- a firm has net sales of $3000, cash expenses including taxes of $1400, and depreciation of $500. if a/c receivable increase in the period by $400, cahs flows from operations equal: a) 1200 b) 1600 c)1700 d) 2100 what i am confused here is that shouldnt we add back the depreciation cost to figure out the CFO? my calculation is $3000 - $1400 +$500 - $400 = 1700 but why the answer explains that we do not add back the depreciation cost and thus its answer is a) 1200. 2) winthrop stores has a capital structure consisting of $150million in 8 percent debt and $300 million in stock outstanding. the firms cost of equity is 20%. winthrop decides to sell $50 million in stock and use the preceeds to buy back $50 million in debt. according to the M&M model of capital structure without taxes or bankcruptcy costs, what effect should their restucturing on the firm’s cost of equity and weighted-average cost of capital? Cost of equity WACC a) dereases decreases b)increases increases c)decreases same d)increases same i dont understand this question coz when we calculate cost of equity, we are based on the RFR and market risk premium to do so, so even the company sells the stocks but RFR and MRP are remaining the same, why cost of equity changes? the answer for this one is c. can someone please explain for me??? thanks,

First question: Firstly, you calculate the net income: 3000 - 1400 -500= 1100 Cash flow from Operations: 1100 (net Income) + 500 (add back depreciation) - 400 (increase to receivable is a cash outflow)= 1200 Second question: Rwacc= 0.33(0.08)+0.67(0.2)= 0.0264 +0.134=16.4% Rwacc after restructuring= 0.29(0.08)+0.71(0.2)= 0.06673 +0.142=14.9% Therefore I think the correct answer is B as the cost of equity increase and the Rwacc decrease

Second: Initial WACC: 150/450*8%+300/450*20%=16%, with a cost of equity of 13.33% After restructuring, only the capital structure changes, not the total capital (debt decreases 50 to a final 100, equity increases 50 to a final 350): 100/450*8%+350/450*20%=17.33%, with a cost of equity of 15.56% Both increased, answer should be B.

for questons one couldn’t you use the direct approach and subtract expense/ change in recievebale from sales? 3000-1400-400 (Increase in AR, decrease in cash) **Depreciation not used in direct method. = 1200

Yes you could…but if the question is more tricky and you dont follow the right path…you will find yourself in a dark wood

true, but it doesn’t explicity say direct or indirect

Well if you start your cash flow from Net Income…it is indirect (it is implicit in the text)

Answer c is correct on this one guys - it’s really fundamental M&M stuff. In a perfect world, the more leverage the company has the higher the return on equity must be and the wacc is unchanged by the how you divvy up financing between debt and equity. Oh and for #1) it’s just cash in = $3000 in sales - $400 for the bums who haven’t paid you yet. cash out = $1400. Cash in - cash out = CFO

i agree strange…i need to stay off the form and do more studying GL

Right. In Modigliani & Miller WACC is not affected by the D/E structure.

Joey, conceptually I agree with you but: - if an equation has two weights (and different interest rates), unless the interest rates are the same, a change in the weight of one of two should change the result. If you look at my early post in this discussion, I have tried to calculate the two different Rwacc pre and after the restructuring and it seems that they change. Can you please explain?

map1 Wrote: ------------------------------------------------------- > Right. In Modigliani & Miller WACC is not affected > by the D/E structure. Can you prove it by using the above number?

This is more of a theory that Modigliani & Miller came up with, and I’m not that smart to contradict it:) Check these links: http://www.pitt.edu/~czutter/fm/ch12.ppt http://www.investopedia.com/terms/m/modigliani-millertheorem.asp

map1 Wrote: ------------------------------------------------------- > This is more of a theory that Modigliani & Miller > came up with, and I’m not that smart to contradict > it:) > > Check these links: > > http://www.pitt.edu/~czutter/fm/ch12.ppt > > http://www.investopedia.com/terms/m/modigliani-mil > lertheorem.asp I am not saying the theorem is wrong (Actually I really respect Modigliani), but I want just to find confirmation in this number.

I don’t need confirmation in the number, I’ll go with the hypothesis:)

strangedays Wrote: ------------------------------------------------------- > Joey, > conceptually I agree with you but: > > - if an equation has two weights (and different > interest rates), unless the interest rates are the > same, a change in the weight of one of two should > change the result. > > If you look at my early post in this discussion, I > have tried to calculate the two different Rwacc > pre and after the restructuring and it seems that > they change. > Can you please explain? Right - M&M gives the cost of equity as a function of leverage. The idea is that as you change the leverage of the company, return on equity changes. That means you can’t just do the weight thing you did but have to use their equation to change the returns. In the end you change the return on equity just enough to make wacc stay the same.

Now make sense. I also refreshed the M&M model and I saw the model they use which is a different from the simple weighting stuff. Thanks for your reply Joey. By the way…Modigliani he is a cool Italian guy…I love is life-cycle hypothesis

Joey, why is the answer is C not D, from your explaination that COE should be increased rather than decreased? can you please explain? JoeyDVivre Wrote: ------------------------------------------------------- > Answer c is correct on this one guys - it’s really > fundamental M&M stuff. In a perfect world, the > more leverage the company has the higher the > return on equity must be and the wacc is unchanged > by the how you divvy up financing between debt and > equity. > > Oh and for #1) it’s just cash in = $3000 in sales > - $400 for the bums who haven’t paid you yet. > cash out = $1400. Cash in - cash out = CFO