Finance Homework Problems

Brigham and Houston, Essentials of Financial Management, 5th Edition, 2023.

No. Topic Problems

1 Financial Statements Analysis Ch 3 Problem: 14

Ch 4 Problems: 11, 14, 15, 19, 20

2 Working Capital Management Ch 17 Problems: 1, 2, 3, 4

3 Time Value of Money Ch 5 Problems: 10, 18, 19, 22, 29, 36, 42

4 Bonds and their Valuation Ch 9 Problems: 8, 10, 17, 19, 22

5 Risk and Return Ch 8 Problems: 12, 13, 16, 19

6 Stocks and their Valuation Ch 10 Problems: 13, 15, 18, 20

7 Cost of Capital Ch 11 Problems: 8, 9, 20, 21

8 Capital Budgeting Ch 12 Problems: 8, 17

3-14. FREE CASH FLOW Arlington Corporation’s financial statements (dollars and
shares are in millions) are provided here.

a. What was net operating working capital for 2020 and 2021? Assume that all
cash is excess cash; i.e., this cash is not needed for operating purposes.

b. What was Arlington’s 2021 free cash flow?

c. Construct Arlington’s 2021 statement of stockholders’ equity.

d. What was Arlington’s 2021 EVA? Assume that its after-tax cost of capital is 10%.

e. What was Arlington’s MVA at year-end 2021? Assume that its stock price at
December 31, 2021 was $25.
4-11. RATIO CALCULATIONS Assume the following relationships for the Caulder
Corp.:
Sales/Total assets 1.3×
Return on assets (ROA) 4.0%
Return on equity (ROE) 8.0%
Calculate Caulder’s profit margin and debt-to-capital ratio assuming the firm uses
only debt and common equity, so total assets equal total invested capital.

4-14. RETURN ON EQUITY Pacific Packaging’s ROE last year was only 5%, but its
management has developed a new operating plan that calls for a debt-to-capital
ratio of 40%, which will result in annual interest charges of $561,000. The firm has
no plans to use preferred stock, and total assets equal total invested capital.
Management projects an EBIT of $1,870,000 on sales of $17,000,000, and it expects
to have a total assets turnover ratio of 2.1. Under these conditions, the tax rate will
be 25%. If the changes are made, what will be the company’s return on equity?

4-15. RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of
$200,000, a net income of $15,000, and the following balance sheet:

The new owner thinks that inventories are excessive and can be lowered to the
point where the current ratio is equal to the industry average, 2.5×, without
affecting sales or net income. If inventories are sold and not replaced (thus reducing
the current ratio to 2.5×), if the funds generated are used to reduce common equity
(stock can be repurchased at book value), and if no other changes occur, by how
much will the ROE change? What will be the firm’s new quick ratio?

4-19. CURRENT RATIO The Stewart Company has $2,392,500 in current assets and
$1,076,625 in current liabilities. Its initial inventory level is $526,350, and it will
raise funds as additional notes payable and use them to increase inventory. How
much can its short-term debt (notes payable) increase without pushing its current
ratio below 2.0?

4-20. DSO AND ACCOUNTS RECEIVABLE Ingraham Inc. currently has $205,000
in accounts receivable, and its days sales outstanding (DSO) is 71 days. It wants to
reduce its DSO to 20 days by pressuring more of its customers to pay their bills on
time. If this policy is adopted, the company’s average sales will fall by 15%. What
will be the level of accounts receivable following the change? Assume a 365-day
year.
17-1. CASH CONVERSION CYCLE Parramore Corp has $12 million of sales, $3
million of inventories, $3.25 million of receivables, and $1.25 million of payables. Its
cost of goods sold is 75% of sales, and it finances working capital with bank loans at
an 8% rate. What is Parramore’s cash conversion cycle (CCC)? If Parramore
could lower its inventories and receivables by 10% each and increase its payables
by 10%, all without affecting sales or cost of goods sold, what would be the new
CCC, how much cash would be freed up, and how would that affect pretax profits?

17-2. RECEIVABLES INVESTMENT Leyton Lumber Company has sales of $12

million per year, all on credit terms calling for payment within 30 days, and its
accounts receivable are $1.5 million. What is Leyton’s DSO, what would it be if all
customers paid on time, and how much capital would be released if Leyton could
take action that led to on-time payments?

17-3. COST OF TRADE CREDIT AND BANK LOAN Lancaster Lumber buys $8
million of materials (net of discounts) on terms of 3/5, net 55, and it currently pays
on the 5th day and takes discounts. Lancaster plans to expand, which will require
additional financing. If Lancaster decides to forgo discounts, how much additional
credit could it obtain, and what would be the nominal and effective cost of that
credit? If the company could get the funds from a bank at a rate of 9%, interest paid
monthly, based on a 365-day year, what would be the effective cost of the bank
loan? Should Lancaster use bank debt or additional trade credit? Explain.

17-4. CASH CONVERSION CYCLE Zane Corporation has an inventory conversion

period of 64 days, an average collection period of 28 days, and a payables deferral
period of 41 days.
a. What is the length of the cash conversion cycle?

b. If Zane’s annual sales are $2,578,235 and all sales are on credit, what is the
investment in accounts receivable?

c. How many times per year does Zane turn over its inventory? Assume that the
cost of goods sold is 75% of sales.
5-10. PRESENT AND FUTURE VALUES FOR DIFFERENT INTEREST
RATES Find the following values. Compounding/discounting occurs annually.
a. An initial $200 compounded for 10 years at 4%

b. An initial $200 compounded for 10 years at 8%

c. The present value of $200 due in 10 years at 4%

d. The present value of $1,870 due in 10 years at 8% and at 4%

e. Define present value and illustrate it using a time line with data from part d. How
are present values affected by interest rates?

5-18. UNEVEN CASH FLOW STREAM

a. Find the present values of the following cash flow streams at a 5% discount rate.

b. What are the PVs of the streams at a 0% discount rate?

5-19. FUTURE VALUE OF AN ANNUITY Your client is 26 years old. She wants to
begin saving for retirement, with the first payment to come one year from now. She
can save $8,000 per year, and you advise her to invest it in the stock market, which
you expect to provide an average return of 10% in the future.
a. If she follows your advice, how much money will she have at 65?
b. How much will she have at 70?
c. She expects to live for 20 years if she retires at 65 and for 15 years if she retires
at 70. If her investments continue to earn the same rate, how much will she be
able to withdraw at the end of each year after retirement at each retirement
age?

5-22. LOAN AMORTIZATION Jan sold her house on December 31 and took a
$10,000 mortgage as part of the payment. The 10-year mortgage has a 10%
nominal interest rate, but it calls for semiannual payments beginning next June 30.
Next year Jan must report on Schedule B of her IRS Form 1040 the amount of
interest that was included in the two payments she received during the year.
a. What is the dollar amount of each payment Jan receives?

b. How much interest was included in the first payment? How much repayment of
principal was included? How do these values change for the second payment?

c. How much interest must Jan report on Schedule B for the first year? Will her
interest income be the same next year?

d. If the payments are constant, why does the amount of interest income change
over time?
5-29. EFFECTIVE VERSUS NOMINAL INTEREST RATES Bank A pays 2%
interest compounded annually on deposits, while Bank B pays 1.75% compounded
daily.
a. Based on the EAR (or EFF%), which bank should you use?
b. Could your choice of banks be influenced by the fact that you might want to
withdraw your funds during the year as opposed to at the end of the year?
Assume that your funds must be left on deposit during an entire compounding
period in order to receive any interest.

5-36. IMPACT OF LOAN TENOR Mustaf and Yalina can afford up to $3,000 for the
monthly installment on their property loan. They need to borrow $350,000 from
the bank. If the interest rate is 6% per annum, monthly compounded, for all loan
tenors, will the money they set aside be sufficient for the monthly loan repayments
if they borrow for 10 years? If not, what is the minimum tenor of the loan they can
borrow (rounded up to the nearest year)?

5-42. PV AND A LAWSUIT SETTLEMENT It is now December 31, 2020 , and a

jury just found in favor of a woman who sued the city for injuries sustained in a
January 2019 accident. She requested recovery of lost wages plus $300,000 for pain
and suffering plus $60,000 for legal expenses. Her doctor testified that she has been
unable to work since the accident and that she will not be able to work in the future.
She is now 62, and the jury decided that she would have worked for another 3
years. She was scheduled to have earned $36,000 in 2019. (To simplify this
problem, assume that the entire annual salary amount would have been received on
December 31, 2019.) Her employer testified that she probably would have received
raises of 3% per year. The actual payment for the jury award will be made on
December 31, 2021. The judge stipulated that all dollar amounts are to be adjusted
to a present value basis on December 31, 2021, using an 8% annual interest rate
and using compound, not simple, interest. Furthermore, he stipulated that the pain
and suffering and legal expenses should be based on a December 31, 2020, date.
How large a check must the city write on December 31, 2021?
9-8. YIELD TO CALL Seven years ago the Templeton Company issued 20-year bonds
with an 11% annual coupon rate at their $1,000 par value. The bonds had a 7.5%
call premium, with 5 years of call protection. Today Templeton called the bonds.
Compute the realized rate of return for an investor who purchased the bonds when
they were issued and held them until they were called. Explain why the investor
should or should not be happy that Templeton called them.

9-10. CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO

MATURITY Pelzer Printing Inc. has bonds outstanding with 9 years left to
maturity. The bonds have a 9% annual coupon rate and were issued 1 year ago at
their par value of $1,000. However, due to changes in interest rates, the bond’s
market price has fallen to $910.30. The capital gains yield last year was −8.97%.
a. What is the yield to maturity?

b. For the coming year, what are the expected current and capital gains yields?
(Hint: Refer to footnote for the definition of the current yield and to Table 9.1.)

c. Will the actual realized yields be equal to the expected yields if interest rates
change? If not, how will they differ?

9-17. BOND VALUATION Bond X is noncallable and has 20 years to maturity, an 8%

annual coupon, and a $1,000 par value. Your required return on Bond X is 9%; if
you buy it, you plan to hold it for 5 years. You (and the market) have expectations
that in 5 years, the yield to maturity on a 15-year bond with similar risk will be
7.5%. How much should you be willing to pay for Bond X today? (Hint: You will
need to know how much the bond will be worth at the end of 5 years.)

9-19. BOND VALUATION You are considering a 10-year, $1,000 par value bond. Its
coupon rate is 8%, and interest is paid semiannually. If you require an “effective”
annual interest rate (not a nominal rate) of 7.1225%, how much should you be
willing to pay for the bond?

9-22. YIELD TO MATURITY AND YIELD TO CALL Kempton Enterprises has

bonds outstanding with a $1,000 face value and 10 years left until maturity. They
have an 11% annual coupon payment, and their current price is $1,185. The bonds
may be called in 5 years at 109% of face value .
a. What is the yield to maturity?

b. What is the yield to call if they are called in 5 years?

c. Which yield might investors expect to earn on these bonds? Why?

d. The bond’s indenture indicates that the call provision gives the firm the right to
call the bonds at the end of each year beginning in Year 5. In Year 5, the bonds
may be called at 109% of face value, but in each of the next 4 years, the call
percentage will decline by 1%. Thus, in Year 6, they may be called at 108% of
face value; in Year 7, they may be called at 107% of face value; and so forth. If
the yield curve is horizontal and interest rates remain at their current level,
when is the latest that investors might expect the firm to call the bonds?
8-12. REQUIRED RATE OF RETURN Suppose rF = 4%, rM = 10%, and βi.
a. What is ri, the required rate of return on Stock i?
b. Now suppose that rF (1) increases to 5% or (2) decreases to 3%. The slope of the
SML remains constant. How would this affect rM and ri?
c. Now assume that rF remains at 4%, but rM (1) increases to 12% or (2) falls to
9%. The slope of the SML does not remain constant. How would these changes
affect ri?

8-13. CAPM, PORTFOLIO RISK, AND RETURN Consider the following

information for Stocks A, B, and C. The returns on the three stocks are positively
correlated, but they are not perfectly correlated. (That is, each of the correlation
coefficients is between 0 and 1.)

Stock Expected Return Standard Deviation Beta

A 9.55% 15% 0.9

B 10.45 15 1.1

C 12.70 15 1.6
Fund P has one-third of its funds invested in each of the three stocks. The risk-free
rate is 5.5%, and the market is in equilibrium. (That is, required returns equal
expected returns.)

a. What is the market risk premium?

b. What is the beta of Fund P?
c. What is the required return of Fund P?
d. Would you expect the standard deviation of Fund P to be less than 15%, equal to
15%, or greater than 15%? Explain.

8-16. CAPM AND PORTFOLIO RETURN You have been managing a $5 million
portfolio that has a beta of 1.15 and a required rate of return of 11.475%. The
current risk-free rate is 4%. Assume that you receive another $500,000. If you
invest the money in a stock with a beta of 0.85, what will be the required return on
your $5.5 million portfolio?

8-19. EVALUATING RISK AND RETURN Stock X has a 10% expected return, a
beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y
has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard
deviation. The risk-free rate is 6%, and the market risk premium is 5%.
a. Calculate each stock’s coefficient of variation.
b. Which stock is riskier for a diversified investor?
c. Calculate each stock’s required rate of return.
d. On the basis of the two stocks’ expected and required returns, which stock
would be more attractive to a diversified investor?
e. Calculate the required return of a portfolio that has $7,500 invested in Stock X
and $2,500 invested in Stock Y.
f. If the market risk premium increased to 6%, which of the two stocks would have
the larger increase in its required return?
10-13. CONSTANT GROWTH Ackerman Inc. has a beta of 1.25. The market risk
premium is 8% and the risk-free rate is 2%. Assume that the market is in
equilibrium and the stock currently sells for $26 a share. Ackerman just paid a
$2.00 dividend this year and the dividend is expected to grow at a constant rate g.
What will the stock price be at the end of two years from now?
10-15. CORPORATE VALUATION Dantzler Corporation is a fast-growing supplier of
office products. Analysts project the following free cash flows (FCFs) during the
next 3 years, after which FCF is expected to grow at a constant 5% rate. Dantzler’s
WACC is 11%.

What is Dantzler’s horizon, or continuing, value? (Hint: Find the value of all free
cash flows beyond Year 3 discounted back to Year 3.)
a. What is the firm’s market value today? Assume that Dantzler has zero
nonoperating assets.
b. Suppose Dantzler has $112.60 million of debt and 25 million shares of stock
outstanding. What is your estimate of the current price per share?
10-18. NONCONSTANT GROWTH STOCK VALUATION Taussig Technologies
Corporation (TTC) has been growing at a rate of 20% per year in recent years. This
same growth rate is expected to last for another 2 years, then decline to gn = 6%.
a. If D0 = $1.60 and rs = 10%, what is TTC’s stock worth today? What are its
expected dividend, and capital gains yields at this time, that is, during Year 1?
b. Now assume that TTC’s period of supernormal growth is to last for 5 years
rather than 2 years. How would this affect the price, dividend yield, and capital
gains yield? Answer in words only.
c. What will TTC’s dividend and capital gains yields be once its period of
supernormal growth ends? (Hint: These values will be the same regardless of
whether you examine the case of 2 or 5 years of supernormal growth; the
calculations are very easy.)
d. Explain why investors are interested in the changing relationship between
dividend and capital gains yields over time.
10-20. CORPORATE VALUE MODEL Assume that today is December 31, 2021, and
that the following information applies to Abner Airlines:
• After-tax operating income [EBIT(1 − T)] for 2022 is expected to be $400
million.
• The depreciation expense for 2022 is expected to be $140 million.
• The capital expenditures for 2022 are expected to be $225 million.
• No change is expected in net operating working capital.
• The free cash flow is expected to grow at a constant rate of 6% per year.
• The required return on equity is 14%.
• The WACC is 10%.
• The firm has $200 million of nonoperating assets.
• The market value of the company’s debt is $3.875 billion.
• 200 million shares of stock are outstanding.
Using the corporate valuation model approach, what should be the company’s stock
price today?
11-8. COST OF COMMON EQUITY AND WACC Palencia Paints Corporation has
a target capital structure of 35% debt and 65% common equity, with no preferred
stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 25%. The current
stock price is P0 = $22.00. The last dividend was D0 = $2.25, and it is expected to
grow at a 5% constant rate. What is its cost of common equity and its WACC?

11-9. WACC The Paulson Company’s year-end balance sheet is shown here. Its cost of
common equity is 14%, its before-tax cost of debt is 10%, and its marginal tax rate
is 25%. Assume that the firm’s long-term debt sells at par value. The firm’s total
debt, which is the sum of the company’s short-term debt and long-term debt, equals
$1,167. The firm has 576 shares of common stock outstanding that sell for $4.00 per
share. Calculate Paulson’s WACC using market-value weights.

11-20. WACC The following table gives Foust Company’s earnings per share for the last
10 years. The common stock, 7.8 million shares outstanding, is now (1/1/22)
selling for $65.00 per share. The expected dividend at the end of the current year
(12/31/22) is 55% of the 2021 EPS. Because investors expect past trends to
continue, g may be based on the historical earnings growth rate. (Note that 9 years
of growth are reflected in the 10 years of data.)

Year EPS

2012 $3.90

2013 4.21

2014 4.55

2015 4.91

2016 5.31

2017 5.73
 Year EPS

2018 6.19

2019 6.68

2020 7.22

2021 7.80

The current interest rate on new debt is 9%; Foust’s marginal tax rate is 25%,
and its target capital structure is 40% debt and 60% equity.
a. Calculate Foust’s after-tax cost of debt and common equity. Calculate the cost of
equity.
b. Find Foust’s WACC.

11-21. CALCULATING THE WACC Here is the condensed 2021 balance sheet for
Skye Computer Company (in thousands of dollars):

Skye’s earnings per share last year were $3.20. The common stock sells for $55.00, last
year’s dividend was $2.10, and a flotation cost of 10% would be required to sell new
common stock. Security analysts are projecting that the common dividend will grow at an
annual rate of 9%. Skye’s preferred stock pays a dividend of $3.30 per share, and its
preferred stock sells for $30.00 per share. The firm’s before-tax cost of debt is 10%, and its
marginal tax rate is 25%. The firm’s currently outstanding 10% annual coupon rate, long-
term debt sells at par value. The market risk premium is 5%, the risk-free rate is 6%, and
Skye’s beta is 1.516. The firm’s total debt, which is the sum of the company’s short-term
debt and long-term debt, equals $1.2 million.
a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost
of preferred stock, the cost of equity from retained earnings, and the cost of newly
issued common stock. Use the DCF method to find the cost of common equity.
b. Now calculate the cost of common equity from retained earnings, using the CAPM
method.
c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference
between re and rs as determined by the DCF method, and add that differential to the
CAPM value for rs.)
d. If Skye continues to use the same market-value capital structure, what is the firm’s
WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands
so rapidly that it must issue new common stock?
12-8. CAPITAL BUDGETING CRITERIA: ETHICAL CONSIDERATIONS A
mining company is considering a new project. Because the mine has received a
permit, the project would be legal, but it would cause significant harm to a nearby
river. The firm could spend an additional $10 million at Year 0 to mitigate the
environmental problem, but it would not be required to do so. Developing the mine
(without mitigation) would require an initial outlay of $60 million, and the expected
cash inflows would be $20 million per year for 5 years. If the firm does invest in
mitigation, the annual inflows would be $21 million. The risk-adjusted WACC is
12%.
a. Calculate the NPV and IRR with and without mitigation.

b. How should the environmental effects be dealt with when this project is
evaluated?

c. Should this project be undertaken? If so, should the firm do the mitigation?

12-17. CAPITAL BUDGETING CRITERIA A company has an 11% WACC and is

considering two mutually exclusive investments (that cannot be repeated) with the
following cash flows:

a. What is each project’s NPV?

b. What is each project’s IRR?
c. What is each project’s MIRR? (Hint: Consider Period 7 as the end of Project B’s
life.)
d. From your answers to parts a, b, and c, which project would be selected? If the
WACC was 18%, which project would be selected?
e. Construct NPV profiles for Projects A and B.
f. Calculate the crossover rate where the two projects’ NPVs are equal.
g. What is each project’s MIRR at a WACC of 18%?