Question 1: (Cost of Capital) Pine Tree Farms Corporation (PTFC) has a target ca

Question

Question 1: (Cost of Capital)

Pine Tree Farms Corporation (PTFC) has a target capital structure of 20% debt, 10% preferred stock, and 70% common equity. Currently PTFC has a capital structure of 70% debt, 10% preferred stock, and 80% common stock. The after tax cost of debt is 4.5%. The preferred stock has a par value of $100 per share, a $5 per share dividend, and a market price of $70 per share. The common stock of PTFC trades at $97 per share and has a projected dividend (D1) of $2.60. The stock price and dividend are expected to continue to grow at 7% per year for the foreseeable future.

What is PTFC’s weighted average cost of capital (WACC)?

Question 2: (Capital Budgeting)

Consider Projects A and B, with net cash flows as follows:

---- Net Cash Flows ----

                                 Project A            Project B

            Initial Cost at T-0 (Now)               ($30,000)              ($50,000)

cash inflow at the end of year 1        10,000                   6,000

cash inflow at the end of year 2          8,000                 16,000

cash inflow at the end of year 3          5,000                 25,000

a. Construct NPV Profiles for these two projects.

b. If the two projects were mutually exclusive, which would you accept if your firm’s cost of capital were 4%? Which would you accept if your firm’s cost of capital were 8%?

Question 3: (Capital Budgeting)

Calculate the IRR of the following project:

                        Year                Cash Flow

                           0                   ($55,000)

                           1                      $21,000

                           2                      $23,000

                           3                      $25,000

Question 4: (Capital Budgeting)

Calculate the Modified Internal Rate of Return (MIRR) of the project in Question 3, assuming your firm’s cost of capital is 7%.

Question 5: (Capital Structure)

Firms R and S are similar firms in the same industry. Firms R and S have the same profit margin and total asset turnover when compared. However, Firm R's capital structure is 70% debt, 30% equity, and Firm S's capital structure is 30% debt, 70% equity. Given the above conditions, which firm will experience the highest return on equity (ROE)? Why?

Question 6: (Capital Structure)

A consultant has collected the following information regarding Hobbit Manufacturing:

Operating income (EBIT) $600 million, Debt $0, Interest expense $0, Tax rate 35%, Cost of equity 7%, WACC 7% . The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends . Hobbit can borrow money at a pre-tax rate of 5%. The consultant believes that if the company moves to a capital structure consisting of 30% debt and 70% equity (based on market values), which would require taking on debt in the amount of $1,779.47 million, that the cost of equity will increase to 8% and the pre-tax cost of debt will remain at 6%, but the value of the firm will rise. Is the consultant correct? If the company makes this change, what will be the increase in total market value for the firm?

Question 7: (Forecasting)

Jolly Joe's Novelties, Inc. had the financial data shown below last year. Jolly Joe's has just invented a new toy which they expect will cause sales to double from $100,000 to $180,000, increasing net income to $12,000. From experience the company knows that when sales changes, all current assets plus accounts payable and accrued expenses change at the same percentage rate, and the company feels they can handle the increase without adding any fixed assets.   a. Will Jolly Joe's need any new outside funding if they pay no dividends?

             b. If so, how much will be needed?

Question 8: (Working Capital Management)

Suppose it takes Jolly Joe’s Novelties, Inc. 5 days to build and sell toys (on average). Also suppose it takes the firm’s customers 35 days, on average, to pay for the toys after they have purchased them on credit. Finally, suppose the firm is able to delay paying for the materials it uses in the manufacturing process for 30 days. Given these conditions, how long is Jolly Joe’s cash conversion cycle?

Question 9: (Working Capital Management)

If Jolly Joe’s buys $100 worth of supplies on credit with terms 3/10 n30 and pays the bill on the 28th day after the purchase:

   a. What is the approximate, or “nominal,” cost of trade credit as an annual rate?

   b. What is the exact cost of trade credit as an annual rate?

Historical Balance Sheet for Jolly Joe's Novelties, Inc ASSETS Current Assets LIABILITIES AND EQUITY Current Liabilities $3,500 $1,500 $8,000 Accounts payable Cash Accounts Receivable $4,500 Accrued Expenses Inventory $9.500 Notes Payable $25,000 $265.000 $290,000 $32,000 $40,000 $72.000 TOTAL LABILITIES AND EQUITY $362.000 S22,000 Total Current Liabilities Total Current Assets Fixed Assets TOTAL ASSETS $340.000 Mortgage $362000 Total Liabilities Common Stock Retained Earnings Total Equity

Explanation / Answer

Answer no. 1

Weighted Average Cost of Capital ( WACC) = Kc *0.2 + Kp *0.1 + Kd*0.7 = 9.68* 0.2 + 5 * 0.1+ 4.5* 0.7 = 5.586 %

Where,

Ke = Cost of equity

Kp = Cost of Preferred stock = 5/100 *100= 5%

Kd = Cost of debt = 4.5%

Weight of debt , prefferred stock , equity in capital structure = 0.7 , 0.1 , 0.2

Note: Calculation of cost of equity

According to Dividend growth model

Current price of Common stock = Projected dividend(d1) / ( Ke -g )

or, 97 = 2.6/ (Ke - 0.07)

ke = 9.68%

Where

g= growth rate

Note : In question , Currently PTFC has a capital structure of 70% debt, 10% preferred stock , 80% Common stock , but weight of Common stock in present capital Structure should be 20 %.

Answer no. 2

Net Present Value at 4% cost of capital

Choose Project B , as NPV is better than Project A.

Net Present Value at 8 % Cost of Capital

Choose project A , NPV better than Project B

Answer no .3

At IRR . net present value of project should be zero . at 11.88% net present value of project is near to zero .

Hence IRR = 11.88% or , 12% ( rounded off)

Answer No.4

Note:

Project A Project B Year Cash Inflow Pvf @ 4% Present Value Cash Inflow Pvf @ 4% Present Value 0          (30,000) 1        (30,000.00)          (50,000) 1        (50,000.00) 1 10000 0.9615385             9,615.39 6000 0.9615385             5,769.23 2 8000 0.9245562             7,396.45 16000 0.9245562           14,792.90 3 5000 0.8889964             4,444.98 25000 0.8889964           22,224.91 Net Present Value           (8,543.18) Net Present Value           (7,212.96)

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