Problem 1Lowell Inc. has no debt and its financial position is given bythe following data:Assets (book = market) $3,000,000EBIT $500,000Cost of equity (Ks) 10%Stock price (P0) $15Shares outstanding n0 200,000Tax rate T 40%The firm is considering selling bonds and simultaneouslyrepurchasing some of its stock. It if moves to capital structurewith 30 percent debt based on market values, its cost of equity,Ks, will increase to 11 percent to reflect the increased risk.Bonds can be sold at a cost (Kd) of 7 percent. Lowell Inc. is ano-growth firm. Hence, all its earnings are paid out asdividends, and earnings are exceptionally constant over time.a. What would be the new WACC?b. What effect would this use of leverage have on the value of thefirm (Va)?c. What would be Lowell Inc.’s stock price?d. What happens to the firm’s earnings per share after therecapitalization?
Problem 2Mass Inc. is trying to estimate its optimal capitalstructure. Right now, Mass Inc. has a capital structurethat consists of 50 percent debt and 50 percent equity,based on market values. (Its D/S ratio is 1.00) The riskfreerate is 6 percent and the market risk premium, K–K, is 5 percent. Currently the company’s cost of equity,which is based on the CAPM, is 12 percent and its tax rateis 40 percent. What would be Mass Inc.’s estimated cost ofequity if it were to change its capital structure to 60percent debt and 40 percent equity?RF
Assignment 8M
Problem 3
Use the following information to:a. Calculate the cash conversion cycle, and interpret thenumbersINCOME STATEMENT COCA-COLA PEPSISalesCost of goods sold23,104 32,5628,195 14,176BALANCE SHEET COCA-COLA PEPSIAssetsCash and Cash Equivalents 4,701 1,716Short-term Investments 66 3,166Accounts Receivables 2,281 3,261Inventory 1,424 1,693Other Current Assets 1,778 618Total Current Assets 10,250 10,454Total Assets 29,427 31,727Financed by: COCA-COLA PEPSIAccounts Payable 5,290 5,357Short-term debt 4,546 2,889Other Current Liabilities 0 1,160Total Current Liabilities 9,836 9,406
Problem 4Assignment 8In-tech Corporation’s sales and purchases for the last threemonths are as following:Sales ($) Purchases ($)October 100,000 80,000November 90,000 100,000December 120,000 75,000For the next three months, it estimates sales and purchasesto be as following:Sales ($) Purchases ($)January 90,000 70,000February 80,000 70,000March 80,000 70,000It pays 40 percent of purchases in cash and gets a 4percent discount. Another 40 percent of purchases are paidthe next month, and the final 20 percent of purchases arepaid in the second month after the purchase (for example,40 percent of October purchases are paid in October, 40percent October purchases are paid in November, and 20percent October purchases are paid in December). Half ofthe sales are made in cash, and the balance is collectedthe next month. Cash sales are given a two percentdiscount, and five percent of credit sales end up as baddebt. The monthly operating expenses for In-techCorporation’s are $10,000. In-tech expects to sell one ofits machinery in March for $25,000. It will buy thereplacement in April for $50,000. The cash balance as onDecember 31 was $50,000. In-tech has a target cash balanceof $50,000. Prepare a monthly cash budget for the nextthree months.
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