EMBA - FINANCIAL MANAGEMENT SPRING 2012

Solutions to Selected Numeric Assigned Home Work Problems

Solutions Set #1
Chapter 2:
5. $2.5 Million
EBITDA = $7,500,000; NI = $1,800,000; Int = $2,000,000; T = 40%; DA = ?

EBITDA $7,500,000
DA 2,500,000 EBITDA DA = EBIT; DA = EBITDA EBIT
EBIT $5,000,000 EBIT = EBT + Int = $3,000,000 + $2,000,000
Int 2,000,000 (Given)
EBT $3,000,000
Taxes (40%) 1,200,000
NI $1,800,000 (Given)

6. NI = $450,000; NCF = $650,000; OCF = $650,000
EBIT = $750,000; DEP = $200,000; AMORT = 0; 100% Equity; T = 40%; NI = ?; NCF = ?; OCF = ?

First, determine net income by setting up an income statement:
EBIT $750,000
Interest 0
EBT $750,000
Taxes (40%) 300,000
NI $450,000

NCF = NI + DEP and AMORT = $450,000 + $200,000 = $650,000.

OCF = EBIT(1 T) + DEP and AMORT = $750,000(0.6) + $200,000 = $650,000.

Note that NCF = OCF because the firm is 100% equity financed.

7. Answer: a
Statements b and d will decrease the amount of cash on a companys balance sheet. Statement a will
increase cash through the sale of common stock. This is a source of cash through financing activities.
On one hand, Statement c would decrease cash; however, it is also possible that Statement c would
increase cash, if the firm receives a tax refund.

8.
a) $2.4 Billion
6 . 0
000 , 800 , 1 $
) T 1 (
000 , 800 , 1 $
=

b) $4.5 Billion
c) $5.4 Billion
d) $1.1 Billion
a. NOPAT = EBIT(1 T)
= $4,000,000,000(0.6)
= $2,400,000,000.

b. NCF = NI + DEP and AMORT
= $1,500,000,000 + $3,000,000,000
= $4,500,000,000.

c. OCF = NOPAT + DEP and AMORT
= $2,400,000,000 + $3,000,000,000
= $5,400,000,000.

d. FCF = NOPAT Net Investment in Operating Capital
= $2,400,000,000 $1,300,000,000
= $1,100,000,000.

11. $89,100,000
Ending R/E = Beg. R/E + Net income Dividends
$278,900,000 = $212,300,000 + Net income $22,500,000
$278,900,000 = $189,800,000 + Net income
Net income = $89,100,000.

Chapter 3:
4. M/B Ratio = 4.27
TA = $10,000,000,000; CL = $1,000,000,000; LT debt = $3,000,000,000; CE = $6,000,000,000; Shares
outstanding = 800,000,000; P
0
= $32; M/B = ?

Book value =
000 , 000 , 800
000 , 000 , 000 , 6 $
= $7.50.

M/B =
50 . 7 $
00 . 32 $
= 4.2667.
6. PM = 2%; Debt Ratio = 40%
We are given ROA = 3% and Sales/Total assets = 1.5.

From the basic Du Pont equation: ROA = Profit margin Total assets turnover
3% = Profit margin(1.5)
Profit margin = 3%/1.5 = 2%.

We can also calculate the companys debt ratio in a similar manner, given the facts of the problem.
We are given ROA(NI/A) and ROE(NI/E); if we use the reciprocal of ROE we have the following
equation:

40%. = 0.40 = 0.60 1 =
A
D
. 60% =
A
E
0.05
1
3% =
A
E
so ,
A
E
1 =
A
D
and
NI
E
A
NI
=
A
E

Alternatively, using the extended Du Pont equation:

ROE = ROA EM
5% = 3% EM
EM = 5%/3% = 5/3 = TA/E.

Take reciprocal: E/TA = 3/5 = 60%; therefore, D/A = 1 0.60 = 0.40 = 40%.

Thus, the firms profit margin = 2% and its debt ratio = 40%.


7. Change in Notes Payable = $262,500
Present current ratio =
$525,000
$1,312,500
= 2.5.

Minimum current ratio =
NP + $525,000
NP + $1,312,500
A
A
= 2.0.

$1,312,500 + ANP = $1,050,000 + 2ANP
ANP = $262,500.

Short-term debt can increase by a maximum of $262,500 without violating a 2 to 1 current ratio,
assuming that the entire increase in notes payable is used to increase current assets. Since we
assumed that the additional funds would be used to increase inventory, the inventory account will
increase to $637,500 and current assets will total $1,575,000, and current liabilities will total $787,500.

10. 23.1%
ROE = Profit margin TA turnover Equity multiplier
= NI/Sales Sales/TA TA/Equity.

Now we need to determine the inputs for the extended Du Pont equation from the data that were
given. On the left we set up an income statement, and we put numbers in it on the right:
Sales (given) $10,000,000
Cost na
EBIT (given) $ 1,000,000
INT (given) 300,000
EBT $ 700,000
Taxes (34%) 238,000
NI $ 462,000

Now we can use some ratios to get some more data:
Total assets turnover = 2 = S/TA; TA = S/2 = $10,000,000/2 = $5,000,000.

D/A = 60%; so E/A = 40%; and, therefore,
Equity multiplier = TA/E = 1/(E/A) = 1/0.4 = 2.5.

Now we can complete the extended Du Pont equation to determine ROE:
ROE = $462,000/$10,000,000 $10,000,000/$5,000,000 2.5 = 0.231 = 23.1%.

22.
a) 1.98x; 1.25x; 76.3 days; 6.66x; 1.70x; 1.7%; 2.9%; 7.6%; 61.9%
b) 7.6%; 9%
a. (Dollar amounts in thousands.)
Industry
Firm Average

s liabilitie Current
assets Current

=
$330,000
$655,000

= 1.98 2.0

s liabilitie Current
s Inventorie assets Current

=
$330,000
500 , 241 $ $655,000

= 1.25 1.3
DSO =
365 Sales/
receivable Accounts

=
11 . 04 $4,4
$336,000

=
76.3
days
35
days

s Inventorie
Sales
=
$241,500
$1,607,500

= 6.66 6.7

assets Total
Sales
=
$947,500
$1,607,500

= 1.70 3.0

Sales
income Net
=
$1,607,500
$27,300

= 1.7% 1.2%

assets Total
income Net
=
$947,500
$27,300

= 2.9% 3.6%

equity Common
income Net

=
$361,000
$27,300

= 7.6% 9.0%

assets Total
debt Total
=
$947,500
$586,500

= 61.9% 60.0%

b. For the firm,
ROE = PM T.A. turnover EM = 1.7% 1.7
$361,000
$947,500
= 7.6%.

For the industry, ROE = 1.2% 3 2.5 = 9%.

Note: To find the industry ratio of assets to common equity, recognize that 1 (Total debt/Total
assets) = Common equity/Total assets. So, Common equity/Total assets = 40%, and 1/0.40 =
2.5 = Total assets/Common equity.

c. The firms days sales outstanding is more than twice as long as the industry average, indicating
that the firm should tighten credit or enforce a more stringent collection policy. The total assets
turnover ratio is well below the industry average so sales should be increased, assets decreased,
or both. While the companys profit margin is higher than the industry average, its other
profitability ratios are low compared to the industrynet income should be higher given the
amount of equity and assets. However, the company seems to be in an average liquidity position
and financial leverage is similar to others in the industry.

d. If 2002 represents a period of supernormal growth for the firm, ratios based on this year will be
distorted and a comparison between them and industry averages will have little meaning.
Potential investors who look only at 2002 ratios will be misled, and a return to normal conditions
in 2003 could hurt the firms stock price.


Chapter 4:
1. 6.33%
r* = 3%; I
1
= 2%; I
2
= 4%; I
3
= 4%; MRP = 0; r
T2
= ?; r
T3
= ?

r = r* + IP + DRP + LP + MRP.

Since these are Treasury securities, DRP = LP = 0.

r
T2
= r* + IP
2
.
IP
2
= (2% + 4%)/2 = 3%.
r
T2
= 3% + 3% = 6%.

r
T3
= r* + IP
3
.
IP
3
= (2% + 4% + 4%)/3 = 3.33%.
r
T3
= 3% + 3.33% = 6.33%.

2. 1.5%
r
T10
= 6%; r
C10
= 8%; LP = 0.5%; DRP = ?

r = r* + IP + DRP + LP + MRP.

r
T10
= 6% = r* + IP
10
+ MRP
10
; DRP = LP = 0.
r
C10
= 8% = r* + IP
10
+ DRP + 0.5% + MRP
10
.

Because both bonds are 10-year bonds the inflation premium and maturity risk premium on both
bonds are equal. The only difference between them is the liquidity and default risk premiums.

r
C10
= 8% = r* + IP + MRP + 0.5% + DRP. But we know from above that r* + IP
10
+ MRP
10
=
6%; therefore,

r
C10
= 8% = 6% + 0.5% + DRP
1.5% = DRP.

11. Real risk free rate = 2.25%
T-bill rate = r* + IP
5.5% = r* + 3.25%
r* = 2.25%.

Chapter 5:
1. Expected return = 11.4%; SD = 26.69%; CV = 2.34

r = (0.1)(-50%) + (0.2)(-5%) + (0.4)(16%) + (0.2)(25%) + (0.1)(60%)
= 11.40%.

o
2
= (-50% 11.40%)
2
(0.1) + (-5% 11.40%)
2
(0.2) + (16% 11.40%)
2
(0.4)
+ (25% 11.40%)
2
(0.2) + (60% 11.40%)
2
(0.1)
o
2
= 712.44; o = 26.69%.

CV =
11.40%
26.69%
= 2.34.

6.
a) 14%
b) SD = 12.20%; CV = 1.45
a.

=
=
N
1 i
i i
r P r .

Y
r = 0.1(-35%) + 0.2(0%) + 0.4(20%) + 0.2(25%) + 0.1(45%)
= 14% versus 12% for X.

b. o =

=

N
1 i
i
2
i
P ) r r ( .

2
X
= (-10% 12%)
2
(0.1) + (2% 12%)
2
(0.2) + (12% 12%)
2
(0.4)
+ (20% 12%)
2
(0.2) + (38% 12%)
2
(0.1) = 148.8%.

o
X
= 12.20% versus 20.35% for Y.

CV
X
= o
X
/ r
X
= 12.20%/12% = 1.02, while

CV
Y
= 20.35%/14% = 1.45.

If Stock Y is less highly correlated with the market than X, then it might have a lower beta than
Stock X, and hence be less risky in a portfolio sense.

8. Approx. beta = 1.16
Old portfolio beta=
$150,000
$142,500
(b) +
$150,000
$7,500
(1.00)
1.12 = 0.95b + 0.05
1.07 = 0.95b
1.1263 = b.

New portfolio beta = 0.95(1.1263) + 0.05(1.75) = 1.1575 ~ 1.16.

Alternative solutions:
1. Old portfolio beta = 1.12 = (0.05)b
1
+ (0.05)b
2
+ ... + (0.05)b
20

1.12 =

) b (
i
(0.05)
i
b = 1.12/0.05 = 22.4.

New portfolio beta = (22.4 1.0 + 1.75)(0.05) = 1.1575 ~ 1.16.

2.
i
b excluding the stock with the beta equal to 1.0 is 22.4 1.0 = 21.4, so the beta of the
portfolio excluding this stock is b = 21.4/19 = 1.1263. The beta of the new portfolio is:
1.1263(0.95) + 1.75(0.05) = 1.1575 ~ 1.16.


9. Required rate of Return (Fund) = 12.1%
Portfolio beta =
$4,000,000
$400,000
(1.50) +
$4,000,000
$600,000
(-0.50) +
$4,000,000
$1,000,000
(1.25) +
$4,000,000
$2,000,000
(0.75)
b
p
= (0.1)(1.5) + (0.15)(-0.50) + (0.25)(1.25) + (0.5)(0.75)
= 0.15 0.075 + 0.3125 + 0.375 = 0.7625.

r
p
= r
RF
+ (r
M
r
RF
)(b
p
) = 6% + (14% 6%)(0.7625) = 12.1%.

Alternative solution: First, calculate the return for each stock using the CAPM equation
[r
RF
+ (r
M
r
RF
)b], and then calculate the weighted average of these returns.

r
RF
= 6% and (r
M
r
RF
) = 8%.

Stock Investment Beta r = r
RF
+ (r
M
r
RF
)b Weight
A $ 400,000 1.50 18% 0.10
B 600,000 (0.50) 2 0.15
C 1,000,000 1.25 16 0.25
D 2,000,000 0.75 12 0.50
Total $4,000,000 1.00

r
p
= 18%(0.10) + 2%(0.15) + 16%(0.25) + 12%(0.50) = 12.1%.
11.
a) CV = 2.0
b) Stock Y
c) For X 10.5%; For Y 12%
d) Stock Y
e) 10.875%
f) Stock Y

X
r = 10%; b
X
= 0.9; o
X
= 35%.

Y
r = 12.5%; b
Y
= 1.2; o
Y
= 25%.

r
RF
= 6%; RP
M
= 5%.

a. CV
X
= 35%/10% = 3.5. CV
Y
= 25%/12.5% = 2.0.

b. For diversified investors the relevant risk is measured by beta. Therefore, the stock with the
higher beta is more risky. Stock Y has the higher beta so it is more risky than Stock X.

c. r
X
= 6% + 5%(0.9)
= 10.5%.

r
Y
= 6% + 5%(1.2)
= 12%.

d. r
X
= 10.5%;
X
r = 10%.
r
Y
= 12%;
Y
r = 12.5%.

Stock Y would be most attractive to a diversified investor since its expected return of 12.5% is
greater than its required return of 12%.

e. b
p
= ($7,500/$10,000)0.9 + ($2,500/$10,000)1.2
= 0.6750 + 0.30
= 0.9750.

r
p
= 6% + 5%(0.975)
= 10.875%.

f. If RP
M
increases from 5% to 6%, the stock with the highest beta will have the largest increase
in its required return. Therefore, Stock Y will have the greatest increase.
Check:
r
X
= 6% + 6%(0.9)
= 11.4%. Increase 10.5% to 11.4%.

r
Y
= 6% + 6%(1.2)
= 13.2%. Increase 12% to 13.2%.
Chapter 6:
4. 11 years
0 1 2 N 2 N 1 N
| | | --- | | |
PV = 42,180.53 5,000 5,000 5,000 5,000 FV = 250,000

Using your financial calculator, enter the following data: I/YR = 12; PV = -42180.53; PMT =
-5000; FV = 250000; N = ? Solve for N = 11. It will take 11 years to accumulate $250,000.

5. 8.01%
0 18
| |
PV = 250,000 FV
18
= 1,000,000

With a financial calculator enter the following: N = 18, PV = -250000, PMT = 0, and FV =
1000000. Solve for I/YR = 8.01% 8%.

8. PV = $923.98; FV = $1,466.24
0 1 2 3 4 5 6
| | | | | | |
100 100 100 200 300 500
PV = ? FV = ?

Using a financial calculator, enter the following: CF
0
= 0; CF
1
= 100; N
j
= 3; CF
4
= 200 (Note
calculator will show CF
2
on screen.); CF
5
= 300 (Note calculator will show CF
3
on screen.); CF
6
=
500 (Note calculator will show CF
4
on screen.); and I/YR = 8. Solve for NPV = $923.98.

To solve for the FV of the cash flow stream with a calculator that doesnt have the NFV key, do the
following: Enter N = 6, I/YR = 8, PV = -923.98, and PMT = 0. Solve for FV = $1,466.24. You can
check this as follows:
0 1 2 3 4 5 6
| | | | | | |
100 100 100 200 300 500
324.00
233.28
125.97
136.05
146.93
$1,466.23

8%
(1.08)
(1.08)
2

(1.08)
3

(1.08)
4

(1.08)
5

9. PMT =$ 444.89; EAR = 12.68%
Using a financial calculator, enter the following: N = 60, I/YR = 1, PV = -20000, and FV = 0. Solve for
PMT = $444.89.

EAR =
M
NOM
M
I
1
|
|
.
|

\
|
+ 1.0
= (1.01)
12
1.0
= 12.68%.

Alternatively, using a financial calculator, enter the following: NOM% = 12 and P/YR = 12. Solve
for EFF% = 12.6825%. Remember to change back to P/YR = 1 on your calculator.
31. 48 month financing PV = 13,290.89; 60 month financing PV = 15,734.26
Using the information given in the problem, you can solve for the maximum car price attainable.

Financed for 48 months Financed for 60 months
N = 48 N = 60
I/YR = 1 (12%/12 = 1%) I/YR = 1
PMT = 350 PMT = 350
FV = 0 FV = 0
PV = 13,290.89 PV = 15,734.26

You must add the value of the down payment to the present value of the car payments. If
financed for 48 months, you can afford a car valued up to $17,290.89 ($13,290.89 + $4,000). If
financing for 60 months, you can afford a car valued up to $19,734.26 ($15,734.26 + $4,000).

32.
a) N = 50 months
b)
c) Approx. 13 months
d) $112.38
a. Using the information given in the problem, you can solve for the length of time required to
pay off the card.

I/YR = 1.5 (18%/12); PV = 350; PMT = -10; FV = 0; and then solve for N = 50 months.

b. If Simon makes monthly payments of $30, we can solve for the length of time required before
the account is paid off.

I/YR = 1.5; PV = 350; PMT = -30; FV = 0; and then solve for N = 12.92 13 months.

With $30 monthly payments, Simon will only need 13 months to pay off the account.

c. Total payments @ $10.month: 50 $10 = $500.00
Total payments @ $30/month: 12.921 $30 = 387.62
Extra interest = $112.38


48.
a) $75,500
b) $10,037
c) $9,385

Step 1: Determine the annual cost of college. The current cost is $15,000 per year, but that is
escalating at a 5% inflation rate:
College Current Years Inflation Cash
Year Cost from Now Adjustment Required
1 $15,000 5 (1.05)
5
$19,144.22
2 15,000 6 (1.05)
6
20,101.43
3 15,000 7 (1.05)
7
21,106.51
4 15,000 8 (1.05)
8
22,161.83

Now put these costs on a time line:
13 14 15 16 17 18 19 20 21
| | | | | | | | |
-19,144 20,101 21,107 22,162

How much must be accumulated by age 18 to provide these payments at ages 18 through
21 if the funds are invested in an account paying 6%, compounded annually?

With a financial calculator enter: CF
0
= 19144, CF
1
= 20101, CF
2
= 21107, CF
3
= 22162,
and I/YR = 6. Solve for NPV = $75,500.00.

Thus, the father must accumulate $75,500 by the time his daughter reaches age 18.

Step 2: The daughter has $7,500 now (age 13) to help achieve that goal. Five years hence, that
$7,500, when invested at 6%, will be worth $10,037: $7,500(1.06)
5
= $10,036.69
$10,037.

Step 3: The father needs to accumulate only $75,500 $10,037 = $65,463. The key to
completing the problem at this point is to realize the series of deposits represent an
ordinary annuity rather than an annuity due, despite the fact the first payment is made at
the beginning of the first year. The reason it is not an annuity due is there is no interest
paid on the last payment that occurs when the daughter is 18.

Using a financial calculator, N = 6, I/YR = 6, PV = 0, and FV = -65463. PMT = $9,384.95
$9,385.