I. The ABD company's cash budget is under revision and you are responsible for completing the analysis. The sales manager forecasts total sales in 1996 at $11 million in the January, February, and March, $30 million in April, $12 million in May, and $5 million in June. Sales in November and December of 1995 were $8 million and $5 million, respectively. On average, 25% of sales are collected in the month of the sale and the rest are collected in the following month. Purchases are smooth throughout the year at approximately $8 million per month. Labor expense has a fixed component of $1.5 million per month and a variable component that is 10% of sales, paid in the following month. Tax payments of $2 million will be due in March and June. ABD has established a policy of holding a minimum cash balance of $2 million to facilitate transactions, and this was the beginning cash balance for 1995. The company also began 1996 with $1.5 million in short term loans and no marketable securities. Prepare a cash budget and calculate ABD's end-of-month balances in the marketable securities and short-term loan accounts for the first 6 months of 1996. Show your work below and clearly label all items. [15 points]

II. You need to determine the appropriate discount rate to use to evaluate an average-risk capital project. Your company is financed with debt and common stock, with a Long-Term-Debt/Equity ratio of .35 based on market values. This capital structure has been determined to be optimal for this company. The marginal tax rate is 34%.

Your company currently has an issue of long-term bonds outstanding with a 8.5% coupon rate (semi-annual payments) and a $1,000 par value. The total face value of the issue is $34 million. These bonds are currently selling at $965, representing a yield to maturity of 9.6%. Your investment banker feels that new bonds could be sold at par at the same yield to maturity as the existing bonds.

Your company also has $5 million of trade credit (accounts payable) and a short-term bank loan for $8 million (7.9% rate) that is used to carry the company through the peak selling season, after which it is paid off within a few months.

Your common stock is not publicly traded, so you don't know your company's ß. However, you have located a company that is very similar in terms of operations, and their publicly traded stock reflects a Beta of 1.20. The other company's capital structure is 30% debt and 70% common equity.

The yield on T-bills is currently 5.85%, the yield on 20-year Treasury Bonds is 7.24%, and the S&P 500 had an average annual increase of 18% over the last two years.

Given this information, answer the following questions:

1. The estimated total market value of the company's common stock is closest to


a. $45.9 million
b. $93.7 million
c. $97.1 million
d. $131 million
e. Not enough information


2. The proportional weight of common stock in the cost of capital equation should be closest to:


a. .35
b. .65
c. .74
d. .55
e. .26


3. The beta for the company's common stock is closest to:


a. 1.15
b. .93
c. 1.0
d. .97
e. .84

What will you use as the cost of equity (common stock) in the cost of capital equation? Provide a brief justification for your selection.

Given your answers above, what is the estimated weighted average cost of capital for the company?

a. The minimum acceptable rate of return on new investments.
b. The expected rate of return on new investments.
c. less than the cost of common equity.
d. More than one of the above.
e. None of the above.

a. The coupon rate on existing bonds is an acceptable estimator for the before-tax cost of debt for most companies.
b. It can never be true that the cost stock is lower than the before-tax cost of debt for a given company.
c. Internal financing (retained earnings) is the most prevalent form of long-term financing because it has the lowest component cost of capital.
d. More than one of the above.
e. None of the above.

a. is present only if fixed payment obligations are present in the capital structure.
b. is the risk of variability in EBIT causing variability in EPS.
c. should definitely be avoided if possible.
d. More than one of the above.
e. None of the above.

a. It is generally true that capital structure has no significant effect on firm value.
b. It is generally true that capital structure has no significant effect on business risk.
c. It is generally true that capital structure has no effect on financial risk.
d. More than one of the above.
e. None of the above.

a. The arbitrage proof of the Modiglianni/Miller theorems is based on the idea that it is not possible to make a profit in a perfect capital market.
b. The arbitrage proof of the Modiglianni/Miller theorems in the no-tax case shows that it should make no difference to equity investors whether a company uses financial leverage or they use personal leverage by borrowing to purchase stock in an unlevered company.
c. The Modiglianni/Miller theorems in the no-tax case imply that capital structure has no significant effect on equity investors.
d. More than one of the above.
e. None of the above.

a. In general, the impact of capital structure decisions on firm value is of major importance compared to the effects of decisions that affect operating policy in a company.
b. The fact that corporate debt is not riskless results in a value curve that first falls and then rises as the company changes its capital structure from no leverage to progressively higher levels of leverage.
c. Financial distress costs do not affect the valuation of a company unless the company is actually experiencing severe financial distress.
d. More than one of the above.
e. None of the above.

a. An increase in the inventory conversion period will cause an increase in the receivables conversion period.
b. An increase in the inventory conversion period will cause an increase in the payables deferral period.
c. An increase in the receivables conversion period will cause an increase in the cash conversion period.
d. More than one of the above.
e. None of the above.

a. An aggressive working capital policy is characterized by a great deal of volatility in operating profit (EBIT).
b. An aggressive working capital policy is characterized by low liquidity and high cost as opposed to a conservative working capital policy.
c. An aggressive working capital policy is characterized by a higher average net working capital position than for a conservative working capital policy.
d. More than one of the above.
e. None of the above.

a. The attraction of an aggressive working capital policy is that is increases the expected return on equity without increasing risk.
b. The attraction of a conservative working capital position is that it minimizes the need for funding sources.
c. Short-term debt is generally less costly than long term funding sources.
d. More than one of the above.
e. None of the above.

a. predicts the best capital structure for the company.
b. predicts the best net working capital policy for the company.
c. minimizes the opportunity costs associated with holding cash.
d. More than one of the above.
e. None of the above.

a. A centralized collection system.
b. A decentralized collection system.
c. A localized collection system.
d. A lockbox system.
e. None of the above.

a. $5,739 saved
b. $5,860 saved
c. $1,735 saved
d. $8,250 saved
e. Not enough information

a. 56.4%
b. 37.2%
c. 30.9%
d. 54.7%
e. Not enough information

a. the firms dividend payout is maximized.
b. the firms risk is minimized.
c. the firm's value is maximized.
d. two of the above.
e. all of the above.

a. The target, or optimal, capital structure if the one that would result in the lowest weighted average cost of capital.
b. An increase in the tax rate will increase the form's cost of capital, other things equal.
c. The higher the level of debt in the capital structure, the higher the variability of EBIT, other things equal.
d. Only two of the above.
e. All of the above.

a. What is Bob Dole's age?
b. What is Newt Gingrich's IQ?
c. What is the sum of Bob Dole's age and Newt Gingrich's IQ?
d. What is the number of years it will take the Democrats to balance the budget?
e. More than one of the above.

ANSWERS:

I. Net cash gain in millions: Jan = -3.50, Feb= +.40, Mar = -1.60, Apr = +5.15

Short term loans outstanding in millions: Jan = 5.0, Feb = 4.60, Mar=6.20, Apr=1.05

Multiple choice answers:

II. (1) B, (2) C, (3) A, (4) E, (5) B, (6) A, (7) B, (8) B, (9) E, (10) C, (11) E, (12) C, (13) E, (14) B, (15) C, (16) A, (17) C, (18) A, (19) C