CORPORATE FINANCE

PRACTICE PROBLEMS

1. Prepare a statement of cash flows for the JETER Corporation.

JETER CORPORATION

INCOME STATEMENT
FOR THE YEAR ENDED 31ST, 2001

Sales $3,300,000

Cost of goods sold 1,950,000

Gross Profit 1,350,000

Selling and Administrative Expense 650,000

Depreciation Expense 230,000

Operating Income 470,000

Interest Expense 80,000

Earnings before Taxes 390,000

Taxes 140,000

Earnings after Taxes 250,000

Preferred Stock dividends 10,000

Earnings available to common $240,000

Shares outstanding 150,000

Earnings per share $1.60

STATEMENT OF RETAINED EARNINGS

FOR THE YEAR ENDED DECEMBER 31, 2001

Retained Earnings, balance, January 1, 2001 $800,000

Deduct: Cash dividends declared and paid in 2002 140,000

Retained Earnings, balance, December 31, 2001 $900,000

COMPARATIVE BALANCE SHEETS

FOR 2000 AND 2001

YEAR-ENDED 2000 YEAR-ENDED 2001

ASSETS

CURRENT ASSETS:

Cash $100,000 $120,000

Account receivable(net) 500,000 510,000

Inventory 610,000 640,000

Prepaid expenses 60,000 30,000

TOTAL CURRENT ASSETS 1,270,000 1,300,000

Investments(long-term) 90,000 80,000

Plant and equipment 2,000,000 2,600,000

Less: accumulated depreciation 1,000,000 1,230,000

Net Plant and Equipment 1,000,000 1,370,000

TOTAL ASSETS $2,360,000 $2,750,000

LIABILITIES ANS STOCKHOLDERS’EQCUUITY

Account Payables $300,000 $550,000

Notes Payable 500,000 500,000

Accrued expenses 70,000 50,000

Total Current Liabilities 870,000 1,100,000

LONG-TERM LIABILITIES

Bonds payable, 2004 100,000 160,000

Total Liabilities 970,000 1,126,000

STOCKHOLDERS’EQUITY:

Preferred Stock, $100 par value 90,000 90,000

Common Stock, $1 par value 150,000 150,000

Capital Paid in excess of Par 350,000 350,000

Retained earnings 800,000 900,000

Total stockholders ‘equity 1,390,000 1,490,000

TOTAL LIABILITIES AND $2,360,000 $2,750,000

2. Network Communications has total assets of $1,400,000 and current assets of $600,000. It turns
over its fixed assets 4 times a year. It has $300,000 of debt. Its return on sale is 5 percent. What
is its return on stockholders ‘equity?
3. Alpha Industries had an asset turnover of 1.4 times per year. If the return on total assets
(investment) was 8.4 percent, what was Alpha’s profit margin? The following year, on the same
level of assets, Alpha’s asset turnover declined to 1.2 times and its profit margin was 7 percent.
How did the return on total assets change from that of the previous year?

4. A firm has net income before interest and taxes of $96,000 and interest expenses of $24,000.
a. What is the times-interest earned ratio?
b. If the firm’s lease payments are $40,000, what is the fixed charge coverage?
5. A firm has sales of $1,2 million, and 10 percent of the sales are for cash. The year-end accounts
receivable balance is $180,000. What is the average collection period?(use a 360-day year):

6. The Bradley Corporation produces a product with the following costs as of July 1, 2001:

Material………………. .$2 per unit

Labor………………………. $4 per unit

Overhead………………. $2 per unit

Beginning inventory at these costs on July 1, was 3,000 units. From July 1 to December 31, 2001,
Bradley produced 12,000 units. These units had a material cost of $3, labor cost of $5, and
overhead cost of $3 per unit. Bradley uses FIFO inventory accounting.

Assuming that Bradley sold 13,000 units during the last six months of the year at $16 each, what
is their gross profit? What is the value of ending inventory?

7. Harry’s Carryout Stores has eight locations. The firm wishes to expand by two more stores and
needs a bank loan to do this. Mr. Wilson, the banker, will finance construction if the firm can
present an acceptable three-month financial plan for January through March. The following are
actual and forecasted sales figures:

Actual Forecast Additional Information

November..$200,000 January….$280,000 April forecast….$330,000

December….220, 000 February…320,000

March….340,000

Of the firm’s sales, 40 percent are for cash and the remaining 60 percent are on credit. Of credit
sales, 30 percent are paid in the month after sale, and 70 percent are paid in the second month
after the sale. Materials cost 30 percent of sales and are purchased and received each month in
an amount sufficient to cover the following’s expected sales. Materials are paid for in the month
after they are received. Labor expense is 40 percent of sales and is paid in the month of sales.
Selling and administrative expense is 5 percent of sales and is also paid in the month of sale.
Overhead expense is $28,000 in cash per month. Depreciation expense is $10,000 per month.
Taxes of $8,000 will be paid in January, and dividends of $2,000 will be paid in March. Cash at
the beginning of January is $80,000 and the minimum desired cash balance is $75,000.

For January, February, and March, Prepare a schedule of monthly cash receipts, monthly cash
payments, and a complete monthly cash budget with borrowings and repayments.
 8. Conn Man’s Shops, Inc. a national clothing chain, had sales of $300 million last year. The
business has a steady net profit margin of 8 percent and a dividend payout ratio of 25 percent.
The balance sheet for the end of last year is shown below

Balance sheet

End-of year

($ million)

ASSETS LIABILITIES AND STOCKHOLDERS’EQUITY

Cash $20 Accounts payable $70

Account receivable 25 Accrues expenses 20

Inventory 75 Other payable 30

Plant and equipment 120

Common stock 40

Retained earnings 80

Total Assets $240 Total Liabilities and SE $240

The firm’s marketing staff has told the president that in the coming year there will be a large increase in
the demand for overcoats and wool slacks. A sales increase of 15 percent is forecast for the company.

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year,
except for common stock and retained earnings. No change is scheduled in the number of common
stock shares outstanding, and retained earnings will change as dictated by the profits and dividend
policy of the firm.

a. Will external financing be required for the company during the coming year?
b. What would be the need for external financing if the net profit margin went up to 9.5 percent
and the dividend payout ratio was increased to 50 percent? Explain.

9. Jay Linoleum Company has fixed costs of $70,000. Its product currently sells for $4 per unit and
has variable costs per unit of $2.60. Mr. Thomas, the head of manufacturing, proposes to buy
 new equipment that will cost $300,000 and drive up fixed costs to $105,000. Although the price
will remain at $4 per unit, the increased automation will reduce variable costs per unit to $2.25.

As a result of Thomas’s suggestion, will the break-even point go up or down? Compute the necessary
numbers.

10. Moe & Chris ‘Delicious Burgers, Inc., sells food to University Cafeterias for $15 a box. The fixed
costs of this operation are $80,000, while the variable cost per box is $10.
a. What is the break-even point in boxes?
b. Calculate the profit or loss on 15,000 boxes and at 30,000 boxes.
c. What is the degree of operating leverage at 20,000 boxes and at 30,000 boxes? Why does
the degree of operating leverage change as the quantity sold increases?
d. If the firm has an annual interest expense of $10,000, calculate the degree of financial
leverage at both 20,000 and 30,000 boxes.
e. What is the degree of combined leverage at both sales levels?

11. Cain Auto Supplies and Able Auto Parts are competitors in the aftermarket for auto supplies. The
separate capital structures for Cain and Able are presented below.

CAIN ABLE

Debt@10% $50,000 Debt@10% $100,000

Common Stock, $10 par 100,000 Common Stock, $10 par 50,000

Total 150,000 Total 150,000

Common shares 10,000 Common shares 5,000

a. Compute earnings per share if earnings before interest and taxes are $10,000, $15,000, and
$50,000 (assume a 30 percent tax rate).
b. Explain the relationship between earnings per share and the level of EBIT.
c. If the cost of debt went up to 12 percent and all other factors remained the same, what would
be the break-even level of EBIT?
12. Ron Rhodes calls his broker to inquire about purchasing a bond of Golden Years Recreation
Corporation. His broker quotes a price of $1,170. Ron is concerned that the bond might be
overpriced based on the facts involved. The $1,000 par value bond pays 13 percent interest, and
it has 18 years remaining to maturity. The current yield to maturity on similar bonds is 11
percent.
Do you think the bond is overpriced? Do the necessary calculations.
 13. Tom Cruise Lines, Inc. issued bonds 5 years ago at $1,000 per bond. These bonds had a 25-year
life when issued and the annual interest payment was then 12 percent. This return was in line
with the required returns by bondholders at that point as described below:
Real rate of return 3%
Inflation premium 5%
Risk premium 4%
Total return 12%

Assume that five years later the inflation premium is only 3 percent and is appropriately
reflected in the required return (or yield to maturity) of the bonds. The bonds have 20 years remaining
until maturity.

Compute the new price of the bond.

14. X-tech Company issued preferred stock many years ago. It carries a fixed dividend of $5.00 per
share. With the passage of time, yields have soared from the original 5 percent to 12 percent.
a. What was the original issue price?
b. What is the current value of the preferred stock?
c. If the yield on the Standard & Poor’s Preferred Stock Index declines, how will the price of the
preferred stock be affected?

15. Sterling Corp. paid a dividend of $0.8 last year on its common stock. Over the next 12 months,
the dividend is expected to grow at a rate of 10 percent, which is the constant growth rate for
the firm (g). The new dividend after 12 months will represent D 1. The required rate of return is
14 percent.
Compute the price of the stock (P 0)

16. Justin Cement Company has had the following pattern of earnings per share over the last five
years:

Year Earnings per share

1997 $4.00

1998 4,20

1999 4.41

2000 4.63

20001 4.86
 The earnings per share have grown at a constant rate (on a rounded basis) and will continue to
do so in the future. Dividends represent 40 percent of earnings.

a. Project earnings and dividends for the next year(2002

17. Hunter Petroleum Corporation paid a $2 dividend last year. The dividend is expected to grow at
a constant rate of 5 percent over the next three years. The required rate of return is 12 percent.
Round all values to three places to the right of the decimal point where appropriate.
a. Compute the anticipated value of the dividends for the next three years. That is, compute D 1, D2,
and D3; for example, D1 is $2.10 ($2.00x1.05).
b. Discount each of these dividends back to the present at a discount rate of 12 percent and then
sum them.
c. Compute the price of the stock at the end of the third year (P 3).

P3= D4 / (Ke –g), where D4 = D3 (1 + 0.05);

d. Add together the answers in part a and part d to get P0, the current value of the stock. This
answer represents the present value of the first three periods of dividends, plus the present
value of the price of the stock after three periods (which, in turn, represents the value of all
future dividends).

18. Bonds issued by Peabody Corporation have a par value of $1,000, are selling for $890, and have
18 years to maturity. The annual interest payment is 8 percent. Find yield to maturity by
combining the trial and error approach with interpolation.

19. Telecom Systems can issue debt yielding 8 percent. The Company is in a 35 percent tax bracket.
What is the after-tax cost of debt?

20. Royal Jewelers, Inc. has an after-tax cost of debt of 6 percent. With a tax rate of 40 percent,
what can you assume the yield on the debt is?

21. Barton Electronics wants you to calculate its cost of common stock. During the next 12 months,
the Company expects to pay dividends (D1) of $1.20 per share, and the current price of its
common stock is $30 per share. The expected growth rate is 9 percent.
a. Compute the cost of retained earnings (K e)
b. If a $2 floatation cost is involved, compute the cost of new common stock (K n).
22. Given the following information, calculate the weighted average cost of capital for Hamilton
Corp.

Percent of capital structure:

Debt………………………………………………30%

Preferred stock……………………………..15

Common equity……………………………..55

Additional information:

Bond coupon rate…………………………13%

Bond yield to maturity………………….11%

Dividend, expected common……….$3.00

Dividend, preferred…………………..$10.00

Price, common…………………………….$50.00

Price, Preferred…………………………..$98

Flotation cost, preferred………………..$5.50

Growth rate………………………………..8%

Corporate tax rate………………………30%