# Financial Management Week 3

9-15

On January 1, the total market value of the Tysseland Company was \$60 million. During the year, the company plans to raise and invest \$30 million in new projects. The firm’s present market value capital structure, shown below, is considered to be optimal. There is no short-term debt.

Debt

\$

30,000,000

Common Equity

\$30,000,000

Total Capital                          \$60,000,000

New bonds will have an 8%coupon rate, and they will be sold at par. Common stock is currently selling at \$30 a share. The stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend id \$1.20, so the dididend yield is \$1.20/\$30 = 4%.) The marginal tax rate is 40%.

9-16

Suppose the Schoof Company has this book value balance sheet:

\$30,000,000

30,000,000

\$80,000,000

 Current Assets Current liabilities \$10,000,000 Fixed assets 50,000,000 Long-term debt Common equity Commom stock (1 million shares) 1,000,000 Retained earnings 39,000,000 Total assets \$80,000,000 Total Claims

The current liabilities consist entirely of notes payable to banks, and the interest rate on this debt is 10%, the same as the rate on new bank loans. These bank loans are not used for seasonal financing but instead are part of the company’s permanent capital structure. The long-term debt consists of 30,000 bonds, each with a par value of \$1,000, and annual coupon interest rate of 6%, and a 20-year maturity. The going rate of interest in new long-term debt, rd, is 10%, and this is the present yield to maturity on the bonds. The common stock sells at a price of \$60 per share. Calculate the firm’s market value capital structure.

10-10

Project S has a cost of \$10,000 and is expected to produce benefits (cash flows) of \$3,000 per year for 5 years. Project L costs \$2

5,000

and is expected to produce cash flows of \$7,400 per year for 5 years. Calculate the two projects’ NPVs, IRRs, MIRRs, and PIs, assuming a cost of capital of 12%. Which project would be selected, assuming they are mutually exclusive, using each ranking method? Which should actually be selected?

10-20

The Aubey Coffee Company is evaluating the within-planet distribution system for its new roasting, grinding, and packing plant. The two alternatives are (1) a conveyor system with a high initial cost but low annual operating costs, and (2) several forklift trucks, which cost less but have considerably higher operating costs. The decision to construct the plant has already been made, and the choice here will have no effect on the overall revenues of the project. The cost capital for the plant is 8%, and the projects’ expected net costs are listed in the following table:

0

1

2-120,000-160,0003-120,000-160,0004-120,000-160,0005

-160,000

 Year Conveyor Forklift -\$500,000 -\$200,000 -120,000 -160,000 -20,000

a.

What is the IRR of each alternative?

b.
What is the present value of the costs of each alternative? Which method should be chosen?

10-22

The Scampini Supplies Company recently purchased a new delivery truck. The new truck cost \$22,500, and it is expected to generate net after-tax operating cash flows, including depreciation, of \$

6,250

per year. The truck has 5-year expected life. The expected salvage values after tax adjustments for the truck are given below. The company’s cost of capital is 10%.

Year

0

-\$22,500

16,250

26,250

36,250

46,2505,00056,2500
 Annual Operating Cash Flow Salvage Value -\$22,500 17,500 14,000 11,000

a.    Should the firm operate the truck until the end of its 5-year physical life? If not, then what is its optimal economic life?

Would the introduction of salvage values, in addition to operating cash flows,