Chapter 17 B1. (Choosing financial targets) Bixton Companys new chief financial officer is evaluating Bixtons capital structure.

She is concerned that the firm might be underleveraged, even though the firm has larger-than-average research and development and foreign tax credits when compared to other firms in its industry. Her staff prepared the industry comparison shown here. a. Bixtons objective is to achieve a credit standing that falls, in the words of the chief financial officer, comfortably within the A range. What target range would you recommend for each of the three credit measures? In order for Brixton to be comfortable they must remain off the low end of the ratings scale. Fixed Charge Coverage: 3.40-4.30 Cash Flow/Total Debt: 55-65 Long-Term Debt/Total Capitalization: 25-30 b. Before settling on these target ranges, what other factors should Bixtons chief financial officer consider? The chief financial officer should consider that the ability to utilize non-interest tax credits and debt management considerations such as issuance costs. He or she should also take into consideration that the intangible assets and arguments lenders could present in order to determine loan levels. c. Before deciding whether the target ranges are really appropriate for Bixton in its current financial situation, what key issues specific to Bixton must the chief financial officer resolve? During some instances, additional tax shield from additional debt can have minimum effects. The chief financial officer should take into consideration the importance of foreign tax credits.
RATING CATEGORY Aa B Baa FIXED CHARGE COVERAGE 4.00-5.25x 3.00-4.30 1.95-3.40 FUNDS FROM OPERATIONS/TOTAL DEBT 60-80% 45-65 35-55 LONG-TERM DEBT/CAPITALIZATION 17-23% 22-32 30-41

Chapter 18 A10. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firms chief financial officer would like the firm to distribute 25% of its annual earnings (POR = 0.25) and adjust the dividend rate to changes in earnings per share at the rate ADJ = 0.75. Regional paid $1.00 per share in dividends last year. It will earn at least $8.00 per share this year and each year in the foreseeable future. Use the dividend adjustment model,

Equation (18.1), to calculate projected dividends per share for this year and the next four. D1= ADJ [POR(EPS1) - D0] + D0 D1= 0.75[0.25 x $8.00 - $1.00] + $1.00 = $1.75 D2= 0.75 [0.25 x $8.00 - $1.75] + $1.75 = $1.94 D3= 0.75 [0.25 x $8.00 - $1.94] + $1.94 = $1.985 D4= 0.75 [0.25 x $8.00 - $1.98] + $1.98 = $2.00 D5= 0.75 [0.25 x $8.00 - $2.00] + $2.00 =$2.00 B2. (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share per year in cash dividends on its common stock. Historically, its payout ratio has ranged from 30% to 35%. Over the next five years it expects the earnings and discretionary cash flow shown below in millions. a. Over the five-year period, what is the maximum overall payout ratio the firm could achieve without triggering a securities issue? Total discretionary cash flow = $50 + $70 + $60 + $20 + $15 = $215 Total earnings = $100 + $125 + $150 + $120 + $140 = $635 Maximum Payout Ratio = $215 / $635 = 33.86% b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5.
1 Earnings Discretionary Cash Flow 100 50 2 125 70 3 150 60 4 120 20 5 140 15 THEREAFTER 150+per year 50+per year

Current dividend = $1.50 x 20 million shares = $30 million The firm could gradually increase the dividend from $30 million to $50million. D1 = $35 / 20 = $1.75 D2 = $39 / 20 = $1.95 D3 = $43 / 20 = $2.15 D4 = $48 / 20 = $2.40 D5 = $50 / 20 = $2.50 *** $35 + $39 + $43 + $48 + $50 = $215, the total discretionary cash flow Due to large discretionary cash flows occurring at the beginning, there is never a discretionary cash deficit.*** Chapter 20 A2. (Comparing borrowing costs) Stephens Security has two financing alternatives: (1) A publicly placed $50 million bond issue. Issuance costs are $1 million, the bond has a 9% coupon paid semiannually, and the bond has a 20-year life. (2) A $50 million private placement with a large pension fund. Issuance costs are $500,000, the bond has a

9.25% annual coupon, and the bond has a 20-year life. Which alternative has the lower cost (annual percentage yield)? Number of Periods (nper) 40(20) = Coupon Payments (pmt) 2,250,000 4,625,000 Net Proceeds of Bond (PV) 49,000,000 (option 1) 49,500,000 (option 2) Face Value of Bond (FV) 50,000,000 (both option 1 & 2) Yield to Maturity 4.61% Bond Equivalent Yield 9.22% (option 1) 9.36% (option 2) 1.n = 40 r = ? PV = -($50 - $1) = -$49 PMT = 9% / 2 x $50 = $2.25 FV = $50r = 4.61% APY = (1 + 0.0461)2-1 = 0.09432521 = 9.4334% 2.n = 20 r = ? PV = -($50 - $0.5) = -$49.5 PMT = 9.25% x $50 = $4.625 FV =$50 r = 9.36% APY = 9.36% Choice 2 (9.36%) has the lower Annual Percentage Yield (APY). Chapter 21 C2. (Including detailed transactions cost in the net advantage of refunding) The net advantage of refunding high-coupon debt can be expressed as where D, N, P, r, r, and T are defined as in Equation (20.4) and B is the market price of the old debt issue (excluding accrued interest); E is the underwriting commissions and other expenses associated with the new debt issue; F is the tax-deductible, out-of-pocket expenses associated with the refunding; and U is the unamortized balance of issuance expenses on the old debt. a. Issuance expenses are tax deductible over the life of the debt issue on a straight-line basis. Interpret the term T [(E U)/N ]. b. The unamortized balance of issuance expenses on the old debt can be written off for tax purposes in the year of refunding. Interpret the term TU. c. Suppose bonds are redeemed at a price that exceeds their market value. Bondholders benefit at the expense of shareholders. Interpret the term P B. Why is it subtracted? d. Explain how the tax treatment of issuance expenses in bond refunding is like the tax treatment of equipment cost in capital budgeting.