Capital budgeting, weighted average cost of capital

(12 pts) 1. Explain the relationship that exists among the following: capital budgeting, weighted average cost of capital and the overall objective of the firm.

(12 pts) 2. Explain the importance of conducting an environmental scan. Also include a discussion of the forces of an environmental scan.

(12 pts) 3. Explain the significance of a required rate of return.

(8 pts) 4. Explain the relationship between the life cycle concept and dividend policy.

(16 pts) 5. Maple Media is considering a proposal to enter a new line of business. In reviewing the proposal, the company’s CFO is considering the following facts:
• The new business will require the company to purchase additional fixed assets that will cost $600,000. These costs will be depreciated on a straight line basis over three years.
• At the end of three years, the company will get out of the business and will sell the fixed assets at a salvage value of $100,000.
• The project will require a $50,000 increase in net operating working capital, which will be recovered at the project’s conclusion.
• The company’s marginal tax rate is 30%.
• The new business is expected to generate $2 million in sales each year. The operating costs excluding depreciation are expected to be $1.4 million per year.
• The project’s cost of capital is 12%.

    What is the project’s net present value (NPV)?  Should the project be           undertaken?

(8 pts) 6. Calculate the price of a 20 year 6 percent coupon bond with 15 years left to maturity and a market interest rate of 8 percent. Assume that the interest payments are semiannual and the par value of the bond is $1,000.

(16 pts) 7. The balance sheet and income statement shown below are for Byrd Inc.

                                          BALANCE SHEET

Cash $ 140.0 Accounts payable $800.0
Accts. Receivable 880.0 Notes payable ` 600.0
Inventories 1,320.0 Accruals 400.0
Total current assets 2,340.0 Total current liabilities 1,800.0 Long-term bonds 1,000.0
Total debt 2,800.0
Common stock 200.0
Retained earnings 1,000.0
Net plant & equip 1,660.0 Total common equity 1,200.0
Total assets $4,000.0 Total liabilities & equity $4,000.0

Net sales $6,000.0
Operating costs 5,599.8
Depreciation 100.2
EBIT $ 300.0
Less: Interest 96.0
EBT $ 204.0
Less: Taxes 81.6
Net income $ 122.4

Account balances in financial statements are in thousands.

a) Construct the DuPont Identity and explain its significance.
b) Calculate the earnings per share and explain its significance.
c) Calculate the current ratio and explain its significance.
d) Calculate the inventory holding period and explain its significance.

(16 pts) 8. Firms A and B are identical except for their level of debt and the interest rates they pay on debt. Each has $2 million in assets, $400,000 of EBIT, and has a 40% tax rate. However, firm A has a debt-to-assets ratio of 50% and pays 12% interest on its debt. While Firm B has a 30% debt ratio and pays only 10% interest on its debt.


a) Determine the return on equity for each firm.
b) Explain why Firm B pays lower interest.

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