Ross Westerfield Jordan

Essentials
of Corporate

Finance
Third Edition
 Problem List
Click on a Problem number to jump to the slide. Click on Return
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Chapter 13 Chapter 14
Problem 1 Problem 3
Problem 9 Problem 6
Problem 10 Problem 13
Problem 15 Problem 16
Chapter 15 Chapter 16
Problem 1 Problem 5
Problem 2 Problem 7
Problem 3 Problem 9
Problem 4 Problem 10
Chapter 17 Chapter 18
Problem 4 Problem 2
Problem 6 Problem 7
Problem 11 Problem 8
Problem 16 Problem 11
Chapter

13
Leverage
and
Capital Structure
 Problem 13-1
Big Apple, Inc., has no debt outstanding and a total market
value of $80,000. Earnings before interest and taxes,
EBIT, are projected to be $10,000 if economic conditions
are normal. If there is a strong expansion in the economy,
then EBIT will be 30 percent higher. If there is a
recession, then EBIT will be 60 percent lower. Big Apple
is considering a $35,000 debt issue with a 5 percent
interest rate. There are currently 4,000 shares
outstanding. The proceeds will be used to repurchases
shares of stock. Ignore taxes for this problem.
a. Calculate earnings per share, EPS, under each of the
three economic scenarios before any debt is issued. Also,
calculate the percentage changes in EPS when the
economy expands or enters a recession.
b. Repeat part (a) assuming that Big Apple goes through
with the recapitalization. What do you observe.
a.

Recession Normal Strong

EBIT $4,000 $10,000 $13,000
Interest 0 0 0
NI $4,000 $10,000 $13,000
EPS $1.00 $2.50 $3.25
EPS% – 60 ––– + 30
b. MV $80,000/4,000 shares = $20 per share
$35,000/$20 = 1,750 shares bought back
Recession Normal Strong
EBIT $4,000 $10,000 $13,000
Interest 1,750 1,750 1,750
NI $2,250 $8,250 $11,250
EPS $1.00 $3.67 $5.00
EPS% – 72.8 ––– + 36.2
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 Problem 13-9
Buffett Enterprises is considering a change from its current
capital structure. Buffett currently has an all equity
capital structure and is considering a capital structure
with 30 percent debt. There are currently 1,000 shares
outstanding at a price per share of $120. EBIT is
expected to remain constant at $19,000. The interest rate
on new debt is 8% and there are no taxes.
a. Rebecca owns $12,000 worth of stock in the company.
If the firm has a 100 percent payout ratio what is her
cash flow?
b. What would her cash flow be under the new capital
structure assuming that she keeps all of her shares?
c. Suppose that the company does convert to the new
capital structure. Show how Rebecca can maintain her
current cash flow.
d. Under you answer to part (c), explain why Buffett’s
choice of capital structure is irrelevant.
a. EPS = $19,000 / 1,000 = $19.00
Rebecca’s cash flow = $19.00(100 shares) = $19,000
b. V = $120(1,000) = $120,000
D = .30($120,000) = $36,000
$36,000 / $120 = 300 shares are repurchased
NI = $19,000 – .30($36,000) = $16,120
EPS = $16,120 / 700 = $23.03
Rebecca’s cash flow = $23.03(100) = $2,303
c. Sell 30 shares of stock and lend the proceeds at 8%
Interest cash flow = 30($120)(.08) = $288
Cash flow from stock = 70($23.02) = $1,612
Total cash flow = $1,612 + 288 = $1,900
d. The capital structure is irrelevant because shareholders
can create their own leverage or unlever the stock to
create the payoff they desire, regardless of the capital
structure the firm actually chooses.

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 Problem 13-10
Angstrom Corp. uses no debt. The weighted average cost
of capital is 14 percent. The current market value of the
company is $30 million. The corporate tax rate is 40
percent. What is the value of the company if Angstrom
converts to a debt-equity ratio of 1? What if the debt-
equity ratio is 2?
D/E = 1 implies 50% debt:
VL = VU + TCD
= $30,000,000 + .40($15,000,000) = $36,000,000

D/E = 6 implies 67% debt:

VL = VU + TCD
= $30,000,000 + .40($20,000,000) = $38,000,000

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 Problem 13-15
Diamond Co. has a 38 percent tax rate. Its total interest
payment for the year just ended was $42 million. What is
the interest tax shield. How do you interpret this amount?

Interest tax shield = $42,000,000(.38) = $15,960,000

The interest tax shield represents the tax savings in current

income due to the deductibility of a firm’s qualified debt
expenses.

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Chapter

14
Dividends
and
Dividend Policy
 Problem 14-3
What If, Inc., has declared a $3.00 per share dividend.
Suppose capital gains are not taxed, but dividends are
taxed at 34 percent. New IRS regulations require that
taxes be withheld at the time the dividend is paid. What
If sells for $70 per share, and the stock is about to go ex-
dividend. What do you think the ex-dividend price will
be?

Aftertax dividend = $3.00(1 – .34) = $1.98

Ex-dividend price = $70.00 – 1.98 = $68.02
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 Problem 14-6
Bermuda Triangle Corporation (BTC) currently has
300,000 shares of stock outstanding that sell for $80 per
share. Assuming no market imperfections or tax effects
exist, what will the share price be after:
a. BTC has a five-for-three stock split?
b. BTC has a 15 percent stock dividend?
c. BTC has a 42.5 percent stock dividend?
d. BTC has a four-for-seven reverse stock split?
e. Determine the number of shares outstanding in parts (a)
through (d).
a. $80(3/5) = $48.00
b. $80(1/1.15) = $69.57
c. $80(1/1.425) = $56.14
d. $80(7/4) = $140.00
e. 300,000(5/3) = 500,000
300,000(1.15) = 345,000
300,000(1.425) = 427,500
300,000(4/7) = 171,429

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 Problem 14-13
Key West Corporation has just declared an annual dividend
of $2.00 per share. For the year just ended, earnings were
$9.00 per share.
a.What is Key West’s payout ratio?
b.Suppose Key West has seven million shares outstanding.
Borrowing for the coming year is planned at $13 million.
What are planned investment outlays assuming a residual
dividend policy? What target capital structure is implicit
in these calculations?
a. Payout ratio = DPS/EPS = $2.00 / $9.00 = .22

b. Equity portion of investment = 7,000,000($9 – $2)

= $49,000,000
D/E ratio = $13,000,000 / $49,000,000 = .265

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 Problem 14-16
You own 1,000 shares of stock in Edsel Communications.
You will receive a $1 per share dividend in one year. In
two years, Edsel will pay a liquidating dividend of $40
per share. The required return on Edsel stock is 15
percent. What is the current share price of your stock
(ignoring taxes). If you would rather have equal
dividends in each of the next two years, show how you
can accomplish this by creating homemade dividends.
Hint: Dividends will be in the form of an annuity.
P0 = $1.00/1.15 + $40.00/1.152 = $31.12

$31.12 = D [1 – 1/1.152]/.15
D = $19.14

You want $19.14(1,000) = $19,140 in one year and will

receive only $1.00(1,000) = $1,000

P1 = $40.00/1.15 = $34.78
In one year, you will sell:
($19,140 – 1,000) / $34.78 = 521.56 shares

Cash flow at time 1:

$1,000 + $34.78(521.56) = $19,140

Cash flow at time 2:

$40(1,000 – 521.56) = $19,140

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Chapter

15
Raising
Capital
 Problem 15-1
The Wren Co. and the Stumpy Co. have both announced
IPOs at $30 per share. One is undervalued by $4, and the
other is overvalued by $4, but you have no way of
knowing which is which. You plan on buying 1,000
shares of each issue. If an issue is underpriced, it will be
rationed, and only half your order will be filled. If you
could get 1,000 shares in Wren and 1,000 shares in
Stumpy, what would your profit be? What profit do you
actually expect? What principle have you illustrated?
If you receive 1,000 shares of each:
Profit = 1,000($4) – 1,000($4) = $0

Expected Profit = 500($4) – 1,000($4) = –$2,000

This is an example of the winner’s curse.

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 Problem 15-2
The Lambert Corporation needs to raise $42 million to
finance its expansion into new markets. The company
will sell new shares of equity via a general cash offering
to raise the needed funds. If the offer price is $75 per
share and the company’s underwriters charge an 8
percent spread, how many shares need to be sold?
Total proceeds(1 – .08) = $42,000,000
Total proceeds = $45,652,174

Shares offered = $45,652,174 / $75 = 608,696

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 Problem 15-3
In the previous problem, if the SEC filing fees and
associated administrative expenses of the offering are
$500,000, how many shares need to be sold now?

Total proceeds(1 – .08) = $42,000,000 + $500,000

Total proceeds = $46,195,652

Shares offered = $46,195,652 / $75 = 615,942

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 Problem 15-4
The Taylor Co. has just gone public. Under a firm
commitment agreement, Taylor received $22 for each of
the 2.5 million shares sold. The initial offering price was
$24 per share, and the stock rose to $29 per share in the
first few minutes of trading. Taylor paid $300,000 in
direct legal and other costs, and $150,000 in indirect
costs. What was the floatation cost as a percentage of the
funds raised?
Net amount raised = 2,500,000($24) = $60,000,000
Total direct costs = $300,000 + ($24 – $22)(2,500,000)
= $5,3000,000
Total indirect costs = $150,000 + ($29 – $24)(2,500,000)
= $12,650,000
Total costs = $5,300,000 + $12,650,000 = $17,950,000
Floatation percentage costs
$17,950,000 / $60,000,000 = 29.92%

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Chapter

16
Short-Term
Financial
Planning
 Problem 16-5
The Belle Meade Company has produced the following
quarterly sales amounts for the coming year:
Q1 Q2 Q3 Q4
Sales $450 $600 $750 $900
a.Accounts receivable at the beginning of the year are
$500. Belle Meade has a 45-day collection period.
Calculate cash collections in each of the following four
quarters by completing the following:
 Q1 Q2 Q3 Q4
Beginning receivables
Sales
Cash collections
Ending receivables

b. Rework (a) assuming a collection period of 60 days.

c. Rework (a) assuming a collection period of 30 days.
a. 45-day collection period implies all receivables
outstanding from previous quarter are collected in the
current quarter, and (90-45)/90 = 1/2 of current sales are
collected.
Q1 Q2 Q3 Q4
Beginning receivables $500 $225 $300 $375
Sales 450 600 750 900
Cash collections (725) (525) (675) (825)
Ending receivables $225 $300 $375 $450
b.60-day collection period implies all receivables
outstanding from previous quarter are collected in the
current quarter, and (90-60)/90 = 1/3 of current sales are
collected.
Q1 Q2 Q3 Q4
Beginning receivables $500 $300 $400 $500
Sales 450 600 750 900
Cash collections (650) (500) (650) (800)
Ending receivables $300 $400 $500 $600
c.30-day collection period implies all receivables
outstanding from previous quarter are collected in the
current quarter, and (90-30)/90 = 2/3 of current sales are
collected.
Q1 Q2 Q3 Q4
Beginning receivables $500 $150 $200 $250
Sales 450 600 750 900
Cash collections (800) (550) (700) (850)
Ending receivables $150 $200 $250 $300

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 Problem 16-7
Your firm has an average collection period of 42 days.
Current practice is to factor all receivables immediately
at a 2 percent discount. What is the effective cost of
borrowing in this case? Assume that default is extremely
unlikely.

number of periods = 365/42 = 8.690

EAR = (1 + .02/.98)8.690 – 1 = 19.19%

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 Problem 16-9
The Thunder Dan’s Corporation’s purchases from
suppliers in a quarter are equal to 75 percent of next
quarter’s forecast sales. The payables period is 60 days.
Wages, taxes and other expenses are 30 percent of sales,
and interest and dividends are $70 per quarter. No capital
expenditures are planned. Projected quarterly sales are:
Q1 Q2 Q3 Q4
Sales $900 $700 $950 $600
Sales for the first quarter of the following year are
projected at $1,040. Calculate Thunder’s cash outflows.

Q1 Q2 Q3 Q4
Payment of accounts
Wages, taxes, other
Long-term financing expenses
Total
Since the payables period is 60 days, payables in each
period = 2/3 of last quarter’s orders, and 1/3 of this
quarter’s orders, or 2/3(.75) times current sales + 1/3(.75)
next period sales.
Q1 Q2 Q3 Q4
Pmt. of accts. $625.00 $587.50 $625.00 $560.00
Wages, taxes 270.00 210.00 285.00 180.00
LT financing 70.00 70.00 70.00 70.00
Total $965.00 $867.50 $980.00 $810.00

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 Problem 16-10
The following is the sales budget for Golden Parachute,
Inc., for the first quarter of 2000:
January February March
Sales budget $140,000 $170,000 $145,000
Credit sales are collected as follows:
60 percent in the month of the sale
20 percent in the month after the sale
15 percent in the second month after the sale
The accounts receivable balance at the end of the previous
quarter was $60,000 ($32,000 of which was uncollected
December sales).
a. Compute the sales for November.
b. Compute the sales for December.
c. Compute the cash collections from sales for each month
from January through March.
a. November sales = ($60,000 – 32,000)/0.15 =
$186,667
b. December sales = $32,000/0.35 = $91,429
c. January collections = .15($186,667) + .20($91,429) +
.65($140,000) = $137,285.85
February collections = .15($91,429) + .20($140,000) +
.65($175,000) = $155,464.35
March collections = .15($140,000) + .20($175,000) +
.65($145,000) = $150,250.00
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Chapter

17
Working
Capital
Management
 Problem 17-4
You place an order for 800 units of Good X at a unit price
of $90. The supplier offers terms of 2/30, net 70.
a. How long do you have to pay before the account is
overdue? If you take the full period, how much should
you remit?
b. What is the discount being offered? How quickly must
you pay to get the discount? If you do take the discount,
how much should you remit?
c. If you don’t take the discount, how much interest are
you paying implicitly? How many days’ credit are you
receiving?
a. You have 70 days until the account is overdue.
Remittance = 800($900) = $72,000

b. 2% discount; 30 day discount period

Remittance = .98($72,000) = $70,560

c. Implicit interest = $72,000 – 70,560 = $1,440

70 – 30 = 40 days credit

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 Problem 17-6
Each business day, on average, a company writes checks
totaling $21,000 to pay its suppliers. The usual clearing
time for checks is five days. Meanwhile, the company is
receiving payments from its customers each day, in the
form of checks, totaling $38,000. The cash from the
payments is available to the firm after two days.
a. Calculate the company’s disbursement float, collection
float, and net float.
b. How would your answer in (a) change if the collected
funds were available in one day instead of two days?
a. Disbursement float = 5($21,000) = $105,000
Collection float = 2($28,000) = $76,000
Net float = $105,000 – 76,000 = $29,000

b. Collection float = 1($38,000) = $38,000

Net float = $105,000 – 38,000 = $67,000

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 Problem 17-11
A firm offers terms of 1/10, net 45. What effective annual
interest rate does the firm earn when a customer does not
take the discount? Without doing any calculations,
explain what will happen to this effective rate if:
a. The discount is changed to 2 percent.
b. The credit period is increased to 60 days.
c. The discount period is increased to 15 days.
d. What is the EAR for each scenario?
Nominal interest rate = .01/.99 = .0101 for 45 – 30 days.
EAR = (1.0101)365/35 – 1 = 11.05%

a. .02/.98 = .0204
EAR = (1.0204)365/35 – 1 = 23.45%
b. EAR = (1.0101)365/50 – 1 = 7.61%
c. EAR = (1.0101)365/30 – 1 = 13.01%

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 Problem 17-16
The Wheeling Pottery Store begins each month with 1,200
pots in stock. This stock is depleted each month and
reordered. If the carrying cost per pot is $8 per year and
the fixed order cost is $90, what is the total carrying cost?
What is the restocking cost? Should Wheeling increase or
decrease its order size? Describe an optimal inventory
policy for Wheeling in terms of order size and order
frequency.
Carrying costs = (1,200/2)($8) = $4,800
Restocking costs = 12($90) = $1,080
EOQ = [2(12)(1,200)($90)/$8]1/2 = 569.21
Number of orders per year = 12(1,200)/569.21 = 25.30

The firm’s policy is not optimal since the costs are not
equal. Wheeling should order 569 pots 25.30 times per
year.

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Chapter

18
International
Aspects of
Financial
Management
 Problem 18-2
Use the information in Figure 18.1 to answer the following
questions:
a. Which would you rather have, $100 or £100? Why?
b. Which would you rather have, FF100 or £100? Why?
c. What is the cross-rate for French francs in terms of
British pounds? For British pounds in terms of French
francs?
a. £100, since (£100)($1.4995/ £1) = $149.95

b. £100, since (£100)($1.4995/ £1)(FF6.8479/$) = FF1,027

c. (FF6.8479/$1)($1.4995/£1) = FF10.27/£1
£1/FF10.27 = £0.974/FF1

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 Problem 18-7
The treasurer of a major U.S. firm has $30 million to
invest for three months. The annual rate of interest in the
United States is .40 percent per month. The interest rate
in Great Britain is .70 percent per month. The spot
exchange rate is £.59, and the three-month forward rate
is £.61. Ignoring transactions costs, in which country
would the treasurer want to invest the company’s funds?
Why?
Invest in U.S.:
$30,000,000(1.0040)3 = $30,361,441.92

Invest in Great Britain:

[($30,000,000)(£.59/$1)(1.0070)3]/(£.61/$1)
$29,630,013.07

Invest in the U.S. since it is worth more in three months.

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 Problem 18-8
Suppose the current exchange rate for the French franc is
FF6.25. The expected exchange rate in three years is
FF7.10. What is the difference in the annual inflation
raters for the United States and France over this period?
Assume that the anticipated rate is constant for both
counties. What relationship are you relying on in
answering?
Using relative purchasing power parity:
FF7.1 = (FF6.25)(1 + {hFC – hUS})3
hFC – hUS = (7.1 / 6.25)1/3 – 1
hFC – hUS = .0434

Inflation in France is expected to exceed inflation in the

U.S. by 4.34% over this period.

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 Problem 18-11
Suppose that the spot and three-month forward rate for the
yen are ¥119 and ¥115, respectively.
a. Is the yen expected to get stronger or weaker?
b. What would you estimate is the difference between the
inflation rates of the United States and Japan?
a. The yen is expected to get stronger, since it will take
less yen to buy one dollar in the future than it does today.

b. hUS – hJap  ( ¥115 – ¥119) / ¥119 = – .0336

hUS – hJap = (1 – .0336)4 – 1 = – .1278
The approximate inflation differential between the U.S.
and Japan is – 12.78%

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