Economic subjects | Finance » Problems, Second Group, Moeller, Corporate Finance

Source: http://www.doksinet Problems: Second Group Moeller- Corporate Finance 1. You have been hired as the CEO of Nortex Sports Corp. This company manufactures and designs in-line skates, skis and snow boards. Your assistant has prepared various reports summarizing the financial position of the company. According to the balance sheet, total shareholders equity is $2.5 million and total long-term debt is $3.0 million The reports also states that there are 15 million shares outstanding with a price of $2 per share and the market value of long-term debt is $2.5 million a. In terms of managing the company, what do you focus on debt or equity, book or market value? b. What is your and your management teams management goal? Give examples of how, as CEO, you would achieve this goal. c. You decide to purchase a company condominium in Telluride Colorado located on the ski slopes. Over the next two years, you use a newly purchased company plane to commute to this retreat on the weekends. You

also use the condominium and plane for twice yearly board of directors and management team meetings. Financial statements reveal that Nortex Sports Corp has severely declining operating cash flows and the stock price has fallen to $1.50 per share i. Is this behavior consistent with your stated goals in part b? Why might a CEO engage in this type of behavior? ii. What can shareholders do about this type of behavior? 2. The current stock price of Summer Sizzled Sausage Corporation is $20 According to your information and analysis, you expect this company to pay its first dividend of $2.50 in year 2, and from year 3 on, you expect to see a steady growth in dividends. Specifically, you figure out that the dividends in year 3 will be $2.75 and will continue to grow for another 10 years at 5% per year, after which it will grow 2% per year forever. The appropriate discount rate is 14%. If you currently own this stock, ignoring transaction costs what should you do according to your

information - buy more stock at the current market price or sell your stock? Why? 3. (Note: This is a portion of the class exercise) The Cash-for-Free Corporation currently operates as a cash cow, i.e, it pays out all its earnings as dividends Last year earnings (t=0) were $240,000 and the corporation has 60,000 shares outstanding. Based on your expectation that Cash-for-Free has good investment opportunities, allowing the 1 Source: http://www.doksinet firm to earn a 12% return on retained earnings every year, you suggest the firm should reduce its dividend pay-out ratio to a new level of 80% starting at t=1. If the required rate of return on the stock is 10%, what is the net present value of the growth opportunities for Cash-for-Free? 4. Consider the following three stocks Stock A is expected to provide a dividend of $10 per share forever. Stock B is expected to pay a dividend of $5 next year, after which dividends are expected to grow forever at 4%. Finally, Stock C is expected

to pay a dividend of $5 next year after which dividend growth is expected to be 20% per year for 5 years and 0% per year thereafter. a. If the required rate of return for each stock is 10%, which stock is the most valuable? b. If the required rate of return for each stock is 7%, which stock is the most valuable? 5. Consider a firm with existing assets that generate EPS of $5 If the firm does not invest except to maintain existing assets, EPS is expected to remain constant at $5 a year. However, starting next year the firm has a chance to invest $1 per share a year in developing a newly discovered source for electricity generation. Each investment is expected to generate a permanent 20% return. However, the source will be fully developed by the fifth year. Assume the investors require a 12% rate of return a. What will the stock price be if they don’t invest in the newly discovered source of electricity? b. Calculate the PVGO if the firm would have had the same investment opportunity

for 5 years maintaining an 80% retention ratio. c. Calculate the PVGO if the firm has the investment opportunity in perpetuity maintaining an 80% retention ratio. d. Calculate the PVGO if the firm has the same investment opportunity for 5 years maintaining a 20% retention ratio. 6. You need to value a stock that you estimate will have the following quarterly dividends. Over the next year (4 quarters), the firm will not pay any dividends The firm will then start paying dividends. The first dividend will be $1 and will experience super growth of 5% per quarter for 2 years. After that period of super growth you estimate the dividend growth rate will drop to 1% per quarter for the next 4 years. Finally dividends will level off and remain constant forever. If the appropriate rate of return for this stock is 18%, what is the value of the stock today? 2 Source: http://www.doksinet 7. What is the value of a 6% annual fixed rate coupon $1,000 par bond whose yield to maturity is 8% and

matures in 5 years? 8. Your CEO is very concerned with maximizing shareholder wealth and wants you to estimate the value of the firm under several different investment choices. The current assets in place of the firm generate 5 million dollars a year in earnings, the expected return on equity is 12% and there are a million shares outstanding. The CEO is debating two different investment plans for the company. The first plan involves putting in place an acquisition strategy where the firm will use 10% of its earnings to purchase other companies each year. The finance department estimates that these mergers will have a return on investment of 15% and opportunities will be available starting at the end of this year and continue indefinitely. The second plan involves making a one-time acquisition two years from now for 5 million dollars and it will have a yearly return on investment of 15%. What is the value of the assets in place? What is the value of the firm if it adopts the first

investment plan? What is the value of the firm if it adopts the second investment plan? What course of action would you recommend to the CEO? Why? 9. XYZ plans on paying a $1 dividend on their common stock which is currently trading at $25 per share. Analysts who cover XYZ believe that their long term growth rate is 20%. XYZ also has publicly traded debt and you have estimated that their Bd is 05 The company economist has predicted that the Rf rate is 3% and the expected market risk premium is 10%. a. What is the return on equity for XYZ? b. What is the return on debt for XYZ? 10. You are given the following information about equipment that is required for your business. Assume the equipment will be replaced as it wears out The required rate of return is 15% per year. Ignore taxes Machine A Machine B $200,000.00 $300,000.00 Operating Cost per year 5,000.00 6,000.00 Life of Machine (years) 8 10 Initial Cost a. What is the equivalent annual cost of Machine A? 3 Source:

http://www.doksinet b. c. What is the equivalent annual cost of Machine B? Which machine would you buy and why? 4