Managerial Finance

ManagerialFinance

ManagerialFinance

Problem13-11:EPScalculations

Parta)

16%Bonds $60,000 =&gt interest = 16% of 60,000 = $9,600

1500preferential stock $5 per share = 1500 × $5 = $7,500

[email protected] 40%

Earningsbefore interest and tax, EBIT = $24600

EBIT

$24,600

Less Interest

16%*60000

($9,600)

EBT

$15,000

Less Tax

@40%*15000

($6,000)

EAT

$9,000

Less Preferential

1500*$5

($7,500)

Distributable Profit

$1,500

EPS

$1500 ÷ 4000

$0.375

Partb)

Earningsbefore interest and tax, EBIT = $30600

EBIT

$30,600

Interest

16%*60000

($9,600)

EBT

$21,000

Tax

@40%*21000

($8,400)

EAT

$12,600

Preferential

1500*$5

($7,500)

Distributable Profit

$5,100

EPS

$5100 ÷ 4000

$1.275

Partc)

Earningsbefore interest and tax, EBIT = $35000

EBIT

$35,000

Interest

16%*60000

($9,600)

EBT

$25,400

Tax

@40%*25400

($10,160)

EAT

$15,240

Preferential

1500*$5

($7,500)

Distributable Profit

$7,740

EPS

$5100 ÷ 4000

$1.935

Problem13-16: Integrative- Leverage and risk

Parta) &nbsp

Firm R

Firm W

Sales

100,000 @$2.0

$200,000

100,000 @$2.5

$250,000

Variable Cost

100,000 @$1.7

$170,000

100,000 @$1.0

$100,000

Contribution

$30,000

$150,000

Fixed cost

$6,000

$62,500

EBIT

$24,000

$87,500

Interest

$10,000

$17,500

$14,000

$70,000

FirmR

Degreeof operating leverage DOL = = = = 1.25 times

Degreeof Financial Leverage (DFL) = = = 1.71times

Partb)

FirmW

Degreeof Operating Leverage DOL = = = = 1.71 times

Degreeof Financial Leverage (DFL) = = = 1.25times

Partc)

FirmW is more risky than firm R. This is because firm W has a higherdegree of operating leverage as compared to firm R. This impliesthat, the higher the DOL, the higher the risk (Lawrence&amp Chad, 2010).

Partd)

Leverageratio indicates the effect that a particular amount of operatingleverage has to the earnings before interest and tax (EBIT) of thecompany. A higher operating leverage indicates that the firm is usinga large proportion of fixed cost as compared to the variable cost forits operations. This therefore shows a higher volatility to the EBITfigure in relation to change in sales ceteris paribus. Thus, thehigher the DOL of the firm, the higher the risk.

Problem13-20: Debtand financial risk

Parta)

TowerInteriors

EBIT Calculation

Probability

0.20

0.60

0.20

Sales

$200,000

$300,000

$400,000

Variable costs (@70%)

140,000

210,000

280,000

Fixed costs

75,000

75,000

75,000

EBIT

$(15,000)

$ 15,000

$ 45,000

Interest

12,000

12,000

12,000

Earnings before taxes

$(27,000)

$ 3,000

$ 33,000

Taxes

10,800

(1,200)

(13,200

EAT

$(16,200)

$ 1,800

$ 19,800

Partb)

CalculatingEarnings per Share, EPS

EAT

$(16,200)

$ 1,800

$19,800

Number of shares

10,000

10,000

10,000

EPS

$ (1.62)

$ 0.18

$ 1.98

ExpectedEPS($1.620.20) ($0.18 0.60) ($1.98 0.20)

ExpectedEPS$0.324$0.108 $0.396

ExpectedEPS$0.18

Partc)

EBIT *

$(15,000)

$15,000

$45,000

Interest

0

0

0

Net profit before taxes

$(15,000)

$15,000

$45,000

Taxes

6,000

(6,000)

(18,000)

Net profits after taxes

$ (9,000)

$ 9,000

$27,000

EPS (15,000 shares)

$ (0.60)

$ 0.60

$ 1.80

ExpectedEPS($0.600.20) ($0.60 0.60) ($1.80 0.20) $0.60

Partd)

Comparison

Part a

Part b

Expected EPS

$0.180

$0.600

EPS

$1.138

$0.759

CVEPS

6.320

1.265

Byincluding debt in the capital structure of Tower Interior, will leadto a lower expected earnings per share, with a higher standarddeviation and a much higher coefficient of variation as compared withno debt capital structure. This implies that, by excluding debt intheir capital structure, the firm will become less risky as it isindicated by the coefficient of variation which is the measure ofrisk.

Problem14-4: Dividendconstraints

Parta)

Commonstock(400,000 shares at $4 par)$1,600,000

Paid-incapital in excess of par $1,000,000

Retainedearnings $1,900,000

Maximumdividends payable= retained earnings ÷ outstanding shares =$1,900,000/400,000=$4.75

Partb)

Ifthe firm does not borrow, then the maximum available for distributionwill be $100,000 + $160,000 = $260,000

Thereforethe per share dividend will be $260,000 ÷ 400,000 = $0.65

Partc)

Journalentries

Ifthe firm pays all dividends, that is, dividends paid = 400000*4.45=$1,900,000

Accounts

DR CR

Dividends 1,900,000

Bank 1,900,000

Ifthe firm does not borrow then the dividends paid = 260,000

Accounts

DR CR

Dividendspayable 260,000

Cash 260,000

Partd)

Theeffect of $80,000 dividend would increase the value of thestockholders’ equity. This is if the firm has a right issue whichgrants the shareholders a right to accumulate their shares instead ofreceiving dividends.

Problem14-11: Stockdividend—Investor

Parta)

Earningsper share EPS = = =$ 2.0

Partb)

WarrenCurrently owns proportion equivalent to .Therefore, Warren owns 1% of the firm.

Partc)

Proportionafter paying dividends

Therefore,after paying up the dividends, Warren will own 1.09% of the firm.

Partd)

Afterthe stock dividend, the market price of the share will rise to $24.That is, $22 + $2 =$24

Parte)

Thepayment of stock dividend would increase the proportion of the sharesthat Warren owns in the firm. However, this would only imply ifWarren does not receive the dividends but leave them to accumulatethe shares. On other side, the earnings of Nutri-Food would reduceafter payment of stock dividends.

Problem14-19: Ethicsproblem

CFOshould always act to serve the interest of the shareholders (Arnold,2008).However in some case they might be confronted by the management toact contrary. For example, in this case, reducing the quarterlyearnings would result to a fall of the stock prices prior to theirannouncement, and this could lead to the creation of inconveniencesto the investors. It is also unethical to provide misleadinginformation to the public, and this can even lead to a civil wrong.Manipulating of earnings above the described value may raise muchconcern tothe investors, and therefore the CFO and CEO should watch out for theannouncements prior to the earnings.

References

LawrenceJ. &amp Chad J. (2010).Principles of Managerial finance13thedition.NewYork:Pearson Education.

Arnold G. (2008). Corporate financial management 4th edition. Britain: Pearson Education.