Solution to chapter 9 problems

9-6

$ 100.00

2.0

$ 200.00

Accounts receivable

200.00

2.0

400.00

Inventories

200.00

2.0

400.00

Net fixed assets*

500.00

1.0

500.00

Cash

Total assets

$1,000.00

Accounts payable

$1,500.00

50.00

$ 100.00

50.00

100.00

Notes payable

150.00

150.00

Long-term debt

400.00

400.00

Common stock

100.00

100.00

Retained earnings**

250.00

+ 40

290.00

Accruals

Total liabilities
and equity

$1,000.00

$1,140.00
AFN =

$ 360.00

*Capacity sales = Sales/0.5 = $1,000/0.5 = $2,000 with respect to existing fixed assets.

Target FA/S ratio = $500/$2,000 = 0.25.

Target FA = 0.25($2,000) = $500 = Required FA. Since the firm currently has $500 of
fixed assets, no new fixed assets will be required.
**Addition to RE = (M)(S1)(1 Payout ratio) = 0.05($2,000)(0.4) = $40.

9-7

a. AFN = (A0*/S0)(S) (L0*/S0)(S) (M)(S1)(1 payout)

$122.5
$350
=

$17.5
$350
($70)

$10.5
$350
($70)

The Excel spreadsheet would look like this:

b.

($420)(0.6) = $13.44 million.

c.

Upton Computers
Pro Forma Balance Sheet
December 31, 2013
(Millions of Dollars)
2013
Forecast

Pro Forma

Basis %

2013

2012

2013 Sales

$ 3.5

0.0100

$ 4.20

$ 4.20

Receivables

26.0

0.0743

31.20

31.20

Inventories

58.0

0.1657

69.60

69.60

$105.00

$105.00

42.00

42.00

$147.00

$147.00

$ 10.80

$ 10.80

Cash

Total current assets

Net fixed assets
Total assets

Accounts payable
Notes payable
Accruals

Additions

$ 87.5
35.0

0.100

$122.5

$ 9.0

0.0257

18.0
8.5

Pro Forma

after

18.00
0.0243

Total current liabilities $ 35.5

Financing

+13.44

Financing

31.44

10.20

10.20

$ 39.00

$ 52.44

Mortgage loan

6.0

6.00

6.00

Common stock

15.0

15.00

15.00

Retained earnings

66.0

73.56

73.56

$133.56

$147.00

Total liab. and equity

$122.5

7.56*

AFN = $ 13.44

*M = $10.5/$350 = 3%.

Payout = $4.2/$10.5 = 40%.

NI = $350 1.2 0.03 = $12.6.
Addition to RE = NI DIV = $12.6 0.4($12.6) = 0.6($12.6) = $7.56.

Solutions to chapter 11 problems

11-9

Total corporate value = Value of operations + marketable securities

= $651 + $47 = $698 million.
Value of equity = Total corporate value debt Preferred stock
= $698 ($65 + $131) - $33 = $469 million.
Price per share = $469 / 10 = $46.90.

11-10 a. NOPAT2013 = $108.6(1-0.4) = $65.16

NOWC2013 = ($5.6 + $56.2 + $112.4) ($11.2 + $28.1) = $134.9 million.

Capital2013 = $134.9 + $397.5 = $532.4 million.

FCF2013 = NOPAT Investment in Capital = $65.16 ($532.4 - $502.2)

= $65.16 - $30.2 = $34.96 million.

b. HV2013 = [$34.96(1.06)]/(0.11-0.06) = $741.152 million.

c. VOp at 12/31/2012 = [$34.96 + $741.152]/(1+0.11) = $699.20 million.

d. Total corporate value = $699.20 + $49.9 = $749.10 million.

e. Value of equity = $749.10 ($69.9 + $140.8) - $35.0 = $503.4 million.

Price per share = $503.4 / 10 = $50.34.

Solution to chapter 15 problems

15-7

a. Here are the steps involved:

(1)

Determine the variable cost per unit at present, V:

Profit
$500,000
50(V)
V

(2)

= P(Q) - FC - V(Q)
= ($100,000)(50) - $2,000,000 - V(50)
= $2,500,000
= $50,000.

Determine the new profit level if the change is made:

New profit

= P2(Q2) - FC2 - V2(Q2)

= $95,000(70) - $2,500,000 - ($50,000 - $10,000)(70)
= $1,350,000.

(3)

Determine the incremental profit:

Profit = $1,350,000 $500,000 = $850,000.

(4)

Estimate the approximate rate of return on new investment:

Return = Profit/Investment = $850,000/$4,000,000 = 21.25%.

Since the return exceeds the 15 percent cost of equity, this analysis suggests that the firm
should go ahead with the change.

b. The change would increase the breakeven point:

Old:

QBE =

F
PV

$2,000,000
$100,000 $50,000
=

= 40 units.

$2,500,000
$95,000 $40,000
New:

QBE =

= 45.45 units.

c. It is impossible to state unequivocally whether the new situation would have more or less
business risk than the old one. We would need information on both the sales probability
distribution and the uncertainty about variable input cost in order to make this determination.
However, since a higher breakeven point, other things held constant, is more risky. Also the
percentage of fixed costs increases:

FC
FC V(Q)
Old:

$2,000,000
$2,000,000 $2,500,000
=

= 44.44%.

FC 2
FC 2 V2 (Q 2 )
New:

$2,500,000
$2,500,000 $2,800,000
=

= 47.17%.

The change in breakeven points--and also the higher percentage of fixed costs--suggests that
the new situation is more risky.

15-10 a. BEAs unlevered beta is bU=b/(1+ (1-T)(D/S))=1.0/(1+(1-0.40)(20/80)) = 0.870.

b. b = bU (1 + (1-T)(D/S)).
At 40 percent debt: bL = 0.87 (1 + 0.6(40%/60%)) = 1.218.
rS = 6 + 1.218(4) = 10.872%
c. WACC = wd rd(1-T) + wcers
= (0.4)(9%)(1-0.4) + (0.6)(10.872%) = 8.683%.

FCF
( EBIT )(1 T ) ($14.933)(1 0.4)

WACC
WACC
0.08683
V=

15-11 Tax rate = 40%

= $103.188 million.

rRF = 5.0%

bU = 0.8

rM rRF = 6.0%

From data given in the problem and table we can develop the following table:
Levered
wd
0
0.2
0.4
0.6
0.8

wce
100%
80%
60%
40%
20%

D/S
0.00
0.25
0.67
1.50
4.00

rd
rd(1 T)
6.0%
3.60%
7.0%
4.20%
8.0%
4.80%
9.0%
5.40%
10.0%
6.00%

betaa
0.80
0.92
1.12
1.52
2.72

r sb
WACCc
9.80%
9.80%
10.52%
9.26%
11.72%
8.95%
14.12%
8.89%
21.32%
9.06%

Notes:
a
These beta estimates were calculated using the Hamada equation,
b = bU[1 + (1 T)(D/S)].
b
These rs estimates were calculated using the CAPM, rs = rRF + (rM rRF)b.
c
These WACC estimates were calculated with the following equation:
WACC = wd(rd)(1 T) + (wce)(rs).
The firms optimal capital structure is that capital structure which minimizes the firms
WACC. The WACC is minimized at a capital structure consisting of 60% debt and 40%
equity. At that capital structure, the firms WACC is 8.89%.