Exam 4 Prep_key

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Feb 20, 2024

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The following are the balance sheet and income statement for BOOMER Corporation that we covered in Chapter 10. Use this information to answer the following questions from Chapter 11. Additional Information:  The par value of common stock is $1/share.  The market price of common stock as of 12/31/2016 is $300/share.  BOOMER Corporation paid $8,000 worth of common dividends in 2016. CH 11 – 13 Exam 4 PREP 1

11-1. Compute the following profitability ratios for BOOMER Corporation and comment on its performance relative to the industry averages. Profitability Ratio Value for BOOMER Corporation and Comments Industry Average Gross Profit Margin 33.33% LESS Pricing Power 35.00% Operating Profit Margin 10.95% MORE Profitable 9.50% Net Profit Margin (or Return on Sales) 7.55% LESS Interest and Tax Expense 5.50% Return on Assets (ROA) 9.66% Generates MORE profit per dollar of investment in assets 7.20% Return on Equity (ROE) 20.33% Earns MORE income per dollar from shareholder investments 10.50% CH 11 – 13 Exam 4 PREP 2

11-2. Compute the following liquidity ratios for BOOMER Corporation and comment on its performance relative to the industry averages. Liquidity Ratio Value for BOOMER Corporation and Comments Industry Average Current Ratio 3.02 LESS overall liquidity 3.70 Quick Ratio 1.32 LARGER amount of the most liquid resources 1.00 Cash Ratio 0.46 LOWER amount of the most liquid resources 0.50 Net Working Capital 42,400 N/A CH 11 – 13 Exam 4 PREP 3

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11-3. Compute the following solvency ratios for BOOMER Corporation and comment on its performance relative to the industry averages. Solvency Ratio Value for BOOMER Corporation and Comments Industry Average Debt-to-Assets Ratio 0.49 LESS overall financial leverage 0.67 Debt-to-Equity Ratio 0.97 LESS overall financial leverage 2.00 Financial Leverage Ratio 1.97 LESS overall financial leverage 3.00 Financial Leverage Ratio (Average) 2.10 3.00 Times Interest Earned (or Interest Coverage) Ratio 7.67 MORE easily satisfy interest payments 4.50 CH 11 – 13 Exam 4 PREP 4

11-4. Compute the following efficiency ratios for BOOMER Corporation and comment on its performance relative to the industry averages. Efficiency Ratio Value for BOOMER Corporation and Comments Industry Average Total Asset Turnover 1.28 MORE overall efficiency 1.25 Fixed Asset Turnover 1.42 LESS overall efficiency 1.60 Accounts Receivable Turnover 51.85 MORE efficient in managing A/R 32.00 Days’ Sales Outstanding (DSO) 7.04 MORE efficient in managing A/R 11.40 Inventory Turnover 16.26 MORE efficient in managing Inventory 15.00 Days’ Inventory Outstanding (DIO) 22.45 MORE efficient in managing Inventory 24.30 Accounts Payable Turnover 49.12 LESS efficient in managing A/P 26.00 Days’ Payable Outstanding (DPO) 7.43 LESS efficient in managing A/P 14.03 Cash Conversion Cycle (CCC) 22.06 LESS efficient in overall cash management 21.67 CH 11 – 13 Exam 4 PREP 5

11-5. Compute the following valuation ratios for BOOMER Corporation and comment on its performance relative to the industry averages. Valuation Ratio Value for BOOMER Corporation and Comments Industry Average Earnings Per Share (EPS) 15.85 N/A Price-to-Earnings (P/E) 18.93 HIGHER expected earnings growth or OVERVALUED 16.50 Dividends Per Share (DPS) 2.00 N/A Dividend Yield 0.67% LOWER dividend payout 1.10% Market-to-Book Value of Equity 3.43 HIGHER valuation 2.50 11-6. Compute ROE for BOOMER Corporation using the DuPont equation. Relative to the industry average for each component, comment on why the ROE for BOOMER Corporation is different than for the industry. CH 11 – 13 Exam 4 PREP 6

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12-A. Consider the following Investment: Time Cash Flow 0 -1,100,000 1 120,000 2 320,000 3 1,100,000 a. What is the payback period for this investment? b. Complete the NPV column below and use the discount rates and NPV columns to construct an NPV profile for the investment using the following discount rates. Be sure to label the axes. Discount Rate NPV 0% $440,000 5% $254,757 10% $100,000 15% ($30,418) 20% ($141,204) 25% ($236,000) 30% ($317,660) NPV Profile b. Indicate the project’s IRR on the NPV profile. CH 11 – 13 Exam 4 PREP 7

c. Refer to your result above for a 14% RRR. If you require a 14% rate of return, what decision would you make with respect to this project? Explain! 12-B. Jen and Keefe have decided to invest in a project that will pay back seven annual cash flows of $1,750,000 beginning one year from now. The initial investment required today is $10,255,000. If the firm’s RRR is 9%, what are the Payback Period, NPV, and IRR for this investment? Payback = 5.86 yrs NPV = (1,447,332.54) IRR = 4.65% 12-C. Compute the profitability index given the data provided in Practice Problem 12-B (initial investment $10,255,000, seven annual cash flows of $1,750,000 beginning one year from now, 9% RRR). 12-D. A new project in the fertilizer industry requires an initial investment of $9.767 million. The annual cash inflows expected for the next five years are given below. The discount rate is 10.5%. Find its Payback Period, NPV, and IRR. Year Cash Inflow ($ million) 1 2.940 2 3.177 3 3.289 4 2.752 5 1.974 CH 11 – 13 Exam 4 PREP 8

12-E. Compute the profitability index given the data provided in Practice Problem 12-D (initial investment $9.767M; CF1 = $2.940M, CF2 = $3.177M, CF3 = $3.289M, CF4 = $2.752M, CF5 = $1.974M; 10.5% discount rate). 12-F. Find the IRR for an investment in the computer manufacturing business with an initial outlay of $7.374 million. The cash inflows will be an annuity of $2.128 million every year for the next seven years, beginning one year from today. 13-1. You purchased an asset for $50,000. It is three-year MACRS property. You sell it after two years for $15,000. a . What is the after-tax salvage value if you have a 35% tax rate? NOTE: If the asset were sold at the end of year 2 for $11,110 (its book value), then the ATSV would be $11,110 (no gain, so no tax). If the asset were sold for a loss (e.g., $10,000), then the taxes would be negative and the ATSV would be greater than the selling price (gain = $10,000 − $11,110 = −$1,110; taxes = 0.35 × –$1,110 = −$389; ATSV = $10,000 – –$389 = $10,389) b. What is the operating cash flow for year 4 if this asset produces revenue of $36,000 in year 4 and cash expenses are $24,000? 13-2. You expect to sell 5,000 units of a NEW project for $35 each. However, you will lose sales of 2,200 units of an existing project that would have sold for $60 each. What is the incremental revenue for the new project? CH 11 – 13 Exam 4 PREP 9

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13-3. A project results in additional accounts receivable of $175,000 and additional inventory of $325,000. If the accounts payable balance increases by $150,000, what is the additional investment in net working capital (NWC)? Assuming that NWC returns to its original level at the end of the project’s six-year life, what is the effect on the project’s NPV solely due to this additional investment in NWC? Assume a required rate of return of 10%. Draw a timeline. CH 11 – 13 Exam 4 PREP 10

13-4. A project requires additional accounts receivable of $200,000 and additional inventory investment of $175,000. It results in additional accounts payable of $100,000. Net working capital will return to its normal level following the ten-year project. What is the effect on the NPV of the project solely due to this investment in net working capital, assuming a 12% required rate of return? 13-5. A new equipment investment costs $300,000 and will be depreciated to an expected salvage value of $30,000 on a straight-line basis over its five-year life. Assuming a tax rate of 30%, what is its after-tax salvage value if the equipment is actually sold after five years for: a.) $50,000? b.) $10,000? 13-6. ABC, Inc. is considering a new project requiring a $12 million initial investment in equipment having a useful life of eight years. The investment will produce $10 million in annual revenues and $7 million in annual costs. Assume a tax rate of 40% and straight-line depreciation. What is the operating cash flow per year? 13-7. PDQ is planning to purchase equipment costing $10 million, which will last six years. At that point it will have a book value of $1 million and a market value of $2.1 million. The new equipment is expected to increase annual revenues by $9 million. Annual costs, though, will go up by $5.5 million. The company uses straight-line depreciation and assume a tax rate of 35%. What are the cash flows associated with this project? CH 11 – 13 Exam 4 PREP 11