FINANCE 3310
PROBLEM SET #1
1. What is the proper goal of management in the modern corporation?
2. What is the agency problem in modern corporations? What are some solutions to the agency problem?
3. Consider the following information: (assume the tax rate is 34%)
| 1995 | 1996 | |
| Sales | $2,083 | $2,245 |
| Cost of Goods Sold | 1,000 | 1,096 |
| Other Expenses | 170 | 140 |
| Interest | 137 | 158 |
| Cash | 1,075 | 1,099 |
| Accounts Receivable | 1,423 | 1,603 |
| Accounts Payable | 1,129 | 1,095 |
| Long-term Debt | 3,808 | 4,395 |
| Net Fixed Assets | 9,015 | 9,230 |
| Inventory | 2,530 | 2,600 |
| Dividends | 250 | 275 |
| Depreciation | 295 | 295 |
| (Note: Depreciation is already in Cost of Goods Sold) |
a. Prepare an income statement and balance sheet for this company for 1995 and 1996.
b. For 1996, calculate the cash flows from assets and show they are equal to cash flows to bondholders and stockholders.
4. Consider the following information for Plight Enterprises:
| 1995 | 1996 | 1995 | 1996 | |||
| Cash | $510 | 302 | Accts Pay | 1,115 | 1,244 | |
| Accts Rec | 1,273 | 1,704 | Other | 30 | 209 | |
| Inventory | 3,109 | 2,955 | 1,145 | 1,453 | ||
| Current Assets | $4,892 | 4,961 | Long-term Debt | 3,117 | 2,500 | |
| Fixed Assets | 9,733 | 10,255 | Common Stock | 10,000 | 10,000 | |
| Retained Earnings | 363 | 1,263 | ||||
| 10,363 | 11,263 | |||||
| Total Assets | $14,625 | $15,216 | Total Liab & Equity | $14,265 | $15,216 | |
| 1996 | |
| Sales | $10,500 |
| Cost of Goods Sold | 4,550 |
| EBIT | 5,959 |
| Interest | 585 |
| Taxable Income | 5,365 |
| Taxes (34%) | 1,824 |
| Net Income | $3,541 |
| Dividends | $2,641 |
Asume depreciation of $650 is already included in cost of goods sold.
a. Calculate the following ratios:
b. Assume Plight has 500 shares of common stock outstanding and the market price per share at the end of 1996 was $63. What is the P/E ratio? What are dividends per share? What is the market to book ratio at the end of 1996?
5. Suppose you invest $4,500.00 now and after 4 years you have $7,125.00. What is your (geometric) average annual rate of return?
6. You are inundated with the good news from Chrysler: 2.9% financing for 3 years, or $2,000 cash back. Upon hearing the news you hurry down to your nearest Chrysler dealer where you intend to buy a Jeep Cherokee. The price for the model you want is $18,000. If you would rather have $2,000 cash back, the interest rate is 9% for a 4 year loan. 9% is the going rate of interest and rate on your money market account. In the fine print it says Chrysler doesn't actually give you the cash, but rather just reduces the purchase price to $16,000. Which option should you take and why? (BONUS PROBLEM)
7. Your Uncle Bernie is saving for retirement. He has dutifully stashed away $2,000 at the end of the year, every year, starting at the end of 1975. In 1990 your Aunt Bess died, and Bernie had to pay for the funeral and consequently, missed his retirement payment. After much grieving, Bernie began his retirement payments again at the end of 1991, though he reduced the amount to $1,500, since Bess would not be there to enjoy it with him. Bernie made his last payment in 1993. Assuming he was able to earn 7% on the money he invested, how much money did Bernie have available for his retirement, which he began in 1994?
8. Suppose Uncle Bernie, because of his forgetfulness, had decided to invest a lump sum at the beginning of 1975, rather than making the annual payments above. How much would he have had to invest at the start of 1975 at a rate of 7% to have the same amount of money for retirement that he had above?
9. UALR has a parking problem!! As a proposed solution, a nearby piece of land can be purchased, paved and painted. The lot will have room for 240 spaces, all of which will be reserved parking. A yearly fee of $185 will be charged to users of the lot. Assuming the university expected to earn 8% forever on endowment funds, what it be willing to pay for the new parking lot?
10. Consider the following series of payments carefully:
$350 --$350 --$350 ----0 -----$350 ---$350 ---$350 ---$350--- $350
|______|______|______|______|______|______|______|______|
0 ------1 --------2 -------3 -------4 --------5 -------6-- ... --29 ----30
A) What is the value of this whole stream of payments at t = 4 if R=10%?
B) What is the present value of this stream if R=10%?
C) What is the future value of this stream (t=30) if R=10%?
11. You are planning your own retirement. Not knowing the price level in 40 years when you plan to retire, you decide that $125,000 a year should be sufficient to live on. You intend to deposit an amount annually at the end of the year. You assume that at retirement you will live for another 20 years. Having no children, spouse or other relatives, and since you 'can't take it with you', you decide you want to die with only $40,000 left, the estimated burial cost in 60 years. Your best guess is that the average annual return over the next 60 years will be approximately 6.5%. You plan to withdraw your $100,000 at the beginning of every year. How much do you need to deposit per year for your 40 working years? How much will be in your account at the start of retirement?
12. Currently there are brochures on campus from Citibank whereby you can 'Get a Credit Card in College (Not a College Credit Card).' The applications have a stated APR of 17.65%. Assuming interest is calculated monthly, what is the effective annual rate on these cards?
13. Suppose you lend $10,000 to a friend. Your friend is to pay you back in 36 monthly installments. The interest rate on the loan is 11%. If you can reinvest the proceeds at 4.5%, what is your effective return or yield on the loan?
14. Forecast Inc. expects sales to grow by 25% next year. Management is currently negotiating a loan with the bank. Besides needing an estimate of next year's cash needs, the loan officer wants a pro forma balance sheet and income statement. Financial statements for the year just ended follow. Forecast is operating at 50% capacity. $700 of notes payable is due before the end of next year. Using the following financial information, prepare a pro-forma
| Cash | 400 | Sales | 15,000 | |
| A/R | 2,200 | Cost of Sales | 10,000 | |
| Inventory | 2,100 | Gross Profit | 5,000 | |
| Net Fixed Assets | 2,900 | Other Expenses | 1,000 | |
| Total Assets | 7,600 | EBIT | 4,000 | |
| Interest | 400 | |||
| Accts. Payable | 1,000 | Taxable Income | 3,600 | |
| Acc. Exp. | 700 | Income Tax | 1,440 | |
| Notes Payble | 2,500 | Net Income | 2,160 | |
| Common Stock | 3,000 | |||
| Retained Earnings | 400 | |||
| Tot. Liab & Equity | 7,600 | |||
Prepare a pro-forma balance sheet and income statement.
15. Your daughter is currently 4 and will begin college in 14 years. College currently costs $10,000 per year, and such costs are expected to increase by 7% per year. Assuming you can earn 9% on a mutual fund, and assuming you make tuition payments at the beginning of each year, the first in exactly 14 years, answer the following:
a. How much will college cost in each of the four years?
b. How much will you have to save annually, assuming you stop saving when college begins?
c. How much will you have to save if you decide to make monthly payments instead?
d. Your father, her grandfather, offers to give you a lump sum now for your daughter's education. How much must he give you?