ASSESSMENT
Instruction : This Assessment is open-book, and you may use your textbooks, other supporting material, and Excel financial formulae for your reference and assistance.
Please answer all questions in Section A, and answer 3 questions in Section B.
All questions carry equal marks.
Section A: Please Answer All TWO Questions.
You should write between 300-500 words for each question in this section.
1. What is capital budgeting? What are the major investment decision criteria?
2. Critically discuss the trade-off between paying dividends and retaining (reinvesting) firm profit.
Section B: Please Answer THREE Questions.
3. (Individual or Component Costs of Capital) Compute the cost for the following sources of Financing:
a. A bond that has a $1,000 par value (face value) and a contract or coupon interior rate of 12%. A new issue would have a flotation cost of 6% of the $1,125 market value. The bonds mature in 10 years. The firm's average tax rate is 30% and its marginal tax rate is 34%.
b. A new common stock issue paid a $1.75 dividend last year. The par value of the stock is $15, and earnings per share have grown at a rate of 8% per year. This growth rate is expected to continue into the foreseeable future. The company maintains a constant dividend/earnings ratio of 30%. The price of this stock is now $28, but 5% flotation costs are anticipated.
c. Internal common equity where the current market price of the common stock is $43.50. The expected dividend this coming year should be $3.25, increasing thereafter at a 7% annual growth rate. The corporation's tax rate is 34%.
4. (Break-even Point and Operating Leverage) Matthew Electronics manufactures a complete line of radio and communication equipment for law enforcement agencies. The average selling price of its finished product is $175 per unit. The variable cost for these same units is $140. Matthew's incurs fixed costs of $550,000 per year.
a. What is the break-even point in units for the company?
b. What is the dollar sales volume the firm must achieve to reach the break-even point?
c. What would be the firm's profit or loss at the following units of production sold: 12,000 units?
d. Find the degree of operating leverage for the production and sales levels given in part c above.
5. (Dividend Policies) The earnings for Carlson Cargo, Inc. have been predicted for the next 5 years and are listed below. There are 1 million shares outstanding. Determine the yearly dividend per share to be paid if the following policies are enacted:
a. Constant dividend payout ratio of 40%.
b. Stable dollar dividend targeted at 40% of the earnings over the 5-year period.
c. Small, regular dividend of $.50 per share plus a year-end extra when the profits in any year exceed $1,500,000. The year-end extra dividend will equal 50% of profits exceeding $1,500,000.
| Year |
Profits After Taxes |
| 1 |
$1,500,000 |
| 2 |
2,000,000 |
| 3 |
1,750,000 |
| 4 |
950,000 |
| 5 |
2,500,000 |