12 - 7

WACC 14%

a)
NPV A $ 0.87 Year Project A Project B
NPV B $ 1.23 0 $ -6 $ -18
1 $ 2 $ 5.6
2 $ 2 $ 5.6
IRR A 20% 3 $ 2 $ 5.6
IRR B 17% 4 $ 2 $ 5.6
5 $ 2 $ 5.6
MIRR A 17%
MIRR B 16%

Year Project A Cumulative Year Project B

0 $ -6 $ -6 0 $ -18
1 $ 2 $ -4 1 $ 5.6
2 $ 2 $ -2 2 $ 5.6
3 $ 2 $ - 3 $ 5.6
4 $ 2 $ 2 4 $ 5.6
5 $ 2 $ 4 5 $ 5.6

Payback A 3.000
Payback B 3.214

Year Project A Discounted Cumulative Year

0 $ -6 $ -6.0 $ -6 0
1 $ 2 $ 1.8 $ -4 1
2 $ 2 $ 1.5 $ -3 2
3 $ 2 $ 1.3 $ -1 3
4 $ 2 $ 1.2 $ -0.2 4
5 $ 2 $ 1.0 $ 1 5

Discounted Payback A 4.086

Discounted Payback B 4.301

b) Reject All project NPV < 0

c) Reject all project NPV < 0

d) Timing differences (cash flow came early/late) & The amount of investment is larger for project A compared to B
 Cumulative
$ -18
$ -12
$ -7
$ -1
$ 4
$ 10

Project A Discounted Cumulative

$ -18 $ -18.00 $ -18.0
$ 5.6 $ 4.91 $ -13.1
$ 5.6 $ 4.31 $ -8.8
$ 5.6 $ 3.78 $ -5.0
$ 5.6 $ 3.32 $ -1.7
$ 5.6 $ 2.91 $ 1.2

r project A compared to B
FINANCIAL ACCOUNTING ASSIGNMENT
Chapter 10 – Stocks and their valuation
DIVA TERTIA ALMIRA – NIU 470320

10 - 1

D1 $ 1.20
g1-2 10%
gn 5%

D1 D0 (1+g1) =
D2 D0 (1+g1) (1+g2) =
D3 D0 (1+g1) (1+g2) (1+gn) =
D4 D0 (1+g1) (1+g2) (1+gn) (1+gn) =

10 - 2

d1 $ 0.50
g 7%
Rs 15%

P̂0 = D1
rs - g

= $ 0.50
8.0%
= 6.25
10 - 3

P0 $ 25.00
r 15%
d0 $ 1.50
g ?

P0 = d0(1+g)
rs - g

25 = 1,5 (1 + g)
15% - g%

25(-15% + g%) = 1,5 (1+g)

3,75 - 25g = 1,5 + 1,5g

-25g = 1,5 + 1,5g - 3,75

 -26,5g = -2.25

g = 8.5%

P1 = P0(1 + g)
= 27.12

10 - 4

D0 1.25
Non constant g 20%
Constant g 5%
r 10%
0 20% 1 2 5% 3

1,25 1,5 1,8 1,89

a) Horizon date at the end of year 2

b)
Pn = D3
rs - g

1.89
5%

Pn = 37.8

c)
PV D1 $ 1.36
PV D2 $ 1.49
PV P3 $ 31.24
P0 $ 34.09

10 - 5

WACC 12%
FCF $ 200,000,000
g 6%
#Shares 100,000,000

0 12% 1 6% 2

200 Mio 212 Mio

$ 178,571,429
HV2 = $ 212,000,000
12% - 6%
$ 3,154,761,905 HV2 = $ 3,533,333,333
$ 3,333,333,333

MV Equity = $ 3,333,333,333
Value/Share = $ 33.33 -

10 - 6

Vp $ 50.00
D $ 4.00
rp ?

Vp = D
rp
$ 50 = $ 4.00
rp
rp = $ 4.00
$ 50.00

8%

10 - 7

D0 6
rp 10%

Vp = D
rp

Vp = 6
10%

Vp = 60

10 - 8

D $ 10.00
rp 8%

a) b)
Vp = D Vp = D
rp rp

Vp = $ 10.00 Vp = $ 10.00
 8% 12%

Vp = $ 125.00 Vp = $ 83.33

10 - 9

D $ 1.00 Quarter
D $ 4.00 Annual
Vp $ 120.00

Vp = D
rp

120 = 4
rp

rp = 3%

10 - 9

D0 $ 5.00
rs 15%
g -5%

P0 = D1
rs - g

P0 = 4.75
20%

P0 = 23.75

10 - 10
$ 1.32
$ 1.45
$ 1.52
$ 1.601
 11 - 1

Coupon 10%
PMT $ 100.00
rd 12%
T 35%

Cost of Debt = rd(1 – T)

= 12% (1-35%)
7.8%

11 - 2

Pp $ 47.50
Dp $ 3.80

rp = Dp
Pp

rp = $ 3.80
$ 47.50

rp = 8%

11 - 3

wd 40%
wc 60%
rd 9%
T 40%
WACC 9.96%

WACC = wd rd(1 – T) + wp rp + wc rs
9,96% = 40% * 9% (1-40%) + 60% * rs
9,96% = 2% + 60%rs
rs = 13.27%

11 - 4

P 30
D 3
g 5%

a)
 rs = D1 + g
P0
3 + 5%
30
rs = 15%

b)
rs = D1 + g
P0 (1 - F)
3 5%
+
30 (1 - 10%)
rs = 16.11%

11 - 5

WACC 10.50%

Project Size (Mio) Rate of Return Accept/Not

A $ 1.00 12% Accept
B $ 2.00 11.50% Accept
C $ 2.00 11.20% Accept
D $ 2.00 11% Accept
E $ 1.00 10.70% Accept
F $ 1.00 10.30%
G $ 1.00 10.20%

11 - 6

g 7%
D0 $ 2.00
D1 $ 2.14
P0 $ 23.00

a) DCF
rs = D1 g
+
P0
rs = $ 2.14 + 7%
$ 23.00
rs = 16.30%

b) CAPM
rs = rRF + (rM – rRF)b
rs = 9% + (13%-9%)1,6
rs = 15.40%
c) Bond-Yield-Plus-Risk-Premium
rs = rd + RP
rs = 12% + 4%
rs = 16%

11 - 7

D1 $ 3.18
g 6%
Ps $ 36.00
Pe $ 32.40

a)
rs = D1 + g
P0
rs = $ 3.18 + 6%
$ 36.00
rs = 14.83%

b)
F= $ 3.60
$ 36.00
F= 10%

c)
rs = D1 + g
P0 (1-F)
rs = $ 3.18 + 6%
$ 32.40
rs = 15.81%

11 - 8

wd 40%
wc 60%
rd (BT) 12%
T 40%
P0 $ 22.50
D0 $ 2.00
g 7%

rd (AT) = 7%

rs = D1 g
+
 +
P0

rs = $ 2.14 + 7%
$ 22.50

rs = 16.51%

WACC = wd rd(1 – T) + wp rp + wc rs
12.79%

11 - 9
Weight
Long-term debt $ 1,152.00 40%
Equity $ 1,728.00 60%
$ 2,880.00
rd (BT) 13%
T 40%
rd (AT) 8%
rs 16%

WACC = wd rd(1 – T) + wp rp + wc rs
WACC = 12.7%

11 - 10

wd 40%
wc 60%
T 40%
Project $ 5,900,000
Debt $ 2,360,000
Equity $ 3,540,000
R/E $ 2,000,000
New Stock $ 1,540,000

rs 12%
re 15%
rd 10%

WACC = wd rd(1 – T) + wp rp + wc rs
WACC = 11.4%

11 - 11

rd 11%
D0 $ 2.00
 P0 $ 24.75
g 7%
T 35%
WACC 13.95%

rd (AT) 7%

rs = D1 + g
P0
rs = $ 2.14 + 7%
$ 24.75

rs = 16%

WACC = wd rd(1 – T) + wp rp + wc rs
13,95% = 0,0715wd + 0,156464646464646(1-wd)
13,95% = 0,0715wd + 0,156464646464646 - 0,156464646464646wd
-2% -0,0849646464646465wd
wd = 20%

11 - 12
 12 - 1

WACC 12%

Year CF
0 $ -52,125
1 $ 12,000
2 $ 12,000
3 $ 12,000
4 $ 12,000
5 $ 12,000
6 $ 12,000
7 $ 12,000
8 $ 12,000

NPV $ 7,487

12 - 2

IRR 16%

12 - 3

MIRR 14%

12 - 4

Year CF Cumulative
0 $ -52,125 $ -52,125
1 $ 12,000 $ -40,125
2 $ 12,000 $ -28,125
3 $ 12,000 $ -16,125
4 $ 12,000 $ -4,125
5 $ 12,000 $ 7,875
6 $ 12,000 $ 19,875
7 $ 12,000 $ 31,875
8 $ 12,000 $ 43,875

Payback 4.34

12 - 5

Year CF Discounted Cumulative

0 $ -52,125 $ -52,125.00 $ -52,125
1 $ 12,000 $ 10,714.29 $ -41,411
2 $ 12,000 $ 9,566.33 $ -31,844
3 $ 12,000 $ 8,541.36 $ -23,303
 4 $ 12,000 $ 7,626.22 $ -15,677
5 $ 12,000 $ 6,809.12 $ -8,868
6 $ 12,000 $ 6,079.57 $ -2,788
7 $ 12,000 $ 5,428.19 $ 2,640
8 $ 12,000 $ 4,846.60 $ 7,487

Discounted Payback 6.23

12 - 6

Year Project A Project B

0 $ -25 $ -20
1 $ 5 $ 10
2 $ 10 $ 9
3 $ 17 $ 6

WACC 1 5%
WACC 2 10%
WACC 3 15%

a)
PROJECT A

NPV (5%) = $ 3.52 Million Accept

NPV (10%) = $ 0.58 Million
NPV (15%) = $ -1.91 Million Don't Accept Both

PROJECT B

NPV (5%) = $ 2.87 Million

NPV (10%) = $ 1.04 Million Accept
NPV (15%) = $ -0.55 Million

b)
PROJECT A

IRR 11%

PROJECT B

IRR 13%
 12 - 7

WACC 14%

a)
NPV A $ -1.44
NPV B $ -0.25

IRR A 11%
IRR B 13%

MIRR A 12%
MIRR B 14%

Year Project A Cumulative Year Project A

0 $ -25 $ -25 0 $ -20
1 $ 5 $ -20 1 $ 10
2 $ 10 $ -10 2 $ 9
3 $ 17 $ 7 3 $ 6

Payback A 2.588
Payback B 2.167

Year Project A Discounted Cumulative Year

0 $ -25 $ -25.0 $ -25 0
1 $ 5 $ 4.4 $ -21 1
2 $ 10 $ 7.7 $ -13 2
3 $ 17 $ 11.5 $ -1 3

Discounted Payback A ?
Discounted Payback B ?

b) Reject All project NPV < 0

c) Reject all project NPV < 0

d) Timing differences (cash flow came early/late) & The amount of investment is larger for project A compared to B

12 - 8

Year Mitigation W/o Mitigation WACC 12%

0 $ -70 $ -60
1 $ 21 $ 20
2 $ 21 $ 20
3 $ 21 $ 20
4 $ 21 $ 20
 5 $ 21 $ 20

a)
NPV Mitigation $ 5.70
NPV W/o Mitigation $ 12.10

IRR Mitigation 15%

IRR W/o Mitigation 20%

b)

c) W/o mitigation is more proftiable but company should use mitigation to avoid any bad effect to enviromant that wil

12 - 9
 Cumulative
$ -20
$ -10
$ -1
$ 5

Project A Discounted Cumulative

$ -20 $ -20.00 $ -20.0
$ 10 $ 8.77 $ -11.2
$ 9 $ 6.93 $ -4.3
$ 6 $ 4.05 $ -0.3

r project A compared to B
effect to enviromant that will in turn affect company's value to public
Integrated Case - 12

WACC 10%

Year Project L Project S PV Project L PV Project S

0 $ -100 $ -100 $ -100 $ -100
1 $ 10 $ 70 $ 9.09 $ 63.64
2 $ 60 $ 50 $ 49.59 $ 41.32
3 $ 80 $ 20 $ 60.11 $ 15.03
$ 18.78 $ 19.98
c)
NPV Project L $ 18.78
NPV Project S $ 19.98

Independent = Both
Mutually Exclusive = Project S

d)
IRR Project L 18.13%
IRR Project S 23.56%

Independent = Both
Mutually Exclusive = Project S

e)
Year Project L Project S ٨ CF
0 $ -100 $ -100 $ -
1 $ 10 $ 70 $ -60
2 $ 60 $ 50 $ 10
3 $ 80 $ 20 $ 60

Cross over rate 8.68%

g)
MIRR Project L 16.50%
MIRR Project S 16.89%

h)

Year Project L Cumulative Year Project L Discounted Cumulative

 0 $ -100 $ -100 0 $ -100 $ -100 $ -100
1 $ 10 $ -90 1 $ 10 $ 9 $ -91
2 $ 60 $ -30 2 $ 60 $ 50 $ -41
3 $ 80 $ 50 3 $ 80 $ 60 $ 19

Payback 2.375 Discounted Payback 2.6875

Year Project S Cumulative Year Project S Discounted Cumulative

0 $ -100 $ -100 0 $ -100 $ -100 $ -100
1 $ 70 $ -30 1 $ 70 $ 64 $ -36
2 $ 50 $ 20 2 $ 50 $ 41 $ 5
3 $ 20 $ 40 3 $ 20 $ 15 $ 20

Payback 3.5 Discounted Payback 1.67

i)
WACC 10%

Year Project L
0 $ -800
1 $ 5,000
2 $ -5,000

NPV $ -386.78
IRR 25%
MRR 6%

Reject Project
 13 - 1
in IDR Mio
Equipment Cost $ 9
∆ NOWC $ 3
Tax 40%

a)
Initial Investment $ 12

b)
No, this is sunk cost not classified as incremental cost

c)
This is an opportunity cost, so it's possible to change the outcome

13 - 2
in IDR Mio
Sales Revenue $ 10
Operating Cost (Excl. Dep) $ 7
Depreciation $ 2
Interest Expense $ 2

Tax 40%
WACC 10%

a)
Total Revenues $ 10
Operating Cost excluding deprciation $ 7
Depreciation $ 2
Total Costs $ 9
EBIT (Operating Income) $ 1
Taxes on Operating Income $ 0.4
EBIT (1 - T) = After - Tax operating Income $ 0.6
Add back Depreciation $ 2
EBIT (1-T) + Depreciation $ 2.6

b)
Cannibalism is part of externalities so it will change the outcome

Total Revenues $ 10
Operating Cost excluding deprciation $ 7
Depreciation $ 2
Externalities $ 1
Total Costs $ 10
EBIT (Operating Income) $ -
Taxes on Operating Income $ -
EBIT (1 - T) = After - Tax operating Income $ -
Add back Depreciation $ 2
EBIT (1-T) + Depreciation $ 2.0

c)
Total Revenues $ 10
Operating Cost excluding deprciation $ 7
Depreciation $ 2
Total Costs $ 9
EBIT (Operating Income) $ 1
Taxes on Operating Income $ 0.3
EBIT (1 - T) = After - Tax operating Income $ 0.7
Add back Depreciation $ 2
EBIT (1-T) + Depreciation $ 2.7

13 - 3

in IDR Mio
Equipment Cost $ 20
Depreciation $ 16
Salvage Value $ 5
Tax 40%

Equipment Book Value $ 4

Salvage Value (Tax as ordinary Income) $ 5

Equipment Book Value $ 4
Gain on Sale $ 1
Tax on Salvage Value $ 0.40
After - Tax Salvage Value $ 4.6

13 - 4

Year CF New Machine

0 $ -40,000.00 WACC
1 $ 9,000.00 10%
2 $ 9,000.00
3 $ 9,000.00 TAX
4 $ 9,000.00 35%
5 $ 9,000.00
6 $ 9,000.00
7 $ 9,000.00
8 $ 9,000.00
9 $ 9,000.00
10 $ 9,000.00
NPV $ 15,301.10

Yes, Buy new Machine

 13 - 5

Year CF System A CF System B

0 $ -20,000.00 $ -12,000.00 WACC
1 $ 6,000.00 $ 6,000.00 10%
2 $ 6,000.00 $ 6,000.00
3 $ 6,000.00 $ 6,000.00
4 $ 6,000.00
5 $ 6,000.00
6 $ 6,000.00
NPV $ 6,131.56 $ 2,921.11
EAA $ 1,532.89 $ 1,460.56

System A, since it generate higher value

13 - 6

Equipment Cost $ 800,000

Tax 40%
WACC 10%

a)
Year MACRS % Straight Line %
1 $ 264,000 33% $ 200,000 25%
2 $ 360,000 45% $ 200,000 25%
3 $ 120,000 15% $ 200,000 25%
4 $ 56,000 7% $ 200,000 25%

b)
Year CF MACRS CF Straight Line Difference Include Tax
1 $ 264,000 $ 200,000 $ 64,000 $ 25,600
2 $ 360,000 $ 200,000 $ 160,000 $ 64,000
3 $ 120,000 $ 200,000 $ -80,000 $ -32,000
4 $ 56,000 $ 200,000 $ -144,000 $ -57,600
$ 12,781.64

13 - 7

NPV $ 12

Economic Probability of Variance *

Scenario Outcome NPV E(NPV)
Probability
Recession 0.05 $ -70 $ -4 266.5
Below Average 0.2 $ -25 $ -5 156.8
Average 0.5 $ 12 $ 6 40.5
Above Average 0.2 $ 20 $ 4 57.8
Boom 0.05 $ 30 $ 2 36.5
 E(NPV) $ 3
σNPV $ 23.62
CV 7.87

13 - 8

a) MACRS Depreciation Rate

Equipment Cost $ 140 Year 1
Installation $ 30 33%
CAPEX $ 170
∆ NOWC $ 8 TAX 40%
Investment Outlays $ 178 WACC 12%

b)
Year 0 Year 1
Total Revenues $ 50
Operating Cost excluding deprciation $ -
Depreciation $ 56
Total Costs $ 56
EBIT (Operating Income) $ -6
Taxes on Operating Income $ -2.4
EBIT (1 - T) = After - Tax operating Income $ -4
Add back Depreciation $ 56
EBIT (1-T) + Depreciation $ 52.4

Salvage Value (Tax as ordinary Income)

Book Value
Tax on Salvage Value
After - Tax Salvage Value
∆ NOWC = Recovery of Net Operating Working Capital
Project Free Cash Flows = EBIT (1-T) + DEP - CAPEX - ∆ NOWC $ -178 $ 52.44
NPV $ -19.55

Don't Purchase

13 - 9

a)
Ignore it since it's a sunk cost and not incremental cost

b)
Equipment Cost $ 108 MACRS Depreciation Rate
Installation $ 12.5 Year 1
CAPEX $ 120.5 33%
Increase in Inventory $ 25.0
Increase in account payable $ 5.0 TAX 35%
∆ NOWC $ 5.5 WACC 12%
Investment Outlays $ 126.00
c)
Year 0 Year 1
Total Revenues $ 44
Operating Cost excluding deprciation $ -
Depreciation $ 40
Total Costs $ 40
EBIT (Operating Income) $ 4
Taxes on Operating Income $ 1.5
EBIT (1 - T) = After - Tax operating Income $ 3
Add back Depreciation $ 40
EBIT (1-T) + Depreciation $ 42.5

Salvage Value (Tax as ordinary Income)

Book Value
Tax on Salvage Value
After - Tax Salvage Value
∆ NOWC = Recovery of Net Operating Working Capital
Project Free Cash Flows = EBIT (1-T) + DEP - CAPEX - ∆ NOWC $ -126 $ 42.52
NPV $ 10.84
 Year 2 Year 3 Year 4
45% 15% 7%

Year 2 Year 3
$ 50 $ 50
$ - $ -
$ 77 $ 26
$ 77 $ 26
$ -27 $ 25
$ -10.6 $ 9.8
$ -16 $ 15
$ 77 $ 26
$ 60.6 $ 40.2

$ 60
$ 12
$ 19
$ 41
$ 8
$ 60.60 $ 88.96 88.96

Year 2 Year 3 Year 4

45% 15% 7%
 Year 2 Year 3
$ 44 $ 44
$ - $ -
$ 54 $ 18
$ 54 $ 18
$ -10 $ 26
$ -3.6 $ 9.1
$ -7 $ 17
$ 54 $ 18
$ 47.6 $ 34.9

$ 65
$ 8
$ 20
$ 45
$ 6
$ 47.58 $ 85.63
End of Year 0
I. Investment Outlays
Equipment Cost $ 200
Installation $ 40
CAPEX $ 240
Increase in Inventory $ 25
Increase in account payable $ 5
∆ NOWC $ 20

II. Project Operating Cashflow

Unit Sales (in thousands)
Price per Unit
Total Revenues
Operating Cost excluding deprciation
Depreciation
Total Costs
EBIT (Operating Income)
Taxes on Operating Income
EBIT (1 - T) = After - Tax operating Income
Add back Depreciation
EBIT (1-T) + Depreciation $ -

III. Project Termination Cash Flow

Salvage Value (Tax as ordinary Income)
Tax on Salvage Value
After - Tax Salvage Value
∆ NOWC = Recovery of Net Operating Working Capital
Project Free Cash Flows = EBIT (1-T) + DEP - CAPEX - ∆ NOWC $ -260
Cuumulative Cash Flow $ -260

IV. Results
NPV $ -3.66
IRR 9.3%
MIRR 9.6%
Payback 3.30

Year
0
1
2
3
4
NPV
EAA
 (in thousands $)
1 2 3 4

100 100 100 100

$ 2 $ 2 $ 2 $ 2
$ 200 $ 200 $ 200 $ 200
$ 120 $ 120 $ 120 $ 120
$ 79 $ 108 $ 36 $ 17
$ 199 $ 228 $ 156 $ 137
$ 1 $ -28 $ 44 $ 63
$ 0.3 $ -11.2 $ 17.6 $ 25.3
$ 0 $ -17 $ 26 $ 38
$ 79 $ 108 $ 36 $ 17
$ 79.7 $ 91.2 $ 62.4 $ 54.7

$ 25
$ 10
$ 15
$ 20
$ 79.68 $ 91.20 $ 62.40 $ 89.72
$ -180.32 $ -89.12 $ -26.72 $ 63.00

CF Machine A CF Machine B Year

$ -50,000.00 $ -50,000.00 0
$ 17,500.00 $ 34,000.00 1
$ 17,500.00 $ 27,500.00 2
$ 17,500.00 3
$ 17,500.00 4
$ 5,472.65 $ 3,636.36 5
$ 1,726.46 $ 2,095.24 6
7
NPV
 MACRS Depreciation Rate
Year 1 Year 2 Year 3 Year 4
33.00% 45.00% 15.00% 7.00%

TAX
40.00%

WACC
10%

CF Machine A CF Machine B
$ -50,000.00 $ -50,000.00
$ 17,500.00 $ 34,000.00
$ 17,500.00 $ -22,500.00
$ 17,500.00 $ 34,000.00
$ -32,500.00 $ 27,500.00
$ 17,500.00
$ 17,500.00
$ 17,500.00
$ 1,046.66 $ 6,641.62
b)
Tax 40%
EBIT $ 400,000
#Shares Outstanding 80,000
Shares Price $ 25
Total Invested Capital $ 2,000,000
EBIT(1  T)
ROIC 
Total invested capital
($400,000) (0.6)

$2,000,000
 12%

ROIC = 12%

c)
  Standard deviation

Debt $ 10,000   Variance  2

Interest 12% N
   (r  r̂ ) 2 Pi
Tax 40% i 1

FIRM U

Total Capital $ 20,000 $ 20,000 $ 20,000

Equity $ 20,000 $ 20,000 $ 20,000
Probability 0.25 0.5 0.25
Sales $ 6,000 $ 9,000 $ 12,000
Operating Cost $ 4,000 $ 6,000 $ 8,000
Earnings before interst & taxes $ 2,000 $ 3,000 $ 4,000
Interest (12%) $ - $ - $ -
Earnings Before Tax $ 2,000 $ 3,000 $ 4,000
Taxes (40%) $ 800 $ 1,200 $ 1,600
Net Income $ 1,200 $ 1,800 $ 2,400
ROIC 6% 9% 12%
ROE 6% 9% 12%
TIE
Expected ROIC 9%
Expected ROE 9%
Expected TIE
Standard Deviation ROIC 2.1%
Standard Deviation ROE 2.1%
Standard Deviation TIE

d) 3.
Tax 40%
EBIT $ 400,000
#Shares Outstanding 80,000
Shares Price $ 25
Total Invested Capital $ 2,000,000

Amount borrowed Debt/Capital Ratio D/E Ratio

$ - 0 0
$ 250 0.13 0.14
 $ 500 0.25 0.33
$ 750 0.38 0.60
$ 1,000 0.50 1.00

Debt $ - EPS 
(EBIT  rdD)(1  T)
Shares outstandin g

EPS 3.00 
($400,000) (0.6)
80,000
 $3.00

EBIT $400,000
TIE    20x
Int. Exp. $20,000

Debt $ 250,000
Shared Repurchase $ 10,000
Shares Remain $ 70,000
EPS 3.26
Interest Expense $ 20,000
TIE 20

Debt $ 500,000
Shared Repurchase $ 20,000
Shares Remain $ 60,000
EPS 3.55
Interest Expense $ 45,000
TIE 8.9

d) 4.
Hamada Equation
rRF 6%
RPm 6%
bu 1

Debt $ 250,000
bl 1.09
rs 12.5%

Debt $ 500,000
bl 1.20
rs 13.2%

d) 5.
Amount borrowed Debt/Capital Ratio D/E Ratio
$ - 0 0
$ 250 13% 0.14
$ 500 25% 0.33
$ 750 38% 0.60
$ 1,000 50% 1.00

d) 6.
D1 EPS DPS Amount borrowed Debt/Capital Ratio D/E Ratio
P̂0   
rs  g rs rs
 D1 EPS DPS
P̂0   
rs  g rs rs $ - 0 0
$ 250 13% 0.14
$ 500 25% 0.33
$ 750 38% 0.60
$ 1,000 50% 1.00
 FIRM L

$ 20,000 $ 20,000 $ 20,000

$ 10,000 $ 10,000 $ 10,000
0.25 0.5 0.25
$ 6,000 $ 9,000 $ 12,000
$ 4,000 $ 6,000 $ 8,000
$ 2,000 $ 3,000 $ 4,000
$ 1,200 $ 1,200 $ 1,200
$ 800 $ 1,800 $ 2,800
$ 320 $ 720 $ 1,120
$ 480 $ 1,080 $ 1,680
6% 9% 12%
5% 11% 17%
1.67 2.50 3.33
9%
11%
2.5
2.1%
4.2%
0.6

Bond Rating rd
0 0
AA 8%
 A 9%
BBB 11.50%
B 14%

(EBIT  rdD)(1  T)
EPS 
Shares outstandin g
($400,000)(0.6)

80,000
 $3.00

Debt $ 750,000
Shared Repurchase $ 30,000
Shares Remain $ 50,000
EPS 3.77
Interest Expense $ 86,250
TIE 4.6

Debt $ 1,000,000
Shared Repurchase $ 40,000
Shares Remain $ 40,000
EPS 3.90
Interest Expense $ 140,000
TIE 2.9

Debt $ -
bl 1.00
rs 12.0%

Debt $ 750,000
bl 1.36
rs 14.2%

Debt $ 1,000,000
bl 1.60
rs 15.6%

rd (1 - T) rs WACC
0.00% 12.0% 12.00%
4.80% 12.5% 11.55%
5.40% 13.2% 11.25%
6.90% 14.2% 11.44%
8.40% 15.6% 12.00%

rd (1 - T) rs EPS P0
0.00% 12.0% $ 3.0 $ 25.00
4.80% 12.5% $ 3.26 $ 26.03
5.40% 13.2% $ 3.55 $ 26.89
6.90% 14.2% $ 3.77 $ 26.59
8.40% 15.6% $ 3.90 $ 25.00
 15 - 1

Fixed Cost $ 600,000

Variable Cost $ 2.0
Sales Price $ 3.0

𝑸=𝑭/(𝑷−𝒗)

Q= 600,000

15 - 2

Debt/Capital Ratio Projected EPS Projected Stock Price

20% $ 3.20 $ 35.00
30% $ 3.45 $ 36.50
40% $ 3.75 $ 36.25
50% $ 3.50 $ 35.50

30% Debt & 70% Equity because it generate highest stock price

15 - 3

a)
Probability
Firm 0.1 0.2 0.4
A $ -1.50 $ 1.80 $ 5.10
B $ -1.20 $ 1.50 $ 4.20
C $ -2.40 $ 1.35 $ 5.10

b)
Firm EPS 𝜎 CV
A $ 5.10 3.615 0.709
B $ 4.20 2.958 0.704
C $ 5.10 4.108 0.805

Firm C is the most risky as it have the highest risk per share

15 - 4

Assets $ 10,000,000
Debt $ 3,000,000
Equity $ 7,000,000
D/E 43%
b 1.2
Tax 40%
 bu = 0.9545

15 - 5
Tax 40%
Invested Capital $ 20,000,000.00

a)
HL LL
Equity $ 10,000,000 $ 14,000,000
Debt $ 10,000,000 $ 6,000,000

EBIT $ 4,000,000 $ 4,000,000

Interest $ 1,200,000 $ 600,000
Earnings Before Tax $ 2,800,000 $ 3,400,000
Tax $ 1,120,000 $ 1,360,000
Net Income $ 1,680,000 $ 2,040,000

ROIC 12.0% 12.0%

ROE 16.8% 14.6%

b)

LL
Equity $ 8,000,000
Debt $ 12,000,000

EBIT $ 4,000,000
Interest $ 1,800,000
Earnings Before Tax $ 2,200,000
Tax $ 880,000
Net Income $ 1,320,000

ROE 16.5%

15 - 6

Fixed Cost $ 140,000

Variable Cost $ 15
Sales Price $ 25

a)
EBIT = PQ - VQ - F
EBIT (8,000 Watches) = $ -60,000
EBIT (18,000 Watches) = $ 40,000

b)
𝑸=𝑭/(𝑷−𝒗)
 Q= 14,000

c)
Sales Price $ 31

Q= 8,750
Apart from Fixed cost, the difference between Price and variable cost also affect BEP quantity
The larger the profitability, the lower BEP quantity

d)
Variable Cost $ 23

Q= 17,500

15 - 7

Total Capital $ 14,000,000

Tax 40%

Probability EBIT Debt/Capital Ratio

0.2 $ 4,200,000 0%
0.5 $ 2,800,000 10%
0.3 $ 700,000 50%
60%

Debt Capital Ratio 0%

Total Capital $ 14,000,000 $ 14,000,000 $ 14,000,000

Equity $ 14,000,000 $ 14,000,000 $ 14,000,000
Probability 0.2 0.5 0.3
Earnings before interst & t $ 4,200,000 $ 2,800,000 $ 700,000
Interest $ - $ - $ -
Earnings Before Tax $ 4,200,000 $ 2,800,000 $ 700,000
Taxes (40%) $ 1,680,000 $ 1,120,000 $ 280,000
Net Income $ 2,520,000 $ 1,680,000 $ 420,000
ROE 18% 12% 3%
Expected ROE 11%
Standard Deviation ROE 5.4%
CV ROE 0.52

Debt Capital Ratio 10%

Debt $ 1,400,000

Total Capital $ 14,000,000 $ 14,000,000 $ 14,000,000

Equity $ 12,600,000 $ 14,000,000 $ 14,000,000
Probability 0.2 0.5 0.3
Earnings before interst & t $ 4,200,000 $ 2,800,000 $ 700,000
Interest $ 126,000 $ 126,000 $ 126,000
Earnings Before Tax $ 4,074,000 $ 2,674,000 $ 574,000
Taxes (40%) $ 1,629,600 $ 1,069,600 $ 229,600
Net Income $ 2,444,400 $ 1,604,400 $ 344,400
ROE 19% 11% 2%
Expected ROE 10%
Standard Deviation ROE 6.0%
CV ROE 0.58

Debt Capital Ratio 50%

Debt $ 7,000,000

Total Capital $ 14,000,000 $ 14,000,000 $ 14,000,000

Equity $ 7,000,000 $ 7,000,000 $ 7,000,000
Probability 0.2 0.5 0.3
Earnings before interst & t $ 4,200,000 $ 2,800,000 $ 700,000
Interest $ 770,000 $ 770,000 $ 770,000
Earnings Before Tax $ 3,430,000 $ 2,030,000 $ -70,000
Taxes (40%) $ 1,372,000 $ 812,000 $ -28,000
Net Income $ 2,058,000 $ 1,218,000 $ -42,000
ROE 29% 17% -1%
Expected ROE 14%
Standard Deviation ROE 10.8%
CV ROE 0.75

Debt Capital Ratio 60%

Debt $ 8,400,000

Total Capital $ 14,000,000 $ 14,000,000 $ 14,000,000

Equity $ 5,600,000 $ 5,600,000 $ 5,600,000
Probability 0.2 0.5 0.3
Earnings before interst & t $ 4,200,000 $ 2,800,000 $ 700,000
Interest $ 1,176,000 $ 1,176,000 $ 1,176,000
Earnings Before Tax $ 3,024,000 $ 1,624,000 $ -476,000
Taxes (40%) $ 1,209,600 $ 649,600 $ -190,400
Net Income $ 1,814,400 $ 974,400 $ -285,600
ROE 32% 17% -5%
Expected ROE 14%
Standard Deviation ROE 13.5%
CV ROE 0.99

15 - 8

Rrf 5%
RPm 6%
Tax 40%
Cost of Equity 14%
Equity 75% New Equity 50%
Debt 25% New Debt 50%

bl 1.5
bu 1.25

New bl 2.0
rs 17%

15 - 9

Total Capital $ 5,000,000

Tax 40%
Net Income 1000000
Dividends 40%
 𝜎

0.2 0.1 E(EPS) 𝜎

$ 8.40 $ 11.70 $ 5.10 3.615
$ 6.90 $ 9.60 $ 4.20 2.958
$ 8.85 $ 12.60 $ 5.10 4.108
D/E 30%
Interest

9%
11%
14%
 c

1)
Capital $ 800,000
Net Income $ 600,000
Equity 60%
Debt 40%

T arg et Total 
Dividends  Net income   equity  capital 
 ratio budget 
 

Dividends = $ 120,000
Dividend Payout = Dividends
Net Income
20%

Net Income $ 400,000

Dividends = $ -80,000
Dividend Payout = -13%
0% issue new stock

Net Income $ 800,000

Dividends = $ 320,000
Dividend Payout = 40%
 16 - 1

Capital $ 3,000,000
Net Income $ 3,000,000
Equity 30%
Debt 70%

T arg et Total 
Dividends  Net income   equity  capital 
 ratio budget 


Dividends = $ 2,100,000
Dividend Payout = Dividends
Net Income
70%

16 - 2

P0 $ 80
Split 4/2

P0 New $ 80
4/2
$ 40

16 - 3

Net Income $ 2,000,000

#Shares 1,000,000
P0 32
Repurchase 20%
#Shares Purchased 200,000
#Shares Remaining 800,000

Current EPS = Net Income

#Shares
2.00

P/E Ratio = P0
EPS
16

New EPS = 2.5

New P/E Ratio = 12.80

16 - 4
Dividend $ 0.9
Split 5/1
Increase 9%

Dividend before split $ 4.50

Dividend Last Year $ 4.1284

16 - 5

Investment $ 10,000,000
Net Income $ 5,000,000
Equity 60%
Debt 40%
Dividend Payout ratio 45% Net Income
Dividend $ 2,250,000
External Equity $ 3,250,000

16 - 6

Net Income $ 7,287,500

Equity 50%
Debt 50%
Investment $ 5,000,000

Dividend $ 2,287,500
Dividend Payout = Dividends
Net Income
31.39%
 d

Inventory Average Payables

CCC  conversion  collection  deferral
period period period
Payables
Days per year Days sales
CCC    deferral
Inventory turnover outstandin g period
365
CCC   46  30
4.82
CCC  76  46  30  92 days

Inventory Turnover 4.82

DSO 45.63
Payables deferral peri 30
Inventory Convesion P 75.72614107884
CCC 91.4 days

Loan $ 3,000,000 $ 3,030,303 gross

Discount 1% if pay in 10 days
Period 40
Days/year 365

Net Daily Purchase $ 8,219

Loan if take discounts $ 82,192
Loan if not $ 328,767
Discount % 365 days
rNOM  
100  Discount % Days credit
 Discount
outstandin g period
Costly trade Credits $ 246,575 
1

365
99 40  10
 0.1229
 12 .29 %
Loss $ 30,303
Rnom 12.29% Rnom 12.29%

Loan $ 100,000
Interest 8% $ 8,000
Period 1 365 days

Annual Interest 8% rNOM = EAR

Face amount $ 108,000

Monthly payment $ 9,000
Avg. loan outstanding $ 50,000
Approximate cost 16%
Add on
To find the exact effective rate, recognize that the firm receives $100,000 and must make monthly payments of $9,0

rNOM = 12 (0.012043)
= 0.1445 = 14.45%
EAR = (1.012043)12 – 1 = 15.45%

Rate 1.2043%
rNOM 14.452%
EAR 15.449%
monthly payments of $9,000 (like an annuity).
 17 - 1

Sales $ 15,000,000
Inventories $ 2,000,000
A/R $ 3,000,000
A/P $ 1,000,000
COGS 80% Sales
$ 12,000,000
Interest 8%
Days Per Year 365
Inventory Conversion period 60.83
DSO /Average Conversion Perio 73
Payables deferral period 30.42
Inventory Average Payables
CCC  conversion  collection  deferral
period period period
Payables
Days per year Days sales
CCC    deferral
Inventory turnover outstandin g period
365
CCC   46  30
4.82
CCC  76  46  30  92 days

CCC 103.42

Inventories $ 1,800,000
A/R $ 2,700,000
A/P $ 1,100,000
Inventory Conversion period 54.75
DSO 65.70
Payables deferral period 33.46
New CCC 86.99

∆ Inventory $ 200,000
∆ A/R $ 300,000
∆ A/P $ 100,000
Cash Freed up $ 400,000
Pre-Tax profit $ 32,000

17 - 2

Sales $ 10,000,000
Credit Period 30 days
Accounts Receivable $ 2,000,000
Days Per Year 365

DSO 73 Days
Paid on time 30 Days
Capital if customer on time

Accounts Receivable $ 821,918

Released Cash $ 1,178,082
 17 - 3

Loan $ 8,000,000
Discount 3% 5 days
1 - Discount 97%
Period 60 days
i Bank 10%
Days Per Year 365
Month 12

Discount % 365 days

rNOM  
100  Discount % Days credit
 Discount
outstandin g period
1 365
 
99 40  10
 0.1229
 12.29%

rNOM 20.52%
Effective Annual Cost 22.40%

Bank Loan EAR 10.47%

Bunga Bank lebih kecil, Lamar sebaiknya menggunakan hutang Bank

17 - 4

Inventory Conversion period 75

Average Collection Period 38
Payables deferral period 30

CCC 83.00

Sales $ 3,421,875
Sales per Day $ 9,375
A/R $ 356,250

COGS $ 2,566,406
COGS per day $ 7,031
Inventory $ 527,344
Inventory Turnover 4.87

17 - 5
Sales $ 912,500
Discount 3% 10 days
1 - Discount 97%
Period 30 days
Collection Period (40%) 10 days 40%
Collection Period (60%) 40 days 60%
Days Per Year 365
A/R $ 70,000 $ 60,000 $ 10,000
DSO 28
Average A/R $ 35,000

40% Trade Credit on 10 days & 60% on 40 days

Collection Period (60%) 30 days 60%

A/R $ 55,000 $ 45,000 $ 10,000
DSO 22

Average A/R $ 27,500

17 - 6

Produce 1,500 per day

Cost 6 per battery
Inventory Conversion period 22 days
Average Collection Period 40 days
Payables deferral period 30 days

CCC 32

Capital 288,000

Payables deferral period 35 days

CCC 27
Capital 243,000
Reduction 45,000

Inventory Conversion period 20 days

Produce 1,800 per day
Cost 7 per battery
CCC 30
Capital 378,000
 17 - 1

Sales $ 15,000,000
Inventories $ 2,000,000
A/R $ 3,000,000
A/P $ 1,000,000
COGS 80% Sales
$ 12,000,000
Interest 8%
Days Per Year 365
Inventory Conversion period 60.83
DSO /Average Conversion Perio 73
Payables deferral period 30.42
Inventory Average Payables
CCC  conversion  collection  deferral
period period period
Payables
Days per year Days sales
CCC    deferral
Inventory turnover outstandin g period
365
CCC   46  30
4.82
CCC  76  46  30  92 days

CCC 103.42

Inventories $ 1,800,000
A/R $ 2,700,000
A/P $ 1,100,000
Inventory Conversion period 54.75
DSO 65.70
Payables deferral period 33.46
New CCC 86.99

∆ Inventory $ 200,000
∆ A/R $ 300,000
∆ A/P $ 100,000
Cash Freed up $ 400,000
Pre-Tax profit $ 32,000

17 - 2

Sales $ 10,000,000
Credit Period 30 days
Accounts Receivable $ 2,000,000
Days Per Year 365

DSO 73 Days
Paid on time 30 Days
Capital if customer on time

Accounts Receivable $ 821,918

Released Cash $ 1,178,082
 17 - 3

Loan $ 8,000,000
Discount 3% 5 days
1 - Discount 97%
Period 60 days
i Bank 10%
Days Per Year 365
Month 12

Discount % 365 days

rNOM  
100  Discount % Days credit
 Discount
outstandin g period
1 365
 
99 40  10
 0.1229
 12.29%

rNOM 20.52%
Effective Annual Cost 22.40%

Bank Loan EAR 10.47%

Bunga Bank lebih kecil, Lamar sebaiknya menggunakan hutang Bank

17 - 4

Inventory Conversion period 75

Average Collection Period 38
Payables deferral period 30

CCC 83.00

Sales $ 3,421,875
Sales per Day $ 9,375
A/R $ 356,250

COGS $ 2,566,406
COGS per day $ 7,031
Inventory $ 527,344
Inventory Turnover 4.87

17 - 5
Sales $ 912,500
Discount 3% 10 days
1 - Discount 97%
Period 30 days
Collection Period (40%) 10 days 40%
Collection Period (60%) 40 days 60%
Days Per Year 365
A/R $ 70,000 $ 60,000 $ 10,000
DSO 28
Average A/R $ 35,000

40% Trade Credit on 10 days & 60% on 40 days

Collection Period (60%) 30 days 60%

A/R $ 55,000 $ 45,000 $ 10,000
DSO 22

Average A/R $ 27,500

17 - 6

Produce 1,500 per day

Cost 6 per battery
Inventory Conversion period 22 days
Average Collection Period 40 days
Payables deferral period 30 days

CCC 32

Capital 288,000

Payables deferral period 35 days

CCC 27
Capital 243,000
Reduction 45,000

Inventory Conversion period 20 days

Produce 1,800 per day
Cost 7 per battery
CCC 30
Capital 378,000