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BUSI 2505
Ex 2: Lease financing
An oil company is trying to decide whether to
lease or buy a new drilling system. The
system costs $9.4 million and qualifies for a
25 percent CCA rate. The equipment will have
a $975,000 salvage value in 5 years. Tax rate
is 36 percent and the firm can borrow at 9
percent. A leasing Company has offered to
lease the drilling equipment for payments of
$2.15 million per year. Lease payments are
made at the beginning of the year.
Ex 3: Ex-dividend
Shares of Markely, Inc. stock are currently
priced at $43.78. The stock goes ex-dividend
tomorrow in preparation for a $.60 quarterly
dividend. The average shareholder faces a
marginal tax rate of 30% and the company
has a cost of equity of 12% and a 35% tax
rate. At what price should the stock open
tomorrow, all else constant?
Answer: $43.36
Ex 4: Capital Restructure
Kate's Dry Goods currently has 15,000
shares of stock outstanding. Kate would
like to reduce the outstanding shares by
one-third by issuing debt and repurchasing
stock. The firm has an EBIT of $8,400 and a
cost of debt of 7%. How much debt does
Kate have to issue to accomplish her goal if
she wishes EBIT to remain constant?
Answer: $40,000
Ex 5: Goodwill
Suppose Perot Mfg. purchases Clinton
Enterprises for $120 million in cash. For
purposes of the acquisition, Clinton's fixed
assets were appraised at $95 million. Further,
assume Clinton Enterprises has working capital
of $15 million and no long-term debt. If Perot
Mfg. uses the purchase accounting method to
account for the acquisition, goodwill of
______________ is created.
Answer: $10 million
Ex 6: Merger payment
Firms A and B are competitors. Both have
similar assets and business risks and are allequity firms. Firm A has aftertax cash flow of
$20,000 per year forever and firm B has
aftertax cash flow of $150,000 per year forever.
If the two firms merge, the perpetual aftertax
cash flow will be $179,000. If the appropriate
discount rate is 15% what is the MOST B will
pay for A?
Answer: $193,333
Ex 7: Cash dividend
Alex, Inc. is financed 100% with equity. The firm
has 100,000 shares of stock outstanding with a
market price of $5 per share. Total earnings for
the most recent year are $50,000. The firm has
cash of $25,000 in excess of what is necessary to
fund its positive NPV projects. The firm is
considering using the cash to pay an extra
dividend of $25,000 or, alternatively, to
repurchase $25,000 of stock. The firm has other
assets worth $475,000 (market value). Assume
there are no transaction costs, taxes, or other
market imperfections.
Ex 8: Bid price
You will bid to supply three jets per year for
each of the next three years to the Navy. To get
set up, you will need $10 million in equipment,
which belongs in a 30% CCA class and will have
no salvage value. Total fixed costs per year are
$5 million, and variable costs are $7 million per
jet. Assuming a tax rate of 30% and a required
return of 10%, what is the minimum price at
which you should offer to supply the jets?
Answer: $11 million
Ex 9: Cash break-even
What is the cash break-even point?
Price = $100 per unit; variable cost
= $24 per unit, fixed cost = $40,000
per year; depreciation = $10,000 per
year. Assume a discount rate of
10%, project initial outlay of
$100,000, project life of 10 years,
and ignore taxes.
Answer: 527 units
Ex 10: DOL
Suppose that a project has a DOL =
0. 75. If the quantity being produced
increases from 96 to 100, what is the
expected percentage change in
operating cash flow?
Answer: 3.1%
Ex 12: EPS
A firm has 30,000 shares of stock
outstanding, $450,000 in debt at a
9% rate, an EBIT of $112,000, and a
tax rate of 0%. What is the EPS?
Answer: $2.38
Ex 14: WACC
The Brassy Co. has expected EBIT =
$910, an unlevered cost of capital of
12%, and debt with a face and
market value of $2,000 paying an
8.5% annual coupon. If the tax rate
is 34%, what is the WACC of Brassy
Co. ?
Answer: 10.56%
Ex 18: NAL
Your company is considering the purchase
of a fleet of cars for $195,000. It can
borrow at 8.5%. The cars can be leased for
$55,000 per year and will be worthless at
the end of four years. The corporate tax
rate is 34% and the cars belong in CCA
class 10 (a 30% class). If you do not
expect to pay taxes for the next four years,
what is the net advantage to leasing?
Answer: $-471
Ex 27: WACC/NPV/flotation
costs
Hartley Inc. needs to purchase equipment
for its 2,000 drive-ins nationwide. The
total cost of the equipment is $2 million.
Aftertax cash inflows from the project will
be $210,000 annually in perpetuity.
Hartley has a market value debt-to-equity
ratio of 40%. The firms cost of equity is
13%, its pretax cost of debt is 8%, and the
flotation costs of debt and equity are 2%
and 8%, respectively. The tax rate is 34%.
Information content of
dividend
For the past four years Doodle Dee has paid quarterly
dividends of $.25 a share. The company just
announced that dividends are being increased by 8%.
As a result, the market price of Doodle Dee stock
increased. The increase in the share price is generally
attributed to the:
A)Increase in the current dividend amount.
B)Change in the dividend policy.
C)Information content of the dividend.
D)Residual effect of the dividend.
E)Reinvestment of the dividend amount.
Operating leases
Which of the following describe(s) an operating lease?
Acquisition by stock
Which one of the following is a characteristic of an
acquisition by stock?
A)Shareholders must vote and approve an acquisition.
B)The target firm's management can be bypassed by
the use of a tender offer.
C)Complete absorption of one firm occurs in an acquisition.
D)Minority shareholders are ignored in the acquisition
process.
E)The acquisition cost is normally lower than that of a
merger.
Synergy
Which of the following refer to
synergistic gains due to tax benefits
in an acquisition?
I. Complementary resources
Merger gain
The incremental gain from a merger is defined as the:
A) Stand-alone value of the target firm minus the
synergistic effects.
B) Value of the combined firm minus the sum of
the stand-alone values of each firm.
C) Stand-alone value of the acquired firm minus the
acquisition costs.
D) The sum of the stand-alone values of both firms
minus the acquisition costs.
E) The value of the purchasing firm plus the
synergistic effects minus the acquisition costs.
Stock splits
A stock has a normal trading range of $22 to $30. The
stock is currently selling at $41 a share. It would be
common for a firm in this situation to:
A)Repurchase outstanding shares by issuing debt
securities.
B)Do a reverse stock split to lower the market price of the
stock
C)Issue a one-time special dividend.
D)Increase the number of outstanding shares via a
stock split.
E)Issue a liquidating dividend to lower the value of the
firm.
Capital Lease
Which of the following characteristics would cause a lease
to be declared a capital lease for accounting purposes?
A) The present value of the lease payments equals 60% of
the fair market value at the start of the lease.
B) The lease does not transfer ownership of the property to
the lessee by the end of the lease term.
C) The lessee can purchase the asset at a price below
fair market value when the lease expires.
D) The lease term is at least 50% of the estimated
economic life of the asset.
E) The lessor maintains the insurance and maintenance on
the leased asset.
Operating Lease
An operating lease usually:
A) Normally has a payment structure
such that the payments are sufficient
to allow the lessor to recover the cost
of the asset.
B) Has a lease period of at least five
years.
C) Cannot be canceled.
D) Requires the lessor to
maintain the asset.