Abby's Retail Limited

Income Statement
For the year ended December 31, 2018

Sales Revenue $ 1,000,000

less:
Cost of Goods Sold 575,000
Gross Profit $ 425,000

Expenses:
Operating Expenses $ 225,000
Marketing Expenses 25,000
Administrative Expenses 25,000
Total Expenses 275,000
EBIT $ 150,000
Interest Expense 15,000
EBT $ 135,000
Taxes 27,000
Net Income $ 108,000
Note: Depreciation Expense = $10,400

Abby's Retail Limited

Statement of Changes in Retained Earnings
For the year ended December 31, 2018

Retained Earnings, January 1 $ 20,000

Add:
Net Income 108,000
Total $ 128,000
less:
Dividends Declared and Paid 120,000
Retained Earnings, December 31 $ 8,000
 Abby's Retail Limited
Balance Sheet
As at December 31, 2018

Assets
2018 2017
Current Assets:
Cash $ 36,900 $ 16,000
Accounts Receivable 6,000 4,000
Inventory 44,000 50,000
Prepaid Expenses 2,000 2,000
Total Current Assets $ 88,900 $ 72,000

Fixed Assets:
Fixtures and Equipment $ 90,000 $ 80,000
less: Accumulated Depreciation 68,000 60,000
Net Fixtures and Equipment 22,000 20,000
Building $ 120,000 $ 120,000
less: Accumulated Depreciation 62,400 60,000
Net Building 57,600 60,000
Total Fixed Assets $ 79,600 $ 80,000

Total Assets $ 168,500 $ 152,000

Liabilities
2018 2017
Current Liabilities:
Accounts Payable $ 30,500 $ 19,000
Taxes Payable 35,000 8,000
Total Current Liabilities $ 65,500 $ 27,000

Long-term Liabilities:
Business Loan $ 25,000 $ 35,000
Mortgage on Building 57,500 60,000
Total Long-term Liabilities 82,500 95,000

Total Liabilities $ 148,000 $ 122,000

Shareholders' Equity
2018 2017
Contributed Capital (Common Shares) $ 12,500 $ 10,000
Retained Earnings 8,000 20,000
Total Shareholders' Equity $ 20,500 $ 30,000

Total Liabilities and Shareholder's Equity $ 168,500 $ 152,000

Building a Balance Sheet: Oakville Ostrich Farm has current assets of $4,000, NFA of $22,500, current liabilities of $3,400, and
long-term debt of $6,800. What is the value of the shareholders' equity account for this firm? How much is net working capital?
Balance sheet, as at December 31, 20XX
CA $ 4,000 CL $ 3,400
NFA 22,500 LTD 6,800
Total assets $ 26,500 Owner equity 16,300
TL & OE $ 26,500

NWC = CA - CL $ 600

Building an Income Statement: Roach Exterminators Inc. has sales of $634,000, costs of $305,000, depreciation expense of
$46,000, interest expense of $29,000, and a tax rate of 35 percent. What is the net income for this firm?
Sales 634,000
Costs 305,000
Depreciation 46,000
EBIT (Earnings before interest and tax 283,000
Interest 29,000
EBT (Earnings before tax) 254,000 Tax rate:
Taxes 88,900 35%
Net income 165,100

Dividend declared & paid $ 86,000

Operating cash flow:

=EBIT + depreciation - tax 240,100

Dividends and Retained Earnings: Suppose the firm in the problem above paid out $86,000 in cash dividends. What is the
addition to retained earnings?

Net income = Dividends + Addition to Retained Earnings

Rearranging: Addition to retained earnings = Net income - Dividends = $165,100 - 86,000
$ 79,100 = Addition to retained earnings
Per-Share Earnings and Dividends: Suppose the firm in the problem above had 30,000 shares of common stock outstanding.
What is the earnings per share, or EPS, figure? What is the dividends per share figure?
EPS = Net income/shares $ 5.50 per share
DPS = Dividends/shares $ 2.87 per share
Market values and book values: Klingon Widgets Inc. purchased new cloaking machinery three years ago for $7 million. The
machinery can be sold to the Romulans today for $3.7 million. Klingon's current balance sheet shows net fixed assets of $2.6
million, current liabilities of $1.3 million, and net working capital of $410,000. If all the current assets were liquidated today, the
company would receive $1.8 million cash. What is the book value of Klingon's assets today? What is the market value?
NWC = CA - CL CA = NWC + CL $ 1,710,000

Book value CA 1,710,000 Market value CA 1,800,000

Book value NFA 2,600,000 Market value NFA 3,700,000
Book value assets 4,310,000 Market value assets 5,500,000

Calculating OCF: Prather Inc. has sales of $14,200, costs of $5,600, depreciation expense of $1,200, and interest expense of $680.
If the tax rate is 35 percent, what is the operating cash flow, or OCF?
Sales 14,200
Costs 5,600
Depreciation 1,200
EBIT 7,400
Interest 680
EBT 6,720
Taxes, at 35% 2,352 0.35
Net income 4,368

OCF = $ 6,248

Calculating Net Capital Spending: Prather Inc.'s 2008 balance sheet showed net fixed assets of $46,000, and the 2009 balance
sheet showed net fixed assets of $52,000. The company's 2009 income statement showed a depreciation expense of $8,750.
What was net capital spending in 2009?
Net capital spending = NFAEND - NFABEG + Depreciation
Net capital spending $ 14,750
Calculating Changes in NWC: Prather Inc.s 2008 balance sheet showed current assets of $1,400 and current liabilities of $870.
The 2009 balance sheet showed current assets of $1,650 and current liabilities of $920. What was the company's 2009 change in
net working capital or NWC?
Change in NWC = NWCEND - NWCBEG
*NWC = CA - CL
Change in NWC: $ 200

Verifying that the cash flow identity holds:

Calculating total cash flows: Calculate the values for the cells highlighted in green, using the information supplied:
Sales 162,000
Costs 93,000
Depreciation 8,400
Other expenses 5,100
EBIT 55,500
Interest 16,500
EBT 39,000 Tax rate:
Taxes 14,820 38%
Net income 24,180
Dividends 9,400
Additions to retained earnings 14,780

Given: Long term debt repaid = 6,400

Cash flow to creditors (CFC) $ 22,900

Given: Net new equity = 7,350

Cash flow to shareholders (CFS) $ 2,050

Cash Flow from Assets (CFA).

CFA = $ 24,950

CFA is also equal to: OCF - Net capital spending - Change in NWC
Operating Cash Flow (OCF or CFO) 49,080 *OCF = EBIT + Depreciation - taxes

New information: NFA increased by $12,000 during the year

Net capital spending = Increase in NFA + Depreciation
$ 20,400
Cash flow from assets = Operating cash flow - Net capital spending - Net working capital spending, therefore:
Change in NWC = OCF - Net capital spending - Cash flow from assets
Solving for NWC: $ 3,730

Check: does it all work out? $ 24,950

Yes. OCF - NCS - NWC spending = CFA

From ch2 Table 2.5 page 38, progressive tax calculation

Take a taxpayer with $150,000 income Federal tax rates Tax owed:
Up to $42,707 15% $ 6,406
$42,708 - 85,414 22% $ 9,396
$85,415 - 132,406 26% $ 12,218
$132,407 and over 29% $ 5,102
Total Tax owed: $ 33,122 Incorrect: $ 43,500
Average tax rate 22%
 Marginal tax rate: 29%

CCA table example

Year Beginning UCC 20%CCA Ending UCC
1 1,000,000 100,000 900,000 28%
2 900,000 180,000 720,000 Tax shield yr 3, with 28% tax rate:
3 720,000 144,000 576,000 40,320
4 576,000 115,200 460,800
5 460,800 92,160 368,640

This calculation can be initiated a little differently however the impact is the same. For example:
 Capital Cost Allowance Schedule

Cost of Capital Asset $ 1,000,000

CCA Rate 20%
Half-year rule applies in year of acquisition.
Asset amortized using the declining balance method.

Year Beginning UCC Additions CCA

1 $ 1,000,000 $ 100,000
2 900,000 180,000
3 720,000 144,000
4 576,000 115,200
5 460,800 92,160
6 368,640 73,728
7 294,912 58,982
8 235,930 47,186
9 188,744 37,749
10 150,995 30,199

If the asset is sold in year 10 for more than $120,796, we would have a recapture; the difference between the selling price
and the closing UCC would be added to taxable income.
If the asset is sold in year 10 for less than $120,796, we would have a terminal loss; the difference between the selling
price and the closing UCC would be deducted from taxable income.
 Closing
UCC Tax shield each year
$ 900,000 $ 25,000
720,000 45,000
576,000 36,000
460,800 28,800
368,640 23,040
294,912 18,432
235,930 14,746
188,744 11,796
150,995 9,437
120,796 7,550
Total: $ 219,801
nce between the selling price

ence between the selling

 7/5/Q1

Simple interest versus compound interest: Bank of Vancouver pays 6 percent simple interest on its savings account
balances, whereas Bank of Calgary pays 6 percent interest compounded annually. If you made a $5,000 deposit in
each bank, how much more money would you earn from your Bank of Calgary account at the end of 10 years?
1 After 10 years:
Bank of Vancouver 300 interest per year
3,000 interest over 10 years 8,000 FV, bank of Vancouver

Bank of Calgary
1 2 3 4 5 6 7 8 9 10
5,000 5,300 5,618 5,955 6,312 6,691 7,093 7,518 7,969 8,447
5,300 5,618 5,955 6,312 6,691 7,093 7,518 7,969 8,447 8,954

8,954 Future value

8,954 Future value, by formula
8,954 By Excel

Calculating future values: For each of the following, compute the future value: 7/5/Q2
Future Value, by
PV Years Interest Rate Future Value formula FV = PV * (1 + r)t
$ 2,250 16 10% $10,339 $10,339 By formula
$ 8,752 13 8% $23,802 $23,802 By cell reference
$ 76,355 4 17% $143,081 $143,081 *Longhand, by calculator
$ 183,796 12 7% $413,944 $413,944 Entering nominal values
Calculating future values: You are scheduled to receive $25,000 in two years. When you receive it, you will invest it
for six more years at 7.9 percent per year. How much will you have in eight years? 7/5/Q19
PV Years Interest Rate Future Value
$ 25,000 6 7.90% $ 39,452 39,452

Calculating present values: For each of the following, compute the present value: 7/5/Q3
To find the PV of a lump sum: PV = FV/(1+r)t
PV can also be found as: PV = FV(1+r)-t

PV, by formula PV, by Excel Years Interest Rate FV

$ 12,211 $12,211 6 4% $ 15,451
$ 24,833 $24,833 7 11% $ 51,557
$ 13,375 $13,375 23 20% $ 886,073
$ 60,965 $60,965 18 13% $ 550,164

Calculating interest rates: Solve for the unknown interest rate in each of the following: 7/5/Q4
Interest Rate, by
PV Years Interest Rate FV Excel r=(FV/PV)(1/t)-1
$ 240.00 2 13.10% $ 307.00 13.10% 13.10%
$ 360.00 10 9.55% $ 896.00 9.55% 9.55%
$ 39,000.00 15 10.50% $ 174,384.00 10.50% 10.50%
$ 38,261.00 30 8.82% $ 483,500.00 8.82% 8.82%
Calculating the number of periods: Solve for the unknown number of years in each of the following: 7/5/Q5
PV Years Interest Rate FV Years, by Excel
$ 560.00 10.78 8.0% $ 1,284.00 10.78 10.78
$ 810.00 19.48 9.0% $ 4,341.00 19.48 19.48
$ 18,400.00 15.67 21.0% $ 364,518.00 15.67 15.67
$ 21,500.00 17.08 13.0% $ 173,439.00 17.08 17.08
t = ln(FV/PV)/ln(1+r)

Calculating interest rates: Solve for the unknown interest rate in each of the following: 7/5/Q6
PV Years Interest Rate Future Value
50,000.00 18 10.04% 280,000.00 r = (FV/PV)^(1/t)-1
50,000.00 18 10.04% 280,000.00 r = (FV/PV)^(1/t)-1 *cell referencing
50,000.00 18 10.04% 280,000.00 By Excel

Calculating the number of periods: Solve for the unknown number of years in each of the following: 7/5/Q7
PV Years Interest Rate Future Value
1 8.04 9.00% 2
Calculating interest rates: Solve for the unknown interest rate : 7/5/Q8
PV Years Interest Rate Future Value
21,608 5 5.29% 27,958

PV Years Interest Rate Future Value 7/5/Q9

40,000 24.05 6.20% 170,000

PV Years Interest Rate Future Value 7/5/Q17

$59,871 10 11.00% 170,000

Example, with multiple level cash flows

The question here is: with deposits of $1,000 at times 1 through 5, what will the final balance in the account be?
0 1 2 3 4 5
1,000 1,000 1,000 1,000 1,000
8.00%
FV = $1,360 $1,260 $1,166 $1,080 $1,000

Total FV = $5,866.60

*In chapter 6 we see that this is an annuity. We can use the same "FV" function in excel, just enter $1,000 as the regular payment:
$5,866.60

Example
0 1 2 3 4 5
1,000 1,000 1,000 1,000 1,000
8%
PV, each separately $ 926 $ 857 $ 794 $ 735 $ 681
Total PV = $ 3,993

*In chapter 6 we see that this is an annuity. We can use the same "PV" function in excel, just enter $1,000 as the regular payment:
$ 3,993
Example from Chapter 5 slides:
0 1 2 3
400 889 432
12%
$1,373.34 $357.14 $708.71 $307.49
Total PV

Investment cost:
$ 1,243.00
Is this a good deal?

Present value and multiple cash flows: Seaborn Co. has identified an investment project with the following cash flows. If the
discount rate is 10 percent, what is the present value of these cash flows? What is the present value at 18 percent? At 24
percent? 7/6/Q1
Year Cash Flow
1 $ 1,100 $1,000.00 10% 18% 2619.72
2 720 $595.04 24% 2339.03
3 940 $706.24
4 1,160 $792.30
$3,093.57
FVA Example: Murray and Celina have an annuity where they receive $500 at the end of each year over 5 years. Calculate the future value, assuming they
deposit each payment in a bank account.
Time 0 1 2 3 4
Cash Flow 0 500 500 500 500
FVs $787 $702 $627 $560
12% Total FV

Present value and multiple cash flows: Investment X offers to pay you $7,000 per year for eight years. Investment Y offers to pay you $9,000 per year for five years. Wh
of these cash flow streams has the higher present value if the discount rate is 5 percent? If the discount rate is 22 percent?
X: $7,000 per year, 5% annual, 8 years The PVA formula: PVA = C(1-(1/(1+r)t))/r
Y: $9,000 per year, 5% annual, 5 years

X@5%: $45,242.49 0 5%
Y@5%: $38,965.29 1 7,000 6,667
2 7,000 6,349
X@22%: $25,334.87 3 7,000 6,047
Y@22%: $25,772.76 4 7,000 5,759
5 7,000 5,485
6 7,000 5,224
7 7,000 4,975
8 7,000 4,738
45,242.49

-$13,826.92 Using a 22% discount rate:

 -$700.41 0 22%
1 7,000 5,738
2 7,000 4,703
3 7,000 3,855
4 7,000 3,160
5 7,000 2,590
6 7,000 2,123
7 7,000 1,740
8 7,000 1,426
25,334.87

Calculating annuity future value: An investment offers $4,600 per year for 15 years, with the first payment occurring one year from now. If the required return is 8
percent, what is the value of the investment? What would the value be if the payments occurred for 40 years? For 75 years?
# Periods Payment Rate per period FVA
15 4,600 8% 124,900
40 4,600 8% 1,191,660
75 4,600 8% 18,411,760

Annuity Future Values: Paradise Inc. has identified investments with the following cash flows. If the discount rate is .8 percent per period, what is the future value of
these cash flows?
PV # Periods Payment Rate per period FVA
0 30 700 0.8% 23,628
0 20 950 0.8% 20,516
0 10 1,200 0.8% 12,441

Annuity present value: An investment offers $4,600 per year for 15 years, with the first payment occurring one year from now. If the required return is 8 percent, what
the value of the investment? What would the value be if the payments occurred for 40 years? For 75 years? Forever?
PVA # Periods Payment Rate per period
39,374 15 4,600 8%
54,853 40 4,600 8%
57,321 75 4,600 8%
57,500 999 4,600 8%
*This last one is actually called a "Perpetuity". The PV PERPETUITY formula is: PVP = C/r
57,500 PV perpetuity, by formula.
Annuity present value: Your company will generate $65,000 in annual revenue each year for the next eight years from a new information database. If the appropriate
interest rate is 8.5%, what is the present value of the savings?
PVA # Periods Payment Rate per period
366,547 8 65,000 9%

Calculating EAR: Find the EAR in each of the following cases:

Find the EAR in each of the following cases:
APR (stated rate) # of time compounEffective Rate (EAR) Effective rate = (1 + APR/m)m/n - 1)
7% Quarterly
18% Monthly
10% Daily
14% Infinite *rough approximation (set n to a very large value)
EAR with infinite compounding: EAR = eq - 1

Calculating rates of return: An investment offers to triple your money in 12 months (don't believe it ;-) ). What rate of return per quarter are you being offered?
Hint: Since we are looking to triple our money, the PV and FV are irrelevant as long as the FV is three times as large as the PV. The number of periods is four, the numbe
quarters per year. So:

FV = $3 = $1(1+r)^(12/3)
 re value, assuming they

5
500
$500
$3,176

you $9,000 per year for five years. Which

5%
9,000 8,571
9,000 8,163
9,000 7,775
9,000 7,404
9,000 7,052

38,965.29
 22%
9,000 7,377
9,000 6,047
9,000 4,956
9,000 4,063
9,000 3,330

25,772.76

m now. If the required return is 8

period, what is the future value of

he required return is 8 percent, what is

mation database. If the appropriate

quarter are you being offered?

number of periods is four, the number of
Perpetuities and Growing Perpetuities: chart examples
Imagine a scholarship where the donor would like to support a $6,000 payout every year. The interest rate is 5%.

PVP $ 120,000
Rate 5.0%

Time Account value Scholarship paid

0 120,000
1 126,000 (6,000) Account value
1 120,000 128,000
2 126,000 (6,000) 126,000
2 120,000 124,000
3 126,000 (6,000) 122,000
3 120,000 120,000
4 126,000 (6,000) 118,000
4 120,000 116,000
0 1 2 3 4 5
5 126,000 (6,000)
5 120,000
6 126,000 (6,000)
6 120,000
7 126,000 (6,000)

Now, imagine a scholarship where the donor would like to support a first-year payout of $6,000 and an annual scholarship grow

PVPG $ 300,000
Rate 5.0%
Growth rate 3.0%

Time Account value Scholarship paid

0 300,000 Account value
1 315,000 (6,000)
1 309,000
2 324,450 (6,180) 400,000
2 318,270
3 334,184 (6,365)
3 327,818 380,000
4 344,209 (6,556)
4 337,653
5 354,535 (6,753)
360,000
5 347,782
6 365,171 (6,956)
6 358,216
340,000
7 376,126 (7,164)
7 368,962
8 387,410 (7,379)
320,000
8 380,031

300,000
0 2 4 6
 320,000

9 399,033 (7,601)
9 391,432
300,000
10 411,004 (7,829) 0 2 4 6
10 403,175
rate is 5%.

Account value

3 4 5 6 7 8

n annual scholarship growth rate of 3%.

Account value

4 6 8 10 12
4 6 8 10 12
Finding PVA and FVA for growing annuity by formula

Example: PVAG and FVAG Calculator. Enter values in green cells

125 C -
0.005 r (per month) -
0.002 g 0.000
50 t (months) 0

5,785 = PVAG = (C/(r-g)) * (1-((1+g)/(1+r))^t) -

7,424 = FVAGROWTH = P * (((1+r)^n - (1+g)^n) / (r-g)) -

Finding PVA for growing annuity using the Net Growth Rate approach
0.299401% Net growth rate = (1 + i)/(1 + g) -1
5,785 *Note: payment must be divided by (1+g)
7,424 Future value

5,785 Check total present value, longhand 7,424

Cash flow Period
$ 125.00 1 $159.61
$ 125.25 2 $159.13
$ 125.50 3 $158.65
$ 125.75 4 $158.18
$ 126.00 5 $157.71
$ 126.26 6 $157.24
$ 126.51 7 $156.77
$ 126.76 8 $156.30
$ 127.01 9 $155.83
$ 127.27 10 $155.37
$ 127.52 11 $154.90
$ 127.78 12 $154.44
$ 128.03 13 $153.98
$ 128.29 14 $153.52
$ 128.55 15 $153.06
$ 128.80 16 $152.61
$ 129.06 17 $152.15
$ 129.32 18 $151.70
$ 129.58 19 $151.24
$ 129.84 20 $150.79
$ 130.10 21 $150.34
$ 130.36 22 $149.89
$ 130.62 23 $149.45
$ 130.88 24 $149.00
$ 131.14 25 $148.55
$ 131.40 26 $148.11
$ 131.67 27 $147.67
$ 131.93 28 $147.23
$ 132.19 29 $146.79
$ 132.46 30 $146.35
$ 132.72 31 $145.91
$ 132.99 32 $145.48
$ 133.25 33 $145.04
$ 133.52 34 $144.61
$ 133.79 35 $144.18
$ 134.05 36 $143.75
$ 134.32 37 $143.32
$ 134.59 38 $142.89
$ 134.86 39 $142.47
$ 135.13 40 $142.04
$ 135.40 41 $141.62
$ 135.67 42 $141.19
$ 135.94 43 $140.77
$ 136.21 44 $140.35
$ 136.49 45 $139.93
$ 136.76 46 $139.52
$ 137.03 47 $139.10
$ 137.31 48 $138.68
$ 137.58 49 $138.27
$ 137.86 50 $137.86
 PV of an arithmetic gradient
25 G (the dollar increase each period)
FVAG Calculator. Enter values in green cells 12% I (the rate per period)
C 12 n
r (per period) $648.81 PV gradient
g
t (in periods)
Texas A&M, Lee Lowery
= PVAG = (C/(r-g)) * (1-((1+g)/(1+r))^t) *Thanks to Troy Shapley for finding this useful resource.
= FVAGROWTH = P * (((1+r)^n - (1+g)^n) / (r-g))
Example: On December 31st, Julio makes a New Years resolution to begin making deposits into his Tax-Free Saving
Account, beginning next year. His first deposit will be $100, and he will make each subsequent deposit exactly $25
than the previous. Calculate the present value of his deposits for the first year.

PV of 12 $100 deposits: $619.44 25

PV of arithmetic gradient: $648.81 12%
Total present value: $1,268.24 12
$648.81

Check FV, longhand

*Check, longhand 12%
1 100 $89.29 $1,268.24
2 125 $99.65
References: 3 150 $106.77
Financeformulas.net, FV of Growing annuity 4 175 $111.22
Financeformulas.net, Growing Annuity 5 200 $113.49
TVMCalcs.com 6 225 $113.99
7 250 $113.09
8 275 $111.07
9 300 $108.18
10 325 $104.64
11 350 $100.62
12 375 $96.25
ts into his Tax-Free Savings
quent deposit exactly $25 larger

G (the dollar increase each period)

I (the rate per period)
n
PV gradient
Rudy's RRSP
1. In his RRSP, Rudy plans to contribute $5,000 at the end of each year for the next 20 years. He expects
a return of 6.5% compounded monthly. What is his expected year-20 balance?

2. What is his expected balance if we assume that his contributions will increase by 2% each year?
6.50%
Part 1: Part 2:
Periods 20 5,000 C
Rate/pd 6.70% 6.70% Rate/pd
PV 0 2.00% g
Payment 5000 20 years
FV $ 198,326 $ 231,043 = FVAGROWTH = P * (((1+r)^n - (1+g)^n) / (r-g))
$63,188 = PVAG = (C/(r-g)) * (1-((1+g)/(1+r))^t)
Carpenter Inc. has 8 percent coupon bonds on the market that have 10 years left to maturity. The bonds make annual payments. If the YTM on these bond
the current bond price?
80 Coupon, once per year
10 years remaining
9.0% YTM - this is our discount rate, stated as an APR
$935.82 Current price

0 1 2 3 4 5 6 7 8
80 80 80 80 80 80 80 80

$ (73.39) $ (67.33) $ (61.77) $ (56.67) $ (51.99) $ (47.70) $ (43.76) $ (40.15)

$ 935.82
$935.82

Bond Yields: Linebacker Co. has 7 percent coupon bonds on the market with nine years left to maturity. The bonds make annual payments. If the bond cu
what is its YTM?

0 1 2 3 4 5 6 7 8
70 70 70 70 70 70 70 70

Coupon Rate Face Value Coupon Payment Periods YTM (Discount Rate) Price
7.0% $ 1,000 $ 70 9 $ (1,080.00)
By approximation: 5.8761%

Coupon rates: Hawk Enterprises has bonds on the market making annual payments, with 16 years to maturity, and selling for $870. The bonds have a YTM
the coupon rate be on the bonds?
Coupon Rate Face Value Coupon Payment Periods YTM (Discount Rate) Price
1000 16 7.5% $ (870.00)

Bond Prices: Cutler Co. issued 11-year bonds a year ago at a coupon rate of 7.8%. The bonds make semi-annual payments. If the YTM on these bonds is 8.6%, what is t
$ 39.00 Coupon, every 6 months
20 periods remaining
 4.30% YTM, per period
$ 1,000.00 Face value
$947.05 Current price

Bond X is a premium bond making annual payments 9% annual coupon, YTM 7%, 13 years to maturity If interest rates don't change, find the price at the f
Coupon Rate Face Value Coupon Payment Periods YTM (Discount Rate) Price
9.0% $ 1,000 $ 90 13 7.0%
9.0% $ 1,000 $ 90 12 7.0%
9.0% $ 1,000 $ 90 11 7.0%
9.0% $ 1,000 $ 90 10 7.0%
9.0% $ 1,000 $ 90 9 7.0%
9.0% $ 1,000 $ 90 8 7.0%
9.0% $ 1,000 $ 90 7 7.0%
9.0% $ 1,000 $ 90 6 7.0%
9.0% $ 1,000 $ 90 5 7.0%
9.0% $ 1,000 $ 90 4 7.0%
9.0% $ 1,000 $ 90 3 7.0%
9.0% $ 1,000 $ 90 2 7.0%
9.0% $ 1,000 $ 90 1 7.0%
9.0% $ 1,000 $ 90 0 7.0%

BOND Y
Coupon Rate Face Value Coupon Payment Periods YTM (Discount Rate) Price
7.0% $ 1,000 $ 70 13 9.0%
7.0% $ 1,000 $ 70 12 9.0%
7.0% $ 1,000 $ 70 11 9.0%
7.0% $ 1,000 $ 70 10 9.0%
7.0% $ 1,000 $ 70 9 9.0%
7.0% $ 1,000 $ 70 8 9.0%
7.0% $ 1,000 $ 70 7 9.0%
7.0% $ 1,000 $ 70 6 9.0%
7.0% $ 1,000 $ 70 5 9.0%
7.0% $ 1,000 $ 70 4 9.0%
7.0% $ 1,000 $ 70 3 9.0%
7.0% $ 1,000 $ 70 2 9.0%
7.0% $ 1,000 $ 70 1 9.0%
7.0% $ 1,000 $ 70 0 9.0%
ts. If the YTM on these bonds is 9 percent, what is

9 10
80 80
1000
$ (36.83) $ (33.79)
$ (422.41)

al payments. If the bond currently sells for $1,080,

9
70

870. The bonds have a YTM of 7.5%. What must

these bonds is 8.6%, what is the current bond price?

ange, find the price at the following times:
Bond pricing example (convergence to par value)
30 year $1,000 bond, 8% coupon, semi-annual payments

YTM 0.060 0.100

$1,400
Periods Remaining Price, YTM = 0.06 Price, YTM = 0.1
60 $1,277 $811
$1,200
59 $1,275 $811
58 $1,273 $812
57 $1,272 $812 $1,000
56 $1,270 $813
55 $1,268 $814 $800
54 $1,266 $814
Column B
53 $1,264 $815 $600 Column C
52 $1,262 $816
51 $1,260 $817 $400
50 $1,257 $817
49 $1,255 $818
$200
48 $1,253 $819
47 $1,250 $820
46 $1,248 $821 $0
45 $1,245 $822 1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61
44 $1,243 $823
43 $1,240 $825
42 $1,237 $826
41 $1,234 $827
40 $1,231 $828
39 $1,228 $830
38 $1,225 $831
37 $1,222 $833
36 $1,218 $835
35 $1,215 $836
34 $1,211 $838
33 $1,208 $840
32 $1,204 $842
31 $1,200 $844
30 $1,196 $846
29 $1,192 $849
28 $1,188 $851
27 $1,183 $854
26 $1,179 $856
25 $1,174 $859
24 $1,169 $862
23 $1,164 $865
22 $1,159 $868
21 $1,154 $872
20 $1,149 $875
19 $1,143 $879
18 $1,138 $883
17 $1,132 $887
16 $1,126 $892
15 $1,119 $896
14 $1,113 $901
13 $1,106 $906
12 $1,100 $911
11 $1,093 $917
10 $1,085 $923
9 $1,078 $929
8 $1,070 $935
7 $1,062 $942
6 $1,054 $949
5 $1,046 $957
4 $1,037 $965
3 $1,028 $973
2 $1,019 $981
1 $1,010 $990
0 $1,000 $1,000
Column B
Column C
TB Ch8 Q8: Big Pond Inc has an issue of preferred stock outstanding that pays a $5.50 dividend every year, in perpetuity. If this
$108 per share, what is the required return?
PVP (or price) = D / r r=

TB Ch8 Q10: Foxtrap Bearings is a young start-up company. No dividends will be paid on the stock over the next nine years bec
plow back its earnings to fuel growth. The company will pay a $10 per share dividend in 10 years and will increase the dividend
thereafter. If the required return on this stock is 14 percent, what is the current share price?

Discussion: Here the stock pays no dividend for 10 years. Once the stock begins paying dividends, it will have a constant growth
can use the constant growth model at that point. It is important to use the constant growth formula.
Price, at time nine 111.11
Price, time zero

Stock Values: The JT Clothing Company just paid a dividend of $1.60 per share on its stock. The dividends are expected to grow
percent per year, indefinitely. If investors require a 12 percent return on the stock, what is the current price? What will the pric
fifteen years?
The constant dividend growth model is:
Pt = Dt x (1 + g) / (R - g)

So the price of the stock today is:

P0 = D0 x (1 + g) / (R - g)
=1.60*(1.06)/(.12-.06)

Next, the price at year 3. We'll need the dividend at year __four_______ for this:
P3 = D3 x (1 + g) / (R - g)
=1.60*(1.06)^4/(.12-.06)

Next, the price at year 15. We'll need the dividend at year __sixteen_______ for this:
P15 = D15 x (1 + g) / (R - g)
=1.60*(1.06)^16/(.12-.06)

Stock Values: The next dividend payment by Top Knot Inc. will be $2.50 per share. The dividends are anticipated to maintain a
forever. If the stock currently sells for $48.00 per share, what is the required return?
Using the constant growth model, we can solve the equation for R.
R = (D1/P0) + g = 2.5/48 + .05

Stock Values: For the company in the previous problem, what is the dividend yield? What is the expected capital gains yield?
Dividend yield = next year's dividend/current price
= D1/P0
Capital gains yield - same idea as the dividend growth rate

Stock Values: Stairway Corporation will pay a $3.60 per share dividend next year. The company pledges to increase its dividend
indefinitely. If you require an 11 percent return on your investment, how much will you pay for the company's stock today?
Using the constant growth model, we find the price of the stock today is:
P0 = D1/(r-g) = $3.60/(.11-.045)

Stock Valuation: Listen Close Company is expected to maintain a constant 6.5 percent growth rate in its dividends indefinitely.
If the company has a dividend yield of 3.6%, what is the required return on the company's stock?

The required return of a stock is made up of two parts: The dividend yield and the capital gains yield. So, the required return
of this stock is:
R = Dividend yield + Capital gains yield

Stock Valuation: Suppose you know that a company's stock currently sells for $60 per share and the required return on the sto
also know that the total return on the stock is evenly divided between a capital gains yield and a dividend yield. If it's the comp
maintain a constant growth rate in its dividends, what is the current dividend per share?
Dividend yield = .5 * .12 = .06 = Capital Gains yield
D1= Dividend yield = D1/P0

This is the dividend next year. The question asks for the dividend this year.

D1 = D0 (1 + .06) D0 = 3.60 / 1.06

Stock Valuation: No More Corporation pays a constant $11 dividend on its stock. The company will maintain this dividend for th
will then cease paying dividends forever. If the required return on this stock is 10 percent, what is the current share price?
What kind of cash flow stream is this? It is a regular annuity.
11 PMT
10% RATE
8 NPER
Value (PV)

Valuing Preferred Stock: Ayden Inc. has an issue of preferred stock outstanding that pays a $6.50 dividend every year in perpet
currently sells for $113 per share, what is the required return?
P0 = D/R, or R = D/P0
R= $6.50/$113

Ch8, Q&P #1
Current price (Pzero) =D1/(r-g) =(1.45*1.06)/(.11-.06)
Price at t=3 =D4/(r-g) =(1.45*1.06^4)/(.11-.06)
Price at t=15 =D16/(r-g) =(1.45*1.06^16)/(.11-.06)

Ch8, Q&P #2 r = Dt+1 / Price + g =1.89/38 + .05

Ch8, Q&P #4 Price = Dt+1 / (r-g) =3.4/(0.11-0.045)
Ch8, Q&P #7 Price = PVA =PV(0.1,11,-9.75,0)
Ch8, Q&P #13 On White Board
Ch8, Q&P #15 Price = Dt+1 / (r-g) =(9.4*(1+-0.04)) / (0.1--0.04)

CR#5

The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred. The
preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth more,
depending on the circumstances.
CR #10
Investors buy such stock because they want it, recognizing that the shares have no voting power. Presumably, investors pay a
little less for such shares than they would otherwise.
end every year, in perpetuity. If this issue currently sells for

e stock over the next nine years because the firm needs to
years and will increase the dividend by 5 percent per year
?

dends, it will have a constant growth rate of dividends. We

formula.

The dividends are expected to grow at a constant rate of 6

he current price? What will the price be in three years? in
Q1/8/7

dends are anticipated to maintain a 5 percent growth rate

Q2/8/7

s the expected capital gains yield? Q3/8/7

any pledges to increase its dividend by 4.5% per year

for the company's stock today? Q4/8/7
 th rate in its dividends indefinitely.
stock? Q5/8/7

ains yield. So, the required return

and the required return on the stock is 12 percent. You

and a dividend yield. If it's the company's policy to always
Q6/8/7

any will maintain this dividend for the next eight years and
what is the current share price? Q7/8/7

$6.50 dividend every year in perpetuity. If this issue

Q8/8/7
s fixed on the preferred. The
he preferred could be worth more,

ower. Presumably, investors pay a

 P/E Ratio - Potential problem

An analyst is reviewing financial information for the

Cornerstone Corporation and the ACME Corporation.
The information they have collected, and their
income forecasts, are shown below:

Cornerstone ACME
Price per share $ 50.00 $ 50.00
Shares outstanding 750,000 750,000
Forecasted Net Income $ 1,500,000 $ 500,000
Earnings per share
P/E Ratio = PPS/EPS
Present value of a football player's future earnings
Discount rate: PV of investor's 20% share Cost: Result for investor
0% $ 13,908,429 $ 10,000,000 $ 3,908,429
5% $ 9,962,929 $ 10,000,000 $ (37,071)
15% $ 6,015,402 $ 10,000,000 $ (3,984,598)
*Note: the discount rate we use should reflect the risk of future cash flows to the investor.

Discount Rate 5%
My forecast for Arian
Period Foster's earnings Present values Total present value Investor's Share at 20%
1 $ 5,255,000 $ 5,004,762 $ 49,814,647 $ 9,962,929.34
2 $ 5,412,650 $ 4,909,433
3 $ 5,575,030 $ 4,815,920
4 $ 5,742,280 $ 4,724,188
5 $ 5,914,549 $ 4,634,204
6 $ 6,091,985 $ 4,545,933
7 $ 6,274,745 $ 4,459,344
8 $ 6,462,987 $ 4,374,404
9 $ 6,656,877 $ 4,291,082
10 $ 6,856,583 $ 4,209,347
11 $ 500,000 $ 292,340 Transition to broadcasting
12 $ 515,000 $ 286,771
13 $ 530,450 $ 281,309
14 $ 546,364 $ 275,951
15 $ 562,754 $ 270,694
16 $ 579,637 $ 265,538
17 $ 597,026 $ 260,481
18 $ 614,937 $ 255,519
19 $ 633,385 $ 250,652
20 $ 652,387 $ 245,878
21 $ 671,958 $ 241,194
22 $ 692,117 $ 236,600
23 $ 712,880 $ 232,093
24 $ 734,267 $ 227,673
25 $ 756,295 $ 223,336

Viewed Dec. 23, 2013 http://profootballtalk.nbcsports.com/2013/10/17/company-plans-to-sell-stock-in-players-starting-with-arian-foster/

Calculating returns: Suppose a stock had an initial price of $84 per share, paid a
dividend of $2.05 per share during the year, and had an ending share price of $97.
Compute the percentage total return. 7/Q1
R= *with dividend
*without the dividend

Calculating Yields: In the previous problem, what was the dividend yield? The capital
gains yield? 7/Q2
Dividend yield
Capital gain yield

Return Calculations: Rework Problems 1 and 2 assuming the ending share price is
$79. 7/Q3
R=
Dividend yield
Capital gain yield

Calculating returns and variability: Using the following returns, calculate the
arithmetic average returns, the variances, and the standard deviations for X and Y. 7/Q7
Year X Y
1 6% 18%
2 24% 39%
3 13% -6%
4 -14% -20%
5 15% 47%
Average
Standard Deviation
STDEV.S
Chapter 9: Net Present Value and Other Investment Criteria
Capital Budgeting Decision Criteria

Discount rate 10.00%

Time 0 1 2 3
Cash flows -50,000 10,000 10,000 15,000
Running tally for payback

Discounted cash flows

Running tally for discounted payback

NPV
IRR *Be sure to solve this manually, using trial & error.
PI
 4 5
15,000 20,000
Years, for full year payback
Years, for part year payback

Years, for discounted payback using full years

Years, for discounted payback using partial years

trial & error.

Payback, from the slides: ABC company
Time 0 1 2 3 4
Cash Flow -100 20 40 50 100
Running Tally
Full year payback
Part year payback

Discounted payback, from the slides: ABC Company

Time - 1 2 3 4
Projected cash flow -100 20 40 50 100
Discounted cash flows
Running Tally
Now…after discounting, we do our running tally on the Discounted Cash Flows, not the original.

Discount rate 20% Full year discounted payback:

Part year discounted payback:

Calculating payback: Old Country Inc. imposes a payback cutoff of three years for its international investment projects. If the company has
the following two projects available, should it accept either project?
Year 0 1 2 3 4
Cash flow A (50,000) 35,000 21,000 10,000 5,000
Running tally, A

Cash flow B (70,000) 15,000 22,000 31,000 240,000

Running tally, B

Discounted Payback
Year 0 1 2 3 4
Cash Flow (8,000) 6,500 7,000 7,500 8,000
PV at 14%
Running tally, on DCFs
 14% *Sign switched to positive somewhere in year 2*
Calculate:
Full year discounted payback
Partial year discounted payback

Calculating NPV at various discount rates

NPV (add across) Discount Rate 0 1 2
14,000 0.0% (30,000) 13,000 19,000
5.0% (30,000)
10.0% (30,000)
15.0% (30,000)
25.0000% (30,000)

Calculating NPV and IRR

Year Cash flow, project A Cash flow, project B
10.00% 10.00%
0 (37,000) (37,000)
1 19,000 6,000
2 14,500 12,500
3 12,000 19,000
4 9,000 23,000
NPV
IRR
*Accept A based on IRR, but the decision is meaningless as we are comparing mutually exclusive projects.

Profitability Index Example, with Capital Rationing: Your company has $50 million to spend on capital projects in the coming year, using the PI criteria which
projects will you select?
Project Investment DCF PI NPV
A $ (10) $ 12 1.21 $ 2.10
B $ (25) $ 30 1.19 $ 4.75
C $ (20) $ 24 1.20 $ 4.00
D $ (15) $ 15 1.01 $ 0.15
 Total NPV, using PI: *Do A, C, want B but can't, so pick D
Choose only projects B & C: *Spend $45M, left with $5 M unspent

Discussion:
In order from highest PI to lowest PI, until your $50 million is used up, you would select:
Project A leaving $40 m.
Project C leaving $20 m.
Project D (since you do not have enough for project B) leaving $5m.
The total NPV of your choices would be $6.25 million. Is this the best mix using NPV criteria?
No – If you were to select projects B and C, you would obtain NPV of $8.75 million.

Problems with IRR: The CFO of Sweet Petroleum Inc. is trying to evaluate a generation project with the following cash flows:
Year 0 1 2
Cash Flow (27,000,000) 46,000,000 (6,000,000)
DCFs at 10% (27,000,000) 41,818,182 (4,958,678) NPV
Based on the NPV approach, this project is acceptable because, at a discount rate of 10%, it has a positive NPV.

b. Compute the IRR for this project. How many IRRs are there? Using the IRR decision rule, should the company accept the project? What's happening here?
The equation for the IRR of the project is:
0 = -$27,000,000 + $46,000,000/(1 + IRR) - $6,000,000/(1 + IRR)^2
From Descartes' rule of signs, we know that there could be as many as two positive IRRs.

Year 0 1 2 NPV
Cash Flow (27,000,000) 46,000,000 (6,000,000) -
0.00
*Note: Goal Seek provides only 1 solution. IRR does the same thing.

Chapter 9, Question 18 - from the 8th edition of the book.

Rate NPV 0 1 2 3
1000% ($658,132) $ (684,680) $ 263,279 $ 294,060 $ 227,604
100% ($440,178)
75% ($377,157) IRR 16.23%
50% ($276,588)
25% ($97,909)
0% $274,619 NPV
$400,000

$200,000

$0
0% 200% 400% 600% 800% 1000% 1200%

($200,000)

($400,000)

($600,000)

($800,000)
years
years

years
years

Q3 7CE/Ch9

years
part years

years
part years

Q4
 years
years

Q7, Q8
3
12,000

Q12

using the PI criteria which

A, C, want B but can't, so pick D
nd $45M, left with $5 M unspent

Q14

9,859,504

? What's happening here?

Discount Rate
56.14%
-85.77%
*By trial & error

4
$ 174,356
1000% 1200%
Year 0 1 2 3 4
Cashflow (252) 1,431 (3,035) 2,850 (1,000)

IRR Guess 1%
Excel Calcs 25%

IRR Guess 35%

Excel Calcs 33%

IRR Guess 45%

Excel Calcs 43%

IRR Guess 70%

Excel Calcs 67%
Ferdinand Gold Mining
Year Cash Flow
0 (450,000,000)
1 63,000,000
2 85,000,000
3 120,000,000
4 145,000,000
5 175,000,000
6 120,000,000
7 95,000,000
8 75,000,000
9 (70,000,000)
IRR
AB Enterprises, from lecture slides
Projected (Pro Forma) Income Statements
Year 0 1 2 3
Sales $ 50,000 $ 50,000 $ 50,000
Variable Costs 30,000 30,000 30,000
Fixed Costs 5,000 5,000 5,000
Depreciation 7,000 7,000 7,000
EBIT 8,000 8,000 8,000
Taxes (34%) 2,720 2,720 2,720
Net income 5,280 5,280 5,280

Projected OCF 12,280 12,280 12,280

Change in NWC (10,000) 10,000
Capital Expenditures (21,000) -
Total (31,000) 12,280 12,280 22,280
0 1 2 3
$ 655
 Chapter 10: The Majestic Mulch and Compost Company
Proforma Income Statements
0 1 2 3 4 5
Unit Sales 3,000 5,000 6,000 6,500 6,000
Unit Price $ 120 $ 120 $ 120 $ 110 $ 110

Revenues $ 360,000 $ 600,000 $ 720,000 $ 715,000 $ 660,000

Variable Costs $ 60 180,000 300,000 360,000 390,000 360,000
Fixed Costs $ 25,000 25,000 25,000 25,000 25,000 25,000
CCA 80,000 144,000 115,200 92,160 73,728
Terminal Loss
EBIT $ 75,000 $ 131,000 $ 219,800 $ 207,840 $ 201,272
Taxes 40% 30,000 52,400 87,920 83,136 80,509
Net Income $ 45,000 $ 78,600 $ 131,880 $ 124,704 $ 120,763

Proforma Annual Cash Flows

EBIT $ 75,000 $ 131,000 $ 219,800 $ 207,840 $ 201,272
plus: CCA 80,000 144,000 115,200 92,160 73,728
plus: Terminal Loss
less: Taxes 30,000 52,400 87,920 83,136 80,509
OCF $ 125,000 $ 222,600 $ 247,080 $ 216,864 $ 194,491
NWC Investment (20,000) (34,000) (36,000) (18,000) 750 8,250
CapX and Salvage (800,000)
Total Cash Flows (820,000) 91,000 186,600 229,080 217,614 202,741
Payback (820,000) (729,000) (542,400) (313,320) (95,706) 107,035

15.0%
Discounted cash flows (820,000) 79,130 141,096 150,624 124,422 100,798
Discounted Payback (820,000) (740,870) (599,773) (449,149) (324,728) (223,930)

NPV $ 4,734 4,117 4,734.39

IRR 15.2%
PI 1.006
Payback 5.00 4.47
Disc. Payback 8.00 7.95

Majestic Mulch and Compost - Net Present Value Calculation and an explanation of a potential NPV error in Excel

0 1 2 3 4 5 6
$ (820,000) $ 91,000 $ 186,600 $ 229,080 $ 217,614 $ 202,741 $ 175,093

15% Discount Rate (Required return on projects like this)

NPV as computed by Excel:
$4,003.40 is this correct? No!
=NPV(A6,A4:I4)

Discounted cash flows:

$ (820,000) $ 79,130 $ 141,096 $ 150,624 $ 124,422 $ 100,798 $ 75,698

Sum of the discounted cash flows:

$ 4,603.91

Why was the Excel calculation wrong? Excel assumed that the -$820,000 initial expense occurred at the END of the first year!

Correction:
4,603.91
=NPV($A6,B4:I4)+A4
pany

6 7 8 CCA Schedule
5,000 4,000 3,000 CCA Rate 20%
$ 110 $ 110 $ 110 Year Beg UCC Additions CCA
1 $ - $ 800,000 $ 80,000
$ 550,000 $ 440,000 $ 330,000 2 720,000 - 144,000
300,000 240,000 180,000 3 576,000 - 115,200
25,000 25,000 25,000 4 460,800 - 92,160
58,982 47,186 37,749 5 368,640 - 73,728
995 6 294,912 - 58,982
$ 166,018 $ 127,814 $ 86,256 7 235,930 - 47,186
66,407 51,126 34,503 8 188,744 - 37,749
$ 99,611 $ 76,688 $ 51,754 Salvage Value
Terminal Loss

$ 166,018 $ 127,814 $ 86,256 Net Working Capital Schedule

58,982 47,186 37,749 15%
995 Year Revenues NWC ∆ NWC
66,407 51,126 34,503 0 $ 20,000 $ 20,000
$ 158,593 $ 123,874 $ 90,497 1 $ 360,000 54,000 34,000
16,500 16,500 66,000 2 600,000 90,000 36,000
150,000 3 720,000 108,000 18,000
175,093 140,374 306,497 4 715,000 107,250 (750)
282,128 422,503 729,000 5 660,000 99,000 (8,250)
6 550,000 82,500 (16,500)
7 440,000 66,000 (16,500)
75,698 52,772 100,195 8 330,000 49,500 (16,500)
(148,232) (95,460) 4,734

error in Excel

7 8
$ 140,374 $ 306,099
 $ 52,772 $ 100,064

e END of the first year!

 End UCC
$ 720,000
576,000
460,800
368,640
294,912
235,930
188,744
150,995
150,000
$ 995
Various approaches to OCF
Basic: OCF = EBIT + Depreciation - Taxes
Bottom up: OCF = Net Income + Depreciation
Top - down: OCF = Sales - Costs - Taxes
Tax shield: OCF = (Sales - Costs)x(1-Tc) + Depreciation x Tc

OCF from several approaches: A proposed new project has projected sales of $96,000, costs of $49,000, and CCA of $4,500.
The tax rate is 35%. Calculate operating cash flow using the four different approaches described in the chapter and verify
that the answer is the same in each case.
Sales 96,000
Variable costs 49,000
Depreciation 4,500
EBIT 42,500
Interest - OCF Basic OCF = EBIT + Depreciation - Taxes
EBT 42,500 OCF Top down Top down OCF: OCF = Sales - Costs - Taxes
Taxes, at 35% 14,875 OCF Tax shield Tax shield approach to OCF: OCF = (Sales-Costs)(1-Tc) +
Net Income 27,625 OCF Bottom up Bottom up OCF: OCF = Net Income + Depreciation

Parker & Stone Inc. is looking at setting up a new manufacturing plant in South Park to produce garden tools. The company
bought some land six years ago for $5 million in anticipation of using it as a warehouse and distribution site, but the
company has since decided to rent these facilities from a competitor instead. If the land were sold today, the company
would net $5.3 million. The company wants to build its new manufacturing plant on this land; the plant will cost $11.6
million to build, and the site requires $425,000 worth of preparation (grading) before it is suitable for construction. What is
the proper cash-flow amount to use as the initial investment in fixed assets when evaluating this project. Why?

Initial Cost: million

Calculating Depreciation: A new electronic process monitor costs $925,000. This cost could be depreciated at 30 percent per
year (Class 10). The monitor would actually be worthless in five years. The new monitor would save $490,000 per year
before taxes and operating costs. If we require a 12 percent return, what is the NPV of the purchase? Assume a tax rate of
40 percent.
Cash flow, time zero
Cash flow, years 1 - 5 294,000 0 1 2 3 4
PV of year 1 - 5 After tax CF 294,000 294,000 294,000 294,000
PV of CCATS
NPV

NPV and NWC Requirements: In the previous question, suppose the new monitor also requires us to increase net working
capital by $36,200 when we buy it. Further suppose that the monitor could actually be worth $100,000 in five years. What
is the new NPV?
Cash flow, time zero:
Cash flow, years 1 - 5 294,000 0 1 2 3 4
PV of year 1 - 5 After tax CF (961,200) 294,000 294,000 294,000 294,000
Ending cash flow
PV of ending cash flow
PV of CCATS
NPV

EAC: HaroldCo is a leading manufacturer of electronic brains for robots. The company is considering two alternative
production methods. The costs and lives associated with each are:
Year Method 1 Method 2
0 -6600 -9100
1 -800 -520
2 -800 -520
3 -800 -520
4 -520
*Note: after our class discussion I changed the values for Method 1, to demonstrate how EAC can change our decision.

Assuming that the company will not replace the equipment when it wears out, which should it buy? If the company is going
to replace the equipment, which should it buy (r = 13%)? Ignore depreciation and taxes in answering.
Assuming Replacement:
Method 1, PV of costs at 13% *These are the "without replacement" numbers.
Method 2, PV of costs at 13%

Difference: $0.00
Method 1, EAC *Now we allow for the differing life spans.
Method 2, EAC
EAC = PV of Costs
[1 – 1/(1+r)n]/r

End of chapter (EOC), Question 7, Chapter 10

0 1 2 3 4 5
Investment (990,000)
NWC Additions -
Operating savings, after tax 276,000 276,000 276,000 276,000 276,000

NPV
Investment (990,000)
PV of after tax savings 925,195
PVCCATS 246,783
NPV $ 181,977

End of chapter, Question 8, Chapter 10

0 1 2 3 4 5
Investment (990,000)
NWC Additions (47,200)
Time zero outflow: (1,037,200)
Operating savings, after tax 276,000 276,000 276,000 276,000 276,000
Salvage value, year 5 100,000
NWC recovery, in year 5 47,200
Time five, total of NWC and salvage 147,200

*Items to be discounted shown in green 990,000 C

NPV 30% d
Time zero outflow: (1,037,200) 15% k
PV of after tax savings 925,195 40% TC
PV of time 5 cash flows 73,184 100,000 S
PVCCATS 233,525 5n
NPV 194,704 233,525 PVCCATS
PVCCATS - What does this value include?
1. All tax shields coming from CCA
2. The present values of all tax shields.
3. Any tax consequences of salvage
4. The present values of any tax consequences of salvage.

When should I/can I use the PVCCATS approach?

1. When the asset pool remains open.
2. When assets remain in the pool.
 Q5

les - Costs - Taxes

CF: OCF = (Sales-Costs)(1-Tc) + Tc(Depreciation)
et Income + Depreciation

7CE/Ch10
Q1

Q7
925,000 C
5 30% d
 294,000 12% k
40% TC
- S
5 n
250127.551 PVCCATS

Q8
925,000 C
5 30% d
294,000 12% k
- 40% TC
100,000 S
5 n
233,915 PVCCATS

ange our decision.

PVCCATS Calculator
990,000 C
30% d
15% k
40% TC
- S
5n
246,783 PVCCATS
TB Example Replacing an asset with a new asset to enhance productivity.
Old equipment, in isolation
New equipment cost: 200,000
Remaining life, new equipment 6 years
Salvage, new equipment 30,000
Old equipment purchase (4 years ago) 150,000 Old equipment purchase 150,000
Remaining life, old equipment 6 years Remaining life, old eq 6 years
Current salvage, old equipment 50,000 Current salvage, old e 50,000
Salvage after 6 more years, old equipment 10,000 Salvage after 6 more y 10,000
Savings, from new equipment 75,000 *New equip. saves $75K/year
NWC: No change NWC: No change

Class 8 assets (old & new), CCA rate of 20%, required return = 15%, tax rate = 44% Class 8 assets (old & new), CCA rate of 20%, required return = 1

Year Year
0 1 2 3 4 5 6 0 1 2
Investment -200 Investment
Salvage on old 50 Salvage on old -50
NWC additions 0 NWC additions 0
Subtotal -150 Subtotal -50
Op. savings 75 75 75 75 75 75 Op. savings
Taxes 33 33 33 33 33 33 Taxes
Subtotal 42 42 42 42 42 42 Subtotal 0 0
Salvage forgone -10 Salvage forgone
Salvage 30 Salvage

NPV
Investment (200,000)
Salvage recovered now 50,000
Operating cash flows 158,948 *Financial calculator, or PVA
PV of salvage forgone (4,323)
PV of salvage recovered 12,970
PVCCATS 33,081
NPV $ 50,675
 New equipment, in isolation (this is a repeat of the first scenario, not a continuation)
New equipment cost: 200,000
Remaining life, new equipment 6 years
Salvage, new equipment 30,000

Savings, from new equipment 75,000 *New equip. saves $75K/year

NWC: No change

of 20%, required return = 15%, tax rate Class 8 assets (old & new), CCA rate of 20%, required return = 15%, tax rate = 44%

Year Year
3 4 5 6 0 1 2 3 4 5 6
Investment -200
Salvage on old
NWC additions 0
Subtotal -200
Op. savings 75 75 75 75 75 75
Taxes 33 33 33 33 33 33
0 0 0 0 Subtotal 42 42 42 42 42 42
10 Salvage forgone
Salvage 30
Calculating costs and Break-Even: Night Shades Inc. (NSI) manufactures sunglasses. The variable materials cost is $5.43 per unit
variable labour cost is $3.13 per unit. Suppose the company incurs fixed costs of $720,000 during a year in which total producti
280,000 units. Depreciation is $220,000 per year. Price is $19.99. Calculate the total variable cost per unit, total cost, and the 3
quantities.

a. Total variable cost per unit: =

b. Total cost = Variable costs + fixed costs
Total costs =
c. Qc = (FC + 0) / (P - v) units. This is the cash break-even quantity.

Qa = (FC + Depreciation)/(P - v) units. This is the accounting break-even quanti

d. Financial break even, assume a discount rate of 15% Assume 5 year life
$ 1,100,000 Assumed initial investment

OCF
QF = (FC + OCF)/(P - v) units. This is the financial break-even quantity.

Whitewater Transmissions Inc. has the following estimates for its new gear assembly project: price = $1,700 per unit; variable c
per unit; fixed costs = $4.1 million; quantity = 95,000 units. Suppose the company believes all of its estimates are accurate only
+/- 15 percent. What values should the company use for the four variables given here when it performs its best-case scenario a
What about the worst-case scenario?
Scenario Unit Sales Unit Price
Base
Best
Worst

Calculating Break-Even: A project has the following estimated data: price = $57 per unit; variable costs = $32 per unit; fixed cos
required return = 12%; initial investment = $18,000; life = four years. Ignoring the effect of taxes, what is the accounting break-
quantity? The cash break-even quantity? The financial break-even quantity? What is the degree of operating leverage at the fin
break-even level of output?

Qc = (FC+0)/ (P - v) = Cash Break-even quantity units

Qa = (FC + Depreciation) / (P - v) units

At the financial break-even point, the project will have a zero NPV. Since this is true, the initial cost of the project must be equa
of the cash flows of the project. Using this relationship, we can find the OCF of the project as follows:

OCF = Investment / ((1-(1+r)^-t)/r)

Qf = (FC+OCF)/ (P - v) = Financial Break-even quantity units

'=(9000+B30) / (57-32)
*Ignore the DOL*
 variable materials cost is $5.43 per unit, and the
000 during a year in which total production is
iable cost per unit, total cost, and the 3 break-even
7CE/Ch11

Q1

This is the cash break-even quantity.

This is the accounting break-even quantity

ed initial investment

This is the financial break-even quantity.

oject: price = $1,700 per unit; variable costs = $480

ves all of its estimates are accurate only to within
when it performs its best-case scenario analysis?

Unit variable cost Fixed cost Q3 - from 9th edition of TB

; variable costs = $32 per unit; fixed costs = $9,000;

t of taxes, what is the accounting break-even
e degree of operating leverage at the financial
Q9

e initial cost of the project must be equal to the PV

ect as follows:
 Scenario Analysis Sensitivity Analy
Base Case Lower Bound Upper Bound
Unit Sales 6,000 5,500 6,500 Unit Sales
Price per unit 80 75 85 Price per unit
Variable costs per unit 60 58 62 Variable costs per unit
Fixed costs per year 50,000 45,000 55,000 Fixed costs per year

*Income statement will remain the same over 5 years. *Income statement will remain the same ov

Base Case Best Case Worst Case

Sales 480,000 552,500 412,500 Sales
Variable costs 360,000 377,000 341,000 Variable costs
Fixed costs 50,000 45,000 55,000 Fixed costs
Depreciation (Given) 40,000 40,000 40,000 Depreciation (Given)
EBIT 30,000 90,500 (23,500) EBIT
Taxes (34%) 10,200 30,770 - Taxes (34%)
Net income 19,800 59,730 (23,500) Net income

OCF, each year 59,800 99,730 16,500 OCF, each year

PVA of OCFs 215,566 359,504 59,479 PVA of OCFs
CapX (200,000) (200,000) (200,000) CapX
PVCCATS 45,969 45,969 45,969 PVCCATS
NPV 61,535 205,474 (94,552) NPV

Discount rate 12%

CCA rate 30%
Tax rate 34%
 Sensitivity Analysis Sensitivity Analysis 2
Base Case Lower Bound Upper Bound Base Case Lower Bound
6,000 5,500 6,500 Unit Sales 6,000 6,000
80 80 80 Price per unit 80 75
60 60 60 Variable costs per unit 60 60
50,000 50,000 50,000 Fixed costs per year 50,000 50,000

ment will remain the same over 5 years. *Income statement will remain the same over 5 years.

Base Case Best Case Worst Case Base Case Best Case
480,000 520,000 440,000 Sales 480,000 510,000
360,000 390,000 330,000 Variable costs 360,000 360,000
50,000 50,000 50,000 Fixed costs 50,000 50,000
40,000 40,000 40,000 Depreciation (Given) 40,000 40,000
30,000 40,000 20,000 EBIT 30,000 60,000
10,200 13,600 6,800 Taxes (34%) 10,200 20,400
19,800 26,400 13,200 Net income 19,800 39,600

59,800 66,400 53,200 OCF, each year 59,800 79,600

215,566 239,357 191,774 PVA of OCFs 215,566 286,940
(200,000) (200,000) (200,000) CapX (200,000) (200,000)
45,969 45,969 45,969 PVCCATS 45,969 45,969
61,535 85,327 37,743 NPV 61,535 132,910
2
Upper Bound
6,000
85
60
50,000

Worst Case
450,000
360,000
50,000
40,000
-
-
-

40,000
144,191
(200,000)
45,969
(9,840)
Hot Dog Stand - Break Even Examples
Cash flow BE: Q = (10,000+0)/(2.50 – 0.50) = 5,000 hot dogs
Accounting BE: Q = (10,000 + 1,000)/(2.50 – 0.50) = 5,500 hot dogs
Financial BE: OCF = 5,000/2.991 = $1,671.90
Q = (10,000 + 1,671.90)/(2.50 – 0.50) = 5,836 hot dogs
SP $ 2.50
VC $ 0.50

Cash Flow Accounting Financial

Sales $ 12,500 13,750 14,590
VC $ 2,500 2,750 2,918
FC $ 10,000 10,000 10,000
Dep'n $ 1,000 1,000 1,000
EBIT $ (1,000.00) $ - $ 672.00
OCF $ - $ 1,000.00 $ 1,672.00

Discount Rate 20%

Cash B/E
Cash Flows:
0 1 2 3 4 5
(5,000.00) - - - - -
(5,000.00) - - - - -
NPV = (5,000)

Accounting B/E
Cash Flows:
0 1 2 3 4 5
(5,000.00) 1,000 1,000 1,000 1,000 1,000
(5,000.00) 833 694 579 482 402
NPV = (2,009)
IRR = 0.00%

Financial B/E
Cash Flows:
0 1 2 3 4 5
(5,000.00) 1,672 1,672 1,672 1,672 1,672
(5,000.00) 1,393 1,161 968 806 672
NPV = 0
IRR = 20%
Calculating cash collections: The Morning Jolt Coffee Company has projected the following quarterly
sales amounts for the coming year:
a. Q1 Q2 Q3 Q4
Sales 790 740 870 950
a. Accounts receivable at the beginning of the year are $360. Morning Jolt has a 45-day collection
period. Calculate cash collections in each of the four quarters by completing the following:

A 45 day collection period implies that ALL receivables outstanding from previous quarter will be
collected in this quarter
(90-45)/90 = 1/2 of current sales are collected.
a. Q1 Q2 Q3 Q4
Beginning receivables 360
Sales 790 740 870 950
Cash collections
Ending receivables

b. Assume 60 days Q1 Q2 Q3 Q4
Beginning rec. 360
Sales 790 740 870 950
Cash collections
Ending receivables

c. Assume 30 days Q1 Q2 Q3 Q4
Beginning rec. 360
Sales 790 740 870 950
Cash collections
Ending receivables

Calculating the Cash Budget for Nashville Nougats: Here are some important figures from the budget
of Nashville Nougats Inc. for the second quarter of 2009:

April May June

Credit sales 390,000 364,000 438,000
Credit purchases 147,800 176,300 208,500
Cash disbursements
Wages, taxes, and expenses 53,800 51,000 78,300
Interest 13,100 13,100 13,100
Equipment purchases 87,000 147,000 -

The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its sales
will be collected in the month of the sale, and the remaining 60 percent will be collected in the
following month. Credit purchases will be paid in the month following the purchase.
In March 2009, credit sales were $245,000, and credit purchases were $168,000. Using this
information, complete the following cash budget:

The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its sales
will be collected in the month of the sale, and the remaining 60 percent will be collected in the
following month. Credit purchases will be paid in the month following the purchase. In March 2009,
credit sales were $245,000, and credit purchases were $168,000. Using this information, complete the
following cash budget:
April May June
Beginning cash balance 140,000
Cash receipts
Cash collections, credit sales
Total cash available
Cash disbursements
Purchases
Wages, taxes, and expenses 53,800 51,000 78,300
Interest 13,100 13,100 13,100
Equipment purchases 87,000 147,000 -
Total cash disbursements
Ending cash balance

Nashville Nougats, Complete Solution

April May June
Credit sales 390,000 364,000 438,000
Credit purchases 147,800 176,300 208,500
Cash disbursements
Wages, taxes, and expenses 53,800 51,000 78,300
Interest 13,100 13,100 13,100
Equipment purchases 87,000 147,000 -

April May June

Beginning cash balance 140,000 101,600 104,100
Cash receipts
Cash collections, credit sales 283,500 361,400 371,700
Total cash available 423,500 463,000 475,800
Cash disbursements
Purchases 168,000 147,800 176,300
Wages, taxes, and expenses 53,800 51,000 78,300
Interest 13,100 13,100 13,100
Equipment purchases 87,000 147,000 -
Total cash disbursements 321,900 358,900 267,700
Ending cash balance 101,600 104,100 208,100
7CE/Ch18
Q5

Q11
c. Banker's acceptance - when a bank guarantees the future payment of a commercial draft
d. Promissory note - an IOU that the customer signs "I Owe You"
e. Trade acceptance - when the buyer accepts the commercial draft and promises to pay it in the future.

Most common form of trade credit: open account

Most common credit instrument: invoice

Character: willingness to pay debts

Capacity: is operating cash flow adequate to cover debts?
Capital: financial reserves, if operating cash flow is inadequate?
Collateral: assets that can be liquidated to pay off the loan in the event of default
Conditions: Customer's ability to weather an economic downturn, and whether such a downturn is likely.

Simplified example of an A/R aging schedule:

ACME Company, accounts receivable aging:
0-30 days 31-60 days 61-90 days 90-120 days
ACME's customers:
ABC Co. $500
BCD Co. $200
YXE Co. $300
XYZ Co. $200
 7CE/Ch20
CR1

CR2

CR4

kely.

120 + days

$100
Calculating WACC: Country Road has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 p
Its cost of equity is 11.20% percent, the cost of preferred stock is 6.25 percent, and the cost of debt is 8 percent. The relevant t
percent.
a. What is the company's WACC?
WACC = WDRD(1 - TC) + WPRP + WERE
WD = Percentage weight, debt
WP = Percentage weight, preferred shares
WE = Percentage weight, common shares (equity)
RD = Rate on debt (YTM)
RP = Rate on preferred shares
RE = Rate on common shares (from div. growth model or CAPM, either can be u

b. The company president has approached you about Country Road's capital structure. He wants to know why the company do
more preferred stock financing because it costs less than debt. What would you tell the president?
Interest is tax-deductible, dividends are not, hence, we must look at the cost of debt after tax:
After tax cost of debt

Flotation Examples:
Imagine you are raising money, with an an upfront Total Direct Cost (flotation cost) of 5%.
You raise, with your bank's help: $ 400,000
The bank charges (up front) 5%
You are left with:

A common mistake:
It's often tempting to multiply the target x F A $ 20,000 This is assumed to be the flotation cost
Total to raise
The bank charges (up front) 5%
You are left with: Note that we end up short

This may not be enough. What if our business opportunity (or machine, land, etc) actually costs $400,000?
Take the initial cost and divide by (1 - F A) = Amount to be raised
The bank charges (up front) 5%
You are left with:
This way, you are left with the proper target amount.
rcent preferred stock, and 35 percent debt.
ebt is 8 percent. The relevant tax rate is 35

odel or CAPM, either can be used)

to know why the company doesn't use

t?

cost of debt

sumed to be the flotation cost

we end up short

t to be raised
Review questions all based on the 9th Canadian Edition of the Ross text.
Ch7, CR 2: All else the same, the government security will have lower coupons because of its lower default risk, so it will have g
interest rate risk.

Ch7, CR 6: Bond issuers look at outstanding bonds of similar maturity and risk. The yields on such bonds are used to establish t
rate necessary for a particular issue to initially sell for par value. Bond issuers also simply ask potential purchasers what coupon
would be necessary to attract them. The coupon rate is fixed and simply determines what the bond’s coupon payments will be
required return is what investors actually demand on the issue, and it will fluctuate through time. The coupon rate and require
are equal only if the bond sells for exactly par.

Q&P 17
PriceSAM 3.50% Price $1,000
PriceDAVE 3.50% Price $1,000

Rates up: % change

PriceSAM 4.50% Price $948 -5.2%
PriceDAVE 4.50% Price $816 -18.4%

Rates down:
PriceSAM 2.50% Price $1,055 5.5%
PriceDAVE 2.50% Price $1,251 25.1%

Ch8, Self-Test, page 284/285

*Solution in text.

Ch8, CR 5: The common stock probably has a higher price because the dividend can grow, whereas it is fixed on the preferred.
the preferred is less risky because of the dividend and liquidation preference, so it is possible the preferred could be worth mo
depending on the circumstances.

Ch8 Example, Supernormal Growth: The ACME company just paid a dividend of $.50 per share. Executives believe that the div
grow at 25% per year for the next 4 years, after which the dividend growth rate will slow to a perpetual 2.5%. The required retu
Calculate the current price of the stock.
0 1 2 3 4 5
Dividend $ 0.50
P4
Total CF

Price

Ch9, CR 12: Yes, they are. Such entities generally need to allocate available capital efficiently, just as for-profits do. However, it
frequently the case that the “revenues” from not-for-profit ventures are not tangible. For example, charitable giving has real op
costs, but the benefits are generally hard to measure. To the extent that benefits are measurable, the question of an appropria
required return remains. Payback rules are commonly used in such cases. Finally, realistic cost/benefit analysis along the lines i
should definitely be used by governments and would go a long way toward balancing the budget!
Ch9 Minicase: See 9MC tab.

Review Ch10, MMCC Tax-shield approach

Review PVCCATS

Ch10 CR 3: The EAC approach is appropriate when comparing mutually exclusive projects with different lives that will be replac
they wear out. This type of analysis is necessary so that the projects have a common life span over which they can be compare
effect, each project is assumed to exist over an infinite horizon of N-year repeating projects. Assuming that this type of analysis
implies that the project cash flows remain the same forever, thus ignoring the possible effects of, among other things: (1) inflati
changing economic conditions, (3) the increasing unreliability of cash flow estimates that occur far into the future, and (4) the
effects of future technology improvement that could alter the project cash flows.

Ch10 CR 4: Depreciation is a non-cash expense, but it is tax-deductible on the income statement. Thus depreciation causes taxe
actual cash outflow, to be reduced by an amount equal to the depreciation tax shield tcD. A reduction in taxes that would othe
paid is the same thing as a cash inflow, so the effects of the depreciation tax shield must be included to get the total increment
cash flows.

Ch10 Q&P 13, Calculating Project OCF: Hubrey Home Inc. is considering a new three-year expansion project that requires an in
asset investment of $3.9 million. The fixed asset falls into Class 10 for tax purposes, with a CCA rate of 30% per year, and at the
the three years can be sold for a salvage value equal to its UCC. The project is estimated to generate $2,650,000 in annual sales
costs of $840,000. If the tax rate is 35%, what is the OCF for each year of this project?

Sales $ 2,650,000 $ 2,650,000 $ 2,650,000 CCA Table

Costs $ 840,000 $ 840,000 $ 840,000 UCCBEG 3,900,000
Depreciation 585,000 994,500 696,150 CCA 585,000
EBIT/EBT $ 1,225,000 $ 815,500 $ 1,113,850 UCCEND 3,315,000
Tax $ 428,750 $ 285,425 $ 389,848

OCF 1,381,250 1,524,575 1,420,153

Ch10 Q&P 14
Salvage Value $ 1,624,350
PV of OCFs $ 3,459,477
PV Salvage $ 1,156,180
NPV $ 715,658

Ch11 CR 4

It is true that if average revenue is less than average cost, the firm is losing money. This much of the statement is therefore cor
the margin, however, accepting a project with a marginal revenue in excess of its marginal cost clearly acts to increase operatin
flow.

Ch11 Q&P #9
Cash B/E = (FC + 0) / (P - v) 1,072

Acctg B/E = (FC + Dep'n) / (P - v) 1,444

Fin'l B/E OCF that provides $0 NPV $8,823.48
= (FC + OCF) / (P - v) 1,562

Ch 18/19/20
Review tab 18, do the Nashville Nougats question. Solution on Tab 18

Ch20, CR 3 - 6

Ch20, CR 3: Credit costs: cost of debt, probability of default, costs of managing credit and credit collections and the cash discou
No-credit costs: lost sales
The sum of these are the carrying costs.

Ch20, CR 4:
1. Character: determines if a customer is willing to pay his or her debts.
2. Capacity: determines if a customer is able to pay debts out of operating cash flow.
3. Capital: determines the customer’s financial reserves in case problems occur with opera-ting cash flow.
4. Collateral: Pledged assets that can be liquidated to pay off the loan in case of default.
5. Conditions: customer’s ability to weather an economic downturn and whether such a down-turn is likely.
Ch20, CR 5:
1. Perishability and collateral value
2. Consumer demand
3. Cost, profitability, and standardization
4. Credit risk
5. The size of the account
6. Competition
7. Customer type
If the credit period exceeds a customer’s operating cycle, then the firm is financing the receivables and other aspects of the cu
business that go beyond the purchase of the selling firm’s merchandise.

Ch20, CR 6:
a. B: A is likely to sell for cash only, unless the product really works. If it does, then they might grant longer credit periods to en
buyers.
b. A: Landlords have significantly greater collateral, and that collateral is not mobile.
c. A: Since A’s customers turn over inventory less frequently, they have a longer inventory period, and thus, will most likely hav
credit period as well.
d. B: Since A’s merchandise is perishable and B’s is not, B will probably have a longer credit period.
e. A: Rugs are fairly standardized and they are transportable, while carpets are custom fit and are not particularly transportable

Q&P 1&6
Ch20, Q&P 1
a. There are 30 days until account is overdue. Full period remittance: $ 49,000
b. For the first 10 days a 1% discount is allowed. Remittance: $ 48,510
c. Implicit interest. This is the difference between the 2 amounts: $ 490
Days' credit offered: 20

Ch20, Q&P 6
Receivables turnover = 365/Average collection period 12.59 times
Annual credit sales = Receivables turnover x Average daily receivables $ 552,534
Ch12, CR 6: Yes, historical information is also public information; weak form efficiency is a subset of semi-strong form efficiency

Ch12, CR 9: The EMH only says, within the bounds of increasingly strong assumptions about the information processing of inve
assets are fairly priced. An implication of this is that, on average, the typical market participant cannot earn excessive profits fr
particular trading strategy. However, that does not mean that a few particular investors cannot outperform the market over a p
investment horizon. Certain investors who do well for a period of time get a lot of attention from the financial press, but the sc
investors who do not do well over the same period of time generally get considerably less attention from the financial press.

Ch13, CR 1: Some of the risk in holding any asset is unique to the asset in question. By investing in a variety of assets, this uniq
of the total risk can be eliminated at little cost. On the other hand, there are some risks that affect all investments. This portion
total risk of an asset cannot be costlessly eliminated. In other words, systematic risk can be controlled, but only by a costly redu
expected returns.

Ch13, CR 3:
a. systematic
b. unsystematic
c. both; probably mostly systematic
d. unsystematic
e. unsystematic
f. systematic

Ch13, CR 4:
a. a change in systematic risk has occurred; market prices in general will most likely decline.
b. no change in unsystematic risk; company price will most likely stay constant.
c. no change in systematic risk; market prices in general will most likely stay constant.
d. a change in unsystematic risk has occurred; company price will most likely decline.
e. no change in systematic risk; market prices in general will most likely stay constant.

Ch14, CR 10: If the different operating divisions were in much different risk classes, then separate cost of capital figures should
for the different divisions; the use of a single, overall cost of capital would be inappropriate. If the single hurdle rate were used
divisions would tend to receive more funds for investment projects, since their return would exceed the hurdle rate despite the
they may actually plot below the SML and, hence, be unprofitable projects on a risk-adjusted basis. The typical problem encou
estimating the cost of capital for a division is that it rarely has its own securities traded on the market, so it is difficult to observ
market’s valuation of the risk of the division. Two typical ways around this are to use a pure play proxy for the division, or to us
subjective adjustments of the overall firm hurdle rate based on the perceived risk of the division.

Ch14 Q&P 10
D/E ratio = 0.35
0.35 parts Debt for every 1 part Equity; hence, firm value = 1.35
Wdebt 25.9% WACC 9.9000%
Wequity 74.1%
Rd 6%
Re 12%
Tax rate 35%
Ch14, Q&P 18:
a. He should look at the weighted average flotation cost, not just the debt cost.

b. The weighted average floatation cost is the weighted average of the floatation costs for debt and equity, so:

fT = 0.03(0.6/1.6) + 0.07(1/1.6) = 0.055 or 5.5%

c. The total cost of the equipment including floatation costs is:

Amount raised(1 – 0.055) = $24,000,000

Amount raised = $24,000,000/(1 – 0.055) = $25,396,825.40

Even if the specific funds are actually being raised completely from debt, the flotation costs, and hence true investment cost,
valued as if the firm’s target capital structure is used.
 default risk, so it will have greater

onds are used to establish the coupon

tial purchasers what coupon rate
’s coupon payments will be. The
he coupon rate and required return

it is fixed on the preferred. However,

eferred could be worth more,

ecutives believe that the dividend will

tual 2.5%. The required return is 12%.

for-profits do. However, it is

charitable giving has real opportunity
he question of an appropriate
efit analysis along the lines indicated
rent lives that will be replaced when
which they can be compared; in
ng that this type of analysis is valid
mong other things: (1) inflation, (2)
nto the future, and (4) the possible

hus depreciation causes taxes paid, an

on in taxes that would otherwise be
d to get the total incremental aftertax

n project that requires an initial fixed

of 30% per year, and at the end of
e $2,650,000 in annual sales, with

3,315,000 2,320,500
994,500 696,150
2,320,500 1,624,350

statement is therefore correct. At

rly acts to increase operating cash
 ections and the cash discount

h flow.
n is likely.

and other aspects of the customer’s

longer credit periods to entice

nd thus, will most likely have a longer

ot particularly transportable.
 semi-strong form efficiency.

ormation processing of investors, that

not earn excessive profits from a
perform the market over a particular
e financial press, but the scores of
from the financial press.

a variety of assets, this unique portion

all investments. This portion of the
ed, but only by a costly reduction in

ost of capital figures should be used

ngle hurdle rate were used, riskier
d the hurdle rate despite the fact that
The typical problem encountered in
et, so it is difficult to observe the
oxy for the division, or to use
equity, so:

ence true investment cost, should be