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Chapter An Overview of Financial Management Learning Objectives After reading this chapter, students should be able to: Identify the three main forms of business organization and describe the advantages and disadvantages of each one Identify the primary goal of the management of a publicly held corporation, and understand the relationship between stock prices and shareholder value Differentiate between what is meant by a stock’s intrinsic value and its market value and understand the concept of equilibrium in the market Briefly explain three important trends that have been occurring in business that have implications for managers Define business ethics and briefly explain what companies are doing in response to a renewed interest in ethics, the consequences of unethical behavior, and how employees should deal with unethical behavior Briefly explain the conflicts between managers and stockholders, and explain useful motivational tools that can help to prevent these conflicts Identify the key officers in the organization and briefly explain their responsibilities Chapter 1: An Overview of Financial Management Learning Objectives Lecture Suggestions Chapter covers some important concepts, and discussing them in class can be interesting However, students can read the chapter on their own, so it can be assigned but not covered in class We spend the first day going over the syllabus and discussing grading and other mechanics relating to the course To the extent that time permits, we talk about the topics that will be covered in the course and the structure of the book We also discuss briefly the fact that it is assumed that managers try to maximize stock prices, but that they may have other goals, hence that it is useful to tie executive compensation to stockholder-oriented performance measures If time permits, we think it’s worthwhile to spend at least a full day on the chapter If not, we ask students to read it on their own, and to keep them honest, we ask one or two questions about the material on the first mid-term exam One point we emphasize in the first class is that students should print a copy of the PowerPoint slides for each chapter covered and purchase a financial calculator immediately, and bring both to class regularly We also put copies of the various versions of our “Brief Calculator Manual,” which in about 12 pages explains how to use the most popular calculators, in the copy center Students will need to learn how to use their calculators immediately as time value of money concepts are covered in Chapter It is important for students to grasp these concepts early as many of the remaining chapters build on the TVM concepts We are often asked what calculator students should buy If they already have a financial calculator that can find IRRs, we tell them that it will do, but if they not have one, we recommend either the HP-10BII or 17BII Please see the “Lecture Suggestions” for Chapter for more on calculators DAYS ON CHAPTER: OF 58 DAYS (50-minute periods) Lecture Suggestions Chapter 1: An Overview of Financial Management 1-1 1-2 1-3 1-4 1-5 1-6 1-7 Answers to End-of-Chapter Questions When you purchase a stock, you expect to receive dividends plus capital gains Not all stocks pay dividends immediately, but those corporations that do, typically pay dividends quarterly Capital gains (losses) are received when the stock is sold Stocks are risky, so you would not be certain that your expectations would be met—as you would if you had purchased a U.S Treasury security, which offers a guaranteed payment every months plus repayment of the purchase price when the security matures No, the stocks of different companies are not equally risky A company might operate in an industry that is viewed as relatively risky, such as biotechnology—where millions of dollars are spent on R&D that may never result in profit A company might also be heavily regulated and this could be perceived as increasing its risk Other factors that could cause a company’s stock to be viewed as relatively risky include: heavy use of debt financing vs equity financing, stock price volatility, and so on If investors are more confident that Company A’s cash flows will be closer to their expected value than Company B’s cash flows, then investors will drive the stock price up for Company A Consequently, Company A will have a higher stock price than Company B No, all corporate projects are not equally risky A firm’s investment decisions have a significant impact on the riskiness of the stock For example, the types of assets a company chooses to invest in can impact the stock’s risk—such as capital intensive vs labor intensive, specialized assets vs general (multipurpose) assets—and how they choose to finance those assets can also impact risk A firm’s intrinsic value is an estimate of a stock’s “true” value based on accurate risk and return data It can be estimated but not measured precisely A stock’s current price is its market price —the value based on perceived but possibly incorrect information as seen by the marginal investor From these definitions, you can see that a stock’s “true long-run value” is more closely related to its intrinsic value rather than its current price Equilibrium is the situation where the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock If a stock is in equilibrium then there is no fundamental imbalance, hence no pressure for a change in the stock’s price At any given time, most stocks are reasonably close to their intrinsic values and thus are at or close to equilibrium However, at times stock prices and equilibrium values are different, so stocks can be temporarily undervalued or overvalued If the three intrinsic value estimates for Stock X were different, I would have the most confidence in Company X’s CFO’s estimate Intrinsic values are strictly estimates, and different analysts with different data and different views of the future will form different estimates of the intrinsic value for any given stock However, a firm’s managers have the best information about the company’s future prospects, so managers’ estimates of intrinsic value are generally better than the estimates of outside investors Preface iii 1-8 If a stock’s market price and intrinsic value are equal, then the stock is in equilibrium and there is no pressure (buying/selling) to change the stock’s price So, theoretically, it is better that the two be equal; however, intrinsic value is a long-run concept Management’s goal should be to maximize the firm’s intrinsic value, not its current price So, maximizing the intrinsic value will maximize the average price over the long run but not necessarily the current price at each point in time So, stockholders in general would probably expect the firm’s market price to be under the intrinsic value—realizing that if management is doing its job that current price at any point in time would not necessarily be maximized However, the CEO would prefer that the market price be high—since it is the current price that he will receive when exercising his stock options In addition, he will be retiring after exercising those options, so there will be no repercussions to him (with respect to his job) if the market price drops—unless he did something illegal during his tenure as CEO 1-9 The board of directors should set CEO compensation dependent on how well the firm performs The compensation package should be sufficient to attract and retain the CEO but not go beyond what is needed Compensation should be structured so that the CEO is rewarded on the basis of the stock’s performance over the long run, not the stock’s price on an option exercise date This means that options (or direct stock awards) should be phased in over a number of years so the CEO will have an incentive to keep the stock price high over time If the intrinsic value could be measured in an objective and verifiable manner, then performance pay could be based on changes in intrinsic value However, it is easier to measure the growth rate in reported profits than the intrinsic value, although reported profits can be manipulated through aggressive accounting procedures and intrinsic value cannot be manipulated Since intrinsic value is not observable, compensation must be based on the stock’s market price—but the price used should be an average over time rather than on a spot date 1-10 The three principal forms of business organization are sole proprietorship, partnership, and corporation The advantages of the first two include the ease and low cost of formation The advantages of the corporation include limited liability, indefinite life, ease of ownership transfer, and access to capital markets The disadvantages of a sole proprietorship are (1) difficulty in obtaining large sums of capital; (2) unlimited personal liability for business debts; and (3) limited life The disadvantages of a partnership are (1) unlimited liability, (2) limited life, (3) difficulty of transferring ownership, and (4) difficulty of raising large amounts of capital The disadvantages of a corporation are (1) double taxation of earnings and (2) setting up a corporation and filing required state and federal reports, which are complex and time-consuming 1-11 Stockholder wealth maximization is a long-run goal Companies, and consequently the stockholders, prosper by management making decisions that will produce long-term earnings increases Actions that are continually shortsighted often “catch up” with a firm and, as a result, it may find itself unable to compete effectively against its competitors There has been much criticism in recent years that U.S firms are too short-run profit-oriented A prime example is the U.S auto industry, which has been accused of continuing to build large “gas guzzler” iv Preface automobiles because they had higher profit margins rather than retooling for smaller, more fuelefficient models 1-12 Useful motivational tools that will aid in aligning stockholders’ and management’s interests include: (1) reasonable compensation packages, (2) direct intervention by shareholders, including firing managers who don’t perform well, and (3) the threat of takeover The compensation package should be sufficient to attract and retain able managers but not go beyond what is needed Also, compensation packages should be structured so that managers are rewarded on the basis of the stock’s performance over the long run, not the stock’s price on an option exercise date This means that options (or direct stock awards) should be phased in over a number of years so managers will have an incentive to keep the stock price high over time Since intrinsic value is not observable, compensation must be based on the stock’s market price —but the price used should be an average over time rather than on a spot date Stockholders can intervene directly with managers Today, the majority of stock is owned by institutional investors and these institutional money managers have the clout to exercise considerable influence over firms’ operations First, they can talk with managers and make suggestions about how the business should be run In effect, these institutional investors act as lobbyists for the body of stockholders Second, any shareholder who has owned $2,000 of a company’s stock for one year can sponsor a proposal that must be voted on at the annual stockholders’ meeting, even if management opposes the proposal Although shareholdersponsored proposals are non-binding, the results of such votes are clearly heard by top management If a firm’s stock is undervalued, then corporate raiders will see it to be a bargain and will attempt to capture the firm in a hostile takeover If the raid is successful, the target’s executives will almost certainly be fired This situation gives managers a strong incentive to take actions to maximize their stock’s price 1-13 a Corporate philanthropy is always a sticky issue, but it can be justified in terms of helping to create a more attractive community that will make it easier to hire a productive work force This corporate philanthropy could be received by stockholders negatively, especially those stockholders not living in its headquarters city Stockholders are interested in actions that maximize share price, and if competing firms are not making similar contributions, the “cost” of this philanthropy has to be borne by someone the stockholders Thus, stock price could decrease b Companies must make investments in the current period in order to generate future cash flows Stockholders should be aware of this, and assuming a correct analysis has been performed, they should react positively to the decision The Mexican plant is in this category Capital budgeting is covered in depth in Part of the text Assuming that the correct capital budgeting analysis has been made, the stock price should increase in the future c U.S Treasury bonds are considered safe investments, while common stock are far more risky If the company were to switch the emergency funds from Treasury bonds to stocks, Preface v stockholders should see this as increasing the firm’s risk because stock returns are not guaranteed—sometimes they go up and sometimes they go down The firm might need the funds when the prices of their investments were low and not have the needed emergency funds Consequently, the firm’s stock price would probably fall 1-14 a No, TIAA-CREF is not an ordinary shareholder Because it is one of the largest institutional shareholders in the United States and it controls nearly $280 billion in pension funds, its voice carries a lot of weight This “shareholder” in effect consists of many individual shareholders whose pensions are invested with this group b The owners of TIAA-CREF are the individual teachers whose pensions are invested with this group c For TIAA-CREF to be effective in wielding its weight, it must act as a coordinated unit In order to this, the fund’s managers should solicit from the individual shareholders their “votes” on the fund’s practices, and from those “votes” act on the majority’s wishes In so doing, the individual teachers whose pensions are invested in the fund have in effect determined the fund’s voting practices 1-15 Earnings per share in the current year will decline due to the cost of the investment made in the current year and no significant performance impact in the short run However, the company’s stock price should increase due to the significant cost savings expected in the future 1-16 The board of directors should set CEO compensation dependent on how well the firm performs The compensation package should be sufficient to attract and retain the CEO but not go beyond what is needed Compensation should be structured so that the CEO is rewarded on the basis of the stock’s performance over the long run, not the stock’s price on an option exercise date This means that options (or direct stock awards) should be phased in over a number of years so the CEO will have an incentive to keep the stock price high over time If the intrinsic value could be measured in an objective and verifiable manner, then performance pay could be based on changes in intrinsic value Since intrinsic value is not observable, compensation must be based on the stock’s market price—but the price used should be an average over time rather than on a spot date The board should probably set the CEO’s compensation as a mix between a fixed salary and stock options The vice president of Company X’s actions would be different than if he were CEO of some other company 1.17 Setting the compensation policy for three division managers would be different than setting the compensation policy for a CEO because performance of each of these managers could be more easily observed For a CEO an award based on stock price performance makes sense, while in this situation it probably doesn’t make sense Each of the managers could still be given stock awards; however, rather than the award being based on stock price it could be determined from some observable measure like increased gas output, oil output, etc vi Preface Answers to End-of-Chapter Problems We present here some intermediate steps and final answers to end-of-chapter problems Please note that your answer may differ slightly from ours due to rounding differences Also, although we hope not, some of the problems may have more than one correct solution, depending on what assumptions are made in working the problem Finally, many of the problems involve some verbal discussion as well as numerical calculations; this verbal material is not presented here Preface vii 2-1 FV5 = $16,105 10 2-2 PV = $1,292.1 2-3 I/YR = 8.01% 2-4 N = 11.01 years 2-5 N = 11 years 2-6 FVA5 = $1,725.2 2; FVA5 = Due $1,845.9 2-7 PV = $923.98; FV = $1,466.2 2-8 PMT = $444.89; EAR = 12.6825 % 2-9 a.$530 d $445 2-10 a $895.42 viii 2-11 2-12 2-13 2-14 2-15 2-16 2-17 2-18 2-19 b $1,552.92 c.$279.20 d $499.99; $867.13 a.14.87% b 7% c.9% d 15% a.10.24 years c.4.19 years a.$6,374.97 d(1) $7,012.47 a.$2,457.83 c.$2,000 d(1) $2,703.61 PV7% = $1,428.57; PV14% = $714.29 9% a.Stream A: $1,251.25 a $423,504.48 b $681,537.69 c(2) $84,550.80 2-20 Contract 2; PV = $10,717,847.1 2-21 2-22 2-23 2-24 2-25 2-26 2-27 2-28 2-29 2-30 a 30year payment plan; PV = $68,249,727 b 10year payment plan; PV = $63,745,773 c.Lump sum; PV = $61,000,000 a.$802.43 c.$984.88 a.$881.17 b $895.42 c.$903.06 d $908.35 e.$910.97 a.$279.20 b $276.84 c.$443.72 a.$5,272.32 b $5,374.07 $17,290.89; $19,734.26 a.Bank A = 4% INOM = 7.8771% 3% a.E = 63.74 yrs.; K = 2-31 2-32 2-33 2-34 2-35 2-36 2-37 2-38 2-39 2-40 41.04 yrs b $35,825.33 a.$35,459.51 b $27,232.49 $496.11 $17,659.50 a.PMT = $10,052.87 b Yr 3: Int/Pymt = 9.09%; Princ/Pymt = 90.91% a.PMT = $34,294.65 b PMT = $7,252.78 c.Balloon PMT = $94,189.69 a.$5,308.12 b $4,877.09 a.50 mos b 13 mos c.$112.38 $309,015 $36,950 $9,385 3-1 3-2 3-3 3-4 3-5 3-6 3-7 $1,000,000 $2,500,000 $3,600,000 $20,000,000 a, possibly c $89,100,000 a.$50,000 b $115,000 3-8 NI = $450,000; NCF = $650,000; OCF = $650,000 3-9 10,500,000 shares Preface 3-10 a $2,400,0 00,000 b $4,500,0 00,000 c $5,400,0 00,000 d $1,100,0 00,000 3-11 $12,681, 482 3-12 a.$592 million b RE04 = $1,374 million c.$1,600 million d $15 million e.$620 million 3-13 a $90,000, 000 b Preface NOWC05 = $192,000,00 0; NOWC04 = $210,000,00 c OC04 = $460,000,00 0; OC05 = $492,000,00 d FCF = $58,000,000 3-14 a.$2,400,000 b NI = 0; NCF = $3,000,000 c.NI = $1,350,000; NCF = $2,100,000 4-1 AR = $800,000 4-2 D/A = 58.33% 4-3 TATO = 5; EM = 1.5 4-4 M/B = 4.2667 4-5 P/E = 12.0 4-6 ROE = 8% 4-7 $112,500 4-8 15.31% 4-9 $142.50 4-10 NI/S = 2%; D/A = 40% 4-11 2.9867 4-12 TIE = 2.25 4-13 TIE = 3.86 4-14 ROE = 23.1% 4-15 ROE = +5.54%; QR = 1.2 4-16 7.2% 4-17 a 4-18 6.0 4-19 $262,500 4-20 $405,682 4-21 $50 4-22 A/P = $90,000; Inv = $90,000; FA = $138,000 4-23 a 4-24 Current ratio = 1.98; DSO = 76.3 days; Total assets turnover = 1.73; Debt ratio = 61.9% a TIE = 11; EBITDA coverage = 9.46; Profit margin = 3.40%; ROE = 8.57% 6-1 b 6-2 6-3 6-4 6-5 6-6 6-7 6-8 6-9 6-10 6-11 6-12 6-13 6-14 6-15 6-16 6-17 6-18 6-19 Upward sloping yield curve c.Inflation expected to increase d Borrow long term 2.25% 6%; 6.33% 1.5% 0.2% 21.8% 5.5% 8.5% 6.8% 6.0% 1.55% 0.35% 1.775% a.r1 in Year = 6% b I1 = 2%; I2 = 5% r1 in Year = 9%; I2 = 7% 14% 7.2% a.r1 = 9.20%; r5 = 7.20% a.8.20% b 10.20% c.r5 = 10.70% 7-1 $935.82 7-2 a.7.11% b 7.22% c.$988.46 7-3 $1,028.60 7-4 YTM = 6.62%; YTC = 6.49%; most likely ix yield = 6.49% 7-5 a 7-6 VL at 5% = $1,518 98; VL at 8% = $1,171 19; VL at 12% = $863.7 a C0 = $1,012 79; Z0 = $693.0 4; C1 = $1,010 02; Z1 = $759.5 7; C2 = $1,006 98; Z2 = $832.4 9; C3 = $1,003 65; Z3 = $912.4 x 7-7 7-8 7-9 7-10 7-11 7-12 1; C4 = $1,000.00; Z4 = $1,000.00 10-year, 10% coupon = 6.75%; 10year zero = 9.75%; 5-year zero = 4.76%; 30-year zero = 32.19%; $100 perpetuity = 14.29% 15.03% a.YTM at $829 ≈ 15% a.YTM = 9.69% b CY = 8.875%; CGY = 0.816% a YTM = 10.37%; YTC = 10.15%; YTC b 10.91% c 0.54% (based on YTM); -0.76% (based on YTC) a.YTM = 8%; 7-13 7-14 7-15 7-16 7-17 7-18 7-19 7-20 8-1 8-2 8-3 8-4 8-5 8-6 8-7 8-8 8-9 8-10 8-11 8-12 YTC = 6.1% VB = $974.42; YTM = 8.64% 10.78% a.5 years b YTC = 6.47% $987.87 $1,067.95 8.88% a.ABS = 6.3%; F = 8% a.8.35% b 8.13% = 11.40%; = 26.69%; CV = 2.34 bp = 1.12 r = 10.9% rM = 11%; r = 12.2% a.b = b r = 13% a rˆ Y = 14% b X = 12.20% bp = 0.7625; rp = 12.1% b = 1.33 4.5% 4.2% r = 17.05% rM – rRF = rˆ 8-13 8-14 8-15 8-16 8-17 8-18 8-19 8-20 8-21 4.375% a.ri = 15.5% b(1) rM = 15%; ri = 16.5% c(1) ri = 18.1% bN = 1.16 7.2% rp = 11.75% 1.7275 a.$0.5 million d(2) 15% a.CVX = 3.5; CVY = 2.0 c.rX = 10.5%; rY = 12% d Stock Y e.rp = 10.875% a.rA = 11.30% c.A = 20.8%; p = 20.1% a.ri = 6% + (5%)bi b 15% c Indifference rate = 16% 9-1 D1 = $1.6050; D3 = $1.8376; D5 = $2.0259 9-2 Pˆ = $6.25 9-3 Pˆ = $21.20; rs = 11.30% 9-4 b $37.80 c.$34.09 9-5 $60 9-6 rp = 8.33% 9-7 a.13.33% b 10% Preface c.8% d 5.71% 9-8 a.$125 b $83.33 9-9 a.10% b 9-10 9-11 9-12 9-13 10.38% $23.75 $13.11 a(1) $9.50 a(2) $13.33 a(3) $21.00 a(4) $44.00 b(1) Undefin ed b(2) $48.00, which is nonsens e a.rC = 8.6%; rD = 5% b No; Pˆ = $32.61 Pˆ = $27.32 C 9-14 Preface 9-15 a.P0 = $32.14 b P0 = $37.50 c.P0 = $50.00 d P0 = $78.28 9-16 P0 = $19.89 9-17 a.$713.33 million b $527.89 million c.$42.79 9-18 6.25% 9-19 a.$2.10; $2.205; $2.31525 b PV = $5.29 c.$24.72 d $30.00 e.$30.00 9-20 a.P0 = $54.11; D1/P0 = 3.55%; CGY = 6.45% 9-21 a $24,112,308 b $321,000,000 c $228,113,612 d $16.81 9-22 $35.00 9-23 a.New price = $44.26 b beta = 0.5107 9-24 a.$2.01; $2.31; $2.66; $3.06; $3.52 b P0 = $39.43 c D1/P0 2006 = 5.10%; CGY2006 = 6.9%; D1/P0 2011 = 7.00%; CGY2011 = 5% 10-1 rd(1 – T) = 7.80% 10-2 rp = 8% 10-3 rs = 13% 10-4 rs = 15%; re = 16.11% 10-5 Projects A through E should be accepted 10-6 a.rs = 16.3% b rs = 15.4% c.rs = 16% d rs AVG = 15.9% 10-7 a.rs = 14.83% b F = 10% c.re = 15.81% 10-8 rs = 16.51%; WACC = 12.79% 10-9 WACC = 12.72% 10-10 WACC = 11.4% 10-11 wd = 20% 10-12 a.rs = 14.40% b WACC = 10.62% c.Project A 10-13 re = 17.26% 10-14 11.94% 10-15 a.g = 9.10% b Payout = 50.39% 10-16 a.g = 8% b D1 = $2.81 c.rs = 15.81% 10-17 a.g = 3% b EPS1 = $5.562 10-18 a.rd = 7%; rp = 10.20%; rs = 15.72% b WACC = 13.86% c.Projects and will be accepted 10-19 a Projects A, C, E, F, and H should be accepted b Projects A, F, and H should be accepted; $12 million c Projects A, C, F, and H should be accepted; $15 million xi 10-20 a.rd(1 – T) = 5.4%; rs = 14.6% b WACC = 10.92% 11-1 NPV = $7,486.6 11-2 IRR = 16% 11-3 MIRR = 13.89% 11-4 4.34 years 11-5 DPP = 6.51 years 11-6 a.5%: NPVA = $3.52; NPVB = $2.87 10%: NPVA = $0.58; NPVB = $1.04 15%: NPVA = $1.91; xii NPVB = -$0.55 b IRRA = 11.10%; IRRB = 13.18% c 5%: Choose A; 10%: Choose B; 15%: Do not choose either one 11-7 a NPVA = $866.16; IRRA = 19.86%; MIRRA = 17.12%; PaybackA = yrs; Discounted Payback = 4.17 yrs; NPVB = $1,225.25; IRRB = 16.80%; MIRRB = 15.51%; PaybackB = 3.21 yrs; Discounted Payback = 4.58 yrs 11-8 a Without 11-9 mitigation: NPV = $12.10 million; With mitigation: NPV = $5.70 million a Without mitigation: NPV = $15.95 million; With mitigation: NPV = -$11.25 million 11-10 Project A; NPVA = $30.16 11-11 NPVS = $448.86; NPVL = $607.20; Accept Project L 11-12 IRRL = 11.74% 11-13 MIRRX = 13.59% 11-14 a.HCC; PV of costs = -$805,009.87 c.HCC; PV of costs = -$767,607.75 LCC; PV of costs = -$686,627.14 11-15 a IRRA = 20%; IRRB = 16.7%; Crossover rate ≈ 16% 11-16 a NPVA = $14,486,808; NPVB = $11,156,893; IRRA = 15.03%; IRRB = 22.26% b Crossover rate ≈ 12% 11-17 a.NPVA = $200.41; NPVB = $145.93 b IRRA = 18.1%; IRRB = 24.0% c MIRRA = 15.10%; MIRRB = 17.03% f MIRRA = 18.05%; MIRRB = 20.48% 11-18 a No; PVOld = $89,910.08; PVNew = -$94,611.45 b $2,470.80 c.22.94% 11-19 b NPV10% = $99,174; NPV20% = $500,000 d 9.54%; 22.87% Preface 11-20 $4,600,0 00 12-4 b b $52,440; $60,600; $40,200 c.$48,760 d NPV = -$19,549; Do not purchase 12-7 b $126,000 c.$42,518; $47,579; $34,926 d $50,702 e.NPV = $10,841; Purchase 12-8 a Accelera ted method; $12,781 64 12-5 E(NPV) = $3,000,0 00; NPV = $23.622 million; CV = 7.874 12-6 a.$178,00 Expected CFA = $6,750; Expected CFB = $7,650; CVA = 0.0703 b NPVA = $10,036; NPVB = $11,624 12-9 NPV5 = $2,211; NPV4 = -$2,081; NPV8 = $13,329 $10,239 20 11-21 MIRR = 10.93% 11-22 $250.01 12-1 a $12,000, 000 12-2 a $2,600,0 00 12-3 Preface 12-10 a.NPV = $37,035.13 b +20%: $77,975.63; -20%: NPV = -$3,905.37 c E(NPV) = $34,800.21; NPV = $35,967.84; CV = 1.03 13-1 a.E(NPV) = $446,998.50 b E(NPV) = $2,806,803.16 c $3,253,801.66 13-2 a.Project B; NPVB = $2,679.46 b Project A; NPVA = $3,773.65 c.Project A; EAAA = $1,190.48 13-3 NPV190-3 = $20,070; NPV360-6 = $22,256 13-4 A; EAAA = $1,407.85 13-5 Projects A, B, C, and D; Optimal capital budget = $3,900000 13-6 NPVA = $9.93 million 13-7 Machine B; Extended NPVB = $3.67 million 13-8 EAAY = $7,433.12 13-9 Wait; NPV = $2,212,964 13-10 No, NPV3 = $1,307.29 13-11 a Accept A, B, C, D, and E; Capital budget = $5,250,000 b Accept A, B, D, and E; Capital budget = $4,000,000 c Accept B, C, D, E, F, and G; Capital budget = $6,000,000 13-12 a.NPV = $4.6795 million b No, NPV = $3.2083 million c.0 13-13 a.NPV = $2,113,481.31 b NPV = $1,973,037.39 xiii c E(NPV) = $70,221 96 d E(NPV) = $832,94 7.27 e $1,116,0 71.43 14-1 QBE = 500,000 14-2 30% debt and 70% equity 14-3 a E(EPSC) = $5.10 14-4 bU = 1.0435 14-5 a.ROELL = 14.6%; ROEHL = 16.8% b ROELL = 16.5% xiv 14-6 a(1) $60,000 b QBE = 14,000 14-7 No leverage: ROE = 10.5%; = 5.4%; CV = 0.51; 60% leverage: ROE = 13.7%; = 13.5%; CV = 0.99 14-8 rs = 17% 14-9 a.P0 = $25 b P0 = $25.81 14-10 a FCA = $80,000; VA = $4.80/unit; PA = $8.00/unit 14-11 a.10.96% b 1.25 c.1.086957 d 14.13% e.10.76% 14-12 a EPSOld = $2.04; New: EPSD = $4.74; EPSS = $3.27 b 339,750 units c QNew, Debt = 272,250 units 14-13 Debt used: E(EPS) = $5.78; EPS = $1.05; E(TIE) = 3.49 Stock used: E(EPS) = $5.51; EPS = $0.85; E(TIE) = 6.00 15-1 15-2 15-3 15-4 15-5 15-6 Payout = 55% P0 = $60 P0 = $40 D0 = $3.44 $3,250,000 Payout = 31.39% 15-7 a.$1.44 b 3% c.$1.20 d 33⅓ % 15-8 a.12% b 18% c.6%; 18% d 6% e.28,800 new shares; $0.13 per share 15-9 a(1) $3,960,000 a(2) $4,800,000 a(3) $9,360,000 a(4) Regular = $3,960,000; Extra = $5,400,000 c.15% d 15% 16-1 103.41 days; 86.99 days; $400,000; $32,000 16-2 73 days; 30 days; $1,178,082 16-3 $1,205,479; 20.5%; 22.4%; 10.47%; bank debt 16-4 a.83 days b $356,250 c.4.87 16-5 a.DSO = 28 days b A/R = $70,000 16-6 a.32 days b $288,000 c.$45,000 d(1) 30 d(2) $378,000 16-7 a.57.33 days b(1) 2 b(2) 12% c(1) 46.5 days c(2) 2.1262 c(3) 12.76% 16-8 a ROET = 11.75%; ROEM = 10.80%; ROER = 9.16% Preface 16-9 b $420,00 c $35,000 16-10 a.Oct loan = $22,800 17-1 AFN = $410,00 17-2 AFN = $610,00 17-3 AFN = $200,00 17-4 a $133.50 million b 39.06% 17-5 a $5,555,5 55,556 b 30.6% c $13,600, 000 Preface 17-6 $67 million; 5.01 17-7 $156 million 17-8 a.$480,000 b $18,750 17-9 ∆S = $68,965.52 17-10 $34.338 million; 34.97 ≈ 35 days 17-11 $19.10625 million; 6.0451 17-12 a $2,500,000,00 b 24% c $24,000,000 17-13 a.AFN = $128,783 b 3.45% 17-14 a.33% b AFN = $2,549 c.ROE = 13.06% 18-1 a.$5.00 b $2.00 18-2 $27.00; $37.00 18-3 a, b, and c 18-4 $1.82 18-5 rd = 5.95%; $91,236 18-6 b Futures = + $4,180,346; Bond = -$2,203,701; Net = $1,976,645 18-7 a.$3.06; $4.29 b 16.67%, 61.46%; -100% c.-16.67%; -100%; 63.40% d No; $30.00 and $27.00 e.Yes; $37.50 and $37.50 19-1 0.6667 pound per dollar 19-2 27.2436 yen per shekel 19-3 yen = $0.00907 19-4 euro = $0.68966 or $1 = 1.45 euros Pou Can Euros Yen Pes nds Dollars os $1,747 $820 $1,206 $8 $93 .10 60 90 97 10 19-7 6.49351 krones 19-8 15 kronas per pound 19-10 rNOM-U.S = 4.6% 19-11 117 pesos 19-12 b $1.6488 19-13 a.$2,772,003 b $2,777,585 c.$3,333,333 19-14 +$250,000 19-15 b $19,865 19-16 $468,837,209 19-17 a.$52.63; 20% b 1.5785 SF per U.S $ c.41.54 Swiss francs; 16.92% 20-1 20-2 20-3 20-4 20-5 20-6 20-8 19-5 Dollars per 1,000 Units of: 55.6%; 50% $196.36 CR = 25 shares a.D/AJ-H = 50%; D/AM-E = 67% a PV cost of leasing = $954,639; Lease equipment a EV = -$3; EV = $0; EV = $4; EV = $49 d 9%; $90 a PV cost of owning = $185,112; PV cost of leasing = xv 20-9 $187,5 34; Purcha se loom b Percen t owners hip: Origin al = 80%; Plan = 53%; Plans and = 57% c 21-1 P0 = $37.04 21-2 P0 = $43.48 21-3 $37.04 to $43.48 21-4 a.16.8% b V = $14.93 million 21-5 NPV = $6,747.71; Do not purchase 21-6 a.14% b TV = $1,143.4; V = $877.2 EPS0 = $0.48; EPS1 = $0.60; EPS2 = $0.64; EPS3 = $0.86 d D/A0 = 73%; D/A1 = 13%; D/A2 = 13%; D/A3 = 48% xvi Preface Chapter 1: An Overview of Financial Management Answers and Solutions 17 ... WACC = 12 .72% 10 -10 WACC = 11 .4% 10 -11 wd = 20% 10 -12 a.rs = 14 .40% b WACC = 10 .62% c.Project A 10 -13 re = 17 .26% 10 -14 11 .94% 10 -15 a.g = 9 .10 % b Payout = 50.39% 10 -16 a.g = 8% b D1 = $2. 81 c.rs... With mitigation: NPV = - $11 .25 million 11 -10 Project A; NPVA = $30 .16 11 -11 NPVS = $448.86; NPVL = $607.20; Accept Project L 11 -12 IRRL = 11 .74% 11 -13 MIRRX = 13 .59% 11 -14 a.HCC; PV of costs =... $1, 747 $820 $1, 206 $8 $93 .10 60 90 97 10 19 -7 6.493 51 krones 19 -8 15 kronas per pound 19 -10 rNOM-U.S = 4.6% 19 -11 11 7 pesos 19 -12 b $1. 6488 19 -13 a.$2,772,003 b $2,777,585 c.$3,333,333 19 -14
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