 3+,*44

6e"r) $40,000 40,000 40,000 40,000 40,000

-resent Galue o. ,.ter-(a9 Cash ;ut.loBs ,.ter-(a9 6iscount -resent Cash ;ut.loBs ?actor at 102 Galue $2',0*4 0)505 $22,*04 24,414 0)*2+ 22,+44 30,113 0)4'1 22,+1' 33,24' 0)+*3 22,40+ 3+,*44 0)+21 22,501 ,$$re$ate -resent Galue = $113,+40

+2

/b0

$200,000 = C? + C? 9 -G,I?4,142 /2)5140 $200,000 = C? /1 + 2)5140 C? = 00000E3)514 C? = $200,000 S 3)514 = $'1,055 or b .inancial calculator8 $'1,102)3* (he "resent value o. the a.ter-ta9 cash out.loBs .or the leasin$ alternative is co%"ute& as .olloBs8 <ear 0 1-4 ' #ease -a %ent $'1,055 '1,055 (a9 Shiel& $ 0 2','45)' 2','45)' ,.ter-(a9 -resent Galue Cash ;ut.loB at 102 $'1,055 $'1,055 2','45)' *0,552 -2','45)' -1',*++ -resent Galue = $11+,22'

15-2

/a0

;"tion ,

,nnuali>e& lease cost /,0 = $20,000E-G,I?3,102 = $20,000E2)4*4 = $*,042 or b .inancial calculator8 $*042)30 ,nnuali>e& %aintenance an& o"eratin$ cost (otal annuali>e& cost ;"tion 3 ,nnuali>e& lease cost /,0 = $+0,000E-G,I?*,52 = $+0,000E')'3' = $10,*40 or b .inancial calculator8 $10,*40)4+ ,nnuali>e& %aintenance an& o"eratin$ cost (otal annuali>e& cost 3,000 $13,*40 4,000 $12,042

;n annuali>e& cost basis, ;"tion , is less costl than ;"tion 3) /b0 ;"tion , ;"tion 3 #ease Cost + ;"eratin$ Cost = (otal ,nnuali>e& Cost $*,042 + 9 = $13,*40 9 = $',45*

,s lon$ as the annual %aintenance an& o"eratin$ cost .or ;"tion , is less than $',45*, ;"tion , Bill re%ain a loBer cost lease than ;"tion 3)
+3

/c0

;"tion 3 ;"tion , #ease Cost + ;"eratin$ Cost = (otal ,nnuali>e& Cost $+0,000E-G,I?*,i2 + $3,000 = $12,042 -G,I?*,i2 = $+0,000E/$12,042-$3,0000 = +)+3+

(he &iscount .actor +)+3+ is .oun& to be a""ro9i%atel 4)4 "ercent) ,s lon$ as the i%"licit interest rate .or ;"tion 3 is less than 4)4 "ercent, ;"tion 3 Bill be the loBest cost lease than ;"tion ,) or b .inancial calculator8 4)3'2) 15-3 /a0 #oan = $24,000 9 -G,I?',122 = $24,000 9 3)+0' = $54,33'

or b .inancial calculator8 $54,32*)5+ /b0 3alance at be$innin$ o. ear 9 Interest rate o. 122 Interest "a %ent (otal "a %ent #ess8 lease "a %ent #oan re"a %ent Initial loan balance #ess8 loan re"a %ent 3alance at en& o. ear 15-4 7..ective interest rate = 0)05E0)50 = 102 $3+,000 = C? 9 -G,I?4,'2 C? = $3+,000 S 3)'4+ = $10,1'2 or b .inancial calculator8 $10,142)43) ,s lon$ as the se%iannual "a %ents .or the sales are less than $10,1'2, the sales contract is less costl than the bank loan) 1st <ear $54,33' 9 122 $11,+*0 $24,000 11,+*0 $1',320 $54,33' 1',320 $*2,01' 2n& <ear $*2,01' 9 122 $ 5,*42 $24,000 5,*42 $14,1'* $*2,01' 14,1'* $+4,*'4

+4

15-' 7n& o. <ear 0 1-5 10 15-+ 3ank -a %ents

,.ter-ta9 #ease (a9 Cash -resent Galue -a %ent Shiel& ;ut.loBs at 102 $100,000 $ 0 $100,000 $100,000 100,000 40,000 +0,000 34','40 -40,000 -1',440 -resent Galue o. ,.ter-(a9 cash out.loBs = 430,100

$1+0,000 = C? 9 -G,I?12,102 /+)*140 C? = $ 1+0,000 S +)*14 = $23,4*1 or b .inancial calculator8 $23,4*2)13) =e &o not nee& to co%"ute the "resent value .or each alternative because there are no ta9es an& "a %ents .or both alternatives are %a&e at the en& o. each ear) (hus, the co%"an shoul& lease at /$22,'000 the co%"uter rather than bu it at /$23,4*10)

+'

CHAPTER 1 ? ? ( ( ? ( ? ( ? ?

GOALS AND FUNCTIONS OF FINANCE

1) (Bo %aIor characteristics o. .inance be.ore the late 15'0s Bere &escri"tive an& & na%ic) 2) (Bo %aIor characteristics o. .inance a.ter the 15'0s Bere anal tical an& static) 3) (he "ri%ar $oal o. the .ir% is to %a9i%i>e stockhol&er Bealth as re.lecte& b "ershare "rice) 4) -ro.it is not the "ro"er obIective o. the .ir% because it i$nores the ti%e value o. %one an& risk) ') 1ost .inancial %ana$ers coul& be assu%e& to be the econo%ic "erson because the %ake &ecisions on the basis o. co%"lete knoBle&$e) +) (he stockhol&ers o. %ost lar$e cor"orations to&a have ver little control over the o"erations o. the co%"an because the are Bell &iversi.ie&) 4) 1ana$ers act in the best interest o. stockhol&ers because the $oals .or these tBo $rou"s o. "eo"le are alBa s consistent Bith each other) *) (o insure that %ana$ers act in the best interest o. the stockhol&ers, a""ro"riate incentives shoul& be $iven to the% an& the have to be %onitore&) 5) (he treasurer o. a co%"an is res"onsible .or cash %ana$e%ent, bankin$, raisin$ .un&s, .inancial accountin$, an& ca"ital bu&$etin$) 10) (he three %aIor .unctions o. the .inancial %ana$er are .inancial "lannin$ an& control, the ac@uisition o. .un&s on .avorable ter%s, an& the "re"aration o. .inancial state%ents on a historical basis) 11) (ra&itionall , the role o. the .inancial %ana$er Bas li%ite& to the e..icient allocation o. .un&s) 12) ?or the risk-averse &ecision %aker, the hi$her the risk o. a "roIect, the hi$her the e9"ecte& return %ust be) 13) (he .inancial %ana$er shoul& e9a%ine available risk-return tra&e-o..s an& %ake his or her &ecisions base& u"on the $oal o. %a9i%i>in$ stockhol&er Bealth) 14) 1o&ern or$ani>ation theor looks u"on a business .ir% as a s ste% Bhich consists o. an &e"art%ents an& &ivisions)

? ( ( (

++

CHAPTER ? ( ( ( ? ? ( ( ? ( ( ? ? ( ?

OPERATING ENVIRONMENT OF FINANCIAL MANAGEMENT

1) (here are various Ba s to %easure the %one su""l , but all counts inclu&e coin, currenc , &e%an& &e"osits, an& ti%e &e"osits) 2) 6e"ositor .inancial institutions inclu&e co%%ercial banks, %utual savin$s banks, savin$s an& loan associations, an& cre&it unions) 3) 3oth %utual savin$s banks an& savin$s an& loan associations "ri%aril %ake %ort$a$e loans to in&ivi&uals) 4) Interest rate ceilin$s on savin$s an& ti%e &e"osits Bere to be "hase& out over ti%e un&er the 6e"ositor Institutions 6ere$ulation an& 1onetar Control ,ct o. 15*0) ') (he ke %one %arket instru%ents inclu&e (reasur bills, co%%ercial "a"er, bankersA acce"tances, an& bon&s) +) (he or$ani>e& securit e9chan$es "rovi&e short-ter% &ebt .inancin$) 4) Cost-"ush in.lation re"resents a situation Bhere "rices rise because o. increases in labor costs) *) (he no%inal rate o. interest consists o. the real interest rate an& the e9"ecte& rate o. in.lation) 5) In.lation re&uces the a%ount o. .un&s re@uire& to con&uct a $iven volu%e o. business) 10) ?inancial inter%e&iation is the "rocess b Bhich savin$s are accu%ulate& in .inancial institutions an& then lent or investe&) 11) (he invest%ent banker acts as a %i&&le%an betBeen issuers an& bu ers o. neB securit issues) 12) ,&vanta$es o. a sole "ro"rietorshi" inclu&es loB start-u" costs, ta9 savin$s, li%ite& liabilit , an& oBnershi" o. all "ro.its) 13) 6isa&vanta$es o. a "artnershi" inclu&e unli%ite& liabilit , &ivi&e& authorit , &i..icult to raise .un&s, an& hi$h or$ani>ational cost) 14) (he three basic .or%s o. business or$ani>ation are the sole "ro"rietorshi", "artnershi", an& cor"oration) 1') (he cor"oration is the &o%inant .or% o. business or$ani>ation in ter%s o. nu%bers)
+4

? (

1+) (he three %aIor a&vanta$es o. the cor"oration inclu&e .ree trans.erabilit o. oBnershi", lack o. continuit , an& ease o. raisin$ .un&s) 14) (he %aIor &isa&vanta$es o. the cor"oration are the costs o. incor"oration, the .ul.ill%ent o. the re@uire%ents set .orth b .e&eral re$ulator a$encies, an& the len$th o. ti%e re@uire& to .or% a cor"oration) 1*) (he %ar$inal ta9 rate is the co%"an As total ta9 bill &ivi&e& b its ta9able inco%e) 15) (he three basic %etho&s o. &e"reciation are strai$ht-line, &ouble &eclinin$-balance, an& su%-o.- ears-&i$its) (he last tBo %etho&s o. &e"reciation are so%eti%es calle& the accelerate& &e"reciation %etho&s) 20) Interest earnin$s %a&e b a cor"oration are .re@uentl subIect to tri"le ta9ation) 21) (he inco%e ta9 rate a""licable to cor"orate inco%e is constant re$ar&less o. the a%ount o. inco%e) 22) 6ivi&en&s receive& b in&ivi&uals .ro% cor"orations are not ta9e& because cor"orate inco%e ta9es have alrea& been "ai&) 23) Cor"orations are %uch %ore heavil re$ulate& b the $overn%ent than are sole "ro"rietorshi"s) 24) Co%%ercial banks are the lar$est t "e o. .inancial institution in the a%ount o. .inancial assets the hol&) 2') ?our %aIor in$re&ients o. a cre&it union are a $rou" o. "eo"le, a co%%on interest, "oole& savin$s, an& loans to each other) 2+) -ension .un&s are establishe& to "rovi&e inco%e to retire& or &isable& "ersons in the econo% ) 24) ?inance co%"anies .or%e& b "arent .ir%s to .inance the sales o. the "arentAs $oo&s are so%eti%es calle& Xca"tiveX .inance co%"anies) 2*) Co%%ercial "a"er consists o. short-ter% unsecure& "ro%issor notes sol& b .inance co%"anies an& certain in&ustrial concerns)

? (

( ? ? ( ( ( ( ( (

+*

CHAPTER 3 ? ? ( ( ? ( ? ( ( ? (

FINANCIAL STATEMENT ANALYSIS

1) (he balance sheet su%%ari>es a .ir%As assets, liabilities, an& stockhol&ersA e@uit &urin$ a "articular "erio& o. ti%e) 2) (he inco%e state%ent reveals the "er.or%ance o. a .ir% on a $iven &ate) 3) (he .our %aIor $rou"s o. the co%"an are short-ter% cre&itors, lon$-ter% cre&itors, %ana$e%ent, an& stockhol&ers) 4) (he .inancial %ana$er shoul& e9"lore the i%"act o. in.lation on ratios because in.lationar .orces &istort so%e .inancial &ata) ') #evera$e ratios %easure the co%"an As abilit to "a its short-ter% obli$ations) +) Quick assets consist o. cash, accounts receivable, an& %arketable securities) 4) , hi$h inventor turnover i%"lies e9cess inventor in relation to sales) *) (he avera$e collection "erio&, the asset turnover, an& the inventor turnover are base& on &ata .ro% both the balance sheet an& the inco%e state%ent) 5) (he return on invest%ent /R;I0 is the "ro.it %ar$in on sales %ulti"lie& b the asset turnover) 10) (he co%%on-si>e balance sheet states each asset, liabilit , an& oBnersA e@uit account as a "ercent o. sales) 11) Ratio anal sis %eans ver little unless the ratios &evelo"e& .or a "articular co%"an at a $iven "oint in ti%e are co%"are& Bith its historical ratios, in&ustr avera$es, or both) 12) (he characteristics o. .inancial ratios &o not var si$ni.icantl .ro% in&ustr to in&ustr ) 13) 3oth 6un K 3ra&street an& Robert 1orris ,ssociates "ublish in&ustr avera$e ratios) 14) I. ever thin$ else is e@ual, &ecreasin$ asset turnover or increasin$ "ro.it %ar$in on sales Bill raise the .ir%As return on invest%ent)

? ( ?

+5

CHAPTER 4 ? ? ( ( ( ( ? ( ? ( ( ( ? ( ?

LEVERAGE AND RISK ANALYSIS

1) 3reak-even anal sis is a &evice to &eter%ine the "oint at Bhich sales Bill Iust cover variable costs) 2) 6e"reciation is one o. the variable costs nee&e& to co%"ute the break-even "oint) 3) (he break-even "oint an& the break-even chart are vali& i. the state& costs an& "rices re%ain constant) 4) ;"eratin$ levera$e causes earnin$s be.ore interest an& ta9es to .luctuate %ore Bi&el than sales volu%e) ') ?inancial levera$e causes earnin$s "er share to .luctuate %ore Bi&el than earnin$s be.ore interest an& ta9es) +) ;ther thin$s bein$ e@ual, the co%"an can increase its break-even "oint b re&ucin$ its "rice) 4) ?inancial levera$e a..ects the le.t-han& si&e o. the balance sheet an& o"eratin$ levera$e in.luences the ri$ht-han& si&e o. the balance sheet) *) (he closer the sales volu%e to the break-even "oint, the $reater the &e$ree o. o"eratin$ levera$e) 5) (he co%bine& e..ect o. o"eratin$ levera$e an& .inancial levera$e is the &e$ree o. o"eratin$ levera$e "lus the &e$ree o. .inancial levera$e) 10) ;"eratin$ risk is the "ossibilit that the co%"an Bill be unable to cover its .i9e& costs) 11) (he un&erl in$ cause o. %ost business .ailures is inco%"etent %ana$e%ent) 12) (he &eter%ination o. the co%"an As o"ti%u% ca"ital structure is not eas , even thou$h there are a nu%ber o. ratios to %easure the .ir%As .inancial risk) 13) Di$h levera$e is o.ten associate& Bith loB risk Bhereas loB levera$e is o.ten associate& Bith hi$h risk) 14) 1an co%"anies increase o"eratin$ an& .inancial levera$e in or&er to increase e9"ecte& earnin$s be.ore interest an& ta9es as Bell as earnin$s "er share) 1') ?i9e& costs inclu&e %ana$e%ent salaries, rent, buil&in$ %aintenance costs, "oBer .or "ro&uction e@ui"%ent, an& real estate "ro"ert ta9es)
40

CHAPTER 5 ( ? ? ( ? ? ? ( ? ( ? ? ( (

FINANCIAL PLANNING AND FORECASTING

1) 3u&$ets are "re-establishe& stan&ar&s to Bhich o"erations are evaluate&, co%"are&, an& a&Iuste& b the e9ercise o. control) 2) (he sales bu&$et is the ke in"ut to all o. the "ro .or%a .inancial state%ents because sales bu&$ets /.orecasts0 are $enerall %ore accurate) 3) (he cash bu&$et in&icates on a historical basis Bhere cash ca%e .ro% an& hoB it Bas use&) 4) -ro .or%a .inancial state%ents "rovi&e esti%ates o. assets, liabilities, e@uities, o"eratin$ e9"enses, an& earnin$s a.ter ta9es) ') (he &ecrease in cash balances &urin$ a $iven "erio& o. ti%e alBa s re"resents the &ecrease in net "ro.its o. the co%"an ) +) In the sources an& uses o. .un&s state%ent, an increase in cash is classi.ie& as a source o. .un&s) 4) Short-ter% cash bu&$ets are t "icall use& to "lan .or o"eratin$ nee&s an& .i9e& asset e9"ansion) *) (he "ro&uction bu&$et re.lects the use o. raB %aterials, labor, an& .acilities) 5) =hen sales are erratic an& the cash balance is loB, %onthl cash bu&$ets %a be %ore &esirable than the Beekl cash bu&$et) 10) (he cash bu&$et is "articularl use.ul to &eter%ine Bhen a&&itional .un&s Bill be re@uire& an& Bhen cash sur"lus Bill occur) 11) (he sales bu&$et re.lects such e9"enses as a&vertisin$, sellin$, an& other sales e9"enses) 12) , sales bu&$et is not usuall nee&e& to &evelo" a cash bu&$et) 13) (he "ercent-o.-sales %etho& assu%es that all accounts on the balance sheet chan$e in so%e .i9e& "ro"ortion to chan$es in sales) 14) Increases in accounts "a able an& accruals are .re@uentl calle& s"ontaneousl $enerate& liabilities because the Boul& auto%aticall .inance a "art o. sales increases)

41

CHAPTER 6 AN OVERVIEW OF WORKING CAPITAL MANAGEMENT ( 1) ,lthou$h Borkin$ ca"ital is &e.ine& as the .ir%As invest%ent in current assets, Borkin$ ca"ital %ana$e%ent re.ers to the %ana$e%ent o. both current assets an& current liabilities) 2) (he ter% Xnet Borkin$ ca"italX is use& to %ean current assets %inus current liabilities) 3) I. the co%"an &esires to re&uce its .inancial risk, it %ust .inance its short-ter% assets Bith its short-ter% .un&s) 4) , conservative Borkin$ ca"ital "olic is likel to have the .eature o. a loB current ratio) ') ;r&inaril , the o"eratin$ c cle starts Bith cash an& en&s Bith the "urchase o. %erchan&ise in cash) +) (he s%aller the "ro"ortion o. current assets to total assets, the lar$er the rate o. return an& the loBer the &e$ree o. risk) 4) ,n a""roach &esi$ne& to %atch the %aturit structure o. the .ir%As assets an& liabilities is knoBn as the %atchin$ "rinci"le) *) (he .ir% inten&s to "a o.. its short-ter% bank loans) (hese .un&s coul& co%e .ro% tra&e cre&it, &ela in$ the "a %ent o. accounts "a able, the sale o. co%%on stock, an& s"ee&in$ u" the collection "rocess o. accounts receivable) 5) #on$-ter% interest rates $enerall .luctuate %ore Bi&el than short-ter% interest rates) 10) 3oth lon$-ter% rates an& short-ter% rates have increase& Bith no interru"tions over the "ast .ive &eca&es) 11) (he cash c cle shoBs that cash out.loBs an& cash in.loBs are not %atche& in both ti%in$ an& a%ount) 12) (he len$th o. the co%"an As o"eratin$ c cle &e"en&s at least "artl u"on the nature o. the business) 13) ,s the level o. sales increases, the level o. "er%anent current assets $roBs) 14) 79"ectations about .uture lon$-ter% interest rates are use& to "re&ict the sha"e o. the iel& curve)
42

( ( ? ? ? ( ?

? ? ( ( ( ?

CHAPTER 7 ? ( ( ( ? ? ( ( ?

CURRENT ASSET MANAGEMENT

1) (he three %aIor %otives .or hol&in$ cash are the transaction %otive, the "recautionar %otive, an& the sa.et %otive) 2) (he lock bo9 s ste% an& the concentration bankin$ are use& to convert custo%ersA "a %ents as @uickl as "ossible into usable .un&s) 3) 1ore .re@uent re@uisitions o. .un&s b &ivisional o..ices .ro% the co%"an As ho%e o..ice ten& to .ree %ore .un&s on a te%"orar basis) 4) (he three %aIor criteria use& in the selection o. %arketable securities are %arketabilit , sa.et , an& %aturit ) ') (he level o. accounts receivable &e"en&s lar$el on the avera$e collection "erio&, the level o. accounts "a able, an& the a%ount o. cre&it sales) +) (he .ive CAs o. cre&it are character, ca"acit , cre&it, collateral, an& con&ition)

4) (he a%ount o. collection e9"en&itures an& the a%ount o. ba& &ebt losses are inversel relate& Bith each other, but the are not linear) *) (he econo%ic or&er @uantit /7;Q0 .or%ula is &esi$ne& to &eter%ine the o"ti%u% inventor si>e) 5) ,n increase in cash an& %arketable securities in co%bination Bith a re&uction in inventories an& accounts receivable tells us that the @ualit o. current assets has &eteriorate&) 10) (he co%"an %a .in& it use.ul to &eter%ine an 7;Q ran$e rather than a "oint i. total inventor costs are sensitive to the or&er si>e) 11) (he lea& ti%e is the "erio& that ela"ses betBeen the ti%e an or&er is "lace& an& it is &elivere&) 12) (here is a &irect relationshi" betBeen the inventor or&er si>e an& the carr in$ costs) 13) (he treasur has raise& %one on an irre$ular basis throu$h the sale o. Xcash %ana$e%entX bills since 1544) 14) Short-ter% invest%ent "oolin$ arran$e%ents are lar$e "ools o. short-ter% .inancial instru%ents)

? ( ( ( (

43

CHAPTER 8 ( ( ? ? ( ( ? ?

SOURCES OF SHORT-TERM FINANCING

1) S"ontaneous liabilities are those that $roB out o. nor%al "atterns o. success.ul o"erations in the business) 2) Co%"anies usuall enIo the lon$est cre&it ter%s Bhen the bu un&er the ter%s o. seasonal &atin$s) 3) (he e..ective rate o. interest an& the no%inal rate o. interest /cou"on interest rate0 are the sa%e Bhen interest is "ai& on a &iscount basis) 4) 3ank loans are %ore volatile an& less &e"en&able than %one %arket sources o. .un&s at ti%es o. shar"l intensi. in$ .inancial strain) ') , %aIor &isa&vanta$e o. co%%ercial "a"er is that it is hi$hl i%"ersonal)

+) I. the co%"an .actors its accounts receivable, it can eli%inate its cre&it &e"art%ent) 4) ?loatin$ liens are e9tre%el "o"ular in "ractice because the len&er can e9ercise ti$ht control over the collateral) *) , line o. cre&it is a .or%al a$ree%ent betBeen a bank an& its custo%er Bith res"ect to the %a9i%u% a%ount o. cre&it that the bank Bill alloB its custo%er to oBe over a $iven "erio& o. ti%e) 5) I. Barehouse recei"ts are use& to .inance inventories, the inventories are in the "ossession o. an in&e"en&ent thirt "art ) 10) Co%%ercial "a"er consists o. secure& "ro%issor notes issue& b relativel BellknoBn co%"anies) 11) (he %aIor a&vanta$es o. tra&e cre&it are its availabilit an& .le9ibilit ) 12) (he three %aIor .or%s o. tra&e cre&it are o"en account, notes "a able, an& tra&e acce"tances) 13) 1ost short-ter% bank loans are %a&e on an unsecure& basis .or business .ir%s to cover their seasonal increases in inventories or accounts receivable) 14) (he "ri%e len&in$ rate is the rate o. interest char$e& on short-ter% business loans to the least cre&it-Borth custo%ers)

( ? ( ( ( ?

44

CHAPTER 9 ? (

TIME VALUE OF MONEY

1) (he "resent value o. a $iven .uture lu%" su% increases as the &iscount rate increases) 2) (he ter% Xannuit X usuall re.ers to a series o. annual "a %ents /recei"ts0 o. an e@ual a%ount, but it %a also a""l to a "a %ent sche&ule Bith various intervals, i)e), such as 30-&a interval or +-%onth interval) 3) (he "resent value o. an annuit .alls as the nu%ber o. co%"oun&in$ /&iscountin$0 "erio&s "er ear increases) 4) (he current "rice o. a bon& is the "resent value o. "erio&ic "a %ents "lus the "resent value o. its %aturit value) ') , "er"etuit is an annuit Bhose ter% be$ins on a &e.inite &ate an& en&s on a &e.inite &ate) +) (he no%inal rate o. interest e@uals the e..ective rate o. interest onl i. interest is co%"oun&e& se%iannuall ) 4) (he relationshi" betBeen the co%"oun& value an& the "resent value is reci"rocal) *) (he sinkin$ .un& sche&ule is the retire%ent o. a &ebt "lus its interest b %akin$ a set o. e@ual "erio&ic "a %ents) 5) =hen a bon& sells .or e9actl its "ar value, the cou"on interest rate an& iel& to %aturit are e@ual) 10) (he value o. an securit is e@ual to the co%"oun& value o. cash .loBs e9"ecte& to be receive& b the investor) 11) (he a%orti>ation %etho& re.ers to the retire%ent o. a &ebt b %akin$ a set o. e@ual "erio&ic "a %ents) (hese "erio&ic "a %ents inclu&e both interest an& "rinci"al) 12) (he value o. a bon& is a..ecte& b the cou"on rate o. the bon&, the %aturit &ate o. the bon&, the &iscount rate / iel& to %aturit 0, an& the recor&e& value o. the .ir%As assets) 13) Co%%on stock invest%ents an& %ost ca"ital invest%ent "roIects involve even cash .loBs)

( ( ? ? ( ? ( ? ( ?

4'

CHAPTER 1 ( ? ? ( ? 1)

VALUATION

(he $oal o. the .ir% is %a9i%i>e the %arket value o. co%%on stock)

2) (he value o. an real or .inancial asset is the .uture value o. the e9"ecte& cash .loBs .ro% the asset co%"oun&e& at the investorTs re@uire& rate o. return) 3) Galuation is a .unction o. e9"ecte& cash .loBs an& historical cost) 4) (he investorsT return on the .un&s investe& is the un&erl in$ .ir%Ts cost o. usin$ the .un&s) ') -rovi&in$ a return to the oBner that beats the co%"etition, Bill encoura$e %arket "artici"ants to bu the Beaker .ir%Ts an& stock /"ushin$ its stock "rice &oBn0 an& sell the stron$er .ir%Ts stock, thereb "ushin$ its stock "rice u" an& vice versa) +) (he seller o. the bon& is the borroBer an& the bu er is the len&er or investor) 4) (he loBer the &esire& iel& to %aturit .or a bon&, the loBer the "rice o. the bon& an& vice versa) *) (hus iel& an& bon& "rice %ove in sa%e &irection) 5) I. the iel& to %aturit on a bon& is $reater than the cou"on rate o. the bon&, the bon& Bill sell at a &iscount) 10) , "er"etuit is a s"ecial .or% o. an annuit Bhose ter% be$ins on a &e.inite &ate an& en& on a &e.inite &ate) 11) (o &eter%ine the a""ro"riate %arket value o. "re.erre& stock, &ivi&e the stockTs annual &ivi&en& b the "re.erre& stockhol&erTs re@uire& rate o. return on the invest%ent) 12) (he "rice o. a share o. co%%on stock %a be inter"rete& b the stockhol&er as the "resent value o. the e9"ecte& .uture &ivi&en&s) 13) (o esti%ate the "resent value o. .uture &ivi&en&s so%e assu%"tion about the co%"an Ts e9"ecte& &ivi&en& $roBth rate is necessar ) 14) In the constant $roBth case, Be assu%e the .ir%Ts &ivi&en& "er share Bill $roB at a constant rate .or a &e.inite "erio& o. ti%e) 1') In the no-$roBth case, the .ir%Ts &ivi&en& is assu%e& to re%ain the sa%e .or in&e.inite "erio&s in the .uture)
4+

( ? ? ( ? (

( ( ? (

CHAPTER 11 ? ( ? ? ( ? ( ( (

THE COST OF CAPITAL

1) (he ca"ital structure consists o. lon$-ter% &ebt, notes "a able, "re.erre& stock, co%%on stock, an& retaine& earnin$s) 2) (he Bei$hte& avera$e cost o. ca"ital is usuall use& as the .ir%As cost o. ca"ital) 3) (he cost o. &ebt is a&Iuste& .or inco%e ta9es because interest "a %ents occur a.ter ta9es) 4) ') +) 4) -re.erre& stock is consi&ere& &ebt to the e9tent that "re.erre& &ivi&en&s are a ta9&e&uctible e9"ense) (he cost o. co%%on e@uit is the %ost &i..icult conce"t to %easure) 7..icient ca"ital %arkets e9ist Bhen securit "rices re.lect all available in.or%ation an& %arket "rices a&Iust sloBl to neB in.or%ation) S ste%atic risk /beta coe..icient0 is an in&e9 o. volatilit in the e9cess return o. one co%%on stock over that o. a %arket "ort.olio)

*) Fns ste%atic risk is al%ost non-e9istent Bhen ca"ital %arkets are e..icient an& investors are Bell &iversi.ie&) 5) (Bo alternative Ba s to s"eci. the "ro"ortions o. the ca"ital structure in calculatin$ the Bei$hte& avera$e cost o. ca"ital are book value Bei$hts an& %arket value Bei$hts)

( ( ( (

10) I. the "ri%ar $oal o. the .ir% is to %a9i%i>e its %arket value, %arket value Bei$hts are consistent Bith the .ir%As obIective) 11) (he cost o. retaine& earnin$s is sli$htl loBer than the cost o. neB co%%on stock because retaine& earnin$s &o not involve .lotation costs) 12) (he o"ti%u% ca"ital structure is &e.ine& as the co%bination o. &ebt, "re.erre& stock, an& co%%on e@uit that iel&s the loBest cost o. ca"ital) 13) (he conce"t o. o"ti%u% ca"ital structure is base& on the assu%"tion that the "ru&ent use o. &ebt can loBer the .ir%As overall cost o. ca"ital)

44

CHAPTER 1CERTAINTY ? ( ? ( ( ? ? ? ? (

CAPITAL .UDGETING UNDER

1) (he entire "rocess o. "lannin$ e9"en&itures Bhose bene.its are e9"ecte& to e9ten& be on& one ear is knoBn as a ca"ital rationin$ constraint) 2) (he ulti%ate success o. co%"an o"erations &e"en& si$ni.icantl u"on soun& ca"ital bu&$etin$ &ecisions) 3) (he ca"ital bu&$etin$ "rocess %ust .olloB an i&eall "rescribe& or&er because there are %an ste"s an& ele%ents in the Bhole "rocess o. "lannin$ ca"ital e9"en&itures) 4) In the case o. cost overrun, co%"anies can reanal >e their "roIects in "ro$ress, aban&on the%, or co%"lete the% Bith a&&e& cost) ') =hat is i%"ortant in ca"ital bu&$etin$ is the conce"t o. cash .loBs rather than the conce"t o. earnin$s a.ter ta9es) +) Such non-cash outla s as &e"reciation char$es have nothin$ to &o Bith the .ir%As abilit to %eet its %aturin$ &ebts) 4) (he o""ortunities .or location o. a .actor in alternate cities coul& be calle& %utuall &e"en&ent "roIects) *) (he construction o. a toll bri&$e an& the o"eration o. a .err across a&Iacent "oints on a river are technicall "ossible an& thus the are %utuall in&e"en&ent "roIects) 5) (he establish%ent o. lon$-ran$e obIective is the last ste" in the ca"ital bu&$etin$ "rocess) 10) :eneral o..ice e9"enses or sunk costs /costs .ro% "ast &ecisions0 are the irrelevant costs in the ca"ital bu&$etin$ anal sis because the are not chan$e& b the acce"tance o. the "roIect) 11) (he results o. "ost-au&its enable the .ir% to co%"are the actual "er.or%ance o. a "roIect Bith establishe& stan&ar&s) 12) 13) In co%"utin$ the cash .loB .ro% an invest%ent "roIect, &e"reciation is &e&ucte& as an e9"ense) (he "ri%ar .unction o. ca"ital bu&$et is to &eter%ine the .un&s .or .uture invest%ents that Bill be raise& throu$h e9ternal .inancin$)

( ? ?

4*

( ( ? ( ( ( ( ( (

14) (he o""ortunit cost is the rate o. return that the .un&s coul& earn i. the Bere investe& in the best available alternative "roIect) 1') (he net "resent value %etho&, the internal rate o. return %etho&, an& the "ro.itabilit in&e9 consi&er the ti%e value o. %one ) 1+) In or&er to %a9i%i>e stockhol&er Bealth /value o. the .ir%0, the co%"an %ust use the internal rate o. return rather than the net "resent value %etho&) 14) (he net "resent value o. a "roIect is "ositive as lon$ as the internal rate o. return .or the "roIect e9cee&s the cost o. ca"ital /&iscount rate0) 1*) (he internal rate o. return is the &iscount rate that e@uates the net invest%ent o. a "roIect Bith the "resent value o. its net cash .loBs) 15) =hen the co%"an has a ca"ital rationin$ constraint, so%e "ro.itable "roIects coul& be reIecte&) 20) I. a "roIectAs internal rate o. return e@uals the cost o. ca"ital, the "roIect has a >ero net "resent value) 21) (he "a back %etho& is "oor because it i$nores the ti%e value o. %one an& returns be on& the "a back "erio&) 22) , "articular "roIect re@uires an initial outla an& then iel&s "ositive cash .loBs in several .uture "erio&s) (he net "resent value o. the "roIect Bill be $reater i. the cost o. ca"ital use& to evaluate the "roIect is loBer) 23) In an acce"t-reIect &ecision, the .ir% shoul& acce"t the "roIect i. its internal rate o. return e9cee&s the cost o. ca"ital) 24) (Bo "roIects are %utuall e9clusive i. one is a&o"te& then the other one cannot be a&o"te&) 2') 6i..erent ca"ital bu&$etin$ techni@ues "ro&uce the sa%e rankin$ .or a set o. invest%ent "roIects) 2+) (he "a back %etho& an& the avera$e rate o. return %etho& are not theoreticall co%"lete because the &o not consi&er the ti%e value o. %one ) 24) Ca"ital assets inclu&e %achines an& tools)

( ( ? ( (

45

CHAPTER 13 ? ? ( ?

OTHER ISSUES IN CAPITAL .UDGETING

1) (he recover o. "ast costs is relevant in ca"ital invest%ent anal sis) 2) Interest e9"enses involve actual cash out.loBs an& thus shoul& be treate& as an initial cash out.loB o. the "roIect) 3) In a&&ition to the invest%ent in a .i9e& asset, a revenue-e9"an&in$ "roIect %a re@uire a&&itional current assets such as accounts receivable an& inventories) 4) ;r&inaril , the conce"t o. annuali>e& net "resent value or annuali>e& cost can be use& to anal >e "roIects Bith &i..erent lives Bhose cash .loBs are e9tre%el irre$ular) ') !or%all , "roIects are evaluate& as thou$h the co%"an Bere co%%itte& to the "roIect over its entire li.e s"an) +) Retire%ent &ecisions are ter%inal &ecisions to the e9tent that an asset Bith&raBn .ro% its ori$inal service Bill not be re"lace& b another asset Bhich Bill "er.or% the sa%e service) 4) I. the .ir% uses the internal-rate-o.-return %etho&, it shoul& retire the "roIect Bhen the rate o. return on its retire%ent value is $reater than the co%"an As cost o. ca"ital) *) (he "resence o. in.lation in the econo% &oes not &istort ca"ital bu&$etin$ &ecisions) 5) (he in.lation-a&Iuste& &iscount rate is &eter%ine& b M/1+k0/1+I0-1N Bhere k is the .ir%As cost o. ca"ital an& I is the in.lation rate) 10) ;r&inaril , the in.lation a&Iuste& net "resent value o. a "roIect is not i&entical Bith the net "resent value o. the "roIect in the absence o. in.lation) 11) !o a&Iust%ent is necessar .or in.lation in the anal sis o. the .ir%As invest%ent o""ortunities because in the in.lationar econo% , the cost o. ca"ital an& the e9"ecte& net cash .loBs re.lect such "rice increases) 12) I. a "roIect has salva$e value at the en& o. its li.e, the salva$e value shoul& be treate& as a cash in.loB)

( (

? ? ( ( ?

*0

CHAPTER 14 ?

CAPITAL .UDGETING UNDER UNCERTAINTY

1) 6ecisions are %a&e un&er risk Bhen the &ecision %aker knoBs all the available alternatives but cannot assi$n "robabilities to the set o. "ossible conse@uences .or each alternative) 2) (he e9"ecte& value o. a "roIect %a be &e.ine& as the Bei$he& avera$e return Bhere the "robabilities o. the various outco%es are use& as Bei$hts) 3) (he se%i variance is si%ilar to the variance but consi&ers onl &eviations above the e9"ecte& value) 4) (he coe..icient o. variation is a relative %easure o. &is"ersion, Bhile the stan&ar& &eviation is an absolute %easure o. &is"ersion) ') Fsuall the stan&ar& &eviation shoul& be use& Bhen "roIect return is state& in &ollars, Bhile the coe..icient o. variation shoul& be use& Bhen "roIect return is state& as a "ercent) +) =ith in&e"en&ence o. cash .loBs over ti%e, successive "erio&sA cash .loBs are relate& in a hi$hl s ste%atic %anner) 4) (he conce"t o. &i%inishin$ %ar$inal utilit states that the risk "re%iu% %ust increase at a &ecreasin$ rate Bhen risk increase at a constant rate) *) =hen the utilit theor is use& as a risk a&Iust%ent techni@ue, there is the "ossibilit that a "ro.itable "roIect Bill be reIecte& because its "ositive net "resent value is too s%all to cover its risk) 5) (he co%"uter si%ulation %o&el assu%es that so%e ke variables such as sales volu%e an& "rice are %utuall &e"en&ent) 10) Sensitivit anal sis alloBs the &ecision %aker to i&enti. %ost critical variables to "roIect returns) 11) (he risk a&Iuste& &iscount rate, the certaint e@uivalent a""roach, an& the ca"ital asset "ricin$ %o&el are the three .or%al a""roaches Bhich are co%%onl use& to incor"orate risk into the anal sis) 12) (he "ort.olio e..ect is $reatest Bhen the coe..icient o. variation betBeen an tBo "roIects is +1)

( ? ( ?

? ? (

? ( (

*1

CHAPTER 15 ? ( ( ( ? ? ( ( ( ? ? ? ( (

INVESTMENT .ANKERS AND CAPITAL MARKETS

1) (he or$ani>e& securit e9chan$e %a be characteri>e& as a "ri%ar %arket) 2) (he &i..erence betBeen the "rice o. a securit to the "ublic an& the "rice "ai& to the issuin$ co%"an is knoBn as the s"rea&) 3) ,n un&erBritin$ s n&icate is a $rou" o. invest%ent bankers that $ot to$ether to bu a neB issue o. securities .or resale to the "ublic) 4) (he over-the-counter %arket %a be characteri>e& as a secon&ar %arket) ') It takes about 40 &a s .or the Securit an& 79chan$e Co%%ission to co%"lete its anal sis on the re$istration state%ent o. the issuin$ co%"an ) +) (he "ree%"tive ri$ht is a "rovision that $ives the current %ana$ers a ri$ht to bu a s"eci.ie& nu%ber o. co%%on shares) 4) (he .lotation cost .or co%%on stock is s%aller than that .or "re.erre& stock) *) 1ar$in re@uire%ents are the cre&it stan&ar&s .or the "urchase o. securities an& &eter%ine& b the 3oar& o. :overnors o. the ?e&eral Reserve S ste%) 5) -rivate "lace%ent o. securities avoi&s the un&erBritin$ s"rea&) 10) (he Securit ,ct o. 1533 create& the Securit an& 79chan$e Co%%ission as a Batch&o$ .or the securities business) 11) 3i$ cit neBs"a"ers an& the =all Street Journal re"ort "re.erre& stock @uotations an& co%%on stock @uotations on the se"arate .inancial "a$es) 12) 1ost bon&s are tra&e& in the or$ani>e& securit e9chan$es) 13) (he invest%ent banker "rovi&es the securit issuer Bith three services8 /10 a&vice an& counsel, /20 un&erBritin$, an& /30 sellin$) 14) (he laB re@uires "ublic utilit an& state bon& issues to be sol& on a co%"etitive basis because it results in a hi$her "rice than a ne$otiate& o..erin$)

*2

CHAPTER 16 ( ? ? ? ( ( ? ? ( ( ? ? ( ( ( (

FI>ED INCOME SECURITIES/ .ONDS AND PREFERRED STOCK

1) Interest "a %ents are assure& but "re.erre& &ivi&en& "a %ents are not assure&) 2) (he issuin$ co%"an e9ercises its call o"tion Bhen interest rates increase si$ni.icantl ) 3) (he iel& o. a callable bon& is usuall less than that o. a non-callable bon&) 4) 6ivi&en&s on non-cu%ulative "re.erre& stock b "asse& in one or %ore ears shoul& be "ai& in ten ears) ') +) 3on&s have "re.erence over both "re.erre& stock an& co%%on stock in clai%s to earnin$s) 6e.ault on "re.erre& &ivi&en&s &oes not necessaril lea& the issuin$ co%"an into bankru"tc )

4) ,n in&enture is an unsecure& lon$-ter% bon&) *) (he co%"an Ts co%%on stockhol&ers &eter%ine the &ivi&en& rate on "re.erre& stock annuall ) 5) ?ro% the investorAs stan&"oint, the risks associate& Bith "re.erre& stocks are $reater than those associate& Bith bon&s) 10) Inco%e bon&s t "icall ste% .ro% cor"orate reor$ani>ations an& their interest "a %ents are ta9 &e&uctible e9"ense) 11) Secure& bon&s are .re@uentl calle& &ebenture bon&s) 12) :enerall , "re.erre& stockhol&ers &o not seek "rotective covenants si%ilar to those .oun& in ter% loans or bon&s) 13) ?loatin$-rate bon&s carr variable interest rates, Bhich %eans that the interest "ai& on the bon& chan$es as %arket interest rates chan$e) 14) (Bo .inancial service .ir%sOStan&ar& K -oorAs Cor"oration an& 1oo& As Investor ServiceOassi$n letter ratin$s to in&icate the @ualit o. bon&s) 1') Yero-cou"on bon&s &o not "a "erio&ic interest but are sol& at a &ee" &iscount .ro% their .ace value) 1+) 1an innovative .or%s o. bon&s have been &evelo"e& in recent ears)
*3

CHAPTER 17 (

COMMON STOCK

1) I. investors "urchase co%%on stock at a "rice s%aller than its "ar value, the %a be hel& liable to the cre&itors in the event o. bankru"tc .or the &i..erence betBeen the "rice the "ai& an& the "ar value) 2) (he authori>e& stock o. a co%"an re"resents the %a9i%u% nu%ber o. co%%on shares that the co%"an can reac@uire un&er the ter%s o. cor"orate charter) 3) ,n increase in co%%on stock %a be &isa&vanta$eous to the issuin$ co%"an because it involves "ossible &ilution o. both earnin$s an& control) 4) (he %arket value o. a Barrant e9cee&s its theoretical value &ue to the s"eculative value) ') Convertibles an& Barrants are use& as sBeeteners Bhen the co%"an issues its bon&s or "re.erre& stock) +) I. the co%"an &esires to re&uce its risk o. bankru"tc , &ebt .inancin$ is better than stock .inancin$) 4) Co%%on shares that have been issue& but reac@uire& b the co%"an are calle& state& ca"ital) *) :enerall , the li@ui&ation value o. a co%"an is $reater than its book value) 5) #e$al ca"ital is "ai& in "ri%aril .or the "rotection o. co%%on stockhol&ers) 10) Fn&er the cu%ulative votin$ s ste%, each sharehol&er can accu%ulate his votes an& cast all o. the% .or a sin$le &irector) 11) (he classi.ie& co%%on stock is use&, in %ost cases, to assure the control o. the co%"an b its .oun&ers an& %ana$e%ent) 12) =hen securities are both callable an& convertible, it is "ossible .or the issuer to .orce conversion) 13) (he sale o. co%%on stock i%"roves the co%"an As abilit to su""ort %ore &ebt because co%%on stock acts as a bu..er a$ainst losses .or the "rotection o. cre&itors) 14) , "ro9 is a .or% b Bhich the stockhol&ers assi$n their ri$ht to vote to another "erson)

? ( ( ( ? ? ? ? ( ( ( ( (

*4

CHAPTER 18 ( ( ? ? ( ( ? ? ? ( (

DIVIDEND POLICY AND RETAINED EARNINGS

1) (he ca"ital i%"air%ent rule states that &ivi&en&s %a not be "ai& i. these &ivi&en&s i%"air ca"ital) 2) 1ost co%"anies &esire to establish a &ivi&en& "olic that can be sustaine& over a "erio& o. ears) 3) (hose co%"anies Bith eas access to e9ternal .un&s are less likel to "a cash &ivi&en&s) 4) ;r&inaril , cor"orate "ro.its ten& to be %ore stable than &ivi&en&s) ') Resi&ual theor o. &ivi&en& "olic states that &ivi&en&s are not "ai& until the co%"an has e9hauste& its "ro.itable invest%ent o""ortunities) +) In $eneral, &ivi&en&s are less risk than the ca"ital $ains that Bill result .ro% retaine& earnin$s) 4) Stock s"lits involve a bookkee"in$ trans.er .ro% retaine& earnin$s to ca"ital stock accounts) *) (he re"urchase o. co%%on stock is not a "o"ular alternative to cash &ivi&en&s) 5) Cor"orate $roBth an& &ivi&en&s are tBo &esirable an& co%"le%entar $oals) 10) ,n ar$u%ent .or the stable &ivi&en& "olic is that an unbroken recor& o. &ivi&en& "a %ents resolves uncertaint in the %in&s o. investors) 11) So%e ar$ue that stock &ivi&en&s are $enerall use& to conserve cash Bhile stock s"lits are usuall utili>e& .or a consi&erable increase in the nu%ber o. co%%on shares outstan&in$) 12) Control is an i%"ortant .actor that a..ects the co%"an As &ivi&en& "olic ) 13) (he co%%on stock is sai& to sell e9-&ivi&en& a.ter the .ourth business &a "rior to the &ate o. recor&) 14) ;ne school o. thou$ht on &ivi&en& "olic sa s that investors are in&i..erent betBeen cash &ivi&en&s an& ca"ital $ains) 1') , ten&er o..er is a .or%al o..er b a co%"an to bu a s"eci.ie& nu%ber o. its oBn shares or the shares o. another co%"an Bithin a s"eci.ie& "erio& ti%e)

( ( ( (

*'

CHAPTER 19 ? ? ? ( ( ( ? ? ( ? ? (

TERM LOANS AND LEASES

1) Inter%e&iate-ter% loans are sou$ht "ri%aril to .inance te%"orar current assets) 2) (he &esirabilit o. a lease arran$e%ent is usuall evaluate& in co%"arison Bith "re.erre& stock .inancin$) 3) (he "rovision that calls .or an e9tra lar$e "a %ent in the last ear o. the loan contract is knoBn as an acceleration clause) 4) , hi$h &e$ree o. .le9ibilit is one o. the %aIor a&vanta$es .or ter% loans) ') (he restriction on the "a %ent o. cash &ivi&en&s is an e9a%"le o. a restrictive "rovision in a ter% loan) +) (er% loans "rovi&e& b insurance co%"anies involve %uch lar$er a%ounts o. %one an& lon$er %aturities than bank ter% loans) 4) ;ne i%"ortant ta9 a&vanta$e o. the bu in$ alternative over the leasin$ alternative occurs Bhen the co%"an ac@uires lan&) *) In o"eratin$ leasin$, the lease ter% is usuall lon$er than the econo%ic li.e o. the lease& "ro"ert ) 5) I. leases a""ear on .inancial state%ents, it Bill alloB users o. the .inancial state%ents to better evaluate the .inancial con&ition o. the co%"an ) 10) , sales an& leaseback arran$e%ent "er%its the co%"an to ac@uire an asset it &i& not oBn "reviousl ) 11) 1ost bank ter% loans have a .inal %aturit o. %ore than ten ears) 12) ,lthou$h there are several &i..erent sources o. .un&s to re"a ter% loans, the borroBerAs net cash .loBs /earnin$s a.ter ta9es an& non-cash char$es0 are the co%%on source) 13) 1ost revolvin$ cre&its re@uire the borroBer to "a a s%all a%ount o. co%%it%ent .ees on the unuse& "ortion o. the cre&it) 14) 1ost banks .in& their hi$hest risks in their loan "ort.olio, but bank ter% loans are also t "icall the %ost "ro.itable bank asset)

( (

*+

CHAPTER ( ? ? ( ( ( ( ? ? ? ( ? ( ( (

CORPORATE GROWTH THROUGH MERGERS

1) (he three basic .or%s o. cor"orate $roBth throu$h business co%bination are hori>ontal $roBth, vertical $roBth, an& con$lo%erate $roBth) 2) (he business co%bination Bhich creates a neB cor"oration is knoBn as a statutor %er$er) 3) , $rou" o. subsi&iaries that o"erate as a se"arate le$al entit is calle& con$lo%erate cor"oration) 4) , s ner$istic e..ect %a be characteri>e& as X2 + 2 = ')X ') (he "ri%ar %otive .or %ost business co%binations is to %a9i%i>e the total value o. a co%"an ) +) , hol&in$ co%"an is a co%"an that has a controllin$ interest in one or %ore other co%"anies) 4) =hen co%"anies are co%bine& un&er a "oolin$ o. interests, %ost o. the co%"anies involve& Boul& continue to e9ist a.ter the co%bination) *) In a business co%bination treate& as a "urchase, the e9cess o. the "rice "ai& over the net Borth o. the ac@uire& co%"an is classi.ie& as an increase in retaine& earnin$s) 5) (he ,ccountin$ -rinci"les 3oar& ;"inion !o) 1+ si$ni.icantl rela9es the con&itions un&er Bhich a "oolin$ o. interests coul& take "lace) 10) , hol&in$ co%"an cannot e9ist onl to control other co%"anies) 11) 3ook values are not i%"ortant as a basis .or valuation in %er$er ne$otiations) 12) #e$al restrictions on internal $roBth are %ore restrictive than those on e9ternal $roBth) 13) ,&vanta$es o. %er$ers inclu&e ta9 a&vanta$es to the stockhol&ers o. the ac@uire& co%"an ) 14) ;ne a&vanta$e o. a hol&in$ co%"an is that the .ailure o. one subsi&iar &oes not cause the .ailure o. the entire hol&in$ co%"an ) 1') 1er$ers %a involve strai$ht cash "urchases, e9chan$e o. stock, or a co%bination o. cash an& securities)

*4

CHAPTER -1 ( ( ? ( ( ? ? ( ? ( ( (

CORPORATE GROWTH THROUGH MULTINATIONAL OPERATIONS

1) (he e..icient allocation o. .un&s an& the ac@uisition o. .un&s on .avorable ter%s are basicall the sa%e .or both &o%estic an& %ultinational co%"anies) 2) (he so-calle& Xtheor o. co%"arative a&vanta$eX e9"lains Bh countries e9chan$e their $oo&s an& services Bith each other) 3) (he "ro&uct li.e c cle theor an& the "ort.olio theor are the tBo theories a&vance& to Iusti. international tra&e) 4) So%e "rivate co%"anies invest abroa& to seek raB %aterials, to seek neB %arkets, or to seek neB knoBle&$e) ') (he tBo basic t "es o. risks involve& in &irect .orei$n invest%ents are "olitical risks an& .orei$n e9chan$e risks) +) In or&er to %ini%i>e "olitical risks, %ultinational .ir%s %ust tr to %aintain technolo$ical in.eriorit over local co%"anies) 4) (hose &ollar-&eno%inate& &e"osits in .orei$n branches o. a F)S) bank are not treate& as 7uro&ollars) *) 1ultinational co%"anies can re&uce their .orei$n e9chan$e risk b he&$in$ in the .orBar& e9chan$e %arket) 5) (he 79"ort-I%"ort 3ank Bas establishe& be.ore the 1530As :reat 6e"ression) 10) (ari..s an& i%"ort @uotas are the tBo "ri%ar %eans o. "rotectionis%) 11) ;li$o"ol e9ists Bhere there are onl a .eB .ir%s Bhose "ro&ucts are usuall close substitutes .or one another) 12) -lanne& &ivest%ent Bithin the conte9t o. .orei$n invest%ent "rovi&es .or the sale o. %aIorit oBnershi" in .orei$n a..iliates to local nationals &urin$ a "reviousl a$ree& u"on "erio& o. ti%e) 13) (he absolute version o. the "urchasin$ "oBer "arit &octrine states that the e@uilibriu% e9chan$e rate betBeen &o%estic an& .orei$n currencies e@uals the rate betBeen &o%estic an& .orei$n "rices)

**

CHAPTER 1 1-1)

GOALS AND FUNCTIONS OF FINANCE

(he &e"ression o. the 1530s cause& .inancial %ana$ers to .ocus on /a0 /b0 /c0 /&0 /e0 &e.ensive as"ects o. bankru"tc e9"ansion as"ects o. %er$ers $overn%ent re$ulations o. securities both /a0 an& /b0 both /a0 an& /c0

1-2) =hich o. the .olloBin$ chan$e/s0 occurre& in the F)S) econo%ic s ste% in recent ears[ /a0 /b0 /c0 /&0 /e0 &ere$ulation o. in&ustries stron$ international co%"etition su""l -si&e econo%ics ra"i& a&vance%ent in technolo$ all o. the above

Z 1-3)

(he "ri%ar $oal o. the .ir% is to %a9i%i>e /a0 /b0 /c0 /&0 /e0 "ro.it %arket share o. its "ro&uct stockhol&ers Bealth earnin$s "er share sales

1)4)

(he &ollar value o. a stockhol&erAs Bealth is obtaine& b %ulti"l in$ the nu%ber o. shares oBne& b the /a0 /b0 /c0 /&0 /e0 current book "rice o. the co%%on stock current li@ui&ation "rice o. the co%"an current earnin$s "er share current stock "rice "er share none o. the above

Z 1)')

3ecause investors Bant to %a9i%i>e their Bealth, the like .ir%s to a&o"t "olicies that %a9i%i>e its HHHHHHHH) /a0 /b0 /c0 /&0 /e0 earnin$s a.ter ta9es sales earnin$s "er share stock "rice %arket share
*5

1-+)

=hich o. the .olloBin$ is not an incentive "rovi&e& to %ana$e%ent to act in the best interest o. the stockhol&ers[ /a0 /b0 /c0 /&0 /e0 bonuses stock o"tions "er@uisites both /a0 an& /b0 are incentives all o. the above are incentives

Z 1-4)

=hich o. the .olloBin$ is a %aIor .unction o. the .inancial %ana$er[ /a0 /b0 /c0 /&0 /e0 .inancial "lannin$ an& control the e..icient allocation o. .un&s the ac@uisition o. .un&s both /a0 an& /c0 all o. the above

Z 1-*) Z

=hich o. the .olloBin$ .inance .unctions inclu&es the "re"aration o. bu&$ets[ /a0 /b0 /c0 /&0 /e0 .inancial "lannin$ an& control the e..icient allocation o. .un&s the ac@uisition o. .un&s both /a0 an& /c0 all o. the above

1-5) Z

:enerall s"eakin$, the hi$her the risk o. a "roIect /a0 /b0 /c0 /&0 the "roIect shoul& be aban&one& the hi$her the e9"ecte& return the hi$her the actual return the "roIect shoul& alBa s be acce"te&

1)10) o. Z

=hich o. the .olloBin$ "rinci"les re.lects the abilit o. .i9e& costs to %a$ni. the rate return[ /a0 levera$e /b0 risk-return tra&eo.. /c0 ti%e value o. %one /&0 %atchin$ "rinci"le /e0 none o. the above

1-11) X(he .inancial %ana$erAs &ile%%aX so%eti%es re.ers to the Z /a0 li@ui&it versus "ro.itabilit tra&eo..
50

/b0 /c0 /&0 /e0

ti%e value o. %one %atchin$ "rinci"le "ort.olio e..ect levera$e e..ect

1-12) (he "ort.olio e..ect states that as %ore assets are a&&e& to a "ort.olio, the risk o. the "ort.olio Z /a0 /b0 /c0 /&0 /e0 increases &ecreases re%ains the sa%e &oes not chan$e cannot be @uanti.ie&

1-13) (he valuation "rinci"le states that the value o. an asset is e@ual to the /a0 /b0 /c0 /&0 /e0 "resent value o. its net "ro.its .uture value o. its cash .loBs "resent value o. its e9"ecte& cash .loBs "resent value o. its e9"ecte& &e"reciation none o. the above

51

CHAPTER 2-1)

OPERATING ENVIRONMENT OF FINANCIAL MANAGEMENT

=hich o. the .olloBin$ is the ke ele%ent o. the .inancial s ste%[ /a0 /b0 /c0 /&0 /e0 .inancial instru%ents .inancial %arkets .inancial institutions both /b0 an& /c0 all o. the above)

Z 2-2)

(he three $eneral classes o. .inancial assets are /a0 /b0 /c0 /&0 /e0 %one -%arket instru%ents, stocks, an& cash %one -%arket instru%ents, stocks, an& bon&s accounts receivable, cash, an& %arketable securities %one -%arket instru%ents, ca"ital %arket instru%ents, an& %one none o. the above

Z 2-3)

1one %arket instru%ents have %aturities o. /a0 /b0 /c0 /&0 /e0 less than + %onths less than 5 %onths less than 12 %onths %ore than 12 %onths %ore than 3 ears

2-4) s%all

(he 1-1 is /a0 /b0 /c0 6e%an& &e"osits, currenc in circulation, !;= accounts, "lus savin$s an& &eno%ination ti%e &e"osit accounts 1-2 "lus lar$e &eno%ination ti%e &e"osits 6e%an& &e"osits, currenc in circulation, "lus %one

%arket %utual .un&

shares) Z 2-') Z /&0 /e0 #ar$e-&eno%ination ti%e &e"osit accounts) 6e%an& &e"osit at co%%ercial banks, currenc in circulation, !;= accounts, an& all transaction accounts)

=hich o. the .olloBin$ $overn%ental or$ani>ations is not a .inance re$ulator a$enc [ /a0 /b0 /c0 /&0 /e0 (he Securities an& 79chan$e Co%%ission (he Geterans ,&%inistration (he ?e&eral Do%e #oan 3ank S ste% (he Co%"troller o. the Currenc (he ?e&eral Reserve S ste%
52

2-+)

1utual savin$s banks t "icall &o not invest in /a0 /b0 /c0 /&0 insure& %ort$a$es hi$h-@ualit bon&s conventional %ort$a$es an o. the above invest%ents

Z 2-4)

=hich o. the .olloBin$ is not a characteristic o. savin$s an& loan associations[ /a0 /b0 /c0 /&0 /e0 the are state or .e&erall chartere& the have %utual or stock .or% o. oBnershi" the s"eciali>e in consu%er loans both /a0 an& /b0 all o. the above

2-*)

=hich o. the .olloBin$ is an in$re&ient o. a cre&it union[ /a0 /b0 /c0 /&0 /e0 a $rou" o. "eo"le "oole& savin$s co%%on interests loans to each other all o. the above

Z 2-5)

=hich o. the .olloBin$ loss/es0 is not covere& b "ro"ert -casualt insurance co%"anies[ /a0 /b0 /c0 /&0 /e0 Bork%enAs co%"ensation li.e .ire, hail, an& Bin&stor%s both /a0 an& /b0 all o. the above

2-10) =hich o. the .olloBin$ is not a characteristic o. %utual .un&s[ /a0 /b0 /c0 /&0 /e0 the ac@uire s%all a%ounts o. %one .ro% %an in&ivi&ual investors their shares are .inancial assets sharehol&ers &o not have ri$ht to sell their shares back to the .un& the are %ana$e& b "ro.essionals the invest heavil in cor"orate securities

2-11) I&enti. the incorrect state%ent re$ar&in$ .inance co%"anies8 Z /a0 /b0 the have access to &e"osit .un&s the issue co%%ercial "a"ers
53

/c0 /&0 /e0

the borroB .ro% banks the %ake loans to in&ivi&uals the so%eti%es hel" sales o. "arent .ir%As $oo&s

2-12) !;= accounts are the sa%e as /a0 /b0 /c0 /&0 /e0 "assbook savin$s account interest-earnin$ savin$s account no interest-earnin$ checkin$ account interest-earnin$ checkin$ accounts all o. the above

2-13) =hich o. the .olloBin$ is not a %one %arket instru%ent[ /a0 /b0 /c0 /&0 /e0 treasur bills bankersA acce"tance re"urchase a$ree%ents co%%on stocks .e&eral .un&s

2-14) =hich o. the .olloBin$ is not a characteristic o. treasur bills[ /a0 /b0 /c0 /&0 /e0 the are the obli$ations o. the F)S) $overn%ent the are %one %arket instru%ents the are auctione& the are sol& on a &iscount basis investors cli" cou"ons to collect interest

2-1') Co%%ercial "a"ers are the obli$ations o. Z /a0 /b0 /c0 /&0 /e0 co%%ercial banks lar$e cor"orations the F)S) $overn%ent .orei$n $overn%ents the various state $overn%ents

2-1+) =hich o. the .olloBin$ is not a characteristic o. bankersA acce"tances[ /a0 /b0 /c0 /&0 /e0 the are %one %arket instru%ents the arise out o. .orei$n tra&e transactions the are ti%e &ra.ts issue& b a .ir% an& acce"te& b a bank the carr hi$h risk both /b0 an& /&0

2-14) !e$otiable certi.icates o. &e"osits are

54

/a0 /b0 /c0 /&0 /e0

issue& b co%%ercial banks %one %arket instru%ents sol& in %aturities o. %ore than one ear both /a0 an& /b0 all o. the above

2-1*) ?e&eral .un&s are /a0 /b0 /c0 /&0 /e0 total .e&eral ta9 revenues .or a .iscal ear 1-1 "lus 1-2 loans betBeen invest%ent co%"anies loans $iven b F)S) treasur to co%%ercial banks loans betBeen banks on an overni$ht basis to %eet reserve re@uire%ents

2-15) =hich o. the .olloBin$ is an e9a%"le o. "ri%ar %arkets[ /a0 /b0 /c0 /&0 /e0 or$ani>e& securit e9chan$es over-the-counter %arkets a .ir% sellin$ securit .or the .irst ti%e in or&er to $o "ublic 1r) S%ith sellin$ 1,000 shares o. I31 this %ornin$ none o. the above

2-20) Cor"orate bon&s /a0 /b0 /c0 /&0 /e0 are sol& in &eno%ination o. $1,000 have .i9e& cou"on rate have .i9e& iel& rate both /a0 an& /b0 are true both /a0 an& /c0 are true

2-21) =hich o. the .olloBin$ is a .eature o. %unici"al bon&s[ /a0 /b0 /c0 /&0 /e0 the are calle& ta9-e9e%"t bon&s the carr loBer interest rates co%"are& to cor"orate bon&s the can be either $eneral obli$ation bon&s or revenue bon&s both /a0 an& /b0 all o. the above

2-22) Co%%on stockhol&ers have a ri$ht to /a0 /b0 /c0 /&0 elect the boar& o. &irectors e9a%ine the books o. the cor"oration vote on %er$ers both /a0 an& /b0
5'

/e0

all o. the above

2-23) =hich o. the .olloBin$ is a %aIor cause o. in.lation in the econo% [ /a0 /b0 /c0 /&0 /e0 too little %one chasin$ too .eB $oo&s &e%an&-"ull in.lation cost-"ush in.lation both /a0 an& /b0 both /b0 an& /c0

2-24) (he real interest rate is Z /a0 /b0 /c0 /&0 /e0 the no%inal rate %inus the e9"ecte& in.lation rate the e9"ecte& in.lation rate "lus the no%inal rate the no%inal rate %inus the unreal rate the a&Iuste& unreal rate "lus the e9"ecte& in.lation rate the no%inal rate %inus the risk "re%iu% on ,aa bon&s

2-2') =hich o. the .olloBin$ is not a .eature o. sole "ro"rietorshi"[ /a0 /b0 /c0 Z /&0 /e0 loB start-u" costs $reatest .ree&o% .ro% re$ulation there are in e9istence %ore nu%ber o. sole "ro"rietorshi"s than cor"orations in the F)S) li%ite& liabilit both /c0 an& /&0

2-2+) In a "artnershi", i. our "artner abscon&s Bith the .ir%As .un&s, ou are /a0 /b0 Z /c0 /&0 /e0 not res"onsible .or an o. the .ir%As liabilities res"onsible .or that "ortion Bhich corres"on&s to our share in the .ir%As oBnershi" in trouble an& shoul& call our accountant or attorne both /a0 an& /b0 are true all o. the above are true

2-24) I&enti. the incorrect state%ent8 , cor"oration is Z /a0 /b0 /c0 /&0 /e0 a le$al entit incor"orate& b the .e&eral $overn%ent a continuin$ entit oBne& b stockhol&ers none o. the above is incorrect

2-2*) =hich o. the .olloBin$ is not an a&vanta$e o. a cor"oration[

5+

/a0 /b0 /c0 /&0 /e0

li%ite& liabilit trans.erabilit o. oBnershi" ease o. raisin$ .un&s %ini%al re$ulation an& re& ta"e all o. the above are a&vanta$es

2-25) 6e"reciation o. an asset is Z /a0 /b0 /c0 /&0 /e0 a ta9 &e&uctible e9"ense a cash consu%in$ "heno%enon "rohibite& b laB .or assets that a""reciate in value both /a0 an& /c0 all o. the above

2-30) Fsin$ the strai$ht-line &e"reciation %etho&, calculate the current book value o. a %achine Bhich Bas "urchase& 3 ears a$o .or $100,000 Bith an ori$inal li.e e9"ectanc o. ' ears an& an esti%ate& salva$e value o. $10,000) /a0 /b0 /c0 /&0 /e0 $+0,000 $40,000 $'4,000 $4+,000 $3+,000

2-31) =hich o. the .olloBin$ state%ents is true[ /a0 /b0 /c0 /&0 /e0 interest an& &ivi&en& "a %ents are ta9 &e&uctible interest "ai& on bon&s b cor"orations is subIect to &ouble ta9ation interest is "ai& out o. a.ter-ta9 earnin$s onl *' "ercent o. &ivi&en&s "ai& b one cor"oration to another is ta9able none o. the above are true

54

CHAPTER 3 3-1)

FINANCIAL STATEMENT ANALYSIS

Ratio ,nal sis involves the use o. /a0 /b0 /c0 /&0 /e0 the balance sheet the "ro&uction bu&$et the inco%e state%ent /a0 an& /b0 /a0 an& /c0

Z 3-2)

=hich o. the .olloBin$ .inancial state%ents re.lect the .ir%As .inancial "osition at a "oint in ti%e[ /a0 /b0 /c0 /&0 /e0 the inco%e state%ent the "ro&uction bu&$et the ca"ital e9"en&iture bu&$et the source an& use o. .un& state%ent the balance sheet

Z 3-3)

=hich o. the .olloBin$ current assets is $enerall consi&ere& least li@ui&[ /a0 /b0 /c0 /&0 /e0 cash accounts receivable %arketable securities inventories all o. the above

Z 3-4)

=hich o. the .olloBin$ is not a "art o. a balance sheet[ /a0 /b0 /c0 /&0 /e0 cash accounts "a able &ivi&en&s net "lant an& e@ui"%ent "ai&-in ca"ital

3-')

=hich o. the .olloBin$ is not .oun& in an inco%e state%ent[ /a0 /b0 /c0 /&0 /e0 sales e9"enses &e"reciation stockhol&ersA e@uit ta9es

Z 3-+)

=hich o. the .olloBin$ is not classi.ie& as a current asset[

5*

/a0 /b0 /c0 /&0 /e0

notes "a able cash inventories accounts receivable %arketable securities

3-4)

( "icall , the %aIor interest $rou"s o. a co%"an are /a0 /b0 /c0 /&0 /e0 short-ter% cre&itors %ana$e%ent stockhol&ers lon$-ter% cre&itors all o. the above

Z 3-*)

Short-ter% cre&itors are "ri%aril intereste& in the abilit o. the co%"an to %eet its /a0 /b0 /c0 /&0 /e0 lease obli$ations co%%on &ivi&en& obli$ations "re.erre& &ivi&en& obli$ations short-ter% obli$ations sinkin$ .un& obli$ations

Z 3-5)

=hich o. the .olloBin$ %etho&s is t "icall use& to value inventories[ /a0 /b0 /c0 /&0 /e0 #I?; ?I?; !I?; both /a0 an& /b0 both /b0 an& /c0

3-10) In "erio&s o. ra"i& in.lation, Bhich is the "re.erre& %etho& o. valuin$ inventories[ Z /a0 /b0 /c0 /&0 /e0 ?I?; #I?; net "resent value %etho& "ercent o. sales %etho& all o. the above

3-11) #i@ui&it ratios %easure the co%"an As Z /a0 /b0 /c0 /&0 /e0 ca"acit to %eet its lon$-ter% obli$ation abilit to "a its short-ter% obli$ations abilit to use its resources return on sales an& invest%ents none o. the above
55

3-12) (he current ratio is /a0 /b0 /c0 /&0 /e0 a "ro.itabilit ratio a levera$e ratio an activit ratio a li@ui&it ratio none o. the above .ro% the current

3-13) In or&er to calculate the aci& test ratio, one nee&s to &e&uct assets be.ore &ivi&in$ it b current liabilities) /a0 /b0 /c0 /&0 /e0 cash account receivables inventories %arketable securities none o. the above

3-14) I. a .ir%Ts interest char$es e@ual its 73I(, Bhat Bill be its ti%es interest earne& ratio[ Z /a0 /b0 /c0 /&0 /e0 one tBo .our ten cannot be calculate& .ro% the available in.or%ation

3)1')

(he total assets turnover is HHHH &ivi&e& b total assets) /a0 /b0 /c0 /&0 /e0 e@uit cost o. $oo&s sol& sales .i9e& assets net earnin$s

3-1+) (he inventor turnover is HHHHHHHH &ivi&e& b inventories) /a0 /b0 /c0 /&0 /e0 cash 73I( $ross "ro.its net "ro.its cost o. $oo&s sol&

3-14) (he avera$e collection "erio& is the nu%ber o. &a s in one ear &ivi&e& b HHHHHH)
100

/a0 /b0 /c0 /&0 /e0

3+' accounts receivable turnover accounts "a able turnover account receivables sales

3-1*) (he "ro.it %ar$in on sales is HHHHHHHHH &ivi&e& b sales) Z /a0 /b0 /c0 /&0 /e0 net inco%e a.ter ta9es 73I( $ross "ro.its cost o. $oo&s sol& &e"reciation

3-15) , .ir%As net Borth is the sa%e as /a0 /b0 /c0 /&0 /e0 total assets %inus current liabilities total assets %inus current assets total liabilities "lus total assets total assets %inus total liabilities current assets %inus current liabilities

3-20) Return on invest%ent is net inco%e a.ter ta9es &ivi&e& b /a0 /b0 /c0 /&0 /e0 e@uit .i9e& assets inventories current assets total assets

3-21) ,ccor&in$ to the 6u-ont s ste%, the return on invest%ent /R;I0 is the Z /a0 /b0 /c0 /&0 /e0 su% o. current assets an& .i9e& assets "ro&uct o. "ro.it %ar$in an& asset turnover "ro&uct o. "ro.it %ar$in an& inventor turnover net "ro.it &ivi&e& b total e@uit su% o. return on .i9e& assets an& return on current liabilities

3-22) ,ccor&in$ to the 6u-ont s ste%, the "ro.it %ar$in ti%es the asset turnover is e@ual to the Z /a0 /b0 /c0 /&0 return on invest%ent return on .i9e& assets return on net Borth return on current assets
101

/e0 3)23)

return on sales

,ccor&in$ to the 6u-ont s ste%, return on invest%ent &ivi&e& b Xone %inus the &ebt ratioX e@uals the /a0 /b0 /c0 /&0 /e0 return on invest%ent return on net Borth return on .i9e& assets return on current assets return on sales

3-24) In or&er .or ratio anal sis to be %eanin$.ul, one shoul& co%"are a $iven ratio Bith its /a0 /b0 /c0 /&0 /e0 historical values in&ustr stan&ar&s tar$et values relate& ratios all o. the above

3-2') =hich one o. the .olloBin$ is not a li%itation o. ratio anal sis8 /a0 /b0 /c0 /&0 /e0 &istortion o. co%"arative &ata &i..erences in accountin$ %etho&s availabilit o. in&ustr avera$e ratios Bin&oB &ressin$ varie& "ro&uct lines

102

Questions 3-2+ throu$h 3-30 re.er to the .olloBin$ "roble%8 \<Y Co%"an 3alance Sheet as o. 6ece%ber 31, 2004 /in thousan&s0 ,ssets Cash 1arketable securities ,ccounts receivable -re"ai& e9"enses Inventories (otal current assets :ross "lant K e@ui"%ent #ess8 ,ccu%ulate& 6e"reciation !et "lant K e@ui"%ent (otal assets #iabilities K !et =orth $ 120 ,ccounts "a able 50 !otes "a able 1*0 ,ccrue& ta9es +0 Current %aturit 4'0 lon$-ter% &ebt $ 500 ;ther accruals (otal current 43' liabilities #on$-ter% &ebt 13' Co%%on stock +00 -ai&-in ca"ital Retaine& earnin$s $l,'00 (otal liabilities ====== an& net Borth \<Y Co%"an Inco%e State%ent <ear 7n&e& 6ece%ber 31, 2004 /in thousan&s0 !et sales #ess8 Cost o. $oo&s sol& :ross "ro.it #ess8 ;"eratin$ e9"enses8 Sellin$ e9"enses :en) K ,&%in) 79"enses #ease "a %ents :ross o"eratin$ inco%e #ess8 6e"reciation !et o"eratin$ inco%e #ess8 Interest !et inco%e be.ore ta9es #ess8 (a9es !et inco%e a.ter ta9es $3,000 2,100 $ 500 $ 50 10' 30 $ 120 50 30 4' 10' $ 420 330 300 1'0 300 $l,'00 ======

22' $ +4' 22' $ 4'0 1'0 $ 300 1'0 $ 1'0 ======

103

3-2+) (he current ratio .or the \<Y Co%"an is /a0 /b0 /c0 /&0 /e0 not a""licable to the balance sheet anal sis 1)00 2)14 2)41 none o. the above

3-24) \<Y Co%"an As ti%es interest earne& is /a0 /b0 /c0 /&0 /e0 1)'0 2)00 3)00 4)'0 0)33

3-2*) (he &ebt ratio .or the \<Y Co%"an is Z /a0 /b0 /c0 /&0 /e0 0)' 1)0 2)' 1)4' none o. the above

3-25) (he inventor turnover .or the \<Y Co%"an is /a0 /b0 /c0 /&0 /e0 20 &a s 40 &a s 4)49 4)49 5)09

3-30) (he avera$e collection "erio& .or the \<Y Co%"an is Z /a0 /b0 /c0 /&0 /e0 20 &a 22 &a 30 &a 3' &a +0 &a s s s s s

104

CHAPTER 4 4-1) Z

LEVERAGE AND RISK ANALYSIS

;"eratin$ levera$e is /a0 /b0 /c0 /&0 /e0 the ratio o. current assets to .i9e& assets the ratio o. .i9e& assets to total assets the ratio o. current assets to total assets the ratio o. .i9e& assets to stockhol&ers e@uit none o. the above

4-2) Z

?inancial levera$e is /a0 /b0 /c0 /&0 /e0 the ratio o. total &ebt to total assets the ratio o. current &ebt to total &ebt the ratio o. lon$-ter% &ebt to total assets the ratio o. current &ebt to lon$-ter% &ebt none o. the above

4-3) Z

,t the break-even level o. out"ut /a0 /b0 /c0 /&0 /e0 total revenue e@uals total .i9e& costs total revenue e@uals total costs total revenue e@uals total variable costs total .i9e& costs e@ual total variable costs none o. the above

4-4)

(he break-even "oint Bill increase i. /a0 /b0 /c0 /&0 /e0 .i9e& costs increase sellin$ "rice increases variable costs increase both /a0 an& /b0 occur both /a0 an& /c0 occur

Z 4-')

I. both .i9e& costs an& variable costs &ecline, the break- even "oint /a0 /b0 /c0 /&0 /e0 increases re%ains the sa%e &ecreases both increases an& &ecreases cannot be calculate& base& u"on the available in.or%ation

4)+)

I. both .i9e& costs an& sellin$ "rice increase, the break-even "oint /a0 increases
10'

Z 4-4)

/b0 /c0 /&0 /c0

re%ains the sa%e &ecreases .irst increases an& then &ecreases cannot be calculate& base& u"on the available in.or%ation

=hich o. the .olloBin$ is not likel to be inclu&e& in the co%"utation o. variable costs[ /a0 /b0 /c0 /&0 /e0 &irect labor raB %aterial costs sales co%%ission %ana$e%ent salar all o. the above are inclu&e&

Z 4-*)

=hich o. the .olloBin$ is not likel to be inclu&e& in the co%"utation o. .i9e& costs[ /a0 /b0 /c0 /&0 /e0 &e"reciation utilities &irect labor su"ervisor salaries all o. the above are inclu&e&

4-5)

Calculate the break-even @uantit .or a .ir% Bhich sells its "ro&uct .or $10 "er unit, has .i9e& costs o. $+00 an& variable costs o. $+ "er unit) /a0 /b0 /c0 /&0 /e0 300 units 2'0 units 200 units 1'0 units none o. the above

4-10) In the above "roble%, calculate the &ollar a%ount o. break-even "oint .or the .ir%) Z /a0 /b0 /c0 /&0 /e0 $3,000 $1,'00 $2,000 $2,'00 none o. the above

4-11) ;"eratin$ levera$e is the result o. Z /a0 /b0 /c0 /&0 /e0 variable costs .i9e& costs total costs total revenue interest char$es
10+

4-12) (he &e$ree o. o"eratin$ levera$e Z /a0 /b0 /c0 /&0 /e0

/6;#0 is &e.ine& as the

"ercenta$e chan$e in 73I( to "ercenta$e chan$e in sales "ercenta$e chan$e in 7-S to "ercenta$e chan$e in 73I( "ercenta$e chan$e in 73I( to "ercenta$e chan$e in 7-S "ercenta$e chan$e in 7-S to "ercenta$e chan$e in sales none o. the above

4-13) =hen the 6;# = 3, a '2 chan$e in sales volu%e Bill result in a /a0 /b0 /c0 /&0 /e0 '2 chan$e into 7-S 1'2 chan$e into 7-S '2 chan$e into 73I( 1'2 chan$e into 73I( none o. the above

4-14) ?inancial levera$e is the result o. Z /a0 /b0 /c0 /&0 /e0 .i9e& o"eratin$ costs .i9e& interest costs variable costs total costs &ivi&en& costs

4)1') Z

?avorable .inancial levera$e occurs Bhen the .ir%As return on invest%ent /R;I0 is $reater than the /a0 /b0 /c0 /&0 /e0 .i9e& cost o. borroBin$ cost o. ca"ital cost o. "re.erre& stock cost o. e@uit all o. the above /6?#0 is &e.ine& as the

4-1+) (he &e$ree o. .inancial levera$e /a0 /b0 /c0 /&0 /e0

"ercenta$e chan$e in 73I( to "ercenta$e chan$e in sales "ercenta$e chan$e in 7-S to "ercenta$e chan$e in sales "ercenta$e chan$e in 73I( to "ercenta$e chan$e in 7-S "ercenta$e chan$e in 7-S to "ercenta$e chan$e in 73I( none o. the above

4-14) I. the 6?# = 2, a 102 chan$e in 73I( Bill result in a /a0 102 chan$e in 7-S
104

/b0 /c0 /&0 /e0

202 chan$e in sales 202 chan$e in net "ro.it 202 chan$e in 7-S 202 chan$e in 6-S

4-1*) (he &e$ree o. co%bine& levera$e /6C#0 is &e.ine& as the Z /a0 /b0 /c0 /&0 /e0 "ercenta$e chan$e in 7-S to "ercenta$e chan$e in sales "ercenta$e chan$e in 73I( to "ercenta$e chan$e in sales "ercenta$e chan$e in 7-S to "ercenta$e chan$e in 73I( "ercenta$e chan$e in 73I( to "ercenta$e chan$e in 7-S none o. the above

4-15) I. the 6C# = ', a '2 chan$e in sales Bill result in a /a0 /b0 /c0 /&0 /e0 '2 chan$e in 7-S 1'2 chan$e in 73I( 2'2 chan$e in 73I( 2'2 chan$e in net "ro.it 2'2 chan$e in 7-S

4-20) 3 increasin$ the use o. o"eratin$ levera$e, the .ir% Bill also increase its Z /a0 /b0 /c0 /&0 /e0 .inancial risk business risk in.lation risk both /a0 an& /b0 all o. the above

4-21) 3 increasin$ the use o. .inancial levera$e, the .ir% Bill also increase its /a0 /b0 /c0 /&0 /e0 business risk in.lation risk .inancial risk both /a0 an& /b0 all o. the above

4)22) Z

6e$ree o. co%bine& levera$e /6C#0 is /a0 /b0 /c0 /&0 /e0 the su% o. 6;# an& 6?# the "ro&uct o. 6;# an& 6?# the coe..icient o. 6;# an& 6?# in&e"en&ent o. 6;# an& 6?# none o. the above
10*

4-23) 6elta Co%"an sells its "ro&uct at $20 "er unit) Its .i9e& costs are $10,000 an& the variable costs are $10 "er unit) Calculate the &e$ree o. o"eratin$ levera$e at 3,000 units o. out"ut) /a0 /b0 /c0 /&0 /e0 3 ti%es 2)' ti%es 2)0 ti%es 1)' ti%es 1)0 ti%es

4-24) Si$%a Cor"oration has an 73I( o. $20,000) ,ssu%in$ its interest char$es are $4,000, calculate its &e$ree o. .inancial levera$e /6?#0) /a0 /b0 /c0 /&0 /e0 ' ti%es 2)' ti%es 1)2' ti%es 1)00 ti%es none o. the above

105

CHAPTER 5 '-1)

FINANCIAL PLANNING AND FORECASTING

=hich o. the .olloBin$ is not a t "ical bu&$et use& b the .ir%[ /a0 /b0 /c0 /&0 /e0 sales bu&$et "ro&uction bu&$et a&%inistrative bu&$et cost o. $oo&s sol& bu&$et .inancial "lannin$ bu&$et

'-2) =hich o. the .olloBin$ bu&$ets constitutes the .irst ste" in the entire bu&$etin$ "rocess[ /a0 /b0 /c0 /&0 /e0 "ro&uction bu&$et a&%inistrative bu&$et sales bu&$et .inancial "lannin$ bu&$et R K 6 bu&$et

'-3)

(he "ro&uction bu&$et re.lects the use o. /a0 /b0 /c0 /&0 /e0 %aterials labor .acilities both /a0 an& /b0 all o. the above

Z '-4)

(he balance sheet bu&$et su%%ari>es the e..ect o. the bu&$etin$ s ste% on the .ir%As /a0 /b0 /c0 /&0 /e0 assets liabilities net Borth both /a0 an& /b0 all o. the above

Z '-') Z

=hat is the %ost co%%on &uration .or Bhich cash bu&$ets are "re"are&[ /a0 /b0 /c0 /&0 /e0 Beekl %onthl @uarterl hal.- earl earl

'-+)

=hich o. the .olloBin$ is not a cash out.loB ite% in the .ir%As cash bu&$et[
110

/a0 /b0 /c0 /&0 /e0

Ba$es an& salaries interest "a %ent &e"reciation char$es overhea& "a %ents sellin$ e9"enses

'-4)

=hich o. the .olloBin$ is not a cash bu&$et ite%[ /a0 /b0 /c0 /&0 /e0 cre&it sales cash sales "urchases overhea& e9"enses accruals

Z ')*)

=hich o. the .olloBin$ ite% .ro% the .ir%As "ro .or%a inco%e state%ent is nee&e& in or&er to "re"are the .ir%As "ro .or%a balance sheet[ /a0 /b0 /c0 /&0 /e0 sales esti%ates retaine& earnin$s esti%ates cost o. $oo&s sol& esti%ates 73I( esti%ates net "ro.it esti%ates

'-5)

, state%ent base& on historical &ata in&icatin$ Bhere .un&s ca%e .ro% an& hoB the Bere use& is knoBn as the /a0 /b0 /c0 /&0 /e0 cash bu&$et inco%e bu&$et ca"ital e9"en&iture bu&$et .inance bu&$et sources an& uses o. .un&s state%ent

'-10) (he .un&s-.loB state%ent is an i%"ortant "lannin$ tool to esti%ate the .ir%As Z /a0 /b0 /c0 /&0 /e0 "ro.itabilit .inancial re@uire%ents &ivi&en& "a %ents &ebt servicin$ "a %ents sales "roIections

'-11) =hich o. the .olloBin$ is not a source o. .un&s[ Z /a0 /b0 increase in cash increase in notes "a able
111

/c0 /&0 /e0

&ecrease in inventories increase in retaine& earnin$s &ecrease in .i9e& assets

'-12) =hich o. the .olloBin$ is not a source o. .un&s[ /a0 /b0 /c0 /&0 /e0 increase in accounts "a ables &ecrease in accounts receivables increase in e@uit ca"ital &ecrease in &e"reciation increase in notes "a ables

'-13) =hich o. the .olloBin$ is not a use o. .un&s[ /a0 /b0 /c0 /&0 /e0 increase in cash &ecrease in notes "a ables increase in &e"reciation &ecrease in lon$-ter% &ebt increase in .i9e& assets

'-14) =hich o. the .olloBin$ is not a use o. .un&s[ Z /a0 /b0 /c0 /&0 /e0 &ecrease in cash increase in inventories &ecrease in accounts "a able increase in accounts receivables &ecrease in lon$-ter% &ebt

')1')

(he "ercent-o.-sales %etho& assu%es that certain balance sheet accounts chan$e in so%e .i9e& "ro"ortion to chan$es in HHHHHHHH) /a0 /b0 /c0 /&0 /e0 assets net "ro.its inco%e state%ent sales sources an& uses o. .un&s

')1+) =hich o. the .olloBin$ is classi.ie& as Xs"ontaneousl $enerate& liabilitiesX Bhich Boul& auto%aticall .inance a "art o. sales increase[ /a0 /b0 /c0 /&0 accounts "a able accruals bon&s both /a0 an& /b0
112

/e0 ')14)

all o. the above

:iven the .olloBin$ balance sheet chan$es, Bhat chan$e, i. an , shoul& a""ear in the retaine& earnin$s[ cash = + +,000C &e"reciation = + $',000C inventories = + $12,000C notes "a able = -$*,000C accounts "a able = + $1',000

/a0 /b0 /c0 /&0 /e0

+$ ',000 +$ +,000 +$10,000 -$ ',000 -$ +,000

'-1*) Ju"iter, Inc) has an 73I( o. $4,2'0,000 an& an interest "a %ent o. $'00,000) :iven a ta9 rate o. '0 "ercent an& a &ivi&en& "a out ratio o. 40 "ercent, Bhat is the co%"an As esti%ate o. retaine& earnin$s[ Z /a0 /b0 /c0 /&0 /e0 $1,12',000 $ 4'0,000 $1,*4',000 $1,24',000 $ *'0,000

'-15) =hich o. the .olloBin$ .orecastin$ %etho&s is %ost so"histicate&[ Z /a0 /b0 /c0 /&0 /e0 the "ercent to sales %etho& the %ulti"le re$ression %etho& the si%"le re$ression %etho& the sales .orce co%"osite %etho& the usersA e9"ectation %etho& esti%ate the value o. a

'-20) =hen tBo or %ore in&e"en&ent variables are use& to &e"en&ent variable, one %ust use Z /a0 /b0 /c0 /&0 /e0 the "ercent to sales %etho& the %ulti"le re$ression %etho& the si%"le re$ression %etho& the sales .orce co%"osite %etho& the usersA e9"ectation %etho&

113

CHAPTER 6 +-1)

AN OVERVIEW OF WORKING CAPITAL MANAGEMENT

(he Borkin$ ca"ital %ana$e%ent re.ers to the %ana$e%ent o. /a0 /b0 /c0 /&0 /e0 .i9e& assets an& liabilities total assets an& current liabilities current assets an& e@uit current assets an& current liabilities .i9e& assets an& current liabilities

Z +-2) Z

Current assets are reasonabl e9"ecte& to be converte& into cash Bithin /a0 /b0 /c0 /&0 /e0 one ear three ears .ive ears ten ears si9 %onths

+-3)

Current assets are liste& on the balance sheet in or&er o. their /a0 /b0 /c0 /&0 /e0 solvenc "riorit "ro.itabilit i%"ortance li@ui&it

Z +-4)

!et Borkin$ ca"ital /a0 /b0 /c0 /&0 /e0 is alBa s "ositive is alBa s $reater than Borkin$ ca"ital e9clu&es accounts receivable is the e9cess o. current assets over current liabilities is less li@ui& than .i9e& assets

Z +-') Z

I. a .ir% has a current ratio o. one, its net Borkin$ ca"ital is /a0 /b0 /c0 /&0 /e0 "ositive >ero ne$ative the sa%e as its current liabilities cannot be ansBere& .ro% the $iven in.or%ation

114

+-+)

(e%"orar increases in short-ter% assets shoul& or&inaril be .inance& .ro% /a0 /b0 /c0 /&0 /e0 lon$-ter% &ebt e@uit short-ter% ca"ital retaine& earnin$s retaine& earnin$s "lus &e"reciation

+-4) Z

(he o"eratin$ c cle or cash c cle is the len$th o. ti%e betBeen /a0 /b0 /c0 /&0 /e0 Bhen a .ir% "urchases raB %aterials an& Bhen it sells its "ro&uct Bhen a .ir% "urchases raB %aterials an& Bhen it collects its account receivables Bhen a .ir% sells its "ro&ucts an& collects it account receivables Bhen a .ir% "urchases its raB %aterials an& Bhen it %anu.actures the .inishe& "ro&uct none o. the above

+)*) Z

, co%bination o. a hi$h level o. current assets Bith a loB level o. current liabilities Bill $enerall iel& the .olloBin$ results /a0 /b0 /c0 /&0 /e0 loBer "ro.itabilit loBer "ro.itabilit hi$her "ro.itabilit hi$her "ro.itabilit none o. the above an& loBer risk an& hi$her risk an& hi$her risk an& loBer risk

+-5)

(he s%aller the "ro"ortion o. current assets to total assets /a0 /b0 /c0 /&0 /e0 the hi$her the rate o. return an& the loBer the &e$ree o. risk the loBer the rate o. return an& the hi$her the &e$ree o. risk the hi$her the rate o. return an& the hi$her the &e$ree o. risk the loBer the rate o. return an& the loBer the &e$ree o. risk none o. the above

+-10) In $eneral, as the ratio o. a .ir%As current liabilities to current assets increases Z /a0 /b0 /c0 /&0 /e0 "ro.itabilit increases an& risk &ecreases both the "ro.itabilit an& risk increase "ro.itabilit &ecreases an& risk increases both the "ro.itabilit an& risk &ecrease none o. the above

11'

+-11) (he %atchin$ "rinci"le re@uires that a .ir% %atch /a0 /b0 /c0 /&0 /e0 current assets to current liabilities .i9e& assets to lon$-ter% ca"ital the %aturit structure o. its assets Bith that o. liabilities current assets to .i9e& assets current liabilities to lon$-ter% ca"ital

11+

CHAPTER 7 4-1)

CURRENT ASSET MANAGEMENT

(hree "ri%ar %otives .or hol&in$ cash are8 /a0 /b0 /c0 /&0 /e0 .inancin$, ca"ital bu&$etin$ an& &ivi&en& li@ui&it , "ro.itabilit an& levera$e %er$ers, ac@uisitions an& inventor .inancin$ transaction, "recautionar an& s"eculative none o. the above

Z 4-2)

=hich o. the .olloBin$ is not a current asset[ /a0 /b0 /c0 /&0 /e0 inventor cash "lant an& e@ui"%ents account receivable %arketable securities

4-3) Z

;n the to"ic o. cash %ana$e%ent, the ter% X.loatX re.ers to /a0 /b0 /c0 /&0 /e0 the "rocess o. .loatin$ a securit the status o. .un&s in the "rocess o. collection the "rocess o. clearin$ checks .ro% the bankin$ s ste% %one hel& in the %one %arket %utual .un&s none o. the above

4-4)

=hich o. the .olloBin$ &oes not re"resent a cate$or o. .loat[ /a0 /b0 /c0 /&0 /c0 invoicin$ .loat %ail .loat "rocessin$ .loat transit .loat collection .loat

Z 4-') Z

=hich o. the .olloBin$ is not use& to s"ee& u" the cash collection into the .ir%[ /a0 /b0 /c0 /&0 lock-bo9 s ste% use o. .loat concentration bankin$ "re-authori>e& checks

4-+) Z

(he lock-bo9 s ste% is &esi$ne& to /a0 /b0 s"ee& u" the "rocess o. cash collection lock u" the i&le cash balances
114

/c0 /&0 /e0 4-4)

increase the .loat $ive e9ten&e& cre&it to custo%ers .ore$o cash &iscounts on accounts "a able

Concentration bankin$ is a "rocess to /a0 /b0 /c0 /&0 /e0 centrali>e the bankin$ s ste% increase the .loat s"ee& u" the cash collection .ro% custo%ers concentrate bankin$ in bi$ cities onl alloB .orei$n banks to o"en o..ices in the Fnite& States /-,Cs0 s ste% has the .olloBin$ a&vanta$e/s0

4-*)

(he "re-authori>e& checks /a0 /b0 /c0 /&0 /e0

Z 4-5) Z

the cash .loBs .ro% this s ste% are hi$hl "re&ictable billin$ an& "osta$e costs are eli%inate& custo%ers are not con.ronte& Bith the "roble%s o. re$ular billin$s both /a0 an& /b0 all o. the above

=hich o. the .olloBin$ %etho&s Bill not hel" to increase cash balance[ /a0 /b0 /c0 /&0 /e0 use o. lock-bo9 s ste% &ecentrali>e& bankin$ &ela in$ &isburse%ents use "re-authori>e& checks all o. the above

4-10) =hich o. the .olloBin$ %etho&/s0 Bill hel" to increase cash balance[ /a0 /b0 /c0 /&0 /e0 use o. lock-bo9 s ste% concentration bankin$ &ela in$ &isburse%ents both /a0 an& /b0 all o. the above

4-11) In or&er to &eter%ine the o"ti%u% cash balance, the .ir% %ust consi&er the .olloBin$ /a0 /b0 /c0 /&0 /e0 the transaction &e%an& .or cash the e..icienc o. its cash %ana$e%ent the co%"ensatin$-balance re@uire%ents o. its bankers both /a0 an& /b0 all o. the above

11*

4)12) Calculate the e..ective cost o. a loan Bhich re@uires a no%inal interest rate o. 12 "ercent an& a co%"ensatin$ balance o. 20 "ercent o. the loan a%ount) Z /a0 /b0 /c0 /&0 /e0 202 1'2 122 102 none o. the above

4-13) 1arketable securities are "ri%aril hel& .or the .olloBin$ reason/s08 /a0 /b0 /c0 /&0 /e0 to "rovi&e bu..er a$ainst cash shorta$es to earn interest on a te%"orar basis to earn interest earnin$s to co%"ensate .or interest e9"enses both /a0 an& /b0 all o. the above

Z 4)14)

=hich o. the .olloBin$ .actor/s0 %ust be consi&ere& Bhile selectin$ %arketable securities[ /a0 /b0 /c0 /&0 /e0 risk o. &e.ault %arketabilit %aturit both /b0 an& /c0 all o. the above

4-1') =hich o. the .olloBin$ is not consi&ere& a t "ical %arketable securit [ /a0 /b0 /c0 /&0 /e0 treasur bills co%%ercial "a"ers bankerAs acce"tance re"urchase a$ree%ents co%%on stock

4-1+) =hich o. the .olloBin$ is not consi&ere& a t "ical cre&it "olic variable[ /a0 /b0 /c0 /&0 /e0 cre&it stan&ar&s cre&it ter%s collection "olic &isburse%ent "olic cash &iscount "olit

115

4-14) ,n increase in cash &iscount ten&s to /a0 /b0 /c0 /&0 /e0 sti%ulate sales shorten the avera$e collection "erio& re&uce ba&-&ebt losses both /a0 an& /b0 all o. the above

4-1*) , ti$ht collection "olic %a ten& to /a0 /b0 /c0 /&0 /e0 &ecrease ba&-&ebt losses re&uce the avera$e collection "erio& re&uce the collection e9"en&itures both /a0 an& /b0 all o. the above

4-15) =hich o. the .olloBin$ is not consi&ere& a t "ical source o. cre&it in.or%ation[ /a0 /b0 /c0 /&0 /e0 re"ort o. cre&it re"ortin$ a$encies .inancial state%ents &e"art%ent stores cre&it car&s cre&it interchan$e bureaus 6un K 3ra&street re"orts

4-20) =hich o. the .olloBin$ is not consi&ere& an essential .actor in cre&it anal sis[ /a0 /b0 /c0 /&0 /e0 character ca"acit collateral courtes ca"ital

4-21) =hich o. the .olloBin$ is not inclu&e& in the carr in$ costs .or inventor [ /a0 /b0 /c0 /&0 /e0 interest on .un&s tie& u" in inventor insurance "re%iu%s stora$e costs lost @uantit &iscounts inventor han&lin$ costs

120

4)22)

Calculate the 7;Q .or a .ir% Bhich sells *,000 units annuall , the or&erin$ costs are $*0, an& the carr in$ costs are $2 "er unit) /a0 /b0 /c0 /&0 /e0 200 400 +00 *00 none o. the above

4-23) In the above "roble%, calculate the total inventor cost) Z /a0 /b0 /c0 /&0 /e0 $2,000 $1,+00 $1,200 $ *00 $ 400

4-24) =hich o. the .olloBin$ .actor/s0 a..ect the si>e o. sa.et stock[ /a0 /b0 /c0 /&0 /e0 .luctuations in &e%an& .or inventor uncertaint o. lea& ti%e the cost o. stock-outs both /a0 an& /b0 all o. the above

4-2') Fn&er con&itions o. uncertaint , the reor&er "oint is &e.ine& as /a0 /b0 /c0 /&0 /e0 the lea& ti%e in &a s ti%es the &ail usa$e the econo%ic or&er @uantit the usa$e &urin$ the lea& ti%e "lus the sa.et stock the 7;Q "lus the sa.et stock none o. the above

4-2+) ?or the .olloBin$ reason/s0, the %ana$e%ent o. inventor is ver i%"ortant /a0 /b0 /c0 /&0 /e0 the re"resent a lar$e se$%ent o. total assets the are least li@ui& o. current assets the are &i..icult to han&le both /a0 an& /b0 all o. the above

121

CHAPTER 8 *-1

SOURCES OF SHORT-TERM FINANCING

Short-ter% cre&it re.ers to &ebt Bhich is e9"ecte& to be re"ai& Bithin /a0 /b0 /c0 /&0 /e0 .ive ears three ears one ear si9 %onths one %onth

*-2

=hich o. the .olloBin$ is not a short-ter% source o. .un&s[ /a0 /b0 /c0 /&0 /e0 tra&e cre&it co%%ercial "a"ers notes "a able ri$hts .inancin$ accounts receivable .inancin$

Z *-3

=hich o. the .olloBin$ are %aIor .or%s o. tra&e cre&it[ /a0 /b0 /c0 /&0 /e0 o"en account tra&e acce"tances notes "a able both /a0 an& /b0 all o. the above

Z *-4) 100[

=hat is the e9act cost o. not takin$ a cash &iscount .or the .olloBin$ ter%8 3E10 net ,ssu%e 3+0 &a s in one ear)

/a0 /b0 /c0 /&0 /e0

12)002 12)342 1')2*2 3)002 1*)4+2

*-') Calculate the cost o. a cash &iscount .or$one .or the .olloBin$ ter%8 2E10 net +0) ,ssu%e 3+0 &a s in one ear) /a0 /b0 /c0 /&0 2)002 1*)2+2 14)+52 3+)432
122

/e0 *-+)

none o. the above

Short-ter% bank loans are %a&e /a0 /b0 /c0 /&0 /e0 on an unsecure& basis to .inance .ir%As seasonal nee&s to .inance .ir%As e9"ansion nee&s both /a0 an& /b0 all o. the above

Z *-4)

=hich o. the .olloBin$ is not a .or% o. short-ter% bank loan[ /a0 /b0 /c0 /&0 /e0 notes "a able lines o. cre&it co%"ensatin$ balance revolvin$ cre&it arran$e%ents all o. the above are .or%s o. short-ter% bank loan

*-*)

, line o. cre&it a$ree%ent has Bhich o. the .olloBin$ characteristic/s0[ /a0 /b0 /c0 /&0 /e0 it is an in.or%al co%%it%ent it is unsecure& it re@uires co%%it%ent .ee .ro% the borroBer both /a0 an& /b0 all o. the above

Z *-5)

, revolvin$ line o. cre&it has Bhich o. the .olloBin$ characteristic/s0[ /a0 /b0 /c0 /&0 /e0 it is a le$al co%%it%ent it is le$all bin&in$ it nor%all runs .ro% one to three &a s both /a0 an& /b0 all o. the above

Z *)10)

, .ir% borroBs $20,000 at 12 "ercent) Co%"ute the e..ective rate o. interest i. the loan is &iscounte&) /a0 /b0 /c0 /&0 /e0 12)002 1')'32 13)+42 11)+*2 24)002

*-11) Co%%ercial "a"ers are

123

/a0 /b0 /c0 /&0 /e0

short-ter% "ro%issor notes unsecure& notes issue& b the %ost cre&it-Borth cor"orations both /a0 an& /b0 all o. the above

*-12) In $eneral, the interest rate on co%%ercial "a"er is Z /a0 /b0 /c0 /&0 /e0 the sa%e as the "ri%e rate beloB the "ri%e rate above the "ri%e rate the sa%e as lon$-ter% ,aa cor"orate bon& rate the sa%e as the cost o. "re.erre& stock

*-13) =hich o. the .olloBin$ is/are0 the a&vanta$e/s0 o. co%%ercial "a"er .inancin$[ /a0 /b0 /c0 /&0 /e0 it is less costl than bank loans it is .ree o. bank re$ulations it has a %aturit o. one ear both /a0 an& /b0 all o. the above

Z *)14) risk Z

=hile "le&$in$ accounts receivable as a %eans o. securin$ short-ter% .inancin$, the o. &e.ault b the custo%er lies Bith the /a0 /b0 /c0 /&0 /e0 len&er borroBer bank cre&it bureau all o. the above

*)1')

(he cost o. an account receivable loan ten&s to be hi$her than the cost o. an unsecure& loan &ue to the .olloBin$ reason/s08 /a0 /b0 /c0 /&0 /e0 co%"anies are usuall .inanciall Beaker Bho use account receivable .inancin$ it re@uires consi&erable a%ount o. "a"erBork account receivable &o not %ake $oo& collateral both /a0 an& /b0 all o. the above

*-1+) In .actorin$, account receivables are /a0 /b0 /c0 sol& on an outri$ht basis .actore& on a non-recourse basis .actore& on noti.ication basis
124

Z *)14)

/&0 /e0

both /a0 an& /b0 all o. the above

Calculate the net "rocee&s available to a .ir% Bhich has .actore& its accounts receivable o. $20,000 &ue in one %onth) (he .actor a&vances 4' "ercent o. the receivables, char$es 1)' "ercent interest "er %onth, an& 2 "ercent .actorin$ co%%ission) 3oth the interest an& the co%%ission are "ai& on a &iscount basis) /a0 /b0 /c0 /&0 /e0 $1',000)00 $14,400)00 $14,'*5)00 $14,44')00 $14,445)'0

*-1*) In the above "roble%, calculate the e..ective annual cost o. the .inancial arran$e%ent) /a0 /b0 /c0 /&0 /e0 +0)'22 45)022 43)142 24)002 1*)'42

*-15) =hich o. the .olloBin$ is not a &esirable .eature o. inventories Bhen it is bein$ use& as a collateral .or securin$ short-ter% loans[ /a0 /b0 /c0 /&0 /e0 %arketabilit &urabilit "rice stabilit "erishabilit &e$ree o. "h sical control b the len&er

Z *)20)

=hich o. the .olloBin$ is not a t "ical arran$e%ent Bhile usin$ inventories as a collateral .or a short-ter% loan[ /a0 /b0 /c0 /&0 /e0 .loatin$ /blanket0 inventor liens .actorin$ inventories trust recei"ts Barehouse recei"ts all o. the above are t "ical arran$e%ents

*)21)

=hich one o. the .olloBin$ %etho&s o. inventor .inancin$ "rovi&es the best "rotection to the len&er[ /a0 .loatin$ /blanket0 inventor liens
12'

/b0 /c0 /&0 /e0

trust recei"ts Barehouse recei"ts .actorin$ inventories all o. the %etho&s "rovi&e e@ual "rotection

*)22)

Calculate the e..ective interest rate on a $10,000 loan at 12 "ercent interest rate i. the bank re@uires a 20 "ercent co%"ensatin$ balance) /a0 /b0 /c0 /&0 /e0 12 "ercent 1' "ercent 1* "ercent 5 "ercent none o. the above

12+

CHAPTER 9 5)1)

TIME VALUE OF MONEY

, "erson &e"osits $1,000 in a savin$s account that "a s ' "ercent interest co%"oun&e& annuall ) DoB %uch %one Boul& the "erson have at the en& o. .ive ears[ /a0 /b0 /c0 /&0 /e0 $1,1'0 $1,2'0 $1,24+ $ 4*4 $','2+

5)2)

DoB %uch Bill $100 investe& to&a at an annual interest rate o. + "ercent co%"oun&e& se%iannuall "rovi&e at the en& o. ei$ht ears[ /a0 /b0 /c0 /&0 /e0 $ 1'0)00 $ 1+0)'0 $ 1*0)2' $ 15')10 $2,01')40

5)3)

I. ou &e"osit $100 a ear at the en& o. ever ear in a savin$s account that "a s + "ercent interest co%"oun&e& annuall , hoB %uch Boul& ou accu%ulate at the en& o. .ive ears[ /a0 /b0 /c0 /&0 /e0 $'+3)40 $133)*0 $421)20 $35')40 $+*3)'1

5)4)

I. ou &e"osit $300 at the en& o. ever si9 %onths in a savin$s account that "a s * "ercent annual interest co%"oun&e& se%iannuall , hoB %uch Boul& ou receive at the en& o. three ears[ /a0 /b0 /c0 /&0 /e0 $1,'42)+0 $15*5)50 $1,*00)00 $1,510)'0 $2,2'0)00

5)')

,t an interest rate o. + "ercent "er ear, hoB %uch %ust ou invest each ear in or&er to have $10,000 .ive ears .ro% noB[

124

Z 5)+) Z

/a0 /b0 /c0 /&0 /e0

$2,000 $1,'54 $2,344 $1,444 $3,025

, .ir% nee&s $',000 at the en& o. 3 ears) ,t an interest rate o. 4 "ercent co%"oun&e& annuall , hoB %uch %one shoul& the .ir% invest to&a [ /a0 /b0 /c0 /&0 /e0 $4,0*0 $4,2'0 $',000 $+,12' $3,0'0

5)4)

<ou are borroBin$ $',000 .ro% a .rien& on a "ro%ise to "a $4,02' at the en& o. 3 ears) =hat is the rate o. interest ou Bill "a on this loan[ /a0 /b0 /c0 /&0 /e0 102 122 142 1'2 1*2

5)*)

,3C Co%"an has a $'00,000 bon& issue outstan&in$ Bhich Bill %ature in ten ears) ,3C Bants to set u" a sinkin$ .un& to retire the bon& issue) I. the .un& earns 12 "ercent interest, Bhat Bill be the annual "a %ents necessar to retire the bon&s[ /a0 /b0 /c0 /&0 /e0 $**,45+ $'0,000 $24,144 $2*,452 $20,'1+

Z 5)5)

,t an interest rate o. 14 "ercent, hoB lon$ Bill it take $2,000 to accu%ulate to the a%ount $+,'04[ /a0 /b0 /c0 /&0 /e0 ' ears + ears 5 ears 12 ears in.init

5)10)

?in& the "resent value o. $',000 &ue at the en& o. three ears i. the %one is Borth 12 "ercent "er ear co%"oun&e& @uarterl )
12*

/a0 /b0 /c0 /&0 /e0

$3,'0' $3,12' $2,4*' $4,0'0 $',000

5)11)

<our uncle o..ere& ou a choice betBeen a lu%" su% "a %ent o. $',000 to&a or an annuit o. $1,340 a ear .or .ive ears) =hich one shoul& ou choose $iven an interest rate o. 10 "ercent[ /a0 /b0 /c0 /&0 /e0 the lu%" su% the annuit cannot %ake a choice both o"tions are e@uall $oo& i$nore the o..er

5-12) <our rich aunt o..ere& ou a choice betBeen a lu%" su% "a %ent o. $+,'00 at the en& o. .ive ears or an annuit o. $1,000 a ear .or .ive ears) =hich one shoul& ou choose $iven an interest rate o. 12 "ercent[ Z /a0 /b0 /c0 /&0 /e0 the lu%" su% the annuit cannot %ake a choice both o"tions are e@uall $oo& i$nore the o..er

5-13) (o hel" our son $et throu$h the ne9t .our ears o. colle$e, this %ornin$ ou &e"osite& $+,4*0 in a bank account that "a s 5 "ercent interest on the &e"osit balance) <ou "lan to have no %one le.t in our bank account b the en& o. .our ears) DoB %uch %one can ou Bith&raB at the en& o. each ear .or the ne9t .our ears[ /a0 /b0 /c0 /&0 /e0 $',000 $4,000 $3,000 $2,000 $1,000

5-14) <ou borroBe& $40,000 to&a .ro% our .rien& an& a$ree& to "a in 12 e@ual se%iannual "a %ents o. $4,441) (he .irst "a %ent Bill be si9 %onths .ro% noB) =hat is the i%"licit annual rate o. interest ou are "a in$ on the loan[ /a0 /b0 +2 *2
125

/c0 /&0 /e0

102 122 142

5-1') <ou bou$ht a $100,000 buil&in$ to&a an& %a&e a 20 "ercent &oBn "a %ent) <ou a$ree& to "a $12,045 at the en& o. each ear to "a the %ort$a$e balance) ,ssu%in$ an interest rate o. 14 "ercent on the loan, hoB lon$ Bill it take ou to "a o.. the loan[ /a0 /b0 /c0 /&0 /e0 10 1' 20 2' 30 ears ears ears ears ears

5-1+) Calculate the current %arket "rice o. a '- ear bon& that "a s $'0 interest ever si9 %onths an& is sol& to iel& 12 "ercent "er ear to be co%"oun&e& se%iannuall ) /a0 /b0 /c0 /&0 /e0 $1,000 $ *'0 $ 52+ $1,12' $1,0'4

5-14) In the above "roble%, i. the interest rate re@uire& b the investors &ecreases .ro% 12 "ercent to 10 "ercent, the %arket "rice o. the bon& Boul& be /a0 /b0 /c0 /&0 /e0 $1,100 $1,0'0 $ 5'0 $1,000 $ *00

Questions 5-1* throu$h 5-21 re.er the .olloBin$ "roble%8 (o% :reen bou$ht a house to&a .or $50,000 an& .inance& the Bhole a%ount .or 30 ears at an interest rate o. 14 "ercent on the &eclinin$ balance) 5-1*) DoB %uch Bill (o% :reen "a .or this annual, e@ual %ort$a$e install%ents[ /a0 /b0 /c0 /&0 /e0 $ l,*00)00 $ 4,'*')41 $ 3,000)00 $12,*'1)+4 $10,00')40
130

5-15) Calculate the total interest "a %ents that (o% :reen Bill "a over the 30- ear li.e o. the %ort$a$e) Z /a0 /b0 /c0 /&0 /e0 $3*','45 $25','45 $134,'+2 $ 44,'+2 $210,1+2

5-20) ,ssu%in$ that the house Bill a""reciate at an annual rate o. 10 "ercent, Bhat Bill be the %arket value o. the house at the en& o. ten ears[ /a0 /b0 /c0 /&0 /e0 $333,+30 $213,030 $233,4+0 $2'','10 $144,030

5-21) DoB %uch %one Boul& (o% :reen accu%ulate at the en& o. 30 ears i. he Bere to invest the e@ual, annual install%ents into an account that "a s interest at a rate o. 12 "ercent[ Z /a0 /b0 /c0 /&0 /e0 $3,101,4*+ $103,'20 $4,'*',1*2 $3*',03' $22','33

5-22) I. ou &e"osit $2,000 in an account that "a s * "ercent interest, a""ro9i%atel hoB lon$ Bill it take .or it to beco%e $4,000[ /a0 /b0 /c0 /&0 /e0 12)' ears 10)0 ears 5)0 ears *)0 ears 14)' ears

5-23) Coo"er Dar&Bare Co%"an borroBe& $2',000 at 1+ "ercent annual interest on the un"ai& balance .or three ears an& a$ree& to a%orti>e the loan b %akin$ e@ual "a %ents at the en& o. ever si9 %onths) =hat Bill be the si>e o. the se%iannual loan "a %ents[ Z /a0 /b0 $4,1+4 $',40*
131

/c0 /&0 /e0

$+,0*0 $3,40* $4,02+

5-24) Calculate the %arket "rice o. a bon& that "ro%ises to "a $120 a ear in&e.initel an& is sol& to iel& 11 "ercent) Z /a0 /b0 /c0 /&0 /e0 $1,200)00 $1,050)51 $1,000)00 $1,320)00 $1,201)'5

5-2') 1ar Jones bou$ht a con&o%iniu% in DaBaii .ive ears a$o .or $120,000) Si%ilar "ro"ert in DaBaii $reB in value at a rate o. 12 "ercent "er ear) =hat is the value o. 1ar JonesA con&o%iniu% to&a [ /a0 /b0 /c0 /&0 /e0 $34','50 $14+,4+0 $202,200 $221,040 $211,440

132

CHAPTER 1

VALUATION

10-1) :enerall s"eakin$, the hi$her the risk o. a "roIect Z /a0 /b0 /c0 /&0 the "roIect shoul& be aban&one& the hi$her the e9"ecte& return the hi$her the actual return the "roIect shoul& alBa s be acce"te&

10-2) (he &iscounte& cash .loB %o&el o. valuation is8 -o = 61E/Ue L $0) DoB Boul& -o chan$e Bith a corres"on&in$ increase in risk .or the .ir% all other thin$s constant[ Z /a0 /b0 /c0 Increase 6ecrease Re%ain constant

10-3) (he valuation "rinci"le states that the value o. an asset is e@ual to the /a0 /b0 /c0 /&0 5e0 "resent value o. its net "ro.its .uture value o. its cash .loBs "resent value o. its e9"ecte& cash .loBs "resent value o. its e9"ecte& &e"reciation none o. the above

10)4)

Calculate the current %arket "rice o. a '- ear, $1000 "ar, bon& that "a s $'0 interest ever si9 %onths an& is sol& to iel& 12 "ercent "er ear to be co%"oun&e& se%iannuall ) /a0 /b0 /c0 /&0 /e0 $1,000 $ *'0 $ 52+ $1,12' $1,0'4

10)')

In the above "roble%, i. the interest rate re@uire& b the investors &ecreases .ro% 12 "ercent to 10 "ercent, the %arket "rice o. the bon& Boul& be /a0 /b0 /c0 /&0 /e0 $1,100 $1,0'0 $ 5'0 $1,000 $ *00

10-+) Cor"orate bon&s

133

/a0 /b0 /c0 /&0 /e0

are sol& in &eno%ination o. $1,000 have .i9e& cou"on rate have .i9e& iel& rate both /a0 an& /b0 are true both /a0 an& /c0 are true

10-4) (he interest rate Bhich e@uates the "resent value o. the cou"on interest "a %ents an& the "rinci"al re"a %ent o. a bon& to its %arket "rice is calle& the /a0 /b0 /c0 /&0 /e0 Bei$hte& avera$e cost o. ca"ital cost o. e@uit cost o. "re.erre& stock cost o. retaine& earnin$s iel& to %aturit

10-*) ,s the $eneral interest rates increase, one Boul& e9"ect the %arket "rices o. %ost bon&s to Z /a0 /b0 /c0 /&0 /e0 &ecline re%ain unchan$e& increase chan$e in an &irection both /a0 an& /&0

10-5) =hich o. the .olloBin$ is not a characteristic o. a &ebt securit [ /a0 /b0 /c0 /&0 /e0 bon&hol&ers are cre&itors bon&hol&ers have "rior clai%s on earnin$s an& assets in li@ui&ation the rate o. return re@uire& b bon&hol&ers is $enerall hi$her than that b stockhol&ers interest "a %ents are a .i9e& char$e interest "a %ents are ta9 &e&uctible

10-10) (he relationshi" betBeen a bon&Ts "rice an& iel& to %aturit 8 Z /a0 /b0 /c0 is inverse is "ositivel correlate& is none o. the above

10-11) , bon&As .ace value is usuall Z /a0 /b0 /c0 /&0 sa%e as its %aturit value %ore than its %arket value less than its %arket value sa%e as its call "rice
134

/e0

@uote& in the )all (treet *ournal

10-12) , bon& Bith a %arket "rice o. $1,0'0 is sai& to be sellin$ at /a0 /b0 /c0 /&0 /e0 &iscount "ar "re%iu% %aturit value none o. the above

10-13) , bon&Ts iel& to %aturit is the rate o. return that e@uates the "resent value o. "rinci"al an& interest "a %ents to the Z /a0 /b0 /c0 /&0 /e0 "ar value o. the bon& current %arket "rice o. the bon& call "rice o. the bon& book value o. the bon& both /a0 an& /b0

10-14) , $1000 "ar value bon& "a s annual cou"on interest o. $*0 an& has 30 ears to %aturit ) I. the bon& is sellin$ at "ar, Bhat is its iel& to %aturit [ /a0 /b0 /c0 /&0 102 122 *2 not enou$h in.or%ation to &eter%ine

10)1') , $1000 "ar bon& "a in$ a cou"on o. 102 Bith 2' ears to %aturit sol& .or a "rice o. $*00 .ive ears a$o) =hat is the annual interest that the investor Boul& receive to&a [ Z /a0 /b0 /c0 /&0 $*0 $100 $1*0 $200

10-1+) =hich o. the .olloBin$ is not a characteristic o. "re.erre& stockhol&ers[ /a0 /b0 /c0 /&0 /e0 the receive a .i9e& inco%e the have "riorit over co%%on stockhol&ers the usuall &o not have a voice in %ana$e%ent the are alBa s entitle& to receive their &ivi&en&s "re.erre& stock issues have no &e.inite %aturit &ate

10-14) =hen a &ebt invest%ent, s"eci.icall a bon&, is hel& to its state& re&e%"tion &ate, it is .or%all re.erre& to as bein$ hel& to its8
13'

/a0 /b0 /c0

call &ate %aturit &ate re&e%"tion

10-1*) It is a $iven .act that the $eneral level o. stock "rices an& the "revailin$ interest on &ebt invest%ents has8 Z /a0 /b0 /c0 a ran&o% rather than a causal relationshi" an inverse relationshi" %ost &e.initel a "ositive relationshi"

10-15) InvestorsT overall re@uire& rate o. return on e@uit invest%ents increases as a result o.8 /a0 /b0 /c0 in.lationar "ressures increases in the $eneral level o. interest on &ebt invest%ents both o. the above

13+

CHAPTER 11

THE COST OF CAPITAL

11-1) (he %ar$inal cost o. ca"ital is &e.ine& as /a0 /b0 /c0 /&0 /e0 the a.ter ta9 cost o. &ebt the Bei$hte& avera$e& cost o. ca"ital the avera$e cost o. ca"ital the cost o. a&&itional .un&s to be raise& b the .ir% the historical cost o. ca"ital

11-2) In or&er to calculate the Bei$hte& avera$e cost o. ca"ital, one %ust co%"ute /a0 /b0 /c0 /&0 /e0 the cost o. in&ivi&ual co%"onents o. the ca"ital structure the "ercenta$e co%"osition o. the ca"ital structure coe..icient o. variation o. the ca"ital structure /a0 an& /b0 all o. the above

11-3) (he a.ter-ta9 cost o. a bon& is e@ual to /a0 /b0 /c0 /&0 the ta9 rate ti%es the be.ore ta9 cost o. the bon& the be.ore ta9 cost o. the bon& %inus the ta9 rate the be.ore ta9 cost o. the bon& ti%es /1 - ta9 rate0 the "rinci"al value o. the bon& ti%es the ta9 rate

11-4) Calculate the a.ter-ta9 cost o. a bon& Bhich has a cou"on rate o. 12 "ercent to be sol& at "ar, $iven a ta9 rate o. 40 "ercent) Z /a0 /b0 /c0 /&0 /e0 4)*2 4)22 12)02 1+)02 none o. the above

11-') Calculate the a.ter-ta9 cost o. a "re.erre& stock Bhich has a cou"on rate o. 14 "ercent to be sol& at "ar, $iven a ta9 rate o. 40 "ercent) Z /a0 /b0 /c0 /&0 /e0 142 *)42 ')+2 4)*2 none o. the above

134

11-+) Calculate the cost o. co%%on e@uit o. a .ir% Bhose stock is sellin$ at $32 a share, an& e9"ecte& to "a a ear-en& &ivi&en& o. $4)00 Bhich is e9"ecte& to $roB at an annual rate o. 3)' "ercent) /a0 /b0 /c0 /&0 /e0 12)'2 5)02 1+)02 10)52 none o. the above

11-4) (he interest rate Bhich e@uates the "resent value o. the cou"on interest "a %ents an& the "rinci"al re"a %ent o. a bon& to its %arket "rice is calle& the /a0 /b0 /c0 /&0 /e0 Bei$hte& avera$e cost o. ca"ital cost o. e@uit cost o. "re.erre& stock cost o. retaine& earnin$s cost o. &ebt, or iel& to %aturit

11-*) ,s the $eneral interest rates increase, one Boul& e9"ect the %arket "rices o. %ost bon&s to Z /a0 /b0 /c0 /&0 /e0 &ecline re%ain unchan$e& increase chan$e in an &irection both /a0 an& /&0

11-5) Calculate the cost o. co%%on e@uit o. ,3C Co%"an $iven the .olloBin$ in.or%ation8 the e9"ecte& rate o. return on the %arket "ort.olio is 1+ "ercent, the treasur bills are iel&in$ 12 "ercent an& the beta o. ,3C Co%"an As co%%on stock is 0)4') /a0 /b0 /c0 /&0 /e0 1+2 122 132 1'2 none o. the above

11-10) 3eta %a be use& to classi. stocks into Bhich o. the tBo .olloBin$ cate$ories[ /a0 /b0 /c0 inco%e stocks an& $roBth stocks &ivi&en& "a in$ stocks an& non-&ivi&en& "a in$ stocks stocks liste& on the !eB <ork Stock 79chan$e an& those tra&e& over-the-counter
13*

/&0 /e0

&e.ensive stocks an& a$$ressive stocks none o. the above

11-11) 6e.ensive stocks have a beta value Z /a0 /b0 /c0 /&0 less than one e@ual to one %ore than one none o. the above

11-12) ,$$ressive stocks have a beta value /a0 /b0 /c0 /&0 less than one e@ual to one %ore than one none o. the above

11-13) 6e.ensive stocks have their return .luctuate /a0 /b0 /c0 /&0 /e0 %ore than the %arket in&e9 sa%e as the %arket in&e9 less than the %arket in&e9 %ore than the a$$ressive stocks none o. the above

11-14) (he stocks Bith beta values e@ual to one are .re@uentl calle& Z /a0 /b0 /c0 /&0 /e0 a$$ressive stocks neutral stocks &e.ensive stocks inco%e stocks "re.erre& stocks

11-1') (o co%"ute the Bei$hte& avera$e cost o. ca"ital, one %ust /a0 /b0 /c0 /&0 /e0 calculate the cost o. each co%"onent &eter%ine the Bei$ht o. each co%"onent %ulti"l each Bei$ht b its corres"on&in$ co%"onent cost su% these "ro&ucts &o all o. the above

11-1+) In the "rocess o. &eter%inin$ the cost o. ca"ital, the book value Bei$hts are /a0 /b0 invariabl the sa%e as the %arket value Bei$hts &erive& .ro% the .ir%As balance sheet
135

/c0 /&0 /e0

eas to calculate /a0 an& /b0 /b0 an& /c0

11-14) =hile &eter%inin$ the cost o. ca"ital, the %arket value Bei$hts are /a0 /b0 /c0 /&0 /e0 base& on the current %arket "rices o. securities invariabl the sa%e as the book value Bei$hts %ore &esirable as the re.lect the true %arket value o. the ca"ital structure /a0 an& /b0 /a0 an& /c0

11-1*) Calculate the be.ore-ta9 cost o. a bon& Bhich has a cou"on rate o. 11 "ercent, a %arket "rice o. $500, a .ace value o. $1,000, an& a %aturit o. 10 ears) /a0 /b0 /c0 /&0 /e0 11)002 11)''2 12)3'2 12)+32 none o. the above

11-15) In the above "roble%, calculate the a.ter-cost o. the bon& assu%in$ a ta9 rate o. 40 "ercent) /a0 /b0 /c0 /&0 /e0 +)+02 +)532 ')0'2 4)'*2 none o. the above

11-20) (he o"ti%u% ca"ital structure is the one that /a0 /b0 /c0 /&0 /e0 &oes not inclu&e &ebt .inancin$ %a9i%i>es the cost o. ca"ital is in&e"en&ent o. the co%"onent costs o. ca"ital iel&s the loBest Bei$hte& avera$e cost o. ca"ital none o. the above

11-21) 6ebt .inancin$ has the .olloBin$ tBo t "es o. costs Z /a0 /b0 /c0 /&0 /e0 no%inal cost an& real cost e9"licit cost an& i%"licit cost e9"ense& cost an& i%"ute& cost interest cost an& &ivi&en& cost none o. the above
140

11-22) (he co%%on stock o. Co%"an , is sellin$ .or $'0 "er share) It e9"ects to "a a &ivi&en& o. $')'0 "er share an& the &ivi&en& Bill $roB at a rate o. ' "ercent "er ear) =hat is the cost o. co%%on stock[ /a0 /b0 /c0 /&0 /e0 10)'2 11)02 14)'2 1+)02 none o. the above

Questions 11-23 throu$h 11-24 re.er to the .olloBin$8 Fnite& ;il Co%"an has $1'0 %illion in total assets) It is "lannin$ to launch a %aIor e9"ansion "ro$ra% Bhich Bill increase its total assets to $200 %illion &urin$ the ear) Its "resent ca"ital structure, Bhich is consi&ere& to be o"ti%al is $iven beloB8 6ebt /102 cou"on bon&s0 -re.erre& stock !et Borth $ +0,000,000 1',000,000 4',000,000 $1'0,000,000

(he .ir%As invest%ent banker a$ree& to sell the neB bon&s at "ar bearin$ a cou"on rate o. 12 "ercent) -re.erre& stock Bill also be sol& at "ar Bith a cou"on rate o. 14 "ercent) Co%%on stock Bith a current %arket "rice o. $+0 can be sol& to net the co%"an $'4 "er share) Stockhol&ers o. the .ir% re@uire a rate o. return esti%ate& to be 1+ "ercent Bhich consists o. a &ivi&en& iel& /61E-00 o. + "ercent an& a $roBth rate o. 10 "ercent) (he retaine& earnin$s available .or the e9"ansion "ro$ra% are esti%ate& to be $4)' %illion) (he .ir% is in the 40 "ercent ta9 bracket) 11-23) DoB %uch o. the neB e@uit .un&s %ust be $enerate& e9ternall [ /a0 /b0 /c0 /&0 /e0 $2',000,000 $20,'00,000 $14,'00,000 $10,000,000 $ 4,'00,000

11-24) =hat is the cost o. internal e@uit [ /a0 /b0 /c0 /&0 /e0 102 122 142 1+2 1*2
141

11-2') =hat is the cost o. e9ternal e@uit [ /a0 /b0 /c0 /&0 /e0 12)0002 1+)0002 1+)+++2 1*)+++2 14)'002

11-2+) =hat is the Bei$hte& avera$e cost o. neB e@uit [ /a0 /b0 /c0 /&0 /e0 1+)0002 1+)2222 1+)4++2 12)04+2 1*)4142

11-24) =hat is the Bei$hte& avera$e cost o. the neB ca"ital[ /a0 /b0 /c0 /&0 /e0 12)0332 11)4532 14)4332 12)'132 1')0212

142

CHAPTER 1-

CAPITAL .UDGETING UNDER CERTAINTY

12-1) (he ca"ital bu&$etin$ "rocess re@uires /a0 /b0 /c0 /&0 /e0 the establish%ent o. lon$-ran$e obIectives the selection o. ca"ital e9"en&iture "ro"osals the "re"aration o. the .inancin$ "ro"osals /a0, an& /b0 onl /a0, /b0, an& /c0

12-2) (he ca"ital bu&$etin$ "roIects can be classi.ie& into the .olloBin$ cate$or /ies0 /a0 /b0 /c0 /&0 /e0 re"lace%ents e9"ansion into neB "ro&ucts e9"ansion into e9istin$ "ro&ucts /a0 an& /b0 onl all o. the above

12-3) (he net cash .loBs .ro% an invest%ent "roIect /a0 /b0 /c0 /&0 /e0 are the sa%e as net "ro.it are esti%ate& on historical basis are earnin$s a.ter ta9 "lus &e"reciation all o. the above none o. the above

12-4) (he econo%ic li.e o. a "roIect Z /a0 /b0 /c0 /&0 /e0 is the sa%e as its "h sical li.e re.ers to the ti%e "erio& &urin$ Bhich the "roIect is e9"ecte& to "rovi&e bene.its is not in.luence& b the nature o. the business is not a..ecte& b the chan$es in technolo$ is none o. the above certaint are

12-') (he %ost co%%onl use& ca"ital bu&$etin$ %etho&s un&er /a0 /b0 /c0 /&0 /e0 "a back avera$e rate o. return net "resent value internal rate o. return all o. the above

Z 12)+)

=hich one o. the .olloBin$ techni@ues is not utili>e& to evaluate "roIects un&er con&itions o. uncertaint [
143

/a0 /b0 /c0 /&0 /e0

co%"uter si%ulation sensitivit anal sis risk-a&Iuste& &iscount rate certaint e@uivalent a""roach "ro .or%a inco%e state%ent an& balance sheet

anal sis

12-4) (Bo "roIects are %utuall e9clusive i. Z /a0 /b0 /c0 /&0 /e0 both have net "resent values less than >ero one is a&o"te&, the other one cannot be a&o"te& both can be a&o"te& &urin$ &i..erent ti%e "erio&s both are co%"le%entar to each other none o. the above

12-*) =hich one o. the .olloBin$ ca"ital bu&$etin$ %etho&s &oes not take into account the ti%e value o. %one [ /a0 /b0 /c0 /&0 /e0 net "resent value internal rate o. return "ro.itabilit in&e9 "a back none o. the above

12-5) =hich o. the .olloBin$ ca"ital bu&$etin$ %etho&s are consi&ere& unso"histicate&[ /a0 /b0 /c0 /&0 /e0 "a back avera$e rate o. return net "resent value /a0 an& /b0 onl all o. the above

12-10) =hich one o. the .olloBin$ state%ents re$ar&in$ the "a back %etho& is incorrect[ Z /a0 /b0 /c0 /&0 "a back "erio& is eas to co%"ute "a back %etho& acknoBle&$es e9"licitl the cash .loBs be on& the "a back "erio& the %etho& e%"hasi>es "roIects Bith shorter "a back "erio&s it i$nores the ti%e "attern o. cash .loBs

144

,nsBer @uestions 12-11 throu$h 12-1' assu%in$ an invest%ent Bith the .olloBin$ cash .loBs an& net "ro.its) (i%e /in ears0 Cash ?loB !et -ro.it 0 -$10,000 O 1 *,000 $4,000 2 *,000 4,000 12-11) (he "a back "erio& is /a0 /b0 /c0 /&0 /e0 tBo ears 1)' ears 1)2' ears 0)*0 ears cannot be calculate&

12-12) (he avera$e rate o. return is Z /a0 /b0 /c0 /&0 /e0 *02 402 202 '02 none o. the above

12-13) I. the cost o. ca"ital Bere 10 "ercent, the net "resent value Boul& be /a0 /b0 /c0 /&0 /e0 $ 13,*** $ 10,000 $ 3,*** $ /2,0000 cannot be calculate& base& u"on the in.or%ation $iven

12-14) (he internal rate o. return is /a0 /b0 /c0 /&0 /e0 102 1*2 2+2 3*2 above 402

12-1') I. the cost o. ca"ital Bere 20 "ercent, the "ro.itabilit in&e9 Boul& be Z /a0 /b0 /c0 1)2224 0)*1*1 1)0000
14'

/&0 /e0

0)*000 none o. the above

12)1+) (he ne9t "resent value o. a "roIect is the "resent value o. the cash in.loBs &iscounte& at the cost o. ca"ital %inus Z /a0 /b0 /c0 /&0 /e0 the "resent value o. the salva$e value the "resent value o. the net cash invest%ent the salva$e value the "resent value o. the .uture &e"reciation ta9 shiel& the cost o. ol& %achine

12-14) (he "ro.itabilit in&e9 is obtaine& b &ivi&in$ the "resent value o. net cash in.loBs b /a0 /b0 /c0 /&0 /e0 the salva$e value the li@ui&atin$ value the &e"reciable value the "resent value o. the salva$e value the net invest%ent

12)14) (he internal rate o. return is the &iscount rate Bhich Bill e@uate the "resent value o. net cash in.loBs to Z /a0 /b0 /c0 /&0 /e0 the initial cost o. invest%ent the li@ui&ation value o. the "roIect the salva$e value o. the "roIect the .uture value o. cash .loBs none o. the above

12-15) =hen a "roIectAs cash .loBs are &iscounte& b its internal rate o. return, it has a /a0 /b0 /c0 /&0 /e0 "ositive net "resent value ne$ative net "resent value >ero net "resent value >ero salva$e value none o. the above

12-20) , "roIect is acce"table Bhen its internal rate o. return is $reater than Z /a0 /b0 /c0 /&0 /e0 >ero .ir%As cost o. ca"ital "roIectAs net "resent value 102 202
14+

12-21) =ith res"ect to an acce"t-reIect &ecision, the .ir% shoul& reIect the invest%ent "roIect i. /a0 /b0 /c0 /&0 /e0 its internal rate o. return e9cee&s the cost o. ca"ital its net "resent value is less than >ero its internal rate o. return e9cee&s >ero but less than its cost o. ca"ital /a0 an& /b0 /b0 an& /c0

12-22) (he avera$e rate o. return %etho& is in.erior to the net "resent value %etho& because Z /a0 /b0 /c0 /&0 /e0 it is &i..icult to calculate it &oes not consi&er the ti%e value o. %one it consi&ers cash .loBs onl rather than net "ro.it /a0 an& /b0 all o. the above

12-23) (he avera$e rate o. return on a "roIect is co%"ute& as /a0 /b0 /c0 /&0 /e0 the avera$e annual cash .loB &ivi&e& b the avera$e net invest%ent the avera$e annual cash .loB &ivi&e& b the initial invest%ent the avera$e annual net "ro.it a.ter ta9es &ivi&e& b the avera$e net invest%ent the avera$e annual net "ro.it a.ter ta9es &ivi&e& b the initial invest%ent the "resent value o. annual net "ro.its &ivi&e& b the avera$e net invest%ent

12)24) =hich o. the .olloBin$ techni@ues i$nores the ti%e value o. %one criteria that shoul& be consi&ere& in ca"ital bu&$etin$[ /a0 /b0 /c0 /&0 /e0 net "resent value internal rate o. return "ro.itabilit in&e9 avera$e rate o. return all o. the above

12-2') =hen the net "resent value o. a "roIect is >ero, the &iscount rate is Z /a0 /b0 /c0 /&0 /e0 the .ir%As cost o. ca"ital the "roIectAs internal rate o. return 102 the "roIectAs annual &e"reciation rate none o. the above

12)2') =hich o. the .olloBin$ is not a reason to illustrate the .act that net "resent value %etho& is better than internal rate o. return8 /a0 !-G hel"s to %a9i%i>e the value o. a .ir%
144

/b0 /c0 /&0 /e0

!-G is &i..icult to co%"ute a sin$le "roIect has onl one !-G at a "articular &iscount rate) uneven &iscount rates can be use& un&er !-G both /b0 an& /&0

12-24) =hich o. the .olloBin$ is not an a&vanta$e o. internal rate o. return %etho&8 /a0 /b0 /c0 /&0 /e0 it is easier to inter"ret it is i&entical to the iel& conce"t it re@uires "rior co%"utation o. the cost o. ca"ital both /a0 an& /c0 all o. the above

14*

CHAPTER 13 13-1) Sunk costs /a0 /b0 /c0 /&0 /e0

OTHER ISSUES IN CAPITAL .UDGETING

%ust alBa s be consi&ere& are those that ste% .ro% "ast &ecisions are irrelevant costs /a0 an& /b0 /b0 an& /c0

13-2) (he relevant costs in ca"ital invest%ent anal sis are Z /a0 /b0 /c0 /&0 /e0 the sunk costs the incre%ental costs the historical costs the cost o. "ro&uction all o. the above

13-3) =hile calculatin$ the cash .loB o. a "roIect, interest e9"enses are nor%all e9clu&e& Z /a0 /b0 /c0 /&0 /e0 in or&er to avoi& a &ouble-countin$ o. the cost o. .un&s because the are sunk costs because the &o not re"resent the o""ortunit cost o. .un&s available because the cannot be calculate& because o. all o. the above reasons

13-4) ?or ca"ital bu&$etin$ "ur"oses, the net Borkin$ ca"ital re@uire%ents o. a "roIect %ust be inclu&e& in /a0 /b0 /c0 /&0 /e0 the &e"reciable cost "ortion o. the "roIect the antici"ate& sales volu%es that the "roIect is e9"ecte& to $enerate the initial cash outla o. the "roIect /a0 an& /b0 all o. the above

13-') =hile co%"arin$ %utuall e9clusive "roIects Bith &i..erent li.e s"ans, it is o.ten use.ul to Z /a0 /b0 /c0 /&0 trans.or% the invest%ent outla s into an annuali>e& cost over the "roIectAs li.e trans.or% the net "resent value into an annuali>e& net "resent value over the "roIectAs li.e trans.or% the salva$e value into an annuali>e& net "resent value over the "roIectAs li.e trans.or% the &e"reciable cost into an annuali>e& cost over the "roIectAs li.e
145

/e0

none o. the above

13-+) , "roIect %a have to be retire& or ter%inate& be.ore its li.e because /a0 /b0 /c0 /&0 /e0 so%e un.oreseen "roble% %a occur initial assu%"tions %a turn out to be incorrect so%e a&&itional invest%ent o""ortunities %a arise "roIect %a no lon$er be &esirable all o. the above

Z 13)4)

In.lation ten&s to a..ect both the cost o. ca"ital an& the cash .loB esti%ates, but in ca"ital bu&$etin$ anal sis it is /a0 /b0 /c0 /&0 /e0 not necessar to a&Iust .or in.lation still necessar to a&Iust .or in.lation auto%aticall a&Iuste& Bithout an e..orts /a0 an& /b0 none o. the above

Questions 13-* throu$h 13-12 re.er to the .olloBin$8 , co%"an bou$ht a %achine .or $*0,000 .ive ears a$o) It can be sol& in the %arket noB .or $20,000) ,t the ti%e o. "urchase, the %achine ha& an e9"ecte& use.ul li.e o. ten ears an& an esti%ate& salva$e value o. $',000 on retire%ent) (he %achine has been &e"reciate& on a strai$ht line basis) (he .ir% has noB &eci&e& to re"lace the ol& %achine Bith a neB one) (he ta9 rate is 40 "ercent) 13-*) =hat are the annual &e"reciation char$es[ Z /a0 /b0 /c0 /&0 /e0 $*,000 $4,'00 $+,000 $',000 none o. the above

13-5) =hat is the current book value o. the %achine[ /a0 /b0 /c0 /&0 /e0 $40,000 $34,'00 $42,'00 $'0,000 $'',000

13-10) =hat is the book loss o. the sale o. the ol& %achine[
1'0

/a0 /b0 /c0 /&0 /e0

$20,000 $22,'00 $14,'00 $30,000 $3',000

13-11) =hat are the ta9 savin$s on the book loss[ /a0 /b0 /c0 /&0 /e0 $ *,000 $12,000 $13,'00 $ 5,000 $14,000

13-12) =hat are the sunk costs o. the ol& %achine[ Z /a0 /b0 /c0 /&0 /e0 $13,'00 $11,000 $12,000 $2+,000 $ 3,'00

13-13) , "roIect Bith a cost o. $'0,000 is e9"ecte& to "ro&uce a net cash .loB o. $20,000 a ear .or the ne9t .our ears) (he cost o. ca"ital is 12 "ercent) =hat is the net "resent value o. the "roIect[ /a0 /b0 /c0 /&0 /e0 $+0,440 $2',*20 $22,100 $10,440 $ *,0+0

13)14) In the above "roble%, i. an a&&itional Borkin$ ca"ital o. $10,000 is also re@uire& over the li.e o. the "roIect, Bhat Boul& be the net "resent value[ /a0 /b0 /c0 /&0 /e0 $+0,000 $10,440 $ +,410 $1+,420 none o. the above

Questions 13-1' throu$h 13-20 re.er to the .olloBin$8

1'1

(he -err 1anu.acturin$ Co%"an is usin$ an in&ustrial robot Bhich Bas ori$inall "urchase& .or $120,000 .ive ears a$o) (he robot has a current %arket /salva$e0 value o. $20,000) ,t the ti%e o. "urchase, the robot ha& an e9"ecte& use.ul li.e o. ten ears an& Bas &e"reciate& toBar&s a >ero esti%ate& salva$e value) 6e"reciation is on a strai$ht line basis) (he .ir% Bishes to re"lace this ol& robot Bith a neB robot Bhose cost is $100,000 Bith an e9"ecte& li.e o. .ive ears an& a >ero esti%ate& salva$e value) It is esti%ate& that the neB robot Bill save $*,000 "er ear an& to be &e"reciate& on a strai$ht line basis) (he cost o. ca"ital is 10 "ercent) Shoul& the .ir% re"lace the ol& robot assu%in$ a ta9 rate o. 40 "ercent[ 13-1') (he ta9 savin$s on the book loss o. sellin$ the ol& robot on an a.ter-ta9 basis Boul& be /a0 /b0 /c0 /&0 /e0 $20,000 $40,000 $24,000 $1+,000 none o. the above

13-1+) (he annual &e"reciation sche&ule on the neB robot on be.ore-ta9 basis Boul& be /a0 /b0 /c0 /&0 /e0 $*,000 $12,000 $1+,000 $20,000 none o. the above

13-14) (he total cash-out.loBs in the current ear /to0 Boul& be Z /a0 /b0 /c0 /&0 /e0 $ *4,000 $ +4,000 $ *0,000 $100,000 none o. the above

13)1*) (he "resent value interest .actor a""licable to the annual cash-in.loBs Boul& be /a0 /b0 /c0 /&0 /e0 1)1+1 0)+21 3)451 +)14' none o. the above

13-15) (he total "resent value o. cash-in.loBs Boul& be Z /a0 /b0 $24,344 $30,32*
1'2

/c0 /&0 /e0

$33,+*0 $50,120 none o. the above

13-20) (he net "resent value o. the "roIect is /a0 /b0 /c0 /&0 /e0 $/'3,+420 $/20,1020 $/33,+420 $25,0'0 none o. the above

1'3

CHAPTER 14

CAPITAL .UDGETING UNDER UNCERTAINTY

14-1) , narroBer "robabilit &istribution in&icates Z /a0 /b0 /c0 /&0 /e0 %ore risk less risk a loBer e9"ecte& value a hi$her correlation both /b0 an& /c0

14-2) (he coe..icient o. variation is &e.ine& as stan&ar& &eviation &ivi&e& b the /a0 /b0 /c0 /&0 /e0 se%i-variance coe..icient o. correlation net "resent value e9"ecte& value variance

14-3) Stan&ar& &eviation is e9"resse& in ter%s o. Z /a0 /b0 /c0 /&0 /e0 relative values absolute values "ercenta$e values Y values none o. the above

14-4) Coe..icient o. variation is e9"resse& in ter%s o. Z /a0 /b0 /c0 /&0 /e0 relative values absolute values nor%al &istribution ran$e Y values none o. the above

14-') =hich o. the .olloBin$ is the %easure o. absolute risk[ /a0 /b0 /c0 /&0 /e0 se%i-variance stan&ar& &eviation e9"ecte& value both /a0 an& /b0 all o. the above

Z 14)+)

?or "roIects Bhose returns are state& in &ollars, Bhich o. the .olloBin$ Boul& "rovi&e a better %easure%ent o. risk[
1'4

/a0 /b0 /c0 /&0 /e0

stan&ar& &eviation variance se%i-variance coe..icient o. variation e9"ecte& value

14-4) ?or "roIects Bhose returns are state& in ter%s o. "ercenta$es, Bhich o. the .olloBin$ Boul& "rovi&e a better %easure%ent o. risk[ Z /a0 /b0 /c0 /&0 /e0 stan&ar& &eviation variance se%i-variance coe..icient o. variation e9"ecte& value

14-*) =hich o. the .olloBin$ %etho&s is not use& to a&Iust a "roIectAs esti%ates .or risk in ca"ital bu&$etin$[ Z /a0 /b0 /c0 /&0 /e0 "a back risk-a&Iuste& &iscount rate certaint e@uivalent ca"ital asset "ricin$ %o&el all o. the above are use&

14-5) ,ccor&in$ to the risk-a&Iuste& &iscount rate %etho& .or incor"oratin$ risk into ca"ital bu&$etin$, ver risk "roIects are &iscounte& b a rate Z /a0 /b0 /c0 /&0 /e0 e@ual to the .ir%As cost o. ca"ital $reater than the .ir%As cost o. ca"ital less than the .ir%As cost o. ca"ital e@ual to the risk-.ree rate Bhich re.lects the .ir%As nor%al risk

14-10) Fn&er the certaint e@uivalent %etho& o. a&Iustin$ risk in ca"ital bu&$etin$, the certaint e@uivalent coe..icient are calculate& b /a0 /b0 /c0 /&0 /e0 %easurin$ the stan&ar& &eviation o. e9"ecte& cash .loBs usin$ a risk-a&Iuste& &iscount rate &ivi&in$ stan&ar& &eviation b a "roIectAs e9"ecte& value &ivi&in$ certain cash .loB b an uncertain cash .loB none o. the above

14-11) (he a""ro"riate &iscount rate to be use& un&er the certaint e@uivalent %etho& is the
1''

/a0 /b0 /c0 /&0 /e0

Bei$hte& avera$e cost o. ca"ital cost o. &ebt ca"ital cost o. e@uit ca"ital risk-a&Iuste& &iscount rate risk-.ree rate

14-12) =hen returns .ro% tBo "roIects ten& to %ove e9actl in the sa%e &irection over a "erio& o. ti%e, the "roIects /a0 /b0 /c0 /&0 /e0 are ne$ativel correlate& are not correlate& are "ositivel correlate& have sa%e e9"ecte& value are acce"table &ue to "ort.olio e..ect

14-13) (he .olloBin$ &iversi.ication alternatives are available to a .ir% alon$ Bith their correlation coe..icients) =hich one shoul& the .ir% select i. it chooses to re&uce its overall riskiness[ Z /a0 /b0 /c0 /&0 /e0 roa& construction - )4 house buil&in$ 0 a""liance %anu.acturin$ +)4 &e"art%ent stores +)' $reetin$ car&s %anu.acturin$ +1)0

Questions 14-14 throu$h 14-20 re.er to the .olloBin$ "roble%8 , .ir% is consi&erin$ tBo %utuall e9clusive invest%ent "roIects, \ an& <) (he "roIects have the .olloBin$ "robabilit &istribution o. their net cash .loBs un&er the &i..erent states o. the econo% 8 State o. 7cono% 3oo% )40 !or%al Recession !et Cash ?loBs -robabilit -roIect \ $+00 $'00 )'0 300 )10 100 -roIect < 400 200

14-14) (he e9"ecte& value o. net cash .loB .or -roIect \ is /a0 /b0 /c0 /&0 $+00 $'00 $400 $300
1'+

/e0

$200

14-1') (he e9"ecte& value o. net cash .loB .or -roIect < is Z /a0 /b0 /c0 /&0 /e0 $+*0 $420 $400 $330 none o. the above

14-1+) (he stan&ar& &eviation .or -roIect \ is /a0 /b0 /c0 /&0 /e0 $200)00 $154)4* $1*0)24 $143)21 none o. the above

14-14) (he stan&ar& &eviation .or -roIect < is /a0 /b0 /c0 /&0 /e0 154)'0 $121)45 $ *4)1* $ '*)44 none o. the above

14-1*) (he coe..icient o. variation .or -roIect \ is /a0 /b0 /c0 /&0 /e0 0)33 0)45 0)43 0)3* 0)3'

14-15) (he coe..icient o. variation .or -roIect < is Z /a0 /b0 /c0 /&0 /e0 0)25 0)21 0)25 0)2+ 0)1*

14-20) =hich invest%ent "roIect shoul& the .ir% choose[ /a0 -roIect \
1'4

/b0 /c0

-roIect < both \ an& <

1'*

CHAPTER 15

INVESTMENT .ANKERS AND CAPITAL MARKETS

1'-1) =hen a .ir% sells its neB securit , the transaction takes "lace in /a0 /b0 /c0 /&0 /e0 the !eB <ork Stock 79chan$e over the counter %arkets the secon&ar %arket a "rivate "lace%ent the "ri%ar %arket

Z 1')2)

=hen the securities o. a .ir% Bhich have alrea& been issue& are sol&, the transaction takes "lace in /a0 /b0 /c0 /&0 /e0 the !eB <ork Stock 79chan$e over the counter %arkets the secon&ar %arket a "rivate "lace%ent the "ri%ar %arket

1'-3) In the !eB <ork Stock 79chan$e, securities are tra&e& on Z /a0 /b0 /c0 /&0 /e0 an auction basis an in.or%al basis a bi&-an&-ask basis both /a0 an& /b0 both /b0 an& /c0

1'-4) In the over-the-counter %arkets, securities are tra&e& on /a0 /b0 /c0 /&0 /e0 an auction basis an in.or%al basis a bi&-an&-ask basis both /a0 an& /b0 both /b0 an& /c0

1'-') (he "rivate "lace%ent o. securities involve the sale o. an entire issue to /a0 /b0 /c0 /&0 /e0 the boar& o. &irectors the e9istin$ stockhol&ers a sin$le or a li%ite& nu%ber o. ulti%ate investors .orei$n investors the .a%il %e%bers

1')+)

=hich o. the .olloBin$ is a service "rovi&e& b an invest%ent banker to the issuer o. a securit [
1'5

Z 1')4)

/a0 /b0 /c0 /&0 /e0

a&vice an& counsel un&erBritin$ sellin$ both /a0 an& /b0 all o. the above

(he un&erBritin$ .ees .or co%%on stocks are HHHHHHH than those .or "re.erre& stocks) /a0 /b0 /c0 /&0 /e0 s%aller $reater the sa%e irrelevant to no%inal

1'-*) S n&icates are e%"lo e& in the &istribution o. securities .or the .olloBin$ reason8 /a0 /b0 /c0 /&0 /e0 to s"rea& the risk to han&le lar$er issues to obtain a better &istribution both /a0 an& /b0 all o. the above

1'-5) Fn&erBritin$ a""lies to Z /a0 /b0 /c0 /&0 /e0 the "ri%ar %arket the secon&ar %arket the !eB <ork Stock 79chan$e the over-the-counter %arkets the "rivate "lace%ent

1')10) =hich t "e o. un&erBritin$ best &escribes the situation Bhen the invest%ent banker &oes not have the res"onsibilit .or unsol& securities[ /a0 /b0 /c0 /&0 /e0 .ir% un&erBritin$ "rivate "lace%ent best-e..ort basis s n&ication all o. the above

1')11) =hen a neB securit is sol& on a co%"etitive basis, it usuall results in a HHHHHHHHH "rice than a ne$otiate& o..erin$) /a0 loBer
1+0

/b0 /c0 /&0 /e0

no%inal hi$her cost "lus bi&

1'-12) =hich o. the .olloBin$ is a bene.it o. "rivate "lace%ent o. securities[ /a0 /b0 /c0 /&0 /c0 it &oes not re@uire re$istration Bith the S7C issuin$ costs are substantiall loBer "ossible to %o&i. the ter%s o. o..erin$ to %eet the nee&s o. investors both /b0 an& /c0 all o. the above

1'-13) (he "re-e%"tive ri$hts "rovi&e that /a0 /b0 /c0 /&0 /e0 ou %ust sell our stock .irst boar& o. &irectors have ri$hts to .irst subscribe the neB shares neB shares be sol& to outsi&ers onl the e9istin$ stockhol&ers have the .irst ri$ht to subscribe the neB shares bon& hol&ers have re.erence over the stockhol&ers

1')14) Fn&er "re-e%"tive ri$hts o..erin$, hoB %an ri$hts are receive& b the e9istin$ sharehol&ers .or each share o. co%%on stock hel&[ Z /a0 /b0 /c0 /&0 /e0 one tBo .ive ten &e"en&s on the ter%s o. o..erin$

Questions 1'-1' throu$h 1'-1* re.er to the .olloBin$8 (he ,3C Co%"an has tBo %illion shares outstan&in$) It "lans to raise a&&itional e@uit ca"ital o. $1' %illion b issuin$ neB co%%on stock Bith "re-e%"tive ri$hts at $30 a share) (he ,3C Co%"an As stock is currentl sellin$ .or $'0 "er share) 1'-1') Calculate the nu%ber o. neB shares to be issue& b the co%"an ) /a0 /b0 /c0 /&0 /e0 ' %illion 1 %illion '00,000 100,000 none o. the above

1'-1+) Calculate the nu%ber o. ri$hts re@uire& to subscribe one neB share)
1+1

/a0 /b0 /c0 /&0 /e0

one tBo three .our .ive

1'-14) Calculate the theoretical value o. one ri$ht) /a0 /b0 /c0 /&0 /e0 $10)00 $ +)+4 $ ')00 $ 4)00 $ 3)33

1'-1*) =hat is the theoretical %arket "rice o. co%%on stock Bhen it $oes e9-ri$ht[ Z /a0 /b0 /c0 /&0 /e0 $'0)00 $4+)00 $4')00 $43)33 $40)00

Questions 1'-15 throu$h 1'-23 re.er to the .olloBin$ @uotation .ro% the "a$es o. the )all (treet *ournal8 134 1E4 55 I31 4)40 3)' 13 1'5*+ 12* 1E2 12' 12' 4E* -3E4 1'-15) =hat is the loBest "rice that stock has tra&e& &urin$ the "revious one ear[ Z /a0 /b0 /c0 /&0 /e0 $134)2' $ 55)00 $ 44)00 $ 13)00 $ 3)'0

1'-20) =hat is the "rice-earnin$s ratio .or the stock[ /a0 /b0 /c0 /&0 /e0 4)409 3)'09 13)009 55)009 none o. the above

1'-21) DoB hi$h has the stock tra&e& .or the &a [
1+2

/a0 /b0 /c0 /&0 /e0

$134)2' $ 55)00 $12*)'0 $12')00 $3'0)00

1'-22) =hat is the current &ivi&en& iel& on the stock[ Z /a0 /b0 /c0 /&0 /e0 13 "ercent 3)' "ercent 4)4 "ercent 10)0 "ercent none o. the above

1'-23) =hat Bas the closin$ "rice o. the stock on the "revious tra&in$ &a [ /a0 /b0 /c0 /&0 /e0 $12' $124 3E4 $12' 1E* $12+ 'E* $125 1E4

Questions 1'-24 throu$h 1'-24 re.er to the .olloBin$ @uotation .ro% the "a$es o. the )all (treet *ournal8 Shell 0 4 1E4 02 12 10 +1 3E4 +1 'E* +1 3E4 +2 1E4

1'-24) In Bhat ear is this bon& sche&ule& to %ature[ /a0 /b0 /c0 /&0 /e0 1552 1555 2000 2002 2020

1'-2') =hat is the current iel& on the bon&[ Z /a0 /b0 /c0 /&0 /e0 4)2' "ercent 12)00 "ercent 10)00 "ercent 22)00 "ercent none o. the above

1'-2+) DoB %an bon&s Bere tra&e& .or the &a [

1+3

/a0 /b0 /c0 /&0 /e0

1,000 1,200 100 120 10

1'-24) =hat Bas the closin$ "rice @uotation .or the bon& on the "revious tra&in$ &a [ /a0 /b0 /c0 /&0 /e0 +4 +0 '5 1E2 '5 1E4 '*

1'-2*) =hich o. the .olloBin$ is not an a&vanta$e to a .ir% seekin$ to $o "ublic[ /a0 /b0 /c0 /&0 /e0 easier to raise neB ca"ital hel".ul in establishin$ value .or the .ir% increase& li@ui&it in.or%ation &isclosures throu$h Securities an& 79chan$e Co%%ission e9ecutive recruit%ent

1+4

CHAPTER 16

FI>ED INCOME SECURITIES/ .ONDS AND PREFERRED STOCK

1+-1) =hich o. the .olloBin$ is not a characteristic o. a &ebt securit [ /a0 /b0 /c0 /&0 /e0 bon&hol&ers are cre&itors bon&hol&ers have "rior clai%s on earnin$s an& assets in li@ui&ation the rate o. return re@uire& b bon&hol&ers is $enerall hi$her than that b stockhol&ers interest "a %ents are a .i9e& char$e interest "a %ents are ta9 &e&uctible

1+-2) , bon&As .ace value is usuall Z /a0 /b0 /c0 /&0 /e0 sa%e as its %aturit value %ore than its %arket value less than its %arket value sa%e as its call "rice @uote& in the )all (treet *ournal

1+-3) , bon& Bith a %arket "rice o. $1,0'0 is sai& to be sellin$ at /a0 /b0 /c0 /&0 /e0 &iscount "ar "re%iu% %aturit value none o. the above

1+-4) , bon& Bith lon$er %aturit Bill $enerall have /a0 /b0 /c0 /&0 /e0 a $reater risk hi$her iel& rate loBer &iscount rate both /a0 an& /b0 all o. the above

Z 1+)')

Calculate the annual interest "a %ent on a bon& that has a cou"on rate o. 10 "ercent an& a iel& rate o. 12 "ercent) /a0 /b0 /c0 /&0 /e0 $ '0 $ +0 $100 $120 cannot be calculate&
1+'

1+)+)

, bon&As iel& to %aturit is the rate o. return that e@uates the "resent value o. "rinci"al an& interest "a %ents to the /a0 /b0 /c0 /&0 /e0 "ar value o. the bon& current %arket "rice o. the bon& call "rice o. the bon& book value o. the bon& both /a0 an& /b0

1+-4) , bon& Bith a call "rovision is $enerall sol& to "rovi&e a Z /a0 /b0 /c0 /&0 /e0 loBer iel& co%"are& to that o. a si%ilar non-callable bon& hi$her iel& co%"are& to that o. a si%ilar non-callable bon& sa%e iel& co%"are& to that o. a si%ilar non-callable bon& si%ilar iel& Bhich is available on .ir%As "re.erre& stock si%ilar iel& Bhich is available on .ir%As co%%on stock

1+)*)

=hich o. the .olloBin$ is not a bene.it to the bon&hol&er because o. the "rovision o. the bon&As sinkin$ .un&[ /a0 /b0 /c0 /&0 /e0 it assures an or&erl retire%ent o. a bon& issue it ten&s to su""ort the %arket "rice o. the bon&s it re&uces bon&hol&ersA e9"osure to risk it in&iscri%inatel retires so%e bon&s Bhile others are still out-stan&in$ all o. the above are the bene.its

1+-5) =hich one o. the .olloBin$ bon&s $enerall carries hi$hest interest iel&[ /a0 /b0 /c0 /&0 /e0 %ort$a$e bon&s chattel %ort$a$e bon&s secon& %ort$a$e bon&s &ebentures inco%e bon&s

1+-10) =hich o. the .olloBin$ is an unsecure& bon&[ /a0 /b0 /c0 /&0 /e0 real estate %ort$a$e bon& chattel %ort$a$e bon& &ebenture collateral trust bon& secon& %ort$a$e bon&

1+-11) Inco%e bon&s

1++

/a0 /b0 /c0 /&0 /e0

alBa s "rovi&e inco%e to its oBner usuall result .ro% cor"orate reor$ani>ations "a s interest onl to the e9tent o. current earnin$s both /a0 an& /b0 both /b0 an& /c0

1+-12) I. the interest "a %ents on a bon& .luctuate, it is calle& Z /a0 /b0 /c0 /&0 /e0 a %ort$a$e bon& a .loatin$-rate bon& an inco%e bon& a >ero-cou"on bon& a &ebenture

1+-13) Yero-cou"on bon&s /a0 /b0 /c0 /&0 /e0 "rovi&e all o. the cash "a %ent on %aturit onl &o not "a "erio&ic interest are sol& at &ee" &iscounts both /a0 an& /b0 are true all o. the above are true

1+)14) ,ccor&in$ to the Stan&ar& an& -oorAs bon& ratin$s, a loBer %e&iu%-$ra&e bon& Bill have a ratin$ o. /a0 /b0 /c0 /&0 /e0 ,, 333 33 3 CCC

1+-1') I&enti. the incorrect state%ent8 3on& ratin$s are i%"ortant because the /a0 /b0 /c0 /&0 /e0 a..ect the interest rate "a able on the bon& a..ect the availabilit o. a&&itional &ebt ca"ital in&icate the @ualit o. the bon& &eter%ine the &ebt ratio o. the .ir% in&icate the riskiness o. the bon& to an investor

1+)1+) =hich o. the .olloBin$ as"ects o. the co%"an an& its &ebt issue is not consi&ere& b the ratin$ a$encies Bhile &eter%inin$ its bon& ratin$s[ /a0 /b0 /c0 @ualit o. %ana$e%ent level an& stabilit o. earnin$s .inancial resources
1+4

/&0 /e0

in&enture "rovisions all o. the above are consi&ere&

1+)14) , .ir% is sai& to have a .avorable .inancial levera$e Bhen its return o. invest%ent e9cee&s its /a0 /b0 /c0 /&0 /e0 cost o. e@uit cost o. ca"ital cost o. "re.erre& stock cost o. retaine& earnin$s cost o. &ebt

1+)1*) I&enti. the incorrect state%ent8 3on& .inancin$ is "re.erable to stock .inancin$ because /a0 /b0 /c0 /&0 /e0 it "revents &ilution o. oBnershi" control it "revents &ilution o. earnin$s interest is ta9 &e&uctible it re&uces the riskiness o. the .ir% &ebtor bene.its in a "erio& o. in.lation

1+-15) =hich o. the .olloBin$ is not a characteristic o. "re.erre& stockhol&ers[ /a0 /b0 /c0 /&0 /e0 the receive a .i9e& inco%e the have "riorit over co%%on stockhol&ers the usuall &o not have a voice in %ana$e%ent the are alBa s entitle& to receive their &ivi&en&s "re.erre& stock issues have no &e.inite %aturit &ate

1+)20) Calculate the a.ter-ta9 cost on a $14 "re.erre& stock sellin$ at "ar /$1000 to the issuin$ cor"orationOBhich is in the 4+ "ercent ta9 bracket) /a0 /b0 /c0 /&0 /e0 *)40 "ercent 4)'+ "ercent 14)00 "ercent 1)40 "ercent 4+)00 "ercent

1+-21) I&enti. the incorrect reason8 (he "ar value o. a "re.erre& stock is %eanin$.ul to its hol&ers because o. the .olloBin$ reasons8 /a0 /b0 /c0 call "rice is .re@uentl calculate& as a "ercenta$e o. the "ar value &ivi&en& is calculate& as a "ercenta$e o. the "er value "ar value establishe& the a%ount that "re.erre& stockhol&ers can clai% in the event o. li@ui&ation
1+*

/&0 /e0

"ar value &eter%ines the %arket value o. the "re.erre& stock all o. the above are correct reasons

1+-22) I. a .ir% e9ercises its o"tion to call a "re.erre& stock issue, it %ust "a /a0 /b0 /c0 /&0 /e0 the "ar value o. the "re.erre& stock a call "re%iu% all accu%ulate& an& un"ai& &ivi&en&s both /a0 an& /b0 all o. the above

1+)23) =hat is the &ollar a%ount o. annual &ivi&en&s to be "ai& on a cu%ulative 12 "ercent "re.erre& stock /$100 "ar0 Bhich has o%itte& its &ivi&en&s .or the last .our consecutive ears[ /a0 /b0 /c0 /&0 /e0 $12 $24 $4* $+0 $42

1+-24) I&enti. the incorrect state%ent8 -re.erre& stock can be either /a0 /b0 /c0 /&0 /e0 cu%ulative or non-cu%ulative "artici"atin$ or non-"artici"atin$ callable or non-callable convertible or non-convertible ta9 &e&uctible or non-ta9 &e&uctible

1+-2') , .ir% can have a .avorable levera$e on "re.erre& stock Bhen its return on invest%ent e9cee&s its Z /a0 /b0 /c0 /&0 /e0 cost o. &ebt cost o. "re.erre& stock cost o. e@uit cost o. overall ca"ital cost o. retaine& earnin$s

1+-2+) =hich o. the .olloBin$ is not a &isa&vanta$e o. "re.erre& stock .inancin$[ /a0 /b0 /c0 /&0 "re.erre& &ivi&en&s are not ta9 &e&uctible it re@uires hi$her iel& as co%"are& to that on bon&s co%%on &ivi&en&s cannot be "ai& unless "re.erre& &ivi&en&s are "ai& .irst both /a0 an& /b0
1+5

/e0

all o. the above

1+-24) In re.un&in$ o. a bon&, the a""ro"riate &iscount rate to .in& the "resent value o. the interest savin$s is the Z /a0 /b0 /c0 /&0 /e0 cost o. ca"ital a.ter-ta9 cost o. neB &ebt a.ter-ta9 cost o. ca"ital cost o. "re.erre& stock cost o. e@uit ca"ital

140

CHAPTER 17

COMMON STOCK

14-1) -ar value o. co%%on stock HHHHHHHH its %arket value /a0 /b0 /c0 /&0 /e0 is %ore than is the sa%e is less than is a&Iuste& to %atch has no relevance to

Z 14)2)

=hen a co%"an issues a neB stock, it shoul& not sell the stock at a "rice less than its "ar value because /a0 /b0 /c0 /&0 /e0 it is too %uch o. a bar$ain to the bu ers stockhol&ers %a be hel& liable to the cre&itors in the event o. bankru"tc it Bill &ilute the earnin$s it Bill &ilute the control it Bill increase &ivi&en& "a out

14-3) (he authori>e& stock o. a co%"an re"resents the Z /a0 /b0 /c0 /&0 /e0 %ini%u% nu%ber o. shares it can issue %a9i%u% nu%ber o. shares it can issue nu%ber o. shares Bhich it has issue& its total e@uit ca"ital none o. the above

14-4) -ai&-in sur"lus is the actual issue "rice o. the stock %inus its /a0 /b0 /c0 /&0 /e0 book value li@ui&atin$ value cash value "ar value %arket value

14-') (reasur stock is /a0 /b0 /c0 /&0 /e0 issue& b the F)S) (reasur the nu%ber o. outstan&in$ shares the shares that have been issue& an& subse@uentl reac@uire& b the co%"an the net stockhol&ersA e@uit both /b0 an& /c0

14-+) 3ook value o. co%%on stock HHHHHHH its %arket value

141

/a0 /b0 /c0 /&0 /e0

&oes not alBa s corres"on& to is the sa%e as is less than is %ore than is a&Iuste& to %atch

14-4) =hich o. the .olloBin$ &oes not re"resent a t "ical characteristic at co%%on stock[ /a0 /b0 /c0 /&0 /e0 election o. boar& o. &irectors "rivile$e to atten& co%"an As annual %eetin$s le$al ri$ht to receive &ivi&en&s no .i9e& %aturit loBest clai% "riorit on earnin$s an& assets

14-*) Fn&er the %aIorit votin$ s ste%, hoB %an &irectors o. a 5-"erson boar& can '1 "ercent o. the stockhol&ers elect[ /a0 /b0 /c0 /&0 /e0 ' 4 4 5 cannot be calculate&

14-5) =hich o. the .olloBin$ a""l to the cu%ulative votin$ /a0 /b0 /c0 Z /&0 /e0 each sharehol&er can accu%ulate his or her votes an& cast all o. the% .or a sin$le &irector enables %inorit stockhol&ers to elect a certain nu%ber o. &irectors $rou" o. sharehol&ers controllin$ '1 "ercent o. the outstan&in$ shares can still elect the entire boar& both /a0 an& /b0 none o. the above

14-10) =hat is the least nu%ber o. shares re@uire& to elect one &irector .ro% a boar& o. 4 &irectors un&er the cu%ulative votin$ s ste% i. there are 4',000 shares outstan&in$[ /a0 /b0 /c0 /&0 /e0 '0,001 34,'01 1',001 1',000 10,'00

14)11) Fn&erBritin$ .ees .or co%%on stock are $enerall $reater than .or "re.erre& stock because
142

/a0 /b0 /c0 /&0 /e0

no one Bants to bu co%%on stock it has hi$her risk not too %an brokera$e houses Bant to sell it it has a thin secon&ar %arket S7C re@uires &isclosure o. in.or%ation

14-12) =hat is the conversion ratio o. a convertible bon& Bith a conversion "rice o. $40[ /a0 /b0 /c0 /&0 /e0 40 30 2' 20 10

14-13) =hat is the conversion "rice o. a convertible bon& Bith a conversion ratio o. 40 an& the co%%on stock is sellin$ at $2* "er share[ /a0 /b0 /c0 /&0 /e0 $1,120 $1,000 $ '+0 $ 2' cannot be calculate&

14-14) =hat is the conversion value o. a convertible bon& Bith a conversion ratio o. 2' shares o. co%%on stock Bhich is sellin$ .or $'0 "er share[ Z /a0 /b0 /c0 /&0 /e0 $1,000 $1,2'0 $ 4'0 $ 500 $1,'00

14-1') =hat is the conversion "re%iu% on a convertible bon& sellin$ at $1,200 Bhich is convertible into 40 shares o. co%%on stock Bhich sells at $2+)2'[ Z /a0 /b0 /c0 /&0 /e0 $200 $1'0 $100 $ '0 none o. the above

14-1+) In the above "roble%, calculate the "ercenta$e conversion "re%iu%) Z /a0 /b0 20)02 14)32
143

/c0 /&0 /e0

12)'2 1')02 11)32

14)14) , Barrant is an o"tion to "urchase HHHHHHHH co%%on shares at a .i9e& "rice Bithin a "rescribe& "erio&) /a0 /b0 /c0 /&0 /e0 a &esire& nu%ber o. unli%ite& 20 10 "ercent o. outstan&in$ a state& nu%ber o.

14)1*) (he o"tion "rice at Bhich Barrants are e9ercisable usuall e9cee&s the "rice o. the co%%on stock at the ti%e o. issuance b HHHHHHHH) /a0 /b0 /c0 /&0 /e0 0-' "ercent '-10 "ercent 10-1' "ercent 1'-20 "ercent 20-2' "ercent

14)15) =hat is the theoretical value o. a Barrant Bhich entitles its oBner to bu tBo shares o. co%%on stock at $40 Bhich are currentl tra&in$ in the %arket .or $'4 a share[ /a0 /b0 /c0 /&0 /e0 $14 $3+ $24 $2* $*0

14)20) =arrants usuall sell at a "re%iu%) =hich o. the .olloBin$ reasons e9"lain this "heno%enon[ /a0 /b0 /c0 /&0 /e0 the have s"eculative a""eal their "rice usuall rises an& .alls at a .aster rate than the "rice o. the associate stock a%ount o. "ossible loss is s%all both /a0 an& /b0 all o. the above

14)21) , Barrant is currentl sellin$ at a "re%iu% o. $3) =hat is the %arket "rice o. this Barrant Bhich entitles its oBner to bu three shares o. co%%on stock at $12 "er share[ (he %arket "ri&e o. co%%on stock is $1+ "er share)
144

/a0 /b0 /c0 /&0 /e0

$12 $1' $1+ $3+ $35

14-22) ,s the "rice o. a stock rises, the "re%iu% on its Barrant HHHHHHHH) /a0 /b0 /c0 /&0 /e0 increases re%ains the sa%e &ecreases increases at an increasin$ rate none o. the above

Questions 14-23 throu$h 14-2+ re.er to the .olloBin$ "roble%8 , co%"an inten&s to issue $200,000 o. * "ercent convertible bon&s at "ar Bith a conversion "rice o. $40 "er share) (he co%"an has *0,000 shares o. co%%on stock outstan&in$ an& e9"ects to earn $*00,000 be.ore interest an& ta9es a ear) (he .e&eral inco%e ta9 rate is '0 "ercent) 14-23) =hat is the earnin$s "er share be.ore the conversion[ Z /a0 /b0 /c0 /&0 /e0 $')00 $4)50 $4)'0 $4)10 none o. the above

14-24) =hat is the conversion ratio[ /a0 /b0 /c0 /&0 /e0 40 20 2' 30 10

14-2') =hat Bill be the nu%ber o. shares outstan&in$ assu%in$ all bon&s are converte&[ Z /a0 /b0 /c0 /&0 /e0 *0,000 *',000 50,000 100,000 40,000
14'

14-2+) =hat Bill be earnin$s "er share a.ter the conversion[ /a0 /b0 /c0 /&0 /e0 $')00 $4)+1 $4)41 $4)'0 $4)20

14+

CHAPTER 18

DIVIDEND POLICY AND RETAINED EARNINGS

1*-1) 6ivi&en&s are "ai& out o. HHHHHHHH) /a0 /b0 /c0 /&0 /e0 retaine& earnin$s &e"reciation e@uit ca"ital &ebt ca"ital net "ro.it

1*-2) I. a .ir% has a &ivi&en& "a out ratio o. +0 "ercent, Bhat is its retaine& earnin$s ratio[ /a0 /b0 /c0 /&0 /e0 100 "ercent +0 "ercent 40 "ercent 20 "ercent 0 "ercent

1*-3) =hat is the "a out ratio .or a .ir% that earns $2)'0 "er share an& "a s a &ivi&en& o. $1)00 "er share[ /a0 /b0 /c0 /&0 /e0 100 "ercent *0 "ercent '0 "ercent 40 "ercent 2' "ercent

1*-4) =hich o. the .olloBin$ is not a le$al restriction Bith res"ect to "a in$ cash &ivi&en&[ /a0 /b0 /c0 /&0 /e0 the net "ro.it rule the ca"ital i%"air%ent rule the cash retention rule the retaine& earnin$s rule the insolvenc rule

1*-') =hich o. the .olloBin$ is not a .actor that has an in.luence on a .ir%As &ivi&en& "olic [ /a0 /b0 /c0 /c0 /e0 li@ui&it access to e9ternal .un&s ti%in$ o. invest%ent o""ortunities control all o. the above have in.luence

1*-+) ,%on$ the .olloBin$ &ivi&en& "olicies, Bhich ones are %ost co%%onl use&[
144

/a0 /b0 /c0 /&0 /e0

stable &ollar a%ount re$ular an& e9tra &ivi&en& tar$et "a out ratios /in the short run onl 0 both /a0 an& /b0 all o. the above

1*-4) (he "ri%ar reason Bh %ost .ir%s .olloB a stable &ivi&en& "olic is because Z /a0 /b0 /c0 /&0 /e0 it lea&s to hi$her stock "rices it is convenient it is %an&ate& b the co%"an charter it hel"s to .inance the $roBth rate all o. the above

1*-*) =hich o. the .olloBin$ .actor &oes not len& to hi$her stock "rices Bhen a co%"an "a s &ivi&en&s[ /a0 /b0 /c0 /&0 /e0 resolution o. uncertaint in the %in&s o. investors stockhol&ersA "re.erence .or current inco%e invest%ent "re.erence b .i&uciar institutions ta9 treat%ent o. &ivi&en& inco%e none o. the above

1*-5) ,ccor&in$ to the resi&ual theor o. &ivi&en& "olic Z /a0 /b0 /c0 /&0 /e0 &ivi&en&s are "ai& out o. retaine& earnin$s the .ir% shoul& "a &ivi&en&s onl a.ter %eetin$ its nee&s to .inance all "ro.itable invest%ent "roIects &ivi&en&s are "ai& out o. resi&ual e@uit ca"ital no &ivi&en&s are "ai& to co%%on stockhol&ers unless "re.erre& stockhol&ers are "ai& .irst none o. the above state%ents are true

1*-10) (he &ivi&en& "a out ratio is the /a0 /b0 /c0 /&0 /e0 ratio o. 73I( to net "ro.it ratio o. retaine& earnin$s to net "ro.it ratio o. net "ro.it to $ross "ro.it ratio o. %ana$e%entAs bonus to .ir%As net "ro.it ratio o. &ivi&en&s to net "ro.it

1*-11) =hich o. the .olloBin$ is true re$ar&in$ stock &ivi&en&s[ /a0 it re"resents a &istribution o. a&&itional shares o. stock to the e9istin$ stockhol&ers
14*

/b0 /c0 Z /&0 /e0

it involves nothin$ %ore than a bookkee"in$ trans.er .ro% retaine& earnin$s to ca"ital stock account a stockhol&erAs "ercenta$e oBnershi" re%ains constant a.ter receivin$ stock &ivi&en& both /a0 an& /b0 all o. the above

1*)12) =hat Bill be the re&uction in the retaine& earnin$s i. a .ir% "a s a 4,000 share stock &ivi&en& /"ar value $200 Bith its current %arket "rice $100 "er share[ /a0 /b0 /c0 /&0 /e0 $1,400,000 $140,000 $400,000 $*40,000 $4,000

1*)13) =hat is the &ivi&en& "a out ratio o. a co%"an that "a s $1)+* "er share in &ivi&en& an& earns $2,*0 "er share[ /a0 /b0 /c0 /&0 /e0 20 "ercent 40 "ercent +0 "ercent *0 "ercent 100 "ercent

1*)14) (he !eB <ork Stock 79chan$e an& the ,%erican Institute o. Certi.ie& -ublic ,ccounts encoura$e that a stock &istribution in e9cess o. HHH be treate& as a stock s"lit) /a0 /b0 /c0 /&0 /e0 0-' "ercent '-10 "ercent 10-1' "ercent 1'-20 "ercent 20-2' "ercent

1*-1') =hich o. the .olloBin$ is true in the event o. a tBo-.or-one stock s"lit[ /a0 /b0 /c0 /&0 /e0 stockhol&ers receive tBo shares .or each one "reviousl hel& the "ar value, book value an& earnin$s "er share are cut in hal. the net Borth is cut in hal. both /a0 an& /b0 all o. the above

1*-1+) =hich o. the .olloBin$ is true in the event o. a tBo-.or-one reverse stock s"lit[ /a0 stockhol&ers receive tBo shares .or each one "reviousl hel&
145

/b0 /c0 /&0 /e0

the "ar value, book value an& earnin$s "er share are &oubt.ul the net Borth re%ains the sa%e both /a0 an& /b0 both /b0 an& /c0

1*)14) =hich o. the .olloBin$ reasons is .re@uentl a&vocate& Bhen co%"anies use stock &ivi&en& as a substitute .or cash &ivi&en&[ /a0 /b0 /c0 /&0 /e0 to conserve cash to .inance "ro.itable invest%ent o""ortunities to a""ease investorsA &esire .or &ivi&en& in ti%es o. .inancial &i..iculties all o. the above

1*-1*) Stock s"lits are "articularl use& to Z /a0 /b0 /c0 /&0 /e0 boost earnin$s "er share to kee" the %arket "rice o. the stock Bithin a "o"ular tra&in$ ran$e boost the i%a$e o. the co%"an increase co%"an As net Borth increase nu%ber o. stockhol&ers

1*-15) (he re"urchase o. co%%on stock is Z /a0 /b0 /c0 /&0 /e0 an alternative to cash &ivi&en& a %etho& o. reBar&in$ to" %ana$e%ent a %etho& o. $ivin$ bonus shares to e%"lo ees &etri%ental to earnin$s "er share ille$al

Questions 1*-20 throu$h 1*-23 re.er to the .olloBin$ "roble%8 , co%"an earne& $44,000 a.ter ta9es, an& $40,000 o. this a%ount turne& out to be e9cess cash) (he current %arket "rice "er share o. its stock is $20 an& there are 22,000 shares outstan&in$) I. the co%"an uses its e9cess cash to re"urchase its shares in the %arket, calculate the .olloBin$8 1*-20) (he current earnin$s "er share /be.ore the re"urchase is0 Z /a0 /b0 /c0 /&0 /e0 $1)'0 $2)00 $2)40 $2)'0 none o. the above
1*0

1*-21) (he current "rice-earnin$s ratio is /a0 /b0 /c0 /&0 /e0 '9 49 109 209 409

1*-22) (he earnin$s "er share a.ter the re"urchase o. shares Bill be /a0 /b0 /c0 /&0 /e0 1)00 2)00 2)20 3)00 4)20

1*)23) ,ssu%in$ the "rice-earnin$s ratio re%ains unchan$e& a.ter the re"urchase, Bhat Bill be the neB %arket "rice o. co%%on stock[ /a0 /b0 /c0 /&0 /e0 $1* $20 $22 $24 $30

1*-24) ?re@uent use o. stock re"urchase b a co%"an %a $ive the i%"ression that its /a0 /b0 /c0 /&0 /e0 %ana$e%ent is a$$ressive %ana$e%ent reall cares .or the stockhol&ers %ana$e%ent in inco%"etent %ana$e%ent is invest%ent-oriente& &ivi&en&s "er share are $oin$ to increase

1*1

CHAPTER 19

TERM LOANS AND LEASES

15-1) Inter%e&iate ter% loans have %aturities Z /a0 /b0 /c0 /&0 /e0 o. less than one ear betBeen one an& ten ears betBeen ten an& .i.teen ears betBeen ten an& tBent ears o. %ore than tBent ears

15-2) (he interest rate on a ter% loan is $enerall hi$her than on short-ter% loans because the ter% loan is /a0 /b0 /c0 /&0 /e0 less li@ui& %ore risk usuall unavailable both /a0 an& /b0 all o. the above

Z 15)3)

=hat is the %a9i%u% "ercenta$e o. a national bankAs ca"ital an& sur"lus Bhich it can len& to a sin$le borroBer[ /a0 /b0 /c0 /&0 /e0 ' "ercent 10 "ercent 1' "ercent 20 "ercent 2' "ercent

15-4) =hat is the kicker clause Bhich is use& as a "art o. a ter% len&in$ a$ree%ent[ Z /a0 /b0 /c0 /&0 /e0 it alloBs the len&er to share "ro.it it %akes the entire loan i%%e&iatel &ue an& "a able it "rohibits the borroBer to bribe the len&er to secure the loan it s"ee&s u" the re"a %ent sche&ule it e9ten&s the %aturit o. the loan

15-') =hat is the acceleration clause Bhich is use& as a "art o. a ter% len&in$ a$ree%ent[ Z /a0 /b0 /c0 /&0 /e0 it alloBs the len&er to share "ro.it it %akes the entire loan i%%e&iatel &ue an& "a able it "rohibits the borroBer to bribe the len&er to secure the loan it s"ee&s u" the re"a %ent sche&ule it e9ten&s the %aturit o. the loan

1*2

15)+)

=hich o. the .olloBin$ "rovisions is usuall incor"orate& as a "art o. a ter% loan a$ree%ent[ /a0 /b0 /c0 /&0 /e0 restrictive "rovisions "rohibitive "rovisions a..ir%ative "rovisions both /a0 an& /b0 all o. the above "rovisions o.

Z 15)4)

=hich o. the .olloBin$ is not .orbi&&en as a "art o. the "rohibitive a ter% loan[ /a0 /b0 /c0 /&0 /e0 the sale o. assets the lease o. assets the "le&$e o. assets the "a %ent o. &ivi&en&s the a&&itional lon$-ter% &ebt

15-*) =hich o. the .olloBin$ is not an e9a%"le o. a..ir%ative "rovisions o. a ter% loan[ Z /a0 /b0 /c0 /&0 /e0 to li%it the cash &ivi&en&s to %aintain a certain a%ount o. Borkin$ ca"ital to carr li.e insurance on ke o..icers to sub%it "erio&ic .inancial state%ents all o. the above are the e9a%"les o. a..ir%ative "rovisions

15-5) =hich o. the .olloBin$ is the criteria use& b banks in $rantin$ ter% loans[ /a0 /b0 /c0 /&0 /e0 re"a %ent arran$e%ents vali&it o. "ur"ose collection both /a0 an& /b0 all o. the above

15-10) =hat are the .ive CAs o. cre&it[ /a0 /b0 /c0 /&0 /e0 character, control, ca"acit , ca"ital, an& collateral character, control, cre&it, ca"acit , an& collateral character, ca"ital, collateral, con&itions, an& ca"acit character, ca"ital, coo"eration, collateral, an& ca"acit character, control, ca"ital, coo"eration, an& collateral HHHHHH rather than HHHHHH)

15-11) 3ank ter% loans an& insurance co%"an ter%s loans are /a0 su""le%entar C co%"le%entar
1*3

/b0 /c0 /&0 /e0

co%"etitiveC su""le%entar con.lictin$C co%"le%entar co%"le%entar C co%"etitive overla""in$C co%"le%entar

15-12) (he obIective o. the S%all 3usiness ,&%inistration is /a0 /b0 /c0 /&0 /e0 to %ake last-resort loans to s%all businesses to "rovi&e technical services on %ana$erial "roble%s to hel" obtain $overn%ent contracts both /a0 an& /b0 all o. the above

15-13) In a lease a$ree%ent, the oBner o. the asset is calle& the /a0 /b0 /c0 /&0 /e0 lessee lan&lor& "rinci"al tenant lessor

15-14) =hich o. the .olloBin$ is not an a&vanta$e o. leasin$[ /a0 /b0 /c0 /&0 /e0 lease "a %ents are ta9 &e&uctible cost o. lease& lan& is ta9 &e&uctible the ta9 laBs alloB the lessee to avail the entire invest%ent ta9 cre&it lessee is alloBe& the &e"reciation char$es leasin$ is an alternative to borroBin$

15)1') ?or a .ir% in a 4+ "ercent ta9 bracket, Bhat is the annual a.ter-ta9 cost o. a $',000 earl lease "a %ent[ Z /a0 /b0 /c0 /&0 /e0 $2,300 $2,400 $2,2'0 $2,4'0 $2,'00

15-1+) =hat is the %ost Bi&el -use& rate .or &iscountin$ the annual lease "a %ents[ /a0 /b0 /c0 /&0 the cost o. ca"ital the cost o. e@uit the a.ter-ta9 cost o. &ebt the a.ter-ta9 cost o. ca"ital
1*4

/e0

the a.ter-ta9 cost o. retaine& earnin$s

15-14) =hich o. the .olloBin$ is not a classi.ication o. a t "e o. lease arran$e%ent[ /a0 /b0 /c0 /&0 /e0 sales-an&-leaseback o"eratin$ leases levera$e& leasin$ .inancial or ca"ital lease all o. the above are leasin$ arran$e%ents

15-1*) =hen a lessor bu s a "ro"ert an& leases it back to the seller, it is knoBn as /a0 /b0 /c0 /&0 /e0 an o"eratin$ lease a .inancial lease a levera$e& lease a ca"ital lease a sale-an&-leaseback arran$e%ent

15-15) =hich o. the .olloBin$ is a characteristic o. an o"eratin$ lease[ /a0 /b0 /c0 Z /&0 /e0 the lessor %aintains the lease& "ro"ert the lessee retains the ri$ht to cancel the lease a$ree%ent be.ore its %aturit the lease contract usuall covers a ti%e "erio& Bhich is less than the econo%ic li.e o. the lease& "ro"ert both /a0 an& /b0 all o. the above

15-20) =hich o. the .olloBin$ is a characteristic o. a .inancial lease[ /a0 /b0 /c0 /&0 /e0 the lessor %aintains the lease& "ro"ert the lessee cannot cancel the lease contract be.ore its %aturit the lessee .ull a%orti>e the lease& "ro"ert both /b0 an& /c0 all o. the above

15)21) , bank re@uires .ive annual "a %ents o. $1',000 to $et re"ai& .or a loan Bhich has an interest rate o. 14 "ercent) =hat is the .ace a%ount o. the loan[ /a0 /b0 /c0 /&0 /e0 $ 4,4*' $2*,*4' $4',000 $'1,45' $55,1'0
1*'

15-22) In the above "roble%, co%"ute the balance o. the loan a.ter the secon& annual "a %ent) Z /a0 /b0 /c0 /&0 /e0 $43,404)30 $34,*22)50 $+*,420)*0 $4',000)00 $+0,000)00

1*+

CHAPTER -

CORPORATE GROWTH THROUGH MERGERS

20-1) =hich o. the .olloBin$ is not a basic .or% o. business co%bination8 Z /a0 /b0 /c0 /&0 %er$er &ivestiture consoli&ation hol&in$ co%"anies

20-2) , consoli&ation betBeen tBo co%"anies occurs Bhen /a0 /b0 /c0 /&0 /e0 a co%"letel neB cor"oration e%er$es ol& co%"anies cease to e9ist shares o. ol& co%"anies are e9chan$e& .or shares in the neB co%"an both /a0 an& /b0 all o. the above

20-3) , %er$er betBeen tBo co%"anies occurs Bhen /a0 /b0 /c0 /&0 /e0 one co%"an loses its i&enti. ac@uirin$ cor"oration "a s cash or co%%on stock tBo co%"anies are o. a""ro9i%atel the sa%e si>e both /a0 an& /b0 all o. the above

20-4) , hol&in$ co%"an has the .olloBin$ characteristic/s08 /a0 /b0 /c0 /&0 /e0 it has controllin$ interest in other co%"anies it is calle& the "arent co%"an it re@uires %aIorit votin$ stock to e9ert Bork control on its subsi&iar both /a0 an& /b0 all o. the above

Z 20)')

;ne o. the %ost i%"ortant .eatures on the ter%s o. %er$er is the HHHHHHHHHHHH e..ect, Bhere the co%bine& co%"anies are Borth %ore than the su% o. their "arts) /a0 /b0 /c0 /&0 /e0 &i..erential s ner$istic har%onistics %ulti"licative s nchronous

20-+) , co%bination o. tBo .ir%s in si%ilar lines o. business is best &escribe& as Z /a0 hori>ontal %er$er
1*4

/b0 /c0 /&0 /e0

vertical %er$er con$lo%erate all o. the above none o. the above

20-4) =hich o. the .olloBin$ is not a %aIor bene.it o. hori>ontal %er$er8 /a0 /b0 /c0 /&0 it "rovi&es econo%ies o. scale it eli%inates &u"licate .acilities it alloBs control over source o. raB %aterials it e9"an&s .ir%As e9istin$ %arket share

Z 20)*)

, co%bination o. tBo .ir%s Bhich enlar$es the ca"abilit o. the ac@uirin$ .ir% to "ro&uce %ore sta$es o. the sa%e "ro&uct or service Boul& best be &escribe& as a /a0 /b0 /c0 /&0 hori>ontal %er$er con$lo%erate %er$er vertical %er$er none o. the above is correct

Z 20)5)

, con$lo%erate %er$er is sai& to occur Bhen tBo or %ore co%"anies in HHHHHHHH lines o. businesses are co%bine&) /a0 /b0 /c0 /&0 /e0 relate& unrelate& co%"le%entar %utuall e9clusive none o. the above

20)10) I. Co%"an , Bishes to seek controllin$ interest in Co%"an 3 Bithout revealin$ its intentions, Co%"an , %a bu co%%on shares o. Co%"an 3 /a0 /b0 /c0 /&0 /e0 throu$h a broker on the o"en %arket throu$h a lar$e hol&er on a ne$otiate& basis throu$h a ten&er o..er throu$h both /a0 an& /b0 throu$h all o. the above

20-11) 1er$ers %a involve /a0 /b0 /c0 /&0 /e0 strai$ht cash "urchase an e9chan$e o. stock a co%bination o. cash an& securities onl /a0 or /b0 all o. the above
1**

20)11) (he ac@uirin$ .ir%As shares are sellin$ at $40 "er share an& the ac@uire& .ir%As shares are sellin$ at $10 "er share) Calculate the %arket-"rice basis Bhen the ac@uirin$ .ir% o..ers 0)2' shares o. its stock in e9chan$e .or one share o. the ac@uire& .ir%) /a0 /b0 /c0 /&0 /e0 4)00 2)00 1)00 0)2' none o. the above

20-13) Fn&er the "urchase %etho& o. business co%binations, /a0 /b0 /c0 /&0 /e0 onl the ac@uirin$ .ir% survives the ac@uire& assets are recor&e& at their %arket value the ac@uire& assets are recor&e& at their historical cost both /a0 an& /b0 both /a0 an& /c0

20-14) Fn&er the "oolin$ o. interests %etho& o. business co%binations, /a0 /b0 /c0 /&0 /e0 no $oo&Bill is create& the co%bine& assets are recor&e& at their %arket values the co%bine& assets are recor&e& at their book values both /a0 an& /b0 both /a0 an& /c0

1*5

CHAPTER -1

CORPORATE GROWTH THROUGH MULTINATIONAL OPERATIONS

21-1) (he theor o. co%"arative a&vanta$e has Bhich o. the .olloBin$ .eature/s08 /a0 /b0 /c0 /&0 /e0 the .actors o. "ro&uction are une@uall &istribute& the e..icient "ro&uction re@uires co%binations o. &i..erent resources an& technolo$ies so%e countries can "ro&uce certain $oo&s %ore e..icientl than others both /a0 an& /c0 all o. the above

21)2) ,ccor&in$ to the theor o. .actor en&oB%ents, a countr %ust s"eciali>e in the "ro&uction an& e9"ort o. an $oo& that uses its lar$e a%ount o. HHHHHHHHHHH "ro&uction .actors) /a0 /b0 /c0 /&0 /e0 scarce li%ite& Baste abun&ant none o. the above is a""licable

21-3) =hich o. the .olloBin$ theories &oes not e9"lain %otives .or Borl& tra&e[ /a0 /b0 /c0 /&0 the theor o. co%"arative a&vanta$e the "ro&uct li.e c cle theor the theor o. .actor en&oB%ents the theor o. %ass %erchan&isin$

Z 21)4)

=hich o. the .olloBin$ techni@ues are use& as a %eans o. "rotectionis% in the conte9t o. Borl& tra&e[ /a0 /b0 /c0 /&0 /e0 i%"ort @uotas tari..s value-a&&e& ta9es both /a0 an& /b0 all o. the above

21-') (ari..s on i%"orte& $oo&s can be i%"ose& .or Bhich o. the .olloBin$ reason/s08 /a0 /b0 /c0 /&0 /e0 revenue national "ri&e "rotection /a0 or /c0 all o. the above
150

21)') I%"ort @uotas s"eci. the HHHHHHHHHH a%ounts o. certain "ro&ucts to be i%"orte& &urin$ a $iven "erio& o. ti%e) Z /a0 /b0 /c0 /&0 /e0 %ini%u% %a9i%u% in&eter%inate unli%ite& s%all

21-4

=hich o. the .olloBin$ theories e9"lain %otives .or .orei$n invest%ent[ /a0 /b0 /c0 /&0 /e0 the "ro&uct li.e c cle theor the "ort.olio theor the oli$o"ol theor both /a0 an& /b0 all o. the above

Z 21-*

6o%estic co%"anies invest abroa& to seek /a0 /b0 /c0 /&0 /e0 raB %aterials "ro&uction e..icienc neB %arkets neB knoBle&$e all o. the above

21-5) (he "ort.olio theor relies on Bhich o. the .olloBin$ variable/s08 /a0 /b0 /c0 /&0 /e0 risk "ro&uct %aturit return /a0 an& /b0 /a0 an& /c0

21)10) (he "ort.olio theor assu%es that .orei$n invest%ent "roIects ten& to be HHHHHHHHHH correlate& Bith each other than &o%estic invest%ent "roIects) Z /a0 /b0 /c0 /&0 /e0 less %ore "er.ectl ne$ativel correlate& "er.ectl "ositive correlate& >ero

21-11) ,n oli$o"ol e9ists Bhen there are HHHHHHHH &o%inatin$ the %arket)
151

/a0 /b0 /c0 /&0 /e0

%an .ir%s one .ir% .eB .ir%s tBo .ir%s %ultinational .ir%s

21)11) =hich o. the .olloBin$ a&vanta$e/s0 t "icall associate Bith a %ultinational .ir% over a &o%estic .ir%8 /a0 /b0 /c0 /&0 /e0 access to technolo$ &i..erentiate& "ro&ucts access to ca"ital su"erior %ana$e%ent all o. the above

21)12) (he o"erational restrictions associate& Bith "olitical risk &oes not inclu&e the .olloBin$ %easure8 /a0 /b0 /c0 /&0 /e0 e%"lo %ent "olicies share& oBnershi" loss o. trans.er .ree&o% con.iscation o. business assets breaches in contracts

21)13) =hich o. the .olloBin$ as"ect/s0 o. nationalis% %a have i%"act on %ultinational .ir%s8 /a0 /b0 /c0 /&0 /e0 %ini%u% local oBnershi" re@uire%ents reservation o. in&ustries .or local co%"anies "re.erence o. local su""liers li%itation on .orei$n e%"lo ees all o. the above

21)14) =hich o. the .olloBin$ is not a su$$este& action Bhich a %ultinational co%"an can un&ertake to "revent "ossible e9"ro"riation o. its assets b the host countr 8 /a0 /b0 /c0 /&0 /e0 %aintain control o. ke "atents control o. ke e9"ort %arkets .or the subsi&iar As "ro&ucts Ioint venture arran$e%ents ca"itali>ation Bith heav e@uit base all o. the above are su$$este& actions

21-1+) ?olloBin$ an e9"ro"riation, Bhich o. the action/s0 can a %ultinational .ir% un&ertake8
152

/a0 /b0 /c0 /&0 /e0

e9"loration o. le$al re%e&ies rational ne$otiation ne$otiation .lavore& Bith "oBer tactics surren&er b seekin$ salva$e value all o. the above

21-14) (he .orei$n e9chan$e %arket consists o. /a0 /b0 /c0 /&0 /e0 .orBar& %arket historical %arket s"ot %arket /a0 an& /b0 /a0 an& /c0

21)1*) (he "urchasin$ "oBer "arit /---0 &octrine states that the e@uilibriu% e9chan$e rate betBeen &o%estic an& .orei$n currencies e@uals the rate betBeen Z /a0 /b0 /c0 /&0 /e0 Bholesale an& retail "rices &o%estic an& .orei$n "rices historical an& .uture "rices :!- an& e9"ort $roBth .ar% an& %anu.acturin$ "rices

21)15) In the s"ot %arket, S? 2 E 1 FS$) ,ssu%e that the F)S) Bill have an in.lation rate o. 20 "ercent an& SBit>erlan& Bill have an in.lation rate o. 10 "ercent .or the co%in$ ear) Calculate the neB e9chan$e rate accor&in$ to the "urchasin$ "oBer "arit &octrine) /a0 /b0 /c0 /&0 /e0 S? 2)00 E $ S? 2)20 E $ S? 1)4' E $ S? 1)*3 E $ none o. the above

21)20) ?orei$n e9chan$e e9"osure re.ers to the "ossibilit that a .ir% Bill HHHHHHHHHHH &ue to chan$es in e9chan$e rates) /a0 /b0 /c0 /&0 /e0 $ain lose $ain an& lose $ain or lose none o. the above

21-21) (he three t "es o. .orei$n e9chan$e e9"osures are /a0 "recautionar , transaction an& s"eculative
153

/b0 /c0 /&0 /e0

translation, econo%ic an& transaction translation, "recautionar an& "olitical transaction, "olitical an& &evaluation none o. the above

21-22) , translation e9"osure Z /a0 /b0 /c0 /&0 /e0 re@uires actual conversion o. one currenc into another occurs Bhen consoli&ation o. .inancial state%ents takes "lace re.lects the chan$in$ cash .loBs o. .orei$n "roIects occurs Bhen a co%"an e9"orts its "ro&ucts all o. the above

21-23) =hich o. the .olloBin$ is not an e9a%"le o. transaction e9"osure8 /a0 /b0 /c0 /&0 /e0 borroBe& .un&s &eno%inate& in .orei$n currencies uncovere& .orBar& contracts cre&it "urchases Bhose "rices are &eno%inate& in &o%estic currenc sales o. $oo&s &eno%inate& in .orei$n currencies all o. the above

21)24) =hen a .ir% has a &ivi&en& "a able &eno%inate& in .orei$n currenc , the .ir% is sai& to have8 /a0 /b0 /c0 /&0 /e0 econo%ic e9"osure translation e9"osure transaction e9"osure ta9 e9"osure none o. the above

21-2') ;ne "ro%isin$ strate$ to re&uce the econo%ic e9"osure is Z /a0 /b0 /c0 /&0 /e0 Borl&Bi&e &iversi.ication o. o"erations use o. .orBar& %arkets use o. %one %arket he&$e to invest onl in &evelo"e& countries none o. the above

21-2+) =hich o. the .olloBin$ is not a &ocu%ent involve& in .orei$n tra&e8 Z /a0 /b0 /c0 /&0 /e0 bill o. la&in$ co%%ercial "a"er letter o. cre&it &ra.t all o. the above are relevant &ocu%ents
154

21-24) , &ra.t is use& in .orei$n tra&e to /a0 /b0 /c0 /&0 /e0 re&uce .orei$n e9chan$e risk %ana$e translation risk e..ect "a %ents %ana$e transaction risk %ake cre&it investi$ation o. i%"orter

21-2*) =hich o. the .olloBin$ con&ition/s0 %ust a &ra.t %eet in or&er .or it to be ne$otiable8 /a0 /b0 /c0 /&0 /e0 contain an uncon&itional "ro%ise or or&er to "a %ust be in Britin$ an& si$ne& b the &raBer "a able on si$ht or at a s"eci.ie& ti%e %a&e out to or&er or to bearer all o. the above

21-25) , bill o. la&in$ is a Z /a0 /b0 /c0 /&0 /e0 ne$otiable instru%ent shi""in$ &ocu%ent state%ent .ro% the char$e car& co%"an &ra.t none o. the above

21-30) , letter o. cre&it is a &ocu%ent issue& b a bank at the re@uest o. the HHHHHHHHHHH) Z /a0 /b0 /c0 /&0 /e0 i%"orter e9"orter shi""in$ co%"an insurance co%"an $overn%ent

21-31) International bankin$ .acilities alloB bank o..ices to /a0 /b0 /c0 /&0 /e0 acce"t ti%e &e"osits .ro% .orei$n custo%ers .orei$n currenc &e"osits .ro% .orei$n custo%ers e9ten& cre&it to .orei$ners both /a0 an& /c0 all o. the above

15'

21-32) 7uro&ollars are HHHHHHHHHHH - &eno%inate& &e"osits in banks outsi&e the F)S) /a0 /b0 /c0 /&0 /e0 :er%an %arks SBiss .rancs 6utch $uil&ers all 7uro"ean currencies &ollar

15+

CASE STUDY 1

WELLINGTON AIRLINES

(his case is &esi$ne& to achieve the .olloBin$ obIectives8 /10 to assess the .ir%As .inancial con&ition base& on a set o. ke ratios, /20 to &iscuss so%e li%itations o. in&ustr avera$e ratios, an& /30 to e9a%ine the basic "ur"ose o. the .un&s-.loB-state%ent) 1) ,) Ratio ,nal sis #i@ui&it Ratios Current ratio /\0 Quick ratio /\0 15*' 2)40 1)2* 15*+ 0)54 0)4' 2+)10 01)14 40)*0 03)4+ 4)0* 4)4+ *)0' In&ustr ,vera$es 3)'0 1)'0 30)00 01)20 4')00 04)10 4)00 4)*0 *)43 7valuation -oor -oor :oo& Satis.actor Satis.actor Satis.actor Satis.actor Satis.actor Satis.actor

3)

,ctivit Ratios ,vera$e collection "erio& /&a s0 ,sset turnover /\0 #evera$e Ratios 6ebt ratio /20 (i%es interest earne& /20 -ro.itabilit Ratios -ro.it %ar$in on sales /20 Return on invest%ent /20 Return on net Borth /20 32)00

C)

6)

2)

=ellin$tonTs li@ui&it , activit , levera$e, an& "ro.itabilit ratios are Bell Bithin the reasonable ran$e o. its res"ective in&ustr avera$es) DoBever, the .ir%As li@ui&it ratios have &ro""e& consi&erabl .or the last ear) ?urther%ore, both current ratio an& @uick ratio are .ar beloB the res"ective in&ustr nor%s) #i%itations o. In&ustr ,vera$e Ratios /a0 1an co%"anies have &iversi.ie& o"erations, but in&ustr avera$e ratios cate$ori>e those o"erations b their "ri%ar stan&ar& in&ustrial classi.ication /SIC0 nu%ber onl ) (hus, it is &i..icult to &evelo" %eanin$.ul in&ustr avera$es .or co%"arative "ur"oses) 6i..erent o"eratin$ accountin$ "ractices, use& b co%"anies Bithin the sa%e in&ustr , can &irectl in.luence the .inancial state%ents an& &istort co%"arisons) 6i..erent "ractices re$ar&in$ inventor values, an& accountin$ .or lease& assets, an& &e"reciation on .i9e& assets coul& invali&ate the co%"arisons) (he "resence o. one or a .eB e9tre%e state%ents can cause a &is"ro"ortionate in.luence on the in&ustr co%"osite) (his is "articularl true in a relativel s%all sa%"le)
154

3)

/b0

/c0

/&0

(he .inancial state%ents use& in the co%"utation o. the in&ustr avera$e ratios %a not be selecte& b an ran&o% or statisticall reliable %etho&) (he .iscal ear-en&s o. the co%"anies co%"risin$ the in&ustr avera$e %i$ht be &i..erent, thereb %akin$ the in&ustr avera$e non-re"resentative .or the s"eci.ic "erio& un&er revieB) So%e .actors resultin$ in variations a%on$ &i..erent co%"anies en$a$e& in the sa%e $eneral line o. business inclu&e &i..erent labor %arkets, $eo$ra"hic locations, sources an& %etho&s o. .inancin$, an& ter%s o. sales)

/b0

4)

=ellin$tonTs ?un&s ?loB State%ent Sources 7arnin$s a.ter ta9es 6e"reciation 6ecrease in accounts receivable Increase in accounts "a able Increase in notes "a able Increase in accruals Increase in lon$-ter% &ebt (otal sources Fses -urchases o. $ross "lant Increase in inventor 6ivi&en&s "ai& (otal uses $352 /0)**30 14 /0)0320 3* /0)0*'0 $444 /1)0000 $ *0 /0)1*00 *4 /0)1*50 42 /0)05'0 13 /0)0250 15+ /0)4410 22 /0)0'00 4 /0)01+0 $444 /1)0000

(he .ir%As li@ui&it "roble% ste%s .ro% a %aIor "urchase &urin$ the 15*'-15*+ .iscal ear o. .i9e& assets /$352 %illion0 Bhich Bas lar$el .inance& throu$h the use o. a short-ter% bank note) (his le& to relativel hi$h interest char$es an& a substantial increase in &e"reciation e9"ense, Bhich in turn contribute& to the .ir%As less than a&e@uate "ro.itabilit ratios) ') (he re"a %ent o. the co%"an As short-ter% note &eserves i%%e&iate consi&eration) 3ecause the short-ter% note Bas use& to .inance .i9e&-asset ac@uisitions, the .ir% violate& the %atchin$ "rinci"le) (he %atchin$ "rinci"le states that a .ir% shoul& .inance its short-ter% .inancial nee&s Bith short-ter% .un&s an& its lon$-ter% .inancial nee&s Bith lon$-ter% .un&s) (he co%"an %ust consi&er re.inancin$ the short-ter% note Bith lon$-ter% sources in or&er to %atch the %aturit structure o. its assets Bith liabilities) (he co%"an %ust also consi&er sellin$ so%e i&le air"lanes an& other e@ui"%ent an&Eor %akin$ sales-leaseback arran$e%ents .or these .i9e& assets)
15*

CASE STUDY -

DUNDAS TOY COMPANY

(his is a strai$ht.orBar& cash bu&$etin$ "roble%) (he basic "ur"ose o. the case is to illustrate the %echanics o. the cash bu&$et an& the t "ical Ba in Bhich a cash bu&$et is use&) It is an e9cellent case to see the situation .ro% the stan&"oint o. both the co%"an "resi&ent an& the len&in$ o..icer) 1) 6un&as (o Co%"an Cash 3u&$et, Secon& Dal., 2004 /in thousan&s o. &ollars0 June Jul ,u$) Se"t) Sales8 '00 +00 1000 Cash /1020 '0 +0 100 Cre&it /5020 400 4'0 '40 500 Collections8 1onth o. sale /2020 50 10* 1*0 1onth a.ter sale /*020 320 3+0 432 (otal cash recei"ts /,0 4+0 '2* 412 -a %ent o. accounts "a able =a$es an& salaries ;verhea& e9"enses Sellin$ e9"enses :eneral K a&%inistrative e9") (otal cash e9"enses /30 (otal cash recei"ts /,0 Cash out.loBs8 (otal cash e9"enses /30 Ca"ital e9"en&itures -a %ent o. inco%e ta9es -rinci"al "a %ent-ter% loan Interest "a %ent-ter% loan 6ivi&en& "a %ent (otal cash out.loBs /C0 !et cash $ain /loss0 &urin$ the %onth /,0 - /C0 3e$innin$ cash balance 7n&in$ cash balance #ess8 %ini%u% cash balance 3orroBin$ re@uire& /re"a %ent0 Cu%ulative loan balance /be$innin$ 3000 2** 120 '2 +0 30 ''0 4+0 ''0 2** 120 '2 +0 30 ''0 '2* ''0 *0 3* 2** 120 '2 +0 30 ''0 412 ''0

;ct) 1200 120 10*0 21+ 420 10'+ 2** 120 '2 +0 30 ''0 10'+ ''0

!ov) +00 +0 '40 10* *+4 1032 2** 120 '2 +0 30 ''0 1032 ''0

6ec) 400 40 3+0 42 432 '44 2** 120 '2 +0 30 ''0 '44 ''0 3* +0 '4 '0 4'2

''0 /500 100 10 100 50 350

155

''0 /220 10 /120 100 112 '02

++*

''0

''0

44 '0+ 4*2 /20*0 /120 32 '3* 1020 32 '3* 1020 *12 100 100 100 100 +* /43*0 /5200 /4120 '40 132

2)

Sur"lus .un&s Cu%ulative #oan 1onth 3alance Jul ,u$ust Se"te%ber ;ctober !ove%ber 6ece%ber $ 350,000 '02,000 '40,000 132,000

4** 1+00 Sur"lus ?un&s

$ 4**,000 1,+00,000

(he "ro"ose& $'00,000 line o. cre&it Bill not be su..icient to cover the antici"ate& nee&s o. the cash bu&$et) Fnless the co%"an can obtain a $+00,000 line o. cre&it .ro% its bank, so%e alternative .inancin$ Bill be re@uire&) 6un&as (o Co%"an %i$ht have re@ueste& an e9tension o. the cre&it "erio& to s"ontaneousl $enerate a&&itional .un&s .or% its su""liers) ,ccounts receivable loans or inventor loans Boul& also be Borth consi&eration as source o. .un&s) 3) (he re$ular cash re@uire%ents o. the co%"an shoul& be .orecaste& to %ake certain that /10 a&e@uate cash .un&s are available .or the ti%el "a %ent o. cre&it "urchases, "a rolls, an& other costsC /20 .un&s Bill be available .or a&&itional ca"ital assetsC an& /30 e9cess .un&s, i. an , are Bisel investe&) (he cash bu&$et enables the co%"an avoi& a cash .loB crisis at a ver later hour) (he cash .loB crisis Bill result in not onl a shar"l re&uce& nu%ber o. alternatives but also "otentiall &evastatin$ "s cholo$ical conse@uences) (he abilit o. the co%"an to "a a "a roll an& other cre&it obli$ations can have a consi&erable ne$ative i%"act on e%"lo ee, %ana$e%ent, cre&itor an& stockhol&er attitu&es) 3ecause 6un&as (o Co%"an is e9"ecte& to have consi&erable a%ount o. e9cess .un&s .or !ove%ber an& 6ece%ber, it Boul& invest these i&le .un&s on a te%"orar basis) (he co%"an Boul& nee& to invest seasonall in short-ter%, loBrisk, li@ui& instru%ents such as F)S) (reasur bills) Such invest%ents Boul& not earn hi$h interest but coul& be arran$e& to %ature accor&in$ to antici"ate& cash nee&s in or&er to avoi& the e9tra costs associate& Bith %ulti"le transactions) -ro&uction $eare& closel to the sales sche&ule coul& create a lot o. "roble%s) (he inclu&e overti%e "re%iu%s, recruitin$ an& trainin$ "roble%s .ro% seasonal e9"ansion an& contraction o. the Bork .orce, an& .re@uent setu" chan$es on the %achiner .ro% accelerate& "ro&uction sche&ules &urin$ the "eak season) #evel "ro&uction Boul& eli%inate these "roble%s, thus increasin$ the "ro.itabilit o. the co%"an ) DoBever, the increase& "ro.it is o..set b the co%%it%ent o. .un&s to .inance a "ile-u" o. inventor in the o..-season) (hus, the increase& "ro.it obtainable un&er a level "ro&uction sche&ule shoul& be Bei$he& a$ainst the risk o. increase& inventor invest%ent an& the &i..icult o. obtainin$ a&e@uate .inancin$)

4)

200

CASE STUDY 3

HAWTHORNE .USINESS INSTRUMENT

(he "ur"ose o. this case is to &eter%ine the e..ect o. Borkin$ ca"ital "olic on "ro.itabilit as %easure& b the rate o. return on co%%on e@uit an& on risk as %easure& b the current ratio) 1) /a0 3alance Sheet / in thousan&s o. &ollars0 Conservative $ 4,320 +,4*0 $10,*00 $ 1,404 4,320 ',04+ $10,*00 Inter%e&iate $ 3,240 4,'+0 $10,*00 $ 1,404 4,320 ',04+ $10,*00 #iberal $ 3,4'4 4,+2' $11,0*1 $ 1,+*' 4,320 ',04+ $11,0*1

Current assets !et .i9e& assets (otal assets Current liabilities /*20 #on$-ter% &ebt /1020 Co%%on e@uit (otal clai%s /b0 Inco%e State%ent

Sales ;"eratin$ e9"enses 73I( Interest (a9able inco%e (a9es /'020 7arnin$s a.ter ta9es /c0 Ue Ratios

Conservative $14,400,000 2,240,000 2,1+0,000 '44,320 $ 1,+1',+*0 *04,*40 $ *04,*40

Inter%e&iate $1',120,000 12,*'2,000 $ 2,2+*,000 '44,320 $1,423,+*0 *+1,*40 $ *+1,*40

#iberal $1',*40,000 13,4+4,000 $ 2,34+,000 '++,*00 $1,*05)200 504,+00 $ 504,+00

Current ratio Return on co%%on e@uit 6ebt to total assets 2)

3)0*\ 1')522 '3)002

2)31\ 1+)5*2 '3)002

2)0'\ 14)*22 '4)002

, tra&eo.. e9ists betBeen risk an& "ro.itabilit ) (he &e$ree o. risk an& the level o. "ro.itabilit &e"en& u"on the a%ount o. invest%ent in current assets an& the a%ount o. current liabilities use& in the o"eration o. the business) (hus, the "ro.itabilit associate& Bith various levels o. current assets an& current liabilities shoul& be evaluate& relative to the risk associate& Bith those levels) (he conservative "olic "rovi&es the co%"an Bith the loBest rate o. return on e@uit /1')5220 but $ives it the hi$hest current ratio /3)0*0) (he liberal "olic "rovi&es the co%"an Bith the hi$hest rate o. return on e@uit but $ives it the loBest current ratio)

201

3)

1r) 7&Bar&s a""ears to .avor the liberal "olic ) (he choice o. the alternative Borkin$ ca"ital "olicies Bill reall &e"en& on Bhether the e9"ecte& "ro.itabilit un&er this "olic is si$ni.icantl hi$her than un&er either o. the other tBo an& Bhether the hi$her e9"ecte& "ro.its are su..icient to o..set the hi$her riskiness o. the liberal "olic ) It is &i..icult to trul &eter%ine the e9tent o. risk un&er the three alternative "olicies because o. insu..icient in.or%ation available in the case) ;ne i%"ortant .actor is the stabilit o. sales an& costs) I. both sales an& costs are relativel stable, 1r) 7&Bar&s %a have a stron$ ar$u%ent in .avor o. a %ore liberal "olic ) DoBever, 1r) 7&Bar&s %a have &i..icult in sellin$ the liberal "olic to other .inance %e%bers because /10 the a""ear to be %ore conservative than 1r) 7&Bar&s, /20 the co%"an As current Borkin$ ca"ital "olic is conservative, an& /30 even the liberal "olic %a not $enerate enou$h ca"ital to .inance the "ro"ose& tBo "lants)

202

CASE STUDY 4

.ROWN TOY COMPANY

(his si%"le case illustrates the use.ulness o. intro&ucin$ an inventor control %o&el in a .ir% Bhich &oes not have an s ste% o. inventor %ana$e%ent) =ith the hel" o. the 7;Q %o&el, savin$s can be reali>e& b the .ir% b re&ucin$ avera$e invest%ents in inventor ) (he case also e9"licitl &eals Bith the stock out costs Bhile esti%atin$ a "ro"er level o. sa.et stock) It shoul& be note& b the stu&ents that the calculation o. stock out costs is a %atter o. $uessBork an& can be hi$hl subIective) 1) Ratios Current ratio Quick ratio Inventor turnover 6ebt ratio !et "ro.it %ar$in 3(C 1)+'9 0)4*9 2)259 3'2 2)*+2 In&ustr ,vera$e 1)+'9 0)*09 5)009 402 *)002 7valuation Satis.actor -oor Ger "oor Satis.actor Ger "oor

1r) Case Sculthor"e is correct in sa in$ that so%e o. the .ir%As ratios are out o. line co%"are& to the in&ustr avera$e) It see%s ver obvious that the .ir% is carr in$ an e9cessive a%ount o. inventor Bhich has a&versel a..ecte& the "ro.itabilit ratio) (he .ir%As li@ui&it is also loB as Iu&$e& .ro% the @uick ratio) ;nce the %ana$e%ent is able to re&uce its invest%ent in inventor , both the li@ui&it an& "ro.itabilit ratios Bill i%"rove) 2) (otal sales or usa$e in units is 4'0,000, or&erin$ cost "er or&er is $1+0, an& carr in$ cost "er unit is $4 /0)2' 9 $1+0) (hus, the .ir%As 7;Q is
2 $1+0 4'0,000 = +,000units $4

E%Q =

3)

!u%ber o. or&ers = 4'0,000E+,000 = 4'

203

4)

(he co%"an As sa.et stock is calculate& b .in&in$ its level Bhere the su% o. the carr in$ cost an& the stock out cost is at its %ini%u% "oint8 /10 ,ssu%e& Sa.et Stock 100 units 200 300 400 '00 +00 400 *00 500 1,000 1,100 1,200 1,300 1,400 1,'00 /20 Carr in$ Costs /10 9 $4 $400 *00 1,200 1,+00 2,000 2,400 2,*00 3,200 3,+00 4,000 4,400 4,*00 ',200 ',+00 +,000 /30 7sti%ate& Stock out Costs $',300 4,+40 4,0+0 3,''' 2,5'0 2,420 1,540 1,'10 1,130 *10 '20 330 200 100 0 /40 (otal Costs /20 + /30 $',400 ',440 ',2+0 ',1'' 4,5'0 4,*20 4,440 4,410 4,430 4,*10 4,520 ',130 ',400 ',400 +,000

(he co%"an is su""ose& to have the loBest su% o. the carr in$ cost an& the stock out cost at *00 units o. inventor ) (hus, *00 units are the sa.et stock) ') ,vera$e inventor = 7;QE2 + sa.et stock = +,000E2 + *00 = 3,*00 units Fnit sales "er &a = 4'0,000E3+0 = 1,2'0 units Reor&er "oint = 4 /&eliver ti%e0 9 1,2'0 + *00 = ',*00 units 4) (he balance sheet in&icates that the .ir% has an inventor o. $3,140,000 at an avera$e cost o. $1+ "er unit) (hus, the inventor in units is $3,140,000E$1+ = 15+,2'0) I. the co%"an a&o"ts its 7;Q %o&el, its avera$e inventor Boul& be 3,*00 units) (hus, the co%"an coul& re&uce its inventor b 152,4'0 units8 Re&uction in inventor = 15+,2'0 - 3,*00 = 152,4'0 (hus, the .ir% can reali>e substantial savin$s in its invest%ent in inventor intro&ucin$ the 7;Q %o&el) b

+)

204

CASE STUDY 5

LAVELY CLOTHING COMPANY

(his case involves three alternatives su$$este& .or i%"rovin$ overall "er.or%ance in the Borkin$ ca"ital area8 bank loan secure& b inventor , accounts receivable "le&$in$, an& accounts receivable .actorin$) Sales at #avel Clothin$ Co%"an have $roBn ra"i&l , Bith about 20 "ercent $roBth rate in 200+ alone) =ith &ivi&en& "a out ratios above 40 "ercent, the %aIorit o. the nee&e& .un&s ca%e .ro% outsi&e sources) Ine"t Borkin$ ca"ital %ana$e%ent an& an inaccessibilit to e9ternal lon$-ter% .inancial %arkets re"resent a classic "roble% o. $roBth, a$$ravate& b an in.le9ible &ivi&en& "olic ) 1) (he e..ective interest cost o. "le&$in$ the accounts receivable %a be lar$er than the state& cost o. an a%ount Xe@ual to the "ri%ate rate o. 12 "ercent "lus 3 "ercent "re%iu%,X because the co%"an Bill be res"onsible .or an ba& &ebt losses) I. the 200+ ba& &ebt losses o. ' "ercent are in&icative o. the 2004 e9"erience, the e..ective cost o. "le&$in$ the accounts receivable .or 2004 Boul& be at least 14 "ercent /122 "ri%e rate + 32 "re%iu% + '2 ba& &ebt losses0) It is i%"ortant to un&erstan& that the a&&itional char$e Bill be i&entical Bith the ba& &ebts e9"erience because all sales are on cre&it) (he co%"an As co%%ission rate o. 2 "ercent e@uals the cost o. its cre&it &e"art%ent o"erations /see ?ootnote 2 in 79hibit 20) (he co%%ission is basicall a char$e .or the .actorAs takin$ over such services as cre&it checkin$, bookkee"in$, collection, an& risk bearin$) 3ecause the .actor is a s"ecialist in cre&it evaluation an& collection, the co%"an As ba& &ebt losses o. ' "ercent Bill &ecrease to the in&ustr avera$e o. 1 "ercent) (hese tBo thin$s tell us that the .actorAs services are e9"ecte& to save the co%"an a cre&it &e"art%ent e9"ense o. 2 "ercent an& ba& &ebt e9"ense o. 4 "ercent) (hus, the e..ective interest cost o. .actorin$ the accounts receivable is 10)' "ercent /122 "re%iu% + 2)'2 "re%iu% - 42 re&uction in ba& &ebt losses0) !et Current Ratio
C u r r e n tA s s e t s A c c o u n t sR e c e i v a b l e C u r r e n tL i a b i l i t i e s [ ( R e c e i v a b l e s ) ( 1 C o m m i s s i o n R a t e ) ]
$3,40+ $1,4*+ = 4)00 $1,53+ /$1,4*+0/1 0)020

2)

3)

!eB 6ebt Ratio

C u r r e n tD e b t s ( R e c e i v a b l e s ) ( 1 C o m m i s s i o n ) + L o n g T e r m D e b t T o t a lA s s e t s A c c o u n t sR e c e i v a b l e
$1,53+ /$1,4*+0/1 0)020 + $'20 = 342 $4,234 $1,4*+

20'

(hus, the current ratio Bill increase .ro% 1)4+ to 4)00 an& the &ebt ratio Bill &ecrease .ro% '* "ercent to 34 "ercent) I. the co%"an &oes not sell to clients Bhich .aile& to obtain cre&it .ro% the .actor, its ba& &ebt losses Bill "robabl &ecrease to the in&ustr avera$e o. 1 "ercent, thus savin$ the co%"an 4 "ercent o. ba& &ebt losses) 4) It is hi$hl unlikel that the 3ench%ark Co%%unit 3ank Bill increase its loan to the co%"an .or a nu%ber o. reasons) ?irst, the co%"an has alrea& obtaine& tBo incre%ents in its loan .ro% the bank /see 79hibit 10) (hese incre%ents have been acco%"anie& b an increasin$ risk "re%iu% over the "ri%e rate /see ?ootnote 2 in 79hibit 10) Secon&, the bank has reacte& tot he co%"an As &eclinin$ current ratio an& its increasin$ &ebt ratio Bith tBo .or%al notices) (he secon& notice in&icates that the entire &ebt Bill beco%e &ue an& "a able unless the current ratio is i%"rove& Bithin tBo %onths) (hir&, *0 "ercent o. the inventor is Bork-in-"rocess an& thus is not ca"able o. bein$ "lace& in a .iel& Barehouse Bithout &isru"tin$ the "ro&uction "rocess) In a&&ition, the bank Boul& .in& it &i..icult to reali>e %uch .ro% the sale o. Bork-in"rocess i. the loan is &e.aulte&) ?actorin$ shoul& be selecte& .or a nu%ber o. reasons) ?irst, the increase& bank loan an& the receivable "le&$in$ Bill i%"rove the current ratio, but the Bill not i%"rove the &ebt ratio) (hese tBo alternatives Bill have little "ositive e..ects on "ro.itabilit ratios) ?urther%ore, the Bill not solve the .ir%As tBo %aIor "roble%s in the Borkin$ ca"ital area--the e9cessive ba& &ebt losses an& the "rotracte& collection "erio&) ?actorin$ Bill substantiall i%"rove the current ratio, &ebt ratio, an& "ro.itabilit ratios) Secon&, .actorin$ Bill enable the co%"an to increase the e..icienc o. the cre&it an& collection .unction Bithout a&&e& cost, because the .actorAs co%%ission rate &oes not e9cee& the current o"eratin$ cost o. the co%"an As cre&it &e"art%ent)

')

20+

CASE STUDY 6

FARMVILLE FI.ER CORPORATION

(he "ur"ose o. this case is to "rovi&e stu&ents Bith an o""ortunit to i&enti. the "roIectAs relevant cash .loBs) (he costs an& cash .loBs inclu&e& in the anal sis o. the -ol ester ?iber "roIect are troubleso%e in several areas) (hese areas inclu&e test %arket costs, increase& Borkin$ ca"ital, the use o. e9cess "ro&uction an& buil&in$ ca"acit , an& the cost o. &ebt) 1) (he ?ar%ville ?iber Cor"oration inclu&es test %arket costs /$2 %illion0 in its anal sis o. the -ol ester ?iber "roIect) 3ecause these costs have alrea& been incurre& at the ti%e o. the case, the shoul& be treate& as sunk costs in the anal sis) It is i%"ortant to reco$ni>e that onl incre%ental .uture cash out.loBs an& in.loBs are relevant in ca"ital e9"en&iture anal sis) (est %arket costs shoul& be consi&ere& as irrelevant costs because the are not chan$e& b the acce"tance or reIection o. the "roIect) 1r) ;r$ain, the "resi&ent o. the co%"an , "ro"oses that the -ol ester ?iber "roIect be char$e& .or the use o. e9cess "ro&uction an& buil&in$ ca"acit ) 3ecause the co%"an Bill use its current e9cess ca"acit in the "ro&uction o. "ol ester .iber, no incre%ental cash .loBs are incurre& an& thus nothin$ shoul& be char$e& a$ainst the "roIect) DoBever, i. e9cess ca"acit has an alternative use or acce"tance o. the "roIect Bill re@uire an even $reater increase in the n lon-.iber "ro&uction ca"acit , it see%s reasonable to inclu&e use o. the n lon-.iber "ro&uction .acilities as costs o. the -ol ester ?iber "roIect) (his "roIect Boul& re@uire $2 %illion in a&&itional Borkin$ ca"ital to "rovi&e the cash, accounts receivable, inventories, an& short-ter% cre&it necessar to su""ort the antici"ate& sales) (he $2 %illion in a&&itional Borkin$ ca"ital shoul& be treate& as an initial cash out.loBs an& a cash in.loB at the en& o. the "roIect li.e) ,lthou$h the invest%ent an& subse@uent recover o. .un&s balance out each other, the are not e@ual because o. the ti%e value o. %one ) (he net cash .loBs &iverte& .ro% sales erosion o. e9istin$ "ro&uct lines shoul& not be treate& as a cash in.loB .or tBo reasons) ?irst, there is no har& veri.iable in.or%ation in the case to su""ort that the -ol ester ?iber "roIect Boul& re&uce the sales volu%e o. ra on an& n lon .ibers) Secon&, these cash .loBs are not incre%ental because the coul& occur an Ba , even i. the "roIect is reIecte&) Certainl , no co%"an Boul& encoura$e the &evelo"%ent an& intro&uction o. "ro&ucts that Boul& si%"l &is"lace its e9istin$ "ro&ucts) (he use o. a ca"ital bu&$etin$ s ste% that "laces a heav e%"hasis on the erosion o. e9istin$ "ro&ucts %i$ht encoura$e the ?ar%ville ?iber Cor"oration to aban&on a nu%ber o. attractive neB "roIects) (hese "ro&ucts %i$ht also be attractive to co%"etitors an& co%"etitors %i$ht intro&uce the% i. ?ar%ville ?iber .aile& to &o so) Fn&er these con&itions, the cash .loB %i$ht be incre%ental because the eventual erosion o. e9istin$ "ro&ucts %i$ht be vieBe& as inevitable Bhether or not the neB "roIect is intro&uce&)

2)

3)

4)

204

')

Fnlike &e"reciation char$es, interest e9"enses involve actual cash out.loBs) DoBever, interest e9"enses are nor%all e9clu&e& .ro% the cash .loB o. the "roIect in or&er to avoi& a &ouble-countin$ o. the cost o. .un&s) (he basic "ur"ose o. the &iscountin$ "rocess is to insure that the net cash .loBs o. acce"te& "roIects are su..icient to cover the cost o. .un&s) Dence, the &ouble countin$ o. interest %a lea& to an incorrect &ecision to reIect otherBise "ro.itable "roIects) (he "roIect cost o. $20 %illion consists o. %achiner an& e@ui"%ent /$140, the %o&i.ication o. n lon-.iber "ro&uction .acilities /$4 %illion0, an& a&&itional Borkin$ ca"ital re@uire%ents /$2 %illion0) Fn&er the assu%"tion that the "roIect inclu&es cash .loBs .ro% sales erosion o. e9istin$ "ro&ucts, the net "resent value an& the "ro.itabilit in&e9 are as .olloBs8 6iscount ?actor at 102 -resent Galue 0)505 $2,+3+,100 0)*2+ 2,44*,000 0)4'1 2,32*,100 0)+*3 2,1*',+00 0)+21 2,045,300 0)'+4 1,514,+00 0)'13 1,45','00 0)4+4 1,+*1,200 0)424 1,'+*,*00 0)3*+ 2,23*,*00 ,$$re$ate "resent value $20,*45,000 1inus8 "roIect cost 20,000,000 !et "resent value $*45,000 Z(he 10th ear cash .loB o. $3)* %illion "lus Borkin$ ca"ital o. $2 %illion) <ear 1 2 3 4 ' + 4 * 5 10
P r e s e n tV a l u eo fN e tC a s h F l o w P r o b a b i l i t yI n d e x = P r o j e c tC o s t
= $20,*45,000 =1)044 $20,000,000

+)

!et Cash ?loBs $2,500,000 3,000,000 3,100,000 3,200,000 3,300,000 3,400,000 3,'00,000 3,+00,000 3,400,000 ',*00,000 Z

(he "roIect shoul& be acce"te& because the net "resent value is "ositive an& the "ro.itabilit in&e9 is $reater than one) (hen un&er the assu%"tion that the "roIect e9clu&es cash .loBs .ro% sales erosion o. e9istin$ "ro&ucts, the net "resent value an& the "ro.itabilit in&e9 are as .olloBs)

20*

6iscount <ear ?actor at 102 -resent Galue 1 0)505 $2,3+3,400 2 0)*2+ 2,230,200 3 0)4'1 2,102,*00 4 0)+*3 1,5*0,400 ' 0)+21 1,*+3,000 + 0)'+4 1,44*,400 4 0)'13 1,+41,+00 * 0)4+4 1,'41,100 5 0)424 1,441,+00 10 0)3*+ 2,123,000 ,$$re$ate "resent value $15,03',*00 1inus8 "roIect cost 20,000,000 !et "resent value -$5+4,200 Z(he 10th ear cash .loB o. $3)' %illion "lus Borkin$ ca"ital o. $2 %illion)
$ 1 9 , 0 3 5 , 8 0 0 P r o f i t a b i l i t y I n d e x = = 0 . 9 5 1 8 $ 2 0 , 0 0 0 , 0 0 0

!et Cash ?loBs $2,+00,000 2,400,000 2,*00,000 2,500,000 3,000,000 3,100,000 3,200,000 3,300,000 3,400,000 ','00,000

(he "roIect shoul& be reIecte& because the net "resent value is ne$ative an& the "ro.itabilit in&e9 is less than one)

205

CASE STUDY 7

FEATHERSTUN TECHNOLOGY COMPANY

(he "ur"ose o. this case is to &iscuss the "roble%s an& alternative a""roaches associate& Bith the &eter%ination o. the Bei$hte& avera$e cost o. ca"ital) 1) 3ook value Bei$hts can be obtaine& .ro% the balance sheet in 79hibit 1 o. the case) Source 6ebt -re.erre& stock Co%%on e@uit (otal sources 3ook Galue $20,000,000 10,000,000 1',000,000 $4',000,000 =ei$ht 0)4' 0)22 0)33 1)00

1arket value Bei$hts are calculate& as .olloBs8 1arket value o. &ebt = $20,000,000 9 0)50 = $1*,000,000 1arket value o. "re.erre& stock = 400,000 shares 9 $20 = $*,000,000 1arket value o. co%%on stock = 2,000,000 shares 9 $14)'0 = $25,000,000 1arket value o. co%%on = 2,000,000 9 $14)'0 = $25,000,000 Sources 6ebt -re.erre& stock Co%%on e@uit (otal sources 2) 3ook Galue $1*,000,000 *,000,000 25,000,000 $'',000,000 =ei$ht 0)33 0)14 0)'3 1)00

(he annual $roBth rate o. &ivi&en&s can be co%"ute& as .olloBs8

1 9 8 4 D i v i d e n d $ 0 . 6 4 D i s c o u n tF a c t o r( 5 y e a r ) = = = 0 . 7 1 1 1 9 8 9 D i v i d e n d $ 0 . 9 0

I. ou look across the .ive- ear roB in (able C /-resent Galue o. $10 at the en& o. the te9tbook, the &iscount .actor 0)411 is un&er the 4-"ercent colu%nC 4 "ercent is the annual $roBth rate o. &ivi&en&s) (hus, the co%%on e@uit is co%"ute& as .olloBs8
ke = $1 $0)50/1 + 0)040 +g = + 0)04 = 13)+2 "0 $14)'0

3)

(he cost o. &ebt an& the cost o. "re.erre& stock are co%"ute& as .olloBs8 Cost o. &ebt a.ter ta9 = 0)124/1 - 0)'00 = +)22 Cost o. "re.erre& stock = $2)2' S $20 = 11)32

210

Fsin$ the book value Bei$hts, the Bei$hte& avera$e cost o. ca"ital is calculate& as .olloBs8 Source 6ebt -re.erre& stock Co%%on e@uit =ei$hte& avera$e cost o. ca"ital =ei$ht 0)4' 0)22 0)33 Cost +)22 11)3 13)+ =ei$hte& Cost 2)452 2)45 4)45 5)442

Fsin$ %arket value Bei$hts, the Bei$hte& avera$e cost o. ca"ital is co%"ute& as .olloBs8 Source 6ebt -re.erre& stock Co%%on e@uit =ei$hte& avera$e cost o. ca"ital 4) =ei$ht 0)33 0)14 0)'3 Cost +)22 11)3 13)+ =ei$hte& Cost 2)0'2 1)'* 4)21 10)*42

?irst, i. a sin$le co%"onent cost is use& as the acce"tance criterion, it is "ossible to acce"t "roIects Bith a loB rate o. return Bhile reIectin$ "roIects Bith a hi$h rate o. return) So%e loB-return "roIects %a be acce"te& because the can be .inance& Bith a chea"er source o. ca"ital such as &ebt) So%e hi$h-return "roIects Boul& be reIecte& because the have to be .inance& Bith an e9"ensive source o. ca"ital such as e@uit ca"ital) I. the .ir% uses u" so%e o. its "otential .or obtainin$ neB loB-cost &ebt, subse@uent e9"ansions Bill re@uire it to use a&&itional e@uit .inancin$ or the &ebt ratio Bill beco%e too lar$e) Secon&, i. the .ir% acce"ts those "roIects that iel& %ore than its Bei$hte& avera$e cost o. ca"ital, it is able to increase the %arket value o. its co%%on stock) (his increase occurs because these "roIects are e9"ecte& to earn %ore on their e@uit -.inance& "ortion than the cost o. e@uit ) (here are tBo %aIor a&vanta$es o. book value Bei$hts8 si%"licit an& stabilit ) (he .irst a&vanta$e is that the values are rea&il obtainable .ro% the .ir%As balance sheet) Secon&, the Bei$hts are stable over ti%e) (he "rinci"al &isa&vanta$e is that the Bei$hts %a %isstate the Bei$hte& avera$e cost o. ca"ital i. the %arket values o. the .ir%As securities have chan$e&) 1arket value Bei$hts are better than book value Bei$hts because book value Bei$hts usuall %isstate the Bei$hte& avera$e cost o. ca"ital an& investors e9"ect a return on the current value .or the .ir%) ;ne &raBback o. usin$ %arket value Bei$hts is that the .luctuate Bi&el )

')

211

CASE STUDY 8

STONE MILL GIFTS5 INC3

(he obIective o. the case is to intro&uce to stu&ents the conce"t o. valuation o. an on$oin$ business) , oun$ entre"reneur Bith .inancial backin$ .ro% his relatives is searchin$ .or a "ro%isin$ business to satis. his earnin$ to be hoB oBn boss) , %e&iu%-si>e& $i.t store is o..ere& to hi%) (he entre"reneur, 1r) Johnn 1ahane , has to esti%ate the .inancial re@uire%ents o. the business at the ti%e o. "urchase an& the "ro.itabilit o. its o"eration in subse@uent ears) (he case lea&er %a use the role-"la in$ %o&el to hi$hli$ht the bar$ainin$ scenario) Stu&ents can be encoura$e& to "la the roles o. various "arties involve& in the case) 1) 1rs) =einstein has o..ere& to sell the store .or a "urchase "rice o. $14',000 e9clu&in$ the cash balance) , cash balance o. $15,2'0 shall be re@uire& base& u"on the national avera$e o. 4 "ercent o. the total assets o. this si>e store) (hus, the initial total invest%ent consistin$ o. the "urchase "rice o. $14',000 an& the cash balance o. $15,2'0 Boul& a%ount to $154,2'0) 3ase& on the in.or%ation "rovi&e& in the case, it see%s that 1r) 1ahane "ossesses a $oo& abilit to run the store) De has so%e e9cellent i&eas to "ro%ote sales, e)$), chan$in$ the %erchan&isin$ %i9 to better suit the clientele o. the sho""in$ %all, institution o. bri&al re$istr , an& la aBa "lans) =hile these services cost e9tra %one to the store, the are usuall Bell a""reciate& b the $i.t bu ers an& %a ver Bell beco%e the &istin$uishin$ .eature o. the store) In 2003, 1rs) =einstein took over the control o. the business) (he .olloBin$ co%"utations "rovi&e the su%%ar o. results &urin$ the tenure o. 1r) 7van =einstein /155*L20020 an& that o. 1rs) =einstein /2003L200408 ,vera$e "ro.it /be.ore ta90 :roBth rate in "ro.its 155*L2002 $1*,*'' +2 2003L2004 $13,44' 22

2)

3)

I. Be assu%e 1r) 7van =einstein ha& not &ie& in 2003 an& still continue& to o"erate the store, the "ro.its .or 200* Boul& be $25,452 /$21,010 9 1)41*0, $iven a co%"oun& $roBth rate o. + "ercent) ;n the other han&, i. Be alloB the "ro.its to $roB at the current $roBth rate o. 2 "ercent, 200* "ro.its Boul& be $14,33+ /$14,0'' 9 1)020) ;ne %a assu%e that 1r) 1ahane Boul& &o %uch better than 1rs) =einstein but not &o so Bell as 1r) 7van =einsteinC Be can .in& esti%ates o. "ro.its .or loB, %i&&le, an& hi$h .or 200*8 #oB 1i&&le Di$h -ro.its be.ore ta9 $14,33+ $22,0+4 $25,452 4) :iven a risk-.ree rate o. return o. a""ro9i%atel 10 "ercent an& the iel& rate on ,aa rate& cor"orate bon&s o. 11 to 12 "ercent in 2003, it %a be reasonable to e9"ect a be.ore-ta9 rate o. return o. 1+ "ercent on an invest%ent as risk as $i.t stores) , rate o.
212

return o. 1' to 1+ "ercent on co%%on stock invest%ent %a esti%ate o. the o""ortunit cost o. .un&s) ')

re"resent a realistic

:iven the "ro.it esti%ates calculate& above an& a ca"itali>ation rate o. 1+ "ercent, one can calculate various valuation esti%ates assu%in$ constant earnin$s) 1ini%u% valuation = $14,33+E0)1+ = $*5,+00 1i&&le valuation = $22,0+4E0)1+ = $134,500 1a9i%u% valuation = $25,452E0)1+ = $1*+,200 Galuation Bill, o. course, chan$e usin$ &i..erent ca"itali>ation rates) =e can &eter%ine the value o. the co%"an usin$ the constant $roBth %o&el) I. Be assu%e an e9"ecte& rate o. return o. 1+ "ercent, an avera$e $roBth rate o. 4 "ercent /avera$e o. + "ercent an& 2 "ercent0, an& an avera$e "ro.it o. $22,0+4
9 ,7 9 2+ 1 4 ,3 3 6 2 2 .or 1r) 1ahane 8

Galue = "ro.itE/e9"ecte& return - $roBth rate0 = $22,0+4E/0)1+ - 0)040 = $1*3,*+4 ,$ain, var in$ assu%"tions Bill iel& &i..erent results) =e can also &eter%ine the value o. the co%"an usin$ book values) (he .olloBin$ co%"utation $ives the revise& value o. assets an& liabilities8 ,ccounts receivable /0)50 9 $'2,2'00 Inventories ?i9e& assets (otal assets #ess8 liabilities Galue o. net assets +) = $ 44,02' 14*,'00 +3,2'0 $2'*,44' 1'',34' $103,400

(he valuation esti%ates, as calculate& above, have a ran$e o. a loB o. $*5,+00 an& a hi$h o. $1*+,200) 1rs)=einstein Boul& at least like to $et a value o. $103,400 Bhich re"resent the net value o. assets assu%in$ an or&erl li@ui&ation) (he %a9i%u% "rice one Boul& be Billin$ to "a .or the store is $1*3,*+4 Bhich is base& on its X$oin$ concernX value) DoB &es"eratel 1r) 1ahane Bants to bu the store an& hoB an9ious 1rs) =einstein is to sell it Bill &eter%ine the actual outco%e) (he .inal "rice Bill also be in.luence& i. there are other bu ers in the %arket bi&&in$ .or the store) In our o"inion, 1r) 1ahane shoul& not "a %ore than $140,000 to $1'0,000 Bhich re"resents the %i&&le $roun&)

In actual case, 1r) 1ahane "ai& the .ull askin$ "rice o. $14',000 as he Bas %ore an9ious to bu the store an& so%eBhat %ore o"ti%istic about the .uture "otential .or the store)
213

CASE STUDY 9

SOUTHSIDE ELECTRIC POWER COMPANY

(his case is &esi$ne& to &iscuss %aIor &eter%inants an& si$ni.icance o. bon& ratin$s in establishin$ a &ebt "olic ) 1) 3on& Ratin$s b Stan&ar& K -oorAs an& 1oo& As ,,, ,, , $ra&e 333 %e&iu% $ra&e 33 ele%ents 3 CCC, CC C 666, 66, 6 1e&iu% $ra&e S"eculative S"eculative ;utri$ht s"eculation Inco%e bon& In &e.ault 3aa 3a 3 Caa Ca C -ossess Fn&esirable -oor S"eculative #oBest $ra&e #oBer s"eculative Di$hest $ra&e Di$h $ra&e F""er %e&iu% $ra&e Stan&ar& K -oorAs ,aa ,a , 1oo& As 3est @ualit Di$h @ualit Di$h %e&iu%

(here are several Ba s to anal >e or co%"are the @ualit o. bon&s) (Bo .inancial service .ir%sOStan&ar& K -oorAs an& 1oo& AsOassi$n letter ratin$s to in&icate the @ualit o. bon&s) (heir ,,, ratin$s in&icate the hi$hest @ualit o. bon&s) 3on&s Bith such ratin$s are .re@uentl re.eree& to as $ilt e&$e because the interest an& "rinci"al are "rotecte& b substantial .inancial stren$th, thus carr in$ the s%allest &e$ree o. invest%ent risk) In other Bor&s, these ratin$s &e"ict the esti%ate& "robabilit o. &e.ault) 3on& ratin$s are i%"ortant because the a..ect he interest rates the co%"an "a s on their neB bon&s an& the a..ect the %arket "rices o. all o. the .ir%As outstan&in$ bon&s to brin$ their iel&s into line Bith that on the neB issue) 2) =hile there is no %a$ic .or%ula .or ratin$s bon&s, the %aIor ratin$ a$encies nor%all investi$ate .ive as"ects o. the co%"an an& the "articular issue in @uestion8 %ana$e%ent, level an& stabilit o. earnin$s, .inancial resources, asset "rotection, an& in&enture "rovisions) ?irst, the a$encies "lace a %aIor e%"hasis on %ana$e%entAs "ru&ence an& ca"abilit in &eter%inin$ bon& ratin$s) (he e9a%ine %ana$e%entAs obIectives an& its "olicies to achieve these obIectives) Secon&, the a$encies assess the
214

abilit o. co%"anies to earn $oo& returns consistentl an& to %aintain a&e@uate interest overa$es /ti%es interest earne&0) Stabilit o. earnin$s is usuall %ore i%"ortant than the earnin$s level) (hir&, a nu%ber o. s"eci.ic ratios such as current ratio, inventor turnover, an& accounts receivable turnover are calculate& to &eter%ine a co%"an As current li@ui&it ) So%e other ratios such as &ebt ratio an& ti%es interest earne& are use& to &eter%ine a co%"an As stabilit to obtain a&&itional .un&s .or% e9ternal sources) ?ourth, the &e$ree o. "rotection a..or&e& b the co%"an As assets are &eter%ine& b so%e s"eci.ic in&ices such as total lon$-ter% &ebtEnet "lant an& net tan$ible assetsEtotal lon$-ter% &ebt) ?i.th, e9istin$ an& "ro"ose& in&enture "rovisions are revieBe& to &eter%ine the re"a %ent sche&ule in the event o. li@ui&ation) In a&&ition, the bon& ratin$ a$encies e9a%ine Bhether there are suitable sa.e$uar&s a$ainst &e.ault, %ana$e%ent is restricte& in the a%ount o. a&&itional &ebt it can raise, an& the ter%s o. issue re@uire a sinkin$ .un&) 3) Case 79hibit 3 in&icates that Southsi&e 7lectric -oBerAs &ebt ratio an& ti%es interest earne& are co%"arable to those o. electric utilit co%"anies rate& &ouble-,) (he co%"an As &ebt ratio has stea&il increase& .ro% 34 "ercent in 155* to 45 "ercent 200+) Its ti%es interest earne& has stea&il .allen .ro% ')32 ti%es to 4 ti%es &urin$ the sa%e "erio&) (hus, the co%"an As bon& ratin$ Bill .all to &ouble-, i. these tBo ratios re%ain the sa%e) (he %aintenance o. a tri"le-, ratin$ is &esirable because the cre&it ratin$ o. a bon& a..ects its interest an& the availabilit o. a&&itional lon$-ter% &ebt) (he co%"an As hu$e ca"ital s"en&in$ re@uire%ents are lar$el non-&e.errable because electric utilit co%"anies are t "icall re@uire& to "rovi&e the level o. service the "ublic &e%an&s at "rices set b the re$ulator bo&ies) (hus, the e9"en&itures %ust be %a&e an& .inance&) 1r) #on$shore &esires to %aintain the hi$hest bon& ratin$ so that his co%"an can have the access to all %aIor sources o. neB ca"ital) I. the co%"an Bants to %aintain its tri"le-, ratin$, it %ust sell a substantial a%ount o. neB co%%on e@uit an&Eor retain a consi&erable a%ount o. "ro.its) (he sale o. neB co%%on stock is not &esirable because its stock Bas sellin$ at $2* in 200+ /see Case 79hibit 30Oat least a 11- ear loB) 3ecause cash &ivi&en&s have "ositive i%"act on stock "rices, the co%"an cannot re&uce its &ivi&en& "a %ents &rasticall ) 79hibit 2 shoBs the .uture "ros"ects .or earnin$s "er share, &ivi&en& "er share, an& return on net Borth o. three &ebt "olicies) 7arnin$s "er share, &ivi&en& "er share, an& return on net Borth are substantiall hi$her at a 45 "ercent &ebt ratio than a 40 "ercent &ebt ratio) ;ne %i$ht ar$ue that these hi$her levels an& their $roBth rate Boul& cause the stock "rice to increase substantiall i. the co%"an a&o"ts a 45 "ercent &ebt ratio) 3ut Be %ust un&erstan& that the increase& &ebt Boul& increase risk, thereb causin$ the stock "rice to .all)

4)

')

21'

CASE STUDY 1

PRESLEY TECHNOLOGY?S ETHICAL DILEMA

(he overall issue o. this case is con.lict o. interest as re.lecte& b tBo se"arate e"iso&es) In 7"iso&e I, the con.lict is betBeen %ana$e%ent an& sharehol&ers) ?rank =illia%, S"ecial ,ssistant to the Gice -resi&ent o. ?inance, .aces a serious ethical &ile%%a re$ar&in$ %ana$e%entAs &esire .or short-ter% "ro.it an& "ersonal $ain) De %ust anal >e his o"tions Bhen %ana$e%ent "ro"oses an un&esirable ac@uisition .or @uestionable reasons) In 7"iso&e II, the con.lict is betBeen sales $roBth an& the co&e o. business con&uct) Sa% =ellin$ton, Gice -resi&ent o. 1arketin$, is un&er heav "ressure to increase his co%"an As overseas sales b 30 "ercent "er ear a%i& a stron$ co%"etition .ro% %aIor co%"uter co%"anies) !evertheless, he %a have to reco%%en& ter%inatin$ a contract Bith a %aIor overseas &istributor Bhose business "ractice a""ears to clash Bith the letter o. the co&e) 1) Fse the &ata in 79hibit 1 to esti%ate the %arket value o. Co%"uter 7n$ineerin$ in the .olloBin$ three Ba s8 /10 "rice-earnin$s ratio, /20 %arket valueEbook value, an& /30 &ivi&en& $roBth %o&el) ,%on$ %an available %etho&s o. valuation, the co%%onl use& ones are "riceearnin$s ratio, %arket valueEbook value, &ivi&en& $roBth %o&el, ca"itali>ation o. earnin$s, an& the use o. co%"arables) So%e a""raisal consultin$ co%"anies as Bell as courts a&vocate the use o. a Bei$hte& avera$e o. the .air values .ro% the above an& other %etho&s) =e use the .irst three %etho&s alon$ Bith Di$h (ech /D(0 as a re.erence co%"an to co%"ute the "er share "rice /-S-0 o. Co%"uter 7n$ineerin$ /C70)
/10 -S- /C70 = "rice "er share /D(0 earnin$s "er share /C70 earnin$s "er share /D(0 $20 = $1 = $10 $2

/20 -S-/C70 =

%arket value /D(0 book value /C70 book value /D(0 $20 = $* = $1+ $10

(3) PSP (CE) =

dividend per share in year 1 (CE) cost of equity (HT) - dividend growth rate (CE) $0.75 = = $7.50 0.14 - 0.04

3ecause Co%"uter 7n$ineerin$ has 1 %illion co%%on shares outstan&in$, its %arket value ran$es .ro% as hi$h as $1+ %illion to as loB as $4)' %illion) -resle (echnolo$ o..ere& to bu Co%"uter 7n$ineerin$ .or 2 %illion shares o. its stock at a ti%e Bhen the
21+

stock Bas sellin$ .or $20 a share, thereb %akin$ the total "urchase "rice o. Co%"uter 7n$ineerin$ $40 %illion) ,lthou$h it is an e9chan$e o. stock, to" e9ecutives o. -resle (echnolo$ coul& still bene.it because the Bill oBn %ore valuable stock) ,nal sis o. Co%"uter 7n$ineerin$ shoul& shoB that b virtuall an valuation %etho&, the ac@uisition &oes not %ake .inance sense) , "re%iu% ran$in$ .ro% $32)' %illion to $24 %illion over the value o. Co%"uter 7n$ineerin$ is bein$ "ai& to the sharehol&ers o. the co%"an ) (hus, the "ro"ose& ac@uisition Bill si$ni.icantl &ilute the value o. all current -resle (echnolo$ shares) 2) #ist an& &iscuss o"tions available to ?rank =illia%) ?rank =illia% has the .olloBin$ three o"tions8 ?irst, he can "re"are a .avorable but "erha"s %islea&in$ or &ece"tive re"ort on the ac@uisition) Secon&, he can re.use to Brite a .avorable re"ort on the ac@uisition an& acce"t the "ossibilit o. &is%issal) (hir&, he can XbloB the BhistleX b sen&in$ a letter to the Xoutsi&eX &irector) 3) 6iscuss tBo %aIor sections o. the ?C-,8 anti-briber an& accountin$) (he anti-briber section Bas the .irst "iece o. le$islation in the FS histor %akin$ it a cri%inal o..ense .or FS co%"anies to corru"tl in.luence .orei$n o..icials or to %ake "a %ents to an "erson Bhen the ha& Xreason to knoBX that "art o. these "a %ents Boul& $o to a .orei$n o..icial) (he accountin$ section establishes tBo interrelate& accountin$ re@uire%ents) ?irst, "ublic co%"anies %ust Xkee" books, recor&s, accounts, Bhich, in reasonable &etail, accuratel an& .airl re.lect the transactions an& &is"ositionsX o. their assets) Secon&, cor"orations are re@uire& to X&evise an& %aintain a s ste% o. internal accountin$ controls su..icient to "rovi&e reasonable assuranceX that transactions have been e9ecute& in accor&ance Bith %ana$e%entAs authori>e& "roce&ures or "olicies) Con$ress conclu&e& that the anti-briber an& accountin$ sections Boul& e..ectivel "revent "a %ents o. .orei$n bribes an& o..-the-book slush .un&s) -enalties .or violations inclu&e .ines o. u" to $2 %illion .or cor"orations an& $100,000Eor .ive ears in Iail .or in&ivi&uals) 4) #ist an& &iscuss "ros an& cons concernin$ cor"orate co&es o. con&uct) -ro"onents o. the ?C-, conten& that i. FS co%"anies are alloBe& to corru"t .orei$n o..icials, in all likelihoo& the Boul& Bish to &o the sa%e in the Fnite& States) (he ?C-, has encoura$e& FS co%"anies to intro&uce cor"orate "olicies a$ainst corru"t .orei$n "a %ents an& to i%"rove internal controls because the ?C-, bans ille$al "a %ents to .orei$n o..icials, an& levies heav "enalties .or violations) !u%erous surve s .oun& that %ost FS co%"anies ha& un&ertaken "ositive ste"s to "revent ille$al "a %ents to .orei$n o..icials an& to i%"rove internal controls) Cor"orate co&es o. con&uct %a be use.ul to8 /10 co%%unicate a &esirable cor"orate cultureC /20 orient neB e%"lo ees to co%"an valuesC /30 create a clear &irection in &ecentrali>e& .ir%sC /40 i%"rove a co%"an As "ublic i%a$e in the e es o. both societ an& re$ulator a$enciesC an& /'0 "rotect to" %ana$e%ent .ro% accusations o. knoBin$l alloBin$ e%"lo ee
214

%iscon&uct) Cor"orate co&es o. con&uct coul& be useless or even har%.ul because the %a 8 /10 be &i..icult to en.orceC /20 co%"el co%"anies to sacri.ice co%"etitivenessC /30 lea& to "enalties .or e%"lo ees Bho .olloB $ui&elines but sacri.ice "ro.its in &oin$ soC an& /40 be costl to &evelo" an& i%"le%ent) 4) I. ou Bere Sa% =ellin$ton, Bhat Boul& ou &o about the situation in these South ,%erican countries[ !athan Stallin$s, a %aIor South-,%erican &istributor .or -resle (echnolo$ "ro&ucts, obtaine& loBer custo%s &uties throu$h briber ) =hen he Bas aske& to co%"l Bith the co%"an co&e o. con&uct, he &ecline& on the $roun& that it Boul& "lace hi% at a co%"etitive &isa&vanta$e) -resle (echnolo$ co&e o. con&uct "rohibite& the co%"an .ro% usin$ &istributors Bho en$a$e& in briber ) In a&&ition, the co%"an Boul& violate the ?C-, i. it ha& reason to knoB that one o. its a$ents Bas bribin$ .orei$n o..icials to obtain business) Sa% =ellin$ton %i$ht ar$ue that in these South ,%erican countries, briber shoul& be alloBe& because /10 it is custo%ar C /20 business $ets &one8 /30 no one is hurtC an& /40 "eo"le in $eneral bene.it) ;r he %i$ht ar$ue that briber is si%"l Bron$ an& -resle (echnolo$ shoul& re.use to reneB !athanAs contract unless he a$rees to abi&e b the co&e) 4) (he Internet Center .or Corru"tion Research "rovi&es the trans"arenc international "erce"tions in&e9 an& a co%"rehensive assess%ent o. countr As inte$rit "er.or%ance) Fse the Bebsite o. this or$ani>ationOBBB)$B&$)&eE]uBvBEicr)ht%Oto i&enti. the .ive %ost corru"t countries an& the .ive least corru"t countries)

21*

CASE STUDY 11 1)

GM OPERATIONS IN ME>ICO AND THE PESO CRISIS

6o ou think that the "eso has .allen .ar enou$h or that it Bill continue to lose value /Dint8 ansBer this @uestion usin$ 7@uation *-30) Is the "re&icte& e9chan$e rate usuall accurate[ Re%e%ber that -s2)54'4 is the sa%e as $0)335') (he "urchasin$ "oBer "arit theor can be use& to &eter%ine Bhether the hu$e .all in the value o. the "eso is Iusti.ie&8 In.lation rate .ro% 1550 to 4th Quarter 1554 = /4th @uarter 1554 in&e9 - 1550 in&e90E1550 in&e98 FS8 /110)1 - 1000E100 = 0)101 1e9ico8 /140)' - 1000E100 = 0)40' -re&icte& e9chan$e rate = $0)335' 9 M/1+0)1010E/1+0)40'0N = $0)2152E-s ,s o. 4th @uarter 1554, the "eso ha& &ro""e& to a value o. $0)1*4* "er "eso or ')32'0 "esos "er &ollar) (hus, the "eso has .allen %ore than the "re&icte& e9chan$e rate /$0)2152 or 4)'+20 "esos0 Boul& in&icate) (he .olloBin$ table shoBs the actual rates an& the "re&icte& rates .ro% 1550 to 4th @uarter 1554, usin$ the 1550 as a base ear) A(+*') '&= P!;=%(+;= E@(A'&:; R'+;8 $,! +A; P;8, 6P;8,8 B;! D,))'!< 1550 2)54'4 O 1551 3)0410 3)'0'1 1552 3)11'4 3)544+ 1553 3)10'5 4)2*4' 3r& Q 1554 3)4040 4)'144 4th Q 155' ')32'0 4)'+20

,ctual Rate -re&icte& Rate

(he "re&icte& e9chan$e rate %a not be accurate .or a nu%ber o. reasons) ?irst, it is "ossible that 1e9icoAs consu%er "rices %i$ht have been su""resse& b the $overn%ent throu$h a variet o. "olicies such as &irect or in&irect controls on Ba$es an& "rices) (he accurac o. the "re&icte& e9chan$e rate also &e"en&s on the base ear) =e use& X1550X as a base ear in "re&ictin$ the e9chan$e rate .or the "eso, but it %a not be a re"resentative ear) ?inall , the "re&icte& e9chan$e rate %a not be accurate because %an other .actors in.luence e9chan$e rates besi&es relative "rices) (hese other .actors inclu&e the balance o. "a %ents, interest rates, international reserves, an& $overn%ent inter.erence in the .orei$n e9chan$e %arket) (here.ore, it is &i..icult to %easure the "recise %a$nitu&e o. e9chan$e rate %ove%ents attributable to &i..erences in in.lation rates) 2) Coul& the "eso .loat have been .orecaste&[ /Dint8 ansBer this @uestion usin$ such econo%ic in&icators as the balance o. "a %ents, international reserves, in.lation, an& %one su""l 0)

215

(he 1e9ican current account Bas ne$ative .or %an ears) ,n& the current account &eteriorate& ra"i&l since 1550) 1e9icoAs international reserves ha& actuall increase& ever ear .ro% 1550 to 1553 because the ca"ital account /(able *-1 &oes not shoB this account0 ha& been consistentl "ositive in all these ears) ;ne can sa that .orei$ners increase& their &irect invest%ents, hol&in$s o. securities, an& loans in 1e9ico) 1e9ico ha& increase& its reserves, but the increase ha& not been in "ro"ortion to its current account &e.icit in recent ears) International Reserves 5,*+3 1+,344 Current ,ccount 6e.icit 4,4'1 21,'2' Reserves as -ercent o. Current ,ccount 6e.icit 1322 4+2

1550 3r& Q 1554

(his %eans that 1e9ico shoul& continue to borroB %one .ro% .orei$n countries in or&er to .inance its &e.icit) (he @uestion is hoB %uch %ore a countr such as 1e9ico can borroB Bhen the countr is in "olitical tur%oil) 1e9icoAs in.lation rate Bas seven ti%es as hi$h as that o. the Fnite& States betBeen 1550 an& 3r& @uarter, 1554) (he in.lation Bas cause& at least in "art b a ra"i& increase in the countr As %one su""l ) (he $roBth rate o. 1e9icoAs %one su""l Bas .ive ti%es as .ast as that o. the Fnite& States) ,ll o. the econo%ic in&icators above si$nale& the nee& .or a &evaluation o. the "eso, but the "ossibilit o. such a &evaluation ha& e9iste& since 15518 the ti%in$ o. a &evaluation, there.ore, Bas %ost &i..icult to "re&ict) In .act, the table in&icates that the "eso ha& been overvalue& si$ni.icantl , as co%"are& Bith the "re&icte& e9chan$e rates) 3) =hat alternatives are available to the 1e9ican $overn%ent .or &ealin$ Bith its balanceo.-"a %ents "roble%s[ (he 1e9ican $overn%ent has a nu%ber o. alternatives to &eal Bith its balance o. "a %ents "roble%s) D;$)'+; +A; E(,&,C#/ (he $overn%ent %a a&o"t ti$ht %onetar an& .iscal "olicies) (o ste% in.lation, it shoul& control $overn%ent bu&$et &e.icits, re&uce $roBth o. %one su""l , an& institute Ba$e an& "rice controls) 3ut these "olicies %a also sloB the econo% ) C,&+%&*; .,!!,D%&:8 (he balance o. "a %ents %a i%"rove as the Borl& econo% reboun&s an& as 1e9ican oil e9"orts increase, thus alloBin$ 1e9ico to "a o.. these loans) 3ut it Bas unlikel that the oil e9"orts Boul& "rovi&e the Bhole solution soon) In a&&ition, the countr As hu$e e9ternal &ebts outstan&in$ Boul& have %a&e it &i..icult to borroB %uch %ore)

220

I&8+%+*+; S+!%(+ E@(A'&:; C,&+!,)88 79chan$e controls Bill alleviate a shorta$e in .orei$n e9chan$e) DoBever, strict e9chan$e controls coul& %ake the s"rea& betBeen o..icial versus %arket rates even Bi&erC it Boul& be &i..icult .or the $overn%ent to en.orce these controlsC an& the %a hurt .orei$n invest%ent an& touris%) F),'+ +A; P;8,8 (he "eso .loat Boul& have an in.lationar i%"act because o. both &e%an& "ull .ro% e9"orts an& cost "ush on i%"orts) (he "eso .loat %i$ht not correct the balance-o.-"a %ents &e.icit i.8 /10 .orei$n %arkets &i& not bu %ore $oo&s in res"onse to loBer "rices, /20 1e9ican co%"anies &i& not have the ca"acit to "ro&uce %ore $oo&s .or e9"orts, /30 1e9icans continue& to i%"ort .orei$n $oo&s re$ar&less o. their hi$her "rices, an& /40 %i&&le%en &i& not "ass on chan$es in "rices to their custo%ers) 4) ,ssu%e that 1e9ico i%"ose& "rolon$e& .orei$n e9chan$e controls an& thus :1 &e 1e9ico, the 1e9ican subsi&iar o. :eneral 1otors, coul& not i%"ort crucial %aterials an& co%"onents .ro% the Fnite& States) 3rie.l outline courses o. action that :1 &e 1e9ico shoul& take to co"e Bith the .orei$n e9chan$e controls) I. the 1e9ican $overn%ent &oes not alloB :1 &e 1e9ico to use scarce .orei$n e9chan$e to i%"ort %aterials an& co%"onents .ro% the Fnite& States, there are a nu%ber o. alternatives available to :18 /10 continue to shi" co%"onents but e9ten& unli%ite& cre&it to the subsi&iar so that "a %ent Bill not have to be %a&eC /20 .in& or &evelo" local su""liers in 1e9ico or have the subsi&iar beco%e a %ore sel.-su..icient co%"an C /30 have the subsi&iar &evelo" e9"ort %arkets in or&er to $et cre&its .ro% the $overn%ent that Bill alloB the i%"ort o. co%"onentsC /40 shi" co%"onents an& consi&er the% as contribution to e@uit C an& /'0 close &oBn o"erations) ') Is there an evi&ence that the t "ical "attern o. e9chan$e rate stabili>ation "ro$ra%s su$$este& b researchers such as =illia% :ruben took "lace in 1e9ico[ (he t "ical "attern o. e9chan$e-rate stabili>ation "ro$ra%s .loBs as .olloBs8 the real e9chan$e rate risesOtra&e an& current account balances &eteriorateO.irst ca"ital in.loBs rises but the in.loBs ulti%atel reverseOthe e9chan$e-rate stabili>ation "ro$ra% callio"es) 7vi&ence su$$ests that this t "ical "attern took "lace in 1e9ico) ?i$ure 11-1 shoBs that real e9chan$e rate a""reciation /.ro% 1550 to 15540 Bas chronic) (able 11-1 shoBs that the nationAs tra&e balance $reB increasin$l ne$ative) ?i$ure 11-2 shoBs that in the earl sta$es o. the "ro$ra%, ca"ital in.loBs, "articularl "ort.olio invest%ent soare& but the in.loBs reverse& in 1554) ?inall , ?i$ure 11-3 shoBs that the 1e9ican "ro$ra% o. e9chan$e-rate stabili>ation colla"se& on 6ece%ber 20, 1554)

221

?i$ure 11-1

?i$ure 11-2

?i$ure 11-3

222