B1. (Choosing financial targets) Bixton Company’s new chief financial officer is evaluating Bixton’s 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. Bixton’s 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? b. Before settling on these target ranges, what other factors should Bixton’s chief financial officer consider? 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? Rating Fixed Funds From Long-Term Debit/ Category Charge Operations/ Capitalization Coverage Total Debt Aa 4.00-5.25x 60-80% 17-23% Aa 3.00-4.30 45-65 22-32 Baa 1.95-3.40 35-55 30-41 A10. (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s 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. Equation: DPS1 − DPS0 = ADJ[POR(EPS1) − DPS0] 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? b. Recommend a reasonable dividend policy for paying out discretionary cash flow in years 1 through 5. 1 2 3 4 5 Thereafter Earnings 100 125 150 120 140 150+ per year Discretionary cash flow 50 70 60 20 15 50+ per year Chapter 20 Problems: 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)? Chapter 21 Problems: C2. (Leasing, taxes, and the time value of money) The lessor can claim the tax deductions associated with asset ownership and realize the leased asset’s residual value. In return, the lessor must pay tax on the rental income. a. Explain why a financial lease represents a secured loan in which the lender’s entire debt service stream is taxable as ordinary income to the lessor/lender. b. In view of this tax cost, what tax condition must hold in order for a financial lease transaction to generate positive net-present-value tax benefits for both the lessor and lessee? c. Suppose the lease payments in Table 21-2 must be made in advance, not arrears. (Assume that the timing of the lease payment tax deductions/obligations changes accordingly but the timing of the depreciation tax deductions does not change). Show that the net advantage to leasing for NACCO must decrease as a result. Explain why this reduction occurs. d. Show that if NACCO is nontaxable, the net advantage to leasing is negative and greater in absolute value than the net advantage of the lease to the lessor. e. Either find a lease rate that will give the financial lease a positive net advantage for both lessor and lessee, or show that no such lease rate exists. f. Explain what your answer to part e implies about the tax costs and tax benefits of the financial lease when lease payments are made in advance.
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