Reference no: EM132363772

Assignment Questions -

Q1. Use the following information for Delta Corporation to answer question 1:

Delta has 500,000 common shares outstanding. The firm is projecting a 20% increase in net sales for the coming year (20X3). Delta uses the percentage of sales approach to plan for its financing needs. In using this approach, the firm assumes that cost of goods sold, depreciation, all assets (current and fixed), and accounts payable will all remain a constant percentage of sales. The firm will aim to maintain its dividend payout of 35% for the foreseeable future. The interest rate charged on notes payable and long-term debt is also expected to remain the same in.

a. Construct the pro-forma statement of comprehensive income and statement of financial position for Delta Corporation for 20X3. Calculate the external financing needed (EFN) for 20X3. Round all your numbers in the pro-forma statements to the nearest dollar.

b. Based on its 20X2 information, what is Delta's capital intensity ratio?

c. What is Delta's full capacity sales if it is currently operating at 70% capacity (20X2)?

d. How will the external financing needed (EFN) for 20X3 be affected if Delta is only operating at 70% capacity? Interpret this EFN number, and explain what the firm can do with it.

e. What is Delta's internal growth rate for 20X2? Round your final answer in percentage to two decimal places.

f. What is Delta's sustainable growth rate for 20X2? Round your final answer in percentage to two decimal places.

g. Explain how Delta could go bankrupt if it wants to grow its sales by 100% for 20X3.

Q2. What are the pitfalls of using financial planning models such as the percentage of sales approach to forecast future financing needs?

Q3. Roadworthy Inc. is a bridge construction company. It has been contracted on a $75 million bridge building project in Edmonton. The contract terms specified that the company must complete the project within three years, and the company will be paid at the end of each year according to the percentage completion on the bridge. For example, at the end of the first year of construction, the company will be paid 25% x $75 million = $18.75 million, as per the company's submitted bid, which indicated the following completion schedule:

• Year 1: 25% completion
• Year 2: 75% completion
• Year 3: 100% completion

The contract terms also specified that should the project fall behind schedule, Roadworthy will be assessed a penalty of $15 million for each year of delay. The discount rate on this project is 15%.

a. Assuming the company completes the project on schedule, what is the present value of this project to the company?

b. If the company completes the project on time, what is the future value to the company at the end of the project (i.e., at the end of Year 3)?

c. During the second year of construction, part of the bridge collapsed due to incorrect construction. Fortunately, the collapse occurred at night, and there were no injuries or casualties. However, new parts and equipment needed to be purchased, and the project had to restart from scratch. The adjusted schedule of completion of the entire project became

• Year 3: 25%
• Year 4: 75%
• Year 5: 100%

Roadworthy would not be receiving any payment in Years 2 and 3, as payment has already been received for 25% completion of the project. If the company's bridge construction went according to the new schedule, it would receive the next payment at the end of Year 4, and the last payment at the end of Year 5.

Furthermore, due to the delay in the project, the City of Edmonton will assess the company $15 million (penalty) for each year of delay, with the penalties due at the end of Years 4 and 5.

What is the future value of this project at the end of Year 5?

d. What is the minimum penalty that the city of Edmonton should charge Roadworthy in order to force it to complete the project by Year 4, with the following completion schedule?

• Year 3: 50%
• Year 4: 100%

With regard to cash flows, remember that 25% of the $75 million contract has already been paid out at the end of Year 1. In this new payment scheme, with the minimum penalty, the company will be paid $0 at the end of Year 2, 25% of the contract at the end of Year 3, and 50% at the end of Year 4. In this new payment scheme, only one penalty will be levied, which will occur at the end of Year 4. This penalty is intended to be a large levy to force Roadworthy to complete the bridge project by the end of Year 4.

(Hint: At the minimum penalty level, the future value of the project to the company will be $0 at end of Year 4.)

Q4. You just won the lottery! You have two choices for payout of your winnings. You can either choose a payment of $6 million in five years' time, or a lump sum of $3.8 million right now.

a. Assuming that you can reinvest any cash you receive at an annual rate of return of 10%-simple interest-which option would you prefer?

b. Assuming that you can reinvest any cash you receive at an annual rate of return of 10%-compound interest-which option would you prefer?

c. At what simple interest rate would you be indifferent between the two options? To solve this problem, you may use the equation manipulation method, the trial and error method, or the Goal Seek function in MS Excel (under Data-What-if-Analysis). If you choose to use trial and error method, try the rates between 11% and 12%, with 0.1% increments. If you choose to use Excel, ensure that you show your Excel formulas when presenting your answer. Marks will be deducted for incomplete or unclear answers.

d. At what compound interest rate would you be indifferent between the two options? To solve this problem, you may use either the equation manipulation method, the trial and error method or the Goal Seek function in MS Excel (under Data-What-if-Analysis). If you choose to use trial and error method, try the rates between 9% and 10%, with 0.1% increments. If you choose to use Excel, ensure that you show your Excel formulas when presenting your answer. Marks will be deducted for incomplete or unclear answers.

e. How far into the future can the $6 million be deferred before we become indifferent between receiving the money now and receiving it in the future, assuming a compound rate of return of 10%?

Q5. Ms. Juliet bought a house for $360,000 exactly five years ago. After making a 20% down-payment, she borrowed the rest of the house payment in the form of a 15-year mortgage from her local cooperative credit union. She negotiated a mortgage rate of 3.5% APR with semi-annual compounding. She makes mortgage payments of an equal dollar amount every two weeks (i.e., biweekly), and her first mortgage payment was due two weeks after she signed the mortgage contract.

a. What is the effective annual rate on Ms. Juliet's mortgage?

b. What is the effective biweekly interest rate on Ms. Juliet's mortgage?

c. What is Ms. Juliet's biweekly mortgage payment?

d. What is her current mortgage balance?

e. If Ms. Juliet can renegotiate a new 10-year mortgage rate of 2.5% APR with monthly compounding on her current mortgage balance, what will be her new biweekly mortgage payment?

f. With the new mortgage rate of 2.5% APR in part (e), complete the following table. Round your answers in the table to two decimal places.

Q6. You are making plans for your retirement. You have just turned 30 and want to retire on your 65th birthday. Once retired, you plan to move to a tax-free Caribbean state, where you believe you can live comfortably on $10,000 per month. Your first payment of $10,000 will occur when you retire at age 65, and you will receive your last instalment from your retirement fund one month before your 85th birthday. On your 85th birthday, you intend to move back to Canada and freeload off your kids until you die.

Your current salary is $60,000 per year, or $5,000 per month. Your personal tax rate is approximately 25%. You estimate that you can earn an average return of 10% APR compounded annually on any money you invest over the next 60 years. You will make your first deposit one month from now and your last deposit on your 65th birthday. To ensure that you are able to achieve your retirement objective, what percentage of your after-tax monthly income must you save?

Q7. A bond is currently selling at 1.15 on its par value of $1,000. This bond has a maturity of 15 years and a coupon rate of 5%, payable semi-annually. If the inflation rate is 3%, what is the real yield on this bond?

Q8. Today is April 15, 2016 (a leap year). We have the prices and yields for the following three bonds. Assume that all the bonds have face values of $1,000, and pay semi-annual coupons.

Fill in the blanks in the following table. Clearly show all reasoning and calculations in your answers.

Q9. Your Uncle Jamie wishes to invest some money in either Bond A or Bond B. Bond A has a face value of $1,000, a coupon rate of 6%, a date to maturity of 3 years, and a current price of $1,000. Bond B has a face value of $1,000, a coupon rate of 8%, and a date to maturity of 3 years. Coupons are paid semi-annually.

a. Which bond has a higher duration?

b. Bond duration measures a bond's sensitivity to interest rate changes: the higher the duration, the more sensitive a bond is to interest rate changes. If Uncle Jamie is risk averse, which bond should he choose?

Q10. Mrs. M owns 5,000 preferred shares of ABC Inc., and she is thinking of selling 150 of these shares to pay for a new computer. These shares pay quarterly dividends of $0.50 per share. If her required effective annual return is 15%, what is the minimum dollar amount for which Mrs. M. should sell her shares?

Q11. Etna Tech is a company set up by two friends, Larry and Mike. The company's only product is a popular online game called Fisticuffs. Etna Tech will be holding an IPO of 5 million shares tomorrow. Market expectations are high for this IPO. The company is expected to pay $1 per share starting one year from now. The dividends are then expected to grow at a supernormal rate of 30% for three years, before dropping down to 15% for three more years, and then to 5% afterwards. What is the total value of this IPO if the required return for similar issues is 18%?