Financial Management Final Exam Part 2

Financial Management Final Exam Part 2

The Financial Management Final Exam Part 2 has 6 Problems (10 points each) 

Show your Work unless otherwise indicated

Problem 1:

• Ronald Smith Co. raised $275 million in new debt and used this to buy back stock. After the recap, Smith’s stock price is $9.50.  If the company had 80 million shares of stock outstanding before the recap, how many shares does it have outstanding after the recap?
• East Winds, Inc. has a beta = 1.30 and its tax rate is 21%. If the company is financed with 30% debt, what is its unlevered beta?

 Problem 2:

•  MPDI, Inc. has currently outstanding bonds with a 7% coupon and 5% yield to maturity. MPDI could issue new bonds at par that would provide the same YTM.  If company’s marginal tax rate is 21%, what is the company’s after-tax cost of debt?
• MPDI has just issued preferred stock for the first time. If the price is $100 per share with an annual dividend of $8.75 per share, what is the company’s cost of preferred stock?
• You have been asked to estimate the required return on common stock for MPDI. If beta = 0.9, the yield on a 10-year T-bond is 4% and the market risk premium is 7.5%, what is the estimated cost of common equity?
• If MPDI’s capital structure is 60% common equity, 10% preferred equity and 30% debt, what is the company’s WACC?

Problem 3 (Note: if you use a financial calculator for Problem 3, you do not need to show your work.)

• Frontier Resources, Inc. is planning a project with an initial cost of $90,000, expected net cash flow of $27,000 per year for 5 years, and a cost of capital of 8%. What is the project’s NPV?
• What is the same project’s IRR?
• What is the same project’s Payback Period?

 Problem 4:

• Adams & Smart, Inc. has stock that is selling for $40/share. The stock’s last dividend was D₀ = $1.25.  The dividend is expected to grow at 4% per year indefinitely. 
• What is the expected stock price one year from now?
• What is the estimated required rate of return on the stock?
• TMU, Inc. has preferred stock with an annual dividend of $12 per share. The preferred shares sell for $135.  What is the stock’s required rate of return?
• Wilbur Industries has never paid a dividend. Its current free cash flow of $875,000 is expected to grow at a constant rate of 7%.  The weighted average cost of capital is WACC=11%.  Calculate Wilbur’s estimated value of operations.

 Problem 5:

Thomas-Jenkins, Inc. (TJ) is considering two new pieces of equipment for this year’s capital budget.  The first is a computer-controlled milling machine and the second is a hydraulic lift.  The projects are independent.  The cash outlay for the milling machine is $70,000 and $88,000 for the lift.  The firm’s cost of capital is 17%.  After-tax cash flows, including depreciation, are as follows:

• Calculate the NPV for each project.
• Based on NPV, what is the correct accept/reject decision for each project?
• Calculate the IRR for each project.
• Based on IRR, what is the correct accept/reject decision for each project?
• Calculate the payback period for each project.
• If TJ has a policy of only accepting projects with a 3-year or less payback period, what would be the accept/reject decision for each project based on payback period?

Problem 6:

McCallum Industries is considering entering a new market.  To do so will require investing in a new warehouse that will cost $10 million, as well as $7 million in net operating working capital.  The company’s tax rate is 21%.

• What is the initial investment outlay?
• The company spent $250,000 on research related to the new market opportunity last year. Would this change your answer? 
• The company has an existing warehouse that it owns but is not now using. After some discussion, the CEO decides to use this warehouse rather than build a new one.  The existing warehouse could be sold for $4.5 million after taxes and commissions.  Does this change the total investment? How would this affect your answer?

Problem 7:

• Howell Manufacturing, Inc. is planning $18 million in capital expenditures next year. The company’s target capital structure is 70% debt and 30% equity.  If net income next year is $10 million, and Howell follows a residual distribution policy, what will be its dividend payout ratio?
• Jeannie Co. has 7 million common shares outstanding with a market price of $11 per share. The firm has $12 million in extra cash that it plans to use in a stock repurchase.  What is the firm’s value of operations, and how many shares will remain after the repurchase?
• What are two advantages of stock repurchases as compared to dividends?
• What are two disadvantages of stock repurchases as compared to dividends?

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