B1. (Choosing financial targets) Bixton Company’s new chief financial officer is evaluating
Bixton’s capital structure. She is concerned that the firm might be underleveraged, even
though the firm has larger-than-average research and development and foreign tax credits
when compared to other firms in its industry. Her staff prepared the industry comparison
shown here.
a. Bixton’s objective is to achieve a credit standing that falls, in the words of the chief
financial officer, “comfortably within the ‘A’ range.” What target range would you recommend
for each of the three credit measures?
b. Before settling on these target ranges, what other factors should Bixton’s chief financial
officer consider?
c. Before deciding whether the target ranges are really appropriate for Bixton in its current
financial situation, what key issues specific to Bixton must the chief financial officer
resolve?
Rating
Category
Fixed charge
Coverage
Aa
A
Baa
4.00–5.25x
3.00–4.30
1.95–3.40
Funds from
operations/
Total debt
60–80%
45–65
35–55
Long-term debt/
capitalization
17–23%
22–32
30–41
A10. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet
software and has begun paying cash dividends. The firm’s chief financial officer would like
the firm to distribute 25% of its annual earnings (POR 0.25) and adjust the dividend
rate to changes in earnings per share at the rate ADJ 0.75. Regional paid $1.00 per share
in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable
future. Use the dividend adjustment model, Equation (18.1), to calculate projected
dividends per share for this year and the next four.
B2. (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out
$1.50 per share per year in cash dividends on its common stock. Historically, its payout
ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary
cash flow shown below in millions.
a. Over the five-year period, what is the maximum overall payout ratio the firm could
achieve without triggering a securities issue?
b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years
1 through 5.
Earnings
Discretionary
Cash flow
1
100
50
2
125
70
3
150
60
4
120
20
5
140
15
THEREAFTER
150per year
50+per year
603. A2. (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly
placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9%
coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement
with a large pension fund. Issuance costs are $500,000, the bond has a 9.25% annual
coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage
yield)?
632. C2. (Leasing, taxes, and the time value of money) The lessor can claim the tax deductions
associated
with asset ownership and realize the leased asset’s residual value. In return, the lessor
must pay tax on the rental income.
a. Explain why a financial lease represents a secured loan in which the lender’s entire debt
service stream is taxable as ordinary income to the lessor/lender.
b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction
to generate positive net-present-value tax benefits for both the lessor and lessee?
c. Suppose the lease payments in Table 21-2 must be made in advance, not arrears.
(Assume that the timing of the lease payment tax deductions/obligations changes
accordingly but the timing of the depreciation tax deductions does not change). Show
that the net advantage to leasing for NACCO must decrease as a result. Explain why this
reduction occurs.
d. Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater
in absolute value than the net advantage of the lease to the lessor.
e. Either find a lease rate that will give the financial lease a positive net advantage for both
lessor and lessee, or show that no such lease rate exists.
f. Explain what your answer to part e implies about the tax costs and tax benefits of the
financial lease when lease payments are made in advance.