AFM291 Final: EXAM REVIEW.docx
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1. Use the attached balance sheet and income statement to compute the required financial ratios for 2012. Use 360 for the number of days in a year. The computations for 2011 are already done for you.
Current ratio_________________________
Quick ratio__________________________
Inventor turnover____________________
Average Collection Period_____________
Total asset turnover__________________
Net profit margin____________________
Operating profit margin_______________
Times Interest Earned_________________
Debt/Net Worth Ratio_________________
Return on Equity ratio__________________
2. Using the computed financial ratios from question 1, compare Grounds Keeperâs performance from 2011 to 2012. Address what areas the company has improved and what areas it has not
A.)Liquidity
B.) Activity / turnover / efficiency
C.) Profitability
D.) Leverage / use of debt / solvency
3. If you were the CEO of Grounds Keeper, what area(s) would you concentrate on to improve the performance of the company?
4. Define the terms capital structure, cost of capital, and working capital. Focus on how they are different from each other and impact both profitability and risk.
5. Determine Grounds Keeperâs capital structure and working capital.
6. If Grounds Keeper has a required rate of return on its long-term debt of 9% (before taxes) and a required rate of return on its common stock, a tax rate of 40%, what is its weighted average cost of capital (WACC) for 2012? How could Grounds Keeper lower its WACC? (HINT: you will need to look at the balance sheet to determine the weight of debt to equity.
7. What are the advantages to Grounds Keeper in using money market instruments as financing? How does this related to financing net working capital?
8. Explain what Grounds Keeper should consider when deciding whether to issue stocks or bonds? Answer using at least 3 different characteristics comparing and contrasting stocks and bonds.
9. Define money market instruments; list at least one type of security that would be considered a money market instrument. What are the advantages to Grounds Keeper in using money market instruments as financing? What are the disadvantages?
Grounds Keeper | ||
Consolidated Balance Sheets | ||
(Dollars in thousands) | ||
2012 | 2011 | |
Assets | ||
Current assets: | ||
Cash and cash equivalents | 78,240 | 44,395 |
Receivables | 399,891 | 340,062 |
Inventories | 844,737 | 736,677 |
Total current assets | 1,322,868 | 1,121,133 |
Fixed assets, net | 1,244,384 | 889,613 |
Other long-term assets | 1,048,537 | 1,187,141 |
Total assets | 3,615,789 | 3,197,887 |
Liabilities and Stockholdersâ Equity | ||
Current liabilities: | ||
Accounts payable | 309,222 | 319,465 |
Accruals | 201,017 | 145,240 |
Notes payable | 9,748 | 6,669 |
Total current liabilities | 519987 | 471374 |
Long-term debt | 834574 | 814298 |
Total liabilities | 1,354,561 | 1,285,672 |
Stockholdersâ equity: | ||
Common stock, $0.10 par value: | 15,268 | 15,447 |
Additional paid-in capital | 1,464,560 | 1,499,616 |
Retained earnings | 781400 | 397152 |
Total stockholdersâ equity | 2,261,228 | 1,912,215 |
Total liabilities and stockholdersâ equity | 3,615,789 | 3,197,887 |
Grounds Keeper | |||||
Consolidated Statements of Operations | |||||
(Dollars in thousands except per share data) | |||||
| 2011 | ||||
Net sales | 3,889,426 | 2,642,390 | |||
Cost of sales | 2,589,799 | 1,746,274 | |||
Gross profit | 1,299,627 | 896,116 | |||
Selling and operating expenses | 481,493 | 348,696 | |||
General and administrative expenses | 219,010 | 187,016 | |||
Operating income | 599,124 | 360,404 | |||
Interest expense | 22,983 | 57,657 | |||
Income before income taxes | 576,141 | 302,747 | |||
Income tax expense | 212,641 | 101,699 | |||
Net Income | 363,500 | 201,048 | |||
Basic income per share: | |||||
Average shares outstanding | 154,933,948 | 146,214,860 | |||
Earnings per common share | 2.35 | 1.38 |
Current Ratio | Current assets/ Current liabilities |
Quick Ratio | Current assets â inventory/ Current liabilities |
Inventory Turnover | Cost of goods sold/ Inventory |
Receivables Turnover | Sales/ Accounts receivables |
Average Collection Period | Receivables/ Sales per day |
Fixed Asset Turnover | Sales/ Fixed assets |
Total Asset Turnover | Sales/ Total Assets |
Gross Profit Margin | Revenues - Cost of goods sold/ Sales |
Operating Profit Margin | Earnings before interest and taxes/ Sales |
Net Profit Margin | Net income/ Sales |
Return on Total Assets | Net income/ Total assets |
Debt/Net Worth Ratio | Total Debt/ Total Equity |
Times-Interest-Earned | Operating Income/ Interest expense |
Return on Equity | Net income/ Total equity |
The following Balance Sheet extract relates to the Snapple Company:
Bonds payable $1,000,000
Common Stock $3,000,000
Preferred Stock $2,000,000
Additional Information:
The bonds are 8%, annual coupon bonds, with 9 years to maturity and are currently selling for 95% of par.
The companyâs common shares which have a book value of $25 per share are currently selling at $20 per share.
The company has an equity beta of 1.5 and the current Treasury bill rate is 3.5%. The market risk premium is 1.5%
The preferred dividends are 5% preferred shares with a book value of $100 per share. These shares are currently selling at $80 per share.
The Companyâs tax rate is 35%.
Required:
a) Calculate Snappleâs cost of debt. [5 marks]
b) Calculate Snappleâs cost of equity. [5 marks]
c) Calculate Snappleâs cost of preferred shares. [3 marks]
d) Calculate Snappleâs Weighted Average Cost of Capital [8 marks]
e) Explain why the cost of debt is cheaper than the cost of equity. [3 marks]
f) Explain why the cost of retained earnings is equivalent to the cost of an existing issue of common stock. [4 marks]
g) Outline two (2) reasons why a firmâs cost of capital is critically important. [2 marks]
2.
The Beacon Inc. is considering two mutually exclusive projects, each with an initial investment of $150,000. The companyâs board of directors has set up a 4-year payback requirement and has set its cost of capital at 9%. The cash inflows associated with the two projects are as follows:
Year | Cash Inflows (CFt) | ||
Project A | Project B | ||
1 | $45,000 | $75,000 | |
2 | $45,000 | $60,000 | |
3 | $45,000 | $30,000 | |
4 | $45,000 | $30,000 | |
5 | $45,000 | $30,000 | |
6 | $45,000 | $30,000 | |
a) Calculate the payback period for each project. [2 marks]
b) Calculate the NPV for each project at 7% and 9%. [6 marks]
c) Based on b) above which project would you choose and why.[ 2 marks]
d) Briefly explain why firms engage in âcapital rationingâ [2 marks]
e) What are Real Options? What are some major types of real options? [3 marks]
3.
The Lifeâs Good Corporation 2012 income statement shows the following:
Income Statement 2012 | |
Sales | $ 5,250,000 |
Costs | 2,173,000 |
Other expenses | 67,400 |
Depreciation expense | 179,000 |
EBIT | $ 2,830,600 |
Interest expense | 85,555 |
EBT | $ 2,745,045 |
Taxes | 89,000 |
Net income | $ 2,656,045 |
Dividends | $ 169,000 |
Addition to retained earnings | $ 2,487,045 |
Lifeâs Good Corp. also issued $106,700 in new equity during the year and redeemed $65,300 in outstanding long-term debt.
i. Calculate the operating cash flow for the firm. (2 marks) $2,920,600
ii. Calculate the cash flow to creditors. (2 marks) $150,855
iii. Calculate the cash flow to stockholders. (2 marks) 62,300
iv. Define free cash flow (FCF) and state one of the equations for computing FCF. (3 marks)
4.
Clarkâs Drug Store, a medium-size drugstore located in Bridgetown Barbados, is owned and operated by Robert Clark. Clarkâs sells pharmaceuticals, cosmetics, toiletries, magazines, and various novelties. Clarkâs most recent annual net income statement is as follows:
Sales Revenue | $2,600,000 |
COGS | 1,460,000 |
Wages and Salaries | 250,000 |
Rent | 190,000 |
Depreciation | 70,000 |
Utilities | 95,000 |
Miscellaneous | 30,000 |
Total Expenses | 2,095,000 |
Net Profit before Tax | 505,000 |
Clarkâs sales and expenses have remained relatively constant over the past few years and are expected to continue unchanged in the near future. To increase sales, Clarkâs is considering using some floor space for a small soda fountain. Clarkâs would operate the soda fountain for an initial three-year period and then would reevaluate its profitability. The soda fountain would require an incremental investment of $85,000 to lease furniture, equipment, utensils, and so on. This is the only capital investment required during the three-year period. At the end of that time, additional capital would be required to continue operating the soda fountain, and no capital would be recovered if it were shut down.
The soda fountain is expected to have annual sales of $670,000 and food and materials expenses of $380,000 per year.
The soda fountain is also expected to increase wage and salary expenses by 6% and utility expenses by 5%. Because the soda fountain will reduce the floor space available for display of other merchandise, sales of non-soda fountain items are expected to decline by 10%.
Calculate net incremental cash flows for the soda fountain. (6 marks)
ii. Assume that Clarkâs has the capital necessary to install the soda fountain and that he places a 12% opportunity cost on those funds. Should the soda fountain be installed? Why or why not? (4 marks)
5. âIn order for a project to be acceptable, its required rate of return must exceed the cost of debtâ. Do you agree? In light of the statement, define what is cost of capital and what role does it play in long-term investment decisions? (5 marks)
6. What do you understand by the term net proceeds in context with a bond sale? How do floatation costs affect the net proceeds? (3 marks)
7. Go-geta Corp. issued 10-year bonds 2 years ago at a coupon rate of 6 percent. The bonds make semiannual payments. If these bonds currently sell for 98 percent of par value, what is the YTM? (2 marks)
FV | $1000 |
PV | $ (980.00) |
Coupon | $ 30.00 |
8. ABC Company has an unusual dividend policy. The company has just paid a dividend of $5 per share and has announced that it will increase the dividend by $2 per share for each of the next four years, and then never pay another dividend. If you required a 9 percent return on the companyâs stock, how much will you pay for a share today? (5 marks)
Dividend D0 | 5.00 | ||
Div increase yrly | 2.00 | ||
Required return | 9.00% | ||
Stock Price | |||
Factor | Price | ||
D (1) | 1.09 | 5.00 | 4.59 |
D (2) | 1.1881 | 7.00 | 5.89 |
D (3) | 1.295029 | 9.00 | 6.95 |
D (4) | 1.411582 | 11.00 | 7.79 |
9 âWhile contemplating to create a portfolio, it is imperative to study the correlation amongst the assets that constitute the portfolioâ. Discuss the statement and explain how diversification helps in reducing the risk of the portfolio as compared to the individual risks of constituting assets. (5 marks)