FNCE 370v8: Assignment 2 – We have the following information for Athabasca Inc.

QUESTION

FNCE
370v8: Assignment 2

Assignment 2 is worth 5% of your final mark. Complete
and submit Assignment 2 after you complete Lesson 6.

There
are 15 questions in this assignment. The break-down of marks for each question
is presented in the table below. Please show all your work as this will help
the marker give you part marks as well as serve as a good study aid as you
prepare for the Final Examination.

Question

Marks
Available

Reference

1

10

Lesson 2

2

5

Lesson 2

3

3

Lesson 2

4

8

Lesson 3

5

6

Lesson 3

6

6

Lesson 3

7

5

Lesson 4

8

10

Lesson 4

9

15

Lesson 4

10

5

Lesson 5

11

5

Lesson 5

12

5

Lesson 5

13

5

Lesson 6

14

5

Lesson 6

15

7

Lesson 6

Total

100

1. We have the
following information for Athabasca Inc.
(10 marks)

Athabasca, Inc.
2010
Income Statement
($ in millions)
Net Sales $1,384
Less: Cost of Goods Sold 605
Less: Depreciation 180
Earnings before interest and
taxes 599
Less: Interest paid 80
Taxable Income 519
Less: Taxes 156
Net Income $ 363

Addition to retained earnings $
254
Cash dividends paid 109

Athabasca, Inc.
12/31/09 and 12/31/10 Balance Sheet
($ in millions)

2009

2010

2009

2010

Cash

$ 100

$ 121

Accounts payable

$ 400

$ 350

A/R

350

425

Notes payable

390

370

Inventory

440

410

Total CL

$ 790

$ 720

Total CA

$ 890

$ 956

Long-term debt

500

550

Net fixed assets

1,556

1,704

Owner’s equity

Common stock

600

580

Retained Earnings

556

810

Total assets

$2,446

$2,660

Total liabilities

$2,446

$2,660

The firm has 180 million
common shares outstanding. Calculate the following:

a. Earnings retention ratio for 2010.
b. The dividend to be paid (in dollars) in 2011. Assume
Athabasca is projecting a 20% increase in sales for the coming year, and that
cost of goods sold and general/administrative expenses remain a constant
percentage of sales. Also assume that depreciation, interest paid, and the
firm’s tax rate remain unchanged and that the firm’s dividend payout is 40%.
c. Capital intensity ratio based on the 2010 results.
d. Full capacity sales if Athabasca is currently operating at
70% capacity.
e. External financing needed (EFN) for 2011 if Athabasca is
projecting a 20% increase in sales for the coming year. Assume that assets, all
costs, and current liabilities are proportional to sales but that long-term
debt is not proportional to sales. Also assume that the firm’s tax rate remains
unchanged and the dividend payout is 40%.
f. External financing needed (EFN) for 2011 if Athabasca is
projecting a 20% increase in sales for the coming year, with current assets,
all costs, and current liabilities proportional to sales. Long-term debt is not
proportional to sales. Assume the firm’s
tax rate remains unchanged, the dividend payout is 40%, and Athabasca is
operating at 70% capacity.
g. Internal growth rate for 2010 (assume the dividend payout
ratio is fixed at 40%).
h. Sustainable growth rate for 2010 (assume the dividend payout
ratio is fixed at 40%).
2. State the
assumptions that underlie the sustainable growth rate and interpret what the
sustainable growth rate means. (5 marks)

3. Suppose a
firm calculates its EFN and finds that it is negative. What are the firm’s options in this
case? (3 marks)

4. Fill in
the blanks in the tables below.

a.

For each of the following, compute
the present value (round answer to 2 decimal places).
(2 marks)

Future value

Years

Interest rate

Present value

543

10

13%

7620

13

6%

18054

15

4%

803851

6

31%

b.

For each of the following,
compute the future value (round answer to 2 decimal places).
(2
marks)

Present value

Years

Interest rate

Future value

543

10

13%

7620

13

8%

18054

15

10.01%

803851

6

1%

c.

Solve for the unknown time period
in each of the following (round answer to 4 decimal places). (2
marks)

Present value

Future value

Interest rate

Time (years)

100

550

10%

2452

3000

13%

12463

234267

15%

139478

285736

9%

d.

Solve for the unknown interest rate
in each of the following (round answer to 4 decimal places). (2
marks)

Present value

Future value

Time (years)

Interest rate

100

550

10

2452

3000

13

12463

234267

15

139478

285736

9

5.
Suppose
your firm is planning to invest in a project that will generate the following
income stream: a negative flow $300,000 per year for 5 years, a positive flow
of $450,000 in the sixth year, and a positive flow of $650,000 per year in
years 7 through 9.

What is
the present value of this income stream if the appropriate discount rate is 10%
for the first 3 years and 13% thereafter? (6 marks)

6.
Annuity
A makes annual year-end payments of $976.50 for each of the next 10 years, while
investment B makes annual year-end payments of $600 per year forever.
Show your work for the following two questions:
(6 marks)

a.
At
what interest rate would you be indifferent between the two investments?

b.
At
interest rates above/below this break-even rate, which investment would you
choose and why?

7.
A
friend who owns a perpetuity that promises to pay $1,000 at the end of each
year, forever, comes to you and offers to sell you all of the payments to be
received after the 25th year for a price of $1,000. Assume an
interest rate of 10%. Be sure to show your work. (5 marks)

a.
Should
you pay the $1,000 today to receive payments from the end of year 26 and
onwards?

b.
What
value would you be willing to pay?

c.
What
does this suggest to you about the value of perpetual payments?

8. Rob and
Laura wish to buy a new home. The price is $300,000 and they plan to put 25%
down. New Rochelle Savings and Loan will lend them the remainder at 8% per
annum, compounded semi-annually for a 25-year term. The monthly payments are to
begin in one month. (10 marks)

a.
How
much will their monthly payments be?

b.
Assuming
they pay off the loan over the 25-year period as planned, what will be the
total cost (principal + interest + down payment) of the house?

c.
What
will the outstanding balance of the loan be after 10 years, assuming they make
the first 120 payments on time?

d.
Suppose
they want to pay off the loan in 15 years. How much extra must they pay each
month to do so?

e.
Show
the first six months in the amortization table for the 25-year mortgage.

9. You are
making plans for your retirement. You have just turned 30 and want to retire on
your 65th birthday. At that time, you plan to move to the Caribbean,
where you believe you can live comfortably on $200,000 per year. You also
understand that inflation can impact your enjoyment of retirement so you would
like the annual payments you receive to increase at a rate of 5% per annum. Your
first payment of $200,000 will occur at age 66. You intend to live in the
Caribbean until your 85th birthday, when you will receive your last
installment from your retirement fund, move back to Canada, and freeload off
your kids. You would also like to save enough money so that you can buy a new
car when you are 35, and pay for a big retirement party when you are 65. You
figure you will need to have $35,000 for the car and $10,000 for the party.
You estimate that you can earn an
average return of 10% per annum on any money you invest over the next 60 years.
You have just begun working and plan on saving $11,000 per year until you are
35 years old. You will make your first deposit one year from now. To ensure
that you are able to achieve your objectives, you must first answer the
following questions: (15 marks)

a.
How
much will you have to accumulate before you retire?

b.
How
much will you have to save yearly, from your 36th to your 65th
birthday, in order to accumulate the amount from part (a) and also pay for your
retirement party?

10.A bond is
currently selling at 0.85 on its par value of $1,000. This bond has a maturity
of 10 years and a coupon rate of 8%, payable semi-annually. If the inflation
rate is 5%, what is the real yield on this bond? (5 marks)

11.The bonds
of Microhard, Inc. carry a 12% annual coupon, have a $1,000 face value, and
mature in 4 years. Bonds of equivalent risk yield 10%. Microhard is having cash
flow problems and has asked its bondholders to accept the following deal:

The firm would like to make the next three coupon payments at
half the scheduled amount, and make the final coupon payment be $300. If this
plan is implemented and investors still demand a 10% return, what will happen
to the market price of the bond?
(5 marks)

12.J&J
Enterprises wants to issue eighty 15-year, $1,000 zero-coupon bonds. If each
bond is priced to yield 9%, how much will J&J receive (ignoring issuance
costs) when the bonds are first sold? (5 marks)

13.McGonigal’s
Meats, Inc. currently pays no dividends. The firm plans to begin paying
dividends in 3 years (at the end of t3). The first dividend at that
time will be $1 and dividends are expected to grow at 5% per annum thereafter.

Given shareholders demand a 12% return on their investments,
what is the price of the stock today (t0)? (5 marks)

14.Suppose
that sales and profits of Oly Enterprises are growing at a rate of 30% per
year. At the end of 4 years (t4) the growth rate will drop to a
steady 5%. Oly recently paid a dividend of $1 per share. If the required return
is 20%, what is the value of one Oly share today (t0)?
(Assume dividends grow at the same rate as earnings after year 4.) (5 marks)

15.Bradley
Broadcasting expects to pay dividends of $1.12, $1.25, and $1.40 in one, two, and
three years, respectively. After that, dividends are expected to grow at a
constant rate of 5% forever (so, t4 to?). Stocks
of similar risk yield 12%. (7 marks)

a.
What
should the price of Bradley Broadcasting stock be today?

b.
What
is growth rate of the Bradley Broadcasting dividend during year 2?

c.
How
much is Bradley’s stock price expected to increase during the first year?

d.
What
is the expected capital gains yield on Bradley Broadcasting stock during year
8?

 

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