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by: Dominic Erdman

ManagerialFinanceII FRL301

Dominic Erdman
CSU Pomona
GPA 3.91


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Class Notes
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This 5 page Class Notes was uploaded by Dominic Erdman on Saturday October 3, 2015. The Class Notes belongs to FRL301 at California State Polytechnic University taught by Staff in Fall. Since its upload, it has received 74 views. For similar materials see /class/218190/frl301-california-state-polytechnic-university in Finance,Real Estate&Law at California State Polytechnic University.

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Date Created: 10/03/15
Chapter 17 1 How is it possible that dividends are so important but at the same time dividend policy is irrelevant Answer Dividend policy deals with the timing of dividend payments not the amounts ultimately paid Dividend policy is irrelevant when the timing of dividend payments doesn t affect the present value of all future dividends 3 On Tuesday December 8 Hometown Co s Board of Directors declares a dividend of 75 cents a share payable on Wednesday January 17quot to shareholders of record as of Wednesday January 3 When is if the eXdividend date Answer Friday December 29 is the eXdividend day Remember not to count January 1 because it is a holiday and the exchanges are closed Anyone who buys the stock before December 29 is entitled to the dividend assuming they do not sell it again before December 29 4 Some corporations like one British company that offers its large shareholders free crematorium use pay dividends in kind that is offer their services to shareholders at belowmarket cost Should mutual funds invest in stocks that pay these dividends in kind The fund holders do not receive these services Answer No because the money could be better invested in stocks that pay dividends in cash which bene t the fund holders directly 1 Much Inc has declared a 460 per share dividend Suppose capital gains are not taxed but dividends are taxed at 15 New IRS regulations require that taxes be withheld at the time the dividend is paid Much sells for 8037 per share and the stock is about to go eXdividend What do you think the ex dividend price will be The aftertax dividend is the pretax dividend times one minus the tax rate so Aftertax dividend 4601 15 391 The stock price should drop by the aftertax dividend amount or Ex dividend price 8037 391 7646 3 Common stock 1 par value 30000 Capital surplus 285000 Retained earnings 649180 Total owners equity 964180 Show how the equity accounts will change if a Quadrangle declares a 4for1 stock split How many shares outstanding now What is the new par value per share New shares outstanding 3000041 120000 The equity accounts are unchanged except the par value ofthe stock is changed by the ratio of new shares to old shares so the new par value is New par value 114 025 per share b Quadrangle declares a lfor5 reverse stock split How many shares are outsnading now What is the new par value per share New shares outstanding 3000015 6000 The equity accounts are unchanged except the par value ofthe stock is changed by the ratio of new shares to old shares so the new par value is New par value 151 500 per share 4 RC currently has 350000 shares of stock outstanding that sell for 90 per share Assuming no market imperfections or tax effects exist what will the share price be a RRC has a 5for3 stock split 9035 5400 b 15 stock dividend 901115 7826 c 425 stock dividend 9011425 6316 d 4for7 reverse stock split 9074 15750 e Determine shares outstanding a 35000053 583333 b 350000115 402500 c 3500001425 498750 d 35000047 200000 5 amp 6 see page 574 Chapter 12 1 Suppose a stock had an initial price of 91 per share paid a dividend of 240 per share during the year and had an ending share price of 102 Compute the percentage total return R 7 102 7 91 240 91 7 1473 or 1473 2 In problem 1 what was the dividend yield Capital gains yield Dividend yield 240 91 0264 or 264 Capital gains yield 102 7 91 91 1209 or 1209 3 Rework problems 1 amp 2 assuming the ending share is 38 Total retumR 83 7 91 240 91 70615 or 15 Dividend yield 240 91 0264 or 264 Capital gains yield 83 7 91 91 70879 or 7879 dividend yield can never be negative 4 Suppose you bought a 7 coupon bond one year ago for 1040 Bond sells today for 1070 a Assuming a 1000 face value what was your total dollar return on this investment over the past year Total dollar return 1070 7 1040 70 100 b What was your total nominal rate of return on this investment over the past year R 1070 7 1040 70 1040 0962 or 962 c Ifthe in ation rate last yr was 4 what was your total real rate of return on this investment 1 R 1 r1 11 Fisher equation r 10962 104 7 1 0540 or 540 7amp 8 seepg397 9 Observed following returns on stock over the past 5 years 7 12 11 38 14 a What was the arithmetic avg return on stock over this 5 yr period Average return 07 712 1138 145 1160 or 1160 b What was the variance of returns over this period Standard deviation Variance 1407 7 11602 712 7 11602 11 7 116 2 38 7 11602 14 7 116A2 0032030 Standard deviation 003230Al2 01790 or 1790 14 You nd a certain stock that had returns of 7 12 18 amp 19 for 4 of the last 5 years Ifthe avg return of the stock over this period was 105 what was the stock s return for the missing year 525 07 7 12 18 19 K R 205 or 205 What is the standard deviation of the stocks return The missing return has to be 205 percent Now we can use the equation for the variance to nd Variance 1407 7 105 2 712 7 105 2 18 7 105 2 7 19 7 105 2 205 7 105A2 0018675 Standard deviation 0018675Al2 01367 or 1367 15 A stock has had returns of 3 38 21 15 29 amp 13 over the last 6 years What are the arithmetic and geometric returns for this stock Arithmetic average return 03 38 21 7 15 29 713 6 1050 or 1050 Geometric average return 1 R1 X 1 R2 gtlt X 1 RTAlT71 170313812117151291713A1671 0860 or 860 16 see pg 398 I 7 Suppose the returns on long term corporate bonds are normally distributed What range of returns would you expect to see 95 of the time What range would you expect to see 99 of the time 19 In problem 18 what is the probability that the return is less than 100 What are the implications for the distribution of the returns Chapter 14 1 Company just issued a dividend of 240 per share in its common stock The company is expected to maintain a constant 55 growth in its dividends inde nitely Ifthe stock sells for 52 a share what is the company s cost of equity RE 240105552 055 1037 or 1037 2 Common stock has a beta of 105 If the riskfree rate is 53 and the expected return on the market is 12 what is the company s cost of equity capital CAPM RE 053 10512 7053 1234 or 1234 3 Stock has a beta of 85 The market risk premium is 8 and tbills are currently yielding 5 The company s most recent dividend was 160 per share and dividends are expected to grow at 6 annual rate inde nitely Ifthe stock sells for 37 per share what is your best estimate of the company s cost of equity CAPM RE 05 08508 1180 or 1180 Dividend Growth ModelRE 16010637 06 1058 or 1058 4 Issued a dividend of 143 per share on its common stock Company paid dividends of 105 112 119 amp 130 per share in the last 4 years If the stock currently sells for 45 what is your best estimate of the company s cost of equity capital using the arithmetic avg growth rate in dividends What if you use the geometric average growth rate g11127105105 0667 or 667 g2 119 7112112 0625 or 625 g3 130 7119119 0924 or 924 g4 143 7130130 1000 or 1000 average arithmetic g 0667 0625 0924 10004 0804 or 804 dividend growth modelRE 143108044500 0804 1147 or 1147 geometric143 1051 g04 g 0803 or 803 23 see pg 468 5 Bank has an issue of preferred stock with a 6 stated dividend that just sold for 96 share What is cost of preferred stock RP 696 0625 or 625 6 Company trying to determine its cost of debt The rm has a debt issue outstanidn with 15 yrs maturity that is quoted at 107 of face value The issue makes semiannual payments and has an embedded cost of 7 annually What is the company s pretax cost of debt P0 1070 35PVIFAR30 1000PVIFR30 R 3137 YTM 2 X 3137 627 If the tax rate is 35 what is the after tax cost of debt RD 06271 7 35 0408 or 408 7 Issued a 30 yr 8 semiannual bond 7 yrs ago Bond currently sells for 95 of its face value Company tax rate is 35 a What is the pretax cost of debt P0 950 40PVIFAR46 1000PVIFR46 R 4249 YTM 2 X 4249 850 b What is the after tax cost of debt RD 08501735 0552 or 552 c Which is more relevant the pretax or the after tax cost of debt The aftertax rate is more relevant because that is the actual cost to the company 8 For problem 7 suppose the book value of the debt issue is 80 million In addition the company had a second debt issue on the market a zero coupon bond with 7 years left to maturity the book value if the issue is 35 million and the bonds sell for 61 of par What is the company s total book value of debt The total market value What is your best estimate of the after tax cost of debt now BVD 80000000 35000000 115000000 MVD 9580000000 6135000000 MVD 76000000 21350000 MVD 97350000 PZ 610 1000PVIFR14 R 3594 YTM 2 X 3594 719 Aftertax cosF RZ 07191735 0467 or 467 RD 0552769735 046721359735 0534 or 534 22 see pg 468 9 Target capital structure of 60 common stock 5 preferred stock and 35 debt Its cost of equity is 14 cost of preferred stock is 6 and the cpst of debt is 8 Relevant tax rate is 35 What is the WACC WACC 6014 0506 35081735 1052 or 1052 Company president has approached you about capital structure He wants you to know why the company doesn t use more preferred stock nancing because it costs less than debt What should you tell the preZ 081 7 35 0520 or 520 Hence on an aftertax basis debt is cheaper than the preferred stock 10 Company has a target debtequity ratio of 65 its cost of equity is 15 and its cost of debt is 9 If the tax rate is 35 what is the company s WACC WACC 151165 09651651735 1140 or 1140 11 WACC of 89 Cost of equity is 12 pretax cost of debt is 79 The tax rate is 35 What is the company s target debtequity ratio WACC 0890 12EV 079DV1 7 35 Rearranged 0890VE 12 07965DE VE 1 DE 0890DE 1 12 05135DE 06765DE 031 DE 8234 14 Inc has a target debt 7equity ratio of 105 Its WACC is 94 and tax rate is 35 a If cost of equity is 14 what is its pretax cost of debt WACC 094 1205 14 1052051 7 35RD RD 0772 or 772 b If instead you know that the after tax cost of debt is 69 what is the cost of equity WACC 094 1205RE 105205068 RE 1213 or 1213 18 Company needs 20 million to build a new line Target debtequity ratio is 75 the otation cost for new equity is 8 but the otation cost for debt is only 5 Boss has decided to fund the project by borrowing money because the otation costs are lower and the needed funds are relatively small a What do you think about the rationale behind borrowing the entire amount He should look at the weighted average otation cost not just the debt cost b What is your company s weighted average otation cost assuming all equity is raised externally fT 0575175 081175 0671 or 671 c What is the true cost of building the line after taking otation costs into account Does it matter in this case that the entire amt is being raised from debt Amount raised 1 7 0671 20000000 Amount raised 200000001 70671 21439510 Even if the speci c funds are actually being raised completely from debt the otation costs and hence true investment cost should be valued as if the rm s target capital structure is used 20 see pg 467 21 see pg 467 19 Needs to raise 45 million to start a new project and will raise the money by selling new bonds Company will generate no intemal equity for the foreseeable future Company has a target capital structure of 65 common stock 5 preferred stock and 30 debt Flotation costs for issuing new common are 9 for new preferred stock 6 amp for new debt 3 What is the true initial cost figure southem should use when evaluating its project fT 6509 0506 3003 071 or 71 Amount raised 1 7 071 45000000 Amount raised 450000001 7071 48413125


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