Problem 1
Lowell Inc. has no debt and its financial position is given by
the following data:
| Assets (book = market) | $3,000,000 |
| EBIT | $500,000 |
| Cost of equity (Ks) | 10% |
| Stock price (P0) | $15 |
| Shares outstanding n0 | 200,000 |
| Tax rate T | 40% |
The firm is considering selling bonds and simultaneously
repurchasing some of its stock. It if moves to capital structure
with 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 a
no-growth firm. Hence, all its earnings are paid out as
dividends, 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 the
firm (Va)?
c. What would be Lowell Inc.’s stock price?
d. What happens to the firm’s earnings per share after the
recapitalization?
Problem 2
Mass Inc. is trying to estimate its optimal capital
structure. Right now, Mass Inc. has a capital structure
that consists of 50 percent debt and 50 percent equity,
based on market values. (Its D/S ratio is 1.00) The riskfree rate is 6 percent and the market risk premium, KM –
KRF, is 5 percent. Currently the company’s cost of equity,
which is based on the CAPM, is 12 percent and its tax rate
is 40 percent. What would be Mass Inc.’s estimated cost of
equity if it were to change its capital structure to 60
percent debt and 40 percent equity?
Assignment 8
Problem 3
Use the following information to:
a. Calculate the cash conversion cycle, and interpret the
numbers
| INCOME STATEMENT | COCA-COLA | PEPSI |
| Sales | 23,104 | 32,562 |
| Cost of goods sold | 8,195 | 14,176 |
| BALANCE SHEET | COCA-COLA | PEPSI |
| Assets |
| Cash and Cash Equivalents | 4,701 | 1,716 |
| Short-term Investments | 66 | 3,166 |
| Accounts Receivables | 2,281 | 3,261 |
| Inventory | 1,424 | 1,693 |
| Other Current Assets | 1,778 | 618 |
| Total Current Assets | 10,250 | 10,454 |
| Total Assets | 29,427 | 31,727 |
| Financed by: | COCA-COLA | PEPSI |
| Accounts Payable | 5,290 | 5,357 |
| Short-term debt | 4,546 | 2,889 |
| Other Current Liabilities | 0 | 1,160 |
| Total Current Liabilities | 9,836 | 9,406 |
Problem 4
In-tech Corporation’s sales and purchases for the last three
months are as following:
| Sales ($) | Purchases ($) |
| October | 100,000 | 80,000 |
| November | 90,000 | 100,000 |
| December | 120,000 | 75,000 |
For the next three months, it estimates sales and purchases
to be as following:
| Sales ($) | Purchases ($) |
| January | 90,000 | 70,000 |
| February | 80,000 | 70,000 |
| March | 80,000 | 70,000 |
It pays 40 percent of purchases in cash and gets a 4
percent discount. Another 40 percent of purchases are paid
the next month, and the final 20 percent of purchases are
paid in the second month after the purchase (for example,
40 percent of October purchases are paid in October, 40
percent October purchases are paid in November, and 20
percent October purchases are paid in December). Half of
the sales are made in cash, and the balance is collected
the next month. Cash sales are given a two percent
discount, and five percent of credit sales end up as bad
debt. The monthly operating expenses for In-tech
Corporation’s are $10,000. In-tech expects to sell one of
its machinery in March for $25,000. It will buy the
replacement in April for $50,000. The cash balance as on
December 31 was $50,000. In-tech has a target cash balance
of $50,000. Prepare a monthly cash budget for the next
three months.
Assignment 8