Posted: December 15th, 2015

f the expected inflation rate suddenly rose by 3 percentage points, causing investors to require a 3 percentage point higher return? Would we now have a discount or a premium bond?

Finance

1.    Jay Pritchett and Claire Dunphy co-own the recently renamed, P&D Closets.

Pritchett and Dunphy, have decided to make a presentation to potential investors

and have asked you to help them by answering the following questions. P&D has bonds

outstanding with $1000 par value, a 12 percent annual coupon, and ten years

remaining.  However, since Claire took over, she argues that risk has declined

substantially and the required rate of return on the bonds is only 8%.
(2 points each=10 total points)
a.  What is the value the outstanding bonds?

12,6848

b. What would be the value of the bond described in question a. if the expected

inflation rate suddenly rose by 3 percentage points, causing investors to require a

3 percentage point higher return? Would we now have a discount or a premium bond?

c. What would be the value of the bond described in question a. if the expected

inflation rate suddenly fell by 3 percentage points? Would we now have a discount

or a premium bond?

d. What are the total return, the current yield, and the capital gains yield for

the bond held for one year in question a.?  Assume the bond is purchased

immediately after the presentation and the investors agree with Claire’s

interpretation of risk. Also assume that the bond is held one year and P&D does not

default on the bond.

e. Now assume that investors don’t agree that risk has fallen. Rather their

required return is identical to when the bond was originally issued.  What is the

value under this required return? Assume that there are 10 years left as in Qa.

Assuming investors purchase it at this price, what are the total return, the

current yield, and the capital gains yield for the bond assuming it is held for one

year?  Assume that the bond is held to maturity and P&D does not default on the

bond.
Q2. Ashley clinic, a for-profit, had revenues of $18m in 2014.  Expenses other than

depreciation, interest, and taxes totaled 75% of revenues, depreciation expense was

$1M and interest expense was 0.5M. All revenues and expenses (other than

depreciation) were paid in cash. Assume taxes were 40% and are paid in cash.
(3 points each=15 total points)
a. Construct Ashley’s income statement. Include subtotals reflecting EBITDA, EBIT,

and earnings before income taxes.

b. What is Ashley’s net income? Total margin? Cash flow Generated?

c.  How would your answer to b. change if depreciation were changed to $3M?  How do

you interpret the change in Cash generated?

d.  How would your answer to b. change if depreciation were changed to $750,000?

e. If you owned Ashley clinic which scenario (a, b, or c) would you prefer? Explain

why.

Q3. Peyton Manning is considering investing in a medical supply company that

specializes in treating plantar fasciitis called “PlantarFacGoBoom”.  He is fresh

from a victory in the 2016 Super Bowl and is looking for a solid company to invest

in.  The company had recently doubled it’s plant capacity, opened new sales offices

across the country, and launched an expensive new advertising campaign for Super

Bowl 2016 which featured Peyton Manning and his new custom-made shoe called

“BrockWho?”  This was part of PlantarFacGoBoom’spush beyond its current market in

North Carolina.
As a result of these expenditures, PlantarFacGoBoom’s most recent financial results

were not satisfactory.  Its board of directors, which consisted of its president

and vice president plus its major stockholders (who were all Charlotte, NC business

people), was most upset when directors learned how the expansion was going.

Suppliers were being paid late and were unhappy, and the bank was also complaining

and threatened to cut off credit. In addition, the Board was frustrated by fact

that it appeared the company had turned its back on the local market by helping the

Denver Broncos in their game against the Carolina Panthers.
Peyton’s advisor, Jake Plummer, collected the financial statements below to help

assess the situation. Upon review of the financial statement, Jake notes that net

income fell dramatically in 2015 in part because of Peyton’s endorsement salary and

the free giveaways (supplies) related to the Super Bowl. Absent these expenditures,

PlantarFacGoBoom would have turned a profit during the last quarter of 2015. Also,

given that the commercials were produced and expensed in 2015 but didn’t air until

2016, he expects sales will recover sufficiently to turn a profit in 2016.
Clearly the lags between spending money and deriving benefits were longer than

PlantarFacGoBoom’s managers had anticipated. For these reasons, Peyton and Jake see

hope for the company—provided it can survive in the short run.  They ask you to

prepare an analysis of where the company is now, what it must do to regain its

financial health, and what actions should be taken.
(25 total points)
Note you can copy and paste the following tables directly into Excel.
PlantarFacGoBoom
Statement of Operations
2014    2015    2016 Projected
Revenue:
Net patient service revenue        $3,335,267    $5,655,054    $7,025,148
Other revenue            $0    $0    $0
Total revenues            $3,335,267    $5,655,054    $7,025,148
Expenses:
Salaries and benefits            $2,789,254    $4,897,502    $5,850,000
Supplies                $240,000    $620,000    $512,960
Insurance and other            $50,000    $50,000    $50,000
Drugs                $50,000    $50,000    $50,000
Depreciation            $18,900    $116,960    $120,000
Interest                $62,500    $176,000    $80,000
Total expenses            $3,210,654    $5,910,462    $6,662,960
Operating income            $124,613    -$255,408    $362,188
Provision for income taxes        $49,845    -$102,163    $144,875
Net income            $74,768    -$153,245    $217,313

PlantarFacGoBoom
Balance Sheet
2014    2015    2016 Projected
Assets
Current assets:
Cash                $9,000    $7,282    $14,000
Marketable securities        $48,600    $20,000    $71,632
Net accounts receivable        $351,200    $632,160    $878,000
Inventories            $715,200    $1,287,360    $1,716,480
Total current assets            $1,124,000    $1,946,802

$2,680,112
Property and equipment        $491,000    $1,202,950    $1,220,000
Less accumulated depreciation        $146,200    $263,160    $383,160
Net property and equipment        $344,800    $939,790    $836,840
Total assets            $1,468,800    $2,886,592    $3,516,952

Liabilities and shareholders’ equity
Current liabilities:
Accounts payable            $145,600    $324,000    $359,800
Accrued expenses            $136,000    $284,960    $380,000
Notes payable            $120,000    $640,000    $220,000
Current portion of long-term debt    $80,000    $80,000    $80,000
Total current liabilities        $481,600    $1,328,960    $1,039,800
Long-term debt            $323,432    $1,000,000    $500,000
Shareholders’ equity:
Common stock            $460,000    $460,000    $1,680,936
Retained earnings            $203,768    $97,632    $296,216
Total shareholders’ equity        $663,768    $557,632    $1,977,152
Total liabilities and shareholders’ equity    $1,468,800    $2,886,592

$3,516,952

Other data:
Stock price            $8.50    $6.00    $12.17
Shares outstanding            100,000    100,000    250,000
Tax rate                40%    40%    40%
Lease payments            $40,000    $40,000    $40,000

A.    The first step is to compute the ratios listed in the table below
Industry
2014    2015    2016 Projected    Average
Profitability ratios
Total margin                        3.6%
Return on assets                        9.0%
Return on equity                        17.9%
Liquidity ratios
Current ratio                        2.70
Days cash on hand                        22.0
Debt management (capital structure) ratios
Debt ratio                        50.0%
Debt to equity ratio                        2.5
Times-interest-earned ratio                    6.2
Cash flow coverage ratio                    8.00
Asset management (activity) ratios
Fixed asset turnover                        7.00
Total asset turnover                        2.50
Days sales outstanding                    32.0

B.    How do you interpret Profitability?

C.    How do you interpret Liquidity?

D.    How do you interpret Debt Management?

E.    How do you interpret Asset Management?

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