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1. The real risk free rate is 2.0%; the expectation for future inflation is 2.

5%;
the required return for the market is 2.5 times the risk free rate. Wildcat
Inc.’s stock is 25% more volatile than the market, while Huskies Corp. has a
beta of .7. What is the required return for both stocks? If the market
became less risk adverse, dropping the required return for the market to 2.25
times the risk free rate, while the risk free rate stays the same, explain which
stock will benefit the most from this change?

2. Muscarella Inc. has the following balance sheet and income statement data:

Cash $14,000 Accounts payable $42,000


Receivables 70,000 Other current liabilities 28,000
Inventories 210,000 Total CL $70,000
Total CA $294,000 Long-term debt 70,000
Net fixed assets 126,000 Common equity 280,000
Total Assets $420,000 Total liab. & equity $420,000
Sales $280,000
Net income $21,000
The new CFO thinks that inventories are excessive and could be lowered
sufficiently to cause the current ratio to equal the industry average, 2.70,
without affecting either sales or net income. Assume inventories were reduced
to get the current ratio to the target level, and the funds generated were used to
buy back common stock at book value, by how much would the ROE change?

3. Quigley Inc. is considering two financial plans for the coming year.
Management expects sales to be $301,770, operating costs to be $266,545,
assets to be $200,000, and its tax rate to be 35%. In both plans the liabilities
and equity side of the balance sheet is made up on only two components---
debt and equity. Under Plan A it would use 25% debt and 75% common
equity. The interest rate on the debt would 8.8%, but the TIE ratio would
have to be kept at 4.00 or more. Under Plan B the maximum debt that met
the TIE constraint would be employed. Assuming that sales, operating
costs, assets, the interest rate, and the tax rate would all remain constant, by
how much would the ROE change in response to the change in the capital
structure?

4. Prock Petroleum’s stock has a required return of 13%, and the stock sells for
$50 per share. The firm just paid an annual dividend of $1.00, and the
dividend is expected to grow by 30% per year for the next 4 years, so D4 =
$1.00(1.30)^4 = $2.8561. After t = 4, the dividend is expected to grow at a
constant rate of X% per year forever. What is the stock’s expected constant
growth rate after t = 4, i.e., what is X?

5. Assume that you are on the financial staff of Michelson Inc., and you have
collected the following data: (1) The yield on the company’ outstanding
bonds is 8.00%, and its tax rate is 40%. (2) The next expected annual
dividend is $.65 a share, and the dividend is expected to grow at a constant
rate of 6.00% a year. (3) The price of Michelson’s stock is $17.50 per share,
and the flotation cost for selling new shares is F = 10%. (4) The target
capital structure is 45% debt and the balance is common equity. What is
Michelson’s WACC, assuming it must issue new stock to finance its capital
budget?

6. Scanlon Inc. is considering Projects S and L, whose cash flows are shown
below. These projects are mutually exclusive, equally risky, and not
repeatable. If the decision is made by choosing the project with the higher
IRR, how much value, if any, will be forgone?

WACC = 10%
Year 0 1 2 3 4
CFs -$2,050 $750 $760 $770 $780
CFl -$4,300 $1,500 $1,518 $1,536 $1,554

Use the following information to answer questions 7, 8 and 9.


Balance Sheet
Assets 2007
Operating cash $10,600
Short term investments 19,427
Account receivables 27,933
Inventories 15,237
Prepaid expenses 5,103
Total current assets $78,300
Property, plant & equip. (net) 51,445
Other long term operating assets 12,342
Total assets $142,087

Liabilities & Common Equity


Current maturities of notes payable $4,080
Accounts payable 6,181
Accrued expenses 17,144
Total current liabilities $27,405
Notes payable $34,440
Total liabilities $61,845
Common equity $80,242
Total liab. & common equity $142,087

Income Statement
2007
Sales $212,117
Cost of goods sold 166,417
Gross profit $45,700
Selling, general & admin. exp. 34,281
Operating profit $11,419
Interest expense 2,389
Interest income 1,415
Earnings before taxes $10,445
Taxes 2,785
Net income $7,660

Net Investment = $2069; WACC = 7%; Common shares outstanding =


7028; Current market price = $17.48.

7. What is NOPAT/NOPLAT for 2007?

8. What is ROIC for 2007? (5 points) Why is ROIC a preferable measure of a


company’s performance than ROA?
9. Assuming a constant future growth rate, what is the value per share? Would
you recommend purchase of the stock based on your analysis?
10. Howton & Howton Worldwide (HHW) is planning its operations for the
coming year, and the CEO wants you to forecast the firm’s additional funds
needed (AFN). Data for use in the forecast are shown below. However, the
CEO is concerned about the impact of a change in the payout ratio from the
10% that was used in the past to 50%, which the firm’s investment bankers
have recommended. Based on the AFN equation, by how much would the
AFN for the coming year change, if HHW increased the payout form 10% to
the new and higher level? All dollars are in millions.

Last year’s sales So = $300.0 Last year’s accounts payable = $50.0


Sales growth rate = 40% Last year’s notes payable (to bank) = $15.0
Last year’s total assets Ao = $500.0 Last year’s accrued liabilities = $20.0
Last year’s profit margin M = 20.0% Initial payout ratio = 10%
New payout ratio = 50%