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17: Chapter Problem 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 Answer: To be comfortably within the range, the firm should stay off the low end of the ratings. 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 Answer: Ability to use fully non-interest tax credits and debt management considerations such as issuance costs. The CFO should also consider that the Firms R&D is an intangible asset and that lenders may not be willing to loan the same percentage of debt to Bixton as to its competitors. 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 Answer: The CFO needs to consider R&D and foreign tax credits. The additional tax shield from additional debt may not be valuable when R&D and foreign tax credits are taken into consideration. Chapter 18: Problem 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. Answer: D1 = ADJ [POR(EPS1) – D0] + D0 Neo 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 Chapter 18: Problem 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 Answer: 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. Answer: Current dividend = $1.50 x 20 million shares = $30 million The firm could gradually increase the dividend from $30 million to $50 million. 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 Note that $35 + $39 + $43 + $48 + $50 = $215, the total discretionary cash flow and since large discretionary cash flows occur at the beginning, there is never a discretionary cash deficit. Chapter Problem 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%

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