Promo Pak has compiled the following financial

| June 7, 2016

Question
1. Promo Pak has compiled the following financial data:

(a)
(b)

Calculate the weighted average cost of capital using book value weights.
Calculate the weighted average cost of capital using market value weights.

2. Galaxy Satellite Co. is attempting to select the best group of independent projects
competing for the firm’s fixed capital budget of $10,000,000. Any unused portion of this
budget will earn less than its 20 percent cost of capital. A summary of key data about the
proposed projects follows.

(a)
Use the NPV approach to select the best group of projects.
(b)
Use the IRR approach to select the best group of projects, if the required rate of
return is 23.5%.

3. Match each marketable security with its description.

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)

Eurodollar deposit
Banker’s acceptance
Federal agency issue
Commercial paper
Repurchase agreement
Treasury bill
Money market mutual fund
Negotiable certificate of deposit
Treasury note

1.

________ A short term, unsecured promissory note issued by a corporation.

2.

________ An obligation of the U.S. Treasury with common maturities of 91 to
182 days.

3.

________ A portfolio of marketable securities.

4.

________ An arrangement whereby a bank or securities dealer sells specific
marketable securities to a firm and agrees to purchase them in the future.

5.

________ An obligation of the U.S. Treasury with mutual maturities of between
one and seven years.

6.

________ Negotiable instrument evidencing the deposit of a certain number of
dollars in a commercial bank.

7.

________ An instrument issued by the Federal National Mortgage Association.

8.

________ Funds deposited in banks located outside the U.S. and denominated in
U.S. dollars.

9.

________ Short term credit arrangement used by businesses to finance
transactions with foreign countries or firms with unknown credit capacities.

4. Aunt Tilly’s Feeds, Inc. is considering obtaining funding through advances against
receivables. Total annual credit sales are $600,000, terms are net 30 days, and payment is
made on an average of 30 days. Western National Bank will advance funds under a
pledging arrangement for 13 percent annual interest. On average, 75 percent of credit
sales will be accepted as collateral. Commodity Finance offers factoring on a nonrecourse
basis for a 1 percent factoring commission, charging 1.5 percent per month on advances
and requiring a 15 percent factor’s reserve. Under this plan, the firm would factor all
accounts and close its credit and collections department, saving $10,000 per year.

(a)
What is the effective interest rate and the average amount of funds available under
pledging and under factoring?
(b)
Which plan do you recommend? Why?

5. Hayley’s Theatrical Supply is in the process of negotiating a line of credit with two local
banks. The prime rate is currently 8 percent. The terms follow:

(a)
(b)

Calculate the effective interest rate of both banks.
Recommend which bank’s line of credit Hayley’s Theatrical Supply should accept.

6. Jia’s Oven Manufacturing is evaluating the acquisition of Cuisinaire Kitchen Appliance
Co. Cuisinaire has a loss carry forward of $1.5 million which resulted from earlier
operations. Jia’s Oven can purchase Cuisinaire for $1.8 million and liquidate the assets
for $1.3 million. Jia’s Oven expects earnings before taxes in the five years following the
acquisition to be as follows:

(These earnings are assumed to fall within the annual limit legally allowed for application
of the tax loss carry forward resulting from the proposed acquisition.) Jia’s Oven is in the
40 percent tax bracket and has a cost of capital of 17 percent.

(a)
What is the tax advantage of the acquisition each year for Jia’s Oven?
(b)
What is the maximum cash price Jia’s Oven would be willing to pay for
Cuisinaire?
(c)
Do you recommend the acquisition? Why or why not?

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