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FIN 321 - Spring 2014 Assignment 4




Question;1. Use the following information to answer questions A through G.Market ValuesCurrent cap. StructureProposed cap. StructureAssets$15 million$15 millionDebt$0$6 millionEquity$15 million$9 millionShare price$25.00$22.50Shares outstanding 600,000???Bond Interest rateN/A8%There are no taxes. EBIT is expected to be $2.5 million, but could be as high as $3.5 million ifan economic expansion occurs, or as low as $2 million if a recession occurs. All values aremarket values.A. What are EPS under the current and proposed capital structure for the three state ofeconomy?B. What are ROE under the current and proposed capital structure for the three state ofeconomy?C. How many shares are outstanding under the proposed capital structure?D. What is the weighted average cost of capital before and after recapitalization?E. What are EPS and ROE if the tax rate is 40%?F. What is the WACC if the tax rate is 40%?G. What is the expected net income and levered value of the firm when the tax rate is 40%?2. As manager of operation at the First California Bank (FCB), Vince Carter is responsible toreduce operational costs, keep FCB competitive with other banks such as National Bank ofCalifornia (NBC), and provide the best customer service to the FCB?s customers.Four years ago, he installed an automated teller machine (ATM) at one of its branches.The machine had the capacity to accept deposits, make withdrawals, and handle inquiriesregarding account balances. Not long afterward, National Bank of California, NBC, installedits own superior and reliable ATM and called it MoneyMax ATM. MoneyMax can doeverything the FCN's ATM can do, and more, including transferring customers' funds betweenchecking and savings, card retraction, receipt printing, customer service requests, dot-matrixJournal printing or electronic journal and any online banking that a computer could do.Since the NBC installed its MoneyMax, FCB has lost many of its customers. As aresult, Vince Carter is planning to install a new, more efficient and productive ATM calledTransax Mini-Bank, because it will handle complete banking activities outside of the bank.When FCB purchased its first ATM, it cost $500,000 and was estimated to have a usefuleconomic life of 10 years. The bank has been depreciating its ATM on a straight -line basis(over 10 years) to an estimated book salvage value of $100,000. The current actual marketvalue of the old ATM is $200,000.Transax Mini-Bank will cost $800,000 and have an expected economic life of 6 years.FCB plans to depreciate the new ATM over 5 years using MACRS. FCB believes that itsTransax Mini-Bank will attract new customers, which are expected to generate $300,000 innew revenues during the first year. Revenues from these new customers are expected to growat 5% per year over the 6-year life of the Transax ATM. Vince Carter also estimated theTranax Mini-Bank ATM would require $40,000 additional Working Capital at the timeinstallation. Thereafter, the working capital would grow with revenue at a constant rate of 6%per year. As an additional cost, annual maintenance costs on the new ATM will be $10,000during the first year and to increase at a rate of 5% per year over the annual maintenance costsof the old ATM.First California Bank has a 40% marginal tax rate, and has the following capital structure:Capital Structure(in millions)Debt$10Preferred Stock$10Common Stock ($5 par,1 million shares)$5Paid-in-capital$5Retained Earnings$10Total$40The debt is based on the FCB bond that the bank issued several years ago. The bond has a 10%coupon rate, a par value of $1,000 and 10 years maturity left. Today, the bond is selling for$900. The preferred stock has a price of $25 with annual dividend of $2.50 per share.The common stock is selling for $31 per share and FCB is expected to pay $3.0 dividend pershare this year. The dividend payment has increased from $1.84 since 10 years ago.Part Ia) Compute the net investment required to purchase the new ATM.b) Compute the annual incremental net cash flows for each year of the ATM's expected 6year life.c) Compute the net present value of Transax Mini-Bank, assuming the new ATM to be ofaverage risk.d) Based on the calculations performed in Questions 1-3, should First California Bankpurchase the new ATM?e) If FCB required a payback of less than 4 years, should FCB purchase new ATM?Part IIThe bank's board of directors require that a risk-adjusted discount rate be used to evaluate anynew capital investment that are seen as expanding the bank's services. Assume that the boardconsiders the new Transax Mini-Bank as falling into this category, and that the Board requiresan additional risk premium to be added when evaluating such an investment. Vince Carter hasestimated that the Beta of this investment to be equal 1.5 with return on the market portfolio of15% and risk-free rate of 5%.f) What is the cost of capital?g) Should the bank purchase the new ATM? Support your answer with calculating eitherNPV or IRR of the new ATM.3. The manager of Alpha Beta Funds is considering addition of the following stocks in hisportfolio:StocksStandard Deviation CovarianceExpected (Ri)A18%0.01220%B15%0.007512%C10%0.01114%D20%0.017516%E14%0.01615%RM10%1.014%RF00.96%a. Calculate the required rate of return for each stock.b. Determine which stock(s) the manager of Alma Funds should include in hisportfolio.4. The Sun Co. was founded five years ago by three former Moon Company employees. Thethree founders own 100% of the Sun Company?s stock which has a market value of $5 pershare. Below is the Balance Sheet of the company.The boards of directors of Sun Company have asked Frank Norman, the financial officer of thecompany, to make the first major decision for the company's future financial planning.The board has asked Frank to evaluate the profitability of two new investments (Table 1) thatthe company considers to acquire for its future survival.The two investments are different in their characteristics and descriptions.Table 1Investment AInvestment BPurchase Price$1,000,000$4,000,000Output2,5002,500Growth in Output5%6%Variable Cost$800$600Growth in Costs3%3%Unit Price$1,000$1,500Price Increase4%4%Beta11.4Tax Rate40%40%The investments would be depreciated on a straight line basis over their five-year life to a zerosalvage value.Frank Norman, being a sophisticated financial analyst, obtained the following information inTable 2 for the analysis of various investment and financial proposals.Market and CompanyVariancInformationExpected ReturneCov (Ri,RM)Risk-Free Rate10%Market Portfolio20 %Sun Co.8%Part Ia. What is the cost of capital for each investment?b. Which of the two investments should be adopted? Why?c. What would be the Sun?s cost of capital if these two investments are adopted?d. Based on the expected rate of return of each investment which investment should beaccepted? Why?Part IIThe financial officer has long believed that Sun's capital structure is not optimal, and hebelieves by financing half of total investment of each investment by debt at the 10% andretires the debt over the life of the investment, the value of each investment will bemaximized. If Frank Norman is correct with his assumptions and if his financial plan isadopted, what would the following be?e. Weighted Average Cost of Capital (WACC).f. Value of each investment.Sun CompanyBalance Sheet (in thousands)Cash$100,000Accounts Payable$150,000AccountReceivable$300,000Notes Payable$50,000Inventory$250,000Accrued Wages$75,000Current Assets$650,000Current Liabilities$275,000Gross FixedAssetsless: AccumulatedDepreciationNet Fixed AssetsTotal Assets$1,850,000Common Stocks (1M shares at parvalue of $1.5)($300,000) Retained Earnings$1,550,000Equity$2,200,000Total Debt & Equity$1,500,000$425,000$1,925,000$2,200,0005. On August 2, 2012, Yen Dollar, a portfolio manager at NewPoint, a mutual fund managementfirm, pored over analysts? write-ups of Global Traders Corp. Global Traders is an expandingconglomerate, is a manufacturing company whose product lines consist of lighting fixtures,videodiscs, electronic timing devices, travel agencies, and self-storage space. Dollar wasconsidering buying some shares for the fund she managed, the NewPoint Large-Cap Fund withan emphasis on value investing. Global Traders Corp's analyst has projected the followingincome statement for the next four years (in millions of dollars):Pro Forma Income Statement2013201420152016Growth Rate0. sales$120 $144$166$182($78Cost of goods sold)($94)($108) ($118)($20Selling/administrative expense)($24)($28)($30)($10Depreciation)($12)($15)($18)EBIT$12$14$15$16Interest($5)($6)($8)($10)EBT$7$8$7$6Taxes (40%)($3)($3)($3)($2)Net income$4$5$4$4All incomes are assumed to occur at end-of-year and it is expected to grow at rate of 5% after2016. Global Traders currently has a market value capital structure of 20 percent debt withinterest rate 10% and a beta of 2. Depreciation-generated funds would be used to finance theneeds in capital equipment, so they would not be available to 5 million Global Traders?shareholders. The risk-free rate is 6 percent and the market risk premium is 8 percent.a.What is the value of the Global Traders based on WACC model?b.What is the value to shareholders?


Paper#50058 | Written in 18-Jul-2015

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