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Question - Page 1 of 6
FNCE 370v8: Assignment 2
Assignment 2 is worth 5% of your final mark. Complete and submit Assignment 2 after you
complete Lesson 6.
There are 15 questions in this assignment. The break -down of marks for each question is
presented in the table below. Please show all your work as this will help the marker give you
part marks as well as serve as a good study aid as you prepare for the Fin al Examination.
Question Marks Available Reference
1 10 Lesson 2
2 5 Lesson 2
3 3 Lesson 2
4 8 Lesson 3
5 6 Lesson 3
6 6 Lesson 3
7 5 Lesson 4
8 10 Lesson 4
9 15 Lesson 4
10 5 Lesson 5
11 5 Lesson 5
12 5 Lesson 5
13 5 Lesson 6
14 5 Lesson 6
15 7 Lesson 6
Total 100
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1. We have the following inf ormation for Athabasca Inc. (10 marks )
Athabasca, Inc.
2010 Income Statement
($ in millions)
Net Sales $1,384
Less: Cost of Goods Sold 605
Less: Depreciation
Earnings before interest and taxes 599
180
Less: Interest paid
Taxable Income 519 80
Less: Taxes
Net Income $ 363 156
Addition to retained earnings $ 254
Cash dividends paid 109
Athabasca, Inc.
12/31/09 and 12/31/ 10 Balance Sheet
($ in millions)
2009 2010 2009 2010
Cash $ 100 $ 121 Accounts payable $ 400 $ 350
A/R 350 425 Notes payable 390 370
Inventory 440 410 Total CL $ 790 $ 720
Total CA $ 890 $ 956 Long -term debt 500 550
Net fixed
assets 1,556
1,704 Owner’s equity
Common stock 600 580
Retained Earnings 556 810
Total assets $2,446 $2,660 Total liabilities $2,446 $2,660
The firm has 180 million common shares outstanding. Calculate the following:
a. Earnings retention ratio for 2010 .
b. The dividend to be paid (in dollars) in 2011. Assume Athabasca is projecting a 20%
increase in sales for the coming year, and that cost of goods sold and
general/ad ministrative expenses remain a constant percentage of sales. Also assume
that depreciation, interest paid, and the firm’s tax rate remain unchanged and that the
firm’s dividend payout is 40%.
c. Capital i ntensity ratio based on the 2010 results.
d. Full capacity sales if Athabasca is currently operating at 70% capacity.
e. External financing needed (EFN) for 2011 if Athabasca is projecting a 20% increase in
sales for the coming year. Assume that assets, all costs, and current liabilities are
proportional to sales bu t that long-term debt is not proportional to sales. Also assume
that the firm’s tax rate remains unchanged and the dividend payout is 40%.
f. External financing needed (EFN) for 2011 if Athabasca is projecting a 20% increase in
sales for the coming year, with current assets, all costs, and current liab ilities
proportional to sales. Long-term debt is not proportional to sales. Assume the firm’s tax
rate remains unchanged, the dividend payout is 40%, and Athabasca is operating at
70% capacity.
g. Internal growth r ate for 2010 (assume the dividend payout ratio is fixed at 40%).
h. Sustainable growth rate for 2010 (assume the dividend payout ratio is fixed at 40%).
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2. State the assumptions that underlie the sustainable growth rate and interpret what the
sustainable growth rate means. (5 marks)
3. Suppose a firm calculates its EFN and finds that it is negative. What are the firm’s
options in this case? (3 marks)
4. Fill in the blanks in the tables below.
a. For each of the following, compute the present value (round answer to 2 decimal
places). ( 2 marks )
Future value Years Interest rate Present value
543 10 13%
7620 13 6%
18054 15 4%
803851 6 31%
b.
For each of the following, compute the future value (round answer to 2 decimal places).
( 2 marks )
Present value Years Interest rate Future value
543 10 13%
7620 13 8%
18054 15 10.01%
803851 6 1%
c. Solve for the unknown time period in each of the following (round answer to 4 decimal
places). ( 2 marks )
Present value Future value Interest rate Time (years)
100 550 10%
2452 3000 13%
12463 234267 15%
139478 285736 9%
d. Solve for the unknown interest rate in each of the following (round answer to 4 decimal
places). ( 2 marks )
Present value Future value Time (years) Interest rate
100 550 10
2452 3000 13
12463 234267 15
139478 285736 9
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5. Suppose your firm is planning to invest in a project that will generate the following
income stream: a negative flow $300,000 per year for 5 years, a positive flow of
$450,000 in the sixth year, and a positive flow of $650,000 per year in
years 7 through 9.
What is the present value of this income stream if the appropriate discount rate is 10%
for the first 3 years and 13% thereafter? (6 marks)
6. Annuity A makes annual year -end payments of $976.50 for each of the next 10 years,
while investment B makes annual year -end payments of $600 per year forever.
S how your work for the following two questions: (6 marks)
a. At what interest rate would you be indifferent between the two investments?
b. At interest rates above/below this break -even rate, which investment would you
choose and why?
7. A friend who owns a perpetuity that promises to pay $1,000 at the end of each year,
forever, comes to you and offers to sell you all of the payments to be received after the
25
th year for a price of $1,000. Assume an interest rate of 10%. Be sure to show your
work. (5 marks)
a. Should you pay the $1,000 today to receive payments from the end of year 26 and
onwards?
b. What value would you be willing to pay?
c. What does this suggest to you about the value of perpetual payments?
8. Rob and Laura wish to buy a new home. The price is $300,000 and they plan to put 25 %
down. New Rochelle Savings and Loan will lend them the remain der at 8% per annum,
compounded se mi-annually for a 25- year term. The monthly payments are to begin in
one month. (10 marks )
a. How much will their monthly payments be?
b. Assuming they pay off the loan over the 25 -year period as planned, what will be the
total cost (principal + interest + down payment) of the hou se?
c. What will the outstanding balance of the loan be after 10 years, assuming they make
the first 120 payments on time?
d. Suppose they want to pay off the loan in 15 years. How much extra must they pay
each month to do so?
e. Show the first six months in the amortization table for the 25 -year mortgage.
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9. You are making plans f or your retirement. You have just turned 30 and want to retire on
your 65
th birthday. At that time, you plan to move to the Caribbean, where you believe
you can live com fortably on $200,000 per year. You also understand that inflation can
impact your enjoyment of retirement so you would like the annual payments you receive
to incre ase at a rate of 5% per annum. Your first payment of $200,000 will occur at age
66. You inte nd to live in the Caribbean until your 85
th birthday, when you will receive
your last installment from your retirement fund , move back to Canada , and freeload off
your kids. You would also like to save enough money so that you can buy a new car
when you ar e 35, and pay for a big retirement party when you are 65. You figure you
will need to have $35,000 for the car and $10,000 for the party.
You estimate that you can earn an average return of 10% per annum on any money you
invest over the next 60 years. You have just begun working and plan on saving $1 1,000
per ye ar until you are 35 years old. You will make your fi rst deposit one year from now.
To ensure that you are able to achieve your objectives, you must first answ er the
following questions: (15 marks )
a. How much will you have to accumulate before you retire?
b. How much will you have to save yearly, from your 36
th to your 65th birthday , in order
to accumulate the amount from part (a) and also pay for your retirement party?
10. A bond is currently selling at 0.85 on its par value of $1,000. This bond has a maturity
of 10 years and a coupon rate of 8%, payable semi -annually. If the inflation rate is 5%,
what is the real yield on this bond? (5 marks)
11. The bonds of Microhard , Inc. carry a 12% annual coupon, have a $1,000 face value, and
mature in 4 years. Bonds of equivalent risk yield 10%. Microhard is having cash flow
problems and has asked its bondholders to accept the following deal:
The firm would like to make the nex t three coupon payments at half the scheduled
amount, and make the final coupon payment be $300. If this plan is implemented and
investors still demand a 10% return, what will happen to the market price of the bond?
( 5 marks)
12. J&J Enterprises wants to iss ue eighty 15-y ear, $1,000 zero -coupon bonds. If each bond
is priced to yield 9%, how much will J&J receive (ignoring issuance costs) when the
bonds are first sold? (5 marks)
13. McGonigal’s Meats, Inc . currently pays no dividends. The firm plans to begin paying
dividends in 3 years (at the end of t
3). The first dividend at that time will be $1 and
dividends are expected to grow at 5% per annum thereafter.
Given shareholders demand a 12% return on their investments, what is the price of the
stock to day (t
0)? (5 marks)
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14. Suppose that sales and profits of Oly Enterprises are growing at a rate of 30% per year.
At the end of 4 years (t
4) the growth rate will drop to a steady 5%. Oly recently paid a
dividend of $1 per share. If the required return is 20%, what is the value of one Oly
share today (t
0)?
( Assume dividends grow at the same rate as earnings after year 4. ) (5 marks)
15. Bradley Broadcasting expects to pay dividends of $1.12, $1.25, and $1.40 in one, two,
and three years, respectively. After that, dividends are expected to grow at a constant
rate of 5% forever (so , t
4 to ∞). Stocks of similar risk yield 12%. (7 marks)
a. What should the price of Bradley Broadcasting stock be today?
b. What is growth rate of the Bradley Broadcasting dividend during year 2?
c. How much is Bradley’s stock price expected to increase during the first year?
d. What is the expected capital gains yield on Bradley Broadcasting stock during year
8? ...Read Less
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