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Questions and Answers of Corporate Finance

Use the DuPont system to explain why a slower-than-average inventory turnover could cause a firm with an above-average net profit margin and an average degree of financial leverage to have a
How can you reconcile investor expectations for a firm with an above-average M/B ratio and a below-average P/E ratio? Could the age of the firm have any effect on this ratio comparison?
How are corporations taxed on ordinary income? What is the difference between the average tax rate and the marginal tax rate on ordinary corporate income?
What are corporate capital gains and capital losses? How are they treated for tax purposes?
Are balance sheets and income statements prepared with the same purpose in mind? How are these two statements different, and how are they related?
Which statements are of greatest interest to creditors, and which would be of greatest interest to stockholders?
How do depreciation and other noncash charges act as cash inflows to the firm? Why does a depreciation allowance exist in the tax laws? For a profitable firm, is it better to depreciate an asset
What is operating cash flow (OCF)? What is free cash flow (FCF), and how is it related to OCF?
Why is the financial manager likely to have great interest in the firm’s statement of cash flows? What type of information can be obtained from this statement?
Which of the categories and individual ratios described in this chapter would be of greatest interest to each of the following parties? a. Existing and prospective creditors (lenders) b. Existing
How could the availability of cash inflow and cash outflow data be used to improve on the accuracy of the liquidity and debt coverage ratios presented previously? What specific ratio measures would
Assume that a firm’s total assets and sales remain constant. Would an increase in each of the ratios below be associated with a cash inflow, a cash out-flow, or would there be no effect on cash? a.
Trish Foods, Inc. had pretax ordinary corporate income during 2009 of $2.7 million. In addition during the year, Trish sold a group of non-depreciable business assets (in the 5-year depreciation
Use the following information to answer the questions that follow.a. Use the DuPont system to compare the two heavy metal companies shown above (HMM and MS) during 2009. Which of the two has a higher
Why is it important for corporate managers to understand how bonds and stocks are priced?
What is the difference between a pure discount bond and an ordinary bond that sells at a discount?
Explain who benefits from the option to convert a bond into shares of common stock, and who benefits from the option to call a bond.
Explain why the yield spread on corporate bonds versus Treasury bonds must always be positive. How do these spreads change (a) as the bond rating declines and (b) as the time to maturity increases?
Explain why the height of the yield curve depends on inflation.
Suppose the Treasury issues two 5- year bonds. One is an ordinary bond that offers a fixed nominal coupon rate of 4 percent. The other bond is an inflation- indexed bond (or TIPS). When the TIPS bond
Keeping in mind Equation, discuss how you determine the price per acre of farmland in a particular region.
Explain the meaning of the term interest rate risk.
Why do bond prices and bond yields move in opposite directions?
Go to www.stockcharts.com/charts/YieldCurve.htm and click on the animated yield-curve graph (be sure JAVA is enabled on your browser). Answer the following questions:a. Is the yield curve typically
A best-selling author decides to cash in on her latest novel by selling the rights to the book’s royalties for the next four years to an investor. Royalty payments arrive once per year, starting
Investors face a tax rate of thirty-three percent on interest paid by corporate bonds. If municipal bonds currently offer yields of 6 percent, what yield would equally risky corporate bonds need to
A one-year Treasury security offers a 4 percent yield to maturity (YTM). A two-year Treasury security offers a 4.25 percent YTM. According to the expectations hypothesis, what is the expected
A one-year Treasury bill offers a 6 percent yield to maturity. The market’s consensus forecast is that one-year T-bills will offer 6.25 percent next year. What is the current yield on a two-year
Why are common stockholders viewed as residual owners?
Using a dividend forecast of $1.24, a required return of 8.5 percent, and a growth rate of 5.3 percent, we obtained a price for National Fuel Gas Company of $38.75. What would happen to this price if
How can the free cash flow approach to valuing an enterprise be used to resolve the valuation challenge presented by firms that do not pay dividends? Compare and contrast this model with the
What rights do they get in exchange for taking more risk than creditors and preferred share-holders take? Most large Japanese corporations hold their annual shareholders meeting on the same day and
What is the difference between a primary market and a secondary market?
When you buy a stock in the secondary market, does the firm that issued the stock receive cash?
Describe broker markets and dealer markets and list several differences between them.
Why is it appropriate to use the perpetuity formula from Chapter 3 to estimate the value of preferred stock?
Describe the role of the underwriting syndicate in a firm-commitment offering.
Does secondary market trading generate capital for the company whose stock is trading?
The value of common stocks cannot be tied to the present value of future dividends because most firms don’t pay dividends. Comment on the validity, or lack thereof, of this statement. Discuss.
The equity section of the balance sheet for Hilton Web-Cams looks like this: Common stock, $0.25 par ........ $400,000 Paid-in capital in excess of par ...... $4,500,000 Retained earnings
A particular preferred stock pays a $1 quarterly dividend and offers investors an effective annual rate of return of 12.55 percent. What is the price per share?
The equity section of the balance sheet for Jackson Halftime Entertainment, Inc. appears below: Common stock, $0.60 par value ...... $_________ Paid-in capital in excess of par
The following stock quotes were taken from The Wall Street Journal:a. Which company had higher earnings per share over the last year?b. What was the closing price of each company's stock the day
Suppose a preferred stock pays a quarterly dividend of $2 per share. The next dividend comes in exactly one-fourth of a year. If the price of the stock is $80, what is the effective annual rate of
In Chapter 4, we defined several bond return measures, including the coupon, the coupon rate, the coupon yield, and the yield to maturity. Indicate whether each of these measures (a) focuses on the
In Figure, why does the line decline steeply at first and then flatten out?
Explain why the dots in Figure appear to be almost randomly scattered.
You buy a stock for $40. During the next year, it pays a dividend of $2, and its price increases to $ 44. Calculate the total dollar and total percentage return and show that each of these is the sum
Why do investors need to pay attention to real returns, as well as nominal returns?
In Table, why are the average real returns lower than the average nominal returns for each asset class? Is it always true that an assets nominal return is higher than its real return?
Suppose nominal bond returns approximately follow a normal distribution. Using the data in Table, construct a range that should contain 95 percent of historical bond returns. Next, refer to Figure.
Suppose there is an asset class with a standard deviation that lies about halfway between the standard deviations of stocks and bonds. Based on Figure, what would you expect the average return on
Why is the standard deviation of a portfolio usually smaller than the standard deviations of the assets that comprise the portfolio?
Notice in Table that the stocks with the lowest standard deviations are Anheuser-Busch, Coca-Cola, Archer Daniels Midland, and Wendy€™s. Is this a surprise?
Look at Figure. The unlabeled dot on the far right of the graph represents the average return and standard deviation of Advanced Micro Devices. Down and to the left from that point you can see the
Look at Table. Compare the best and worst years for Tbills in terms of their nominal returns, and then compare the best and worst years in terms of real returns. Comment on what you find.
Notice in Figure that 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 bills?
Refer again to Figure. 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 than
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
In this problem we will use Fig 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 to
A financial adviser claims that a particular stock earned a total return of 10 percent last year. During the year the stock price rose from $30 to $32.50. What dividend did the stock pay?
The table below shows annual returns on the pharmaceutical leader Merck and chip maker Advanced Micro Devices. The last column of the table shows the annual return that a portfolio invested 50% in
In this problem you will generate a graph similar to Figure 6.8. The table below shows the standard deviation for various portfolios of stocks listed in Table 6.5. Plot the relationship between the
D. S. Trucking Company stock pays a $1.50 dividend every year. A year ago the stock sold for $25 per share, and its total return during the past year was 20%. What does the stock sell for today?
At the end of each line, we show the nominal value in 2006 of a $1 investment in stocks, bonds, and bills. Calculate the ratio of the 2006 value of $1 invested in stocks divided by the 2006 value of
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
What is the difference between assets expected return and its actual return? Why are expected returns so important to investors and managers?
If prices move almost at random, then why should we place any value on the CAPM, which makes predictions about expected asset returns?
Contrast the historical approach to estimating expected returns with the probabilistic approach.
Why should stock betas and expected returns be related, while no such relationship exists between stock standard deviations and expected returns?
Why is the risk-based approach the best method for estimating stocks expected return?
How can the weight given to a particular stock in a portfolio exceed 100 percent?
Why is the standard deviation of a portfolio typically less than the weighted average of the standard deviations of the assets in the portfolio, while a portfolios beta equals the weighted average of
If a particular stock had no systematic risk, only un-systematic risk, what would be its expected return?
In an odd twist of fate, the return on the stock market has been exactly 1 percent in each of the last eight months. The return on Simon Entertainment stock in the past eight months has been as
Refer to Figure 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 determines
Kevin Federline recently inherited $1 million and has decided to invest it. His portfolio consists of the following positions in several stocks. Calculate the portfolio weights to fill in the bottom
What are the desirable characteristics of a capital budgeting decision- making tool?
Describe the scale problem and the timing problem and explain the potential effects of these problems on the choice of mutually exclusive projects, using IRR versus NPV.
What important flaw do both the IRR and PI share? Explain.
Why do managers focus on the effect that an investment will have on reported earnings rather than on the investments cash flow consequences?
What factors determine whether the annual ac-counting rate of return on a given project will be high or low in the early years of the investments life? In the latter years?
What factors account for the popularity of the pay-back method? In what situations is it often used as the primary decision- making technique? Why?
Describe how the IRR and NPV approaches are related.
If the IRR for a given project exceeds a firm’s hurdle rate, does that mean that the project necessarily has a positive NPV? Explain.
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
For each of the projects shown in the following table, calculate the internal rate of return (IRR).
Why is it important for the financial analyst to:(a) Focus on incremental cash flows,(b) Ignore financing costs,(c) Consider taxes, and(d) Adjust for noncash expenses when estimating projects
When a firm is faced with capital rationing, how can the profitability index (PI) be used to select the best projects? Why does choosing the projects with the highest PI not always lead to the best
Under what circumstance is the use of the equivalent annual cost (EAC) method to compare substitutable projects with different lives clearly more efficient computationally than using multiple
In almost every example so far, firms must decide to invest in a project immediately or not at all. But suppose that a firm could invest in a project today or it could wait one year before investing.
Can you articulate circumstances under which the cost of excess capacity is zero? Think about why the cost of excess capacity normally is not zero.
What role does the human element play in the capital budgeting decision process? Could it cause a negative NPV project to be accepted?
Why do we consider changes in net working capital associated with a project to be cash inflows or out-flow rather than consider the absolute level of net working capital?
For what kinds of investments does terminal value account for a substantial fraction of the total project NPV, and for what kinds of investments is terminal value relatively unimportant?
What is meant by potential investments relevant cash flows? What are sunk costs and cannibalization, and do they affect the process of determining proposed investments incremental cash flows?
A real estate development firm owns a fully leased forty-story office building. A tenant recently moved its offices out of two stories of the building, leaving the space temporarily vacant. If the
Suppose that an analyst makes a mistake and calculates the NPV of an investment project by discounting the projects contribution to net income each year rather than by discounting its relevant cash
Calculate the present value of depreciation tax savings on a depreciable asset with a purchase price of $5 million and zero salvage value, assuming a 10 percent discount rate, a 34 percent tax rate,
Why is using the cost of equity to discount project cash flows inappropriate when a firm uses both debt and equity in its capital structure?

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