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1. The assumptions are a $500,000 mortgage, a 3.875% FRM 30 and a 2.875% FRM 15 and a four year holding period.
a) . In excel,show the differential cash flows for a 5 year holding period. Determine in the Excel Worksheet the differential (or incremental) cash flows for both the selection of an FRM15 instead of an FRM30 and the FRM30 vs the FRM15.
Incremental Cash Flows FRM15
Instructions for b) & c) below: Using an Excel worksheet (as above in a), determine the rate of return (IRR) and net present value (NPV) on the incremental cash flows from selecting either the FRM15 or the FRM30. Use the FRM30 rate as the discount rate for the NPV. Enter answers below for b) and c)
IRR from selecting the FRM 15 instead of the FRM 30 =
IRR from selecting the FRM 30 instead of the FRM 15 =
NPV from selecting the FRM 15 instead of the FRM 30 =
NPV from selecting the FRM 30 instead of the FRM 15 =
Use the IRR above to decide which mortgage to select – the FRM15 or the FRM30. Support your answer interpreting the IRR results.
Choose the (FRM15 or FRM30). Highlight your choice..
Support your decision below:
If you chose the FRM15, you effectively created an incremental investment. Describe the risk of that investment.
f) What would be the monthly payments for the FRM30? (Show steps for on Excel document’s Worksheet entitled “Monthly Payment”)
Monthly Payment on FRM30 =
g) Assume the borrower is in the 20% tax bracket and itemized taxes. What are the after-tax cash flows in year 1 for the FRM30? (In “Yearly Payment”, see Lines 39&40 for a work section)
Cash flows for FRM30 in year 1 (ignoring taxes) =
The after-tax cash flows year 1 =
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2. Instead of a choice between the FRM15 and the FRM30, we discussed how you could reframe the choice using only one mortgage. Identify the two correct answer(s).
a) Between an FRM15 and an FRM15 + Investment
b) Between an FRM15 and an FRM15 + Loan
c) Between an FRM30 and an FRM30 + Investment
d) Between an FRM30 and an FRM30 + Loan
3. Identify the below as true or false by entering your answer in the blank before the statement.
________In forecasting the financials to determine needs for external financing as demonstrated in Chapter 3, the answer to the external financing required (EFR) is as follows:
EFR = Assets – Debt – Equity
4. Retained earnings for 2014was $1,580; the profit from the income statement that was forecasted for 2015 was 234; the retained earnings for 2015 was $1,697. But $1,580 + $234 is not equal to $1,697. Explain.
5. Your financial forecast indicates Assets = $10,000; Liabilities = 6,000; Common Stock = $1,000; Retained earnings = $2,000. So the deficiency in funds is $1,000. You plan to borrow to make up the deficiency. The interest rate is 10%; the tax rate is 20%; the dividend payout ratio is 25%. How much do you need to borrow to satisfy the deficiency? Show work in the Worksheet “Other” for credit.
Loan amount =
6. ROE = NI/Sales X Sales/Total Assets X Total Assets/Equity.
Total Assets/Equity involves financial leverage. Show below how Total Assets/Equity can be derived and expressed in terms of Debt/Equity.
7. Assume Company A and Company B are identical with $4,000 in assets and both companies have an EBIT of $500. Company A has financed its assets with all equity; Company B has financed its assets with 80% debt at a 10% interest rate and the remainder in equity. The tax rate is 25%. Compute ROA, ROE, and ROIC on the Excel Worksheet entitled ROE ROA ROIC and put the answers below. For credit, you must show your math in the Excel worksheet entitled ROE ROA ROIC.
Company A Company B
8. ROE = ROIC + (ROIC – I’) X (D/E)
Company A expects a project to provide an ROIC of 10%. Company A plans to finance the project with an interest rate of 12%. The tax rate is 30%. Will this project and its financing increase or decrease ROE?
a) Increase ROE
b) Decrease ROE
9. Referring to your decision in #8 above, show the math for your decision in the space below.
10. A B
Assets $1,000 $1,000
Debt None $ 900
Equity $1,000 $ 100
EBIT 200 200
Int (10%) 0 90
EBT 200 110
Tx (20%) -40 -22
PAT 160 88
If you add the combined payments to shareholders and creditors, Firm A has $18 less than Firm B. Explain.
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