2, 3, 7, 8, & 14 ICE FIN380 SOLVED

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Quinnipiac University *

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Apr 3, 2024

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Date: Quinnipiac University - School of Business FIN 380 Intermediate Corporate Finance SOLVED Chapters II, III, VII, VIII, & XIV In-class Exercises Q1: An financial advisor for High Heat Corp. is trying to choose among three investment opportunities: AAA corporate bonds, which yield 8.5 per cent, state-issued municipal bonds, which yield five per cent, and preferred stock from Co & Co., in which HHC owns less than 20 per cent, with a dividend yield of seven per cent. The relevant corporate tax rate is 20 per cent. Which one is the most attractive investment opportunity? Returns Pre-tax After-tax AAA Corp. Bond 8.5% C  (1 - T) = 8.5%  (1 - 0.2) = 6.8% Taxable Income Municipal Bond 5% 5% Tax-exempt Preferred Stock 7% P  (1 – (0.3)  (T)) = 7%  (1 - (0.3)  (0.2) = 6.58% 70% Tax-exempt Best option for HHC is to invest in the AAA Corp Bonds that yield an after-tax return of 6.8% Q2: Use the following accounting statements to answer the following questions. Bayesian Balance Sheet Bayesian Income Statement 2022 2021 2022 2021 Cash and Equivalents $100 $85 Sales $2,00 0 $1,50 0 Accounts Receivable 275 200 Operating Costs Excluding Depreciation 1,250 1,000 Inventories 375 250 EBITDA $75 0 $500 Total Current Assets $750 $635 Depreciation & Amortization 100 75 Net Plant and Equipment 2,000 1,490 EBIT $650 $425 Total Assets $2,75 0 $2,12 5 Interest 60 45 Accounts Payable $150 $85 EBT $590 $380 Accruals 75 50 Taxes (20%) $118 152 Notes Payable 150 75 Net Income $472 $228 Total Current Liabilities $375 $210 Long-term Debt 450 290 Dividends Paid $52 $48 Common Stock 1,225 1,225 Addition to Retained Earnings $420 $180 Retained Earnings 700 400 Shares Outstanding 120 120 Total Liabilities and Equity $2,75 0 $2,12 5 Price $20.8 3 $18.3 3 a. What is Bayesian's 2022 Net Operating Cash Flow (OCF)? OCF = EBIT + D - T = $650,000 + $100,000 - $118,000 = $632,000 b. What is Bayesian's Change in Net Working Capital (ΔNWC)? Copyrighted by RBT

Date: ΔNWC = NWC 22 – NWC 21 = (CA 22 - CL 22 ) - (CA 21 - CL 21 ) = $375,000 - $425,000 = -$50,000 NWC 22 = (CA 22 - CL 22 ) = $750,000 - $375,000 = $375,000 NWC 21 = (CA 21 - CL 21 ) = $635,000 - $210,000 = $425,000 c. What is Bayesian's Net Capital Expenditure (NCS)? NCS = NFA 22 – NFA 21 + D = $2,000,000 - $1,490,000 + $100,000 = $610,000 d. What is Bayesian's Free Cash Flow or Cash Flow from Assets (FCF or CFFA)? CFFA = OCF – ΔNWC – NCS = $632,000 - (-$50,000) - $610,000 = $72,000 Q3: In 2010 Sternum Solutions sold a 20-year bond issue with a 14 per cent annual coupon rate and a nine per cent call premium. In 2017 the company called the bonds. The bonds originally were sold at their face value of $1,000. Compute the realized rate of return for investors who purchased the bonds when they were issued and who had to surrender them in exchange for the call price. Bond PV -$1,000 FV $1,000 + 9%Premium = $1,090 PMT 14% ($1,000) = $140 annual I/Y ?  14.8178 2937 % N 7 years Q4: Nu Enterprises' callable semi-annual bonds have a 10 left until maturity, and a 6.25 per cent coupon. The going interest rate is 4.75 per cent. The bonds can be called in five years with a 3.5 per cent premium. a. What is the bond's current yield (CY)? CY = Annual Coupon PMT/ PV = $62.5/ $1,118.311185 = 0.0558878431  CY = 5.5888% Bond PV ?  $1,118.311185 FV $1,000 PMT 14% ($1,000) = $62.5 annual/ 2 I/Y 4.75%/ 2 N 10 years  2 b. What is the bond’s total expected return and CGY? Overall Expected Return = YTM = 4.75% YTM = CY + CGY  CGY = YTM - CY = 4.75% - 5.5888% = -0.8388% c. What is the bond’s YTC? Bond PV -$1,118.311185 FV $1,000 + 3.5% Premium = $1,035 PMT 14% ($1,000) = $62.5 annual/ 2 I/Y YTC = ?  2.117686388  2 = Copyrighted by RBT

Date: 4.2354% N 5 years  2 Q6: Keith Designs, Inc., is expanding rapidly; hence, the firm anticipates no dividend payout for nine years in order to cover part of its financing needs. KD’s financial manager forecasts to approve its first dividend by 2029, in the amount of $12 per share. The expectation is that the dividend will increase by four per cent annually. If the average investor requires a 12 per cent return on this stock, what is the current share price? CMG P o = ? P t = D t+1 / (R - g) P 2028 = D 2029 / (R - g) = $12/ (0.12 - 0.04) = $150 P o = PV = ?  $85.114 FV = P 2028 = $150 PMT = $0 I/Y = 12% N = 2028 - 2023 Q7: Nephrite Corp. just paid a dividend of $10 per share and has announced the following dividends over the next four years: $5.3, $16.3, $21.3, & $3.1. The company has a beta of 1.2, the market risk premium is five per cent, and the return on the three-moth T-bill is two per cent. If afterwards, the company pledges to maintain a constant 5.75 per cent growth rate in dividends, forever, what would the current share price be? NCGM + CGM P o = ? P o = NPV CMG P t = D t+1 / (R - g) P 4 = D 5 / (R - g) = [$3.1 × (1 + 0.0575)]/ (0.08 - 0.0575) = $3.27825/ (0.0225) = $145.7 CAPM R i = R f + [R M – R f ] ×  = 0.02 + 0.05 × 1.2 = 0.08 Year CF 0 $10 1 $5.3 2 $16.3 3 $21.3 4 $3.1 + $145.7 CPT NPV (@8%; CF o = $0; CF 1 = $5.3; CF 2 = $16.3; CF 3 = $21.3; CF 4 = $3.1 + $145.7) = $145.1631 Q8: Vedder, Inc. has 6.9 million shares of common stock outstanding, currently trading at $61.90 per share, with a book value of $24.90 per share. The firm trades in the S&P 500, which has had a remarkable nine per cent annual return; Sharper’s estimated beta is 0.9. The most recent dividend paid by Sharper Lighting was $3.30; traditionally, the firm has maintained a dividend growth rate of five per cent and stock analysts, following the firm, expect the same growth to continue in the future. Further, the firm has one million shares of preferred stock outstanding, currently trading at $100 per share, with a book value of $20 per share and a face value of $100 as well. Sharper Inc.’s preferred stock pays a perpetual dividend of five per cent. Despite low T-bills rates, currently at two per cent, the company maintains two bond issues, both making semiannual payments, and offering the same annual coupon rate of 7.4 per cent. The first set of outstanding bonds, maturing in 18 years, was issued at a face value of $70.9 million, and currently sells for 93.5 per cent of par. The second set of bonds issued by the firm, has 10 years left to maturity, amounts to a face value of $35.9 million, and currently sells for 92.5 per cent of par. Assume that the Copyrighted by RBT

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Date: overall cost of debt is the weighted average of the individual costs of debt derived from the two outstanding debt issues. Sharper’s profits are still subject to a 20 per cent tax liability. What is the company’s WACC? WACC =w E × r E + w P × r P + w D × (1-T) × r D w E = E/V = $427,110,000/ $626,609,000 = 0.681621  68.1621% E= N o of Common Shares × PPS Common Stock = 6,900,000 × $61.90 = $427,110,000 w P = P/V = $100,000,000/ $626,609,000 = 0.159589  15.9589% P= N o of Preferred Shares × PPS Preferred Equity = 1,000,000 × $100 = $100,000,000 w D1 = D 1 /V = $66,291,500/ $626,609,000 = 0.105794  10.5794% D 1 = % of Par × Par Value = 93.5% × $70,900,000 = $66,291,500 w D2 = D 2 /V = $33,207,500/ $626,609,000 = 0.052996  5.2996% D 2 = % of Par × Par Value = 92.5% × $35,900,000 = $33,207,500 V= E + P + D1 + D2 = $626,609,000 Two ways to estimate Cost of Equity: 1. Constant Growth Model r E or R = D 1 /P o + g D o = $3.3 Po = $61.90 β i = 1.08 g = 5% D 1 = Do×(1+g)= $3.3(1.05)= $3.465 r E or R = D 1 /P o + g = $3.465/ $61.90 + 0.05 = 0.115977  10.5977% 2. CAPM: r E or E(R i ) = R f + [E(R M )-R f ]×β i R f = 2% E(R M ) = 9% β i = 0.9 r E or E(R i ) = R f + [E(R M )-R f ]×β i = 0.02 +[ 0.09 - 0.02]×0.9 = 0.083  8.3% Overall r E = [R + E(R i )]/2 = (0.105977+0.083)/2= 0.094488  9.4488% r P or R = D/P = 5%×$100 /$100 = $5/$100 = 0.05  5% D1 PV = 93.5% ( FV)= -$935 FV = 1,000 PMT = 7.4%(FV)=$74/2 I/Y = YTM or r D ?  4.0411  4.0411 ×2 = 8.0919% N= 18 ×2 D2 PV = 92.5% ( FV)= -$925 FV = 1,000 PMT = 7.4%(FV)=$74/2 I/Y = YTM or r D ?  4.2648  4.2648 ×2 = 8.5298% N= 10 ×2 Copyrighted by RBT

Date: WACC =w E × r E + w P × r P + w D1 × (1-T) × r D1 + w D2 × (1-T) × r D2 WACC = 0.681621 × 0.094488 + 0.159589 × 0.05 + 0.105794 × (1- 0.2) × 0.080919 + 0.052996 × (1- 0.2) × 0.085298 = 0.082849 WACC = 8.2849% Copyrighted by RBT