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Questions and Answers of Corporate Finance

Explain one way that the Dodd–Frank Act is in conflict with (a) the Basel international regulations (b) the regulations introduced by other national governments.
A bank has the following balance sheetCash3Retail Deposits (stable)25Treasury Bonds (>1 year)5Retail Deposits (less stable)15Corporate Bonds Rated A4Wholesale Deposits44Residential
Suppose that an investor owns the $10 million portfolio in Table 13.1 on September 30, 2014. The values of the four indices on that day were 17,042.90, 6622.7, 4,416.24, 16,173.52. The exchange rates
A company enters into a short futures contract to sell 5,000 bushels of wheat for 250 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead
A trader buys 200 shares of a stock on margin. The price of the stock is $20. The initial margin is 60% and the maintenance margin is 30%. How much money does the trader have to provide initially?
In Figure 18.3 where the CCP is used, suppose that an extra transaction between A and C which is worth 140 to A is cleared bilaterally. What effect does this have on the tables in Figure 18.3?
Suppose a three-year corporate bond provides a coupon of 7% per year payable semiannually and has a yield of 5% (expressed with semiannual compounding). The yields for all maturities on risk-free
A company has one- and two-year bonds outstanding, each providing a coupon of 8% per year payable annually. The yields on the bonds (expressed with continuous compounding are 6.0% and 6.6%,
The value of a company’s equity is $4 million and the volatility of its equity is 60%. The debt that will have to be repaid in two years is $15 million. The risk-free interest rate is 6% per annum.
Extend Example 20.3 to calculate CVA when default can happen in the middle of each month. Assume that the default probability during the first year is 0.001667 per month and the default
Calculate DVA for the bank in Example 20.2. Assume that the bank can default in the middle of each month and that the default probability is 0.001 per month for the two years. Assume that the
Consider a European call option on a non-dividend-paying stock where the stock price is $52, the strike price $50, the risk-free rate is 5%, the volatility is 30%, and the time to maturity is one
Suppose that the spread between the yield on a three-year riskless zero-coupon bond and a three-year zero-coupon bond issued by a bank is 210 basis points. The Black-Scholes–Merton price of an
Explain carefully the distinction between real-world and risk-neutral default probabilities. Which is higher? A bank enters into a credit derivative where it agrees to pay $100 at the end of one year
Suppose that a bank has a total of $10 million of small exposures of a certain type. The one-year probability of default is 1% and the recovery rate averages 40%. Estimate the 99.5% one-year credit
Use the transition matrix in Table 21.1 and software on the author’s web site to calculate the transition matrix over 1.25 years.
What difference does it make to the worst-case scenario in Example 22.1 if(a) the options are American rather than European and(b) the options are barrier options that are knocked out if the asset
What difference does it make to the VaR calculated in Example 22.2 if the exponentially weighted moving average model is used to assign weights to scenarios as described in Section 13.3?
Suppose that there is a 1% probability that operational risk losses of a certain type exceed $10 million. Use the power law to estimate the 99.97% worst-case operational risk loss when the _
Consider the following two events:(a) A bank loses $1 billion from an unexpected lawsuit relating to its transactions with a counterparty and(b) An insurance company loses $1 billion because of an
The worksheet used to produce Figure 23.2 is on the author’s web site. How does the loss distribution change when the loss severity has a beta distribution with upper bound of 5, lower bound of
Discuss whether hedge funds are good or bad for the liquidity of markets.
Suppose that a trader has bought some illiquid shares. In particular, the trader has 100 shares of A, which is bid $50 and offer $60, and 200 shares of B, which is bid $25 offer $35. What are the
A trader wishes to unwind a position of 200,000 units in an asset over eight days. The dollar bid–offer spread, as a function of daily trading volume q, is a + b cq where a = 0.2, b = 0.15 and c =
Suppose that all options traders decide to switch from Black–Scholes to another model that makes different assumptions about the behavior of asset prices. What effect do you think this would have
Using Table 25.1, calculate the volatility a trader would use for an 11-month option with a strike price of 0.98.
Suppose that a financial institution uses an imprecise model for pricing and hedging a particular type of structured product. Discuss how, if at all, it is likely to realize its mistake.
A futures price is currently at $40. The risk-free interest rate is 5%. Some news is expected tomorrow that will cause the volatility over the next three months to be either 10% or 30%. There is a
Suppose that daily gains (losses) are normally distributed with standard deviation of $5 million.(a) Estimate the minimum regulatory capital the bank is required to hold. (Assume a multiplicative
Suppose that the economic capital estimates for two business units areThe correlation between market risk and credit risk in the same business unit is 0.3. The correlation between credit risk in one
Suppose that a bank’s sole business is to lend in two regions of the world. The lending in each region has the same characteristics as in Example 26.5 of Section 26.8. Lending to Region A is three
Suppose daily losses (gains) from trading are independent and normally distributed with mean zero. Calculate in terms of the standard deviation of the daily losses (gains) (a) the basic Basel I
A fund's risk appetite is such that it wants to be 97.5% certain it will not lose more than 25% in any one year. Using the performance of the S&P 500 between 1994 and 2003 (see Table 27.2) determine
Assume that in Business Snapshot 27.1, the change in the three-month Euribor rate in each quarter, is normally distributed with mean zero and a standard deviation equal to x basis points. Use Monte
A number of terms are listed below: Accounting rate of return.... accrual accounting rate of return (AARR) Adjusted rate of return....... capital budgeting Discount rate......... discounted cash
Guelph Company runs hardware stores in Ontario’s Golden Triangle area. Guelph’s management estimates that if it invests $160,000 in a new computer system, it can save $60,000 in annual cash
Panayiotis, the owner and manager of Micos Ltd., is evaluating the acquisition of new equipment needed to attend a new line of business. He has two alternatives: either buy two small machines or one
Norberto Garcia, general manager of the Argentinean subsidiary of Innovation Inc., is considering the purchase of new industrial equipment to improve efficiency at its Cordoba plant. The equipment
Capital budgeting with uneven cash flows, no income taxes. Southern Cola is considering the purchase of a special-purpose bottling machine for $23,000. It is expected to have a useful life of four
New Bio Corporation is a rapidly growing biotech company that has a required rate of return of 12%. It plans to build a new facility in Mississauga, Ontario. The building will take two years to
Andrews Construction is analyzing its capital expenditure proposals for the purchase of equipment in the coming year.The capital budget is limited to $6,000,000 for the year. Lori Bart, staff analyst
Century Lab plans to purchase a new centrifuge machine for its Manitoba facility. The machine costs $137,500 and is expected to have a useful life of eight years, with a terminal disposal value of
Muskoka Landscaping Ltd. is planning to buy equipment costing $25,000 to improve its services. The equipment is expected to save $8,000 in cash operating costs per year. Its estimated useful life is
Edilcan Inc. has been offered an automated special-purpose welder (robot) for $60,000. The machine is expected to have a useful life of eight years with a terminal disposal price of $12,000. Savings
Edgeley Inc., a logistics operator located in Concord, Ontario, is considering replacing one of its tractor trailers (informally known as a 53’ truck). The truck was purchased for $64,800 two years
Ready Ink and Paper Ltd. sells and distributes office supplies for printers and photocopy machines; its overall margin on sales is 10%. Ready Ink and Paper has customers of two kinds: low and high
Fox Valley Healthcare Inc. is a not-for-profit organization that operates eight nursing homes and ten assisted-living facilities. The company has grown consider ably over the last three years and
Landom Corporation is an international manufacturer of fragrances for women. Management at Landom is considering expanding the product line to men’s fragrances. From the best estimates of the
Crumbly Cookie Company is considering expanding by buying a new (additional) machine that costs $42,000, has zero terminal disposal value, and has a ten-year useful life. It expects the annual
The Strubel Company currently makes as many units of Part No. 789 as it needs. David Lin, general manager of the Strubel Company, has received a bid from the Gabriella Company for making Part No.
Christen Granite sells granite counter tops to the construction industry.Christen Granite has three customers: Homebuilders, a small construction company that builds private luxury homes; Kitchen
Nate Stately, a manager of the Plate division for the Great Slate Manufacturing Company, has the opportunity to expand the division by investing in additional machinery costing $320,000. He would
Met-All Manufacturing manufactures over 20,000 different products made from metal, including building materials, tools, and furniture parts. The manager of the Furniture Parts division has proposed
Ludmilla Quagg owns a fitness centre and is thinking of replacing the old Fit-O-Matic machine with a brand new Flab-Buster 3000. The old Fit-O-Matic has a historical cost of $50,000 andaccumulated
The management of Kleinburg Industrial Bakery is analyzing two competing investment projects and they must decide which one can be done immediately and which one can be postponed for at least a year.
Francesca Freed wants a Burg-N-Fry franchise. The buy-in is $500,000. Burg-N-Fry headquarters tells Francesca that typical annual operating costs are $160,000 (cash) and that she can bring in “as
Relevant costs, capital budgeting, strategic decision. (M. Porporato, adapted) Wilcox is a family-owned company that has been making microwaves for almost 20 years. The company’s production line
Describe three types of cash flows affected by income taxes.
What approaches might be used to recognize risk in capital budgeting?
"Discounted cash flow techniques are relevant only to profit-seeking organizations." Do you agree? Explain.
"The net present value method and the internal rate-of-return method always rank different projects identically.” Do you agree? Explain.
A number of terms are listed below: Adjusted cost base (ACB)......... amortization Capital cost allowance (CCA)....... capital gain Capital loss.............. eligible capital expenditure Eligible
Presentation Graphics prepares slides and other aids for individuals making presentations. It estimates it can save $42,000 a year in cash operating costs for the next five years if it buys a
Just in-Time Distributors, an operator of a large distribution network of health-related products, is considering an automated materials-handling system for its major warehouse in Toronto to reduce
A specialized automobile parts manufacturer is considering the acquisition of a new machine. The new machine is far more efficient than the present machine. It would cost $87,600, would cut annual
Saskatoon Hospital, a non-profit organization, estimates that it can save $28,000 a year in cash operating costs for the next ten years if it buys a special-purpose eye-testing machine at a cost of
Assume the same facts as in Exercise 22-18, except that a different hospital, City Hospital, is a taxpaying entity. The income tax rate is 30% for all transactions that affect income
"It doesn't matter what accounting amortization method is used. The total-dollar tax bills are the same." Do you agree? Explain.
Northern Petroleum is considering two capital projects. The first project, viewed as a high-risk investment, is drilling equipment for oil exploration activities. Northern expects the drilling
An investment of $254,200 in special tools, with a life expectancy of four years and a residual price of $24,000, is being examined at December 31, 2012 by StrengthCo. The tools will enable
KopiPro is considering the purchase of a photocopying machine for $5,500 on December 31, 2012. It has a useful life of five years and a zero residual disposal price. Amortization will be applied on a
The ChipTech Company is considering the acquisition of four capital investment projects. The projects under consideration are mutually exclusive. The company is considering buying new design
Anna's Bakery plans to purchase a new oven for its store. The oven has an estimated useful life of four years. The estimated pretax cash flows for the oven are as shown in the table that follows,
Innovation Inc. is considering the purchase of a new industrial electric motor to improve efficiency at its Fremont plant. The motor has an estimated useful life of five years. The estimated pretax
The Apex Company is evaluating a capital budgeting proposal for the current year. Deal with operating cash flow, not operating income. The relevant data are as follows: Present Value of an Annuity
Pro Chips is a manufacturer of prototype chips based in Dublin, Ireland. Next year, in 2013, Pro Chips expects to deliver 552 prototype chips at an average price of $80,000. Pro Chips' marketing vice
Assume the same facts as in Problem 22-27, except that the plant is located in Kamloops, B.C. Pro Chips has no special waiver on income taxes. It pays a 30% tax rate on all income. Proceeds from
Sapna Patel is manager of the customer-service division of an electrical appliance store. Sapna is considering buying a repairing machine that costs $12,000 on December 31, 2012. The machine will
Give examples of categories of cash flows considered in capital budgeting analyses.
The WRL Company operates a snack food centre at the Hartsfield Airport. On January 2, 2013, WRL purchased a special cookie-cutting machine, which has been used for three years. WRL is considering
Comfort Footwear Inc. is considering whether to add a new line of running shoes to be sold to its retail customers. To produce these shoes, special machines costing a total of $131,040 must be
Frank Hart, Sparkling Enterprises' controller, has gathered the following data to analyze an investment in new mining equipment which will allow the company to extract gold ore from once inaccessible
Waterford Specialties Corporation, a clothing manufacturer, has a plant that will become idle on December 31, 2012. John Landry, corpor ate controller, has been asked to look at three options
Conglomerates has not yet told Sam Pilon what the total amount of funds available for capital projects at Firthing Manufacturing will be, except for the after-tax required rate of return being
Cost-Less Foods is considering replacing all of its old cash registers with new ones. The old registers are fully depreciated and have no disposal value. The new regis ters cost $600,000 (in total).
Refer to the information in the preceding problem, but now assume that the tax rate is 30% and that you are not ignoring taxes. Equipment is subject to 20% CCA rate declining balance for income tax
Claude Marchand, the manager of Homestead Products, a wholly owned division of Crosslink Inc., has asked Thandie Ng, the management accountant, to analyze the possibility of introducing a new product
Sales of a new product line for Petrus S.A. as of December 2013 are forecast at SFr. 2,400,000 per year, from which a sales commission of 15% would be paid to sales agents. Actual sales are to be
Mark Hatcher, CFO, was instrumental in convincing the board of directors of Modern Food Services (MFS), preparers of microwaveable frozen foods, to open the Western Plant. Now, unless significant
Assume that six projects, A to F in the table that follows, have been submitted for inclusion in the coming year's budget for capital expenditures:REQUIRED 1. Compute the internal rates of return (to
Describe three ways income taxes can affect the cash inflows or outflows in a motor-vehicle replacement decision by a taxpaying company.
What are the two basic types of capital cost allowance classes?
Distinguish between the nominal rate of return and the real rate of return.
How can capital budgeting tools assist in evaluating a manager who is responsible for retaining customers of a cellular telephone company?
What are the benefits of a long-term perspective on value creation? For companies? For the economy?
What is the relationship between the stock market and the real economy in terms of measures such as gross domestic product (GDP), inflation, and interest rates?
What are some of the common features of the 2007–2009 stock market crash and previous market crashes—for example, Japan’s in the 1990s or the Internet bubble around the turn of the millennium?
If growth is a significant value driver, does getting bigger translate into creating value?
What are some of the differences between the ways the equity and credit markets operate?
Provide examples of businesses where network effects would or would not apply.

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