A newly floated farming company is financed with senior bonds, junior bonds, cumulative non-voting preferred stock and common stock. The new company has no retained profits and due to floods it was unable to record any revenues this year, leading to a loss. The firm is not bankrupt yet since it still has substantial contributed equity (same as paid-up capital).
On which securities must it pay interest or dividend payments in this terrible financial year?
Question 418 capital budgeting, NPV, interest tax shield, WACC, CFFA, CAPM
| Project Data | ||
| Project life | 1 year | |
| Initial investment in equipment | $8m | |
| Depreciation of equipment per year | $8m | |
| Expected sale price of equipment at end of project | 0 | |
| Unit sales per year | 4m | |
| Sale price per unit | $10 | |
| Variable cost per unit | $5 | |
| Fixed costs per year, paid at the end of each year | $2m | |
| Interest expense in first year (at t=1) | $0.562m | |
| Corporate tax rate | 30% | |
| Government treasury bond yield | 5% | |
| Bank loan debt yield | 9% | |
| Market portfolio return | 10% | |
| Covariance of levered equity returns with market | 0.32 | |
| Variance of market portfolio returns | 0.16 | |
| Firm's and project's debt-to-equity ratio | 50% | |
Notes
- Due to the project, current assets will increase by $6m now (t=0) and fall by $6m at the end (t=1). Current liabilities will not be affected.
Assumptions
- The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio.
- Millions are represented by 'm'.
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 2% pa. All rates are given as effective annual rates.
- The project is undertaken by a firm, not an individual.
What is the net present value (NPV) of the project?
Question 446 working capital decision, corporate financial decision theory
The working capital decision primarily affects which part of a business?
Question 578 inflation, real and nominal returns and cash flows
Which of the following statements about inflation is NOT correct?
Question 638 option, option payoff at maturity, no explanation
Which of the below formulas gives the payoff ##(f)## at maturity ##(T)## from being long a put option? Let the underlying asset price at maturity be ##S_T## and the exercise price be ##X_T##.
How much more can you borrow using an interest-only loan compared to a 25-year fully amortising loan if interest rates are 6% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula:
###\text{Proportional Increase} = \dfrac{V_\text{0,interest only}}{V_\text{0,fully amortising}} - 1###One year ago you bought a $1,000,000 house partly funded using a mortgage loan. The loan size was $800,000 and the other $200,000 was your wealth or 'equity' in the house asset.
The interest rate on the home loan was 4% pa.
Over the year, the house produced a net rental yield of 2% pa and a capital gain of 2.5% pa.
Assuming that all cash flows (interest payments and net rental payments) were paid and received at the end of the year, and all rates are given as effective annual rates, what was the total return on your wealth over the past year?
Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).
Question 869 economic order quantity
A Queensland farmer grows strawberries in greenhouses and supplies Australian supermarkets all year round. The farmer must decide how often he should contract the truck driver to deliver his strawberries and how many boxes to send on each delivery. The farmer:
- Sells 100,000 boxes of strawberries per year;
- Incurs holding costs (refrigeration and spoilage) of $16 per box per year; and
- Must pay the truck driver delivery fees at $0.20 per box plus a $500 fixed fee per delivery.
Which of the following statements about the Economic Order Quantity is NOT correct?
The present value of an annuity of 3 annual payments of $5,000 in arrears (at the end of each year) is $12,434.26 when interest rates are 10% pa compounding annually.
If the same amount of $12,434.26 is put in the bank at the same interest rate of 10% pa compounded annually and the same cash flow of $5,000 is withdrawn at the end of every year, how much money will be in the bank in 3 years, just after that third $5,000 payment is withdrawn?
Question 977 comparative advantage in trade, production possibilities curve, no explanation
Arthur and Bindi are the only people on a remote island. Their production possibility curves are shown in the graph.
Which of the following statements is NOT correct?