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Dharma Supply

1. Dharma Supply has earnings before interest and taxes​ (EBIT) of $581000 interest expenses of

​$305000 and faces a corporate tax rate of 35 percent.

a.  What is Dharma​ Supply’s net​ income?

b.  What would​ Dharma’s net income be if it​ didn’t have any debt​ (and consequently no interest​ expense)?

c.  What are the​ firm’s interest tax​ savings?

a.  Dharma​ Supply’s net income is

​$ 

b.  If it​ didn’t have any​ debt, Dharma​ Supply’s net income is

​$  

c.  The​ firm’s interest tax savings are

​$ 

​2. (Common stock​ valuation) Gilliland​ Motor, Inc., paid a $3.58 dividend last year. If​ Gilliland’s return on equity is 31 percent, and its retention rate is 36 percent, what is the value of the common stock if the investors require a rate of return of 21 percent?

The value of the common stock is

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​3.Moody’s to Put Bank Hybrids on Review for Downgrades

​Source: McDonald, Sarah and John​ Glover, “Moody’s to Put Bank Hybrids on Review for​ Downgrades,” Bloomberg.com,

http://www.bloomberg.com/apps/news?pid=20601009&sid=avUDyRtb9qdI#​,

posted​ 11/17/2009.

The financial crisis and subsequent government intervention in the banking industry has created some uncertainty for bondholders. In many cases the​ government’s efforts to prop up troubled financial institutions has actually been harmful to bondholders. For​ example, in some countries financial institution bonds have skipped interest payments without defaulting due to government mandates.

Hybrid securities have been particularly problematic since they have characteristics of both debt and equity. Based on the way that some countries have treated these securities​ Moody’s has been forced to reevaluate some of the underlying assumptions used when the bonds were rated. The new model will likely result in a number of downgrades for many hybrids since the level of risk of these securities is higher than previously thought.  

Thinking Critically Questions

1. All of the following are bond rating agencies​ except;

A.

NYSE Bond Raters

B.

Standard and Poors

C.

​Moody’s

D.

Fitches

2. Companies with higher bond ratings can borrow money at a               rate.

A.

higher

B.

Fed funds

C.

prime

D.

lower

3. Unrated debt typically carries a higher interest rate because investors assume it must be                         .

A.

higher risk

B.

lower risk

C.

a better investment

D.

risk free

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4 ​(Defining capital structure​ weights)  In August of 2009 the capital structure of the Emerson Electric Corporation​ (EMR) (measured in book and market​ values) appeared as​ follows:

​ (Thousands of​ dollars) Book Values Market Values  
​ Short-term debt    ​$1217000    ​$1217000
​ Long-term debt   11892000   11892000
Common equity  9123000 26092000
Total capital  $ 22232000  $ 39201000

What weights should Emerson use when computing the​ firm’s weighted average cost of​ capital?

The appropriate weight of​ debt, w Subscript d​, is          ​%.

​(Round to one decimal​ place.)

The appropriate weight of common​ equity, w Subscript cs​, is           ​%.

​(Round to one decimal​ place.)

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​5 (Cost of preferred​ stock)  Your firm is planning to issue preferred stock. The stock is expected to sell for

​$98.76 a share and will have a $100 par value on which the firm will pay a

13.5 percent dividend. What is the cost of capital to the firm for the preferred​ stock?

The​ firm’s cost of capital for the preferred stock is             ​%.

​(Round to two decimal​ places.)

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 6 ​(Discretionary financing​ needs)  In the spring of 2013 the Caswell Publishing Company established a custom publishing business for its business clients. These clients consisted principally of​ small- to​ medium-size companies in Round​ Rock, Texas. ​ However, the​ company’s plans were disrupted when they landed a large printing contract from Dell Computers Corp.​ (DELL) that they expected would run for several years. ​ Specifically, the new contract would increase firm revenues by 100 percent. ​ Consequently, Caswell’s management knew they would need to make some significant changes in firm​ capacity, and quickly. The following balance sheet for 2013 and pro forma balance sheet for 2014 reflect the​ firm’s estimates of the financial impact of the 100 percent revenue​ growth:  

.

a.  How much new discretionary financing will Caswell require based on the above​ estimates?

b.  Given the nature of the new contract and the specific needs for financing that the firm​ expects, what recommendations might you offer to the​ firm’s CFO as to specific sources of financing the firm should seek to fulfill its​ DFN?

a. The discretionary financing needs are  $ 

b.  Given the nature of the new contract and the specific needs for financing that the firm​ expects, what recommendations might you offer to the​ firm’s chief financial officer as to specific sources of financing the firm should seek to fulfill its​ DFN?  ​(Select all the choices that apply​ below.)

A.

Common stock.

B.

Retained earnings.

C.

Notes payable.

D.

Sale of fixed assets.

E.

​Long-term debt.

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Pioneer’s preferred stock is selling for $77 in the market and pays a $4.60 annual dividend.

a.  If the​ market’s required yield is 7 percent, what is the value of the stock for that​ investor?

b.  Should the investor acquire the​ stock?

a.  The value of the stock for that investor is

​$                         per share.  ​(Round to the nearest​ cent.)

b.  Should the investor acquire the​ stock?  ​(Select from the​ drop-down menus.)

The investor

should not

should

acquire the stock because it is currently

overpriced

underpriced

in the market.

7(Cost of​ debt)  Belton Distribution Company is issuing a

​$1000 par value bond that pays 7.0percent annual interest and matures in 15 years that is paid semiannually. Investors are willing to pay $958for the bond. The company is in the

18 percent marginal tax bracket. What is the​ firm’s after-tax cost of debt on the​ bond?

The​ firm’s after-tax cost of debt on the bond is

Measuring growth)  If​ Pepperdine, Inc.’s return on equity is 19 percent and the management plans to retain 59 percent of earnings for investment​ purposes, what will be the​ firm’s growth​ rate?

The​ firm’s growth rate will be

8(Common stock valuation​)

Header​ Motor, Inc., paid a $2.85 dividend last year. At a constant growth rate of 6

percent, what is the value of the common stock if the investors require a 11 percent rate of​ return?

The value of the common stock is

9)(Measuring growth)  If​ Pepperdine, Inc.’s return on equity is 19 percent and the management plans to retain 59 percent of earnings for investment​ purposes, what will be the​ firm’s growth​ rate?

The​ firm’s growth rate will be

10) Zapatera Enterprises is evaluating its financing requirements for the coming year. The firm has only been in business for one​ year, but its CFO predicts that the​ firm’s operating​ expenses, current​ assets, net fixed​ assets, and current liabilities will remain at their current proportion of sales.  

Last year Zapatera had $11.29 million in sales with net income of $1.19 million. The firm anticipates that next​ year’s sales will reach $14.92 million with net income rising to $2.07

million. Given its present high rate of​ growth, the firm retains all of its earnings to help defray the cost of new investments.

The​ firm’s balance sheet for the year just ended is as​ follows:  

.

Estimate​ Zapatera’s total financing requirements​ (total assets) and its net funding requirements​ (discretionary financing​ needed) for 2014.  

Use the percentage of sales given in Zapatera​ Enterprises’ balance sheet for 2013.

​Hint: Make sure to round all intermediate calculations to at least five decimal places.

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The 2014 retained earnings are?

12) Thompson Trucking Company

Current Assets 10.48

Net Fixed Assets 14.04

Total 24.52

Accounts Payable 5.99

Notes Payable 0.00

Bonds Payable 10.69

Common Equity 7.84

Total 24.52

.

TTC had sales for the year ended​ 12/31/13 of $49.65 million. The firm follows a policy of paying all net earnings out to its common stockholders in cash dividends. ​ Thus, TTC generates no funds from its earnings that can be used to expand its operations. ​ (Assume that depreciation expense is just equal to the cost of replacing​ worn-out assets.).​ Hint: Make sure to round all intermediate calculations to at least five decimal places.

a. If TTC anticipates sales of $80.02 million during the coming​ year, develop a pro forma balance sheet for the firm for​ 12/31/14. Assume that current assets vary as a percent of​ sales, net fixed assets remain​ unchanged, and accounts payable vary as a percent of sales. Use notes payable as a balancing entry.

b.  How much​ “new” financing will TTC need next​ year?

c.  What limitation does the​ percent-of-sales forecast method suffer​ from? Discuss briefly.

a.  If TTC anticipates sales of $80.02million during the coming​ year, develop a pro forma balance sheet for the firm for​ 12/31/14. Assume that current assets vary as a percent of​ sales, net fixed assets remain​ unchanged, and accounts payable vary as a percent of sales. Use notes payable as a balancing entry.  ​(Round to the nearest​ dollar.)

Thompson Trucking Company  
Pro Forma Balance Sheet as of 12/31/14
Current assets $  
Net fixed assets    
Total assets $  
Accounts payable    
Notes payable  
Bonds payable  
Common equity  
Total liabilities and common equity $  

b. How much new financing will TTC need next year

c. What limitations does the percent of sales forecast method come from

 
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