Professional Documents
Culture Documents
Appendix B
Solutions to
Self-Test Problems
Chapter 1
$104,150
d. Average tax rate 33.6%
$310,000
Marginal tax rate 39%
B-1
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Chapter 2
ST2–1
Ratio Too high Too low
Current ratio May indicate that the firm is May indicate poor ability to satisfy
current assets/ holding excessive cash, accounts short-term obligations.
current liabilities receivable, or inventory.
Inventory turnover May indicate lower level of May indicate poor inventory man-
CGS/inventory inventory, which may cause agement, excessive inventory, or
stockouts and lost sales. obsolete inventory.
Times interest earned May indicate poor ability to pay
earnings before interest contractual interest payments.
and taxes/interest
Gross profit margin Indicates the low cost of merchan- Indicates the high cost of the mer-
gross profits/sales dise sold relative to the sales price; chandise sold relative to the sales
may indicate noncompetitive price; may indicate either a low sales
pricing and potential lost sales. price or a high cost of goods sold.
Return on total assets Indicates ineffective management in
net profits after generating profits with the available
taxes/total assets assets.
Price/earnings (P/E) Investors may have an excessive Investors lack confidence in the
ratio market price degree of confidence in the firm’s future outcomes and feel
per share of common firm’s future and underestimate that the firm has an excessive
stock/earnings per share its risk. level of risk.
ST2–2
O’Keefe Industries
Balance Sheet
December 31, 2006
B-3 APPENDIX B
Chapter 3
Percentages Depreciation
Costa (from Table 3.2) [(1) (2)]
Year (1) (2) (3)
b. Accounting definition:
Financial definition:
Operating
NOPAT cash flows
EBIT [(1) (1 0.40)] Depreciation [(2) (3)]
Year (1) (2) (3) (4)
ST3–2 a.
B-5 APPENDIX B
Chapter 4
ST4–1 a. Bank A:
FV3 $10,000 FVIF4%/3yrs $10,000 1.125 $11,250
(Calculator solution $11,248.64)
Bank B:
FV3 $10,000 FVIF4%/2,2 3yrs $10,000 FVIF2%,6yrs
$10,000 1.126 $11,260
(Calculator solution $11,261.62)
Bank C:
FV3 $10,000 FVIF4%/4,4 3yrs $10,000 FVIF1%,12yrs
$10,000 1.127 $11,270
(Calculator solution $11,268.25)
b. Bank A:
EAR (1 4%/1)1 1 (1 0.04)1 1 1.04 1 0.04 4%
Bank B:
EAR (1 4%/2)2 1 (1 0.02)2 1 1.0404 1 0.0404 4.04%
Bank C:
EAR (1 4%/4)4 1 (1 0.01)4 1 1.0406 1 0.0406 4.06%
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c. Ms. Martin should deal with Bank C: The quarterly compounding of interest
at the given 4% rate results in the highest future value as a result of the
corresponding highest effective annual rate.
d. Bank D:
FV3 $10,000 FVIF4%,3yrs (continuous compounding)
$10,000 e0.043 $10,000 e0.12
$10,000 1.127497
$11,274.97
This alternative is better than Bank C; it results in a higher future value
because of the use of continuous compounding, which with otherwise
identical cash flows always results in the highest future value of any com-
pounding period.
ST4–2 a. On a purely subjective basis, annuity Y looks more attractive than annuity X
because it provides $1,000 more each year than does annuity X. Of course,
the fact that X is an annuity due means that the $9,000 would be received
at the beginning of the first year, unlike the $10,000 at the end of the year,
and this makes annuity X awfully tempting.
b. Annuity X:
FVA6 $9,000 FVIFA15%,6yrs (1 0.15)
$9,000 8.754 1.15 $90,603.90
(Calculator solution $90,601.19)
Annuity Y:
FVA6 $10,000 FVIFA15%,6yrs
$10,000 8.754 $87,540.00
(Calculator solution $87,537.38)
c. Annuity X is more attractive, because its future value at the end of year 6,
FVA6, of$90,603.90 is greater than annuity Y’s end-of-year-6 future value,
FVA6, of $87,540.00. The subjective assessment in part a was incorrect. The
benefit of receiving annuity X’s cash inflows at the beginning of each year
appears to have outweighed the fact that annuity Y’s annual cash inflow,
which occurs at the end of each year, is $1,000 larger ($10,000 vs. $9,000)
than annuity X’s.
ST4–3 Alternative A:
Cash flow stream:
PVA5 $700 PVIFA9%,5yrs
$700 3.890 $2,723
(Calculator solution $2,722.76)
Single amount: $2,825
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B-7 APPENDIX B
Alternative B:
Cash flow stream:
Present value
Cash flow FVIF9%,n [(1) (2)]
Year (n) (1) (2) (3)
Chapter 5
SReturns
ST5–1 a. Expected return, k (Equation 5.2a in footnote 9)
3
12% 1 14% 1 16% 42%
kA 14%
3 3
16% 1 14% 1 12% 42%
kB 14%
3 3
12% 1 14% 1 16% 42%
kC 14%
3 3
n
a (ki 2 k)
2
j51
ã
b. Standard deviation, sk 5 (Equation 5.3a in footnote 10)
n21
2007 (0.50 12%) (0.50 16%) 14% (0.50 12%) (0.50 12%) 12%
2008 (0.50 14%) (0.50 14%) 14% (0.50 14%) (0.50 14%) 14%
2009 (0.50 16%) (0.50 12%) 14% (0.50 16%) (0.50 16%) 16%
ST5–2 a. When the market return increases by 10%, the project’s required return
would be expected to increase by 15% (1.50 10%). When the market
return decreases by 10%, the project’s required return would be expected
to decrease by 15% [1.50 (10%)].
b. kj RF [bj (km RF)]
7% [1.50 (10% 7%)]
7% 4.5% 11.5%
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B-9 APPENDIX B
c. No, the project should be rejected, because its expected return of 11% is less
than the 11.5% return required from the project.
d. kj 7% [1.50 (9% 7%)]
7% 3% 10%
The project would now be acceptable, because its expected return of 11% is
now in excess of the required return, which has declined to 10% as a result
of investors in the marketplace becoming less risk-averse.
Chapter 6
ST6–2 a. B0 $1,150
I 0.11 $1,000 $110
M $1,000
n 18 yrs
$1,150 $110 (PVIFAkd,18yrs) $1,000 (PVIFkd,18yrs)
Because if kd 11%, B0 $1,000 M, try kd 10%.
B0 $110 (PVIFA10%,18yrs) $1,000 (PVIF10%,18yrs)
($110 8.201) ($1,000 0.180)
$902.11 $180.00 $1,082.11
Because $1,082.11 $1,150, try kd 9%.
B0 $110 (PVIFA9%,18yrs) $1,000 (PVIF9%,18yrs)
($110 8.756) ($1,000 0.212)
$963.16 $212.00 $1,175.16
Because the $1,175.16 value at 9% is higher than $1,150, and the $1,082.11
value at 10% rate is lower than $1,150, the bond’s yield to maturity must
be between 9% and 10%. Because the $1,175.16 value is closer to $1,150,
rounding to the nearest whole percent, the YTM is 9%. (By using interpola-
tion, the more precise YTM value is 9.27%.)
(Calculator solution 9.26%)
b. The calculated YTM of 9% is below the bond’s 11% coupon interest rate,
because the bond’s market value of $1,150 is above its $1,000 par value.
Whenever a bond’s market value is above its par value (it sells at a premium),
its YTM will be below its coupon interest rate; when a bond sells at par, the
YTM will equal its coupon interest rate; and when the bond sells for less than
par (at a discount), its YTM will be greater than its coupon interest rate.
Chapter 7
ST7–1 D0 $1.80/share
ks 12%
a. Zero growth:
D1 D1 5 D0 5 $1.80
P0 $15/share
ks 0.12
b. Constant growth, g 5%:
D1 D0 (1 g) $1.80 (1 0.05) $1.89/share
D1 $1.89 $1.89
P0 $27/share
ks 2 g 0.12 2 0.05 0.07
c. Variable growth, N 3, g1 5% for years 1 to 3 and g2 4% for years 4 to ` :
D1 D0 (1 g1)1 $1.80 (1 0.05)1 $1.89/share
D2 D0 (1 g1)2 $1.80 (1 0.05)2 $1.98/share
D3 D0 (1 g1)3 $1.80 (1 0.05)3 $2.08/share
D4 D3 (1 g2) $2.08 (1 0.04) $2.16/share
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B-11 APPENDIX B
N D0 3 (1 1 g1 )t
a b
1 DN11
P0 a t N
t51 (1 1 ks ) (1 1 ks ) ks 2 g2
N D0 3 (1 1 g1 )t 1.89 1.98 2.08
a t
1
2
t51 (1 1 ks ) (1 1 0.12) (1 1 0.12) (1 1 0.12)3
[$1.89 (PVIF12%,1yr)] [$1.98 (PVIF12%,2yrs)]
[$2.08 (PVIF12%,3yrs)]
($1.89 0.893) ($1.98 0.797) ($2.08 0.712)
$1.69 $1.58 $1.48 $4.75
c d 5
1 DN11 1 D4 5 $2.16
N
3 3
3
(1 1 ks ) ks 2 g2 (1 1 0.12) 0.12 2 0.04
$2.16
(PVIF12%,3yrs)
0.08
0.712 $27.00 $19.22
N D0 3 (1 1 g1 )t
1 c d 5 $4.75 1 $19.22
1 DN11
P0 a t N
3
t51 (1 1 k s ) (1 1 ks ) ks 2 g2
5 $23.97/share
ST7–2 a. Step 1: Present value of free cash flow from end of 2011 to infinity measured
at the end of 2010.
FCF2011 $1,500,000 (1 0.04) $1,560,000
$1,560,000 $1,560,000
Value of FCF2011 S` $26,000,000
0.10 2 0.04 0.06
Step 2: Add the value found in Step 1 to the 2010 FCF.
Total FCF2010 $1,500,000 $26,000,000 $27,500,000
Step 3: Find the sum of the present values of the FCFs for 2007 through
2010 to determine company value,VC.
$9,052,300
c. Price per share $18.10/share
500,000
(Calculator solution $18.11/share)
Chapter 8
ST8–1 a. Book value Installed cost Accumulated depreciation
Installed cost $50,000
Accumulated depreciation $50,000 (0.20 0.32 0.19 0.12)
$50,000 0.83 $41,500
Book value $50,000 $41,500 $8,500
b. Taxes on sale of old equipment:
Gain on sale Sale price Book value
$55,000 $8,500 $46,500
Taxes 0.40 $46,500 $18,600
c. Initial investment:
Installed cost of new equipment
Cost of new equipment $75,000
Installation costs 5,000
Total installed cost—new $80,000
After-tax proceeds from sale of old equipment
Proceeds from sale of old equipment $55,000
Taxes on sale of old equipment 18,600
Total after-tax proceeds—old 36,400
Change in net working capital 15,000
Initial investment $58,600
B-13 APPENDIX B
aThe total of $19,200 represents the book value of the old machine at the end of
the second year, which was calculated in part a.
1 2 3 4
Incremental (relevant)
New machinea Old machinea [(1) (2)]
Year (1) (2) (3)
d.
0
1 2 3
$137,120
End of Year
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B-15 APPENDIX B
Note: The year-4 incremental operating cash inflow of $3,400 is not directly
included; it is instead reflected in the book values used to calculate the taxes
on sale of the machines at the end of year 3 and is therefore part of the
terminal cash flow.
Chapter 9
1 $11,000 $11,000
2 10,000 21,000 d
3 9,000 30,000
4 8,000 38,000
$27,000 2 $21,000
2 years
$9,000
$6,000
2 years 2.67 years
$9,000
Present value
at 14%
Cash inflows (CFt) PVIF14%,t [(1) (2)]
Year (t) (1) (2) (3)
M N
aPreferred project.
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B-17 APPENDIX B
Project N is recommended, because it has the shorter payback period and the
higher NPV, which is greater than zero, and the larger IRR, which is greater
than the 14% cost of capital.
e. Net present value profiles:
Data
NPV
0% $11,500a $11,000b
14 640 1,148
15 0 —
16 — 0
From the NPV profile that follows, it can be seen that if the firm has a cost
of capital below approximately 6% (exact value is 5.75%), conflicting rank-
ings of the projects would exist using the NPV and IRR decision techniques.
Because the firm’s cost of capital is 14%, it can be seen in part d that no
conflict exists.
16
14 Project M
12
NPV ($000)
10
8
6
IRRN = 16%
4 Project N
2
0
N
–2 M
IRRM = 15%
–4
5 10 15 20
5.75%
Discount Rate (%)
Chapter 10
Chapter 11
B-19 APPENDIX B
$6
6.0% 7.5% 6.0% 13.5%
$80
Cost of new common stock, kn
D1
kn g
Nn
D1 $6
Nn $80 $4 underpricing $4 flotation cost $72
g 6.0%
$6
kn 6.0% 8.3% 6.0% 14.3%
$72
Weighted cost
Weight Cost [(1) (2)]
Source of capital (1) (2) (3)
Weighted cost
Weight Cost [(1) (2)]
Source of capital (1) (2) (3)
17 D
Weighted Average Cost
of Capital and IRR (%)
16
15
14
C
13
12 E
A 10.7%
11 10.4% WMCC
10 G IOS
9 F B
Chapter 12
FC
ST12–1 a. Q
P 2 VC
$250,000 $250,000
55,556 units
$7.50 2 $3.00 $4.50
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B-21 APPENDIX B
b. 20%
45%
169%
Long-term debt $60,000 at 12% annual interest $50,000 at 12% annual interest
Annual interest 0.12 $60,000 $7,200 0.12 $50,000 $6,000
Common stock 10,000 shares 11,000 shares
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Coordinates
EBIT
$30,000 $40,000
Earnings
Financing plan per share (EPS)
b.
2.00
Plan A (Bond)
Plan B (Stock)
1.00
EPS ($)
0
B
–0.75
10 20 30 40 50 60
EBIT ($000)
c. The bond plan (Plan A) becomes superior to the stock plan (Plan B) at
around $20,000 of EBIT, as represented by the dashed vertical line in the
figure in part b. (Note: The actual point is $19,200, which was determined
algebraically by using the technique described in footnote 22.)
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B-23 APPENDIX B
Chapter 13
$2,000,000 earnings available
ST13–1 a. Earnings per share (EPS)
500,000 shares of common outstanding
$4.00/share
Chapter 14
ST14–2 a. Data:
S 60,000 gallons
O $200 per order
C $1 per gallon per year
Calculation:
23S3O
Å
EOQ 5
C
2 3 60,000 3 $200
Å
5
$1
5 "24,000,000
5 4,899 gallons
b. Data:
Lead time 20 days
Daily usage 60,000 gallons/365 days
164.38 gallons/day
Calculation:
Reorder point lead time in days daily usage
20 days 164.38 gallons/day
3,287.6 gallons
ST14–3 Tabular Calculation of the Effects of Relaxing Credit Standards on Regency Rug
Repair Company:
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B-25 APPENDIX B
Chapter 15
ST15–1 a.
Approximate cost of
Supplier giving up cash discount
b. Supplier Recommendation
c. Stretching accounts payable for supplier Z would change the cost of giving
up the cash discount to
2% [365/[(60 20) 20]) 2% 365/60 2% 6.1 12.2%
In this case, in light of the 15% interest cost from the bank, the recommended
strategy in part b would be to give up the discount, because the 12.2% cost of
giving up the discount would be less than the 15% interest cost from the bank.
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Chapter 16
ST16–1 a. (1) and (2). In tabular form—after-tax cash outflows in column 3 and present
value of the cash outflows in column 5.
Payments
Beginning End-of-year
Loan of-year Interest Principal principal
End of payments principal [0.15 (2)] [(1) (3)] [(2) (4)]
year (1) (2) (3) (4) (5)
B-27 APPENDIX B
Present value
After-tax Present value of outflows
End of cash outflowsa factorsb [(1) (2)]
year (1) (2) (3)
$20 40 $ 800
25 (conversion price) 40 1,000 (par value)
28 40 1,120
35 40 1,400
50 40 2,000
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c. The bond would be expected to sell at the higher of the conversion value
and the straight value. In no case would it be expected to sell for less
than the straight value of $853.30. Therefore, at a price of $20, the bond
would sell for its straight value of $853.30, and at prices of $25, $28, $35,
and $50, the bond would be expected to sell at the associated conversion
values (calculated in part b) of $1,000, $1,120, $1,400, and $2,000,
respectively.
d. The straight bond value of $853.30.
Chapter 17
aPresent value interest factors for annuities, PVIFA, from Table A–4.
aPresent value interest factors for annuities, PVIFA, from Table A–4.
B-29 APPENDIX B
End-of-year Number
Initial Future value value of shares EPS
value factor at 5%a [(1) (2)] outstanding [(3) (4)]
Year (1) (2) (3) (4) (5)
Lake Industries
c. Comparing the EPS without the proposed merger calculated in part a (see
column 5 of table in part a) with the EPS with the proposed merger calcu-
lated in part b (see column 7 of table in part b), we can see that after 2008,
the EPS with the merger rises above the EPS without the merger. Clearly,
over the long run, the EPS with the merger will exceed those without the
merger. This outcome is attributed to the higher rate of growth associated
with Butler’s earnings (10% versus 5% for Lake).
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Chapter 18