Applied Financial Management

Q1. The subject Financial Planning discusses the fact that pro forma financial statements and the
calculation of AFN (additional funds needed) are important as they allow the firm to estimate potential
capital needs or excesses. Why is it so important for the firm to understand the projected excess or
deficit? Be sure to discuss the importance in both scenarios (deficit and excess) and tie your response to
how both relate to the goal of the firm.
Q2. Briefly explain why both convertible bonds and bonds with warrants can allow firms to issue debt at
lower coupon rates than a regular debt instrument would allow. Given they have lower attached coupon
rates, what is the investor receiving in exchange (discuss the response to this for both convertible bonds
and bonds with warrants)?
Q3. A firm is considering adopting a capital budgeting project that will affect the firm’s future EBIT. The
CFO produced the table below showing the expected EBIT with and without adopting the project at
different levels of sales. Unit sales are expected to average 50,000 units every year in the future, but
annual sales could fluctuate by as much as 10,000 units each year. Given this information, what would
your recommendation be? Clearly identify the reasoning for your decision and any factors that affect
the decision both from the positive and negative standpoint.
Sales EBIT without the project EBIT with the project
40,000 $4 million $3 million
50,000 $5 million $5.1 million
60,000 $6 million $7.2 million
Q4. You have been hired by a firm as an outside consultant to examine their current capital structure
decisions. In doing your research on the firm’s industry, you recognize that the industry in which the firm
operates has substantial uncertainty surrounding cash flows period-over-period. Some periods sales are
outstanding, while other periods are lackluster. Furthermore, the costs of good sold varies substantially
with material input prices being highly uncertain. Given this understanding about the industry in which
the firm operates, how might this affect your recommended level of leverage, all else equal? You do not
need to specific regarding the actual capital structure weights, but given this knowledge would it make
the firm a candidate for a high amount of leverage or a low amount of leverage? Why?
Q5. Your firm has an optimal capital structure that has been identified as 50% debt and 50% equity.
Despite this, your firm’s executives have decided to operate for the foreseeable future with a capital
structure of 30% debt and 70% equity. Briefly discuss the effect this might have on the firm’s cost of
equity (it has been calculated that it would have been 12% if the firm were operating at its optimal
capital structure). Furthermore, discuss how this decision is likely to affect shareholder wealth.

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