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Questions and Answers of
Corporate Finance
Propulsion Sciences’ (PS) stock dividend has grown at 10 % per year for many years. Investors believe that a year from now the company will pay a dividend of $3 and that dividends will continue
Gail Dribble is analyzing the shares of Petscan Radiology. Petscan’s stock pays a dividend once each year, and it just distributed this year’s $0.85 dividend. The market price of the stock is
Carbohydrates Anonymous (CA) operates a chain of weight-loss centers for carb lovers. Its services have been in great demand in recent years and its profits have soared. CA recently paid an annual
Hill Propane Distributors sells propane gas throughout the eastern half of the state of Texas. Because of population growth and a construction boom in recent years, the company has prospered and
Yesterday, September 22, 2012, Wireless Logic Corp. (WLC) paid its annual dividend of $1.25 per share. Because WLC’s financial prospects are particularly bright, investors believe that the company
Today’s date is March 30, 2012. E-Pay, Inc., stock pays a dividend every year on March 29. The most recent dividend was $1.50 per share. You expect the company’s dividends to increase at a rate
One year from today, investors anticipate that Groningen Distillers Inc. stock will pay a dividend of $3.25 per share. After that, investors believe that the dividend will grow at 20% per year for
Investors expect the following series of dividends from a particular common stock:Year 1 ...... $1.10Year 2......$1.25Year 3......$1.45Year 4......$1.60Year 5......$1.75After the fifth year,
In the constant-growth model we can apply the equation that P = D ÷ (r-g) only under the assumption that r > g. Suppose someone tries to argue with you that for a certain stock, r < g forever, not
Roban Corporation is considering going public but is unsure of a fair offering price for the company. Before hiring an investment banker to assist in making the public offering, managers at Roban
Dean and Estevez, Inc. (D&E) is a firm that provides temporary employees to businesses. D&E’s client base has grown rapidly in recent years, and the firm has been quite profitable. The firm’s
Dauterive Barber Shops (DBS) specializes in providing quick and inexpensive haircuts for middle-aged men. The company retains about half of its earnings each year and pays the rest out as a
Owners of the Internet bargain site FROOGLE.com have decided to take their company pubic by conducting an initial public offering of common stock. They have agreed with their investment banker to
Day trading, which typically refers to the practice of buying a stock and selling it very quickly (on the same day), was a popular activity during the Internet stock boom in the late 1990s.If a
1. The analyst who produced report A makes the assumption that Vegas Chips will remain a small, regional company that, although profitable, is not expected to grow. In this case, Vegas Chips’
Why is it important to focus on total returns when measuring an investment’s performance?
Why do real returns matter more than nominal returns?
Under what conditions will the components of a bond’s return have the opposite sign?
Explain why dollar returns and percentage returns can sometimes send conflicting signals when you are comparing two different investments.
Do the rankings of investment alternatives depend on whether we rank based on nominal returns or real returns?
Compare the best and worst years for T-bills in terms of their nominal returns, and then compare the best and worst years in terms of real returns. Comment on what you find.
Over the last 111 years, 1981 was the top year for nominal bill returns and 1982 was the top year for nominal bond returns. Why do you think that these two years saw such high returns on bonds and
Table calculates the risk premiums on stocks and bonds relative to T-bills by taking the difference in average nominal total returns on each asset class. Would these risk premiums be much different
Are there diminishing returns to risk taking?
Notice in Table that the average standard deviation among the ten stocks is 31.4%, yet Figure shows that a portfolio comprised of ten stocks has a standard deviation of about 20%. Explain why these
Suppose you had to invest all of your money in just one of these stocks (excluding Intel). Which one seems most attractive and why? Which stock seems least attractive?
Classify each of the following events as a source of systematic or unsystematic risk. a. Ben Bernanke retires as Chairman of the Federal Reserve and Arnold Schwarzenegger is appointed to take his
You purchase 1,000 shares of Spears Grinders Inc. stock for $45 per share. A year later, the stock pays a dividend of $1.25 per share and it sells for $49. a. Calculate your total dollar return. b.
Nano-Motors Corp. has stock outstanding which sells for $10 per share. Macro-Motors Inc. shares cost $50 each. Neither stock pays dividends at present. a. An investor buys 100 shares of Nano-Motors.
David Rawlings pays $1,000 to buy a five-year Treasury bond that pays a 6% coupon rate (for simplicity, assume annual coupon payments). One year later, the market’s required return on this bond has
G. Welch purchases a corporate bond that was originally issued for $1,000 several years ago. The bond has four years remaining until it matures, the market price now is $1,054.45, and the
In this advanced problem, let’s look at the behavior of ordinary Treasury bonds and inflation-indexed bonds, or TIPS. We will simplify by assuming annual interest payments rather than
The U.S. stock market hit an all-time high in October 1929 before crashing dramatically. Following the market crash, the U.S. entered a prolonged economic downturn dubbed The Great Depression. Using
Refer again to Figure 6.2. At the stock market peak in 1929, look at the gap that exists between equities and bonds. At the end of 1929, the $1 investment in stocks was worth about five times more
The following data shows the rate of return on stocks and bonds for several recent years. Calculate the risk premium on equities vs. bonds each year, and then calculate the average risk premium. Do
The current yield to maturity on a one-year Treasury bill is 2 %. You believe that the expected risk premium on stocks vs. bills equals 7.7 %.a. Estimate the expected return on the stock market next
In this problem we will use Figure to estimate the expected return on the stock market. To estimate the expected return, we will create a list of possible returns and we will assign a probability
Here are the nominal returns on stocks, bonds, and bills for the 1920s and 1930s. For each decade, calculate the standard deviation of returns for each asset class. How do those figures compare with
Use the data below to calculate the standard deviation of nominal and real Treasury bill returns from 1972-1982. Do you think that when they purchased T-bills investors expected to earn negative real
Troy McClain wants to form a portfolio of four different stocks. Summary data on the four stocks follows. First calculate the average standard deviation across the four stocks, and then answer this
The table below shows annual returns on Archer Daniels Midland (ADM) and Walmart. The last column of the table shows the annual return that a portfolio invested 50% in ADM and 50% in Walmart would
The table below shows annual returns for Merck and one of its major competitors, Eli Lilly. The final column shows the annual return on a portfolio invested 50% in Lilly and 50% in Merck. The
In this problem you will generate a graph similar to Figure. The table below shows the standard deviation for various portfolios of stocks listed in Table 6.5. Plot the relationship between the
Use the following information to compare the recent performance of the S&P 500 Index, the Nasdaq Index, and the Treasury Bill Index from 1983-2003. Each of these index numbers is calculated in a way
Based on the graphs below, which stock has more systematic risk, and which stock has more unsystematic risk?
The table below shows the expected return and standard deviation for two stocks. Is the pattern shown in the table possible?
According to the Capital Asset Pricing Model, is the following data possible? Explain your answer.
Stock A has a beta of 1.5, and stock B has a beta of 1.0. Determine whether each of the statements below is true or false. a. Stock A must have a higher standard deviation than Stock B. b. Stock A
If an asset lies above the security market line, is it overpriced or underpriced? Explain why.
A stock has a beta equal to 1.0. Is the standard deviation of the stock equal to the standard deviation of the market?
Explain why the efficient markets hypothesis implies that a well-run company is not necessarily a good investment.
a. Suppose that, over the long run, the risk-premium on stocks relative to Treasury bills has been 7.6 % in the United States. Suppose also that the current Treasury bill yield is 1.5%, but the
The table below shows the difference in returns between stocks and Treasury bills and the difference between stocks and Treasury bonds at 10-year intervals.a. At the end of 1973, the yield on
Calculate the expected return, variance, and standard deviation for the stocks in the table below.
Calculate the expected return, variance, and standard deviation for each stock listed below.
Refer to Figure 7.2 and answer the following questions. a. What return would you expect on a stock with a beta of 2.0? b. What return would you expect on a stock with a beta of 0.66? c. What
Wendi Deng recently inherited $1 million and has decided to invest it. Her portfolio consists of the following positions in several stocks. Calculate the portfolio weights to fill in the bottom row
Victoria Goldman is a financial advisor who manages money for high net worth individuals. For a particular client, Victoria recommends the following portfolio of stocks.a. Calculate the portfolio
Calculate the expected return, variance, and standard deviation for the stocks in the table below. Next, form an equally weighted portfolio of all three stocks and calculate its mean, variance, and
You analyze the prospects of several companies and come to the following conclusions about the expected return on each: Stock Expected Return Starbucks................
Calculate the expected return of the portfolio described in the accompanying table.
Calculate the portfolio weights based on the dollar investments in the table below. Interpret the negative sign on one investment. What is the size of the initial investment on which an investor’s
Pete Pablo has $20,000 to invest. He is very optimistic about the prospects of two companies, 919 Brands Inc., and Diaries.com. However, Pete has a very pessimistic view of one firm, a financial
Shares in Springfield Nuclear Power Corp. (SNP) currently sell for $25. You believe that the shares will be worth $30 in one year, and this implies that return you expect on these shares is 20% (the
You are given the following data on several stocks:a. Calculate the expected return and standard deviation for each stock.b. Calculate the expected return and standard deviation for a portfolio
In an odd twist of fate, the return on the stock market has been exactly 1% in each of the last eight months. The return on Simon Entertainment stock in the past eight months has been as follows: 8%,
The risk-free rate is currently 5%, and the expected risk premium on the market portfolio is 7%. What is the expected return on a stock with a beta of 1.2?
The expected return on the market portfolio equals 12%. The current risk-free rate is 6%. What is the expected return on a stock with a beta of 0.66?
The expected return on a particular stock is 14%. The stock’s beta is 1.5. What is the risk-free rate if the expected return on the market portfolio equals 10%?
If the risk-free rate equals 4% and a stock with a beta of 0.75 has an expected return of 10%, what is the expected return on the market portfolio?
You believe that a particular stock has an expected return of 15%. The stock’s beta is 1.2, the risk-free rate is 3%, and the expected market risk premium is 6%. Based on this, is your view that
A particular stock sells for $30. The stock’s beta is 1.25, the risk-free rate is 4%, and the expected return on the market portfolio is 10%. If you forecast that the stock will be worth $33 next
Currently the risk-free rate equals 5% and the expected return on the market portfolio equals 11%. An investment analyst provides you with the following information:a. Indicate whether each stock is
1. Calculate the expected rate of return for Tech.com Incorporated, Sam’s Grocery Corporation, and the S&P 500 Index.2. Calculate the standard deviations of the estimated rates of return
You name some industries where the payback period is unavoidably long?
In statistics, you learn about Type I and Type II errors. A Type I error occurs when a statistical test rejects a hypothesis when the hypothesis is actually true. A Type II error occurs when a test
In what way is the NPV consistent with the principle of shareholder wealth maximization? What happens to the value of a firm if a positive-NPV project is accepted? If a negative-NPV project is
A particular firm’s shareholders demand a 15% return on their investment, given the firm’s risk. However, this firm has historically generated returns in excess of shareholder expectations, with
What are the potential faults in using the IRR as a capital budgeting technique? Given these faults, why is this technique so popular among corporate managers?
Why is the NPV considered to be theoretically superior to all other capital budgeting techniques? Reconcile this result with the prevalence of the use of IRR in practice. How would you respond to
Outline the differences between NPV, IRR, and PI. What are the advantages and disadvantages of each technique? Do they agree with regard to simple accept or reject decisions?
Under what circumstances will the NPV, IRR, and PI techniques provide different capital budgeting decisions? What are the underlying causes of the differences often found in the ranking of mutually
Suppose that a 30-year U.S. Treasury bond offers a 4% coupon rate, paid semiannually. The market price of the bond is $1,000, equal to its par value.a. What is the payback period for this bond?b.
The cash flows associated with three different projects are as follows:a. Calculate the payback period of each investment.b. Which investments does the firm accept if the cutoff payback period is
Kenneth Gould is the general manager at a small-town newspaper that is part of a national media chain. He is seeking approval from corporate headquarters (HQ) to spend $20,000 to buy some Macintosh
Calculate the net present value (NPV) for the following 20-year projects. Comment on the acceptability of each. Assume that the firm has an opportunity cost of 14%. a. Initial cash outlay is
Michael’s Bakery is evaluating a new electronic oven. The oven requires an initial cash outlay of $19,000 and will generate after-tax cash inflows of $4,000 per year for eight years. For each of
Using a 14% cost of capital, calculate the NPV for each of the projects shown in the following table and indicate whether or not each is acceptable.
Scotty Manufacturing is considering the replacement of one of its machine tools. Three alternative replacement tools€”A, B, and C€”are under consideration. The cash flows associated with each
Erwin Enterprises has 10 million shares outstanding with a current market price of $10 per share. There is one investment available to Erwin, and its cash flows are provided below. Erwin has a cost
A certain investment requires an initial outlay of $12 million and subsequently produces annual cash inflows of $1.4 million in perpetuity. A firm evaluating this investment uses a discount rate of
For each of the projects shown in the following table, calculate the internal rate of return (IRR).
William Industries is attempting to choose the better of two mutually exclusive projects for expanding the firm€™s production capacity. The relevant cash flows for the projects are shown in the
Contract Manufacturing, Inc. is considering two alternative investment proposals. The first proposal calls for a major renovation of the company€™s manufacturing facility. The second involves
Consider a project with the following cash flows and a firm with a 15% cost of capital. YearCash Flow0.............−$20,0001.............. 50,0002................. −10,000a. What are the two IRRs
A certain project has the following stream of cash flows:YearCash Flow0.............. $ 17,5001.............. −80,5002.............. 138,4253..............−105,4554.............. 30,030a. Fill in
Evaluate the following three projects, using the profitability index. Assume a cost of capital of 15%.a. Rank these projects by their PIs. b. If the projects are independent, which would you accept
You have a $10 million capital budget and must make the decision about which investments your firm should accept for the coming year. Use the following information on three mutually exclusive
Both Old Line Industries and New Tech, Inc., use the IRR to make investment decisions. Both firms are considering investing in a more efficient $4.5 million mail-order processor. This machine could
Butler Products has prepared the following estimates for an investment it is considering. The initial cash outflow is $20,000, and the project is expected to yield cash inflows of $4,400 per year for
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