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business
foundations of finance
Questions and Answers of
Foundations of Finance
Synopticom Inc. plans a bond issue for the near future and wants to estimate its current cost of debt capital. After talking with the firm’s investment banker, the firm’s chief financial officer
San Antonio Edison has a preferred stock issue outstanding on which it pays an annual dividend of $4.25 per share. On August 24, 2011, the stock price was $58.50 per share. If the firm were to sell a
The Talbot Corporation’s common shareholders anticipate receiving a $2.20 per share dividend next year, based on the fact that they received $2 last year and expect dividends to grow 10 percent
The Talbot Corporation’s beta coefficient is estimated to be 1.40. Furthermore, the risk-free rate of interest is currently 3.75 percent, and the expected rate of return on a diversified portfolio
Ash Inc.’s capital structure and estimated capital costs are found in Table 9-2. Note that the sum of the capital structure weights must equal 100 percent if we have properly accounted for all
In early 2016, Alfa Corporation issued new common stock at a market price of $30. Dividends last year were $2.00 and are expected to grow at an annual rate of 3 percent forever. Floatation costs will
LLC International is issuing a $2,000 par value bond that pays 8 percent annual interest and matures in 10 years. Investors are willing to pay $1,800 for the bond. Floatation costs will be 4 percent
The preferred stock of LLC International sells for $35 and pays 5 percent dividends. The net price of the stock is $30. What is the cost of capital for the preferred stock?
Corporation Beta sells common stock for $50. The floatation cost for new issue of stocks will be 5 percent. The company pays 50 percent of its earnings in dividends, and a $4 dividend was recently
Microfinance Company needs to raise $800,000 to improve the position of cash. It has decided to issue a $1,000 par value bond with 15 percent annual coupon rate and 5-year maturity. The investors
The capital structure for the ABC Corporation is provided hereThe company plans to keep its debt structure in the future. The after-tax cost of debt is 7 percent, 12.5 percent is the cost of
Alfa trading operates a quite successful chain of milk products and tea houses across the South Caucasus, Alfa plans to expand in Ukraine and Moldova, so it needs to raise some funds. The Company’s
Socar Corporation is an integrated oil company which is based in Baku, Azerbaijan, which has large operations in nearby regions. For a long period of time Socar used to be the main one in South
Star Corporation is a provider of computer software and IT services in two large regions of Easter Europe. The company uses 12 percent to evaluate investments; however, due to latest developments it
TBC Bank, based in Georgia, is growing rapidly since 2010, it introduced regional branches in South Caucasus, has been rated as the best corporate bank in region and listed on London international
Why is it so difficult to find an exceptionally profitable project?
Why is the search for new profitable projects so important?
Provide an intuitive definition of an internal rate of return for a project.
What does a net present value profile tell you, and how is it constructed?
What is the difference between the IRR and the MIRR?
Why do the net present value and profitability index always yield the same accept/reject decision for any project?
How might capital rationing conflict with the goal of maximizing shareholders’ wealth?
What are mutually exclusive projects? How might they complicate the capital-budgeting process?
Ski-Doo is considering new machinery that would reduce manufacturing costs associated with its Mach Z snowmobile, for which the free cash flows are shown in Table 10-3. If the firm has a 12 percent
A firm is considering the purchase of a new computer system, which will cost $30,000 initially, to aid in credit billing and inventory management. The free cash flows resulting from this project are
A firm with a 10 percent required rate of return is considering investing in a new machine with an expected life of 6 years. The free cash flows resulting from this investment are given in Table
Consider the following investment proposal:If the required rate of return is 15 percent, should this project be accepted? Initial outlay FCF in year 1 FCF in year 2 FCF in year 3 FCF in year 4
Let’s look at an example of a project with a 3-year life and a required rate of return of 10 percent, assuming the following cash flows are associated with it:Determine the MIRR of the project.
Suppose a firm is considering two mutually exclusive projects, A and B; both have required rates of return of 10 percent. Project A involves a $200 initial outlay and a cash inflow of $300 at the end
Suppose a firm with a required rate of return or cost of capital of 10 percent and with no capital constraint is considering the two mutually exclusive projects illustrated in Table 10-9. How do we
Suppose a firm with a 10 percent required rate of return must replace an aging machine and is considering two replacement machines, one with a 3-year life and one with a 6-year life. The relevant
What are mutually exclusive projects and what kind of difficulties may be associated with their ranking?
What is the unequal lives problem in ranking mutually exclusive projects?How do managers deal with it?
Strada Company is considering purchasing new machinery for its business line. This investment required an initial outlay of $200,000 and will generate free cash inflow of $20,000 per year for 15
TBC Bank is considering purchasing a new building for newly opened branch in region. Required rate of return for the project is 10 percent, and it will generate the following cash flows; cash inflows
(IRR) Ives Roche, a perfume and cosmetics store, is considering a new project, which costs $1,000,000 and is expected to last 15 years. The project will produce $150,000 cash flows per year. The
Ace publishing company needs new equipment for a new branch in the region. According to prior estimates, the following positive cash flow will be generated during 5 years:Estimated pay-back period
Alfa Company is considering a new project which requires $300,000 initial investment and an additional $100,000 cash outflow on the last year of the project. The project will last 7 years and will
Ariel company decided to invest $10 million in new machinery. The investment will generate $3,000,000 net cash inflow during the next 7 years. Calculate MIRR fora. 10 percent required rate of
Kurta Company Ltd. has a budget of $10 million for new projects. The projects are independent and have the following costs and profitability indexes associated with them:a. Make your selection under
Industrial Zone Group, which operates in building industry in South Caucasus, is considering making investments in regional projects. The CEO of the group was offered two projects regarding
Microfinance Company Alfa Cash Capital had financial problems recently. According to independent auditors’ report, the main sources of the problems were a shortage of financial analyses and
What is an incremental cash flow? What is a sunk cost? Why must you account for opportunity costs?
If Ford introduces a new auto line, might some of the cash flows from that new car line be diverted from existing product lines? How should you deal with this?
In general, a project’s cash flows will fall into one of three categories. What are these categories?
What is a free cash flow? How do we calculate it?
Although depreciation is not a cash flow item, it plays an important role in the calculation of cash flows. How does depreciation affect a project’s cash flows?
Give an example of an option to delay a project. Why might this be of value?
Give an example of an option to expand a project. Why might this be of value?
Give an example of an option to abandon a project. Why might this be of value?
Is a project’s standing-alone-risk the appropriate level of risk for capital budgeting? Why or why not?
What problems are associated with using systematic risk as the measure for risk in capital budgeting?
What is the most commonly used method for incorporating risk into the capital-budgeting decision? How is this technique related to Principle 3: Risk Requires a Reward?
Explain how simulations work.
What is a scenario analysis? What is a sensitivity analysis? When would you perform a sensitivity analysis?
Assume that a new project will annually generate additional revenues of $1 million and additional fixed and variable costs of $500,000, while increasing depreciation by $150,000 per year. If the
You are considering expanding your product line that currently consists of Lee’s Press-on Nails to take advantage of the fitness craze. The new product you are considering introducing is Press-on
A toy manufacturer is considering introducing a line of fishing equipment with an expected life of 5 years. In the past, the firm has been quite conservative in its investment in new products,
SCOP TI is considering introducing a variation of its current breakfast tea, Earl Grey 1336. The new tea bags will be similar to the old with the exception that it will contain small caramel-flavored
Metal Winds Ltd is considering a new project that involves the introduction of a new technology for developing small-sized wind mills. Given the uncertain future of this particular technology, it has
Memphis Restaurants has come up with a new fast casual restaurant combining some of the features consumers like in Delicatessen, Quick, and Hippopotamus, but it is not quite sure how the public in
Why do managers care about the volatility of their firms’ earnings?
What are the three determinants of the volatility of a firm’s earnings?
Describe the sources of business risk.
What is the determinant of a firm’s operating risk?
Distinguish among fixed costs, variable costs, and semi-variable costs.
When is it useful or sometimes necessary to compute the break-even point in terms of sales dollars rather than units of output?
How can we identify when a firm has operating leverage?
What is the effect of operating leverage on the volatility of a firm’s EBIT in response to changing sales?
What creates financial leverage in a firm’s capital structure?
How does financial leverage affect the volatility of firm earnings in response to changes in EBIT?
If the ratio of the percent change in earnings per share to the corresponding percent change in EBIT were 2, what percent change in earnings would you expect to follow a 15 percent decline in EBIT?
How do operating and financial leverage interact to affect the volatility of a firm’s earnings per share?
What is the basic controversy surrounding capital structure theory?
Explain the independence hypothesis as it relates to capital structure management.
Explain the moderate view of the relationship between a firm’s financing mix and its average cost of capital.
How do agency costs and free cash flow relate to capital structure management?
Explain the meaning of the EBIT-EPS indifference point.
How are various leverage ratios and industry norms used in capital structure management?
Identify several factors that influence the decision to issue debt.
Why is capital structure design both an art and a science?
Even though Pierce Grain Company manufactures several different products, it has observed over a lengthy period that its product mix is rather constant. This allows management to conduct its
Assume that plan B presented earlier in Table 12-4 is the existing capital structure for the Pierce Grain Company. Furthermore, the asset structure of the firm is such that EBIT is expected to be
Which of the following sources of new earnings volatility represents the effect of business versus financial risk (discuss the rationale for your decisions):a. Pajala AB in Sweden is considering
Tenny Inc. is planning to sell 50,000 units of its products next year. Fixed costs will total €6 million, and the variable costs are planned to be 60 percent of the sales.a. The firm wants to
King Inc. is a health wine company in China. The average selling price of its finished product is 38 Chinese Yuan Renminbi (RMB) per bottle (500 ml/bottle). The variable cost of the same bottle of
Define the EBIT-EPS indifference point.
Imagine that you were a new CFO of Beily Inc., a children’s bicycle manufacturer. The president, Mr. Zhao, started the business 2 years ago. The firm manufactures two types of products, bicycles
Top Performance has been operating for several years in the outskirts of Ostersund, Sweden, and is a new manufacturer of a top-of-the-line outdoor jacket. You are starting an internship as assistant
Provide a financial executive with a useful definition of the term dividend payout ratio.
Summarize the position that a dividend policy may be irrelevant with regard to the firm’s stock price.
What is meant by the bird-in-the-hand dividend theory?
Why are cash dividend payments thought to be more certain than capital gains?
How might personal taxes affect both the firm’s dividend policy and its share price?
Distinguish between the residual dividend theory and the clientele effect.
Identify some practical considerations that affect a firm’s payout policy.
Identify and explain three different dividend policies. (Hint: One of these is a constant dividend payout ratio.)
What is the typical frequency with which cash dividends are paid to investors?
Distinguish among the(a) declaration date,(b) date of record, (c) ex-dividend date.
What managerial logic might lie behind a stock split or a stock dividend?
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