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Questions and Answers of
Corporate Finance
As discussed in the text, an annuity due is identical to an ordinary annuity except that the periodic payments occur at the beginning of each period and not at the end of the period. Show that the
A 10-year annual annuity due with the first payment occurring at date t = 7 has a current value of $85,000. If the discount rate is 9 percent per year, what is the annuity payment amount?
Take a look back at Figure 5.4 . Notice the wide range of coupon rates. Why are they so different?
What is the price of a 15-year, zero coupon bond paying $1,000 at maturity if the YTM is: a. 5 percent? b. 10 percent? c. 15 percent?
Locate the Treasury bond in Figure 5.4 maturing in August 2028. What is its coupon rate? What is its bid price? What was the previous days asked price?
Locate the Treasury bond in Figure 5.4 maturing in February 2039. Is this a premium or a discount bond? What is its current yield? What is its yield to maturity? What is the bid-ask spread?
Mega Software has 7.4 percent coupon bonds on the market with 9 years to maturity. The bonds make semiannual payments and currently sell for 105 percent of par. What is the current yield on the
Wyland Co. wants to issue new 25-year bonds for some much-needed expansion projects. The company currently has 8 percent coupon bonds on the market that sell for $1,063, make semiannual payments, and
Cavo Corp. has 7 percent coupon bonds making annual payments with a YTM of 8.34 percent. The current yield on these bonds is 8.13 percent. How many years do these bonds have left until they mature?
Suppose the following bond quote for IOU Corporation appears in the financial page of todays newspaper. Assume the bond has a face value of $1,000 and the current date is April 15, 2010.
Bond P is a premium bond with a 9 percent coupon. Bond D is a 5 percent coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 7 percent, and have eight years to
Consider the prices in the following three Treasury issues as of February 24, 2010:The bond in the middle is callable in February 2011. What is the implied value of the call feature? Is there a way
Hollin Corporation has bonds on the market with 13.5 years to maturity, a YTM of 7.3 percent, and a current price of $1,080. The bonds make semiannual payments. What must the coupon rate be on these
What are the three factors that determine a company’s price-earnings ratio?
Osbourne, Inc., has an odd dividend policy. The company has just paid a dividend of $12 per share and has announced that it will increase the dividend by $3 per share for each of the next five years,
South Side Corporation is expected to pay the following dividends over the next four years: $10, $8, $5, and $3. Afterward, the company pledges to maintain a constant 5 percent growth rate in
Antiques R Us is a mature manufacturing firm. The company just paid a $12 dividend, but management expects to reduce the payout by 4 percent per year, indefinitely. If you require a 9 percent return
Mustaine Corporation stock currently sells for $57.25 per share. The market requires an 11 percent return on the firm’s stock. If the company maintains a constant 5 percent growth rate in
You have found the following stock quote for RJW Enterprises, Inc., in the financial pages of todays newspaper. What is the annual dividend? What was the closing price for this stock that
The next dividend payment by ZYX, Inc., will be $2.85 per share. The dividends are anticipated to maintain a 4.5 percent growth rate, forever. If ZYX stock currently sells for $84 per share, what is
Johnson, Inc., is expected to pay equal dividends at the end of each of the next two years. Thereafter, the dividend will grow at a constant annual rate of 4.5 percent, forever. The current stock
Pre Satellite Corporation earned $12 million for the fiscal year ending yesterday. The firm also paid out 40 percent of its earnings as dividends yesterday. The firm will continue to pay out 40
Mickelson Corporation will pay a $2.90 per share dividend next year. The company pledges to increase its dividend by 4.75 percent per year, indefinitely. If you require an 11 percent return on your
Shelter, Inc., is expected to maintain a constant 5.2 percent growth rate in its dividends, indefinitely. If the company has a dividend yield of 4.4 percent, what is the required return on the
Oberholser, Inc., has an issue of preferred stock outstanding that pays a $4.70 dividend every year, in perpetuity. If this issue currently sells for $103 per share, what is the required return?
The newspaper reported last week that Lowery Enterprises earned $30 million this year. The report also stated that the firm’s return on equity is 14 percent. Lowery retains 70 percent of its
Projects A and B have the following cash flows:a. If the cash flows from the projects are identical, which of the two projects would have a higher IRR? Why?b. If C1B = 2C1A, C2B = 2C2A, and C3B =
You are evaluating two projects, Project A and Project B . Project A has a short period of future cash flows, while Project B has relatively long future cash flows. Which project will be more
One potential criticism of the net present value technique is that there is an implicit assumption that this technique assumes the intermediate cash flows of the project are reinvested at the
One potential criticism of the internal rate of return technique is that there is an implicit assumption that this technique assumes the intermediate cash flows of the project are reinvested at
Define each of the following investment rules and discuss any potential shortcomings of each. In your definition, state the criterion for accepting or rejecting independent projects under each
In January 2008, automobile manufacturer Volkswagen announced plans to build an automatic transmission and engine plant in South Carolina. Volkswagen apparently believed it would be better able to
What are some of the difficulties that might come up in actual applications of the various criteria we discussed in this chapter? Which one would be the easiest to implement in actual applications?
Consider the following two mutually exclusive projects available to Global Investments, Inc.The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake
eGolf, Inc., has the following mutually exclusive projects.a. Suppose eGolfs payback period cutoff is two years. Which of these two projects should be chosen? b. Suppose eGolf uses the
Suppose the following two independent investment opportunities are available to Scott, Inc. The appropriate discount rate is 10 percent.a. Compute the profitability indexes for each of the two
Suppose you are offered a project with the following payments.a. What is the IRR of this offer? b. If the appropriate discount rate is 10 percent, should you accept this offer? c. If the appropriate
Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 15 percent.As a financial analyst for BRC,
The Romo Corporation is trying to choose between the following two mutually exclusive design projects:a. If the required return is 10 percent and the company applies the profitability index decision
Bohrer Mining, Inc., is trying to evaluate a generation project with the following cash flows:a. If the company requires a 10 percent return on its investments, should it accept this project? Why? b.
Mario Brothers, a game manufacturer, has a new idea for an adventure game. It can either market the game as a traditional board game or as an interactive CD-ROM, but not both. Consider the following
Pixie Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology. It is considering investments in three different technologies to develop wireless
Consider the following cash flows of two mutually exclusive projects for AZ-Motorcars. Assume the discount rate for AZ-Motorcars is 10 percent.a. Based on the payback period, which project should be
The treasurer of Amaro Canned Fruits, Inc., has projected the cash fl ows of projects A, B , and C as follows.Suppose the relevant discount rate is 12 percent a year. a. Compute the profitability
Consider the following cash flows of two mutually exclusive projects for Spartan Rubber Company. Assume the discount rate for Spartan Rubber Company is 10 percent.a. Based on the payback period,
Consider two mutually exclusive new product launch projects that Nagano Golf is considering. Assume the discount rate for both projects is 12 percent.Project A: Nagano NP-30Professional clubs that
Consider two mutually exclusive R&D projects that ADM is considering. Assume the discount rate for ADM is 15 percent.Project A: Server CPU .13 micron processing projectBy shrinking the die size to
You are a senior manager at Poeing Aircrafts and have been authorized to spend up to $300,000 for projects. The three projects that you are considering have the following characteristics:Project A:
This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? Search between 20 percent and 70
The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash in
Darin Clay, the CFO of MakeMoney.com , has to decide between the following two projects:The expected rate of return for either of the two projects is 12 percent. What is the range of initial
An investment project has annual cash inflows of $6,400, $6,900, $7,300, and $6,100, and a discount rate of 12 percent. What is the discounted payback period for these cash flows if the initial
Thunderstruck Corp. has a project with the following cash flows:What is the IRR of the project? What is happening here?
Your firm is considering purchasing a machine with the following annual, end-of-year, book investment accounts.The machine generates, on average, $4,700 per year in additional net income. a. What is
The Waitangi Group has invested $18,000 in a high-tech project lasting three years. Depreciation is $5,300, $7,800, and $4,900 in years 1, 2, and 3, respectively. The project generates pretax income
Pluto Planet, Inc., has a project with the following cash flows.The company evaluates all projects by applying the IRR rule. If the appropriate interest rate is 9 percent, should the company accept
Compute the internal rate of return for the cash flows of the following two projects.
1. In evaluating the Cayenne, would you consider the possible damage to Porsche’s reputation as erosion?2. Porsche was one of the last manufacturers to enter the sports utility vehicle market. Why
Who Dat Restaurant is considering the purchase of a $39,000 souffle maker. The souffle maker has an economic life of six years and will be fully depreciated by the straight-line method. The machine
You are evaluating two different silicon wafer milling machines. The Techron I costs $450,000, has a three-year life, and has pretax operating costs of $85,000 per year. The Techron II costs
Yasmin Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $475,000 is estimated to result in $183,000 in annual pretax cost savings.
CBOE Manufacturing is trying to decide between two different conveyor belt systems. System A costs $530,000, has a four-year life, and requires $141,000 in pretax annual operating costs. System B
Suppose in the previous problem that the company always needs a conveyor belt system; when one wears out, it must be replaced. Which project should the firm choose now?
Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,900,000 and will last for six years. Variable costs are 35 percent of sales, and fixed
Consider the following cash flows on two mutually exclusive projects.The cash flows of Project A are expressed in real terms while those of Project B are expressed in nominal terms. The appropriate
Sparkling Water, Inc., expects to sell 5 million bottles of drinking water each year in perpetuity. This year, each bottle will sell for $1.10 in real terms and will cost $0.89 in real terms. Sales
Price, Inc. is considering an investment of $450,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first
Leno Industries runs a small manufacturing operation. For this fiscal year, it expects real net cash flows of $210,000. The company is an ongoing operation, but it expects competitive pressures to
AGT Golf Academy is evaluating different golf practice equipment. The “Dimple-Max” equipment costs $71,000, has a seven-year life, and costs $6,500 per year to operate. The relevant discount rate
The Dante Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated below. The corporate tax rate is 34 percent. Assume all sales revenue is
Zoysia University must purchase mowers for its landscape department. The university can buy 10 EVF mowers that cost $8,500 each and have annual, year-end maintenance costs of $1,800 per mower. The
Nata, Inc., is considering the purchase of a $540,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market
A firm is considering an investment in a new machine with a price of $11.5 million to replace its existing machine. The current machine has a book value of $3 million, and a market value of $5.2
Mustaine Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $1,140,000. The facility is to be fully depreciated on a straightline basis over seven years. It is
With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital,
You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago
Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value is $1.8 million. Its current book value is $1.1 million. If not sold, the old machine will require
Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of $2,800,000. The fixed asset will be depreciated straight-line to zero
Gold Star Industries is contemplating a purchase of computers. The firm has narrowed its choices to the SAL 5000 and the HAL 1000. Gold Star would need 9 SALs, and each SAL costs $3,700 and requires
Earp Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $820,000 and its economic life is five years. The machine will be fully
Aria Acoustics, Inc., (AAI), projects unit sales for a new 7-octave voice emulation implant as follows:Production of the implants will require $1,500,000 in net working capital to start and
Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus, the bid price
The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price, that is, set the project NPV
Your company has been approached to bid on a contract to sell 24,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be
Suppose we are thinking about replacing an old computer with a new one. The old one cost us $430,000; the new one will cost $465,000. The new machine will be depreciated straight-line to zero over
In the previous problem, suppose the project requires an initial investment in net working capital of $300,000 and the fixed asset will have a market value of $450,000 at the end of the project. What
Benson Enterprises is evaluating alternative uses for a three-story manufacturing and warehousing building that it has purchased for $1,500,000. The company can continue to rent the building to the
The Biological Insect Control Corporation (BICC) has hired you as a consultant to evaluate the NPV of its proposed toad ranch. BICC plans to breed toads and sell them as ecologically desirable insect
Sony International has an investment opportunity to produce a new stereo HDTV. The required investment on January 1 of this year is $75 million. The firm will depreciate the investment to zero using
J. Smythe, Inc., manufactures fine furniture. The company is deciding whether to introduce a new mahogany dining room table set. The set will sell for $6,500, including a set of eight chairs. The
In the previous problem, suppose the fixed asset actually falls into the three-year MACRS class. All the other facts are the same. What is the project’s Year 1 net cash flow now? Year 2? Year 3?
Symon Meats is looking at a new sausage system with an installed cost of $290,000. This cost will be depreciated straight-line to zero over the project’s five-year life, at the end of which the
Assume a firm is considering a new project that requires an initial investment and has equal sales and costs over its life. Will the project reach the accounting, cash, or financial break-even point
We are evaluating a project that costs $804,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected
Consider a four-year project with the following information: initial fixed asset investment = $430,000; straight-line depreciation to zero over the four-year life; zero salvage value; price = $29;
You are considering a new product launch. The project will cost $720,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 180 units per
McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $700 per set and have a variable cost of $310 per set. The company has spent $150,000 for a marketing study that
In the previous problem, you feel that the units sold, variable costs, and fixed costs are accurate to within only ± 10 percent. What are the best-case and worst-case NPVs? The price and variable
McGilla Golf (see Problem 14) would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. What is the sensitivity of the NPV to each of
We are examining a new project. We expect to sell 13,000 units per year at $70 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $70 ×
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