Best Case
Worst Case
Realistic Scenario
Short-Term Investments
- Balance—p.50
- Interest Income: (ST Investments + New ST Investments)*Interest Earned
- Risk Level p. 50—0 Lowest Risk 90 day T-Bill, 9 Highest Risk -40% to +45%
- Cash Shortages and Marketable Securities Liquidation p.50
- If there is no cash, marketable securities will be liquidated with a 3% penalty—cash shortage X 1.03 = mkt sec liquidated
- The 3% penalty is charged as interest expense (finance charges)
- Mkt securities are liquidated at the end of the period, so there is interest
- Tax reduction from account penalty loan interest
- Cash Shortage = Short Term Penalty Loan + Reduction of Mkt Securities
- If not enough marketable securities, then ST Penalty Loan at the rate of 8% QUARTERLY; Penalty Debt automatically retired in next period
- Penalty Loan Shortage: Cash Shortage + 8% to pay for the interest p.52
- The tax benefit of paying interest charges will give a positive cash ending balance== 40% of interest charges
Dividends (Common Stock) p. 75
- Dividend Payout Rate = Annual Dividends Per Share/EPS
- Stability = negative when the dividends in dollar terms are reduced
- The greater the NPV projects, the lower the Dividend Payout Rate should be. P.27
- The Higher the Earnings Growth Rate, the lower the Dividend Payout Rate
- Dividend Yield = (Dividend X 4)/Stock Price p. 76
- Dividend Yield is more important in slow growth environments p. 77
- Common stock dividends cannot cause negative common stockholder equity. P.75
Debt: p. 63
- When debt is issued, there is a .00125 or .125% charge per million dollars of debt issued in the quarter
- The riskier the company, the greater the interest expense
Short Term Loans P. 64
- 1 Year Loans—repaid in 4 equal, quarterly payments p. 64
- Retiring the debt early is not an option p. 64
- The loan is at the beginning of the quarter; however, 25% is paid back at the end of the year. So, you will have interest on the full loan, but the balance sheet will only show 75% of the loan amount. P. 64
Intermediate-Term Loans: Two-year (8 quarters) and three-year (12 quarters) P. 65
Two Year (8 Quarter) Loans
- The loan is at the beginning of the quarter and repaid in equal installments over 8 quarters.
- Debt due in four quarters will be listed as a current liability.
- Retirement before maturity is allowed without penalty.
- For interest calculation purposes, a retirement is viewed as taking place at the beginning of the quarter. P. 65
Long-Term Bonds
- Issued for 10 years or 40 quarters
- Repayable in 40 equal quarterly principal payments starting at the end of the issuance quarter
- $50,000 flotation cost every time a bond is issued—part of the bond interest expense
- Callable Bonds: premium rate of 8 percent if retired before maturity—8% is listed as a bond redemption cost on the income statement
- most distant payments are retired first
- a specific issue is not retired
- The four quarters bond debt due is listed as a current liability
Common Stock
- Affected by Six Items p. 71
- Issuance of Common Stock
- $50,000 underwriting charge per secondary offering
- 5% of current price is a flotation charge
- Receipts per share: p 73
- Don’t forget, when shares are issued, you will pay a dividend on the shares
- Issuing additional shares is dilutive
- Repurchase (aka stock buy back) of Common Stock (p. 73)
- Must specify the number of shares to buy back
- Must determine the tender price per share
- A lower price share requires a higher percent premium
- An “all or none” repurchase is not available.
- A $1 charge per share occurs on shares requested to be tendered but are NOT
- The debt/common equity must be 4:1 or stronger. Short term, intermediate, and long-term debt are the debt items used in the calculation; the condition applies to repurchase of common stock not the issuance of debt.
Cost of Capital (or Weighted Average Cost of Capital) p. 25
- Debt cost of capital= Interest Rate * (1 – tax rate)
- Commons stock cost of capital: As a start— cost of preferred stock + (preferred stock cost of capital – before tax bond cost of capital
- New or declining firms have a higher cost of capital vs. established or mature companies
Capital Budgeting
See Excel spreadsheet
Plants-- Units of Plant Purchased— P. 54
- It takes two quarters to build a new plant—e.g., plant ordered in q2 is usable in q4
- Plant life: 20 quarters; Depreciation—straight line—1/20th; starts when operational
- Fixed $250,000 order cost every time plant capacity is purchased
- Total plant cost is cash outflow in period it is ordered
- Purchase Plant by units—e.g., (20,000 units X $321 per unit) + $250,000
Machinery-- Units of Machinery Purchased
- 1 unit of machine capacity = the ability to produce 1 unit
- Purchase in period 1, available/operational in period 2
- Depreciation = 1/8—starts in period after acquisition
- Machinery: 8 quarter useful life
- Machinery can only be purchased—sale is not an option
Warehousing Fees
Note: As long as I control how much you produce, warehousing fees will be difficult to control
- Ending inventory-- $1 first 2,000; $3.00 next 5,000; $8.00 thereafter
- Part of COGS