Videos
Assume that Hogan Surgical Instruments Co. has
a. Compute the anticipated return after financing costs with the most aggressive asset financing mix.
b. Compute the anticipated return after financing costs with the most conservative asset financing mix.
c. Compute the anticipated return after financing costs with the two moderate approaches to the asset financing mix.
d. Would you necessarily accept the plan with the highest return after financing costs? Briefly explain.
a.
To calculate: The anticipated return, after deducting the finance costs, with the most aggressive approach of the asset financing mix.
Introduction:
Anticipated return:
It is the amount that an individual or company has estimated to earn from an investment. It is one of the factors taken into account by an investor before selecting an investment plan.
Aggressive approach:
When a company selects a plan of low liquidity with high return and long-term financing, it is termed as an aggressive approach.
Answer to Problem 10P
The anticipated return, after deducting the finance costs, with the most aggressive asset financing mix approach is $200,000.
Explanation of Solution
The calculation of the anticipated return is as follows.
Working notes:
The calculation of the return from the low liquidity plan is as follows.
The calculation of the finance cost of short-term financing is as follows.
b.
To calculate: The anticipated return, after deducting the finance costs, with the most conservative approach of the asset financing mix.
Introduction:
Conservative approach:
When a company selects a plan of high-liquidity with low return and short-term financing, it is termed as a conservative approach.
Answer to Problem 10P
The anticipated return, after deducting the finance costs, with the most conservative asset financing mix approach is $50,000.
Explanation of Solution
The calculation of the anticipated return is as follows.
Working notes:
The calculation of the return from the high liquidity plan is as follows.
The calculation of the finance cost of the long-term finance is as follows:
c.
To calculate: The anticipated return, after deducting the finance costs with the two moderate approaches of the asset financing mix.
Introduction:
Moderate approach:
When a company selects a plan of low liquidity with high return and short-term financing or one of high liquidity with low return and long-term financing, it is termed as a moderate approach.
Answer to Problem 10P
The anticipated return, after deducting the finance costs, with the moderate approach of the low liquidity plan and long-term financing of the asset financing mix is $150,000.
The anticipated return, after deducting the finance costs, with the moderate approach of the high liquidity plan and short-term financing of the asset financing mix is $100,000.
Explanation of Solution
Anticipated return in the moderate approach of the low liquidity plan and long-term financing of asset financing mix:
The calculation of the anticipated return is as follows.
Working notes:
The calculation of the return from the low liquidity plan is as follows.
The calculation of the finance costs of long-term financing is as follows.
Anticipated return in the moderate approach of the high liquidity plan and short-term financing of the asset financing mix:
The calculation of the anticipated return is as follows.
Working notes:
The calculation of the return from the high-liquidity plan is as follows.
The calculation of the finance costs of short-term financing is as follows.
d.
To explain: Whether the plan with highest return after deducting the financing cost shall be accepted.
Introduction:
Finance Cost:
It is the cost that a company incurs to raise finance through debt or borrowed funds. Examples of borrowing costs are the interests paid on a loan (both short term and long term), the financial charges for finance leases, etc.
Answer to Problem 10P
No, it is not necessary to accept the plan that has high returns even after deducting the finance costs because risk also has to be taken into consideration while making the decision.
Explanation of Solution
The decision of selecting a plan does not only depend on the returns but also on its risk. High return is usually earned by taking high risks, but certain companies are not able to take such risks, which is why they choose a plan that has an average risk with average returns.
Want to see more full solutions like this?
Chapter 6 Solutions
Foundations of Financial Management
- Cully Company needs to raise $23 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. Flotation costs for issuing new common stock are 8 percent, for new preferred stock, 6 percent, and for new debt, 4 percent. What is the true initial cost figure Southern should use when evaluating its project? $23,589,744 $24,472,000 $24,572,650 $21,620,000 $25,555,556arrow_forwardQuigley Inc. is considering two financial plans for the coming year. Management expects sales to be $335,000, operating costs to be $290,000, assets (which is equal to its total invested capital) to be $210,000, and its tax rate to be 25%. Under Plan A it would finance the firm using 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 4.2. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, total invested capital, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure? Do not round your intermediate calculations.arrow_forwardLebleu, Incorporated, is considering a project that will result in initial aftertax cash savings of $1.71 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debt-equity ratio of .75, a cost of equity of 11.1 percent, and an aftertax cost of debt of 3.9 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +2 percent to the cost of capital for such risky projects. What is the maximum initial cost the company would be willing to pay for the project? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567.)arrow_forward
- Shinedown Company needs to raise $55 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 70 percent common stock, 15 percent preferred stock, and 15 percent debt. Flotation costs for issuing new common stock are 9 percent, for new preferred stock, 6 percent, and for new debt, 2 percent. What is the true initial cost figure the company should use when evaluating its project?arrow_forwardLebleu, Incorporated, is considering a project that will result in initial aftertax cash savings of $1.73 million at the end of the first year, and these savings will grow at a rate of 3 percent per year indefinitely. The firm has a target debt-equity ratio of .85, a cost of equity of 11.3 percent, and an aftertax cost of debt of 4.1 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +2 percent to the cost of capital for such risky projects. What is the maximum initial cost the company would be willing to pay for the project? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567.) The answer I got is $24,749.643 and it is incorrect. This is my work Find WACC = (weight of debt x after tax cost of debt ) + (weight of equity x cost of equity) =(debt/total capital x after tax…arrow_forwardSeattle Health Plans currently uses zero-debt financing. Its operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent. What impact would the new capital structure have on the firm’s profit, total dollar return to investors, and return on equity? Redo the analysis, but now assume that the debt financing would cost 15 percent. Repeat the analysis required for part a, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Compare the results with those obtained in part aarrow_forward
- Lible, Incorporated, is considering a project that will result in initial aftertax cash savings of $1.74 million at the end of the first year, and these savings will grow at a rate of 1 percent per year indefinitely. The firm has a target debt-equity ratio of .75, a cost of equity of 11.4 percent, and an aftertax cost of debt of 4.2 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +2 percent to the cost of capital for such risky projects. What is the maximum initial cost the company would be willing to pay for the project? (Do not round intermediate calculations and enter your answer in dollars, not millions, rounded to the nearest whole number, e.g., 1,234,567.)arrow_forwardSpeckle Delivery Systems can buy a piece of equipment that is anticipated to provide an 8% return and can be financed at 5% with debt. Later in the year, the company turns down an opportunity to buy a new machine that would yield a 15% return but would cost 17% to finance through common equity. Assume debt and common equity each represent 50% of the company’s capital structure. Compute the weighted average cost of capital (WACC). Which product(s) should be accepted in your opinion? Why?arrow_forwardSuppose your company needs $15 million to build a new assembly line. Your target debt-equity ratio is .65. The flotation cost for new equity is 8 percent, but the flotation cost for debt is only 5 percent. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small. a. What is your company’s weighted average flotation cost, assuming all equity is raised externally? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. What is the true cost of building the new assembly line after taking flotation costs into account? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g. 1,234,567.)arrow_forward
- Mahomes Manufacturing needs to raise $80 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 55 percent common stock, 15 percent preferred stock, and 30 percent debt. Flotation costs for issuing new common stock are 5 percent, for new preferred stock, 3 percent, and for new debt, 2 percent. What is the true initial cost figure the company should use when evaluating its project?arrow_forwardNeko Inc. uses Additional Funds Needed as a plug item. If the company had forecast its additional financing needed to be 2,340,000, its capital budget at 3,600,000, and net income at 1,800,000, what is its retention ratio?arrow_forwardAlpha Inc. has a target debt-to-value ratio of .6. The pretax cost of debt is 10 percent, the tax rate is 21 percent, and the unlevered cost of equity 14 percent. A project the firm is considering has a cash flow to the levered equity holders of $49,661 and an initial unborrowed cost of $220,000. What is the NPV of the project?arrow_forward
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT