Review Problems for Finance Final, BA 654
1. Use the following information to do a lease vs. buy analysis.
Equipment price is $150,000.
Depreciated using 3 year MACRS:
MACRS 3-year Year
%
1
33
2
45
3
15
4
7
The asset will be used for 4 years, it has an estimated residual (salvage) value of $40,000 at the end of
four years.
Lease terms: four payments of $40,000 at the beginning of each year; lessee provides maintenance
which is estimated to cost $5,000 annually.
Lessee can borrow for 8% and has a weighted average cost of capital of 10%.
Lessee’s tax rate is 40%.
(a) Calculate the lessee’s after-tax cash flows associated with the lease.
(b) Calculate the present value of the after-tax lease cash flows.
(c) Calculate the after-tax cash flows associated with buying and owning the asset for four years.
(d) Calculate the present value of the after-tax cash flows associated with buying and owning the asset
for four years.
(e) Calculate the net advantage of leasing (NAL) for the lessee and decide whether the asset should be
purchased or leased.
2. Use the financial statements below to answer the questions on the next page.
Balance Sheets
Assets
Cash and equivalents
Marketable securities
Accounts receivable
Inventories
Total current assets
Gross Fixed Assets
Less Accumulated Dep.
Net Fixed Assets
Total Assets
Liabilities and equity
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total liabilities
Common stock (100,000 shares)
Retained earnings
Total common equity
Total liabilities and
equity
12/31/2005
$7,282
$20,000
$632,160
$1,611,036
$2,270,478
$1,202,950
$263,160
$939,790
$3,210,268
12/31/2006
$14,000
$71,632
$878,000
$1,716,480
$2,680,112
$1,220,000
$383,160
$836,840
$3,516,952
$324,000
$720,000
$284,960
$1,328,960
$1,000,000
$2,328,960
$783,676
$97,632
$557,632
$359,800
$300,000
$380,000
$1,039,800
$500,000
$1,539,800
$1,680,936
$296,216
$1,977,152
$3,210,268
$3,516,952
2005
$5,834,400
$4,980,000
$720,000
$116,960
$5,816,960
$17,440
$176,000
-$158,560
-$63,424
-$95,136
2006
$7,035,600
$5,800,000
$612,960
$120,000
$6,532,960
$502,640
$80,000
$422,640
$169,056
$253,584
($0.951)
$0.110
$5.576
$1.014
$0.220
$7.909
Income Statements
Net sales
Costs of Goods Sold
Other Expenses
Depreciation
Total Operating Cost
Earnings before interest and taxes (EBIT)
Less interest
Earnings before taxes (EBT)
Taxes (40%)
Net Income before preferred dividends
EPS
DPS
Book Value Per Share
Prob. 2, continued. Use the financial statements on the previous page to:
a. Calculate NOPAT for 2006.
b. Calculate net operating capital as of the end of 2006
c. If operating capital at the end of 2005 is $2,581,308, calculate free cash flow for 2006.
3. Your employer is considering acquiring Charlie's Chocolate Factory. The following information
reflects Charlie’s pre-merger situation:
Tax rate = 30%
Debt ratio = 20%
Beta on Charlie stock = 1.2
Post-merger information on Charlie is:
Tax rate = 30%
Debt ratio = 40%
The interest rate on debt = 8%
The risk-free rate is 5% and the expected return on the market is 11%.
a. Calculate the unleveraged beta for Charlie.
b. Calculate the post-merger leveraged beta for Charlie.
c. Calculate the post-merger required return on equity (rs) for Charlie.
d. Calculate the post-merger WACC for Charlie.
4. Mega Corp. is considering the acquisition of Co. Y. You have the following information.
Pre-merger information for Co. Y:
Debt ratio is 20%, with an interest rate of 6%
The required return on Co. Y stock is 10%
Tax rate is 40%
The pre-merger WACC is 8.72%
Post-merger information for Co. Y:
Debt ratio: 40%, with an interest rate of 7%
Tax rate: 40%
The new required return on Co. Y stock is 11%
The new WACC will be 8.28%
Mega forecasts the following free cash flows (FCF) from the acquisition (in millions of dollars):
Year
1
2
3
FCF
$0
5 mil
10 mil
a. FCF is expected to increase at an annual rate of 5% following the 3-year planning horizon.
Calculate the horizon value (or terminal value) of Co. Y.
b. Calculate the value of Y’s operations.
Co. Y currently has $100 million in debt and has financial assets equal to $25 million.
c. Calculate the total value of Y’s equity.
d. If Co. Y has 10 million shares of common stock outstanding, what is the value per share to
Mega Corp?
5. Pettit Mfg. has hired you to evaluate possible changes to its capital structure. The following
information applies to the existing situation:
EBIT = $12 million annually
WACC = 8.1%
Total market value of the firm is $103.7 million, consisting of 1 million shares of stock with a
market price of $73.70 per share, and $30 million of debt with an interest rate of 6 percent.
Tax rate (T) = 30%.
Required return on equity (r S) = 10%
Dividend payout = 100% of earnings, so the growth rate = 0.
Pettit is considering a proposal to increase its debt ratio to 50 percent by issuing new bonds with
an interest rate of 8 percent. If Pettit increases its financial leverage, it will use the proceeds of
the new bond issue to pay off the existing bonds and repurchase stock. The increase in debt will
cause the required return on equity (rS) to increase to 12%.
Calculate the following if the restructuring occurs:
(a) Calculate the new weighted average cost of capital (WACC1).
(b) The new total value of the firm (V1)
(c) Should Pettit restructure by increasing its debt? State why or why not.
Check answers which I believe are correct, but cannot guarantee:
1. NAL = -$14,277
2. FCF = $177,372
3. WACC = 10.64%
4. Value per share = P0 = $18.93
5. New firm value = V1 = $95.5 million