1. A firm’s latest 12 months’ EBIT is $30 million, and its interest expense for the same period is $10 million. Calculate the interest coverage ratio.
2. Nathan’s Catering is a gourmet catering service located in Southampton, New York. It has an unleveraged required return of r = 43%. Nathan’s rebalances its capital structure each year to a target of L = 0.52. T* = 0.20. Nathan’s can borrow currently at a rate of rd = 26%. What is Nathan’s WACC?
3. Sensor Technologies pays a regular dividend of $0.10 per quarter plus an extra dividend in the fourth quarter equal to 40% of the amount that annual earnings per share exceeds $2.00.
a. If annual earnings per share are $2.80, what is the fourth-quarter extra dividend?
b. If annual earnings per share are $1.75, what is the fourth-quarter extra dividend?
4. Alcoa recently announced a new dividend policy. The firm said it would pay a base cash dividend of 40 cents per common share each quarter. In addition, the firm said it would pay 30% of any excess in annual earnings per share above $6.00 as an extra year-end dividend.
a. If Alcoa earns $7.50 per share next year, what percentage of next year’s earnings would it pay out as cash dividends under the new policy?
b. For what types of firms would Alcoa’s new dividend policy be appropriate? Explain.
5. Dallas Instruments has a large bond issue whose covenants require:
(1) that DI’s interest coverage ratio exceeds 4.0; (2) that DI’s ratio of tangible assets to longterm debt exceeds 1.50; and (3) that cumulative dividends and share repurchases not exceed 60% of cumulative earnings since the date of the issuance of the bonds. DI has earnings before interest and taxes of $70 million and interest expense of $14 million. Tangible assets are $400 million and long-term debt is $175 million. Since the bonds were issued, DI has earned $200 million, paid dividends of $40 million, and repurchased $40 million of common stock. Is DI in compliance with its bond covenants?
6. Arkansas Instruments (AI) can purchase a sonic cleaner for $1,000,000. The machine has a five-year life and would be depreciated straight line to a $100,000 salvage value. Hibernia Leasing will lease the same machine to AI for five annual $300,000 lease payments paid in arrears (at the end of each year). AI is in the 40% tax bracket. The before-tax cost of borrowing is 10%, and the after-tax cost of capital for the project would be 12%.
a. What cash flows does AI realize if it leases the machine instead of buying it?
b. What is the net advantage to leasing (NAL)?