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Questions and Answers of
Corporate Finance
How would you go about finding the expected return on a stock? Note how such information would be used in the stock selection process.
Briefly describe the P/E approach to stock valuation and note how this approach differs from the variable-growth DVM. Describe the P/CF approach and note how it is used in the stock valuation
In this chapter, we examined 9 stock valuation procedures:• Zero-growth DVM• Constant-growth DVM• Variable-growth DVM• Dividends-and-earnings (D&E) approach• Expected return (IRR)
Explain the role that the future plays in the stock valuation process. Why not just base the valuation on historical information? Explain how the intrinsic value of a stock is related to its required
Assume an investor uses the constant-growth DVM to value a stock. Listed below are various situations that could affect the computed value of a stock. Look at each one of these individually and
An investor estimates that next year’s sales for Dursley’s Hotels Inc. should amount to about $100 million. The company has 5.0 million shares outstanding, generates a net profit margin of about
Larry, Moe, and Curley are brothers. They’re all serious investors, but each has a different approach to valuing stocks. Larry, the oldest, likes to use a 1-year holding period to value common
Assume you’ve generated the following information about the stock of Bufford’s Burger Barns: The company’s latest dividends of $4 a share are expected to grow to $4.32 next year, to $4.67 the
Let’s assume that you’re thinking about buying stock in West Coast Electronics. So far in your analysis, you’ve uncovered the following information: The stock pays annual dividends of $2.50 a
The price of Myrtle’s Plumbing Supply Co. is now $80. The company pays no dividends. Ms. Bossard expects the price 4 years from now to be $110 per share. Should she buy Myrtle’s Plumbing stock if
This year, Shoreline Light and Gas (SL&G) paid its stockholders an annual dividend of $3 a share. A major brokerage firm recently put out a report on SL&G stating that, in its opinion, the
Assume there are 3 companies that in the past year paid exactly the same annual dividend of $2.25 a share. In addition, the future annual rate of growth in dividends for each of the 3 companies has
New Millennium Company’s stock sells at a P/E ratio of 21 times earnings. It is expected to pay dividends of $2 per share in each of the next 5 years and to generate an EPS of $5 in year 5. Using
A particular company currently has sales of $250 million; sales are expected to grow by 20% next year (year 1). For the year after next (year 2), the growth rate in sales is expected to equal 10%.
Assume a major investment service has just given Oasis Electronics its highest investment rating, along with a strong buy recommendation. As a result, you decide to take a look for yourself and to
Consolidated Software doesn’t currently pay any dividends but is expected to start doing so in 4 years. That is, Consolidated will go 3 more years without paying dividends and then is expected to
Assume you obtain the following information about a certain company:Total assets ...... $50,000,000Total equity ...... $25,000,000Net income ....... $3,750,000EPS ........$5.00 per shareDividend
You’re thinking about buying some stock in Affiliated Computer Corporation and want to use the P/E approach to value the shares. You’ve estimated that next year’s earnings should come in at
AviBank Plastics generated an EPS of $2.75 over the last 12 months. The company’s earnings are expected to grow by 25% next year, and because there will be no significant change in the number of
Newco is a young company that has yet to make a profit. You are trying to place a value on the stock, but it pays no dividends and you obviously cannot calculate a P/E ratio. As a result, you decide
World Wide Web Wares (4W, for short) is an online retailer of small kitchen appliances and utensils. The firm has been around for a few years and has created a nice market niche for itself. In fact,
Granger Toothpaste Corp. has total equity of $400 million and 100 million shares out-standing. Its ROE is 20%. Calculate the company’s EPS.
Goodstuff Corporation has total equity of $500 million and 100 million shares out-standing. Its ROE is 15%. The dividend payout ratio is 33.3%. Calculate the company’s dividends per share (round to
HighTeck has an ROE of 15%. Its earnings per share are $2.00, and its dividends per shareare $0.20. Estimate HighTeck’s growth rate.
Last year, InDebt Company paid $75 million of interest expense, and its average rate of interest for the year was 10%. The company’s ROE is 15%, and it pays no dividends. Estimate next year’s
Melissa Popp is thinking about buying some shares of R. H. Lawncare Equipment, at $48 per share. She expects the price of the stock to rise to $60 over the next 3 years. During that time she also
Amalgamated Aircraft Parts, Inc., is expected to pays a dividend of $1.50 in the coming year. The required rate of return is 16%, and dividends are expected to grow at 7% per year. Using the dividend
Chris Norton is a young Hollywood writer who is well on his way to television superstardom. After writing several successful television specials, he was recently named the head writer for one of
Marc Dodier is a recent university graduate and a security analyst with the Kansas City brokerage firm of Lippman, Brickbats, and Shaft. Marc has been following one of the hottest issues on Wall
What is the random walk hypothesis, and how does it apply to stocks? What is an efficient market? How can a market be efficient if its prices behave in a random fashion?
Briefly describe each of the following and note how it is computed and how it is used by technicians: a. Advance-decline lines b. Arms index c. On-balance volume d. Relative strength index e. Moving
What is a stock chart? What kind of information can be put on charts, and what is the purpose of charting?
Explain why it is difficult, if not impossible, to consistently outperform an efficient market. a. Does this mean that high rates of return are not available in the stock market? b. How can an
What are market anomalies and how do they come about? Do they support or refute the EMH? Briefly describe each of the following: a. The January effect b. The size effect c. The value effect
How can behavioral finance have any bearing on investor returns? Do supporters of behavioral finance believe in efficient markets? Explain.
Briefly explain how behavioral finance can affect each of the following: a. The trading activity of investors b. The tendency of value stocks to outperform growth stocks c. The tendency of stock
What is the purpose of technical analysis? Explain how and why it is used by technicians; note how it can be helpful in timing investment decisions.
Can the market really have a measurable effect on the price behavior of individual securities? Explain.
Describe the confidence index, and note the feature that makes it unique.
Briefly describe each of the following and explain how it is used in technical analysis: a. Breadth of the market b. Short interest c. Odd-lot trading
Much has been written about the concept of an efficient market. It’s probably safe to say that some of your classmates believe the markets are efficient and others believe they are not. Have a
Each year financial periodicals like the Wall Street Journal and Money Magazine publish a list of the top performing mutual fund managers. And every year there are some fund managers who earn much
Briefly define each of the following terms and describe how it can affect investors’ decisions. a. Loss aversion b. Representativeness c. Narrow framing d. Overconfidence e. Biased self-attribution
Describe how representativeness may lead to biases in stock valuation.
Briefly describe how technical analysis is used as part of the stock valuation process. What role does it play in an investor’s decision to buy or sell a stock?
Describe each of the following approaches to technical analysis and note how it would be used by investors. a. Confidence index b. Arms index c. Trading action d. Odd-lot trading e. Charting f.
Briefly define each of the following and note the conditions that would suggest the market is technically strong. a. Breadth of the market b. Short interest c. Relative strength index d. Theory of
Compute the Arms index for the S&P 500 over the following 3 days:Which of the 3 days would be considered the most bullish? Explain why.
You find the closing prices for a stock you own. You want to use a 10-day moving average to monitor the stock. Calculate the 10-day moving average for days 11 through 20. Based on the data in the
Listed below are data that pertain to the corporate bond market.a. Compute the confidence index for each of the 4 periods listed above. b. Assume that the latest confidence index (for period 0, in
Compute the level of on-balance volume (OBV) for the following 3-day period for a stock, if the beginning level of OBV is 50,000 and the stock closed yesterday at $25.Does the movement in OBV appear
Below are figures representing the number of stocks making new highs and new lows for each month over a six-month period:Would a technical analyst consider the trend to be bullish or bearish over
You are given the following information:a. Calculate the 10-day moving-average NH-NL indicator. b. If there are 120 new highs and 20 new lows today, what is the new 10-day movingaverage NH-NL
You are presented with the following data:Calculate the MFCR for each week. Based on the result, are you bullish or bearish?
Brett Daly is an active stock trader and an avid market technician. He got into technical analysis about 10 years ago, and although he now uses the Internet for much of his analytical work, he still
Several months ago, Deb Forrester received a substantial sum of money from the estate of her late aunt. Deb initially placed the money in a savings account because she was not sure what to do with
What appeal do bonds hold for investors? Give several reasons why bonds make attractive investment outlets. behavior of bonds? Explain. is the central idea behind securitization?
Briefly describe each of the following types of bonds: (a) Treasury bonds, (b) Agency issues, (c) Municipal securities, and (d) Corporate bonds. Note some of the major advantages and
Briefly define each of the following and note how they might be used by fixed-income investors: (a) zero-coupon bonds, (b) CMOs, (c) Junk bonds, and (d) Yankee bonds.
What are the special tax features of (a) Treasury securities, (b) Agency issues, and (c) Municipal bonds?
Describe an asset-backed security (ABS) and identify some of the different forms of collateral used with these issues. Briefly note how an ABS differs from an MBS. What
What’s the difference between dollar-denominated and non-dollar-denominated (for-eign-pay) bonds? Briefly describe the 2 major types of U.S.-pay bonds. Can currency exchange rates affect the total
What is a convertible debenture? How does a convertible bond differ from a convertible preferred?
Identify the equity kicker of a convertible security and explain how it affects the value and price behavior of convertibles.
Explain why it is necessary to examine both the bond and stock properties of a convertible debenture when determining its investment appeal.
What is the difference between conversion parity and conversion value? How would you describe the payback period on a convertible? What is the investment value of a convertible, and what does it
How would you describe the behavior of market interest rates and bond returns over the last 30 years? Do swings in market interest rates have any bearing on bond returns? Explain.
Identify and briefly describe the 5 types of risk to which bonds are exposed. What is the most important source of risk for bonds in general? Explain.
Can issue characteristics (such as coupon and call features) affect the yield and price
What is the difference between a call feature and a sinking-fund provision? Briefly describe the 3 types of call features. Can a bond be freely callable but nonrefundable?
What is the difference between a premium bond and a discount bond? What 3 attributes are most important in determining an issue’s price volatility?
Bonds are said to be quoted “as a percent of par.” What does that mean? What is 1 point worth in the bond market?
What are bond ratings, and how can they affect investor returns? What are split ratings?
From the perspective of an individual investor, what good are bond ratings? Do bond ratings indicate the amount of market risk embedded in a bond? Explain.
Using the bond returns in Table 10.1 as a basis of discussion: a. Compare the returns during the 1970s to those produced in the 1980s. How do you explain the differences? b. How did the bond market
Identify and briefly describe each of the following types of bonds. a. Agency bonds b. Municipal bonds c. Zero-coupon bonds d. Junk bonds e. Foreign bonds f. Collateralized mortgage obligations
“Treasury securities are guaranteed by the U.S. government. Therefore, there is no risk in the ownership of such bonds.” Briefly discuss the wisdom (or folly) of this statement.
Select the security in the left-hand column that best fits the investors desire described in the right-hand column.
Why do companies like to issue convertible securities? What’s in it for them?
Describe LYONs, and note how they differ from conventional convertible securities. Are there any similarities between LYONs and conventional convertibles? Explain.
An 8%, 10-year bond is callable in 2 years at a call price of $1,080. The bond is currently priced in the market at $888.89. What is the issue’s current yield?
Colwyn buys a 10% corporate bond with a current yield of 6%. When he sells the bond 1 year later, the current yield on the bond is 7%. How much did Col make on this investment?
In early January 2007, you purchased $30,000 worth of some high-grade corporate bonds. The bonds carried a coupon of 81/8% and mature in 2021. You paid $94.125 when you bought the bonds. Over the
Rhett purchased a 13% zero-coupon bond with a 15-year maturity and a $20,000 par value 15 years ago. The bond matures tomorrow. How much will Rhett receive in total from this investment, assuming
Letticia Garcia, an aggressive bond investor, is currently thinking about investing in a foreign (non-dollar-denominated) government bond. In particular, she’s looking at a Swiss government bond
Red Electrica España SA (E.REE) is refinancing its bank loans by issuing Eurobonds to investors. You are considering buying $10,000 of these bonds, which will yield 6%. You are also looking at a
A certain convertible bond has a conversion ratio of 21 and a conversion premium of 20%. The current market price of the underlying common stock is $40. What is the bond’s conversion equivalent?
You are considering investing $800 in Higgs B. Technology Inc. You can buy common stock at $25 per share; this stock pays no dividends. You can also buy a convertible bond ($1,000 par value) that is
A certain 6% annual pay convertible bond (maturing in 20 years) is convertible at the holder’s option into 20 shares of common stock. The bond is currently trading at $800. The stock (which pays
An 8% convertible bond carries a par value of $1,000 and a conversion ratio of 20. Assume that an investor has $5,000 to invest and that the convertible sells at a price of $1,000 (which includes a
A certain bond has a current yield of 6.5% and a market price of $846.15. What is the bond’s coupon rate?
Assume you just paid $1,200 for a convertible bond that carries a 7½% coupon and has 15 years to maturity. The bond can be converted into 24 shares of stock, which are now trading at $50 a share.
Find the conversion value of a convertible preferred stock that carries a conversion ratio of 1.8, given that the market price of the underlying common stock is $40 a share. Would there be any
Zack buys a 10% corporate bond with a current yield of 6%. How much did he pay for the bond?
An investor is in the 28% tax bracket and lives in a state with no income tax. He is trying to decide which of 2 bonds to purchase. One is a 7.5% corporate bond that is selling at par. The other is a
An investor lives in a state with a 3% tax rate. Her federal income tax bracket is 35%. She wants to invest in 1 of 2 bonds that are similar in terms of risk (and both bonds currently sell at par
Maria Lopez is a wealthy investor who’s looking for a tax shelter. Maria is in the maximum (35%) federal tax bracket and lives in a state with a very high state income tax. (She pays the maximum of
Wesley Jenkins is looking for a fixed-income investment. He is considering 2 bond issues:a. A Treasury with a yield of 5%b. An in-state municipal bond with a yield of 4%Wesley is in the 33% federal
Which of the following bonds offers the highest current yield? a. A 91/2%, 20-year bond quoted at 973/4 b. A 16%, 15-year bond quoted at 1645/8 c. A 51/4%, 18-year bond quoted at 54
Assume that you pay $850 for a long-term bond that carries a 71/2% coupon. Over the course of the next 12 months, interest rates drop sharply. As a result, you sell the bond at a price of $962.50. a.
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