Questions: Companies Capital And Futures Contracts

1. | Question 😐 (TCO C) Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure of 60 percent debt and 40 percent equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? (a) 40. 61% (b) 42. 75% (c) 45. 00% (d) 47. 37% (e) 49. 74% | | | Student Answer:|  | (d) 47. 37 Equity required (Residual income) = $625,000*40% = $250,000 Dividend paid = $475,000 – $250,000 = $225,000 Dividend payout ratio = 225000/475000 = 47. 37% |  | Instructor Explanation:| Answer is: d

Text: pp. 570-572 – Residual Dividends, Chapter 14 Capital budget $625,000 Equity ratio 40% Net income (NI) $475,000 Dividends paid = NI – (Equity ratio)(Capital budget) $225,000 Dividend payout ratio = Dividends paid/NI 47. 37% | | | | Points Received:| 10 of 10 | | Comments:| | | | 2. | Question 😐 (TCO F) The following data applies to Saunders Corporation’s convertible bonds: Maturity: 10 Stock price: $30. 00 Par value: $1,000. 00 Conversion price: $35. 00 Annual coupon: 5. 00% Straight-debt yield: 8. 00% What is the bond’s conversion value? (a) $698. 15 (b) $734. 89 (c) $773. 57 (d) $814. 29 e) $857. 14 | | | Student Answer:|  | (e) $857. 14 Conversion ratio = Par value / Conversion Price= 28. 5714 =1000/35 Current share price= $30. 00 Therefore, conversion value of the bond= $857. 14 =28. 5714×30 |  | Instructor Explanation:| Answer is: e Chapter 19: pp. 770-774 Conversion value = Conversion ratio x Market price of stock = $857. 14 | | | | Points Received:| 10 of 10 | | Comments:| | | | 3. | Question 😐 (TCO B) SA – Your firm has debt worth $350,000, with a yield of 12. 5 percent, and equity worth $700,000. It is growing at a seven percent rate, and faces a 40 percent tax rate.

A similar firm with no debt has a cost equity of 17 percent. Under the MM extension with growth, what is its cost of equity? (a) 19. 25% (b) 21. 75% (c) 18. 0% (d) 17. 5% (e) 18. 4% | | | Student Answer:|  | | | Instructor Explanation:| A is correct. Instructor Explanation: M & M Extension with Growth – Section 26. 4 (pp. 1011-1015) rsL = rsU + (rsU – rd)(D/S) 19. 25% = 17% + (17%-12. 5%)(350,000/700,000)| | | | Points Received:| 10 of 20 | | Comments:| this is you emailed solution – 4. (TCO B) SA – Your firm has debt worth $350,000, with a yield of 12. 5 percent, and equity worth $700,000.

It is growing at a seven percent rate, and faces a 40 percent tax rate. A similar firm with no debt has a cost equity of 17 percent. Under the MM extension with growth, what is its cost of equity? My answer is: (d) 17. 5% rsL = rsU + (rsU – rd)(D/S) 17. 5% = 15% + (15%-10%)(200,000/400,000 I am not sure where you got the 15% number for the rsU or the 200,000 for D or the 400,000 for S the calculations and formula are correct but you used all incorrect inputs so I will give you 1/2 credit A is correct. Instructor Explanation: M & M Extension with Growth – Section 26. (pp. 1011-1015) rsL = rsU + (rsU – rd)(D/S) 19. 25% = 17% + (17%-12. 5%)(350,000/700,000) | | | 4. | Question 😐 (TCO B) Firm L has debt with a market value of $200,000 and a yield of nine percent. The firm’s equity has a market value of $300,000, its earnings are growing at a five percent rate, and its tax rate is 40 percent. A similar firm with no debt has a cost of equity of 12 percent. Under the MM extension with growth, what would Firm L’s total value be if it had no debt? (a) $358,421 (b) $377,286 (c) $397,143 (d) $417,000 (e) $437,850 | | Student Answer:|  | (c) $397,143 VTotal = VU + VTS, so VU = VTotal – VTS = D + S – VTS. Value tax shelter = VTS = rdTD/(rsU – g) = 0. 09(0. 40)($200,000)/(0. 12 – 0. 05) = $102,857 VU = $300,000 + $200,000 – $102,857 = $397,143 |  | Instructor Explanation:| Answer is: c Chapter 26, pp. 1011-1015 Debt: $200,000 Equity: $300,000 rd: 9% rsU : 12% T: 40% g: 5% Firm L has a total value of $200,000 + $300,000 = $500,000. A similar firm with no debt should have a smaller valu(e) Here is the calculation: VTotal = VU + VTS, so VU = VTotal – VTS = D + S – VTS. Value tax shelter = VTS = rdTD/(rsU – g) = 0. 9(0. 40)($200,000)/(0. 12 – 0. 05) = $102,857 VU = $300,000 + $200,000 – $102,857 = $397,143 | | | | Points Received:| 20 of 20 | | Comments:| | | | 5. | Question 😐 (TCO A) Which of the following statements is CORRECT? (a) An option’s value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can’t sell for more than its exercise value. (b) As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases. c) Issuing options provides companies with a low cost method of raising capital. (d) The market value of an option depends in part on the option’s time to maturity and also on the variability of the underlying stock’s price. (e) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger. | | | Student Answer:|  | (c) Issuing options provides companies with a low cost method of raising capital. |  | Instructor Explanation:| Answer is: d Chapter 8, pp. 306-310 | | | | Points Received:| 0 of 20 | Comments:| Companies do not issue Options – they are a trading vehicle of the exchanges – no capital from options go to the firm | | | 6. | Question 😐 (TCO F) Suppose the December CBOT Treasury bond futures contract has a quoted price of 80-07. What is the implied annual interest rate inherent in the futures contract? Assume this contract is based on a 20 year Treasury bond with semi-annual interest payments. The face value of the bond is $1000, and the semi-annual coupon payments are $30. The annual coupon rate on the bonds is $60 per bond (or 6%).

The futures contract has 100 bonds. (a) 6. 86% (b) 7. 22% (c) 7. 60% (d) 8. 00% (e) 8. 40% | | | Student Answer:|  | (d) 8% Quote: 80’07 0. 80 0. 07 N: 40 PV = (0. 80+0. 07/32) ? $1,000 = -$802. 1875 FV = $1,000 PMT = $30 I/YR = 4. 00% Annual rate: I/YR ? 2 = 8. 00% |  | Instructor Explanation:| Answer is: d Chapter 23, pp. 917-923 Answer Detail: Quote: 80-07 0. 80 0. 07 N: 40 PV = (0. 80+0. 07/32) ? $1,000 = -$802. 1875 FV = $1,000 PMT = $30 I/YR = 4. 00% Annual rate: I/YR ? 2 = 8. 00% | | | | Points Received:| 20 of 20 | | Comments:| | | | | |