Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $\$ 3.00$ dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is $60 \%$ equity and $40 \%$ debt, it has $1,000,000$ shares of common equity outstanding, and its net income is $\$ 8$ million. The company forecasts that it will require $\$ 10$ million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year.

a. If Buena Terra follows the residual dividend model, how much retained earnings will it need to fund its capital budget?

b. If Buena Terra follows the residual dividend model, what will be the company's dividend per share and payout ratio for the upcoming year?

c. If Buena Terra maintains its current $\$ 3.00$ DPS for next year, how much retained earnings will be available for the firm's capital budget?

d. Can the company maintain its current capital structure, the $\$ 3.00$ DPS, and a $\$ 10$ million capital budget without having to raise new common stock?

e. Suppose that Buena Terra's management is firmly opposed to cutting the dividend; that is, it wants to maintain the $\$ 3.00$ dividend for the next year. Also, assume that the company was committed to funding all profitable projects and was willing to issue more debt (along with the available retained earnings) to help finance the company's capital budget. Assume that the resulting change in capital structure has a minimal effect on the company's composite cost of capital so that the capital budget remains at $\$ 10$ million. What portion of this year's capital budget would have to be financed with debt?

f. Suppose once again that Buena Terra's management wants to maintain the $\$ 3.00$ DPS. In addition, the company wants to maintain its target capital structure ( $60 \%$ equity and $40 \%$ debt) and its $\$ 10$ million capital budget. What is the minimum dollar amount of new common stock that the company would have to issue to meet each of its objectives?

g. Now consider the case where Buena Terra's management wants to maintain the $\$ 3.00$ DPS and its target capital structure, but it wants to avoid issuing new common stock. The company is willing to cut its capital budget to meet its other objectives. Assuming that the company's projects are divisible, what will be the company's capital budget for the next year?

h. What actions can a firm that follows the residual dividend model take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget?

Kraxton Chemie Company consists of seven divisions. Divisions One through Five make products that are sold in the competitive market. Divisions Two and Three make their own investment and transfer pricing decisions. Twenty-five percent of Division Two's output is devoted to a component that is transferred to Division Three as part of the subassembly of Division Three's main product. Divisions Six and Seven provide services to the other divisions. Eighty percent of Division Six's output is environmental cleanup services provided to Divisions One and Two. The remaining twenty percent is sold to external customers. Finally, Division Seven is devoted to $R \& D$ activities that support the entire company. What type of responsibility center design would you recommend for Kraxton Chemie Company?

Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $\$ 3.00$ dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is $60 \%$ equity and $40 \%$ debt, it has $1,000,000$ shares of common equity outstanding, and its net income is $\$ 8$ million. The company forecasts that it will require $\$ 10$ million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year.

If Buena Terra maintains its current $\$ 3.00$ DPS for next year, how much retained earnings will be available for the firm's capital budget?

Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $\$ 3.00$ dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is $60 \%$ equity and $40 \%$ debt, it has $1,000,000$ shares of common equity outstanding, and its net income is $\$ 8$ million. The company forecasts that it will require $\$ 10$ million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year.

What actions can a firm that follows the residual dividend model take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget?

Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $\$ 3.00$ dividend per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is $60 \%$ equity and $40 \%$ debt, it has $1,000,000$ shares of common equity outstanding, and its net income is $\$ 8$ million. The company forecasts that it will require $\$ 10$ million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year.

If Buena Terra follows the residual dividend model, what will be the company's dividend per share and payout ratio for the upcoming year?

A bond has a $1,000 par value, 12 years to maturity, and an 8% annual coupon and sells for$980. a. What is its yield to maturity (YTM)? b. Assume that the yield to maturity remains constant for the next three years. What will the price be 3 years from today?

A bond that matures in $8$ years has a par value of $\$ 1,000$ and an annual coupon payment of $\$ 70$; its market interest rate is $9 \%$. What is its price? ($\$889.30$)

On January 1, 2015, Glover Corporation issued $2,400,000 of 5-year, 8% bonds at 95. The bonds pay interest annually on January 1. By January 1, 2017, the market rate of interest for bonds of risk similar to those of Glover Corporation had risen. As a result, the market value of these bonds was$2,000,000 on January 1, 2017—below their carrying value. Joanna Glover, president of the company, suggests repurchasing all of these bonds in the open market at the $2,000,000 price. To do so, the company will have to issue$2,000,000 (face value) of new 10-year, 11% bonds at par. The president asks you, as controller, “What is the feasibility of my proposed repurchase plan?”

Instructions With the class divided into groups, answer the following. (a) What is the carrying value of the outstanding Glover Corporation 5-year bonds on January 1, 2017? (Assume straight-line amortization.)

Esfandairi Enterprises is considering a new three-year expansion project that requires an initial fixed asset investment of $2.18 million. The fixed asset will be depreciated straight-line to zero over its three-year tax life, after which time it will be worthless. The project is estimated to generate$1.645 million in annual sales, with costs of $610,000. If the tax rate is 21 percent, what is the OCF for this project?

Concerning NPV:
a. Describe how NPV is calculated, and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule?
b. Why is NPV considered a superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flows is computed to be $\$ 2,500$. What does this number represent with respect to the firm's shareholders?

Project X is very risky and has an NPV of $3 million. Project Y is very safe and has an NPV of$2.5 million. They are mutually exclusive, and project risk has been properly considered in the NPV analyses. Which project should be chosen? Explain.

Assume Plainfield Manufacturing has debt of $6,500,000 with a cost of capital of 9.5% and equity of$4,500,000 with a cost of capital of 11.5%. What is Tyler’s weighted average cost of capital?

The Bigbee Bottling Company is contemplating the replacement of one of its bottling machines with a newer and more efficient one. The old machine has a book value of $600,000 and a remaining useful life of 5 years. The firm does not expect to realize any return from scrapping the old machine in 5 years, but it can sell it now to another firm in the industry for$265,000. The old machine is being depreciated by $120,000 per year, using the straight-line method. The new machine has a purchase price of$1,175,000, an estimated useful life and MACRS class life of 5 years, and an estimated salvage value of $145,000. The applicable depreciation rates are 20%, 32%, 19%, 12%, 11%, and 6%. It is expected to economize on electric power usage, labor, and repair costs, as well as to reduce the number of defective bottles. In total, an annual savings of$255,000 will be realized if the new machine is installed. The company’s marginal tax rate is 35% and it has a 12% WACC. a. What initial cash outlay is required for the new machine? b. Calculate the annual depreciation allowances for both machines and compute the change in the annual depreciation expense if the replacement is made. c. What are the incremental cash flows in Years 1 through 5? d. Should the firm purchase the new machine? Support your answer. e. In general, how would each of the following factors affect the investment decision, and how should each be treated? 1. The expected life of the existing machine decreases. 2. The WACC is not constant, but is increasing as Bigbee adds more projects into its capital budget for the year.

Measure Company A’s market share and the growth rate of the market it operates in from the following data. Comment on your results.

$$\begin{array}{|l|c|c|} \hline & \textbf{ 2013 } & \textbf{ 2014 } \\ \hline \text { Total market sales (units) } & 36000 & 48000 \\ \hline \text{ Total market value (\$ in millions) } & 5.0 & 6.5 \\ \hline \text { Company A's sales (units) } & 3600 & 5000 \\ \hline \text { Company A's sales value }(\$ \mathrm{~m}) & 0.5 & 0.6 \\ \hline \end{array}$$