Finance Answers

Discussion Questions: According to an article by CNBC, a new survey finds the median American household has $2,729 in a savings account in 2019 and 34% of Americans have nothing saved. What does this say about Americans' financial management? How does the lack of saving impact other Americans?

Prompt: This says that some Americans either can't or won't save money. Those who can either don't put a lot into savings or don't make a lot of money to put into savings. The lack of savings in people's accounts can lead to debts that come from sudden purchases or debts from planned purchases that the person either doesn't have enough money and is forced to have a small amount of debt, or the person who doesn't save and gains tons of debt.

Instructions: According to the discussion questions, include in your response whether or not you agree or not and the reason(s) why in regards to the prompt.

Identify the main causes of the financial crisis of 2008? identify the main risks that contributed to the crisis

Discuss key sources of innovative funding citing relevant examples (10 mrks)

The King Food Corp. currently has no debt in its capital structure. The beta of its capital is 1.5. The King Food Corp’s free cash flow is expected to equal £30 million next year. This cash flow is expected to grow at 2% per year for the foreseeable future. King Food Corp. is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 50% debt-to-equity ratio (D/E=50%) after the change, and it will maintain this debt-equity ratio forever. Assuming King Food Corp’s pretax cost of debt will be 5%. King Food Corp. faces a corporate tax rate 40%. Assuming that the CAPM holds, the risk-free rate is 3%, and the expected market index risk premium is 8%.

(b) Using the information provided and your calculations in part (a) and (b), determine the value of tax shield acquired by King Food Corp. if it changes its capital structure with a 50% debt-to-equity ratio (D/E=50%).                                   

The King Food Corp. currently has no debt in its capital structure. The beta of its capital is 1.5. The King Food Corp’s free cash flow is expected to equal £30 million next year. This cash flow is expected to grow at 2% per year for the foreseeable future. King Food Corp. is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 50% debt-to-equity ratio (D/E=50%) after the change, and it will maintain this debt-equity ratio forever. Assuming King Food Corp’s pretax cost of debt will be 5%. King Food Corp. faces a corporate tax rate 40%. Assuming that the CAPM holds, the risk-free rate is 3%, and the expected market index risk premium is 8%.

(a)  Calculate the WACC before the change in capital structure and after change in the capital structure, respectively.                                                            

The King Food Corp. currently has no debt in its capital structure. The beta of its capital is 1.5. The King Food Corp’s free cash flow is expected to equal £30 million next year. This cash flow is expected to grow at 2% per year for the foreseeable future. King Food Corp. is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 50% debt-to-equity ratio (D/E=50%) after the change, and it will maintain this debt-equity ratio forever. Assuming King Food Corp’s pretax cost of debt will be 5%. King Food Corp. faces a corporate tax rate 40%. Assuming that the CAPM holds, the risk-free rate is 3%, and the expected market index risk premium is 8%.

A friend of yours recently graduated from law school with $125,000 in student debt. The interest rate on these loans is 6.25%. Your friend has various options on how to repay the loans and is asking for your help to understand the pros and cons of the various options.

2.    The second option is to repay the loan with a fixed amount per month for 25-years

a.    How much will your friend pay each month?

b.    How much will your friend pay in interest over the life of the loan?

 3.    The third and final option is to repay the loan using a graduated repayment plan. Under the graduated repayment plan your friend’s payments will start low and increase each month at an annualized rate of 3%. The graduated repayment plan will repay the loan over a 10-year period.

a.    How much will your friend pay the first month?

b.    How much will your friend pay the second month?

c.    How much will your friend pay the final month?

d.    How much will your friend pay in interest over the life of the loan?

You have recently been hired to be the COO (Chief Operating Office) of a start-up company and your primary goal is to help grow the business. The company reported sales of $2 million last fiscal year. The company currently does not offer trade credits because the majority of its customers use credit cards. In a bid to expand the business, you are asked to determine whether extending trade credits is a good idea.  

(a) List and explain 4 factors that will be important for you to make this decision? Meaning, as the COO, what factors do you need to take into consideration if you are planning to start offering trade credit.

(b) Given what you know, are you for or against the company offering trade credits.

Essex Cosmetic Corp. has marginal tax rate of 40%. Table 2 gives the details of the balance sheet. The stock of Essex Cosmetic Corp. has a market-to-book ratio of 2. The firm’s bonds have a face value of £150 million and sell at a price of 120% of face value. The cost of equity is 12%, pretax cost of debt is 7%.

 Essex Cosmetic Corp. (Book values, £ million) 

                     Asset Value      £330. Debt    £ 150

Equity £ 180

                                              £330            £ 330

a.    Essex Cosmetic Corp wants to invest in machine with cash flows of £ 5 million per year pretax and it continues indefinitely. What is value of machine, given initial investment of £20 million. The machine cost of £20 million will be financed with £10 million in new debt initially. Compute the value of the machine using the APV method, assuming Essex Cosmetic Corp. will maintain a constant debt-equity ratio for this investment. 

The King Food Corp. currently has no debt in its capital structure. The beta of its capital is 1.5. The King Food Corp’s free cash flow is expected to equal £30 million next year. This cash flow is expected to grow at 2% per year for the foreseeable future. King Food Corp. is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 50% debt-to-equity ratio (D/E=50%) after the change, and it will maintain this debt-equity ratio forever. Assuming King Food Corp’s pretax cost of debt will be 5%. King Food Corp. faces a corporate tax rate 40%. Assuming that the CAPM holds, the risk-free rate is 3%, and the expected market index risk premium is 8%.

(a)  Calculate the cost of equity before the change in capital structure and after change in the capital structure, respectively.