Hedging with forward contracts) The Specialty Chemical Company operates a crude oil refinery located in New Iberia,

| November 9, 2018

1)
Hedging with forward
contracts)

The Specialty
Chemical Company operates a crude oil refinery located in New Iberia, LA . The company refines crude oil and sells the
by-products to companies that make plastic bottles and jugs. The firm is
currently planning for its refining needs for one year hence. Specifically, the firm’s analysts estimate
that Specialty will need to purchase 1 million barrels of crude oil at the end
of the current year to provide the feed stock for its refining needs for the
coming year. The 1 million barrels of
crude will be converted into by-products at an average cost of $15 per barrel
that Specialty expects to sell for $170 million, or 4170 per barrel of crude
used. The current spot price of oil is
$115 per barrel and Specialty has been offered a forward contract by its
investment banker to purchase the needed oil for a delivery price in one year
of $120 per barrel.

a)
Ignoring taxes, what will
Specialty’s profits be if oil prices in one year are as low as $100 or as high
as $140, assuming that the firm does not enter into the forward contract? (Round to the nearest dollar)

Price of Oil/bbl
Unhedged Annual Profits

$100
$ __________________

$105 $
__________________

$110 $ ___________________

$115 $ ___________________

$120
$ ___________________

$125 $ ___________________

$130 $ ___________________

$135 $ ___________________

$140 $ ___________________

b)
If the firm were to enter into
the forward contract, demonstrate how this would effectively lock in the firm’s
cost of fuel today, thus hedging the risk of fluctuating crude oil prices on
the firm’s profits for the next year.

2)
Margin requirements and marking
to market

Discuss how the
exchange requirements that mandate traders to put up collateral in the form of
a margin requirement and to use this account to mark their profits or losses
for the day serve to eliminate credit or default risk.

·
Because (neither party has OR
both parties have) to post margin when they enter into a futures contract and
because they mark to market (everyday until the delivery date OR on the
delivery date), we are (not assured OR assured) the party and the counterparty
to the contract have already posted the gain or loss to the other and the risk
of default (is thereby negated OR still exists).

3)
Forward contract payout

Construct a
delivery date profit or loss graph for a short position in a forward contract
with a delivery price of $55. Analyze the profit or loss values of the
underlying asset ranging from $25 to $75.

4)
Forward contract payout

Construct a
delivery date profit or loss graph for a long position in a forward contract
with a delivery price of $50. Analyze
the profit or loss values of the underlying asset ranging from $20 to $75.

5)
Individual or component cost of
capital

Compute the cost
of capital for the following:

a)
A bond that has a $1000 par
value (face value) and a contract or coupon interest rate of 11.3%. The bonds have a current market value of
$1,125 and will mature in 10 years. The
firm’s marginal tax rate is 34%.

·
The cost of capital from this bond
debit is ________%

b)
A new common stock issue that
paid a $1.78 dividend last year.
The firm’s dividends are
expected to continue to grow at 7.8% per year forever. The price of the firm’s
common stock is now $27.98.

c)
A preferred stock paying a 9.8%
dividend on a $135 par value.

d)
A bond selling to yield 12.6%
where the firm’s tax rate is 34%

6)
Individual or component costs
of capital

Your firm is
considering a new investment proposal and would like to calculate its weighted
average cost of capital. To help in
this, compute the cost of capital for the firm for the following:

a)
A bond that has a $1,000 par
value (face value) and a contract or coupon interest rate of 12.5%. The bond is currently selling for a price of
$1,127 and will mature in 10 years. The
firm’s tax rate is 34%.

The cost of
capital from this bond debit is ________%

b)
If the firm’s bonds are not
frequently traded, how would you o about determining a cost of debt for this
company?

c)
A new common stock issue that
paid is $1.72 dividend last year. The
par value of the stock is $15, and the firm’s dividends per share have grown at
a rate of 8.5% per year. This growth
rate is expected to continue into the foreseeable future. The price of this stock is now $28.83

d)
A preferred stock paying a 9.9%
dividend on a $124 par value. The
preferred shares are currently selling for $146.92

e)
A bond selling to yield 12.7%
for the purchaser of the bond. The
borrowing firm faces a tax rate of 34%.

7)
Individual or component costs
of capital

Compute the cost
of capital for the following:

a)
A bond that has a $1,000 par
value (face value) and a contractor coupon interest rate of 10.1%. The bonds have a current market value of
$1,124 and will mature in 10 years. The
firm’s marginal tax rate is 34%.

The cost of
capital from this bond debit is __________%

b)
A new common stock issue that
paid a $1.76 dividend last year. The firm’s dividends are expected to continue
to grow at 6.2% per year forever. The
price of the firm’s common stock is now $27.01.

c)
A preferred stock paying a 9.9%
dividend on a $100 par value.

d)
A bond selling to yield 11.3%
where the firm’s tax rate is 34%.

8)
Individual or component costs
of capital

Your firm is
considering a new investment proposal and would like to calculate its weighted
average cost of capital. To help in
this, compute the cost of capital for the firm for the following:

a)
A bond that has a $1000 par
value (face value) and a contract or coupon interest rate of 11.1%. The bond is currently selling for a price of
$1,128 and will mature in 10 years. The
firm’s tax rate is 34%.

The cost of
capital from this bond debt is ____________%

(Round to two decimal places)

b)
If the firm’s bonds are not
frequently traded, how would you go about determining a cost of debit for this
company?

c)
A new common stock issue that
paid a $1.76 dividend last year. The par
value of the stock is $16, and the firm’s dividends per share have grown at a
rate of 7.5% per year. This growth rate is expected to continue into the
foreseeable future. The price of this stock is now $28.77.

d)
A preferred stock paying a
10.1% dividend on a $129 par value. The
preferred shares are currently selling for $147.24

e)
A bond selling to yield 12.8%
for the purchaser of the bond. The
borrowing firm faces a tax rate of 34%.

9)
Capital Structure Analysis

The liabilities
and owner’s equity for Campbell Industries is:

Accounts payable
——————————– $ 483,000

Notes payable
———————————— $ 243,000

Current
liabilities ——————————– $ 726,000

Long-term debt
———————————- $1,100,000

Common equity
———————————- $5,065,000
Total
Liabilities and equity ——————- $6,891,000

a)
What percentage of the firm’s
assets does the firm finance using debt (liabilities)? Round to one decimal place.

b)
If Campbell were to purchase a new
warehouse for $1.2 million and finance it entirely with long-term debt, what
would be the firm’s new debt ratio?

10) Future value

To what amout
will $5,000 invested for 10 years at 9% compounded annually accumulate? (Round to the nearest cent)

11) Compound interest with non-annual periods

You just
received a bonus of $2000

a)
Calculate the future value of
$2000, given that it will be held in the bank for 10 years and earn an annual
interest rate of 4%. (Round to the
nearest cent)

b)
Recalculate part (a) using a
compounding period that is (1) semiannual and (2) bimonthly.

c)
Recalculate parts (a) and (b)
using an annual interest rate of 8%.

d)
Recalculate part (a) using a
time horizon of 20 years at an annual interest rate of 4%

e)
What conclusions can you draw
when you compare the answers in parts © and (d) with the answers in parts (a)
and (b)?

12) Break-Even Analysis

The Marvel Mfg
Company is considering whether or not to construct a new robotic production
facility. The cost of this new facility
is $612,000 and it is expected to have a six-year life with annual depreciation
expense of $102,000 and no salvage value.
Annual sales from the new facility are expected to be 1,970 units with a
price of $990 per unit. Variable production costs are $610 per unit, while
fixed cash expenses are $80,000 per year.

a)
Find the accounting and the
cash break-even units of production.
(Round to the nearest integer)

b)
Will the plant make a profit
based on its current expected level of operations?

c)
Will the plant contribute cash
flow to the firm at the expected level of operations?

13) Preparation of a cash budget

The Sharpe
Corporation’s projected sales for the first eight months of 2011 are:

January
——————– $90,600

February
——————-$120,000

March
———————-$135,800

April
——————-$239,800

May
——————–$299,200

June
——————–$270,900

July
———————$225,300

August
——————$150,000

Of Sharpe’s sales, 10 percent is for cash,
another 60 percent is collected in the month following the sale, and 30 percent
is collected in the second month following the sale. November and December
sales for 2010 were $221,000 and $175,000, respectively. Sharpe purchases its
raw materials two months in advance of its sales equal to 60 percent of their
final sales price. The supplier is paid
one month after it makes delivery. For example, purchases for April sales are
made in February and payment is made in March.
In addition, Sharpe pays $10,600 per month for rent and $19,500 each
month for other expenditures. Tax prepayments of $21,500 are made each quarter,
beginning in March.

The company’s cash balance at December 21,
2010 was $21,100; a minimum balance of $15,000 must be maintained at all
times. Assume that any short-term
financing needed to maintain the cash balance is paid off in the month
following the month of financing if sufficient funds are available. Interest on short-term loans (10 percent) is
paid monthly. Borrowing to meet
estimated monthly cash needs takes place at the beginning of the month. Thus, if in the month of April the firm
expects to have a need for an additional $58,610, these funds would be borrowed
at the beginning of April with interest of $488 owed for April being paid at
the beginning of May.

a)
Prepare a cash budget for
Sharpe covering the first seven months of 2011.

Sales

November ————-$221,000

December ————–$175,700

January —————–$90,600

Cash Receipts:

Sales for cash (10%) $______________

First month after sales (60%) $______________

Second month after sales (30%) $______________

Total cash receipts $_____________

Cash disbursements $______________

Raw materials
$_____________

Rent
$ ______________

Other expenditures
$______________

Tax prepayments $ ______________

Total Cash Disbursements $ _____________

Net Change in Cash

Net change in cash for period $______________

(+)
Beginning cash balance
$ _____________

(–) Interest of short term borrowing $___________

(–) Short term borrowing repayments
$___________

(=) Ending cash balance b/borrowing $___________

New Financing Needed

Financing needed for period $_____________

Ending cash balance $21,100 $_____________

Cumulative borrowing $____________

b)
Sharpe has $199,100 in notes payable due in July that must be repaid or
renegotiated for an extension. Will the
firm have sufficient cash to repay the notes?

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