# 5 question in excel.

For the final exam you will be expected to make computations and/or present analysis/recommendations related to some, or all, of the following concepts:

1. Impact of financial leverage on EPS.

2. Future value of single sum Present value of single sum
Future value of annuity                                                              Present value of annuity

Sample problem:

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You wish to retire in 14 years, at which time you want to have accumulated enough money to receive an annual annuity of \$17,000 for 19 years after retirement. During the period before retirement you can earn 8 percent annually, while after retirement you can earn 10 percent on your money.

What annual contributions to the retirement fund will allow you to receive the \$17,000 annuity?

Start making contributions today of \$5,872.56

See Excel file for calculations

1. Measures of risk: standard deviation and beta
Measures of return:  total return, average return, geometric mean return, portfolio return

Review Risk-Return Workbook

Total return in \$ = (Current price – Purchase price) + SUM of dividends received

Total return in % = Total return in \$/Purchase price

Average return = arithmetic average (AVERAGE) of all the individual year returns

Geomean return = [(1 + r1)* (1 + r2)* (1 + r2)*… (1 + rn)]1/n – 1

On Excel first find the 1+return column, then use =GEOMEAN(range of 1+returns) – 1

Portfolio return = (W*r1 + W*r2+…W*rn), where W = weight of security in portfolio

1. Weighted average cost of capital (WACC) by market value approach
(count on calculating of market value of a bond as part of the problem)

Sample problem:

For Caterpillar Inc. calculate their WACC based on 2019 financial data provided.

Market price of equity = \$202.82
Caterpillar beta = 0.95
YTM of 30-yr Treasuries = 2.08%
YTM of other 30-yr A-rated bonds = 4.01%
Rm = 11.5%

Ke by CAPM = Rf + (Rm-Rf)B = 2.08% + (11.5% – 2.08%)0.95 = 11.03%

Ke by DVM = D0(1+g)/P0 + g = [3.95(1+0.0722)/202.82] + 0.0722 = 9.31%

g = 7.22%, D0 = 3.95, P0 = 202.82

Overall Ke = (11.03 + 9.31)/2 = 0.1017 or 10.17%

After-tax Kd = YTM(1-tax rate) = 4.01%(1-0.224) = 3.11%

Weight of equity/Total capital structure = (# shares outstanding * market price)/D + E =

Numerator =  561,600,000 * 202.82 = \$113,903,700,000

Market value of debt = # of bonds outstanding * price of bond = 26,281,000 * 1413.15 = 37,137,580,000

Total value of capital structure = \$113,903,700,000 + \$37,137,580,000 = 113,904 + 37,138 = 151,042

WACC = 37,138/151,042*.0311 + 113,904/151,042 * .1017

WACC = 0.2459 * 0.0311 + 0.7541 * 0.1017 = 8.43%

1. Capital budgeting techniques: NPV, MIRR, payback period

Sample Problem:  Caterpillar is considering two projects.  Cash flows are provided below. Use WACC calculated above as the discount rate.  Reinvestment rate is 3.75%.

Dollar values are in millions

 Year Project A Project B 0 \$ -13,000 \$ -20,000 1 3,000 8,000 2 4,000 8,000 3 5,000 8,000 4 6,000 -2,000

 Technique Project A Project B Payback 3.17 years 2.5 years NPV \$1,431.73 (989.02) MIRR 9.72% 4.77%

**See Excel for calculations**

1. Dividend policy, including dividend yield and payout ratio.

Sample Problem:

Based on Caterpillar’s data, what type of dividend policy do they appear to be following?
Residual Theory while trying to steadily increase dollar amount of dividend.

What is Caterpillar’s dividend payout ratio?
Dividend per share/EPS = \$3.95/\$10.85 = 36.41%

What is Caterpillar’s dividend yield (use current market price and last declared dividend)
\$3.95/\$202.82 = 1.95%

1. Equity Financing:
2. Raising funds through investment banker (evaluating the cost relative to amount received)
b. Convertible preferred or bonds and warrants

Sample Problem:

Caterpillar needs to raise the \$13,000,000,000 above.  The finance team is creating a proposal with three different means.

1. Rights offering to existing shareholders. Subscription price is \$125.00. Every outstanding share is issued one right. It takes the subscription price plus three rights to acquire one new share of stock.

What is the value of one right? R = (Me – S)/N = (\$202.82 – \$125.00)/3 = \$25.94

1. Issuing convertible bonds. Assuming \$1,000 par-value convertible bonds are more attractive to investors, the coupon rate is 3.13%, paid semi-annually. Bonds will mature in 10 years and are callable after five years with a 5% call premium.  One bond can be converted into seven (7) shares of stock.

What is the current market value of these bonds? \$1,413.15
* Assume same YTM on similar A-rated bonds as above.

What is the conversion value of one bond? Stock price * Conversion ratio = \$202.82 * 3 = \$608.46

All your analysis is within the goal of the financial manager constrained by the three underlying rules of finance.

Goal of the financial manager – build long-term shareholder wealth while looking out for your stakeholders.

Underlying Rules of Finance –
1. Higher the risk, higher the required rate of return and vice versa.
2. For a given level of risk, select the option with the highest return.
3. A dollar today is worth more than a dollar sometime in the future.

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