Problem Set #2

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Apr 3, 2024

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Fin 317 Problem Set #2 Time Value of Money Problems (Ch. 5) 1. Consider a person, Sonali, who retires at age 61. She wants to spend $100,000 each year and not run out of savings until she is 100 years old. To be concrete, on December 31, 2060, Sonali will take $100,000 out of her savings account. She will continue to take $100,000 on each December 31 st until December 31, 2099. She wants the account to have exactly $100,000 on December 31, 2099. How much money does Sonali need to have in her account on Dec 31, 2060 if she can earn 8.46% compounded quarterly? 2. Suppose you borrow $40,000 today. The interest rate is 7.5% per year compounded annually, and it requires 4 equal end-of-year payments. Set up an amortization schedule that shows the annual payments, interest payments, principal repayments, and beginning and ending loan balances. 3. You borrowed $30,000 at 18% APR to buy a car, and you have to make equal monthly payments for 24 months, starting next month. What is the fixed monthly payment you will have to make? Write out the amortization table for this loan for the first three months of the loan.

Financial Statements Problems (Ch.3) 4. Byron Books Inc. recently reported $3 million of net income. Its EBIT was $6.9 million, and its tax rate was 40%. What was its interest expense? [Hint: Write out the headings for an income statement, and then fill in the known values. Then divide $3 million of net income by (1 - T) = 0.6 to find the pretax income. The difference between EBIT and taxable income must be interest expense.] 5. In its most recent financial statements, Nessler Inc. reported $80 million of net income and $960 million of retained earnings. The previous retained earnings were $893 million. How much in dividends were paid to shareholders during the year? Assume that all dividends declared were actually paid.

6. Over the years, Masterson Corporation’s stockholders have provided $34,000,000 of capital when they purchased new issues of stock and allowed management to retain some of the firm’s earnings. The firm now has 2,000,000 shares of common stock outstanding, and the shares sell at a price of $28 per share. How much value has Masterson’s management added to stockholder wealth over the years, that is, what is Masterson’s MVA? 7. Susan and Stan Britton are a married couple who file a joint income tax return, where the tax rates are based on the tax tables presented in the chapter. Assume that their taxable income this year was $375,000. What is their federal tax liability? What is their marginal tax rate? What is their average tax rate?

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8. Arlington Corporation’s financial statements (dollars and shares are in millions) are provided here. a. What was net operating working capital for 2020 and 2021? Assume that all cash is excess cash; i.e., this cash is not needed for operating purposes.

b. What was Arlington’s 2021 free cash flow? c. Construct Arlington’s 2021 statement of stockholder equity 9. EZ Toy, Inc., lists fixed assets of $25 million on its balance sheet. The firm’s fixed assets were recently appraised at $32 million. EZ Toy, Inc.’s balance sheet also lists currents assets at $10 million. Current assets were appraised at $11 million. Current liabilities’ book and market values stand at $6 million and firm’s long-term debt is $15 million. Construct two balance sheets for EZ Toy, Inc. - one with the book values and the other with market values.

10. Suppose you are considering a stock investment in one of two firms (AllDebt, Inc. and AllEquity, Inc.), both of which operate in the same industry and have identical operating incomes of $5 million. AllDebt, Inc. finances its $12 million in assets with $11 million in debt (on which it pays 10% interest) and $1 million in equity. AllEquity, Inc. finances its $12 million in assets with no debt and $12 million in equity. Both firms pay 21% tax on their taxable income. Calculate the income that each firm has available to pay its debt and stockholders (the firms’ asset funders) and the resulting returns to these asset funders for the two firms (denominator for return calculation should be $12 million). Financial Ratios (Ch. 4) 11. A firm has 6,300,117 shares outstanding. The price per share is $22.15. What is the firm’s (equity) market cap?

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12. A firm has a price per share of $165.25. The (equity) market cap of the firm is $781.6 billion. How many shares are outstanding? 13. Kaye’s Kitchenware has a market/book ratio equal to 1. Its stock price is $12 per share and it has 4.8 million shares outstanding. The firm’s total capital is $110 million and it finances with only debt and common equity. What is its debt-to-capital ratio? 14. A firm has a profit margin of 3% and has debt = 90% of equity. Its sales are $150 million and it has total assets of $60 million. What is its ROE?

15. Pacific Packaging’s ROE last year was only 5%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest charges of $561,000. The firm has no plans to use preferred stock, and total assets equal total invested capital. Management projects an EBIT of $1,870,000 on sales of $17,000,000, and it expects to have a total assets turnover ratio of 2.1. Under these conditions, the tax rate will be 25%. If the changes are made, what will be the company’s return on equity? 16. Precious Metal Mining has $17 million in sales, its ROE is 17%, and its total assets turnover is 3.2x. Common equity on the firm’s balance sheet is 50% of its total assets. What is its net income?

17. The Stewart Company has $2,392,500 in current assets and $1,076,625 in current liabilities. Its initial inventory level is $526,350, and it will raise funds as additional notes payable and use them to increase inventory. How much can its short-term debt (notes payable) increase without pushing its current ratio below 2.0? 18. Ingraham Inc. currently has $205,000 in accounts receivable, and its days sales outstanding (DSO) is 71 days. It wants to reduce its DSO to 20 days by pressuring more of its customers to pay their bills on time. If this policy is adopted, the company’s average sales will fall by 15%What will be the level of accounts receivable following the change? Assume a 365-day year.

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