Use the following information for Questions 1
through 3:
Boehm Corporation has had stable earnings growth of
8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million
on net income of $9.8 million. However, in 2014 earnings are expected to jump
to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion.
This one-time unusual earnings growth won’t be maintained, though, and after
2014 Boehm will return to its previous 8% earnings growth rate. Its target debt
ratio is 35%.
Calculate Boehm’s total dividends for 2014 under each of the following
policies:
1. Its 2014 dividend payment is set to force dividends
to grow at the long-run growth rate in earnings.
2. It continues the 2013 dividend payout ratio.
3. It uses a pure residual policy with all
distributions in the form of dividends (35% of the $7.3 million investment is
financed with debt).
4. It employs a regular-dividend-plus-extras policy,
with the regular dividend being based on the long-run growth rate and the extra
dividend being set according to the residual policy.
Use the following information for
Questions 5 and 6:
Schweser Satellites Inc. produces satellite earth
stations that sell for $100,000 each. The firm’s fixed costs, F, are $2
million, 50 earth stations are produced and sold each year, profits total
$500,000, and the firm’s assets (all equity financed) are $5 million. The firm
estimates that it can change its production process, adding $4 million to
investment and $500,000 to fixed operating costs. This change will (1) reduce
variable costs per unit by $10,000 and (2) increase output by 20 units, but (3)
the sales price on all units will have to be lowered to $95,000 to permit sales
of the additional output. The firm has tax loss
carryforwards that render its tax rate zero, its cost of equity is 16%, and
it uses no debt.
5. What is the incremental profit? To get a rough idea
of the project’s profitability, what is the project’s expected rate of return
for the next year (defined as the incremental profit divided by the
investment)? Should the firm make the investment? Why or why not?
6. Would the firm’s break-even point increase or
decrease if it made the change?
Use the following information for Questions 7 and
8:
Suppose you are provided the following balance
sheet information for two firms, Firm A and Firm B (in thousands of dollars).
|
Firm A |
Firm B |
||
|
Current assets |
$150,000 |
$120,000 |
|
|
Fixed assets (net) |
150,000 |
180,000 |
|
|
Total assets |
$300,000 |
$300,000 |
|
|
Current liabilities |
$20,000 |
$80,000 |
|
|
Long-term debt |
80,000 |
20,000 |
|
|
Common stock |
100,000 |
100,000 |
|
|
Retained earnings |
100,000 |
100,000 |
|
|
Total liabilities and equity |
$300,000 |
$300,000 |
|
Earnings before interest and taxes for both firms
are $30 million, and the effective federal plus-state tax rate is 35%.
7. What is the return on equity for each firm if the
interest rate on current liabilities is12% and the rate on long-term debt is
15%?
8. Assume that the short-term rate rises to 20%, that
the rate on new long-term debt rises to 16%, and that the rate on existing
long-term debt remains unchanged. What would be the return on equity for Firm A
and Firm B under these conditions?
9. In 1983 the Japanese yen-U.S. dollar exchange rate
was 250 yen per dollar, and the dollar cost of a compact Japanese-manufactured
car was $10,000. Suppose that now the exchange rate is 120 yen per dollar.
Assume there has been no inflation in the yen cost of an automobile so that all
price changes are due to exchange rate changes. What would the dollar price of the
car be now, assuming the car’s price changes only with exchange rates?
