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FundamentalsofFinancialManagementEleventhEdition
FundamentalsofFinancialManagement
EleventhEdition
SOLUTIONSTOPROBLEMS
CONTENTS
CHAPTER4TheValuationofLong-TermSecurities
CHAPTER5RiskandReturn
CHAPTER8OverviewofWorkingCapitalManagement
CHAPTER9CashandMarketableSecuritiesManagement
CHAPTER10AccountsReceivable
CHAPTER11Short-TermFinancing
CHAPTER15RequiredReturnsandtheCostofCapital
CHAPTER16OperatingandFinancialLeverage
CHAPTER17CapitalStructureDetermination
CHAPTER18DividendPolicy
CHAPTER19TheCapitalMarket
CHAPTER20Long-TermDebt,PreferredStock,andCommonStock
CHAPTER4
1.Priceperbond$907.10
2.Priceperbond$904.30
3.Currentprice:
p0=$80.00
Laterprice:
p0=$66.67
Thepricedropsby$13.33
4.Rateofreturn=20%
5.PresentvalueofstockV=$22.63
6.a)$37.5
b)$30.00
c)$37.50
Eitherthepresentstrategy(a)orstrategy(c)bothresultinthesamemarketpricepershare.
7.a)8percent
b)YTC=9.64percent
wesolveforYTCbycomputer
8.V=$75
9.V=$689.41
10.a)g=0.05
b)expecteddividendyield=0.07
c)expectedcapitalgainsyield=g=0.05
11.a)semiannualyield=0.0402
b)0.0804
c)effectiveannualyield=0.0820
12.a)tryinga4percentsemiannualYTMasastartingpointforatrial-and-errorapproach,weget
P0=$1,067.55
Since$1,067.55islessthan$1,120,weneedtotryalowerdiscountrate,say3percent
P0=$1,223.47
Toapproximatetheactualdiscountrate,weinterpolatebetween3and4percent,
X=0.0066
Inaddition,semiannualYTM=0.03+0.0066=0.0366,or3.66percent.(TheuseofacomputerprovidesaprecisesemiannualYTMfigureof3.64percent.)
b)semiannualYTM*2=nominalYTM
nominalYTM=0.0732
C)effectiveannualYTM=0.0754
13.a)oldChicago’s12-yearbondsshouldshowagreaterpricechangethanRedFrog’sbonds.Witheverything,thesameexceptformaturity,thelongerthematurity,thegreaterthepricefluctuationassociatedwithagivenchangeinmarketrequiredreturn.Thecloserintimethatyouaretotherelativelylargematurityvaluebeingrealized,thelessimportantareinterestpaymentsindeterminingthemarketprice,andthelessimportantisachangeinmarketrequiredreturnonthemarketpriceofthesecurity.
b)RedFrog:
P0=$1,041
OldChicago:
P0=$1,086.14
OldChicago’spriceperbondchangesby($1,086.14-$1,000=$86.14,whileRedFrog’spriceperbondchangesbylessthanhalfthatamount,or($1,041-$$1,000)=$41
14.a)$36.67
b)$31.14
c)$44.40
CHAPTER5
1.a)Thestandarddeviationis11.36%
b)Thereisa30percentprobabilitythattheactualreturnwillbezero(prob.E(R)=0Is20%)orless(prob.E(R)also,byinspectionweseethatthedistributionisskewedtotheleft.
2.a)Forareturnthatwillbezeroorless,standardizingthedeviationfromtheexpectedvalueofreturnweobtain(0%-20%)/15%=-1.333standarddeviations.TurningtoTableVatthebackofthebook,1.333fallsbetweenstandarddeviationsof1.30and1.35.Thesestandarddeviationscorrespondtoareasunderthecurveof0.0968and0.0885respectively.Thismeansthatthereisapproximatelya9%probabilitythatactualreturnwillbezeroorless.(Interpolatingfor1.333,wefindtheprobabilitytobe9.13%)
b)10percent:
Standardizeddeviation(10%-20%)/15%=-0.667.
probabilityof10percentorlessreturn=(approx.)25percent.
Probabilityof10percentormorereturn=75percent.
20percent:
50percentprobabilityofreturnbeingabove20percent.
30percent:
standardizeddeviation=(30%-20%)/15%=0.667.Probabilityf30percentormorereturn=(approx.)25percent.
40percent:
standardizeddeviation=1.333
probabilityof40percentormorereturn=(approx.)9percent
50percent:
Standardizeddeviation=2.00
Probabilityof50percentormorereturn=2.28percent
3.Thebetaisapproximately0.5.Thisindicatesthatexcessreturnsforthestockfluctuatelessthanexcessreturnsforthemarketportfolio.Thestockhasmuchlesssystematicriskthanthemarketasawhole.Itwouldbeadefensiveinvestment.
4.Req.(RA)=0.16
Req.(RB)=0.13
Req.(RC)=0.106
Req.(RD)=0.190
Req.(RE)=0.148
5.Expectedreturn=0.1538
7.a)Selena’sexpectedreturnis0.1602.
b)TheexpectedreturnonSelena’sportfolioincreasesto16.82percent,becausetheadditionalfundsareinvestedinthehighestexpectedreturnstock.
8.Requiredreturn=0.154
Assumingthattheperpetualdividendgrowthmodelisappropriate,wegetV=$45.45
9.A)thebetaofaportfolioissimplyaweightedaverageofthebetasoftheindividualsecuritiesthatmakeuptheportfolio.
Theportfoliobetais1.115
b)Expectedportfolioreturn=14.69%or0.1469
SolutiontoAppendixAproblem
10.E(Rp)=0.121
Thestandarddeviationoftheportfolioequalsto0.00856
CHAPTER8
1.
a)Totalassetturnover=1.867
Returnonassetsbeforetaxes=18.67%
b)
Profit
CurrentAssets
FixedAssets
TotalAssets
ReturnonAssets
28,000
10,000
100,000
110,000
25.45%
28,000
25,000
100,000
125,000
22.4%
28,000
40,000
100,000
140,000
20%
28,000
55,000
100,000
155,000
18.06%
28,000
70,000
100,000
170,000
16.47%
28,000
85,000
100,000
185,000
15.14%
28,000
100,000
100,000
200,000
14.00%
c)Theimplicitassumptionin(b)aboveisthatthelevelofworkingcapitalhasnoimpactonsalesorcosts.Onecanvisualizesituationswheresalesarelostbecauseofstockoutsandcostsmayincreaseasmorelosttimeinproductioniscausedbyshortagesofmaterials.
2.
b)Finance$4millionofworkingcapitalwithpermanentsourcesoffunds.Financefixedasseswithcommonstockandretainedearnings.Financehetemporaryworkingcapitalwithshort-termdebt.
3.A)Alternative1:
bankloancost:
$96,000
Alternative2:
Termloancost$67,500
Bankloancost$42,000
Totalcost$109,500
Alternative3:
Termloancost$135,000
Bankloancost$12,000
Totalcost$147,000
Alternative1islowestincostbecausethecompanyborrowsatlowerrate,12percentversus13.5percent,andbecauseitdoesnotpayinterestonfundsemployedwhentheyarenotneeded.
b)Whilealternative1ischeapestitentailsfinancingtheexpectedbuildupinpermanentfundsrequirements($500,000)onashort-termbasis.Thereisariskconsiderationinthatifthingsturnbadthecompanyisdependentonitbankforcontinuingsupport.Thereisriskofloanrenewalandinterestrateschanging.
Alternative2involvesborrowingtheexpectedincreaseinpermanentfundsrequirementsonatermbasis.Asaresult,onlytheexpectedseasonalcomponentftotalneedswouldbefinancedwithshort-termdebt.
Alternative3,themostconservativefinancingplanofthethree,involvesfinancingonatermbasismorethantheexpectedbuild-upinpermanentfundsrequirements.Inallthreecases,thereistheriskthatactualtotalfundsrequirementswilldifferfromthosethatareexpected.
Chapter9
1.a)$2,520,000
b)Fundsreleased=$840,000
Valueoffundsreleasedonanannualbasis=$75,600
Thecompanyshouldnotinauguratetheplan.
c)Valueoffundsreleasedonanannualbasis=$37,800
Thecompanyshouldundertaketheplan.
2.a)annualsaving=$35,000
b)maximumchargebyNewOrleansbank=$105,000
3.Ifthecompanywerecertainofthepatternshown,itwouldwishtohavethefollowingdepositsinitspayrollaccountinordertocoverthechecksthatwerecashed:
Friday$30,000
Monday60,000
Tuesday37,500
Wednesday15,000
Thursday7,500
$150,000
Ifemployeecheckcashingbehaviorissubjecttofluctuations,thecompanywillneedtomaintain“buffer”cashintheaccount.Thegreatertheuncertainty,thegreaterthebufferthatwillbeneeded.
4.a)$1,230,000
b)$615,000
c)Interestearned=$615,000*10%=$61,500
Cost=250transfers*41stores*$7cost=$71,750
Asthecostexceedstheinterestearnedonthenetreleasedfunds,thearrangementwouldnotbeworthwhile.Thetransfersarenotlargeenoughtooffsetthefixedcost.0
5.Nospecificsolutionrecommended.
Chapter10
1.
CreditPolicy
A
B
C
D
a.Incrementalsales
$28,800,000
$1,800,000
$1,200,000
$600,000
b.Incrementalprofitability
28,000
180,000
120,000
60,000
c.Newreceivable
Turnover
8
6
4
2.5
d.Additionalreceivables
$350,000
$300,000
$300,000
$240,000
e.Additional
Investment
315,000
270,000
270,000
216,000
f.Opportunitycost
94,500
81,000
81,000
64,800
g.b>f?
Yes
Yes
Yes
No
ThecompanyshouldadoptcreditpolicyCbecauseincrementalprofitabilityexceedstheincreasedcarryingcostsforpoliciesA,B,C,butnotforpolicyD.
2.
CreditPolicy
A
B
C
D
a.Incrementalsales
$28,800,000
$1,800,000
$1,200,000
$600,000
b.Percentdefault
3%
6%
10%
15%
b.Incrementalbad-debtlosses
$84,000
108,000
120,000
90,000
d.opportunitycost
94,500
81,000
81,000
64,800
e.Totalcosts
178,500
189,000
201,000
154,800
b.Incrementalprofitability
280,000
180,000
120,000
60,000
g.f>e?
Yes
No
No
No
AdoptcreditpolicyA.itistheonlyonewhereincrementalprofitabilityexceedsopportunitycostsplusbad-debtlosses.
3.
CreditPolicy
A
B
C
D
a.Incrementalsales
$28,800,000
$1,800,000
$1,200,000
$600,000
b.Percentdefault
1.5%
3%
5%
7.5%
b.Incrementalbad-debtlosses
$42,000
54,000
60,000
45,000
d.opportunitycost
94,500
81,000
81,000
64,800
e.Totalcosts
136,500
135,000
141,000
109,800
b.Incrementalprofitability
280,000
180,000
120,000
60,000
g.f>e?
Yes
yes
No
No
CreditpolicyBnowwouldbebest.Anymoreliberalcreditpolicybeyondthispointwouldonlyresultinmoreincrementalcoststhanbene