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A-3 (Coverage ratio) The firm in the two preceding problems also had $6 million of principal repayments during the latest 12 months. Its marginal tax rate is 40%. Calculate the debt service coverage ratio.

Debt-Service Coverage Ratio = (EBIT + 1/3 Rentals) / (Interest Expense + 1/3 Rentals + Principal Repayments / (1 - T)) = ($30 + $15 / 3) / ($10 + $15 / 3 + $6 / (1 - 0.40)) = 1.40

A-4 (WACC with rebalancing) 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 r 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?

WACC = r - T* L rd [(1 + r) / (1 + rd)]
WACC = 0.43 - 0.20 x 0.52 x 0.26 [(1 + 0.43) / (1 + 0.26)] = 0.3993 = 39.93%

A-10 (Dividend adjustment model) Regional Software has made a bundle selling spreadsheet software and has begun paying cash dividends. The firm’s 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.

D1 = ADJ [POR(EPS1) - D0] + D0

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

B-2 (Dividend policy) A firm has 20 million common shares outstanding. It currently pays out $1.50 per share...
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